Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)

Executives

John Mackey - CEO

Walter Robb - Co-President and COO

A.C. Gallo - Co-President and COO

Glenda Chamberlain - EVP and CFO

Jim Sud - EVP of Growth & Development

Lee Valkenaar - EVP of Global Support

Cindy McCann - VP, IR

Analysts

Simeon Gutman - Goldman Sachs

Ed Aaron - RBC Capital Markets

Mark Miller - William Blair

Greg Badishkanian - Citigroup

Mark Wiltamuth - Morgan Stanley

Steve Chick - JP Morgan

Mark Husson - HSBC

Meredith Adler - Lehman

Whole Foods Market Inc. (WFMI) F4Q07 (Qtr End 9/30/07) Earnings Call November 20, 2007 5:00 PM ET

Operator

Welcome to today's teleconference. At this time, allparticipants are in a listen only mode. Later, there will be an opportunity toask questions during our Q&A session. Please note this call may berecorded. I will now turn the program over to Mr. John Mackey.

John Mackey

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

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

These risks include but are not limited to general businessconditions, the timely development and opening of new stores, the impact ofcompetition, and other risks detailed from time to time in the company's SECreports, including the reports on Form 10-K for the fiscal year ended September24th, 2006. The company does not undertake any obligation to updateforward-looking statements.

Our press release is now available on our website atwww.wholefoodsmarket.com along with the scripted portion of this call andadditional supplemental financial data.

I am hoping you have all had a chance to read our pressrelease. We recognize that this quarter is a bit confusing given the 13-weekrather than the 12-week quarter and that our results include Wild Oats for thelast five weeks of the quarter.

We have adjusted percentage increases to exclude the extraweek to allow for proper year-over-year comparisons, and for several keymetrics, we have broken out the estimated impact of the Wild Oats stores tohighlight the results for our existing stores.

I think I speak for everyone when I say words cannot fullyexpress how excited we all are to have finally completed our merger with WildOats. We believe the synergies gained from this combination will createlong-term value for our customers, vendors and shareholders, as well asexciting opportunities for our team members.

All of our 11 operating regions gained stores. Three of oursmallest regions gained critical mass, and we gained immediate entry into 15new markets and five new states. Over time, we expect to recognize significantsynergies through G&A cost reductions, greater purchasing power andincreased utilization of our facilities.

Tremendous strides have already been made operationally andculturally thanks to the hard work and dedication of our team members, bothexisting and new.

We are happy to say we were able to retain approximately 90%of the Wild Oats store team members and are in the process of transitioningthese team members to our pay guidelines and progressive benefits package. Anincredible amount of positive energy has been generated through Town Hallmeetings, vision days, and training at the regions and in Austin.

Customers in the Wild Oats stores are already experiencingan improved shopping experience thanks to the expanded product offerings,particularly on the fresh food side, as well as price cuts on over 1,000 items.We are already directly sourcing and distributing produce, seafood, bakery andprepared food items to the stores, which has raised the quality of theperishable offerings significantly. We think customers will also respondpositively to our in-store programs for the upcoming holidays.

We sold the 35 Henry's and Sun Harvest stores on September30th and have since closed nine of the Wild Oats stores, including one storethat was closed in conjunction with the opening of a new Whole Foods Marketstore in the same area.

We also temporarily closed two stores for major renovations,one of which is scheduled to re-open later this fiscal year. Of the 63 storesthat currently remain, we plan to close one additional store in the firstquarter and then close seven more stores over the next few years as we opennearby Whole Foods Market stores that are currently in development.

We have started to make changes inside the stores includingnew packaging, equipment, signage, displays and team member aprons. We plan to invest$40 million to $50 million this year in Wild Oats remodels, and our regionalpresidents are working on plans for the renovations that will take place laterthis fiscal year after which we expect to re-brand the stores as Whole FoodsMarket stores. Some stores are planning to rebrand as soon as early 2008.

For the five-week period, excluding the Henry's and SunHarvest stores, sales from the 74 Wild Oats stores were $82 million. Thesestores, averaging 24,400 square feet in size and nine years of age, had averageweekly sales of $214,000 per store and sales per square foot of $457 in thequarter. Of the 63 stores that currently remain open, averaging 24,400 squarefeet and nine years of age, average weekly sales were $224,000 per store andsales per square foot were $478.

While the Wild Oats stores are older and smaller than ourstores, we do believe that over time we will raise their sales productivity tolevels in line with our stores. We have two historical examples of where weopened stores in Wild Oats locations that had closed due to poor performance,and subsequently significantly improved their sales.

At one location, we saw a greater than six-fold increase inaverage weekly sales over a period of about six years, and at the other store,we saw an increase of just under five-fold over a period of about six years.While these results aren't necessarily predictive of all the Wild Oats storeswe acquired, they do demonstrate the potential value we can produce over thelong term.

In a short time, our integration has gone faster, further,and deeper than in any of our prior mergers, and we feel very positive aboutthe results we have seen so far. The Wild Oats stores open longer than a year,excluding the divested stores and the stores we closed in the first quarter,have shown a healthy increase in sales growth from 3.9% over the last fiveweeks of Q4 to 6.6% over the first seven weeks of Q1, and we expect thesestores to drive strong sales this year and higher comparable store sales growthin fiscal 2009 and beyond.

I will now turn to our results for the quarter, excludingthe Wild Oats stores.

Our sales increased 16% to $1.6 billion driven by 18% endingsquare footage growth and 8.2% comparable store sales growth, which was on topof an 8.6% increase in the prior year. Identical store sales, which exclude sixrelocated stores and two major expansions, increased 6%.

The spread between comps and idents increased 95 basispoints in Q4 compared to Q3, primarily reflecting the inclusion of the Kensingtonrelocation in Londonfor the entire fourth quarter versus only three weeks in the third quarter andthe two additional relocations that opened in Q4. Year-over-year, averagetransactions per week increased approximately 5.5% to 3.5 million, and our averagebasket size increased approximately 2.5% to $33.

Note the Wild Oats stores will not be included in the compbase until the 53rd week following the acquisition.

Average weekly sales were $628,000 per store, excluding theWild Oats stores, in the quarter, a 7.5% increase year-over-year, translatingto sales per square foot of $892.

We opened a record eight new stores during the quarter and arecord 21 new stores during the fiscal year, a significant increase from the 13new stores we opened in fiscal year 2006. We relocated five stores, enteredthree new markets and completely revitalized our brand image in the Chicago area with theaddition of four new stores.

Our new stores include a number of innovations that not onlyhelp us continue to redefine the marketplace but also create an incredibleamount of excitement and positive momentum within our company.

For the quarter, our new stores averaged 57,000 square feetin size and were just over six months old. They produced average weekly salesof $630,000 translating to sales per square foot of $573.

Our new stores open at least one year continue to run aheadof our sales projections for the first year and are on track to reach our realestate investment hurdle rate of cumulatively positive EVA within seven yearsor less.

We are actively continuing to further differentiate ourproduct offerings in ways that speak to our authenticity and leadership rolewithin natural and organic products. These initiatives include the continuedexpansion of our private label products which saw a 13% increase in SKU count year-over-yearand currently represent 19% of our total grocery and Whole Body sales, ourexpanded "Buying Local" efforts and local product selection, ourWhole Trade Program, and our new Five-Step Animal Welfare Rating Program, whichallows shoppers to easily understand how the animals from which the meat andpoultry products they are buying were raised and treated.

We were pleased to recently announce that we have nowadministered over $1 million in low-interest loans under our new Local ProducerLoan Program. Loan recipients include small-scale food producers and growersfrom 12 states. Among their products are fresh produce, body care products, andartisan foods including nut butters, ice cream, granolas and cheeses.

Our fourth quarter was very positive for the many reasons wehave outlined, but we did see some expenses increase as a percentage of salesto levels higher than our historical averages. Excluding the Wild Oats stores,gross profit improved eight basis points; however, this improvement was offsetby a 65 basis point increase in direct store expenses resulting in a 57 basispoint decline in store contribution.

For stores in the comparable store base, gross marginimproved 27 basis points, and direct store expenses increased 23 basis pointsas a percentage of sales resulting in a four basis point improvement in storecontribution as a percentage of sales. The $2.6 million LIFO charge in Q4compared to the $0.6 million credit in Q4 last year negatively impacted grossmargin by approximately 20 basis points.

It is helpful to point out that in Q4 we had 25 new storesthat averaged six months of age compared to the prior year, when we had only 15new stores that averaged eight months of age. For stores in the comp base, the23 basis point increase in direct store expenses in Q4 was in line with theyear-over-year increase we saw in Q3 and was once again driven primarily by anincrease in health care costs as a percentage of sales.

Rising health care costs continue to be an issue for mostbusinesses, and while our annual increases and our health care cost per teammember are still well below industry norms, we are seeing health care costscontinuing to grow.

Our goal is to continue to educate our team members on howto best use the medical resources available, to avoid emergency room visits forless urgent care, and to encourage wellness programs and overall good healthsteps.

Including Wild Oats, G&A expenses increased to 3.9% ofsales, primarily due to approximately $13 million, or $0.06 per diluted share,in costs related to legal matters, integration efforts and the addition of WildOats' G&A expenses. We continue to expect significant synergies throughG&A cost reductions over time, but there will be some temporary costsassociated with integrating the Wild Oats acquisition, along with the cost offully staffing our three smallest regions, which gained the greatest number ofstores relative to their existing base in the merger.

Now to turn to a summary of our guidance for fiscal year2008, our sales guidance is for higher-than-average sales growth of 25% to 30%,of which approximately 10% is expected to come from the Wild Oats stores, andcomparable store sales growth of 7.5% to 9.5%.

We expect to return to a more historical comp level, despiteincreasing competition, a greater degree of cannibalization, and the possiblenegative impact of any slowdown in consumer spending. This expectation is basedon easier year-over-year comparisons, a higher number of new stores enteringthe comp base, transfer of sales from some of the Wild Oats' store closures,and the 9.5% comps and 7.2% idents we have averaged so far quarter-to-date.

In the first quarter, we have opened four new stores andplan to open two more stores. We have also permanently closed nine stores,temporarily closed two stores for major remodels, and plan to permanently closeone additional store.

We expect to end the first quarter with 270 stores. Fourteenof our tendered stores are scheduled to open this fiscal year, and we willannounce additional stores tendered for openings this year with our Q1 earningsrelease in February. We expect to open approximately the same number of newstores this year as last year.

We do not expect to produce operating leverage for the yeardue primarily to a decrease in store contribution as a percentage of salesdriven by a higher percentage of sales from new and acquired stores, which havea lower contribution than our existing stores, investments in labor andbenefits at the Wild Oats stores, and continued, though more moderate,increases in health care costs as a percentage of sales.

In addition, we expect G&A as a percent of sales to bein line with the 3.3% we reported in fiscal year 2007, due mainly to thetemporary costs associated with integrating the acquisition, along with thecost of fully staffing our three smallest regions which gained the greatestnumber of stores in the merger. G&A as a percentage of sales should improvesequentially from the first half to the second half of the year.

We expect pre-opening expenses in the range of $80 millionto $90 million, half of which relates to stores scheduled to open this fiscalyear. On an average weekly basis, we expect quarterly pre-opening and relocationexpense to ramp up throughout the year.

Due primarily to the financing of the acquisition, we expectnet interest expense in the range of $35 million to $40 million in fiscal year2008.

Capital expenditures for the fiscal year are expected to bein the range of $575 million to $625 million. Of this amount, approximately 65%to 70% relates to new stores opening in fiscal year 2008 and beyond, andapproximately 7% to 8% relates to the remodels at the Wild Oats stores.

Our company is focused on EVA, and given our strong,consistent operating cash flow, we are comfortable with our current debt levelsand the utilization of our credit line to fund capital expenditures as well asfuture dividends and any potential stock repurchases. In fact, today we arepleased to announce an 11% increase in our quarterly dividend to $0.20 pershare, our fifth increase since we declared our first dividend in November2003.

We recently signed five new store leases averaging 47,000square feet in size. We now have 87 stores under development totaling 4.5million square feet or 48% of our existing square footage. These stores average51,000 square feet in size and include 22 relocations and 14 new markets.

Our business model is very successful and continues tobenefit all of our stakeholders. We are executing at a high level, continuingto produce higher sales, comps and sales per square foot than our publiccompetitors. We believe the investments we are making today in our new,acquired and existing stores will result in strong earnings growth in the nearfuture.

Given our recent merger, strong historical sales growth,significant store development pipeline, and acceleration in store openings, webelieve we are well positioned to achieve our goal of $12 billion in sales inthe year 2010. Over the longer term, however, we believe the sales potentialfor Whole Foods Market is much greater than $12 billion as the market continuesto grow and as our company continues to improve.

We have grown our stock price at an average compound annualrate of 21% since going public in 1992, and we encourage our shareholders tostay focused on the long term.

We will now take your questions but ask that you limit yourquestions so that everyone has an opportunity to ask questions. Thank you.

Operator you are with us?

Question-and-AnswerSession

Operator

Yes, I am still here. (Operator Instructions) And we willtake our first question from the side of Simeon Gutman of Goldman Sachs. Goahead please.

Simeon Gutman -Goldman Sachs

Hey, with respect to the core business, excluding the Oatsinvestment, is it fair to assume net earnings growth would have approximatedcloser to historical levels and that of course bakes in, pre-opening would be alittle bit higher and interest income probably a little lower due to less cashbalances? And then second of all: when do you expect Oats to be accretive?

Glenda Chamberlain

We are not answering the second question; we haven't givenany guidance on when we expect Oats to be accretive and we have given a lot ofinformation in the press release about our core results excluding Oats. So yearwise we would not have had interest expense of course on the $700 million, butwe do have a significant increase year-over-year in pre-opening expenses, andeven without Oats we had seen a decline year-over-year and income beforepre-opening and interest expense due to the increase in direct store expenses,which was primarily health care and the results of the new stores. Thank you,John. As we said we had 25 new stores in the fourth quarter compared to 15 newstores in the fourth quarter of the prior year.

Simeon Gutman, -Goldman Sachs

Okay. And then the second one and last one if I could: Areyou seeing any signs of a weakening consumer in some of the regions where thereis more pressure, for example California or Florida?

John Mackey

Yeah, we are not. One of the myths out there about WholeFoods Markets, I mean, is that we are some kind of luxury retailer and we getonce in that category and whenever the economy gets weak everybody comes outand says: “gosh, Whole Food sales are going to fall”. However, that's neverbeen the case. We've been doing this for 29 years and every time there is arecession our sales don’t fall, in fact, during the recession our comps went upinto double-digits, they increased during the recession. So I just think that'sa myth that no matter how many times we prove that wrong its mini head of hydrowe can't seem to kill all the heads. And I might as well address the California question as well: No, we are not seeing anyweakness in our California stores due to theso called bubble burst and we are going actually extend the [wall] in California.

Simeon Gutman -Goldman Sachs

Okay, thanks.

Operator

We will take our next question from the side of Ed Aaron ofRBC Capital Markets. Go ahead please. Mr. Aaron, your line is open.

Ed Aaron - RBCCapital Markets

Can you hear me? Sorry about that. On the new store openingsfor '08, I know you didn’t give specific guidance on this before today, butbased on the number of leases that were tendered, I was expecting a number thatwas a little bit bigger than what you are looking for. Can you help me get myhead around that?

Glenda Chamberlain

One of the things to note is that we had two stores thatopened right at the end of fiscal '07, that we actually had originally thoughtwould open in fiscal '08. So, that would have been a shift from '07 to '08. Sowith those we would have opened a few more stores in '08 than we had in '07.

Ed Aaron - RBC CapitalMarkets

Okay. And then I wanted to ask a question on the Wild Oatsbusinesses you seem to make improvements since you bought it. Can you give us asense of the difference between the trends you are seeing in the Oats storeswhere you didn’t have a big presence with your existing Whole Foods base versusthe markets where you had an established Whole Foods base before the merger? Isthere any difference there?

A. C. Gallo

Ed, this is A. C. It's a little early to tell, because itsreally not been that many weeks, but there are a few stores that are, say closeby right in the middle of an existing operating region, in the east here sayfor instance, because our stores are so close we are able to make changes tothe them a lot quicker, able to move team members in from existing stores, theproduct coordinators are able to visit them a little more. So some of thosestores have jumped a little quicker than maybe some stores that are in marketsthat are far away from one of our existing regional centers, but its reallyearly to tell what's going to happen exactly.

Walter Robb

This is Walter, I just want to tag on A. C. and say thatwe've got 15 new markets here with us and this jump from 3.9 to 6 andcontinuing as strong across, this is not just inbound store, this is across,this is a broad base trend across all of these new markets that we're into.There is enthusiasm excitement from [Tustin] to Little Rock to Oregon to Maine really, so it'spretty strong Ed.

A. C. Gallo

Yeah, I want to add on just Ed: I've been touring aroundvisiting all the stores in the east the Wild Oats store that we acquired intoeach region. I have just been amazed at how enthusiastic the team members arein the stores and how happy they are, to be a part of our company. It's reallybeen uplifting for me to go visit the stores to see their excitement.

Ed Aaron - RBCCapital Markets

Thank you. And one more if I could. The magnitude of thecontribution margin expected decline for '08. I know you didn't give specificguidance to that, but maybe in the context of what you experienced in fiscal'07. Is it, do you think it's something similar to that or could I ask a littlebit of direction there?

Glenda Chamberlain

Honestly, we gave as much direction as we are comfortable,the other thing we did say that we expect to continue to see increases inhealth care although more moderate than we had in '07 as compared to '06.

Ed Aaron - RBCCapital Markets

Thank you.

Operator

Our next question will come from the side of Mark Miller of WilliamBlair. Go ahead please.

Mark Miller - WilliamBlair

Hi. Good afternoon. I was hoping you could speak about someof the transition steps that are forthcoming with Wild Oats, notably theassortment change, the training and incentive programs going in and thenre-branding. I'd like to understand which of these you think are most importantand kind of when we begin to see those effects begin to roll-in?

And then a little bit longer-term, you talk about yourobjective or thought that these stores could achieve sales per square footequivalent to that of Whole Foods. What is the reasonable timeframe to thinkabout that opportunity?

John Mackey

Walter and A.C., you guys want to take that one?

Walter Robb

Yeah, I'll take a first stab at it, we usually say themergers take up to two years to come up and fully land and that may still be agood framework and I am talking operationally here not financially. But I thinkthat this one is going faster and I think it's because of the gap over thesummer and everybody having time too really and the excitement that'shappenings with it.

So, first you start with the culture and establishing thetrust and recognizing what they have accomplished and establishing the trust interms of the transition and I think or have to really, I think both A.C. and Iwould agree our regional presidents as group has done a tremendous job creatingthat connection with the Oats stores.

And then you start to have the people moving in between thetwo stores, we have leaders going both directions and people going bothdirections and that spreads it more quickly. We have product that's nowlanding, both private label product and also fresh perishable product. Weswitched the stores to our perishable product and customers are telling us theysee the noticeable difference and its showing up in the sales and that's onlygoing to continue and from there into the programs. So it even up to remodelsand equipment and changing the name.

The first store will probably change name in mid-January somethinglike that and the Oats team members will land on our benefits programs afterthe first of the year. So all of these things begin to just build momentum andcontinue the momentum that will translate into a sales strength and also buildinto financial results that that we'll see from that, A.C. you want to add tothat or --?

A.C. Gallo

Yeah, I think, actually its Walter working with the teammembers and really getting the culture aligned was the first thing we did andthen getting them on our perishables distribution was the second. The otherthing that we've done is we've lowered a lot of prices down to prices of higherWild Oats. So we are getting these comp increases even despite the fact thatquite a few prices have been lowered.

The other timing factor is really, in order to really getthe type of sales increase per square foot that we are talking about, a lot ofthat will come in a lot of these stores until they are remodeled, because a lotof these stores are old, older stores that have older equipment and its notuntil -- we can put our products in there but not until we can get storeslooking a little bit better and flowing a little bit better that we start tosee the jump in sales.

So also those remodels will happen during the course of thisyear and so I think the real jumps in comps won't really come until thoseremodels happen towards the end of this year or the beginning of next. So Ithink we'll see a steady increase and then more of jump in each store as itgets remodeled over the course of this year.

Walter Robb

Yeah, it's kind of a dance between sales margin and labor,we're going to keep pushing the sales, you're going to see a slight up-tick inthe gross margins as we bring some of our programs in and we're also going toinvest in the labor cost the team members to bring them on in our with ourhealth care and our benefits and so forth. So, all those things will be movingin a sort of dynamic balance.

Mark Miller - WilliamBlair

I have additional question on the Wild Oats stores that havebeen closed. Could you talk about your success thus far, I know its not been along time, but your ability to recapture those customers in nearby Whole Foodstores and Project Gold Mine there is some objectives can you just speak abouthow that's gone?

A. C. Gallo

Well. Some of the stores have closed like we closed a verylow volume store in Saugus, Massachusetts that was not nearany of our stores. And whether we picked up, say we're not really clear if wepicked up any sales from that, sales were so low and it was another part oftown. We closed Medford, Massachusetts store which is just aboutthree miles from our Fresh Pond store and closed that down to do a completeremodel. It's going to reopen in the spring. We definitely saw a little pick upin sales there.

Probably the most dramatic thing we did we closed the Nashville store, the Wild Oats store at Nashville when we opened ours up about threeweeks ago and we saw a tremendous transfer of sales and that store has openedup at pretty incredible volume. Their volume plus all the new volume we've got.So that's really been our only experience so far in the east regions.

Walter Robb

I think the big thing here is the fact that we in the end ofour processes we closed less stores than that number that was out there, Idon't, there is a lot more enthusiasm and optimism about operating the storesand what potentially can happen here and so that the numbers are much loweroverall what we decided to do and it does bit range as you said our Bridgeport,Oregon store we closed that one right across the street and obviously thebusiness moved across the street, others that are a little further away. But weare definitely achieving out or above the targets that we set for ourselvesinternally in terms of the business transfer.

Mark Miller - WilliamBlair

Okay, great. And then, hopefully a quick final question.Glenda, could you tell us what slightly dilutive for Wild Oats means, maybe Iwill get to the number before the end of the night, but if you can just tell uswhat that EPS impact was that would be great?

Glenda Chamberlain

A slightly dilutive is as close as we are going to get. It'snot nearly as clear as you might think, because truly we have integrated and weare one company. So, it's harder to determine an exact dilution number, but webelieve that we have given you enough information where you can get prettyclose.

Mark Miller - WilliamBlair

Okay. Thanks.

Operator

Now, I'd like to remind everyone to please limit yourself toone question today. Our next question will come from the side of GregBadishkanian of Citigroup. Go ahead, please.

Greg Badishkanian -Citigroup

Great. Thank you. I'll ask one quick question and follow-up.In terms of the $0.06 per share, the impact from the Wild Oats acquisition, howmuch of that was G&A and then of the G&A how much is actually going togo away after another quarter or two?

Glenda Chamberlain

Just to be clear, the $13 million, the $0.06 we mentioned inthe press release is all G&A.

Greg Badishkanian -Citigroup

Okay.

Glenda Chamberlain

That are intended to be necessarily the impact of the Oatsacquisition. It is the unusually high G&A cost that we've had in thequarter and of that number the majority of it is due to Wild Oats both theG&A that we acquired in their office in Boulder, as well as the additionalcost here of the integration and other costs.

Greg Badishkanian -Citigroup

Yeah, I was thinking, I meant to say the addition of WildOats G&A expenses, the sort of step-up function of just having to theiroverhead and other G&A.

Glenda Chamberlain

Right, and for the five weeks that number was about half ofthe $13 million and we do expect that that will continue on into fiscal '08,although it will decline sequentially from quarter-to-quarter.

Greg Badishkanian -Citigroup

Okay. Good, that's helpful and also just as you look out atjust a different initiative, you have very nice improvement at Oats. Is thereother, what would you say are there one or two things that are just the reallow hanging fruit that you were able to fix and may be were some initiativesthat you thought you could improve, but maybe will take you a bit longer toimprove?

John Mackey

Well, A.C. and Walter kind of mentioned the lowest hangingfruit is we've put our product in the stores, we've upgraded their perishablestremendously, already by just switching into our distribution centers andsecondly we lowered about a 1,000 prices. So that's the lowest hanging fruit.And then, the harder fruit that's going to pay dividends, we'll start seeing itby the end of fiscal '08, but the bigger impact will be in '09.

We are going to invest $40 million to $50 million to remodeland upgrade the stores and a lot of that Oats stores are in desperate need ofrefurbishing. So, we are going to improve the stores and as we upgrade thestores, we upgrade the customer experience and as the Wild Oats stores, theteam members become well trained and they understand the Whole Foods culture,as they really embrace the Whole Foods culture, we are going to see synergiesgain from that as well.

So the low hanging fruit has been improving the quality ofthe perishables and lowering prices, kind of the opposite of what was predictedmight happen. With lower prices and improved quality and that's why the saleshave gone up so much, so far in Q1. We expect that to continue to go up as weremodel and upgrade the stores and as the Wild Oats team members embrace theWhole Foods culture of service and empowerment.

So, we think this is going to be something that's paying offalready in terms of increased sales, but we are going to see those salesaccelerate overtime, as we upgrade the stores and upgrade the customerexperience. So, this is something we are going to have synergistic beneficialeffects well into the next two years.

Greg Badishkanian -Citigroup

Yeah, interesting that you ended up lowering prices afterall was said and done. And on that: would you say that that's something thatmight be sustainable? You're seeing a very good return on that, I am assuming?

John Mackey

Yeah. We think its specific, if you notice that we've beenable to lower prices and yet, if you compared Wild Oats' gross margin to WholeFoods pre-merger, you'll see Whole Foods has much higher gross margins. So, wethink, we can get higher gross margins and lower prices for the customers. Andso, it's going to be a win for our shareholders and a win for our customers. Bythe way, it just means we lowered their prices to make an equal with our own,we haven't had any Whole Foods prices.

Walter Robb

Just update as. I will just update that number for you, justchecked this morning in Denver for example we've lowered 1,500 prices alreadyand there is definitely a correlation between that and the sales activity.

Greg Badishkanian -Citigroup

Great, that's helpful. Thanks guys.

Operator

Our next question comes from the side of Mark Wiltamuth of MorganStanley. Go ahead, please.

Mark Wiltamuth -Morgan Stanley

Hi, question for Glenda. You look at your guidance for nooperating leverage in fiscal '08. Is that just versus the 4.5% operating marginyou delivered in '07 or versus the pro forma for the combined company? And if Iam looking at that right, does that kind of imply $1.38 to $1.45 if it's justthe 4.5% margin?

Glenda Chamberlain

It's relative to the 4.5%, that was reported and we are notgoing to convert into EPS guidance.

Mark Wiltamuth -Morgan Stanley

Okay, and since we didn't see the clean numbers for WildOats after you did the divestitures. Is there anyway you can give us an idea ofthe gross margin levels of the remaining business or maybe an operating marginof the remaining business after you did the divestitures?

Glenda Chamberlain

We actually spend a lot of time deciding what numbers wewanted to announce and which ones we didn't. If you want to you can look atwhat the Oats numbers were in their third quarter. I think they reported a 6.1%store contribution percentage in that quarter.

Mark Wiltamuth -Morgan Stanley

Okay. Thank you.

Operator

Our next question comes from the side of Steve Chick of JPMorgan. Go ahead, please.

Steve Chick - JPMorgan

Hi, thanks. A couple of questions, in your G&A guidanceto stay at 3.3% for next year that looks to be, I guess, $270 million or so.How much Oats G&A is there on a run rate basis? And how much of thoseG&A costs you expect to collapse down in synergies in the first year, ifyou follow me?

Glenda Chamberlain

No, the information,I am willing to give about that is that, of the $13 million that was high G&Ain Q4, approximately half of that was the Wild Oats office expenses forthe five weeks, and we do expect that those will continue into fiscal year '08,although they will decline sequentially over the course of the year.

We also have a ramp up in G&A in our three smallestregions, and that will continue over the course of the year, and in fact, thatwas not reflected really in the fourth quarter. That will show up in fiscalyear '08. We'll begin to leverage those regions G&A in '09, but those werethe smallest of regions and they acquired the greatest number of stores. So wehad to ramp them up to fully staffing whereas they were sharing with the regionthey had split off from before.

John Mackey

I think we've guided that, there are not going to be anyG&A leverage in '08 due to the fact that there was this transition of OatsG&A. We are going to have higher G&A in Q1 and then it's going to getsequentially better. I expect that you will see significant G&A leverage in2009, as that we've finally gotten rid of all of the Oats G&A overhangthat's continuing, and we've got it well integrated and we've got a bunch ofnew stores opened up. We'll start to see into G&A leverage, but we're notguiding for the investment community but expect to see it in 2008.

Glenda Chamberlain

And then we would see more in Q4.

John Mackey

Yeah. Exactly.

Glenda Chamberlain

Obviously because Q4 this year was so high.

John Mackey

Yeah.

Steve Chick - JPMorgan

All right. No, I think I followed that. Just if I take the$6.5 million over five weeks that's a run rate annually of $68 million or so,which is a lot, and let's say -- I don’t know -- can you speak to, I mean, wehave kind of heard in the media that there has been some corporate headcountreductions already and I would assume that the bulk of those would be done bythe first part of FY '08. So I am just -- I am trying to -- seems like you arebeing pretty conservative maybe with your G&A assumptions?

Glenda Chamberlain

Well that is where a lot of the -- a lot of the people inthat office are still -- that are there now will still be there at leastthrough the first few quarters of the year and we are paying significant staybonuses.

John Mackey

The superiors.

Steve Chick - JPMorgan

Stay bonuses. Okay.

Glenda Chamberlain

Two quarters.

Steve Chick - JPMorgan

Okay. So sorry, so you are not -- do have planned headcountreductions of people of corporate?

Glenda Chamberlain

We have already made a lot of the headcount reductions. Thepeople that are there now will be there for another couple of quarters and thenwe are not certain as to what will happen at that point in time. It depends onthe speed at which the Whole Foods Market stores are taken off of the Wild Oatssystems and we don’t have an ending date for that at this point in time.

John Mackey

The other way around and while….

Glenda Chamberlain

Model Stores are -- it depends on the speed at which theWild Oats stores are taken off the Wild Oats systems and put on to the WholeFoods Market system.

Steve Chick - JPMorgan

Okay. And so I guess longer term those G&A costs thatthe Wild Oats have incurred to operate their company and whatever is 60 plusmillion. Is that -- as you guys are -- when once you are fully integrated, howmuch of that should ultimately would you think would come and go away, I amthinking it would be [8 or what]?

John Mackey

We are not going to guide for 2009 at this time. But we doexpect to see significant G&A leverage for 2009 going forward. Here is athing, Steve. We are more concerned about not (inaudible) up the integrationand making to go as smoothly as possible then we are in giving immediateG&A reductions. So there is going to be some overhang while we make thetransition particularly in human resources and information technologies werethe two areas you can (inaudible) up the most.

So, there is going to be some overlap until we are very,very comfortable and we've made this transition. It's going to last a couple ofquarters, but by the end of fiscal year it should all be completed. We'll startseeing significant leverage in the fourth quarter '08, and then we’ll guide ayear from now for '09, and I think it will be a significant leverage. But Ican't tell you what its going to be now. I am not going to give you guidancefor '09 at this time, but should be significant leverage in G&A.

Steve Chick - JPMorgan

Okay. Now it is right, I think that's why just because thatlittle one item, may it's pretty large, that's where some of the accretion canultimately get very interesting, I think. So I just want to try to nail it downa little bit?

John Mackey

We agree, we think there is going to be significantaccretion in that particular area over the long-term.

Steve Chick - JPMorgan

Right. Okay. And now within the $30 million, okay, we know6.5 came from this G&A. I guess it implies that the other 6.5 million wasintegration costs and legal costs. Do you have a number of how many, what typeof integration related costs you'll incur in addition or is that kind of baked intoyour common to a G&A leverage at 3.3%. You are follow what I am saying,like are there additional integration costs above that or is that in there?

Glenda Chamberlain

The majority of the integration costs were in those fiveweeks.

Steve Chick - JPMorgan

Okay. Now second thing, if I could. The 40 to, I think yousaid $40 million to $45 million of capital to remodel old stores. So, $40million to $50 million, okay. Is that or will that -- does that kind of compensate -- does that account forbasically a 100% banner changes and will that -- can we assume that that willall be complete by the end of 2008?

John Mackey

Walter, A.C. we can have it all done by '08 or is somethinggoing to linger into '09?

Walter Robb

Having done a few of this before, sometimes things don'thappen as quite as fast as you hope. And so, I think the majority of them willbe done, I think all the banner changes will be done by the end of the year. Ithink the banner changes will be done. There could be a few remodels that aren'tcompletely done at the end of the fiscal year we maybe in the middle of themstill going into the fall and we may have decided to hold off on one for alittle while, but I would say the majority should be done by the end of thefiscal year.

Steve Chick - JPMorgan

Okay. And the national example that you commented on, thatis I think one of the early relocations that you've benefited from. Can yougive us the number of sales that you are able to divert from the Oats storesthere into the new one, I know its early but --

A. C. Gallo

It's hard to tell, it's hard to tell exactly, because it isearly, the stores only did open for two full weeks. So, you are still in themiddle of that initial excitement of around the new stores. So until thingsreally settle down, we won't really know, but that store only really moved ablock from where it was. So, our sense is that we transferred the majority ofbusiness over.

John Mackey

We will never know, because it's not a controlled experimentwe don't know, what we would have done, if we hadn't closed the stores. So, butas A.C. mentioned, the sales are tremendous, they are very strong and they aremuch stronger than they were prior, that is 100% greater than what Wild Oats isdoing or more.

So there has been significant new pickup and there has beentransfer, but as A.C. mentioned were are only few weeks in, so we don't whatthe J curve is going to look like. We don't know what it will settle down atbefore it beings it a long climb up again. So we are still very early in theprocess.

Steve Chick - JPMorgan

Okay. And then last if I could. Glenda, do you have a proforma depreciation and amortization expense number for '08. I know withgoodwill accounting that can get a little tricky, but what's the total companyG&A that you will project?

Glenda Chamberlain

There is no goodwill amortization, goodwill does notamortize. It just stays on your balance sheet you review it quarterly forimpairments, but unless there is an impairment there in no expense related togoodwill.

Steve Chick - JPMorgan

No, yeah, I follow that, I mean kind of what is allocated toassets values versus the goodwill, sort of do you have a --?

Glenda Chamberlain

You can see that in the 8-K.

Steve Chick - JPMorgan

Okay, alright. Thank you

Operator

Our next question comes from the side of Mark Husson ofHSBC. Go ahead, please.

Mark Husson - HSBC

Yeah, good evening, I was going to ask: whether your fullEPS is going to be up or down this year? But it doesn't sound like you aregoing to answer that one or indeed what the synergy number is going to be forthis deal overtime. But if you will give that it will be great, but in a backupjust thinking about EVA: which is the way you like to measure things? Could youjust say whether or not opening new stores in the regular course of businessthat you have been very successful at doing, whether the EVA there is betterthan you've modeled at Wild Oats and better than London?

John Mackey

Mark, take another stab at rephrasing that question, we are notsure exactly what you are aiming at.

Mark Husson - HSBC

Okay. So, if you use EVA as your yard stick for efficientuse of capital. If you look at your historical store opening program andcompare the EVA there to the EVA that you modeled out for Wild Oats and the EVAyou modeled out for London.Could you talk about the relative success of those two other projects comparedto core?

John Mackey

We are not going to talk specifically about London, we don’t talkspecifically about any particular store, so we can [scrap] that off the list.The question about Wild Oats is, it's too early to know what's going to happento those sales. And the EVA model by far, if you do a sensitivity study ofsales are the most important factor that gives you wildly [disparate] EVAresults on a present value basis depending on what sales number you punch inthere.

We're very encouraged with how strong Wild Oats sales, we'vebarely done anything and sales are ratcheting up at a rapid rate. Once, wereally get them remodeled and upgraded. So we're encouraged and we havedifferent scenarios in terms of what EVA will be produced, based on what we'reable do with Wild Oats sales. But its way premature to give you, I mean, and aguess about what we think the EVA is going to be.

Let me put it this way. Based on the start and if we get thekind of, it looks like we're going to get more of the upper end potential onWild Oats sales if we continue to see this kind of increase when we get theremodels done. And we're going to have tremendously good EVA returns on WildOats and above what we originally modeled in when we did the acquisition.

So, how does that compare to new stores? Well, it dependssince on which stores we're talking about and in what period of time. There isless risk in an acquisition in the new stores in a lot of ways at least inWhole Foods case, because we know we can improve the sales of the stores thatwe acquire and at the new store there is a little bit greater unpredictabilityin terms of what the sales will actually end up being.

We think we can have -- all we know is that we think we'regoing to produce very strong EVA returns on both our new stores and developmentas well as Wild Oats, and might add as well as in London. So, we're verybullish on, the short-term here as things are a little bit messy. It's hard tosort all this out. We're not managing our company for the next quarter or totry to cut our G&A down to make the next quarter look good. We are tryingto build long-term shareholder value. We built a lot of long-term shareholdervalue since we founded the company. And we are very bullish about this merger,we think it's going to produce tremendous long-term shareholder value. We thinkwe've got great stores in development that are going to produce great long-termshareholder value and are going to all produce very good EVA. I think time willtell.

Mark Husson - HSBC

The observation about London,just because you had split that the cost growth for stores that were in thecomp base and those which weren't and Londonis a biggest single contributor towards that pocket of stores that aren't inthe comp base.

John Mackey

I know it is.

Mark Husson - HSBC

And the expenses are up 65 basis points in that pocketcompared to the comp base was up by half of that. So, I am trying to work outwhether Londonhas got the same gross margins as average, with quite a lot higher cost orwhat. I mean, doesn't that -- would I be wrong in trying to read that from thatsplit?

John Mackey

You are making an assumption there. I don't know what's yourevidence is, that Londonis the lion share of the other big stores that aren't. The other stores thatare not in the comp base, that are new stores. We've remodeled and relocatedother stores that like in Portland, Maine for example, that also havea big impact. And our store in Dallas or, sothere are lots of other factors besides Londonthat are going into that equation. So, I wouldn't read too much into that juston the basis of London.

But basically Londonis doing very well for us. It is an expensive store. We did put a lot ofcapital into it. We are looking forward it to be a long-term payoff, we signeda really long-term lease there, but the store is performing, the sales arequite are very high and we think it's going to produce a very good long-termEVA for us. So, we are looking, we are hoping to announce additional storesigned in the UK this call, but we weren't able to but we anticipate we will beable to do that over the next quarter or two. So, we are bullish on that and weare still bullish on London.I know you are not, but we are.

Mark Husson - HSBC

No, I think absolutely, I just think its subscale for thecountry as a whole and it is difficult to get those sites, but if you gotanother one coming along then you could be proved be wrong, so congratulations.

John Mackey

I am dedicated to that proposition.

Operator

And our last question will come from the site of MeredithAdler of Lehman. Go ahead, please.

Meredith Adler -Lehman

Hi, thank you very much. I was wondering if you couldcomment at all about the lease cost of the stores that you have closed. Haveyou bought out any landlords and maybe talk a little bit about what ongoinglease liability you anticipate having for those stores?

Jim Sud

Hi, Meredith, this is Jim Sud. We have bought out a numberof the leases that we paid for termination agreements and we had modeledcertain numbers in our pro forma for the Oats acquisitions and so far its lookslike we are coming in well below our anticipated number. So, we've been prettysuccessful in my view at this stage of the game in on the lease terminationside of things.

Meredith Adler -Lehman

And is that included in -- that's not included in thecapital numbers, that's not included in the project price, right. Those all arein repo incremental?

Glenda Chamberlain

We do have about, if you look on the balance sheet there isa number of a long-term liabilities and the majority of that is what's accruedfor future store closures including rent due and any buyout on those stores.

Meredith Adler -Lehman

Okay. And I was just wondering if you could just talk about:on the stores that where you've put some new stuff in, and you have loweredprices, the Oats stores? Have you done any advertising at all yet to tellpeople about the lower prices?

John Mackey

Walter, A.C. we are advertising of course, is that correct?

Walter Robb

Yeah, we've got suppliers who take tender, for example wherewe have 21 stores from Oat suite, we've mentioned earlier that we have lowered1,500 prices, we did that over the process of four weeks. Will Paradise and his team out there and they did that in partsupported by a flyer that included those prices in there, but, so yes, butwe'll probably find it in the stores too as well.

Meredith Adler -Lehman

Okay. And then just, my final question since everybody hasasked more than one. If you look at the trend of sales at the Oats storesbeforehand, I was just kind of surprised to hear you compare the performancepost-acquisition to the performance pre-acquisition because this yield draggedon for a long time and its hard to imagine that morale was at its highest likebefore the deal closed. So, I am just kind of wondering if you compare therecent progress versus our longer-term look at Oats. What does it look like?

Walter Robb

Well, I mean honestly Meredith, if you look at Oats justthrough the last number of years, not just the last previous time, their compnumbers was negative to (inaudible) but actually I think that 3.9% number mightactually be generous. But the gain here is real, I mean that the -- if you gointo the stores and feel the changes, the momentum is real and its transferringto a up-tick of a run rate over whatever period of time you wanted to extent toOats. So, this looks like so far at least a real gain from four to six a goodgain over the run rate.

Meredith Adler -Lehman

That's great. Thank you very much.

Operator

I will now turn the call back over to Mr. Mackey. Please goahead sir.

John Mackey

I hope our call today has relayed our confidence in ourbusiness model and the progress we have made in terms of integrating the WildOats stores. We expect to see high sales growth this year and expect the WildOats stores along with our new stores to drive strong comparable store salesgrowth in fiscal year 2009 and beyond. We look forward to speaking with youagain in February on our first quarter earnings call.

A transcript of the scripted portion of this call along withrecording of the call is available on our website at www.wholefoodsmarket.com.

Everybody have a great Thanksgiving. We'll talk to you inFebruary. Bye.

Operator

This concludes today's teleconference. You may disconnectanytime. Thank you and have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Whole Foods Market F4Q07 (Qtr End 9/30/07) Earnings Call Transcript

Check out Seeking Alpha’s new Earnings Center »

This Transcript
All Transcripts