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Executives

John Mackey - Chairman and CEO

Walter Robb - Co-President and COO

A.C. Gallo - Co-President and COO

Glenda Chamberlain - EVP and CFO

Jim Sud - EVP, Growth and Business Development

Lee Valkenaar - EVP, Global Support

Cindy McCainn - VP, IR

Analysts

Simeon Gutman - Goldman Sachs

Mark Miller - William Blair

Ed Aaron - RBC Capital Markets

Steve Chick - JPMorgan

Jason Whitmer - Cleveland Research

Meredith Adler - Lehman Brothers

Scott Van Winkle - Canaccord Adams

Andrew Wolf - BB&T

Whole Foods Market Inc. (WFMI) F1Q08 Earnings Call February 19, 2008 5:00 AM ET

Operator

Good day and welcome to the Whole Foods Quarterly Financial Results Conference Call. Please note this call maybe recorded. For opening remarks, I will now turn the call over to Mr. John Mackey. Please go ahead, sir.

John Mackey

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

First, for the legalities. The following constitutes the Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995. Except for the historical information contained herein and the matters discussed in this press release are forward-looking statements that involve risk 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 successful integration of acquired businesses in to our operations, 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 30, 2007. The company does not undertake any obligation to update forward-looking statements.

On today's call we will also speak on certain non-GAAP financial measures, which are defined and reconciled in our earnings press release, which is available on our website. 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've all had a chance to read our press release, which is quite comprehensive. On today's call, I will highlight the results of our core stores, discuss the estimate and impact to the Wild Oats stores, and give you a progress report on the integration. I will then speak on current trends and what we expect going forward.

Our total sales increased 31% to $2.5 billion. Sales excluding Wild Oats increased 18.6% to $2.2 billion, driven by 19% ending square footage growth and 9.3% comparable store sales growth which was on top of the 7% increase in the prior year. Identical store sales which exclude five relocated stores and three major expansions increased 7.1% on top of the 6.2% increase last year.

We are continuing to see a sequential decline in our two year comps and idents as we are still cycling over the double-digits comps we produced in the first half of fiscal year 2006. Account breakout is roughly in line with our historical 60% to 40% split between the increases in transaction count and basket size. Our average transactions per week increased to approximately 5% to $3.5 million and our average basket size increased approximately 4% to $36. The increase in basket size was due to an increase in the average price per item as has been the case over the last six quarters.

Our average weekly sales per store excluding Wild Oats increased 8.4% to $672,000 translating sales per square foot of $930. We continue to expand our product label offerings, SKU accounts increased 15% year-over-year to just over 2200 SKUs, and currently represent 19% of our total grocery and whole body sales. We opened six new stores during the, quarter including a 49,000 square store at Napa, next door to the Trader Joe's. We have successfully implemented a very aggressive and well communicated competitive strategy with price matching and valued at every term.

The Napa store has only been open for one month but is producing very strong sales per square foot and gross margin we believe is a great example of our ability to remain true to our core values and quality standards, while delivering compelling values within our product offering.

For the quarter, our new and relocated stores average 57,000 square feet in size and were just over six months old. It produced average weekly sales of $694,000 translating sales per square foot of $630. Our new and relocated 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.

For all stores, excluding Wild Oats our gross profit in direct store expenses and store contributions were outside of our five year ranges and average. However we attribute this to the acceleration of our new store openings last fiscal year of which we are seeing the full impact this year.

In the first quarter of this year we had 24 new and relocated stores that accounted for 11% of our sales, compared to the prior year when we had 13 new and relocated stores that accounted for 7% of our sales. As you know, we typically report gross margin, direct store expenses and store contribution for all stores and then break out stores in the comp base separately to highlight both the performance of our existing stores and the negative impact of our new stores, which tend to initially have lower gross margins and higher direct store expenses as a percentage of sales, given that relocations, our new stores, but are included and given the number of relocations we have opened has increased, we believe that breaking out identical store is a better indicator.

For stores in the ident base, which average 7.9 years of age and 35,400 square feet in size, gross profit improved 42 basis point and direct store expenses improved 45 basis points resulting in an 88 basis point increase in store contribution.

G&A expenses increased 41 basis points to 3.4% of sales, primarily due to an increase in legal and professional fees, along with an increase in wages at the regional and global offices. Excluding the estimated impact of the Wild Oats acquisition, adjusted net income was $51 million and adjusted diluted earnings per share was $0.36.

I will now turn the estimated impact to Wild Oats on our result. Sales of Wild Oats were $239 million in the first quarter or 9.7% of total sales. We closed 12 stores during the quarter, including a remodel that we will reopen later this year, ending the quarter with 62 stores.

Sales for the 62 continuing Wild Oats stores were $228 million and identical stores sales growth was 8.6%. The continuing stores averaging 24,000 square feet in size and 9.4 years of age had average weekly sales per store of $230,000, sales per square foot of $495 and store contribution of $7.9 million or 3.5% of sales.

We estimate the negative impact of Wild Oats on our total results was approximately $20 million pretax, of which $12.7 million related to interest expense and amortization of intangibles, $2.8 million related to losses of the closed locations, $2.4 million related to accretion of the store closure reserve and other store closure cost, and $9.9 million related to the Wild Oats home office in Boulder. This translates to a negative impact of $12 million on net income or $0.08 per share. Our estimates exclude certain unquantifiable synergies and costs.

The interest expense, amortization expense, and accretion of the store closure reserve will continue throughout the year. We also expect some additional store losses related to the closing of up to three additional Wild Oat stores, in connection with nearby Whole Foods Market stores opening in the second half of the fiscal year 2008. However, the headcount at the Boulder home office has already decreased from 87 at the end of Q1 to 56 currently. We expect to see the Whole Foods G&A expenses decline substantially in the second and third quarters, and be essentially eliminated by the end of the fiscal year.

Note that a small portion of this expense will transfer to the Rocky Mountain and other regional offices. The point I want to underscore is that as with many of our past mergers, we are making upfront investments to raise the Wild Oat stores up to our high standards including investments and repairs and maintenance of the stores, lower prices and expanded perishables offering and increased labor, and these costs are in advance of what we expect to be a significant long-term improvement in sales.

We are encouraged that the remaining stores are producing positive store contribution and we expect to see continuous improvement as we move further along in our integration process.

Wild Oats was a highly centralized company, thus we have taken a cautious approach to unplugging the stores from Boulder. We commented during our last call about starting with the culture. I think our regional leadership has done a great job of establishing trust and creating a connection with Wild Oats team members. This has resulted in a very high moral within the stores to a degree above what we've experienced relative to any of our past mergers.

During the first quarter, we began to transition in human resources and information technology. At the beginning of the calendar year we transitioned all the Wild Oats team members to our payroll and benefits plans, and as of the end of the quarter, we have converted 23 of the 62 Wild Oats stores for our purchasing and information system.

Since then another 23 stores have converted, and we expect the remaining stores to convert by the end of the second quarter. The systems' conversion is critical to managing inventory, pricing and merchandising programs in the stores. Once converted, store leadership is empowered and can work together to improve the financial performance of the stores. It will take some time for the new processes to be fully internalized, but we expect continuous improvement during the fiscal year.

We have already touched on some of the low hanging fruit, in terms of adding our product into the stores, upgrading perishable and lowering prices. But we expect to see the real sales pay-off to occur once we remodel, upgrade and rebrand the stores. Towards the end of the first quarter we rebranded five stores in Raintree, Arizona; Long Beach, California; West Hartford Connecticut; West Port, Connecticut, and Andover Massachusetts.

So far in the second quarter, we have re-branded four additional stores in Glendale, Colorado; Superior Colorado; Hinsdale, Illinois and Park City, Utah. These stores are selling a full selection of both these market products and perishables and non-perishables and we are excited about the notable improvements we're seeing in the year-over-year sales increases following the re-branding.

We expect to have almost all of the Wild Oats stores re-branded by the end of the year. In just 25 weeks, our integration has gone faster, further and deeper than any of our prior mergers. We feel very positive about results we have seen so far. We continue to expect these stores to drive strong sales this year and higher comparable store sales growth in fiscal 2009 and beyond.

In our earnings release we’ve introduced an updated version of EBITDA that we are calling EBITANCE or earnings before interest, taxes and non-cash expenses. For the quarter EBITANCE was $167.5 million or $1.19 per diluted share, compared to $147.9 million or $1.03 per diluted share in the prior year. We believe this measure better reflects the current accounting reality of significant non-cash expenses beyond depreciation and amortization such as share based compensation, deferred rent, and LIFO.

Now, I'll turn to our summary of our guidance for fiscal year 2008. Our guidance is for higher than average sales growth of 25% to 30% and comparable store sales growth of 7.5% to 9.5%. Excluding the Wild Oats stores, we expect sales growth of 15% to 20% for the fiscal year. For the first four weeks of the second quarter, comparable store sales growth was 8.9% and identical stores sales growth was 6.9%.

Sales at the 62 continuing Wild Oats stores increased 6.2%. The Wild Oats stores had substantial increases in one week sales last year, resulting from a company-wide promotion, making a comparison this year is very difficult for that week.

We estimate the negative impact on quarter-to-date Wild Oats sales growth from this combined with the store cycling over a strong opening last year was approximately 2.5 percentage points.

We realized there are a lot of questions out there about a slowing economy. How a slowing economy might impact our sales? Historically our sales have been highly resilient during economic downturns.

We attribute our strong sales to many factors including our loyal core customers and their dedication to a natural organic lifestyle, a high percentage of perishable product sales, and our extensive selection of high quality prepared foods that attract customers trading down from restaurants.

In addition, we sell a high percentage of relatively small ticket items, and we're better positioned to date than we have ever been from a value perspective. Given our prior experience, strong year-to-date comps, easier year-over-year comparisons, and the increased number of new stores entering the comp base, we are confident and reaffirming our comp guidance of 7.5% to 9.5% for the fiscal year.

As for our ability to pass on higher food cost, we continue to have a market base pricing strategy and historically have tended to follow the market in terms of passing on or absorbing this higher cost. To date, we haven't experienced anything different in this regard.

We have opened six stores here to-date, of our 26 currently tender stores, we expect to open two stores in the second quarter, and up to 13 stores in the second half of the 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 and labor and benefits of the Wild Oats stores continued, though more moderate increases in healthcare cost, as a percentage of sales. In addition, we expect G&A as a percentage of sales to be in line with the 3.3% we've reported in fiscal year 2007 due mainly to the temporary cost associated with integrating the acquisition.

The cost of fully staffing our three smallest regions which gained the greatest number of stores in the merger as a percentage of the resisting store base and higher legal and professional fees. G&A as a percentage of sales should improve sequentially from the first half to the second half of the year.

Our company is focused on EDA and we're comfortable with our current debt levels. We produce strong consistent operating cash flow and our credit line is available to fund our cash needs in excess of our cash flow from operations. Currently we have $50 million drawn on our $250 million credit line.

In the second quarter we expect to expand our credit line to $350 million as allowed under the accordion feature in our credit agreement and anticipation of additional borrowings throughout the remainder of the year. These borrowing are contemplated and our interest expense guidance, net of investment and other income of $35 million to $40 million for the fiscal year.

We recently signed six new stores leases averaging 50,500 square feet in size and we now have 89 stores under development totaling 4.6 million square feet or 49% of our existing square footage. These stores average 51,500 square feet in size and include 22 relocations and 15 new markets.

A large portion of our growth for the next few years is already on the books, and I feel highly confident in our ability to deliver good results. In other news, we are extremely pleased to learn last month that for the 11th consecutive year we made Fortune's List of the 100 best companies to work for. We are one of only 14 companies to be named every year since the list inception.

We also receive an unprecedented amount of favorable publicity following our recent announcement to end the use of disposable plastic grocery bags at the check-out in all of our 270 stores in the United States, Canada and the UK, with the goal of being plastic bag free by Earth Day, April 22, 2008. Our effort was clearly aligned with our customer values as evidenced by the sale to date of over 700,000 of our better bags which are made from recycled plastic bottles.

Our business model is very successful and continues to benefit all of our stakeholders. We're executing on a high level, continuing to produce higher sales, comps, and sales per square foot than our public competitors. We believe the investments we're making today on our new acquired and existing stores will result in strong earnings growth in the future.

Given our recent mergers, 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 and average comp annual growth rate of 20% since going public 1992. 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 participate. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions). We will take our first question comes from the side of Simeon Gutman of Goldman Sachs. Please go ahead.

Simeon Gutman - Goldman Sachs

Hey guys. First two questions about the performance of the Oats stores. Can you quantify and I know it's early, what the re-branded stores are comping at so far. And then second, the context of the 6.2% that the entire chain has been doing so far. Are there any distinguishing factors realizing that 6.2 is an average, any factors you are seeing among different stores that are making them more successful or less than other, such as the real estate, competition etcetera?

Walter Robbs

Simeon this is Walter, I will take a wack at it. The re-branding efforts are fairly new, again we did the first one in the middle of January. So, it's early but the results are very encouraging. I don’t think we’re going to give you the specifics, but they are strong and that too encourage us to consider accelerating that effort because of the clear power of the Whole Foods brand and it's significant, and with respect to the number across the chain, there is a number of different factors, the size of the store, the real estate, the location of the regions, what's happening in that particular part of that country.

But I think we should let it play out little bit more before we give you any - more specific commentary. We'll see over the last several weeks in particular that the growth in those Oats stores is sequentially improving relative to the Whole Foods stores, suggesting that our efforts are really gaining traction.

Simeon Gutman - Goldman Sachs

Okay, so its sounds like those rebranding stores are beating your expectations?

Walter Robbs

We had good expectations, but it’s a strong result so far.

Simeon Gutman - Goldman Sachs

Okay. And then just on the earnings front, and I don't want to put words into what you said last time, but I think the words slightly dilutive were used on the last call, so I might have the first quarter dilution, can I still be slightly dilutive for the year?

Walter Robbs

Glenda, did you want to speak to that?

Glenda Chamberlain

Yes, I will. We have done our best to give you the breakdown of the dilution in the first quarter, and even some guidance on how those line items will impact the remaining quarters of the year. With respect to store contribution, percentage from 62 stores, we definitely expect to see continual improvements there.

The G&A in the first quarter was substantial, that would be eliminated to almost zero by the end of the year and those were obviously the two biggest of the items, and interest expenses easily calculated. So we hope that we would have given you all the information that you need to answer that question for yourself without us giving specific guidance as to dilution from Oats.

Simeon Gutman - Goldman Sachs

Okay, am I correct in assuming that the trends for sales from closed Oats stores into Whole Foods, whatever that's helping that's not in the table, that's laid on the press release.

Glenda Chamberlain

Correct, that is not a number that we can easily calculate the income statement effective that.

Simeon Gutman - Goldman Sachs

Okay, thank you.

Operator

We'll then go on to Mark Miller of William Blair, please go ahead.

Mark Miller - William Blair

Hi, good afternoon. I wanted to get more perspective on the identical store of margin improvements. It looked quite strong both on gross margins as well as improvement on store operating expenses. Could you talk about some of the factors that seem to have driven this performance and then, you changed from comp store to identical stores, so any help on what that change also meant and that comparison would be appreciated?

Glenda Chamberlain

I'll answer the second part of that question, and then I'll let Walter and A.C. answer the first of it. But we switched from comps to idents because relocated store does mirror a new store in its metrics much more so than it mirrors a comp store, so we feel like that's a more valid comparison. We did see improvement in comp stores in the store contribution percentage, but it was half of what the ident improvement and that is, as expected, you would always think that the ident improvement would be substantially better than the comp improvement because of the impact of relocated stores. So Walter and A.C., do you want to answer the first part of the question?

A.C. Gallo

Sure, it's A.C. The improvement in the existing stores, we had in -- and part of it is Q1 last year, we had some lower margin performance in certain of our departments and we worked on that this year to make sure that we went through that holiday period this year that we had less shrink and better performance there. And the other thing is that, some of the programs that we've been working on to improve our -- in purchasing improve our cost to good sold have also shown up in the quarter as well. So it's largely a combination of better execution and better purchasing.

Mark Miller - William Blair

I also wanted to ask, at Wild Oats the store contribution margins 3.5% was down from 6.5% something like that for '07 for Wild Oats. Obviously the composition of the stores has changed with some being sold, but what's pushed that down? Is that coming from lower gross margin at Wild Oats initially with lowering prices or is that more so adding labor and operating expenses. And then for that to go up, is that really depended upon just higher sales from here or were there significant upfront training in systems cost that also fell into that calculation, thanks.

Glenda Chamberlain

Yeah, this is Glenda, I'll take that. Remember first of all that Oats ran their stores with higher prices and low labor. That was coming in their operating model. So, that's very different than the Whole Foods Market operating model. And as has been the case with our other acquisitions, we definitely have seen an impact in the very early days and months of the acquisition where we make investments early on that do lower prices and therefore lower gross margins and raise labor expenses which of course increases DSE.

So, what we believe we'll see going forward is that the increase in direct store expenses will stay probably at the same level we're seeing in the first quarter, but we expect the gross margins to improve particularly, as we get the Whole Foods Market systems in the stores. We did not convert the merchandising and inventory systems, we converted only about 23 of the stores during the quarter, we've converted another 23 since then, and we have more to go. So that's a big part of getting the improvement from gross margins, but we'll see that happen continually over the course of the year.

Mark Miller - William Blair

Yeah, just to tag on there, you got in that number, you got a number of the product write-offs, transition of product inventory levels, the things that are naturally a one-time thing associated with the transition like this. And cant' stress enough the importance of the visibility when you are running parallel system. The operators just can't see as clearly or as quickly what's going on to make adjustments and Wild Oats store managers did not have visibility into the results.

And so, as we say we're two-thirds through the systems conversions, we're almost there, in March we'll be there, and so again, you have the ability to be reacting real time to the numbers and we are investing in the labor and in the team structure. We've got everybody on our team structure and benefits at this juncture, and I agree, we are going to expect to see incremental improvement there.

Mark Miller - William Blair

I appreciate the additional disclosure too on the Wild Oats.

John Mackey

Mark, John Mackey here, and a couple of other important points to make. One is that, the Whole Foods model works better than in the Wild Oats model. It means that's why we are acquiring them rather than the other way around. Our store contribution model produces higher store contribution than the Wild Oats model does. And what I expect to see happen is, I expect to see overtime, not in the first quarter of the merger, but we'll see continuous improvements from quarter-to-quarter.

I expect to see sales increase. We had 8.9% comp in our first four quarter of running Wild Oats. So, [seems] like some Wild Oats producing 8.9% comp. So, what we expect to see strong comps on a go-forward basis for except from Oats, although of course we won't probably be breaking an out passed fiscal year 2008. But I expect to see those stores comp very strongly for several years in the future.

As their sales per square foot begins to get up closer to Whole Foods Market level, and with increasing sales, we will see a little bit of leverage in direct store expenses. Things like rent and utilities for example, are leveraged, depreciation is leveraged. And I also expect to see gross margins continually improved, because as sales increase the amount of shrink and spoilage declines.

So, we're very encouraged that we’ve already seen such a strong sales increase at Wild Oats, and the power of compounding cannot be over estimated in understanding A, the Whole Foods Market model and B, what we expect to happen at Wild Oats. Just compounded out a few years and 230,000 a week, it's 400,000 a week and then it's 500,000 a week and sales per square foot go from $495 per square foot to $930 per square foot as Whole Foods averages, and those stores will start producing 9%, 10%, 11%, 12% contribution margins similar to Whole Foods Market.

However, we do not have a magic wand that allows us to do it in the first quarter. But we're encouraged by the start, sales are strong, and if you get sales right, ultimately everything else gets corrected. So, we're tackling the most important things first and we're very encouraged with the start that we’ve produced so far.

Walter Robbs

And remember also the first quarter doesn’t include any of the rebranding efforts as well.

Mark Miller - William Blair

Yeah, I appreciate all that.

Operator

We'll now go on to Ed Aaron of RBC Capital Markets. Please go ahead.

Ed Aaron - RBC Capital Markets

Great, thanks. Wanted to ask about the contribution margin degradation from the Whole Food stores. Just based on the information you provided for the identical stores, the lower margins seemed entirely isolated to the newer stores, so I am just trying to understand, how much of the impact is due to the overall number of new stores versus how these stores are actually performing relative to, how these stores have performed in the past and also the extent to which London might be contributing to that?

Glenda Chamberlain

It's all about the number of stores, the actual performance of those stores in the first quarter of '08 was slightly better than it was in first quarter of '07, that class of stores. So it's all about the number of stores.

John Mackey

It's not that the new stores are performing poorly, it's that we have more of them, and they don't perform as well as matured stores do and we have more new stores contributing to our total sales and that drags everything else downward. As you saw, the identical store sales or gross margins and direct store expenses and contribution profits were all up. So we just have more new stores, I think what we report, 24 versus 13?

Ed Aaron - RBC Capital Markets

That right.

John Mackey

On a year-over-year basis, that's a significant impact in the overall blended rate, and it's the growth paradox. As the sales increase in these stores, they tend to, because they're not fully matured, they tend to increase sales, increase comps, but have negative impact on gross margins, direct store expenses and store contribution until the growth rate begins to level out.

Ed Aaron - RBC Capital Markets

When you look out at your growth plans, at what point do you think that the weighted average storage, excluding Wild Oats is going to bottom out, because it's been declining in recent quarters?

John Mackey

Don't know, it depends on how fast we grow over the next five or 10 years.

Ed Aaron - RBC Capital Markets

Okay. And then finally, Walter, I think you mentioned that you're considering accelerating the pace at which you re-brand the Wild Oats stores, just in response to the strong trends you're seeing for the ones you've done so far. At the same time though, obviously you want to presumably make sure those stores are functioning at a high enough level to earn the Whole Foods banner. Does that mean that you're going to accelerate the pace at which you're remodeling and upgrading those stores as well?

Walter Robbs

I don’t think, we don't have to wait till we remodel in order to re-brand. I mean the re-branding is going to be done sequentially over all the stores depending on where we individually are. Remember they are spread across all the region. So, I think A said on last conference call that we're going to get it more rebranded by the end of the year.

I think the pace at which we may do some of them will accelerate, because the potential for that is so powerful. And I think the regional Presidents and the regional teams are doing a great job. I'd say we're headed where we expected to be in terms of getting product and programs in place in those stores, which would earn them the banner. And from everything I can tell for any other stores, the Oat stores, they clearly want it, they want the banner.

A.C. Gallo

The stores that we've rebranded so far haven't been really remodeled. Mainly they have been, we've gotten better products in there, we've worked to improve the service, and we've done some minor cleanup and stuff in the stores. So they've really been remodeled yet. Most of the pick-ups come just through better performing within the existing store and at the rebranding.

I was out last week; I visited the stores, the Wild Oats stores in Kentucky and in Ohio that we picked up. And the stores are, they looked great. They haven't really been remodeled but the quality of the product looks good in there and the morale is really good in the stores, and we feel very comfortable rebranding those as Whole Food stores, which we're going to do in the next four to six weeks.

So it really doesn't -- the remodels will come later, probably a lot of them starting this summer and going into early next year, probably.

Ed Aaron - RBC Capital Markets

Thank you.

Operator

We'll now go on to Steve Chick of JPMorgan. Please go ahead.

Steve Chick - JPMorgan

Hi, thanks. Congratulations on your sales runs. I guess a couple of questions. You've only spend $6 million of the allocated capital that you're projecting for Oats. So I think its $40 million to $50 million target. And hopefully this is a case. But are you seeing a disproportionate sales lift and increase in those stores where the 6 million is being allocated.

A.C. Gallo

Good question, I don’t think we haven’t really done any large remodel.

Steve Chick - JPMorgan

That’s right.

A.C. Gallo

Mostly the amount we've spent is all been for smaller stuff and also in order to remerchandise a lot of these stores, we needed to put in new bolts in the daily department, new racks for the produce department, new bins for displaying fruit. I mean a lot of it's been small stuff spread out across a lot of stores, just to bring the merchandising levels up. Paintings and things like that, but there hasn’t really been where we've gone in and spent significant amount of money in a store and that we've allocated it that way. It's all been mostly little stuff.

Walter Robbs

Yes, signage and sometimes in case of dealing with code or name change, you had to upgrade the code. So, we really have that card yet to play, and we don't expect to play it in the - definitely the back half of the year. You got to line up everything else first and then you come in with the investment, and there's a number of these stores out there, that really going to yield nice results with the remodel, we really haven’t played that card yet.

Steve Chick - JPMorgan

Okay. And just to clarify, in the first four weeks of this quarter, Oats, I think you said the comp was up 6.2, but without that week comparison are you guys implying that it's really kind of trending more like an 8.7. I think you thought the impact was about 200 --.

Glenda Chamberlain

Yes.

Steve Chick - JPMorgan

Okay. That’s how to look at that.

Glenda Chamberlain

Yes.

Steve Chick - JPMorgan

All right. Now second thing if I could and it relates to the Wild Oats contribution margins for the quarter of 3.5%. In the stores it kind of seems like some of these non-quantifiable cost that you guys have spoken to in the press release could be pretty material. I mean we've seen a lot of inventory being liquidate that looks like it isn’t going to be carried going forward. I don't know if where the POS system transfer costs are, do you know what's there? Can you specify an unquantifiable cost, what kind of activities are these? I don't know if there's a way to speak to that a little bit.

Glenda Chamberlain

The inventory wouldn't be included, but the unquantifiable cost are like the cost of converting all of their team members to our benefits in payroll systems that's at the beginning of the calendar year. The cost that are incurred in the regional offices that are converting the Wild Oats stores, those are not included, those were the types of cost that we didn't try to quantify and include in that number.

Steve Chick - JPMorgan

Okay. And what kind cost are in the $9.9 million G&: I know you said it severance, is that simply the Boulder headquarters in severance or

Glenda Chamberlain

That is the Boulder headquarters and severance and stay bonuses are a big portion of the cost, so we wanted to point those out particularly.

Steve Chick - JPMorgan

Okay, thanks. And last if you could. Just given your - what you guys have in your plate here, with both Wild Oats and opening up a lot of net new stores. You signed six new leases this quarter and looks like you have in 89 in the pipeline. When does the pipeline seem pretty good where we start to see the lease signings maybe they'll start to update a little bit. Is that in the near future or is it, or are you guys going to continue to sign leases, you've been on a run-rate of anywhere from five to eight a quarter, have you thought about that at all?

Walter Robbs

Jim.

Jim Sud

Well the lease signing is going to start to abate. I don't know we're about a 100 billion in sales. I mean it's funny that for many years we heard that perhaps we weren't growing fast enough and we've accelerated our growth and we're very excited.

We think we've got 89 really good stores in development, and as we get larger we have a bigger base of stores, it's easier and easier to open stores, because we have more resources there to support the stores. And this is an unusual year because we've added Oats to the mix and that's increased sales about 10%. If we take Oats out of the mix then our growth rates 18%, 19%, 20% which we think is pretty sustainable level.

This is just a very weird year because of the merger integration, but I think our core growth rate in terms of the number of stores opening 20, 21, 25 stores a year with 11 a region is just a couple of stores per region, is a very sustainable growth rate. And so I guess we'll stop stuffing the pipeline when we run out of good location, and when that starts happening I got a feeling we'll start hearing about hopefully it's the growth story over. So kind of a catch 22 there.

Walter Robbs

Maybe what you are asking - -

Steve Chick - JPMorgan

[We’ll keep] buying good stores.

Walter Robbs

Maybe what you are asking Steve is a question that some people would ask about our ability to do all this and again I think that I don't know that's what you are asking, is that's what you are asking?

Steve Chick - JPMorgan

Yeah, a little bit, I mean it's a lot going on and clearly you're managing through it a bit but

Walter Robbs

I think the way to understand that is to break it down, and when we talked about last quarters these things don't layout and they don't all lay on individual regions in the same way, that the regions that are doing the bulk of the integration on Oats is the three regions; Florida, Rocky Mountain and Seattle, Northwest. But that's not where the majority of the new stores are landing.

So it's distributed work across the whole country and we're really in a good place to do both of these pieces of work, and besides that when you look at the overall market opportunity for what we are doing, we think that the door is wide open and we intend to drive our Whole Foods Market car right through it. We think the demand for our products and our brand is greater than it ever has been and we got the paddle to the metal.

Steve Chick - JPMorgan

Okay, thanks. And one last if I could, the Boulder head quarter facility, is that -- is the idea that you'll eventually close that facility in total or are there plans to keep it for some reason?

Glenda Chamberlain

We intend to keep it but we will probably, sub-lease a great portion of it, but we don't needed it to be nearly as large as it was under Wild Oats.

Steve Chick - JPMorgan

Okay, thank you.

Operator

We'll now go on to Jason Whitmer of Cleveland Research. Please go ahead.

Jason Whitmer - Cleveland Research

Hi, afternoon. Have you ever articulated any longer term thoughts with Wild Oats either on the sum of the sales opportunity or more importantly, the synergies or any potential accretion?

Glenda Chamberlain

We haven't attempted to quantify. We have said that the Wild Oats store level productivity is much lower than ours, and we do expect to be able to raise it significantly overtime and probably not ever to exactly the same level as Whole Foods, because the quality of the real estate may not be exactly equal but we think that there is substantial sales increases to be had there. I see [beyond] end of that.

Jason Whitmer - Cleveland Research

Is there anything on the earning side with the long-term thoughts in it, and may be just an interim plan as to what the timeline is for any of these positive contributions?

Glenda Chamberlain

Well, I don't know how to answer that without giving any guidance about it. We have said that we expect to see continual improvements on the Wild Oat stores particularly in gross margin, but probably also in direct store expenses.

Jason Whitmer - Cleveland Research

Okay. The only other question I had is on the sales strength, is there anything specific to highlight within the food service department's prepared food. Is that something that is seeing some incremental strength maybe a trade down from restaurants I think that was mentioned earlier, and maybe just thoughts on food inflation and the magnitude there overall on sales.

John Mackey

Walter and A.C. is going to comment on that.

Walter Robb

I will go first and A.C. you can jump in the food service. I mean historically you’ve seen during the down turn times that people leave restaurants that appears to be the case in this time as well, and it does usually include us because we have the food service business and there is some truth to that.

I am not sure exactly what you're asking there, but I think there is a similar pattern this time as the previous time. And with respect to - and that is of the one of the thing that I think we do very well. The food inflation question I think, two things, John already made the point that.

We're market based and like everybody, like we're part of the world and we got to keep adjusting as these prices, it is a kind of inflationary time line now the food business and we just got to stay at top of those increase. But I think what's different for us this time is that we have taken some steps from last few years with the commodities buyers, put some contracts in place to lock up our supplier, and also hedge to some extent against some of the pricing and we're in a much better play structurally to deal with that than we were two, three years ago. So, A.C. you want to add to that?

A.C. Gallo

I think what you just said, in terms of the inflation part, we have a much better global structure in place to track the costs to make sure that first of all that we have buying is as good as we can and we have a lot of contracts in place for a lot of commodities now.

And then secondly to make sure, to really carefully follow what's going out in the retail marketplace. And if we’re very, very focused now on what our competitors are doing and we kind of go along with the market. We are certainly not going to, its not going to happen is, we're not going to raise our prices and make ourselves uncompetitive where the marketplace is, we're going to follow the trend of what other food retailers are doing.

Jason Whitmer - Cleveland Research

You only other follow-up on the food store side, is that mix increasing meaningfully with your new stores and is that an opportunity within the Wild Oats so as to drive that up pretty significantly?

Walter Robbs

We don't break our mix in the stores as you know, but yes there is a difference between the Whole Foods and the Oats stores and that's certainly a component of the ability to grow out that business.

A.C. Gallo

Yeah, we think there is tremendous opportunity in the prepared foods side. Some of that Wild Oats stores in the east, some of the ones I have visited in Ohio last week, very, very low percentage of sales in prepared foods, and we think that that's an area that we can see significant improvement over the next couple of years.

Jason Whitmer - Cleveland Research

Great, thanks.

Operator

We'll now go on to Meredith Adler of Lehman Brothers. Please go ahead.

Meredith Adler - Lehman Brothers

I was wondering if - I've heard some people saying that the store in the UK and London is not doing as well as expectations and you've obviously got a lot on your plate in the US, what are your thoughts now about continuing your expansion in the UK?

John Mackey

We're not going to comment rumors, but Kensington remains the top 10 store for us in terms of sales so we're very please with the sales of the store, its being executed at a very high level. We did invest quite a bit in the store, so it's going to be probably a year or so, more before we can make a profitable. But we're basically pleased with the results of the store from a sales and operating standpoint, and in terms of additional stores, I'll let Jim comment on that.

Jim Sud

Hey, Meredith, it's Jim Sud. I would add to that, that we continue to be aggressive in our approach to the UK and committed to the UK. We recently hired a new VP of real estate who just started in January, a person who lives in London to oversee our real estate activities over there.

And so, in just the first few weeks that she's been on the job, she's really started to turn up a number of opportunities for us, which is good news as far as we're concerned. So, we're hoping that we're going to see more opportunities in the future to do new stores in the UK and remain committed to it.

Meredith Adler - Lehman Brothers

Great, that's wonderful. And then just another question, if you could talk about, the comment, I think John made a comment about, obviously overtime the Oats store are going to improve their sales productivity. I'm wondering if you have confidence that they're going to get close. The thing that seems to stand out is that a lot of the stores that you'll be keeping are in somewhat smaller, less dense market. Obviously, those are also smaller boxes. But when you compare the Oats stores with your own stores in those somewhat less dense markets, you certainly don't get to 930, I don't think in your core stores, doesn't that impact the potential for the Oats store?

A.C. Gallo

I mean, we already closed down the Dogs at Wild Oats. I mean those are the stores that have been shut down, and we've got a number of other stores that's going to be relocated. So, I think it's partly a myth that the stores that remain are somehow or another not good stores and don't have good locations. I think that there is tremendous potential and some of those stores are in very densely populated area. And although I'm not guiding through this, I'm not saying it's going to happen, I personally believe that within five years, I fully expect Wild Oats store to be close to $900 a square foot.

I expect Whole Foods to be significantly over $1000 square foot at that point, because we continue to be able to increase our sales per square foot on average year after year after year, because we keep getting better. And we've already seen significant increase in Wild Oats and we've been managing it for less than 6 months. And as we continue to make upgrades and improvements, I'll be the most surprised person if we are not seeing sales per square foot begin to mirror Whole Foods Markets, not immediately but over the next few years, that's exactly what I expect to have happened.

Meredith Adler - Lehman Brothers

Okay. And my final question is, it looks like the stores in the pipeline are still pretty big. I thought of a barbell strategy do you have very big stores in certain markets and some are smaller stores again in the less dense markets or is that 51,000 kind of where most of the stores fit?

John Mackey

Walter, you've got that one?

Walter Robb

Sure. Where we talk a lot about recently about right sizing stores, and I'm looking at the list right now that yielded that blend. But I can tell you this mix of stores we have this particular year is reflective of the right sizing. We have a range of stores from the 25,000 to 30,000; you still have a couple of the larger one.

So, I think our strategy has become, it's the right sizing for the right market and so you've got the -- we're still planning. This year for example we have two flagships in Dallas and Houston which, these are great A sites, it couldn't get any better, they are main and main and we should play the larger 75,000 per foot store in those locations. But we also have some 25 to 30s which is - we didn't have to operate those and so, the 51,000 maybe a little generic in terms of if you break that down, you'll find a nice range of sizes appropriate to the individual markets.

Meredith Adler - Lehman Brothers

Okay, that's it.

Walter Robb

And then I want to make a comment to your last question which is that, you're kind of assuming a sort of a static situation with the Oat stores. You could take individual markets where we currently have a 25,000 foot store and if we grow that market in three or four years, Jim's team is going to reload that to 35 or 40, and so we're not going to be constrained by that box, just because that’s the store we have right now, and our history shows we are able to do that pretty well.

Glenda Chamberlain

I then have to add more capital into my calculation if you're going to just relocate the store, which is set to be complicated.

Walter Robbs

Fair enough.

Meredith Adler - Lehman Brothers

Okay. That’s it, for me thanks.

Operator

We will now go on to Scott Van Winkle of Canaccord Adams. Please go ahead.

Scott Van Winkle - Canaccord Adams

The earlier questions about the store contribution margin at Wild Oats this year versus last; and I guess relative to people expectations. You mentioned it was a combination of both lower gross margin and higher store operating expenses. Are both of those fixed by volume or is there something else that drives improved gross margin at the Wild Oats stores?

John Mackey

I will make a quick comment it and then Walter and A.C. can throw some color on it. Well, sales are a huge factor in it because the higher your sales, particularly for perishable on products, your shrinkage begins to decline and your spoilage decreases.

But it's not the only factor, I mean Wild Oats has to be converted over completely to Whole Foods Markets empowerment model into our systems. So, we're in a transition pace right now, and we're investing before we reap you might say. And I mean two-third of the stores are converted over, but only one-third was converted over at the end of the last, at the end of the quarter.

So, as the store team leaders at Wild Oats and the team leaders become familiar with Whole Foods Markets, we are doing things, as they are trained and as they get experienced. They are going to be producing results similar to a Whole Foods store team leaders produce. And that will result in higher gross margins.

If you looks historically, Whole Foods Markets' gross margin have always been significantly higher than Wild Oats gross margin. There is no intrinsic reason why Wild Oats stores will not reflect Whole Foods Markets gross margins within a year or two of the merger closing. But I'd like to say it always takes a year to two years to successfully integrate a new company into Whole Foods Markets culture and that's been the case for the last 20 years.

And we're pleased with the results that we're getting so far. Sales are better than we expected initially, but there is just something that no matter how many people we put on it, its still going to take a year or so to fully integrate them into our culture and get all other people up to speed, and if that happens, you're going to start seeing fantastic results out of those stores. Walter and A.C. you want to add something?

A.C. Gallo

You remember that these Wild Oats stores were, the majority of their sales were in non-perishables, the grocery and their whole body departments and so we really having build a lot of the perishable expertise in the stores from scratch, just putting high quality produce meat, seafood, prepared foods in the stores that automatically get it to sell.

We’ve got to train the folks there and we have to, we want to have transferring a fair number of people over the first quarter into the Wild Oats and a lot of these different apartments, perishables and taking the Wild Oats folks and bring them into our stores and training them.

And its just take some time, and its kind of a chicken-and-egg thing, where you've got to put a product in there but then you have to get the team members to understand how to take care of it and then you go to the customers, build a confidence in it and it’s a kind of a you got to get that upwards spiral going, and once you get that going in a store and then sales really start picking up. Then you really start to see the gross margin come along with it.

And the timing is a little bit, a little varied on how long its going to take each store. But, I think we're in good shape in terms of, we've got much more expertise in the company's ability to get these stores to improve, than we have in past mergers that we have done.

Scott Van Winkle - Canaccord Adams

And following up on the idea of moving Oats employees to Whole Foods Stores and vice versa; is there a meaningful percentage of Wild Oats store managers today that had been brought over from Whole Food Stores?

Walter Robbs

Brought over as store team leaders, you mean?

Scott Van Winkle - Canaccord Adams

Correct.

Walter Robbs

In the same position? Not a meaningful number, no there have been some and some have moved into associate position or different positions. There has been a more meaningful move of Whole Foods to Wild Oats.

Scott Van Winkle - Canaccord Adams

And then the last question, and I take a lot of my examples from the Andover, Mass Store, that A.C. probably knows well. But what happens to the private label and how do you handle keeping customers happy if they are used to a certain Wild Oats private label products and when it becomes a 365 or Whole Foods branded?

A.C. Gallo

There's a quite of few items that were the same, that were under Wild Oats and 365, they were coming from the same vendors, very similar products. There are some products though that Wild Oats had it, we didn't have under 365, and the plan is to continue with a number of those products, although we may have change the brand to a different, to a Whole Foods brand.

And I've been in the stores quite a bit and I've talked to people and, they say that, yes sir, there's a few products that we discontinued but, there are a few customers who miss them, who wish they -- like that particular serial or that particular kind of oil and you don’t it anymore, but the more they say that -- but there is a lot of people who are very happy with the 365 products, once we explain to them the quality and they found that they are selling very well.

So, in any transition there is going to be some people who aren't happy with any change at all. That one product we dropped was their absolute favorite product and why they came to the store and that's unfortunate but that always happens, but hopefully we add more things that more people want than things that we take away.

Scott Van Winkle - Canaccord Adams

Thank you.

Operator

And lastly, our final question comes from Andrew Wolf of BB&T. Please go ahead.

Andrew Wolf - BB&T

A couple of follow-ups if I could. On the $9.9 million G&A expense at Wild Oats, did you say or can you say how much of that is actually severance?

Glenda Chamberlain

I did not say, I did say that severance and stay bonuses was all significant amount in the quarter, and also we said that by the end of the year, that G&A will be virtually zero.

Andrew Wolf - BB&T

Okay. Was it the majority of it? And then I'll stop bugging you up there.

Glenda Chamberlain

It was a significant amount.

Andrew Wolf - BB&T

All right.

Glenda Chamberlain

Severance and stay bonuses were significant amount.

Andrew Wolf - BB&T

All right. On the inflation side, my observations have been that it's been incredible inflation in the conventional side of things where you're seeing Milk go up over $1.50 a gallon. And at least until this point, it's been less severe in the organic side, and that's been my observation. I know you all kind of track those kind of gaps. Has that been your observation to this point? And if that's been or if the gap has narrowed favorably for an organic growth, is that sustainable or do you think there is going to be rapid organic cost inflation as well?

John Mackey

Walter and A.C., you want to comment on inflation.

Walter Robb

Well you have a lot of things going on right down. I mean you've the supply and demand on the organic side, but there is inflation on the organic side particularly on the grain, the grains corn, wheat of side. Not only is there a growing demand for those products, but there is also constrained supply, and so you've got some inflation there, particularly with ethanol and the demand from other countries for those crops.

So, the things are moving around a lot, I mean conventional amount last year was $12 a hundredweight and its $16 a hundredweight, now you got as high as $20 a hundredweight. So, it's kind of bouncing around. I am not sure, there is a clear pattern in terms of spread between the two, each has got their challenges. However, I will say I think the fundamentals around the pricing of food, the era of cheap food maybe well be over in America and conventional food stuffs are going to be more expensive. And so generally saying, I would say, its going to result in narrowing of the gap and people, that making the organic offering perhaps look a little more attractive from that perspective. But there is lot of moving parts right now.

A.C. Gallo

I love to add to that. This isn’t a talk about short-term, but in the medium to longer term, my experience has always been in this business that when the price for organic goes up few years down the road, you see big increase in supply, because there is still very low percentage of organic - product that’s raised organically in this country and around the world, and when people see our prices, growers tend to convert more.

So, I think we had a -- buyers just get back from South America and they were in Chile and they said that the amount of new crop of organic apples, the land and the organic apples that are planted down there is phenomenal. And that supply should start coming in next year.

Andrew Wolf - BB&T

Okay. Just a last question, on the capital returns on the stores that are less than two years old. This is sort of the third quarter, where they have been well below, what they normally are. Could you just get some color on that, is that related -- the storage ramping up is it related to whatever issues in Kensington, would you just, if you don't mind speaking to that somewhat.

Glenda Chamberlain

Well, Kensington does have a big impact, but the results from our stores in not in the comp base or not the ident base. In first quarter of this year we're slightly better than they were in the first quarter of last year. So we are very pleased with our new store results.

Walter Robbs

And to add, I think we talked with you about again we’ve sharpening up our disciplines around size of store relative market and so as we're working through this class of stores that were substantially larger and we finding the right mix of size, I think our return on capital should incrementally improve.

Andrew Wolf - BB&T

Okay, that's sort of what I was figuring. So a lot of it is just the overall net or the [renting] or those kind of things, it's just much bigger hit on the bigger stores.

Walter Robbs

Well, the bigger stores perhaps in, I think bigger stores in some markets or maybe if we had to do over we might have them a little smaller, but I think we're a lot better and we're disciplined around the right size for the right market now, which will lead to better returns on capital.

Andrew Wolf - BB&T

Right, thank you very much.

John Mackey

No further questions, right?

Operator

Yes, no further questions.

John Mackey

Okay, thanks for listening in. 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 invite you attend either in person or via the webcast our upcoming annual shareholders meeting on March 10 in Austin. We also look forward to speaking with you again in May, on our second quarter earnings call.

A transcript of the scripted portion of this call along with the recording of the call is available on our website at www.wholefoodsmarket.com. Talk to everyone next quarter. Bye, bye.

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Source: Whole Foods Market F1Q08 (Qtr End 1/20/08) Earnings Call Transcript
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