Whole Foods Market F3Q07 (Qtr End 7/1/07) Earnings Call Transcript

Jul.31.07 | About: Whole Foods (WFM)
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Whole Foods Market Inc. (WFMI)

F3Q07 Earnings Call

July 31, 2007 5:00 pm ET

Executives

John Mackey – Chairman and CEO

Walter Robb - Co-President and Chief Operating Officer

Glenda Chamberlain – EVP and Chief Financial Officer

Lee Valkenaar – EVP Global Support

Cindy McCann - Vice President of Investor Relations

Analysts

Simeon Gutman - Goldman Sachs

Mark Miller - William Blair

Steve Chick - JP Morgan

Mark Husson - HSBC

Scott Mushkin - Banc of America

Ed Aaron - RBC Capital Markets

Greg Badishkanian - Citigroup

Analyst for Meredith Adler - Lehman Brothers

Mark Wiltamuth - Morgan Stanley

Jason Whitmer - Cleveland Research

Andrew Wolf - BB&T Capital Markets

Ursula Moran - Bear Stearns

Daniel Santiago – Brass Hat Capital

Presentation

Operator

(Operator Instructions) I will now turn the call over to Mr. John Mackey. Mr. Mackey you may now begin.

John Mackey

Good afternoon. Joining me today are Walter Robb, Co-President and Chief Operating Officer; Glenda Chamberlain, Executive Vice President and Chief Financial Officer; Lee Valkenaar, Executive Vice President of Global Support; and Cindy McCann, Vice President of Investor Relations.

First for the legalities: The following constitutes a 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 timely 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 undertake any obligation to update forward-looking statements.

Our press release is now available on our website at www.wholefoodsmarket.com along with the scripted portion of this call and additional supplemental financial data.

I am hoping you have all had a chance to read our press release. Please note it includes a reconciliation to adjusted diluted earnings per share of $0.35 for the third quarter of last year which excludes $3.7 million of credits related to Hurricane Katrina.

Our sales for the third quarter increased 13% to $1.5 billion. Average weekly sales for all stores increased 7% to $647,000, translating to sales per square foot of $933.

Our 17 new stores, including four relocations and two new markets, averaged 58,000 square feet in size and produced average weekly sales of $637,000 in the quarter translating to sales per square foot of $575.

Our new stores open at least one year continue to run ahead of our sales projections for the first year and are on track to reach our real estate hurdle rate of cumulatively positive EVA within seven years or less.

Our comparable store sales grew 7% on top of a 9.9% increase in the prior year. This reflects a negative impact of approximately 76 basis points from Easter shifting from the third quarter last year to the second quarter this year. Our Kensington store was a relocation of a Fresh & Wild store, so it was included in the comp base for three weeks of the 12 week quarter but was excluded from identical store sales growth. Identical store sales, which exclude four relocated stores and two major expansions, increased 5.8%.The variance between comps and idents increased 30 basis points in Q3 compared to Q2. Year over year, average transactions per week increased approximately 4% to 3.5 million, and our average basket size increased approximately 3% to $34.

We believe that third quarter results, combined with our current quarter-to-date comps of 7.6%, are an indication that our comps have stabilized.

We are constantly experimenting, innovating and evolving. We are opening a record number of 18 to 20 stores this year, many of which are incredibly exciting stores that will help us continue to redefine the marketplace and further differentiate our shopping experience from other food retailers. We are actively continuing to further differentiate our product offering in ways that speak to our authenticity and leadership role within natural and organic products.

These initiatives include the continued expansion of our private label products which saw a 14% increase in SKU count year over year and currently represent 18% of our total grocery and Whole Body sales, our expanded "Buying Local" efforts and local product selection, our Whole Trade Program, and the recent launch of our new Five-Step Animal Welfare Rating Program which allows shoppers to easily understand how the animals from which the meat and poultry products they are buying were raised and treated.

While the Whole Foods Market brand is synonymous with the highest quality natural and organic products, we are also known for our emphasis on perishables, beautiful stores uniquely designed for their market, and exceptional customer service, all of which translate into a fun shopping experience that is very hard to replicate.

Now, back to our results for the quarter.

On an adjusted basis, taking into account certain operational changes that shifted some costs from cost of goods sold to direct store expenses, our comparable stores produced a very healthy 42 basis point improvement in gross margin which was partially offset by a 23 basis point increase in direct store expenses, resulting in a store contribution improvement of 19 basis points to 10.3% of sales.

Historically our second and third quarters are our strongest quarters in terms of average weekly sales and gross margin, and we typically see flat to sequentially lower gross margin in the fourth quarter compared to the third.

Direct store expenses for comparable stores increased primarily due to increases in health care and share-based compensation expense, which were partially offset by leverage in wages as a percentage of sales. Share-based compensation expense increased $1.8 million primarily due to an adjustment for the accelerated vesting of stock options. Excluding this charge, the year-over-year increase in our comparable store direct store expense would have been about in line with what we reported in the second quarter of this year.

For the quarter, our pre-opening and relocation costs were $15 million, or $0.06 per share, nearly double our costs in the prior year of $7.9 million, or $0.03 per share.

For the quarter, diluted earnings per share were $0.35, in line with our adjusted prior-year results.

In the third quarter, we opened two new stores in El Segundo and Sonoma, California and relocated one of our Fresh & Wild stores to a new Whole Foods Market location in London, ending the quarter with 196 stores and approximately 7.1 million square feet in operation. Including the new Chicago store opened last week, we have opened 14 stores this fiscal year and 18 over the last twelve months. We expect to open four to six additional stores, including two relocations, in the fourth quarter bringing us to our goal of 18 to 20 new stores for the year.

We are extremely excited to have opened our flagship UK store in Central London. Spread across three floors within the historic Barkers building on High Street Kensington, the landmark store offers a fresh and distinctive approach to the UK grocery shopping experience with excellent customer service, food sampling and prepared foods selections mingling with thousands of fresh, organic and all natural ingredients. A few highlights include:

- a cheese room, where shoppers can taste and select the finest cheeses from Britain and around the world with cut-to-order service,

- an extensive wine department offering over 1,000 different labels,

- a meat department that offers an in-house dry aging case, fresh sausage made in-house daily and meat labeled with our new Five-Step Animal Welfare Rating Program which allows shoppers to easily understand how the meats they are buying were raised and treated, and

- a vibrant food hall on the top floor. From the sit-down experiences of the tapas bar, the champagne and oyster bar, the pub, and the sushi and dim sum eatery to the open format of the other venues, the 13 dining venues offer plenty of choices along with seating for more than 350 diners.

The store has been warmly received and is off to a great start, setting new opening day and first week sales records for the company and ranking among our top five stores in sales volume over the last eight weeks since opening. Our real estate team is working diligently in London, and we hope to have additional sites to announce in the near future.

Our new store pipeline continues to increase with today's announcement of seven new store leases averaging 39,000 square feet in size with expected opening dates through 2010. We now have 94 stores under development totaling just over five million square feet or 70% of our existing square footage. These stores average 53,000 square feet in size and include 17 relocations and 21 new markets.

Over the last five fiscal years, our average store size has increased 20%, while our average weekly sales per store have increased 68%, and our average contribution per store increase 69%, both more than triple the increase in store size.

Our current average store size is just over 36,000 square feet, while our average store size for stores in development is currently 53,000. We have continued to sign and open smaller stores, typically in markets where it is hard to find larger boxes, while experimenting with opening some very large format stores. We currently operate 14 stores over 60,000 square feet.

On average, we are pleased with the results from these stores and believe they will produce very strong EVA over the long term as they will take longer to reach capacity. We plan to continue to selectively sign sites for these larger format stores, which showcase extensive prepared foods and sit-down venues, but they will predominantly be in dense urban markets or relocations of some of our very successful existing stores.

We believe our "sweet spot" for most markets is a footprint between 45,000 and 60,000 square feet which allows us to create the exciting shopping experience we are known for while simultaneously maximizing our return on invested capital. We currently have 21 stores, including eight relocations, over 60,000 square feet in our 94-store pipeline. We are in the process of reviewing our entire pipeline and are selectively "rightsizing" the lease size or decreasing the selling square footage in the store design. We adjusted two leases and are in the process of adjusting another six leases representing an average reduction of 9,000 square feet per lease. We believe the average size of our stores in development will probably be around 50,000 to 55,000 square feet for the near future.

Now I will turn to our thoughts for the remainder of the year.

Please note that the fourth quarter will be thirteen weeks versus twelve weeks in the prior year. Our guidance is presented on an adjusted 12-week to 12-week basis and excludes any impact from the proposed Wild Oats merger, as it has not yet closed.

For fiscal year 2007, we are maintaining our guidance of 13% to 17% sales growth, 6% to 8% comparable sales growth, and 18 to 20 new store openings resulting in 16% ending square footage growth, and expect operating income before pre-opening and relocation costs as a percentage of sales will be in line with our 5.9% results year to date. We expect pre opening expense in the fourth quarter of $20 million to $24 million.

We are constantly experimenting, innovating and evolving and have a demonstrated track record of competing, executing and delivering strong results. As expected, fiscal year 2007 has been an investment year as we have accelerated our new store openings while comping against tough comparisons.

Of our 25 stores currently tendered, 23 are scheduled to open between now and the end of fiscal year 2008, and we expect to announce additional stores over the next two quarters tendered for openings in fiscal year 2008. Therefore, we can expect this investment period will extend into next year, but to a lesser extent than we have experienced this year, as we do not expect to have the same level of year-over-year increase in our total pre opening expenses.

Our business model is very successful and continues to benefit all of our stakeholders. We are executing at a high level, continuing to produce higher sales, comps and sales per square foot than our public competitors. Given our strong historical sales growth, record store development pipeline, and acceleration in store openings, 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 the 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 rate of 20% since going public, and we encourage our shareholders to stay focused on the long term.

Today is the first day of the U.S. District Court for the District of Columbia preliminary injunction hearing to decide whether to approve the FTC's application for an injunction to block our proposed merger with Wild Oats. The hearing is scheduled to conclude tomorrow, and we expect to receive a ruling by the middle of August.

We are hopeful that the court will rule in our favor and that we will be allowed to move forward; however, we believe that merger or no merger, Whole Foods Market has a very bright future. We currently have 94 stores in our pipeline representing 70% of our existing square footage, and we believe we are on track to meet our goal of $12 billion in sales in 2010. If the merger is approved, just as we have done with our many previous acquisitions, we will improve the Wild Oats stores to make them more profitable and create an improved shopping experience for customers

Before we take any questions, I ask that we devote this Q&A time to discussing our current results and future prospects. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) We will take our first question from Simeon Gutman - Goldman Sachs.

Simeon Gutman - Goldman Sachs

John, first on the gross margin strengths, what is driving it? Even if you exclude some of the benefits from the operational changes that still was up nicely. Are you seeing any impact from inflation, and I ask that specifically because some of your conventional competitors cited it in the perimeter of the store.

Walter Robb

We are really pleased with our execution in the quarter. We were a little lower than we wanted to be in Q1 and Q2, and I think we really put some focus on basic disciplines around that, so we are happy to see the strength there.

I think also we’re making some real strides on the buy side of our business, on the purchasing; we’ve talked about this on previous calls. But in this case, growth is our friend in this respect; we’re being able to lock down some deals on many of the perishable areas and that is giving us some advantages on the gross margin side.

We have a nice contract with UNFI which has helped us this year, we’ve got some commodity buying that is taking place that we haven’t been able to do; scale has been helpful to us in this regard.

Glenda Chamberlain

Walter I just want to add on to that, that historically our growth margins in the second and third quarter have been some of the strongest for the year, and we may see that doesn’t continue into the fourth quarter to that same level.

Walter Robb

Good point.

Operator

Your next question comes from Mark Miller - William Blair.

Mark Miller - William Blair

John, I was hoping you could talk about the new stores that are being originated, averaging under 40,000? I’m gathering that there may be some mix effect with the stores in Hawaii. Can you talk more broadly about what you think might be your ability to capture the same experience in the smaller store, and what have you learned and as you try to maybe reel that back in a little bit on some of these new sites?

John Mackey

Mark, there isn’t really a change in our strategy. You’re right, the Hawaii stores do bring that average down; they are smaller stores. It’s all about getting the right size store for the market. In dense urban environments, in dense urban markets like in New York City or Chicago, or in a market where we’ve been doing business for a decade or longer and we have a really successful store, those are the situations where we want to open larger format stores – 60,000 to 80,000 square feet -- because we don’t take much risk there. We’re certain that those are going to be successful stores.

But in general, we’re concluding our sweet spot is kind of 45,000 to 60,000 square feet. I think you’re going to see most of our stores that we announced going forward to be in that range. But in some cases, we can operate stores that would be very successful and have very high return on invested capital that are 25,000 to 45,000 square foot stores. So it just depends upon the market, and we are continuing to think about and we’re continuing to study.

Every store is an experiment, so we continue to study and look at the EDAs and returns on invested capital we’re getting for each of our different size stores in the particular markets. We’re beginning to draw some conclusions, because we have enough data points out there to realize that in certain markets, the 60,000 to 80,000 square foot store, like Austin, for example, can be hugely profitable for us.

In other markets, we may not want to open an 80,000 square foot store because it’s a new market, it’s not densely populated, and we don’t have any existing stores there. We haven’t built up a customer following. So it’s just about getting the right sized store for a particular market. Did that answer your question?

Mark Miller - William Blair

Yes, that was helpful. Do you think there’s a risk, John, that we go through a period where returns will be weighed down by the origination of many of these larger stores? It’s going to depend on how long they mature, but I know you anticipate you may not need to relocate them as quickly. Anything incremental you can offer to help us understand how the class of stores play out? Or may we see a little bit of depressed results as they work their way through?

John Mackey

Well I mean if you look on our press release, Mark, on page 2, where we have there our chart on the comparable store sales. You’ll see a little asterisk there. You’ll see there our ROIC, if you take Kensington out, we’ve got the full investment in Kensington in there which was only open for three weeks, so it has really distorted the figures. But if you take that out, you’ll see that the ROIC was a phenomenal 10%, for our stores that are less than two years old, and an average size of 54,000 square feet. That’s better, significantly better than our historical average has been.

So I wouldn’t draw the conclusion that you’re drawing. In fact, a lot of the new stores we have opened up, the larger stores, have done really well. As we’ve indicated, our average store size has increased 20% over the last five years, but our sales and our profits have increased significantly more than that. So I wouldn’t draw the conclusion you’re drawing, I don’t think the data supports it.

Glenda Chamberlain

If you look at our overall returns to the extent that the amount of square footage we have in that category goes up relative to other categories, then it may have a drag on our overall returns, because of course we don’t produce the same returns on invested capital in new stores that we do in older stores. So I think that that may have more of a drag effect than the fact that we have, over time, opened larger stores.

John Mackey

Exactly. As we’re accelerating our growth in 2007 and 2008, we’re going to begin to see the average store age begin to slowly decline, we’re going to begin to see more younger stores in the total mix. Those aren’t going to produce the same ROICs as the store that’s ten years old. Or on the other hand, it’ll also increase cost as we expect to see our costs increase as the average age of the store declines, and we have more and more younger stores in the mix, because younger stores comp better on average than older stores do. So we’ll have those two trends going on there somewhat; in some ways they’re counter trends.

Operator

Your next question comes from Steve Chick - JP Morgan.

Steve Chick - JP Morgan

Good quarter. I think maybe for Glenda possibly, the average development cost per square foot that’s in your press release, I think that’s a new figure that you’re giving us, I don’t think I’ve seen that before. It’s 282 for the stores open year-to-date, and 258 for the ones open in FY06. Can you just clarify if that development cost excludes pre-opening and excludes the rent figures? Or is that all-inclusive?

Glenda Chamberlain

It does exclude pre-opening. It is the first time that we’ve given it. We hope it’s meaningful information.

Steve Chick - JP Morgan

I think it is going to be helpful. It’s up 9% over the stores opened in ‘06. As you open stores in your pipeline going forward, is that a cost that would be pretty stable or would it go up or is there opportunity maybe to decrease it?

Walter Robb

I can weigh in on that. It’s a relatively stable number, but it’s going to vary depending on the mix of stores in that particular year. In this particular year we had some larger stores with some more extensive programs, it’s going to put that cost up a little bit. I think it might be helpful ultimately to evolve that to some sort of range. That might be helpful there.

Operator

Your next question comes from Mark Husson - HSBC.

Mark Husson - HSBC

Yes, just a couple of questions. Firstly on London and Kensington, and the effects on numbers, you’ve given us some description of how well it’s done to start with, but just in terms of thinking about profitability for that whole market. Can the Kensington store effectively stand alone and make an adequate return? Or do you need to sort of cover the UK with 20 or 30 stores in due course?

John Mackey

Well I mean I do think that store can stand alone. First of all, it’s not standing alone because we have five other Fresh & Wild stores that are open there.

Mark Husson - HSBC

But you’re probably going to close those. They’re too small.

John Mackey

Well we won’t close them until we have a new store to relocate them to. So the point is Kensington will never be alone. The other smaller stores are good stores, they’ll just close as we have bigger locations to relocate them to. We don’t intend to stand alone. Kensington, as we mentioned, is a top 5 store in the company right now and it’s only been opened for eight weeks, contrary to what a lot of people predicted. That store is off to a phenomenal start and we’re very proud of it. It’s one of the best stores we’ve ever opened and it’s a precursor to a number of new stores in the UK and we look forward to announcing those stores over the next few quarters.

Mark Husson - HSBC

You said the impact on the identical wasn’t --

John Mackey

I didn’t catch the last part of your question.

Operator

It looks like his line has dropped out of the queue by accident.

Glenda Chamberlain

I think I know where he was going. He was asking about the impact of Kensington on comps and idents and Kensington is in the comps but it’s not in the idents and the information we’re giving about that is that the variance between comps and idents increased 30 basis points in Q3 versus Q2 and in Q3 we had Kensington opened for three weeks, plus we had the full impact of the Portland Maine relocation, which that store opened midway through Q2. So that’s really all the help we’re going to give on Kensington sales and impact on comps.

Operator

Your next question comes from Scott Mushkin - Banc of America.

Scott Mushkin - Banc of America

Two questions, one just clarity. The 5.9% EBIT ex preopenings, that’s over 12 weeks so the 13 weeks would actually make that 5 97ish or something like that? Is that the way to read that? Or am I wrong? That’s number one.

The second thing I was hoping you could talk about, it’s kind of along the lines that Steve Chick was talking about, cost controls vis-a-vis how much money you’re actually putting to work in the stores. Both from a capital perspective and also a labor perspective, what have you learned as you’ve gone through this ramp-up process that maybe you can take into the future to the other side of the EVA equation? If you could take labor down and capital down, it makes it easier to jump over those hurdles.

Walter Robb

I’ll take the second one, if you want John.

John Mackey

Okay. Hit it Walter, and Glenda will take the first part.

Walter Robb

Scott, the second part of the answer to Steve’s question is part of the right sizing is really finding in the right amount of capital to spend in the right market, and I think we’re really maturing as a company in making those choices, and I think the lineup reflects that. So yes, you start with spending a little less money because you’ve got your store set up in the right size. In addition to that, I think we’re investing a lot of time internally in best practices and ways of doing the work for the right amount of money.

So I think the learning is to get all of those things lined up and as we do that, that is why I think it might be helpful to see a range on those development costs, because I think you’re going to see some up and down there in that range.

With respect to the learnings on labor, essentially it’s been that, as I think John mentioned last quarter, that we got irrationally exuberant about the things that we saw at the Lamar store in Austin and you saw them as well, the food service venues. I think the learnings are where do we do those and where do we not do those? There’s a full range of food service things that we can do, some have more labor and some have less labor and the learnings are how do we put the right venues, the right retailing applications in the different stores? The labor costs follow on with that. If we get the right mix of retailing going on there, we get the right mix of costs.

So those are some of the learnings in the last year or so in the store development area. Glenda, the first part?

Glenda Chamberlain

Yes, regarding the first part. We’ve said that we expect operating income before pre-opening and relocation costs as a percentage of sales will be in line for the full year with our 5.9% result year-to-date and that is not effected one way or the other by the fact that we have 13 weeks in the fourth quarter. We’ll have 13 weeks worth of revenue and we’ll have 13 weeks worth of expenses.

Operator

Your next question comes from Ed Aaron - RBC Capital Markets.

Ed Aaron - RBC Capital Markets

You obviously had a lot of media coverage recently, some of which has been on the negative side. It doesn’t really seem to have influenced your performance, at least this quarter. Just curious to know what, if anything, you have done or might do to help employee morale or even consumer perception for that matter, just in light of the media attention that you have been getting?

John Mackey

Ed, we haven’t really seen an effect on our sales. Comps, as we mentioned, so far in the quarter were 7.6%, so we’re not seeing any impact on our sales and we’re hopeful that while those mergers are going to be able to go through, we think that will be positive PR and I’m really not going to comment on the postings due to the fact that there is an FTC informal investigation going on at this time. So, we’re not going to talk about that, we want to talk about the current quarter and talk about the business.

Walter Robb

Ed, this is Walter, and I just want to add to what John said. We’re keeping our head down and looking straight ahead. It’s a very competitive marketplace out there and there’s a lot to do and we’ve opened more stores in this last bit of time than we ever have, and we’ve got more ahead of ourselves and so I think we’re really keeping our eyes on the ball in terms of operating the business and moving the company forward.

A lot of that stuff that swirls around out there, not everybody picks up on it or truly gets into it to the extent that some of the media folks do and we’re trying to just keep our focus on operating the business.

Operator

We will take our next question from the site of Greg Badishkanian - Citigroup.

Greg Badishkanian - Citigroup

Yes, great, thanks. Customer service is probably one of your greatest competitive advantages and as you accelerate your new store growth, potentially acquire Oats, what are you doing to keep that high level of service, as well as maintain the strong culture in your stores?

Walter Robb

I think you just hit the nail on the head. It’s the culture and I think the few times where that’s not been as successful where we haven’t had the culture implanted, I think what we are doing is investing in training programs and bench strength programs and things like that to develop leaders and develop folks and the culture is strong at Whole Foods. When we take good incremental steps like the potential merger with Oats or opening new stores like that, team members move over, the culture moves over, and the traditions carry on.

I think we really, through all this competitive fight over the last couple years, we’ve clearly seen that as you said, that is our strength, that is who we are and I think people have realized that. The leadership has realized that, the team members know that and so we continue to invest in that.

Operator

Your next question comes from Meredith Adler - Lehman Brothers.

Analyst for Meredith Adler - Lehman Brothers

I note earlier on the call, you said the margin was helped by some strides you’re making in terms of better purchasing. Is it possible for you to quantify how much inflation you saw this quarter versus a quarter a year ago?

Glenda Chamberlain

What we can say is that our average price per item was about 3% year over year in the current quarter. Does that help? Also, we did have a higher LIFO charge in the current quarter and that was certainly because the CPI indexes were up, which is also reflective of inflation.

Operator

Your next question comes from Mark Wiltamuth - Morgan Stanley.

Mark Wiltamuth - Morgan Stanley

Glenda, just try to get a little more sense of magnitude on the pre-opening expense for 2008. It sounds like you’re still talking about an investment in dollar terms there. Should we still anticipate a drag in terms of percentage of sales versus the 2007 year?

Glenda Chamberlain

We’re not ready yet to give guidance on next year. We want to wait while this merger happens and then we’ll be prepared to answer those kinds of questions.

Operator

Your next question comes from Jason Whitmer - Cleveland Research.

Jason Whitmer - Cleveland Research

John, have you taken time to rethink or evaluate some of the long-term revenue growth rates for the company all-in, inclusive of square footage? The new rate of comps here over last few quarters and how that translates to earnings? Do you expect an equal flow through or do you think we can actually see either flattening or improvement in operating margins going forward?

John Mackey

We’re actually going to significant sales growth in the next few years as a percentage. We’re going to be over 20% for the next few years, which to get to our $12 billion sales target and our own internal projections indicate we’ll be able to achieve that.

As long as we’re accelerating our sales growth, we will not see that translated into, it’ll be likely a drag on our earnings growth. When our sales growth is accelerating, our earnings growth decelerates temporarily, but then when our growth rate and sales begins to moderate, the opposite occurs; we see acceleration of our earnings growth rate.

That is simply mathematics due to the number of new stores that enter in and the average age of the stores beginning to decline. So, it’s not anything that we can do anything about that. It’s not that there’s anything wrong with the operating model, it’s just simple mathematics of younger stores. Less mature stores don’t produce the same profits that a more mature store does. So as the store matures and the growth rate of sales begins to slow down, we will see that translate to rising increase in earnings.

We’ve been doing this so long now. We’ve actually been public for 15 years now and I’ve seen the cycle many times, where we see the sell side concerned that there’s something wrong with the business model as our sales begin to accelerate, we begin to see a little weakness in the earnings growth doesn’t match the sales growth; the sales growth is accelerating and everybody wonders gosh, what’s wrong, what’s wrong with the model? And then of course, when the sales begin to slow down, then the opposite begins to occur.

So we’re just in that part of the curve again and it’ll probably be that way. As we said, we expect 2008 to be at least for a good significant part of the year to be another investment year because our sales are going to significantly increase as a percentage in 2008. So, that’s the way it is and we just need our investors to take a long-term view and understand the actual dynamics of what’s occurring here because if they do, then they’re going to see 2009, 2010 be awesome years.

Operator, it doesn’t seem like people are able to follow-up with questions. Is that possible? It seems like people, I know they want to comment but they’re not having a chance to comment. Is that something you can do something about?

Operator

Yes I will allow for follow-up questions now. Your next question comes from Andrew Wolf - BB&T Capital Markets.

Andrew Wolf - BB&T Capital Markets

Good afternoon. In light of this being the first expansion of gross margin in quite a while and I’ve heard some of Walter’s explanation, but I’d like you to also address some of the price perception issues you talked about in the past and update us on what you think your customers in the marketplace perception is? Has been change either way presumably for the better given what occurred with gross margin? If you could just elaborate on that?

John Mackey

Well Andy, I’ll let Walter elaborate on the customer perception but I just want to point out that our year-to-date for the first three quarters of this fiscal year, our gross profit margins were 34.9%. That is within the historical range that our company’s produced over the last five years which our press release clearly outlines. With our low of 34.2% and the high of 35.1%, so then you think our 34.9% is on a high end of what we have averaged in the last five years. So I don’t agree that we have shown weak gross margin this fiscal year. We’re on the high end of our historical range.

Walter, do you want to address the question about customer perception?

Walter Robb

You bet, let me do that. First, I want to say that you look at the gross margin in conjunction with the sales and what you see is you’re seeing incremental sales strength here this quarter along with the gross margins so it’s not at the expense of it. I would argue that suggests that customers are finding the value they’re and the reason to come in.

Second of all, I point out that the gross margin expansion I think we’ll see how sustainable this is in Q4 and beyond but a lot of this is on the buy side which doesn’t necessarily translate. It’s not higher prices we’re talking about here. It’s about using our scale to do a better job. This is definitely true in seafood, meat. We started [financial meat buying], for example, for the first time to leverage our buy side.

Those are pick ups that we are as a company able to get. I think other companies have long since taken those types of scale buy side gains and I think we’re in the position to take those now to help our gross margins but not at the expense our retail prices.

Third, I think that we’re gaining some sophistication in our ability to manage the pricing. It’s obviously done regionally and it’s done according to the competition and so forth. So I would argue that we’re finding a nice balance here. We’re picking up some strength. We’re increasing our private label which has good price points on particularly the 365 and finding the right balance here for the growth.

Just to add one more thing. I think at the end of the day, we’re not a price house as a retailer. Quality service, price -- you can do two of three well. I think we do two extremely well. I think we do the price to the extent that we offer good value, but look; we’re not retailers of cheap food. That’s not what we’re here to do and we’re here to stand for quality food and offer that alternative to the marketplace. If we were to chase that all around all the time, that’s not who we are and that’s not to say we don’t offer good value. I think the results this quarter and I hope going forward suggest that we’re finding the right balance there.

Andrew Wolf - BB&T Capital Markets

I would say the results do support that. That’s why I asked the question. To put it in the context, a double negative, do you feel there’s less to the extent there has been price investment, say dry grocery in a market like Washington where Redmond’s might come in with lower pricing? Not necessarily vis-à-vis the entire market, whether it is perception or competitive environment. Do you feel there is less price investment this quarter compared to last, or is that too granular for you all to figure out?

Walter Robb

It is a little hard to jump from the general to get right down to the individual store situation. I’d say the attention on the price investment is very high. We are a competitive machine and we are very focused on individual situations and individual retailers, where the price burn is the right thing to do to hold your space. I think we’ve come to the realization that there is a limit to that, and a limit to the return to Whole Foods for pursing that road, and I think, you know, what we are coming to is finding the right balance.

I would argue that some of the pick up there is in finding the balance a little bit better this quarter, but also on some of these buy side pick ups, and remember we’ve had a nice contract with our distributor and we have been doing some things on the commodity side of the business to put our self in a better position to put ourselves in a better position on the supply side.

John Mackey

Andy, on my end everyone is telling me that I misunderstood your question, sorry if I did that wasn’t my intention.

Andrew Wolf - BB&T Capital Markets

No, don’t worry about it. Your question was more in the context of longer term, and I kind of got the answer with Walter’s elaboration. My question was answered, so thank you.

Operator

We will take our next question from the side of Steve Chick - JP Morgan.

Steve Chick - JP Morgan

Just a follow-up question on comps. I can appreciate you are not speaking to what the London contribution would be, but with the 7.6% comp figure for the first month of this next quarter London is probably going to be, I guess a bigger impact on that. Are identical store sales increasing sequentially at the same rate? Can you give us that?

John Mackey

I don’t think we have that data right now handy. However, it is obvious that Kensington is going to have a bigger impact for the full quarter. I mean it is having an impact and it only impacted it three weeks and this quarter will impact it 12 weeks -- well 13 weeks, so it will have a bigger impact.

The main reason we don’t want to give the exact figure is because we had it in our script originally, but I kind of took it out, because these sell-side analysts are really smart. They’ll be able to figure out, if we tell them how much an impact, they will be able to know exactly what the sales are, and then we said it is a top 5 store, then they will basically know our sales for our top 5 stores, and that’ll be released in reports, so we just didn’t want to give that data to you guys because you guys will figure it out, and we don’t want the world to know what our highest volume stores are doing in sales, because it is competitively sensitive. So that is the reason why we don’t want to give more detail.

Steve Chick - JP Morgan

We are not trying to submarine you on comps either, so.

John Mackey

Well that is why we report both idents and comps and I don’t know if idents are up, but probably we will just have to wait until next quarter is over, then you will be able to see it, and you will see the scrub between idents and comps.

Steve Chick - JP Morgan

Second, if I could Walter, with the reduction of those select leases, where you reduced square footage by on average 9,000 square feet, can you just confirm that there is not extra cost of going back and renegotiating something like that? That’s pretty easy, picking the one you want to do that. I mean that’s not that big of a deal for you guys, right?

Walter Robb

No, it’s not that big of a deal. I mean there are two ways to do that. One we may be too far along in this particular cycle because remember, the right sizing has started already in real estate where that maturity of the right size for the right market. But in that group of stores we had it does include something where we might keep the whole space but just build out 5,000 to 10,000 square foot less, hence our development costs to your earlier questions are lower.

It also includes situations where we, in fact, reduced the lease exposure and in most cases we have been able to do it with the landlord can just turn around and rent that space at actually at a higher rate to somebody else. So it has been fairly painless that way. I think it puts us in a much better position in terms of return on invested capital.

Operator

We will take our next question from the side of Ursula Moran- Bear Stearns.

Ursula Moran- Bear Stearns

Given your phenomenal success in Manhattan, do you have additional Manhattan plans? I missed the first three minutes of the call. So I apologize if this is redundant and could you give us at least a directional sense of schedule because it seems like there is still lots of new burbs you are not in.

John Mackey

Well we have two stores that we have announced, in Manhattan, that are in development, one in Tribeca and another one on the Upper West Side. We have a great site in Brooklyn. So, yes, I think we got several more locations that we can do in Manhattan. It’s a phenomenal market; it’s got the highest density and number of college graduates of any city in the United States. It’s simply the most phenomenal food market.

Ursula Moran- Bear Stearns

Yes, I agree. But if I could, with your permission, ask a follow up. I know there were some construction issues at a site that is rumored to be you, but I don’t know if it’s you, and that is the Upper West Side site.

John Mackey

Well we announced that site.

Ursula Moran- Bear Stearns

No, no but I mean is it on schedule, because they were fairly significant impediments.

John Mackey

Yes, I don’t know. I don’t think we have announced an opening date on that one.

Ursula Moran- Bear Stearns

Okay. So you can’t be behind schedule if you don’t have a schedule.

John Mackey

That is our major strategy for not announcing. Nobody can say you are behind schedule if there is no schedule.

Ursula Moran- Bear Stearns

But you’re coming to the Upper West Side. So we are happy to hear it.

John Mackey

We will get there. New York is an extremely difficult market to develop in because you have to jump over a lot of hurdles to get a store open there. Fortunately, we have done enough of them now that we’re beginning to understand the patterns and we are getting better at it.

Ursula Moran- Bear Stearns

Well, I hope it gets easier.

John Mackey

Well, frankly the hardest thing we found in New York City is we really want to have a store that sells wine. We’re very frustrated because the city keeps blocking us.

Ursula Moran- Bear Stearns

What about a partner?

John Mackey

They keep blocking us and it’s very frustrating, particularly when Trader Joe’s got their license. Hopefully we will get that for Upper West Side

Operator

Your next question comes from Scott Mushkin - Banc of America.

Scott Mushkin - Banc of America

Your margins obviously have come down, overall EBITDA margins, because of this investment period. How quickly do we rebound, in theory, to that 5.5% level and does it change? Does the look of the change, in your minds, given the significant mix shift that is going on in the stores to the perimeter and prepared foods?

Glenda Chamberlain

You know it all depends, Scott, on how many stores we open and what happens to the average age of the stores. We don’t know when the end of that cycle will be. We hope that we continue to be a growth company for many years to come.

Scott Mushkin - Banc of America

Any thoughts on the mix shift that is going on in the store as these larger, more perishable-oriented stores or prepared food oriented stores open up is that going to shift your notion of direct store expenses, labor and also maybe gross margin or is that not really something you see with these large stores?

John Mackey

We do see it with the large stores. They have higher gross margins and they have higher direct store expenses because as you just said, prepared foods is a bigger percentage of the overall mix. But remember we are not just opening up 60,000 to 80,000 square foot stores and the sweet spot of those 45,000 to 60,000 square foot stores does not have as big of an impact in that way on the prepared foods shift in mix.

Glenda Chamberlain

But perishables as a percentage of sales for us is currently about 68%, 67% and has been at that level for quite awhile now.

Walter Robb

The incremental move really has not been as great the last bit of time as it has been the previous two years. Actually we don’t give out individual team comps but we are seeing some wonderful strength in center store as well, combined with the fact that we are adding more of the 50,000 square foot stores and their balance of margin and labor is different. I think there is a nice rebalancing going on.

Scott Mushkin - Banc of America

Walter, do you think as you flex expenses down you will be able to maybe do some things on pricing in the perimeter that would actual see acceleration in sales as you do that? Or is that a bad way to look at things as you move forward?

Walter Robb

I am not sure I would think about it that way. I think that we are back to what we said, which is that the pricing is competitive in nature, it is market driven depending on the individual situation. Certainly if you are a little stronger there it does give you a little more flexibility to do that where you need to.

Glenda Chamberlain

I just want to conclude by saying that we still believe that our five-year historical ranges are the best indications of the future.

Operator

We will take our next question from side of Daniel Santiago – Brass Hat Capital.

Daniel Santiago – Brass Hat Capital

Just one question here regarding expenses control on the direct store expenses line. I do a lot of adjustments for your square footage growth, it looks like we would have some deleverage this year in the direct store expense. Could you talk a little about this line? Are you expecting some of the leverage there on mature store basis?

Glenda Chamberlain

What we had in the quarter was some deleverage in the comp stores about the same as what we saw in the second quarter. We had in this quarter a significant increase in stock-based compensation, primarily because of an adjustment to the acceleration charge that we took several years ago and also because as we said in the second quarter, our health care costs as a percentage of sales were higher. We do have initiatives in place to try and work on health care costs as well as all of our expenses. Although I will say that on a per team member basis, our healthcare costs still are lower than what we see at other retailers.

So we certainly have initiatives in place and we are focusing on our direct store expenses and no we would not expect to be in a situation where we would continually see deleverage in our comp stores.

Daniel Santiago – Brass Hat Capital

For the future, though, do you have any plans to lower your cost base by any kind of objective or is it something that you don’t plan to do?

Glenda Chamberlain

No, we do not plan to change our overall business strategy. We think we have a very successful business strategy.

John Mackey

Just got to keep opening up good stores that do well. If we can keep doing that, the investment community is going to be happy with our performance.

Operator

Your next question comes from Ed Aaron - RBC Capital Markets.

Ed Aaron - RBC Capital Markets

Just want to ask a couple follow-ups on the London store. I know you mentioned it’s been strong, but just curious to know what the J curve had looked like there, and where we are along that J curve right now?

As a follow-up to that, just with the flooding that’s taken place in the UK, any impact on traffic from that or more importantly on supply?

Walter Robb

I just talked to them today, and though you might be asking that question. But we’re already past the bottom of the J curve and on our way. You know the weather stinks over there this summer, but it’s already building towards fall, and we just put our holiday plans in place for Christmas, and the anticipation is the traffic is going to continue to build from here.

So we feel like we’ve already bottomed and on our way up. There really hasn’t been any effect on supply. I mean, it’s a single store, and the team over there did a fantastic job; a single store finding the sources, the supply for that store on the fresh side and the dry side, and that hasn’t been an issue thus far.

Operator

Your next question comes from Mark Wiltamuth - Morgan Stanley.

Mark Wiltamuth - Morgan Stanley

I just wanted to ask one question about the Wild Oats merger. You had talked about divesting 35 stores. Any sense on how you’ll look at potential store closures? Looking at the court case itself, if the definition of the market changes, does the FTC have any further role in looking at market overlaps?

John Mackey

Well, we’ve already announced that we’re going to sell off the Farmer’s Markets, the Henry’s and Sun Harvest stores. So that’s 35 stores we will divest. Regarding the stores that we will keep, it’s honestly impossible for us; nothing has changed since we made the announcement in February, because we still have not, until this deal can close, we will not be able to look at the individual profit performance, sales or profit performance for the Wild Oats stores on an individual basis. So it’s impossible to know for sure what stores we might close or relocate until we have the data.

Hopefully, we’ll have that data here maybe by the end of the summer or in early September, if all things go well. So, by the time we have the next quarterly call, the Oats thing should be figured out one way or another, and we’ll have more definitive answers to be able to give to the investment community.

Did I answer the full question? Or was there another part to it, Mark?

Mark Wiltamuth - Morgan Stanley

Just the second part was, you know, if the definition of the market changes, and it’s not just natural and organic stores, does the FTC still have any role in reviewing the transaction or is this court ruling it, and then you’re free to proceed with the merger?

John Mackey

Now that’s an interesting question. The FTC has reserved the right to continue to pursue this transaction in their own administrative courts. However, if the temporary restraining order is removed by this judge and an appeal is made and the appeal doesn’t stop it -- if we’re allowed to go through and close this transaction, we’re going to do so and we’re going to begin to look at the results, we’ll start closing stores. We’ll start integrating the companies. So the FTC may continue with its review, they have the regulatory authority to do that, but if the courts won’t let them stop the merger, we’re going to go through with the merger.

You might say once the eggs get scrambled they’re kind of hard to unscramble. So we will see what happens here and hopefully we’ll know something in the next few weeks. But you know, regardless of whether or not this deal goes through, we’ve got 94 stores in development and its future looks great. It’s been a long haul. We made this announcement back in February and it’s almost August now.

So from a Whole Food’s perspective, we’ll be glad one way or another to have this situation resolved because it’s taken a lot of management time, and we spent a lot of money on lawyers and as we’ve mentioned 20 million documents went to the SEC. It’s been incredibly burdensome on us. So we’ll be glad to have this situation resolved one way or another, so that it doesn’t take any more of management’s time filling out requests of various lawyers.

Is that it for the calls, operator?

Operator

Yes it is. I will go ahead and turn it back over to you, Mr. Mackey.

John Mackey

Thanks for listening in. Visit our website for transcripts of the scripted portion of this call. A recording of the call will also be available online through a link on our website at www.wholefoodsmarket.com. Thanks for tuning in today. We’ll talk to everybody next quarter. Take care.

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