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Executives

John Mackey – Chairman & CEO

Walter Robb – Co-President & COO

A.C. Gallo – Co-President & COO

Glenda Chamberlain – Executive VP & CFO

Jim Sud – Executive VP Growth & Business Development

Lee Valkenaar – Executive VP Global Support

Cindy McCainn – VP Investor Relations

Analysts

Edward Aaron – RBC Capital Markets

Mark Wiltamuth – Morgan Stanley

Simeone Gutman – Goldman Sachs

Edward Kelly – Credit Suisse

Steve Chick – JP Morgan

Mark Miller – William Blair & Company

Neil Currie – UBS

Greg Badishkanian - Citigroup

Carol Byers – The Boston Company

Andrew Wolf – BB&T Capital Markets

Whole Foods Markets, Inc. (WFMI) Q2 2008 Earnings Call May 13, 2008 5:00 PM ET

Operator

Good day and welcome to the Whole Foods Markets teleconference. (Operator Instructions) It’s now my pleasure to turn the program over to Mr. John Mackey; please continue.

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 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 into 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.

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’m 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 estimated impact to the Wild Oats stores and give you a progress report on the integration. I will then speak to current trends and what we expect going forward.

Our total sales increased 28% to $1.9 billion. Sales excluding Wild Oats increased 16% to $1.7 billion driven by 15% ending square footage growth and 6.7% comparable stores sales growth. Identical store sales which exclude four relocated stores and two major expansions increased 5.1%. We continue to see healthy increases in both transaction count and basket size. Our comp breakout was split roughly 50-50 with an average basket in Q2 of $35 and average transactions per week of 3.7 million. Our average weekly sales per store, excluding Wild Oats increased 5.7% to $671,000 translating to sales per square foot of $922.

We are continuing to gain market share at a much faster rate than our competition as evidenced by our comps and sales per square foot which continue to run well above that of average US food retailers. Given these unusual economic times however, we offer some general observations on our comps during the quarter. We reported a 6.7% comp for Q2 after reporting an 8.9% comp for the first four weeks of the quarter.

During the quarter our weekly comps varied dramatically from week to week and we faced tougher comparisons throughout the quarter. Mid-way through the quarter we also cycled over the opening of our relocated Portland, Maine store, previously our second biggest contributor to comps behind Kensington so our change in comparable store sales growth from Q1 to Q2 was greater than our change in identical store sales growth.

As is always the case, some regions comped below the chain average and some comped as high as low double-digits. Results varied based on many factors including differing degrees of cannibalization from new stores, competition, and changes in the economy, making it hard to attribute our performance to one factor over another. We do believe we have experienced a greater amount of cannibalization this year related to the acceleration in our new store openings.

Despite the short-term negative impact however, our experience has typically been that our new stores average positive comps in their first full quarter in the comp base after opening and by then our cannibalized stores are back to positive comps as well reflecting our increased market share and make this the right growth strategy for us.

We are continuing to make selective price investments. We believe that strengthening our price image on commodity-type branded products to broaden our appeal is not only the right long-term strategy, but the right short-term strategy particularly in today’s market. We are fortunate that we continue to find many opportunities to lower our cost of goods sold to help offset these price investments and minimize the gross margin impact. In addition we continue to expand our private label offerings with SKU count increasing 15% year-over-year to just over 2,200. Our private label sales continue to increase, currently representing 22& of our total grocery and whole body sales up from 15% three years ago.

For all stores excluding Wild Oats, our gross profit in Q2 increased 36 basis points to 35.5% of sales, slightly above our five-year range for the second quarter of 35.3%. We are very pleased to be producing such strong results and given the current environment, we plan to be more aggressive in expanding the availability of our value items, particularly in the perishable areas.

We continue to have a market-based pricing strategy. We are generally priced in line on like items to many supermarket peers and at a premium when the quality or uniqueness of an item allow for that. Food inflation is running upwards of four percent in the United States and we are impacted by arising food costs as all food retailers are. We tend to follow the market in terms of passing on or absorbing these higher costs but our retail price increases in the second quarter were below the US average. The impact of the acceleration in our new store openings as well as continuing increases in health care costs as a percentage of sales in our existing stores is continuing to show up in our direct stores expenses, which increased 49 basis points to 26.4% of sales.

For the quarter, our 22 new and relocated stores averaged 57,000 square feet in size and were 7.4 months old. They produced average weekly sales of $661,000 translating to sales per square foot of $604. As a class our new stores during the quarter produced a higher store contribution as a percentage of sales than our class of new stores in Q2 last year, but they accounted for 10% of our sales, up from seven percent last year. On the whole our new and relocated stores 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 stores in the identical base which averaged 7.7 years of age and 36,000 square feet in size, Q2 gross margin improved 65 basis points and direct store expenses improved 10 basis points, resulting in a 75 basis point increase in store contribution.

G&A expenses increased to 3.7% of sales. This was largely due to the costs of integrating and supporting the Wild Oats stores as well as front-loaded G&A expenditures to support our 2008 and 2009 growth. We expect G&A costs in fiscal year 2009 to return to historical levels. Income before pre-opening and interest was down from last year as a percentage of sales due primarily to the increase in G&A offsetting strong results in identical stores. However we had a solid 87 basis point sequential improvement to 5.4% of sales in the second quarter from 4.6% in the first quarter.

I will now turn to the estimated impact of Wild Oats on our results.

We closed four stores subsequent to the end of the quarter. Sales for the 58 continuing Wild Oats stores for the quarter were $169 million and identical store sales growth was 5.9%. The continuing stores averaging 24,000 square feet in size and 9.3 years of age had average weekly sales per store of $243,000 sales per square foot of $523 and store contribution of $3.8 million, or 2.3% of sales. This was down from 3.5% in the first quarter due primarily to a 179 basis point increase in salaries and benefits as a percentage of sales which was partially offset by a 72 basis point improvement in gross margin.

Regarding margins we completed the conversion of all Wild Oats stores to our purchasing and information systems during the second quarter but at the start of the quarter, less than 40% of the stores had been converted. These conversions were critical to managing our store-level inventory, pricing and merchandising programs and should be a driver of stronger margin gains in the future. Regarding the increase in salaries and benefits, the Wild Oats team members transitioned to our payroll and benefits plan on January 1, so the stores had a full-quarter impact of our higher payroll and benefits load in the second quarter versus only a three-week impact in Q1.

As with many of our past mergers, we are making up-front investments in labor, pricing and repairs and maintenance to raise the Wild Oats stores up to our standards and these costs are in advance of what we expect to be a significant long-term improvement in sales. We continue to expect store contribution in the Wild Oats stores to improve in the second half of the fiscal year.  

We made substantial progress reducing G&A expenses at the Wild Oats home office during the second quarter. The number of corporate positions in Boulder dropped to 27 at the end of Q2 from 87 at the end of Q1 and as of today, only five corporate positions remain. We continue to expect G&A expenses to be substantially eliminated by the end of the fiscal year with the exception of $2 million to $3 million per quarter of rent and other expenses that will transfer to become part of our global and regional office G&A starting in June.

Integrating acquisitions is generally a two-year process. In addition to completing the conversion of the Wild Oats stores to our purchasing and information systems in the second quarter, we have so far re-branded 27 Wild Oats stores; five stores in the first quarter, 13 in the second quarter and nine so far in the third quarter. These stores are now selling a full selection of Whole Food Markets product in perishables and non-perishables, and we are excited about the notable improvements we are seeing in the year-over-year sales increases following re-branding. Sales growth at the re-branded stores has accelerated from 6% on average before re-branding to 12% after. We expect to have most all of the Wild Oats stores re-branded by the end of the fiscal year, and we expect these stores to continue to show improving sales this year and higher comparable store sales growth in fiscal 2009 and beyond.

Now I will turn to a summary of our guidance for fiscal year 2008.

Our guidance for fiscal 2008 is for sales growth of 25% to 30% and comparable store sales growth of 7.5% to 9.5%. We expect the spread between comparable store sales growth and identical store sales growth to decline over the remainder of the year, as the number of relocations and major expansions drops to two by the end of fiscal 2008 from seven at the end of fiscal 2007. Excluding the Wild Oats stores, we expect sales growth of 15% to 20% for the fiscal year.       

For the first four weeks of Q3, comparable store sales growth was 5.7% a deceleration from the second quarter that was due in large part to the relocated Portland, Maine store cycling over its opening and the Kensington store being removed from the comparable store base for the first several weeks in the third quarter. Identical store sales growth was 5.0% for the first four weeks of Q3, and comparable sales at the 58 continuing Wild Oats stores increased 5.6%.

Based on our 8.2% year-to-year comparable store sales growth, we are maintaining our comp guidance of 7.5% to 9.5% for the fiscal year. We have opened eight stores through the second quarter and one store so far in the third quarter. We expect to open four more stores in the third quarter and up to eight stores in the fourth quarter. 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, 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 now expect G&A as a percent of sales for fiscal year 2008 to be slightly below our 3.6% average in the first half of the year. We expect G&A expenses as a percentage of sales in fiscal year 2009 to return to historical levels. Including the impact of Wild Oats, we expect to see a moderation in the year-over-year declines in income before pre-opening and interest as a percentage of sales during the second half of the fiscal year compared to the first half.

Our company is focused on EVA and we are 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. We recently secured additional commitments totaling $100 million and we expect to complete the increase of our credit line to $350 million in the third quarter. Currently we have $88 million drawn on that line.

Our business model is very successful and continues to benefit all of our stakeholders. We are continuing to produce higher sales, comps and sales per square foot than our public competitors and the results in our core stores remain very strong. Our goal is to produce sales of $12 billion 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 our company continues to improve. 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)

Your first question comes from the line of Edward Aaron - RBC Capital Markets

Edward Aaron - RBC Capital Markets

With comps having decelerated but gross margin holding up as well as it is how are you currently thinking about the trade off between your comps and your gross margin?

Walter Robb

Well its always a delicate balance between those two but I think that some of the – we’re thinking that we’re pleased with the results in the gross margin particularly in the core stores and think that reflects some of our strength on the buy side investment infrastructure in our increasing sophistication with price management. We also think we have some opportunities to use some of that for additional investments in value and value positions. I think we’re finding a good balance here between those two and will continue to look for opportunities in that area.

Edward Aaron - RBC Capital Markets

I think you mentioned in your prepared remarks that you expect moderating declines in earnings in the second half of the year, its seems reasonable to assume that Q3 earnings would be lower than last year but Q4 is when you anniversary the acquisition of Wild Oats and would have expected maybe earnings to be up in that quarter. But just to be clear are you saying that in the aggregate you do expect earnings to be lower in the second half of this year versus last year?

Glenda Chamberlain

We’re saying that in the aggregate we expect it to be a slight improvement relative to last year compared to what it was in the first half of the year because we’re including the impact of Wild Oats which we expect to lessen in the second half of the year.

Edward Aaron - RBC Capital Markets

So it’s still down year-over-year but by a lesser magnitude than in the first half?

Glenda Chamberlain

Yes, on aggregate for the second half of the year. We don’t give specific quarterly guidance.

Edward Aaron - RBC Capital Markets

Could you maybe talk a little bit about anything you’re seeing within the store in terms of certain categories performing better or worse than others, ones that have been given closer consideration to and our weaker economy as to prepared foods, I’m just curious to know what you’re seeing there?

A.C. Gallo

Our prepared foods sales have held up well. Its really varies by market and there’s no real clear patterns there but the it seems like prepared foods are holding up well. Whether or not we can say are people trading down from restaurants and coming into us, there’s really no clear pattern of that. I just would say that overall prepared food sales have been very steady.

Operator

Your next question comes from the line of Mark Wiltamuth – Morgan Stanley

Mark Wiltamuth – Morgan Stanley

I wanted to ask about the performance in the core Whole Foods business. If you look back at the last two press releases and kind of back into how you did on the quarter, it looks like the core operating earnings growth was about 4%, I just want to check if that was about right?

Glenda Chamberlain

The results in the ident stores were a 75 basis point improvement in store contribution. I haven’t calculated it the way that you did, but it sounds about right.

Mark Wiltamuth – Morgan Stanley

Okay so the issue really is the new and relocated stores are still a margin drag? Is that the primary issue?

Glenda Chamberlain

That is the only issue yes, because we had strong improvement in margins and even leverage in direct store expenses in the ident stores so it is the impact of the new stores which accounted for 10% of our sales in this quarter that’s bringing down the overall number.

Mark Wiltamuth – Morgan Stanley

Okay and just to look at your comp guidance obviously you’ve slowed down to 5.7% in the current quarter, just wondering how you get back to the 7.5% to 9.5% that’s in the guidance. What are you thoughts for the second half?

John Mackey

We’re going to see some cannibalization begin to disappear in the second half of the year in comps particularly in Q4. We had a number of stores open in Chicago for example, in Q4 last year that are going to anniversary and when those anniversary it’ll be a noticeable improvement in comps in Chicago and there are a few markets like that. And it’s awfully early to know for sure but that’s what we expect.

Mark Wiltamuth – Morgan Stanley

And then we had seem some big trading down to private label at a Safeway’s quarter, have you seen any change in customer patterns there and in general are you still viewing your private label as a way to sharpen your pricing or is it a margin enhancer for you as well?

Lee Valkenaar

It’s definitely the pricing sharpening. We’ve never really looked at it as a margin builder and we are seeing healthy growth in it and we’re very happy with that.

John Mackey

Remember 67% of our sales are in perishable items so the center store is less important in our business model than it is in Safeway’s.

Operator

Your next question comes from the line of Simeone Gutman – Goldman Sachs

Simeone Gutman – Goldman Sachs

It looks like the back half of the quarter from a sales perspective, ID and comp, things got a little worse but if you look at the number that you’re looking at for the perspective quarter, this third quarter, it looks like things actually got a little better from there. Is that not the right chronology and can you just comment on that? Is it the same affect of cannibalization that you’re citing?

Glenda Chamberlain

The comps did and the idents for the three weeks so far are just about the same as they have been in the back half of the third quarter. The difference in the comp number is greater because of the drop-off of Portland and Kensington out of the comps.

Simeone Gutman – Goldman Sachs

Okay but to clarify the read on the prior quarter you were doing roughly a 6.9% in the first four weeks and you finished with a 5% or so for the quarter.

Glenda Chamberlain

Right 5.1% for the quarter.

Simeone Gutman – Goldman Sachs

Which means the back half was probably around 4.2% or so if that math is right and now you’re ending up, you’re looking at something like a 5% for the first four weeks of this next quarter?

John Mackey

Yes. Don’t read too much into those week to week trends. They don’t necessarily indicate how the quarter will end up being.

Simeone Gutman – Goldman Sachs

Okay and then on the early read for store openings next year, and I know this was, the annual meeting you discussed 25 to 30 and this year it looks like you are on par to do the same amount as the prior year but are any stores going to be from this year, being pushed back into next year for any reason and is 25 to 30 the right number or does that even end up being higher?

John Mackey

We’re sticking with the 25 to 30 store guidance at this time.

Simeone Gutman – Goldman Sachs

On the cash flow situation, I know you mentioned it in the prepared remarks, the $350 from the revolver should, and cash flows from operations should be sufficient for you to get through at least fiscal ’08 without having to look at additional debt?

Glenda Chamberlain

I’m not prepared to give guidance – oh for fiscal ’08, absolutely and we’re not prepared to talk about ’09 at this stage but Whole Foods feels confident in our ability to manage our cash and we are not in a position where we need to worry about that but if we did get in a position where cash was tight then as we said many times in the past we can control our expenditures particularly CapEx, to manage that.

Operator

Your next question comes from the line of Edward Kelly – Credit Suisse

Edward Kelly – Credit Suisse

Could you help us maybe better understand the deceleration in your IDs from Q1, I know you mentioned cannibalization but wasn’t that present in the first quarter and then you really didn’t place much emphasis at all on economy, so is it, are you basically saying that the economy really didn’t have much to do at all with the slowing in sales?

John Mackey

We don’t know why our comps are high and we don’t know when they go down low. We just make guesses. We don’t really know. We can see if there’s an impact from cannibalization. We can see if a competitor opens up near by, but on the margins, we don’t really know if it’s the economy or if the competitors in the neighborhood have sharpened up. It’s impossible to break it out with any kind of true accuracy. But everybody always wants to know so we speculate on it and that’s all we can do in this situation. Unfortunately every time I make these speculations it always gets written down as if I had received wisdom from on high someplace. So it could be the economy. It’s a weird economy. Its not like, in my 30 years in this business I have never seen an economy quite as weird as this one. So there could be economic factors going on. We definitely know competitors are definitely tougher. There’s a lot of competition and it’s gotten more intense in the last year. That’s a factor. There are possibly media impacts from the media continuing to report that they tell stories about people switching over from Whole Foods and maybe that influences people, I don’t really know. In general though we’re pretty positive about our comps because they’re still so much stronger than our competitors that we see in the public marketplace so there’s been some, there’s a big difference between decelerating comps and actually negative comps. Our comps aren’t quite as strong as they were in the first quarter, there were perhaps a year ago but they’re still running ahead of food inflation. We’re still gaining market share at our competitors’ expense so we tend to focus on the positive there and yes we wish they were 15% right now but they are what they are and strong incentives for us to do better and compete stronger with our competition.

Edward Kelly – Credit Suisse

How much do you currently have available under your revolver?

John Mackey

I think we said we were increasing it to $350 million and we’ve taken out $88 million.

Glenda Chamberlain

We have letters of credit outstanding against that also so the availability is $182 million.

Edward Kelly – Credit Suisse

And that includes the accordion, is that right?

Glenda Chamberlain

Yes.

Edward Kelly – Credit Suisse

And then the $100 million in additional financing, that’s on top of that or is the $100 million the accordion?

Glenda Chamberlain

The $100 million is the accordion.

Edward Kelly – Credit Suisse

Okay so you really have $182 million in total liquidity. Could you maybe just help us understand the rationale behind the fact of you continue to pay a dividend yet your free cash flow negative this year by my math, you’ll be free cash flow negative next year and maybe have to borrow again so could you just help us understand the puts and takes there?

John Mackey

We feel like we’re EVA driven company and we feel like we have adequate cash through cash flow and debt to service both our growth and to pay a dividend to our shareholders.

Edward Kelly – Credit Suisse

Okay and then direct store expenses at Wild Oats are pretty fair amount below core Whole Foods, by my math it was about 40% before this quarter, I’m not sure what it is now, but how should we think about the difference there. I assume it’s primarily labor. How is that ramp up going to take place over time and should we anticipate that at some point direct store expense at Wild Oats will be equivalent to Whole Foods on a per [scrifa] basis?

Glenda Chamberlain

We think that over time the store contribution percentage of Wild Oats stores will migrate toward Whole Foods both in margins and in direct store expenses.

John Mackey

The Wild Oats stores are being converted over to the Whole Foods model and initially that requires spending as we increase wages and benefits. We staff at higher levels and we invest more capital to upgrade and improve the stores. But then we also begin to see comps go up. We see gross margins go up and it becomes more and more like the Whole Foods Market stores over time. So we’re still very early in that transition. We’re still in really the first seven or eight months of what’s usually about a 24-month process. But we’re encouraged by the results we’re seeing so far particularly on the rebranding side of it. The stores we’ve converted over to Whole Foods Markets brand have shown significant sales increases.

Operator

Your next question comes from the line of Steve Chick – JP Morgan

Steve Chick – JP Morgan

On the ID sales you mentioned that ID sales slowed from a 5.1% to a 5% and we know that the 5.1% versus a 5.1% in the previous year, so what is the comparison for the 5%?

Glenda Chamberlain

She wants to know what our idents were in the first four weeks of the same quarter last year and I don’t that we disclosed that.

Steve Chick – JP Morgan

So you wouldn’t know then what it would be for Wild Oats either?

John Mackey

No. I don’t think we do or –

Glenda Chamberlain

We know, I don’t have it at my fingertips but we do have that information but we haven’t disclosed it.

Steve Chick – JP Morgan

Okay and then switching over to Wild Oats obviously the contribution margin roughly a 2.2%, last quarter you mentioned that there were a lot of training costs, labor costs and inventory costs that were weighing down when it hit the 35, I’m wondering what’s weighing down that contribution margin here even further to the 2.2%?

Glenda Chamberlain

The difference between the first quarter and the second quarter is because we switched to the Whole Foods Market labor and benefits programs on January 1st, or approximately January 1st. So in the second quarter we had a full impact of that, in the first quarter we only had three weeks of impact of that so that’s the primary difference between the first quarter and the second quarter.

Steve Chick – JP Morgan

So it’s really just the labor costs on the Whole Foods side then?

Glenda Chamberlain

Yes we do have a richer payroll or labor and benefits program at Whole Foods than Wild Oats has.

Walter Robb

The other piece there I think is it took the first quarter second quarter to do the conversions to our IT systems and get the full transparency into the purchasing and pricing information so the margin is going to come along after getting those systems set and quarter two was all that work was happening to get that in place.

Steve Chick – JP Morgan

Inventory feels okay, I guess the first quarter versus the second quarter? You mentioned in the first quarter that inventory played a role in that 35 margin.

Walter Robb

Are you talking about the private label inventory?

Steve Chick – JP Morgan

Yes.

Walter Robb

For the most part we’ve worked through that.

Steve Chick – JP Morgan

You mentioned that you’re seeing I think it was a 12% sales growth on average, post the rebrand on the 27 stores, now by my math that just shows that the, it looks like the 31 non rebranded stores are seeing maybe growth of 50 to 100 basis points, is that the right way to look at that?

John Mackey

Well there are a number of Wild Oats stores that have negative comps. We inherited a number of stores with negative comps and some of those stores are going to be relocated to Whole Foods Market later on. A good example is in Naples, Florida where they have very negative comps right now but we’re going to relocate that to our new Naples, Whole Foods is opening in Naples, Florida store in August and when that happens of course that store will go out of the, the negatives will go out of the calculation. So it’s going to take us a couple of quarters more to really start showing that forward momentum. As we get all the rest of the stores converted over to the Whole Foods Market brand which we believe we’ll have done before this fiscal year is over. I think you’re going to start seeing strong comps for Wild Oats on a reported basis particularly as we relocate some of those negative comps. We kept those stores around simply because we’re waiting to relocate them and when we do they go out of the, negative comps disappear.

Operator

Your next question comes from the line of Mark Miller – William Blair & Company

Mark Miller – William Blair & Company

Can you tell us those 27 stores that you selected, is there anything in common they have versus those that were not rebranded and then how does that 12% increase compare versus prior acquisitions and based on your experience is that signify a spike and then it drops back down or do you expect to continue to hold that level?

A.C. Gallo

I don’t think there’s anything unique about the ones that have been rebranded. Some regions especially the ones that have fewer stores like the Westport, Connecticut store which was just one store in that region, some of the regions with fewer stores were actually able to move forward and rebrand our stores faster. So there’s not, I don’t think there’s anything in particular about why we chose those stores. We really left it up to the regions to determine if they were ready to get the stores rebranded. And sometimes we had to wait for jurisdictions to, landlords to approve signage changes, things like that. As far as how this compares to previous integrations, when we did, the biggest integration we had done previously was in [Freshfields] and it’s fairly similar, we had some stores in the [Freshfields] that we, and again we didn’t change the branding on those until much later. But we had some stores that responded fairly quickly to changes we made and other ones which took a while longer. The stores may have had much more just basic renovation that needed to be done to bring them up to speed, so I would say that it’s been fairly similar in a way but I would say that some of these stores have, we’ve been able, because of our experience in being a much larger company, we’ve actually been able to get into some of the stores with a much more Whole Foods staffing and change the product mixes over and we seen quite a large increase in some of these stores, quicker than we probably have seen in any other acquisition.

Walter Robb

I just want to add one more comment on Oats just again that this represents less than half of the stores on the rebranding effort and we really again as we said, haven’t done the remodel work yet and may not do that, some of that will be in next year. I think the foundation we built was the morale first, the system second and now we’re really in on the product mix and the rebranding and this is more of a softer piece of data, but we’ve had a number of Oats stores that continue to set store records last quarter and this quarter. In some cases, you take Hinsdale, Illinois, they just keep popping up records and this is, a little bit of a softer piece, but it seems like momentum, its like the car is picking up some speed here and the miles per hour is gradually increasing. Very positive piece of information.

Mark Miller – William Blair & Company

Okay the other part of that question was in your experience does that, is that 12% is that a shorter term spike up or is it kind of plateau at that rate of growth pretty steadily?

John Mackey

We don’t know but we think its going to build from there at least for a few years.

Mark Miller – William Blair & Company

On your comments about increasing the availability of value items, I was hoping you could expand on that. Are you seeing a change in the consumer off-take of conventional items as compared to organic and natural, is that what you’re alluding to within that comment about particularly in perishables?

A.C. Gallo

Could you rephrase the question, I just want to make sure I understand exactly what you’re asking us?

Mark Miller – William Blair & Company

You highlighted in your opening commentary that, right expanding the availability of more value oriented items, particularly in the perishable area and I’m wondering if you’re seeing the consumer less apt to trade-up to some of the items that have a higher price, so I’m thinking more the organic and natural, are you seeing the consumer selecting more the conventional items and what else might you be looking at in that way?

Walter Robb

Okay so yes, I think our store, it’s a bit of a mixed bag in terms of consumers’ choices and they seem, we seem to be, they’re making a range of choices across the categories and we’ve been studying that to kind of see what’s emerging but I think clearly we have opportunities to continue to offer more value choices in the perishables and that doesn’t necessarily mean they won’t buy the other things, it just means I think having a range of choices is the correct retail strategy for us and will allow us to continue to drive the comp growth and the sales growth and its interesting, the conventional prices actually have gone twice as fast as the organic items during this time and so I’m not sure its not clear that the conventional trade-off is as clear as that in terms of the organic. And organic is still showing strong growth in terms of the sales growth.

A.C. Gallo

A lot of organic items we’ve been able actually to hold our prices fairly steady because of contracts we have in place and so we haven’t seen a huge increase there. We are trying to make it easier for our customers to find value by making sure that we have the stores merchandised in a way to really show people the value items. I haven’t heard really from any of the regions where they say that they feel like customers are switching from organic down to conventional products. I think we’ve made sure that we have a good selection of organic products at good values. That’s been our focus both in our specials, that’s been our focus with our 365 program and we think, we’re seeing a continued strong demand for organic products in our stores.

Walter Robb

Again I think we said over the previous quarters we don’t think we get quite enough credit for how competitive we are but we’re tracking price data across all the markets, across the country and we have an outside service that helps us with this in addition to our own surveys. We are incredibly competitive and I would invite any of you to go do your own surveys on that and check a market basket of items and have a look yourself and we think as that value story continues to come out and we continue to help that to come out as AC said by making it easier for our customers to find that value there’s going to be good rewards for us in that.

Operator

Your next question comes from the line of Neil Currie - UBS

Neil Currie – UBS

I would agree with you, we have done some price checking and we do think that your value proposition on like products is pretty compelling right now. The issue is though that you don’t sell a lot of like products as supermarkets, the products you sell tend to be very high quality and upscale and if you think about Whole Foods development over the past eight years, you’ve morphed from being more of a specialty health store to more of an upscale gourmet store with a broader demographic reach. Aren’t you just inherently more cyclical than you have been in the past and if that’s statement is true and you may disagree, when you look across the store and look at gourmet items versus health food items, service items, service counters, which parts of the store tend to be more robust than others?

John Mackey

Well probably we’re just a lot bigger corporation than we were the last time the last recession rolled around, we are three or four times bigger than we were seven years ago. We are tapping into a wider market. Our sales are a lot higher so we’ve gotten more into the mainstream. Whole Foods may be a little more vulnerable to the economic downturn than it was previous. I don’t whether its because we’re more of a gourmet store, I’m not sure that’s true but I do think our appeal has gone wider than it was before, but that’s partly just the migration of the market to eating healthier and more consciously than it was seven, eight, nine, ten years ago.

Neil Currie – UBS

I just wonder if you look across the store, because obviously the store has increased in size in the past eight years and whether the new parts of Whole Foods versus the traditional part of Whole Foods which is the [inaudible] store, organics, natural foods, does that prove to be a bit more resilient in the past few quarters than the as the new parts, more the more exciting foods that you’ve been introducing in the past five years or so?

John Mackey

I don’t think we think about it that. We don’t think about our business quite that way. We don’t really like to talk about, I mean AC referred to our prepared foods are doing very well and you could say that’s a newer part of the store. What we’re hesitant to do is talk about the parts of the store that aren’t doing quite as well because that ends up being what people hear and remember so and want to know what’s wrong with that so obviously there’s some areas of the store that are doing better than other areas but we really don’t want to discuss the breakdown of what’s doing relatively better than other parts of the store. It’s always the case that something is doing better and something is not doing as well. But in general we’re pretty pleased with our results in a difficult economic time with increased competition and we anticipate we’re going to continue to integrate Wild Oats and that we’re going to get that behind us here in the next six months or so and we won’t look back.

Neil Currie – UBS

If you look at traffic versus ticket trends, how were they during the quarter and how have they developed?

Glenda Chamberlain

They were pretty much like we have seen historically with 50% coming from basket side and 50% coming from transaction count.

Neil Currie – UBS

In terms of the converted stores, clearly seeing the 12% in the converted stores, how has that been trending? Is it continuing to accelerate that overall number?

John Mackey

It’s pretty early. It’s hard to make, we can just report what is done and –

Glenda Chamberlain

And some of that rebranding has only happened in the very recent weeks. We’re not going to really want to get into color on whether that’s accelerating or what’s happening to it. There’s just not enough numbers there.

John Mackey

Q2 we’ll give you another report on it so you can begin to see the trend lines and then we’ll do one in Q4 and then after that we’re not breaking, as we go into the Q1 of ’09 we won’t be breaking Wild Oats out any longer. It will be fully integrated from a reporting standpoint.

Walter Robb

The upscale gourmet thing, I think is we really don’t think about our business that way and we think of ourselves as a full scale, fresh food marketplace and I think John makes a good comment when he said we certainly broadened our appeal. We don’t recognize we don’t appeal to everybody but that word gourmet is sort of a tag that I don’t think we really, certainly we have some of those types of products but we’re an everyday shop with our strong 365 program that offers values in all the categories in high quality fresh food end to end and I think we see ourselves much more as a, striving to be the best quality food retailer in every market that we serve. And again if you look at our sales numbers in the context of the market many of the other competitors are decelerating and decelerating faster so clearly we don’t have a robust sales environment in general right now that everybody’s operating in and I think we’ve held our position fairly well relative to some of the other food retailers out there. That’s more how we think about ourselves.

Operator

Your next question comes from the line of Greg Badishkanian - Citigroup

Greg Badishkanian - Citigroup

Just regarding the stores opened between eight and 11 years, comps I think were up about 1.2% and just wondering were those being impacted by cannibalization or is there any common thread with that tranch of stores?

Walter Robb

Exactly, it’s the higher concentration of stores in the lower comping regions from the impact of cannibalization.

John Mackey

Its also got a small cohort of stores only 28 stores, and what these numbers are never static because every quarter we have to recalculate them and some stores that were in the five to eight years old went between eight and 11 in this quarter and some that were eight and 11 years old went to over 11 years old so its, I always tell people not to read too much into these numbers on the basis of one quarter. You should look at the trend lines perhaps over several quarters and that can give you some indication of it but there have been other times when our stores over 11 years old had the lowest comps. That’s more typical. I wouldn’t make too big a deal out of that 1% to 2% eight to 11 years old. It could be very different next quarter.

Greg Badishkanian - Citigroup

With respect to rebranding do you think that that’s do to the name change with the Whole Foods brand or is that merchandising or what do you think is the key driver of that six point bump up in comps?

A.C. Gallo

It’s a little hard to say because usually there’s a combination of things going on. When we’re getting a store ready to be branded we usually make sure that we have the staffing levels up to proper levels and that we have our products in there and we’ve improved the quality of the perishables so that they’re proper for a Whole Foods stores. At the same time we’re changing the name so it’s hard to say if it’s just, oh you put the name on there and it jumps. I think it’s a combination of getting the store ready to be a Whole Foods and then changing the name.

Walter Robb

Anecdotally I think you got some stores saying that people when they literally see the sign they turn the car and come in the parking lot and even say –

A.C. Gallo

Its true even in the Westport store, we had gotten all those other things in place and were doing very well seeing a nice comp and the day we changed the name the comp just jumped another few percent as people starting coming in and saying I was wondering when it was going to change to Whole Foods.

John Mackey

One thing I can say for sure we haven’t seen our sales drop from changing the name for Wild Oats to Whole Foods Market. Its gone up in every instance so I think its fair to conclude the name change alone has an impact but I think what AC said is also true. If it was just the name we would have switched all the stores over already. We don’t want to rebrand them until we feel like they’re sort of worthy of having the Whole Foods Market name on it. So we’re rapidly moving to get those stores up to Whole Foods standards and by the end of this fiscal year we should have 100% of the Wild Oats stores should be rebranded. So that will put us in a good position for comps for 2009 I think.

Operator

Your next question comes from the line of Chris Roth – Piper Jaffray

Chris Roth – Piper Jaffray

-- rebranding to be done this year, do you expect the remodels to be complete, or what percentage of the remodels do you think will be complete this year just roughly speaking, is it maybe half the stores, less than half the stores?

John Mackey

We’re just going to get most of them started I think.

A.C. Gallo

It varies because some stores, for instance the Medford, Massachusetts store we decided that needed to be completely redone and we closed that store down last fall and it’s reopening tomorrow as a Whole Foods Market. That’s one end of the spectrum. And then there are some other stores where we will have some significant remodeling done probably 50% of what we might eventually do by the end of the year and there are other stores that will just have very little done. We try to do with these acquisitions; we try to do an incremental process especially in markets that might be a little bit unknown to us. It’s better to go in and change some things like remodel a department say for instance, and see how customers react. And then work it over time and then when we did the [Freshfields] integration, some of the stores we actually took three years to completely finish remodeling because we did it over a period of three years and let the sales build momentum build as we continue to do work. Other stores needed so much work that we decided just to do it all at once so it really kind of varies. So to put a percentage on it it’s going to be difficult at this point.

Chris Roth – Piper Jaffray

Are you still holding to that $40 to $50 million CapEx target for the remodels, is that right?

Glenda Chamberlain

We have not changed that number.

Chris Roth – Piper Jaffray

And that’s associated with all the remodels regardless of when they’re complete. It’s not just a 2008 CapEx number?

Glenda Chamberlain

Correct.

Chris Roth – Piper Jaffray

What are do you see the greatest potential for sales lifts in the Oats stores once you complete all those remodels. Its looks like the benefits from produce have already been realized so what store segment now are you looking for the greatest improvement. Would it be in prepared foods or center store or what?

A.C. Gallo

That’s the gift that keeps on giving when you bring in, when you’re shifting Oats stores which are primarily packaged goods and supplement stores and you’re moving them over to a broader range of product those gains continue again we’re really on the front end of this thing and to your earlier question we really haven’t done the remodels at all yet and we’re just getting the other pieces in place and so it’s a matter of just getting consumer confidence in the fresh products whether its fish, meat or produce and continuing to build on that week to week and that’s what we’re beginning to see.

Operator

Your next question comes from the line of Carol Byers – The Boston Company

Carol Byers – The Boston Company

I was hoping just to get some more clarification on your back half guidance, I know you don’t give specific quarters but Glenda did you allude to the fact that the September ’08 quarter would actually be done year-over-year despite all the upfront costs that we saw?

Glenda Chamberlain

I did not talk anything specifically about the third quarter versus the fourth quarter, our guidance with respect to the back half of the year.

Carol Byers – The Boston Company

So can you just repeat what you said about the back half of the year with regard to earnings?

Glenda Chamberlain

I haven’t said anything that wasn’t in our prepared remarks.

Carol Byers – The Boston Company

In the press release you’re saying?

Glenda Chamberlain

Yes and in the script that John read which is posted on the website.

Carol Byers – The Boston Company

And then just to clarify too if you look at the back half, should we assume that the, and I appreciate you giving the dilution for Oats, but should we assume that the amount of dilution in the back half actually improves?

Glenda Chamberlain

Yes, if you look at the components of the dilution in the second quarter for example, a big item is the write-off of the private label that won’t recur in the third and fourth quarters. The G&A impact from Oats is going to be significantly less in the third and fourth quarters then it was in the first and second quarters and we do hope to see some improvement in the store contribution percentage from the Oats stores in the third and fourth quarters also.

Operator

Your final question comes from the line of Andrew Wolf – BB&T Capital Markets

Andrew Wolf – BB&T Capital Markets

On the four stores that, Wild Oats stores that were recently closed, are those permanent closures or are they part of a planned relocation?

John Mackey

No those stores are permanent closures.

Andrew Wolf – BB&T Capital Markets

Were those stores, had you already revealed that you were going to close them or were they more like on the bubble and if they were on the bubble could you maybe talk a little about why they were closed instead of tried to be rebranded?

John Mackey

You have to remember that when we, when this whole merger thing was going on, it was held up in the FTC, it was held up in the judicial system, dragged on and on and on and we didn’t have any information about Wild Oats. We didn’t have detailed financial information because there was always a risk the deal was going to be disallowed so naturally Wild Oats didn’t want to give us detailed information. And then as soon as the deal, we got the injunction was removed and we merged the two companies together, that’s the first time we looked at financial information and we tried to make as quickly as possible within just a few days, to be able to tell obviously which stores we wanted to close and we made that kind of announcement and but there were a few stores that were kind of on the bubble. It took us a little while to get in there and dig into those stores and look deeper to realize you know what, we don’t think we can fix this. And so those four stores will be closed, kind of fall into that category.

Walter Robb

And to be more specific and to add to John, in some cases it was the code requirements or just the upgrades to the building that were required were far more substantial than we understood without the proper look at that.

John Mackey

Yes, we just didn’t know and when we finally got a good hard look at it, we got the information we needed we didn’t want to keep those stores. So we think we’ve finished with that at this point.

Andrew Wolf – BB&T Capital Markets

To get to your, the follow-up on Oats, to get within pretty close to your 24-month target, post the acquisition on Oats, is this more about, I know you’re going to say both, but maybe you can put some color on it, is it more about getting the sales productivity up and the square footage heading in the right direction or is it more about the merchandising systems and I can even add to that, let’s just say the adoption of the Whole Foods culture. What gets the margin moving and where you need it to be? Is it more leveraging sales or merchandising systems and the human resource capability of the store?

John Mackey

It’s mostly a cultural thing. We just finished the systems conversion so that’s not it. Whole Foods does business differently than practically any food retailer out there. Certainly we do business very different than Wild Oats did and it takes a while to be able to retrain people and get them integrated into the culture of Whole Foods Markets so that it’s internalized. The people at Wild Oats are very enthusiastic from a morale standpoint, this merger and its probably the best we’ve ever done but there’s just the nuts and bolts of getting them to understand an empowerment model that Whole Foods has and not just understand it but get some experience at trying to do it and learn from their mistakes and get better at it.

A.C. Gallo

We have made the conversion so that the systems are in place. For the most part the product has been changed although we’ve put in our quality meat and seafood for instance in a lot of the stores, we’ve probably replaced very few old meat, seafood cases and re-merchandised those departments in that way. So there’s still, what will happen over the 24 months is that we will go in and upgrade say the things that need it the most. That will be done by the end of the 24 months. And that will really help with the sales. And it is true, it takes a while first of all for us to understand which folks, especially in leadership in the stores can really make the transition and understand the model and sometimes it might be a little difficult for them and they may need to go into one of our existing stores for awhile and train there and may need to put in an experienced Whole Foods Market leader into the store. Whether it be a store team leader or just a team leader of a department. It takes a while to sort that out and then it really takes people a while to understand how we operate and how they can, how they’re really responsible to figure out how to serve their customers so that really takes a couple of years for people to really get that and get a store so they really starts to operate properly.

Operator

This does conclude our Q&A session for today.

John Mackey

I would like to thank you for listening in today. 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. We’ll talk to everybody next quarter. Bye.

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Source: Whole Foods Markets, Inc. F2Q08 (Qtr End 04/13/08) Earnings Call Transcript
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