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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, all participants are in a listen only mode. Later, there will be an opportunity to ask questions during our Q&A session. Please note this call may be recorded. 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 Vice President of Growth and Business Development, 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 24th, 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. We recognize that this quarter is a bit confusing given the 13-week rather than the 12-week quarter and that our results include Wild Oats for the last five weeks of the quarter.

We have adjusted percentage increases to exclude the extra week to allow for proper year-over-year comparisons, and for several key metrics, we have broken out the estimated impact of the Wild Oats stores to highlight the results for our existing stores.

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

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

Tremendous strides have already been made operationally and culturally thanks to the hard work and dedication of our team members, both existing 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 transitioning these team members to our pay guidelines and progressive benefits package. An incredible amount of positive energy has been generated through Town Hall meetings, vision days, and training at the regions and in Austin.

Customers in the Wild Oats stores are already experiencing an 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 and prepared food items to the stores, which has raised the quality of the perishable offerings significantly. We think customers will also respond positively to our in-store programs for the upcoming holidays.

We sold the 35 Henry's and Sun Harvest stores on September 30th and have since closed nine of the Wild Oats stores, including one store that was closed in conjunction with the opening of a new Whole Foods Market store 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 stores that currently remain, we plan to close one additional store in the first quarter and then close seven more stores over the next few years as we open nearby Whole Foods Market stores that are currently in development.

We have started to make changes inside the stores including new 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 regional presidents are working on plans for the renovations that will take place later this fiscal year after which we expect to re-brand the stores as Whole Foods Market stores. Some stores are planning to rebrand as soon as early 2008.

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

While the Wild Oats stores are older and smaller than our stores, we do believe that over time we will raise their sales productivity to levels in line with our stores. We have two historical examples of where we opened 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 in average 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 stores we acquired, they do demonstrate the potential value we can produce over the long 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 about the 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 five weeks of Q4 to 6.6% over the first seven weeks of Q1, and we expect these stores to drive strong sales this year and higher comparable store sales growth in fiscal 2009 and beyond.

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

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

The spread between comps and idents increased 95 basis points in Q4 compared to Q3, primarily reflecting the inclusion of the Kensington relocation in London for the entire fourth quarter versus only three weeks in the third quarter and the two additional relocations that opened in Q4. Year-over-year, average transactions per week increased approximately 5.5% to 3.5 million, and our average basket size increased approximately 2.5% to $33.

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

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

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

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

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

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 investment hurdle rate of cumulatively positive EVA within seven years or less.

We are actively continuing to further differentiate our product offerings 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 13% increase in SKU count year-over-year and currently represent 19% of our total grocery and Whole Body sales, our expanded "Buying Local" efforts and local product selection, our Whole Trade Program, and 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.

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

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

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

It is helpful to point out that in Q4 we had 25 new stores that averaged six months of age compared to the prior year, when we had only 15 new stores that averaged eight months of age. For stores in the comp base, the 23 basis point increase in direct store expenses in Q4 was in line with the year-over-year increase we saw in Q3 and was once again driven primarily by an increase in health care costs as a percentage of sales.

Rising health care costs continue to be an issue for most businesses, and while our annual increases and our health care cost per team member are still well below industry norms, we are seeing health care costs continuing to grow.

Our goal is to continue to educate our team members on how to best use the medical resources available, to avoid emergency room visits for less urgent care, and to encourage wellness programs and overall good health steps.

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

Now to turn to a summary of our guidance for fiscal year 2008, 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, and comparable store sales growth of 7.5% to 9.5%.

We expect to return to a more historical comp level, despite increasing competition, a greater degree of cannibalization, and the possible negative impact of any slowdown in consumer spending. This expectation is based on easier year-over-year comparisons, a higher number of new stores entering the 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 and plan to open two more stores. We have also permanently closed nine stores, temporarily closed two stores for major remodels, and plan to permanently close one additional store.

We expect to end the first quarter with 270 stores. Fourteen of our tendered stores are scheduled to open this fiscal year, and we will announce additional stores tendered for openings this year with our Q1 earnings release in February. We expect to open approximately the same number of new stores this year as last year.

We do not expect to produce operating leverage for the year due primarily to a decrease in store contribution as a percentage of sales driven by a higher percentage of sales from new and acquired stores, which have a lower contribution than our existing stores, investments in labor and benefits 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 be in line with the 3.3% we reported in fiscal year 2007, due mainly to the temporary costs associated with integrating the acquisition, along with the cost of fully staffing our three smallest regions which gained the greatest number of stores in the merger. G&A as a percentage of sales should improve sequentially from the first half to the second half of the year.

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

Due primarily to the financing of the acquisition, we expect net interest expense in the range of $35 million to $40 million in fiscal year 2008.

Capital expenditures for the fiscal year are expected to be in 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, and approximately 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 levels and the utilization of our credit line to fund capital expenditures as well as future dividends and any potential stock repurchases. In fact, today we are pleased to announce an 11% increase in our quarterly dividend to $0.20 per share, our fifth increase since we declared our first dividend in November 2003.

We recently signed five new store leases averaging 47,000 square feet in size. We now have 87 stores under development totaling 4.5 million square feet or 48% of our existing square footage. These stores average 51,000 square feet in size and include 22 relocations and 14 new markets.

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. We believe the investments we are making today in our new, acquired and existing stores will result in strong earnings growth in the near future.

Given our recent merger, strong historical sales growth, significant 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 21% since going public in 1992, and we encourage our shareholders to stay focused on the long term.

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

Operator you are with us?

Question-and-Answer Session

Operator

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

Simeon Gutman - Goldman Sachs

Hey, with respect to the core business, excluding the Oats investment, is it fair to assume net earnings growth would have approximated closer to historical levels and that of course bakes in, pre-opening would be a little bit higher and interest income probably a little lower due to less cash balances? 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 given any guidance on when we expect Oats to be accretive and we have given a lot of information in the press release about our core results excluding Oats. So year wise we would not have had interest expense of course on the $700 million, but we do have a significant increase year-over-year in pre-opening expenses, and even without Oats we had seen a decline year-over-year and income before pre-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 new stores in the fourth quarter of the prior year.

Simeon Gutman, - Goldman Sachs

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

John Mackey

Yeah, we are not. One of the myths out there about Whole Foods Markets, I mean, is that we are some kind of luxury retailer and we get once in that category and whenever the economy gets weak everybody comes out and says: “gosh, Whole Food sales are going to fall”. However, that's never been the case. We've been doing this for 29 years and every time there is a recession our sales don’t fall, in fact, during the recession our comps went up into double-digits, they increased during the recession. So I just think that's a myth that no matter how many times we prove that wrong its mini head of hydro we can't seem to kill all the heads. And I might as well address the California question as well: No, we are not seeing any weakness in our California stores due to the so 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 of RBC Capital Markets. Go ahead please. Mr. Aaron, your line is open.

Ed Aaron - RBC Capital Markets

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

Glenda Chamberlain

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

Ed Aaron - RBC Capital Markets

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

A. C. Gallo

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

Walter Robb

This is Walter, I just want to tag on A. C. and say that we've got 15 new markets here with us and this jump from 3.9 to 6 and continuing 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's pretty strong Ed.

A. C. Gallo

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

Ed Aaron - RBC Capital Markets

Thank you. And one more if I could. The magnitude of the contribution margin expected decline for '08. I know you didn't give specific guidance 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 little bit 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 in health care although more moderate than we had in '07 as compared to '06.

Ed Aaron - RBC Capital Markets

Thank you.

Operator

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

Mark Miller - William Blair

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

And then a little bit longer-term, you talk about your objective or thought that these stores could achieve sales per square foot equivalent to that of Whole Foods. What is the reasonable timeframe to think about 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 the mergers take up to two years to come up and fully land and that may still be a good framework and I am talking operationally here not financially. But I think that this one is going faster and I think it's because of the gap over the summer and everybody having time too really and the excitement that's happenings with it.

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

And then you start to have the people moving in between the two stores, we have leaders going both directions and people going both directions and that spreads it more quickly. We have product that's now landing, both private label product and also fresh perishable product. We switched the stores to our perishable product and customers are telling us they see the noticeable difference and its showing up in the sales and that's only going to continue and from there into the programs. So it even up to remodels and equipment and changing the name.

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

A.C. Gallo

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

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

So also those remodels will happen during the course of this year and so I think the real jumps in comps won't really come until those remodels happen towards the end of this year or the beginning of next. So I think we'll see a steady increase and then more of jump in each store as it gets 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 in the gross margins as we bring some of our programs in and we're also going to invest in the labor cost the team members to bring them on in our with our health care and our benefits and so forth. So, all those things will be moving in a sort of dynamic balance.

Mark Miller - William Blair

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

A. C. Gallo

Well. Some of the stores have closed like we closed a very low volume store in Saugus, Massachusetts that was not near any of our stores. And whether we picked up, say we're not really clear if we picked up any sales from that, sales were so low and it was another part of town. We closed Medford, Massachusetts store which is just about three miles from our Fresh Pond store and closed that down to do a complete remodel. It's going to reopen in the spring. We definitely saw a little pick up in 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 three weeks ago and we saw a tremendous transfer of sales and that store has opened up 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 of our processes we closed less stores than that number that was out there, I don't, there is a lot more enthusiasm and optimism about operating the stores and what potentially can happen here and so that the numbers are much lower overall 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 the business moved across the street, others that are a little further away. But we are definitely achieving out or above the targets that we set for ourselves internally in terms of the business transfer.

Mark Miller - William Blair

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

Glenda Chamberlain

A slightly dilutive is as close as we are going to get. It's not nearly as clear as you might think, because truly we have integrated and we are one company. So, it's harder to determine an exact dilution number, but we believe that we have given you enough information where you can get pretty close.

Mark Miller - William Blair

Okay. Thanks.

Operator

Now, I'd like to remind everyone to please limit yourself to one question today. Our next question will come from the side of Greg Badishkanian 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, how much of that was G&A and then of the G&A how much is actually going to go away after another quarter or two?

Glenda Chamberlain

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

Greg Badishkanian - Citigroup

Okay.

Glenda Chamberlain

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

Greg Badishkanian - Citigroup

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

Glenda Chamberlain

Right, and for the five weeks that number was about half of the $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 at just a different initiative, you have very nice improvement at Oats. Is there other, what would you say are there one or two things that are just the real low hanging fruit that you were able to fix and may be were some initiatives that you thought you could improve, but maybe will take you a bit longer to improve?

John Mackey

Well, A.C. and Walter kind of mentioned the lowest hanging fruit is we've put our product in the stores, we've upgraded their perishables tremendously, already by just switching into our distribution centers and secondly 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 it by the end of fiscal '08, but the bigger impact will be in '09.

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

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

So, we think this is going to be something that's paying off already in terms of increased sales, but we are going to see those sales accelerate overtime, as we upgrade the stores and upgrade the customer experience. So, this is something we are going to have synergistic beneficial effects well into the next two years.

Greg Badishkanian - Citigroup

Yeah, interesting that you ended up lowering prices after all was said and done. And on that: would you say that that's something that might 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 been able to lower prices and yet, if you compared Wild Oats' gross margin to Whole Foods pre-merger, you'll see Whole Foods has much higher gross margins. So, we think, we can get higher gross margins and lower prices for the customers. And so, it's going to be a win for our shareholders and a win for our customers. By the 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, just checked this morning in Denver for example we've lowered 1,500 prices already and 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 Morgan Stanley. Go ahead, please.

Mark Wiltamuth - Morgan Stanley

Hi, question for Glenda. You look at your guidance for no operating leverage in fiscal '08. Is that just versus the 4.5% operating margin you delivered in '07 or versus the pro forma for the combined company? And if I am looking at that right, does that kind of imply $1.38 to $1.45 if it's just the 4.5% margin?

Glenda Chamberlain

It's relative to the 4.5%, that was reported and we are not going to convert into EPS guidance.

Mark Wiltamuth - Morgan Stanley

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

Glenda Chamberlain

We actually spend a lot of time deciding what numbers we wanted to announce and which ones we didn't. If you want to you can look at what 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 JP Morgan. Go ahead, please.

Steve Chick - JP Morgan

Hi, thanks. A couple of questions, in your G&A guidance to 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 those G&A costs you expect to collapse down in synergies in the first year, if you follow me?

Glenda Chamberlain

No, the information, I am willing to give about that is that, of the $13 million that was high G&A in Q4, approximately half of that was the Wild Oats office expenses for the 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 smallest regions, and that will continue over the course of the year, and in fact, that was not reflected really in the fourth quarter. That will show up in fiscal year '08. We'll begin to leverage those regions G&A in '09, but those were the smallest of regions and they acquired the greatest number of stores. So we had to ramp them up to fully staffing whereas they were sharing with the region they had split off from before.

John Mackey

I think we've guided that, there are not going to be any G&A leverage in '08 due to the fact that there was this transition of Oats G&A. We are going to have higher G&A in Q1 and then it's going to get sequentially better. I expect that you will see significant G&A leverage in 2009, as that we've finally gotten rid of all of the Oats G&A overhang that's continuing, and we've got it well integrated and we've got a bunch of new stores opened up. We'll start to see into G&A leverage, but we're not guiding 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 - JP Morgan

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, we have kind of heard in the media that there has been some corporate headcount reductions already and I would assume that the bulk of those would be done by the first part of FY '08. So I am just -- I am trying to -- seems like you are being pretty conservative maybe with your G&A assumptions?

Glenda Chamberlain

Well that is where a lot of the -- a lot of the people in that office are still -- that are there now will still be there at least through the first few quarters of the year and we are paying significant stay bonuses.

John Mackey

The superiors.

Steve Chick - JP Morgan

Stay bonuses. Okay.

Glenda Chamberlain

Two quarters.

Steve Chick - JP Morgan

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

Glenda Chamberlain

We have already made a lot of the headcount reductions. The people that are there now will be there for another couple of quarters and then we are not certain as to what will happen at that point in time. It depends on the speed at which the Whole Foods Market stores are taken off of the Wild Oats systems 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 the Wild Oats stores are taken off the Wild Oats systems and put on to the Whole Foods Market system.

Steve Chick - JP Morgan

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

John Mackey

We are not going to guide for 2009 at this time. But we do expect to see significant G&A leverage for 2009 going forward. Here is a thing, Steve. We are more concerned about not (inaudible) up the integration and making to go as smoothly as possible then we are in giving immediate G&A reductions. So there is going to be some overhang while we make the transition particularly in human resources and information technologies were the 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 of quarters, but by the end of fiscal year it should all be completed. We'll start seeing significant leverage in the fourth quarter '08, and then we’ll guide a year from now for '09, and I think it will be a significant leverage. But I can't tell you what its going to be now. I am not going to give you guidance for '09 at this time, but should be significant leverage in G&A.

Steve Chick - JP Morgan

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

John Mackey

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

Steve Chick - JP Morgan

Right. Okay. And now within the $30 million, okay, we know 6.5 came from this G&A. I guess it implies that the other 6.5 million was integration costs and legal costs. Do you have a number of how many, what type of integration related costs you'll incur in addition or is that kind of baked into your 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 five weeks.

Steve Chick - JP Morgan

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

John Mackey

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

Walter Robb

Having done a few of this before, sometimes things don't happen as quite as fast as you hope. And so, I think the majority of them will be done, I think all the banner changes will be done by the end of the year. I think the banner changes will be done. There could be a few remodels that aren't completely done at the end of the fiscal year we maybe in the middle of them still going into the fall and we may have decided to hold off on one for a little while, but I would say the majority should be done by the end of the fiscal year.

Steve Chick - JP Morgan

Okay. And the national example that you commented on, that is I think one of the early relocations that you've benefited from. Can you give us the number of sales that you are able to divert from the Oats stores there 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 is early, the stores only did open for two full weeks. So, you are still in the middle of that initial excitement of around the new stores. So until things really settle down, we won't really know, but that store only really moved a block from where it was. So, our sense is that we transferred the majority of business over.

John Mackey

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

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

Steve Chick - JP Morgan

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

Glenda Chamberlain

There is no goodwill amortization, goodwill does not amortize. It just stays on your balance sheet you review it quarterly for impairments, but unless there is an impairment there in no expense related to goodwill.

Steve Chick - JP Morgan

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

Glenda Chamberlain

You can see that in the 8-K.

Steve Chick - JP Morgan

Okay, alright. Thank you

Operator

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

Mark Husson - HSBC

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

John Mackey

Mark, take another stab at rephrasing that question, we are not sure exactly what you are aiming at.

Mark Husson - HSBC

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

John Mackey

We are not going to talk specifically about London, we don’t talk specifically 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 happen to those sales. And the EVA model by far, if you do a sensitivity study of sales are the most important factor that gives you wildly [disparate] EVA results on a present value basis depending on what sales number you punch in there.

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

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

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

We think we can have -- all we know is that we think we're going to produce very strong EVA returns on both our new stores and development as well as Wild Oats, and might add as well as in London. So, we're very bullish on, the short-term here as things are a little bit messy. It's hard to sort all this out. We're not managing our company for the next quarter or to try to cut our G&A down to make the next quarter look good. We are trying to build long-term shareholder value. We built a lot of long-term shareholder value 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 think we've got great stores in development that are going to produce great long-term shareholder value and are going to all produce very good EVA. I think time will tell.

Mark Husson - HSBC

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

John Mackey

I know it is.

Mark Husson - HSBC

And the expenses are up 65 basis points in that pocket compared to the comp base was up by half of that. So, I am trying to work out whether London has got the same gross margins as average, with quite a lot higher cost or what. I mean, doesn't that -- would I be wrong in trying to read that from that split?

John Mackey

You are making an assumption there. I don't know what's your evidence is, that London is the lion share of the other big stores that aren't. The other stores that are not in the comp base, that are new stores. We've remodeled and relocated other stores that like in Portland, Maine for example, that also have a big impact. And our store in Dallas or, so there are lots of other factors besides London that are going into that equation. So, I wouldn't read too much into that just on the basis of London.

But basically London is doing very well for us. It is an expensive store. We did put a lot of capital into it. We are looking forward it to be a long-term payoff, we signed a really long-term lease there, but the store is performing, the sales are quite are very high and we think it's going to produce a very good long-term EVA for us. So, we are looking, we are hoping to announce additional store signed in the UK this call, but we weren't able to but we anticipate we will be able to do that over the next quarter or two. So, we are bullish on that and we are 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 the country as a whole and it is difficult to get those sites, but if you got another 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 Meredith Adler of Lehman. Go ahead, please.

Meredith Adler - Lehman

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

Jim Sud

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

Meredith Adler - Lehman

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

Glenda Chamberlain

We do have about, if you look on the balance sheet there is a number of a long-term liabilities and the majority of that is what's accrued for 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 lowered prices, the Oats stores? Have you done any advertising at all yet to tell people 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 where we have 21 stores from Oat suite, we've mentioned earlier that we have lowered 1,500 prices, we did that over the process of four weeks. Will Paradise and his team out there and they did that in part supported by a flyer that included those prices in there, but, so yes, but we'll probably find it in the stores too as well.

Meredith Adler - Lehman

Okay. And then just, my final question since everybody has asked more than one. If you look at the trend of sales at the Oats stores beforehand, I was just kind of surprised to hear you compare the performance post-acquisition to the performance pre-acquisition because this yield dragged on for a long time and its hard to imagine that morale was at its highest like before the deal closed. So, I am just kind of wondering if you compare the recent 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 just through the last number of years, not just the last previous time, their comp numbers was negative to (inaudible) but actually I think that 3.9% number might actually be generous. But the gain here is real, I mean that the -- if you go into the stores and feel the changes, the momentum is real and its transferring to a up-tick of a run rate over whatever period of time you wanted to extent to Oats. So, this looks like so far at least a real gain from four to six a good gain 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 go ahead sir.

John Mackey

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

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

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

Operator

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

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