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Executives

John Mackey – CEO

Walter Robb – Co-President & COO

A.C. Gallo – Co-President & COO

Glenda Chamberlain – Executive VP & CFO

Jim Sud – Executive VP Growth & Business Development

Cindy McCann – VP Investor Relations

Analysts

Simeone Gutman – Goldman Sachs

Edward Aaron – RBC Capital Markets

Edward Kelly – Credit Suisse

Meredith Adler – Lehman Brothers

Greg Badishkanian - Citigroup

Mark Wiltamuth – Morgan Stanley

Neil Currie – UBS

Susan Price – Think Equity Partners

Andrew Wolf – BB&T Capital Markets

Scott Mushkin – Jeffries & Company

Whole Foods Markets, Inc. (WFMI) Q3 2008 Earnings Call August 5, 2008 5:00 PM ET

Operator

Good day and welcome to the Whole Foods Markets teleconference. (Operator Instructions) At this time I’d like to turn it over to your speaker, John Mackey; please go ahead.

John Mackey

Good afternoon. Joining me today are Walter Robb and A.C. Gallo, Co-Presidents and Chief Operating Officers; Glenda Chamberlain, Executive Vice President and Chief Financial Officer; Jim Sud, Executive Vice President of Growth and Business Development; 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, changes in the overall economic conditions that impact consumer spending, the impact of competition, changes in the availability of capital, successful resolution of ongoing FTC matters, and other risks detailed from time to time in the SEC reports of Whole Foods Market including Whole Foods Market’s report on Form 10-K for the fiscal year ending 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. Whole Foods has experienced tremendous success over our twenty-eight year history. We have a strong customer base that is aligned with our mission and our core values. We are dedicated to maintaining our leadership position as the authentic retailer of natural and organic foods.

We recently announced our newly enhanced farmed seafood standards, becoming the first food retailer to require that our vendor partners successfully pass an independent, third-party audit to ensure compliance with our standards. These enhanced standards were created to minimize environmental impacts and are the end result of two years of hard work by our quality standards team.

We believe it is this commitment to continuing to raise the bar that reinforces our authenticity and makes us the choice for customers aspiring to a healthier lifestyle. Our business model has been highly successful and with fewer than 300 stores today, we remain very bullish on our long-term growth prospects as the market for natural and organic products continues to grow and as our company continues to evolve.

Today's economic environment however is the most challenging I have experienced in my 30 years in retail. Consumer confidence for June hit its lowest level in more than a decade. American consumers are spending less as they are feeling the squeeze from more expensive fuel and food on one side, to lower home values and less available credit on the other.

Our sales grew 22% in the third quarter. We reported sales growth in comparable stores and identical stores of 2.6% and 1.9% respectively. Our comp increase was almost entirely driven by increased average basket size with only a slight increase year-over-year in our transaction count.

Cannibalization continues to negatively impact our comps, but the estimated negative impact in the quarter was not significantly different than in Q2. While some regions still performed well with idents in the mid-to-high single digits, idents in every region decelerated from Q2. We believe that the economic hardships consumers are facing are impacting their behavior in various ways from making fewer trips to making more conscious value decisions.

The Whole Foods Market brand stands for the highest quality and over the last several years we have worked hard to increase the value choices within our grocery and Whole Body departments without sacrificing our standards. Last quarter we announced our intent to do the same in our perishable departments.

We have been doing a much better job of communicating both internally and externally the values that we offer. In July, we launched a new national program called the Whole Deal which includes an in-store guide providing specially priced product discounts, money-saving coupons and tips, as well as budget recipes.

In addition, several stores now have value gurus who lead customer tours highlighting our values as well as educating customers on how to stretch their food dollars by choosing our 365 private label brand, buying bulk, purchasing by the caseload, etc.

We continue to make positive strides in differentiating our product selection with a major emphasis on expanding our exclusive offerings in private label, control brands and in branded products. Our SKU count increased 21% year over year to just over 2,300. Our private label sales continue to increase, currently representing 21% of our total grocery and Whole Body sales, up from 15% three years ago.

At the same time we are trying to help meet our customers' needs by increasing our value offerings. We are fighting rising food costs which are having some negative impact on our gross margin. However for identical stores, our gross profit in Q3 was still a healthy 35.2% of sales versus near record gross margin of 35.6% last year. We attribute the 48 basis point decrease to some delays in passing on higher commodity costs, higher utility costs, and increased promotional activity year-over-year.

We believe that strengthening our value image throughout the store is the right strategy over the short and long-term, and we are fortunate that we continue to find many opportunities to lower our cost of goods sold to help minimize the gross margin impact. We were pleased to see our identical stores deliver a 36 basis point improvement in direct stores expenses driven primarily by leverage in wages.

We are very pleased with the early sales in our five new stores opened over the last six weeks. Our Tribeca store, which is our fifth store in New York City, is off to an especially great start setting a New York City record for opening day sales.

For the quarter, our 22 new and relocated stores averaged 56,000 square feet in size and were 7.5 months old. They produced average weekly sales of $604,000, translating in sales per square foot of $560. 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 Q3 last year, and accounted for approximately eight percent of our sales in both years.

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.

Wild Oats' sales trends continue to improve with comparable store sales growth of 5.4% for Q3 and 7% Q4 to date. We are seeing improvements in gross margin despite lowering prices throughout the store. However the margin improvements are being offset by increased salaries and benefits which are continuing to have a negative impact on store contribution.

We are still less than a year into this merger, and as with many of our past mergers, we are making up-front investments in product quality, labor, pricing and repairs and maintenance to raise the overall shopping experience in 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.

In the 38 stores we have re-branded thus far, we have seen sales growth double from six percent before re-branding to 12% after. We expect these stores to continue to show improving sales this year and higher comparable store sales growth in fiscal 2009. The dilutive impact from Oats was approximately $0.03 in the quarter.

We are disappointed in our results in the UK. Over the last four quarters our UK operations lost approximately $18.4 million before tax, or $0.09 per share. Results have shown some improvement and our annual run rate during the last two quarters was approximately $16 million.

We are carefully evaluating all aspects of our operations in the UK and expect steady year-over-year sales growth at our Kensington store to help drive further improvement. Our goal is to reduce our operating losses to $13 million in fiscal year 2009, $7 million in fiscal year 2010 and to approach break even in fiscal year 2011.

To put the UK results in context, we thought it might helpful to relate it to our experience in Canada, which was our first experiment outside of the United States. We initially lost money in Canada. However our stores there continue to grow and improve each year and are now very profitable.

Our Canadian operations contributed $14.6 million or $0.07 per share over the last four quarters, almost offsetting our losses in the UK. We believe the long-term growth potential in the UK is much greater than in Canada and expect our investment to deliver strong returns over the long-term.

In Q3 we produced approximately $122 million in EBITDA and $135 million in earnings before interest, taxes, depreciation and amortization and other non-cash expenses or EBITANCE.

While we are still producing strong cash flow the challenging economic environment appears to be negatively impacting our sales and bottom line. This combined with our commitment to maintaining financial flexibility and investing prudently in our long-term growth, has led us to announce the following proactive strategy.

We are lowering our expected new store openings in fiscal 2009 to 15 from our prior range of 25 to 30. While we were ready to execute on the acceleration in our store openings, we now wish to take a more conservative approach to our growth and business strategy over the short-term.

We have cut all discretionary capital expenditure budgets not related to new stores by 50%. We believe our existing store base is in very good shape based on our philosophy of continual investment and do not expect this decision to have any negative consequences over the short- term in terms of our customers' in-store shopping experience.

We are focused on the right size store for each market and since announcing in Q3 of 2007 our intent to decrease the size of several leases in development, we have downsized eight leases by an average of 9,000 square feet each. Throughout our history we have continued to push the envelope on store size. When we opened our enormously successful 80,000 square foot store in Austin it had a ripple effect on store size and format throughout the company.

With hindsight, reflection, and some data points in front of us, we see that the really large stores are very powerful in limited markets and circumstances and that smaller stores can also produce great returns for us. We believe that a store size of 35,000 to 50,000 square feet is more appropriate in most circumstances to maximize return on investment and EVA, and we expect the majority of our stores to fall within that range going forward. We are also actively working to drive down the average development cost per square foot.

G&A was 3.3% of sales in Q3, reflecting certain cost containment measures that have already been implemented. For fiscal year 2009 we expect G&A to return to historical levels of approximately 3.2% of sales.

We are also announcing the suspension of our cash dividend. At this time we no longer have excess cash available to distribute to our shareholders, as that cash is needed to fund our growth going forward.

We believe that through these decisions, which we have not undertaken lightly, our company will emerge stronger and better positioned to realize our growth potential and fulfill our long-term mission and core values.

Now I will turn to our guidance for the remainder of fiscal year 2008 and to our early assumptions for fiscal year 2009. We believe these are unusual times and that in order to set appropriate expectations, we are giving more guidance than we typically do.

If our comparable store sales growth for the fourth quarter is in line with or slightly below our quarter-to-date results of 1.5%, this would result in comparable store sales growth for fiscal year 2008 of approximately five percent.

Total sales growth on a 52-week to 52-week basis would be approximately 12% for the fourth quarter and approximately 23% for the fiscal year. Please note that the prior year included five weeks of sales from the subsequently closed Wild Oats and divested Henry's and Sun Harvest stores.

Based on these sales assumptions and the expense guidance outlined in our press release, we expect EBITDA in the range of $98 million to $102 million for the fourth quarter, resulting in a range of $501 million to $505 million for the full fiscal year. EBITANCE is expected to be in the range of $113 million to $117 million in the fourth quarter, resulting in a range of $559 million to $563 million for the full fiscal year. We expect diluted earnings per share in the range of $0.13 to $0.15 for the fourth quarter, bringing the full year to $0.93 to $0.95 per share.

We are providing the following preliminary assumptions and expectations for fiscal year 2009 which we expect to update with our fourth quarter earnings announcement in early November.

Assuming no dramatic change in economic trends, we are planning for total sales growth in fiscal 2009 of 6% to 10%. We expect comparable store sales growth of 1% to 5% and identical store sales growth of zero to 4%. Year-over-year square footage growth is expected to be approximately 7%, based on 15 new store openings of which approximately six will be relocations.

Based on these sales assumptions along with the more detailed guidance provided in our press release, we expect EBITDA in the range of $560 million to $580 million and EBITANCE in the range of $625 million to $650 million. We expect diluted earnings per share in the range of $1.08 to $1.14, a 15% to 20% increase year-over-year. This includes an estimated $0.07 to $0.09 per share in dilution from Wild Oats and approximately $0.06 per share in dilution from our UK operations.

We are hopeful that sales trends will stabilize and then improve as we continue to execute on our differentiation strategy while gaining increasing credit for the value that we offer. We cannot completely control the impact of the economy on our sales, but we can control our costs. With our renewed focus on expense control, the reduction in our store openings and discretionary capital expenditures, and the reinvestment in our balance sheet through a suspension of our dividend, we are committed and focused on delivering strong EBITANCE and earnings growth in fiscal year 2009 and beyond. We are an adaptive and resilient company that will adapt in a prudent manner to these uncertain economic times.

We will now take your questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Simeone Gutman – Goldman Sachs

Simeone Gutman – Goldman Sachs

With respect to some of the value offerings that the company is pursuing do you view them as being cyclical changes or is there something more structural to them?

John Mackey

I think they are, I think we are always endeavoring to get more credit for the value that we have offered but at the present time we’re investing, we’re making a stronger push for value in the perimeters so that is a structural change in those.

Walter Robb

Its cyclical in the sense as when the economy turns back up again and customers feel more financially secure we expect they’ll probably return to previous purchasing patterns so we’ll still have the value focus and we think that will position us better competitively for the long run but we do think customer purchasing patterns will evolve as the economy evolves.

Simeone Gutman – Goldman Sachs

And do you think there’s a trade-off between creating more of a value perception versus keeping some of the uniqueness of the stores. Can that be done and both be additive.

Walter Robb

Absolutely. Its not value for the expense of just going after value its emphasizing the range of choices that we offer as a retailer. We are strengthening the perception around value and there are some significant differences in the perimeter of the store in particular but the formula going forward is as John said earlier, its cutting costs, its building sales through the value but also through the differentiation of products. We’re not hanging our whole hat just on value.

John Mackey

Basically we’re not sacrificing our quality standards; it’s the same quality standards. We’re making a greater effort to educate our customers in terms of the value that we have in our stores. We think that we are misperceived, the media in particular, they invented that term whole paycheck and they continue to repeat it. So we’re endeavoring to educate our customers and through our value tours, through our education and signage in the stores, through our merchandising, to make sure that our customers understand the compelling values that Whole Foods already has.

Simeone Gutman – Goldman Sachs

Do you think any of the cost containment measures and I guess it might depend on their severity will they impact the Whole Foods culture in any way and how can morale be kept high if store hours are reduced, and there’s less store growth in the pipeline?

John Mackey

Well we’re not reducing any store hours. We didn’t make an announcement about. So and we didn’t announce that we were closing down a bunch of stores so we have 55,000 team members and nothing we’ve announced today is impactful to the great majority of those store team members so their morale shouldn’t be impacted at all. We’re tightening up our G&A and our overhead there but we don’t have any radical actions anticipated there either so I don’t anticipate that any of the decisions we’re making today are going to impact the morale of our team members; possibly quite the opposite.

We are making a commitment to improve value and improve our stores and improve our positioning which we think will be positive for our team member base. So I guess I don’t anticipate major morale challenges.

Operator

Your next question comes from the line of Edward Aaron – RBC Capital Markets

Edward Aaron – RBC Capital Markets

Could you talk about the ease of getting out of those leases for fiscal 2009, did you incur any costs of exiting those leases and also were you able to get out of all the ones that you wanted to get out of or did you have to maybe sacrifice some that you still actually wanted just for the sake of slowing down the growth?

Jim Sud

The macroeconomic conditions are affecting not only Whole Foods they’re affecting our landlords our developers, and pretty much across the board so some of the projects that are currently on our store development schedule are experiencing some delays and have caused landlords to miss tender dates or key milestones within the lease so being able to get out of those leases was an easy thing for us to do.

And for the most part actually we really didn’t terminate any lease that we weren’t comfortable doing. But having said that we remain very bullish on our long-term growth prospects. We think we have a very strong pipeline going forward. We’re going to move forward in a prudent and cautious manner that is appropriate given the current macroeconomic conditions.

As to the cost to get out of these, it looks like its somewhere in the range of about $1 million cumulatively but those numbers are reflected in our guidance.

Edward Aaron – RBC Capital Markets

You mentioned some challenges with passing on costs on a timely basis and I wanted to get your view on how well equipped your systems are for all the moving parts that go into pricing because we are in this environment of volatility on the cost side and then you’re also making a lot of pricing investments so just curious to get more color on that.

Walter Robb

Actually in the last few years our systems are a lot more robust and we’ve got pretty good rollup now so actually the price increases that we saw in the quarter were in the range of 2% which is below some of the manufacturing community announced price increases and we’ve been able to pass those along in terms of our retail price increases so we’ve got pretty good ability there in our tracking. We’ve got a market basket now of 1,000 items internally and we’re looking at conventional items, natural items and organic items to track the movement in all three of those categories and we got pretty good visibility into that now.

Obviously commodities are up 5% to 7% depending on which numbers you look at but the offset to that for us is we have a great commodities buying program now and we have major contracts in place for the next 12 to 24 months on all the major commodities. So some good visibility and some good leverage on the buy side here that we didn’t have a couple of years ago.

Edward Aaron – RBC Capital Markets

As far as the pricing investments are concerned, I’m assuming you’re of the view that the consumer isn’t giving you enough credit for what you’ve done there, and I’m wondering if that’s the case and continues to be the case do you plan to just continue to get more aggressive until those perceptions change or is there a point where you come to and just say its just not worth it anymore because you don’t get enough credit no matter what you do.

Walter Robb

I think the feeling in the company is we’re in action and we’re doing something. I think that we’re going to be strategy and selective about those price investments and I think that’s what you’re seeing in the gross margin results here. But I do think we don’t get enough credit. I think we offer very good high quality food at very competitive prices and I think it’s fair to say that we haven’t gotten the credit that we deserve for the pricing that we have been offering. I think more and more the media is starting to with our help pick up on that. I think we also have made selected investments in particularly in the perimeter that so that prices are different.

We have made some investments there to make the point even more clear that there’s value there in the perimeter. So I think it’s a balancing act between being strategy and selective about that but being more visible and John mentioned the value gurus, the value tours, even some of you may have seen the article in The Times last week. We’ve gotten over 100 responses internally here on that article. Perceptions are changed not over night but over time but I think we’re making a good whack at it and the read we’re getting from customers that they’re noticing it and they appreciate it.

Operator

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

Edward Kelly – Credit Suisse

Your business is clearly turning out to be more discretionary then you thought and the question here really is what gives you the confidence that we will not see a further deterioration in comps either in Q4 or into next year and then if we see this what does it do to your liquidity profile. At this standpoint you’re an $8 billion company with $130 million available under a revolver. It looks like you’re going to be free cash flow negative in Q4, kind of looks like you’re guiding to be neutral free cash flow next year, why don’t you need more liquidity in case things get worse?

John Mackey

First we don’t accept your fundamental premise that we’re discretionary. Whole Foods is still reporting positive comps at this time, that means our sales are higher this year then they were a year ago. So we’re not in negative comps at this point and there’s been a deceleration but I think I wouldn’t buy your first premise. I think you don’t understand how loyal our core customers are to Whole Foods Market and some of this slowdown has been on the margin as opposed to the core and also people just maybe making a little bit less frequent trips and maybe trading down a little bit when they are in our stores.

In terms of our cash reserves if you do the math from the press release you’ll see that we are predicting an EBITDANCE range of $625 million to $650 million that’ll be all the cash that we produce when all of the non-cash expenses are backed out of it, depreciation and amortization. We’re only expecting capital expenditure range of $400 million to $450 million in fiscal year 2009. So we’re talking about an additional of margin of error there or cushion of potential of $200 million to $250 million in excess cash being produced in fiscal year 2009. So we’re proceeding conservatively but with the intention to produce quite a bit of free cash flow next year.

Walter Robb

In the last 12 weeks, looking at the data here clearly we had an uptick in our items in the basket, we’re getting, there’s clear evidence that our offering a broader range of choices and highlighting the value in the perimeter is working both in item and basket count. Transaction count is still a challenge and it is for everybody but again even there is some evidence of a [floor] beginning to form. And there’s some evidence that efforts are working in terms of the shops.

Second of all I’d make the point that we do have a higher percentage of partial basket shoppers then chain stores like Kroeger or Safeway or those sorts of folks. They have most of their shoppers, there are more of those stores but the good news is as this thing cycles over those partial basket shoppers we can again move them towards being full basket shoppers. We have a lot more room to run horizontally as well as vertically.

And finally I’m going to make the case that healthy food is always a good choice and while people are stressed right now in terms of their pocketbook and their choices if you look everyday at the information and the science and the articles that are coming out connecting what people eat with how they feel and their healthcare bill, the trend is moving our way and we and good health is always an excellent choice in any time and we’re very well positioned to support those healthy choices.

Edward Kelly – Credit Suisse

If you look at your comp stores you do have a bucket that’s actually turned negative, so that’s the one thing that I would point out. If you look at your cash flow for next year when you start backing out taxes you’re going to pay, interest that you’ve got to pay, it looks like its closer to me then a couple of hundred million dollars. But in any event, you talked about the average store size is 35,000 to 50,000 going forward but the 80 stores in development average 51,000 square feet, so what percentage of those stores in your mind are still too big?

John Mackey

We don’t have that figure. I’m not sure that we think any of them are too big. We downsized eight stores and the ones that are larger we think are probably the appropriate size so again we announced a range of 35,000 to 51,000 square feet, the limited number of stores that are going to be bigger stores, we’ve got a big store in development, a couple of 80,000 square foot stores in development in very strong markets for us in Houston and Dallas for example.

We’re relocating our Lincoln Park store which is one of our highest volume stores in the company to right across the street to an 80,000 square foot store so the ones that bring up the average are actually stores that we feel very confident are going to be very high volume, very profitable stores for us. And the great majority of our stores are in that 40,000 45,000 square foot range. I feel very good about the stores we have in development and the ones that we have gotten out of the leases on are the ones that were maybe a little bit more on the margin on lower comp assumptions we’re going to have difficulty making seven year EVA targets out of it.

Glenda Chamberlain

I’d like to clarify something about the cash flow, you’re right of course interest is a cash expense and taxes, most of the taxes is a cash expense although not all of it, but if you add those back and also the availability on our line of credit, that gets you to the $200 million that we have available next year.

Operator

Your next question comes from the line of Meredith Adler – Lehman Brothers

Meredith Adler – Lehman Brothers

I believe that you are paying rent on some closed Wild Oats stores, and I was wondering, that doesn’t flow through the P&L, what kind of an annual cash drain that is.

Glenda Chamberlain

It’s approximately $10 million to $13 million.

Meredith Adler – Lehman Brothers

That’s annual?

Glenda Chamberlain

Yes.

Meredith Adler – Lehman Brothers

I was wondering if you could talk about what your expense control efforts are maybe be more specific about cutting labor hours or reconfiguring business processes.

John Mackey

We haven’t talked about that we’re, we feel like our stores are very successful and very profitable so we don’t have expense control initiatives put in our stores. The expense control we talked about has been at our regional and corporate G&A, that overhead expense is where we’re implementing strong cost controls. So we think our stores have very high returns on invested capital and we don’t really have a problem there. But our G&A was built ahead of or growth and with the sales slowdown we’re hanging out there with a little bit higher G&A percentage then we’ve historically had. We’re going to do what we need to do to bring that back in line in 2009.

Glenda Chamberlain

The systems that we have in the stores manage the labor with the sales so there’s no need to take any costs out of the stores although certainly as always the stores are looking for ways to manage their other costs. So we’re doing that in addition to what we’re doing in the global support and the regional offices in our G&A line items.

Meredith Adler – Lehman Brothers

But there’s a bottom amount of labor that any store has to have and I guess I don’t understand if your comps have slowed, sales per square foot will be slowing why wouldn’t you want to change a little bit about your cost structure to match a lower level of sales? Why would you leave it the same?

John Mackey

I think what you don’t understand is how our labor system works at our stores. We have a very unique labor system with our gain sharing program. It automatically adjusts a sales flow down in gain sharing bonuses or lessens the stores if there’s attrition that’s not replaced, they sort of self regulate themselves. We are not seeing; remember our comps are still positive. We are doing more business today on a per store basis then we were doing a year ago. So our comps have decelerated, we are still in positive territory with our sales.

In fact as we said in the press release we are pleased to see our identical stores deliver a 36 basis point improvement in direct store expenses which is driven primarily by leverage in wages. So contrary to your hypothesis we’re actually getting leverage on our stores even those sales have slowed down in terms of labor expenses.

Walter Robb

Broadly speaking the name of our system, store ops workbook, it’s a business process system that we have that works throughout the company to address inventory control strength and labor and that along with the pro activity of the regions in projecting sales and matching expenses to the sales have allowed us to bring these results. Which again one of the questions over the quarters has been our ability to do that at lower sales and I think some of these results demonstrate that we’re getting a little better at that.

Operator

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

Greg Badishkanian – Citigroup

With respect to comps I know the economy has had a bit of an impact, are there some other impacts like increasing competition, maybe cannibalization, maybe some stores reaching capacity I know that’s been an issue in the past, or is it just the economy?

John Mackey

We think it’s the economy because all you’ve got to do is go back two quarters which is only six months ago and we produced a 9% comp number at Q1. We saw that go to 6.7% in Q2 and down to 2.6% here in Q3. Competition of course is a factor and as is cannibalization but they are not any more intense right now then they were in Q2 or Q1. So although we can’t know for certain we think it’s reasonable to conclude that the deceleration in our comp store growth has primarily been due to the economy.

Greg Badishkanian – Citigroup

Your fourth quarter guidance guided $0.13 to $0.15 are there some one-time expenses that are in that that are making it a little bit lower then what I was forecasting?

Glenda Chamberlain

No the fourth quarter is our toughest quarter of the year and we generally see sequential declines from the third quarter to the fourth quarter. We also have eight new stores opening in the fourth quarter so those are some of the factors that lead to that number.

Operator

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

Mark Wiltamuth – Morgan Stanley

On the unit growth slowdown are we talking a multi year slowdown given that you’ve made some adjustments in the lease portfolio or is it really just a one or two year slowdown and what do you think the long-term target for growth is now?

John Mackey

We don’t really want to provide guidance for that. We hope it’s a one year slowdown and it depends upon if we’re in recession how deep and long lasting it is. We’re prepared obviously to turn on the gas if we need to accelerate our growth in fiscal year 2010 and we will do so if the economic environment warrants it. If it continues to be a really difficult time then I expect to see that we will also be, we’ll moderate our growth for 2010. but we’re keeping our fingers crossed that we are going to be, the economy is going to turn around, that we’re going to return to our historical time of strong comp sales growth and I tend to be bullish and optimistic so I do think this is probably a one year factor but I can’t say for sure.

We’ve got less than 300 stores in operations right now so and we’ve got 81 stores in development so its just a question of the rate that we process them through the assembly line here but and that’ll depend somewhat on the economy, how much operating cash flow we’re putting off, and credit markets, etc. etc. so its too far out to look to what exactly we might be doing in 2010 and we’re giving you guidance for 2009 and you ought to be content with that for the time being.

Mark Wiltamuth – Morgan Stanley

On the UK business is the problem there more one of sales density or has the labor budget just been a little heavy because you were introducing new store there, characterize some of the loss there for us.

A.C. Gallo

The Kensington store traditionally a lot of times when we open up a new store in a new market we go through a trend of the first year of the store not profitable and usually a couple years of normal growth out of that it works its way up. I think what really happened in the Kensington store is that we built one of our largest stores there and it was a very expensive store to build and it hasn’t done the kind of business that we thought it would do or hoped it would do at the beginning so we have a lot of overhead there that we have to work through.

Initially especially in a new store in a new country labor is a little high at first because you really have to, you have so many new people to train and we had to bring a lot of people over from the US to help train them so that added to a lot of cost. And margins often start off weak especially in a large store so but we’ve been encouraged that we’ve seen really good improvement throughout the year that it’s been open. We brought labor, it is now down to a very respectable level in the store and margins are improving period to period.

So we really think that as we said in our guidance there, really expect to see, we’re currently in the last couple of quarters improved considerably over the initial opening of the store and we expect with our normal growth that we should see there on a new store that will continue to help improve labor and margins and we think that we can see sequentially a reduction in that loss from a, next year and the year after that as well.

Mark Wiltamuth – Morgan Stanley

About the Wild Oats FTC dispute, a lot of us are scratching our head on what kind of remediation could be asked for if you in fact lost that suit. Obviously if you win you just continue on as if nothing happened but if you did lose what kind of remediation could be asked for?

John Mackey

You got me. I don’t know. The merger is completed. We’ve paid the Wild Oats shareholders. We’ve sold off the Henry stores. We’ve changed the name of two-thirds of the stores. We’ve put Whole Foods Market systems in. We have Whole Foods Market store team leaders. We’ve rebranded most of the stores. We’ve lowered prices across the board at Wild Oats stores. We’ve improved quality. We’ve increased the sales. I really don’t know. We’re trying to figure it out so we don’t know what our next move is going to be and we’re still discussing that internally and we don’t have anything to announce on it today.

Operator

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

Neil Currie – UBS

I’d agree that you do have a great value relative to the quality of the product that you sell, but you are what you are, you sell high quality products and the price points generally tends to be higher. Is there ever any temptation to adjust the quality standards that you have or to introduce another layer of slightly inferior quality products or less good quality products in order to get the right price points in order to demonstrate value in real dollar terms?

John Mackey

We’re not really tempted to do that. We are a mission driven company and we think our business model is very successful. If you look at our sales per square foot compared to most other US food retailers are much higher, our stores even with the deceleration in comps if you look at our return on invested capital for our stores that are open that we published in the press release the model works. And it’s unfortunate that for the, honestly these are the lowest comps I’ve had in doing Whole Foods for 28 years. Its kind of unchartered waters for us but I don’t think we’re going to change our quality standards. I don’t think we’re going to lower our quality. I don’t think that’s in the cards.

Walter Robb

Quality is our compass and we’re going to continue to steer by it because that’s who we are and that’s who we are in the marketplace and I think customers know that and appreciate it but again I’m going to just say to your, we give you the same challenge. I know you’ve looked at prices over the years but take the challenge. Go out and look for yourself and do the competitive price check.

We are offering high quality fresh products day in and day out at very competitive prices not only in the center of the store but also on the perimeter and when you talk about value in real dollar terms blueberries two for four or, that’s a real dollar and that’s a real dollar value and I’m going to suggest to you that that is what’s available now, within the context of a range of choices.

We’re not going to just start selling price items that’s not who we are but we are clearly offering the value items if that’s the choice that you want to make and it should be clearly visible particularly now in the perimeter of the store. So I offer you that challenge to go out and look.

Neil Currie – UBS

I wouldn’t disagree with you to be honest with you. It is really all about perception at the end of the day and it just may take some time to change those perceptions. If it takes some time to change perceptions and the economy, I remember you saying well that’s [inaudible] but it was a weird economy which I thought was actually one of the best ways to describe this economy that we’ve got, what if sales do deteriorate or don’t grow or even fall, what’s the next step that you take in terms of preserving your cash flow, would it be to curtail CapEx further or would it be to then step in and start looking at store costs and maybe reduce labor which I know you don’t want to do?

John Mackey

I don’t think we’re prepared to talk about what we’d do in even a more negative environment. Honestly we’ve had those discussions internally. We have some strategies that we would execute but we’re not going to talk about it today. It’s premature to do so. But we are aware that it’s possible that the economy could get a lot worse and if so Whole Foods is prepared to do something about it. We’re just not prepared to talk about it publically at this time.

Neil Currie – UBS

On the UK are you going to plan any more stores from here or just wait and see how the first store goes?

Jim Sud

We are continuing to look for new opportunities in the UK in a very strong way. We have a VP of Real Estate who is over there doing a great job turning up lots of opportunities for us and so as soon as we find the location that works for us that we’re able to sign we will do so. Its full steam ahead there.

John Mackey

I think it’s safe to say we’re not going to open any 80,000 plus square foot stores. I think we’ll be in the 25,000 to 35,000 to 40,000 square foot range for new stores in the UK going forward. We still anticipate opening new stores in the UK over the next couple of years.

Operator

Your next question comes from the line of Susan Price – Think Equity Partners

Susan Price – Think Equity Partners

Have you seen any more weakness in the middle of the store versus the perimeter of the store and if there’s a difference there in terms of the economic effect?

Walter Robb

We have actually seen strength in the center of the store and our speculation is that I think once we’ve been working on the image in both price and branded products in the center of the store over some period of time that we’re, that’ showing really good strength.

Operator

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

Andrew Wolf – BB&T Capital Markets

On your same store sales breakdown between the basket size and transaction, could you either give the number or an indication of whether they’re both positive?

Glenda Chamberlain

They’re both positive but the transaction count was barely positive.

Andrew Wolf – BB&T Capital Markets

Looking back in 2001, the last slowdown, you fared a lot better, your comps were strong and the transactions were way up and I think at the time you posited that it was you were benefiting that the chain was benefiting from the trade down from restaurants so forth. What do you think has changed, do you think it’s either the economy is tougher or people shifting where they’re spending or do you think there’s more competition for the kind of restaurant equivalent type food or close to equivalent type food that can be provided at other outlets?

John Mackey

We’re not positive what it is. We speculate two things that are different in 2008 from 2001 is one the oil prices are so high and gasoline is so expensive. Whole Foods has always attracted because we have such unique and special stores, we’ve always attracted a wider geographical radius then conventional supermarkets do. People drive further to come to Whole Foods. And we think that with the price of gasoline right now that people aren’t driving as far as frequently to our stores as they used to. So we think on the margin that’s hurting our comps.

Secondly although we don’t want to break it out I will say that the real estate markets that have been the hardest hit on the whole subprime mess we have felt that. We’ve seen a greater slowdown in comps in those markets then we have in the markets that have been less affected. So I think those two things are factors, the price of oil i.e. gasoline and the markets that have particularly been hit hard by the housing downturn. Those have both affected Whole Foods comps.

Andrew Wolf – BB&T Capital Markets

On the perception image issues in the store and it sounds like you think that on the dry grocery and the isles that you’ve got your pricing and the image and perception pretty good in the consumer take away is good, what’s your own assessment of where pricing is and image or perception in the perimeter and how long do you think that will take to sink similar to the inside of the store?

Walter Robb

I would say we’re definitely on the front end of that effort. I think particularly at end of Q2 I think really realizing that we needed to make some movement there and making some stronger strides but it should show up, we’re definitely on the front end of that, it should show up (a) in terms of the team members I think we’ve been doing store meetings across the company to get the team members involved and aware, having them go out and do price checks just so that everybody can be aware that this in fact is the truth and second of all it should show up in terms of the signage and the merchandising. I don’t think that you’ll, we’re going to get rid of, but you should see that is a range of choices. You should have other choices you can make right along side of that so you can make whatever choice is appropriate for your particular situation.

So I think we’re on the front end of that. The data that I’m seeing and I’m looking at it weekly, item, basket and customer count is very encouraging. It suggests that we’re beginning to get some traction with this. I don’t want to be premature but we’re getting some traction and we’ve also, that’s my answer to your question. I think also we’ve got, when you understand our comps you got to remember we got Chicago and LA that particularly have had strong cannibalization this last year. We’re cycling over that. And our Oats stores are finally starting to find some stride here in terms of the comps as well.

Andrew Wolf – BB&T Capital Markets

So broadly speaking it sounds like you think your pricing in the perimeter broadly speaking is fairly right versus the competition and now you need to do what you can whether its through in-store through your sales associates or what have you to communicate that, is that what you want us to take away here?

Walter Robb

I want you to communicate that we’re moving and in action and you should see evidence of that yourself in the stores and I think that the customers are. Obviously and the perimeter is where quality standards are the most challenging, like for like because when you’ve got meat with hormones and antibiotics it doesn’t compare as well to meat that doesn’t have those things and so we’re working hard to do that through portion control, through highlighting just good prices on items but I think the take away for you is that we’re investing in that, we’re making it visible, we’re doing it internally as well as externally but we’re, within the context of our quality standards.

Andrew Wolf – BB&T Capital Markets

It sounds like it’s obviously there’s more complexity because of the lack of identical items to compare on so, that adds some clarity.

Walter Robb

But there’s not complete lack of identical items, there are items you can compare and again we’d invite you to do that for yourself and have a look.

Operator

Your final question comes from the line of Scott Mushkin – Jeffries & Company

Scott Mushkin – Jeffries & Company

I wanted to get back to a question revolving around morale, I remember when you changed your option programs and people were concerned about this issue. I think John said that you’re forced to pay your people because if it’s a problem, we’ll do that. And then listening to your answer to the gain sharing question which is a great way to have the kind of thing self correct but it also suggests people are kind of getting a little less money in their pockets with their expenses up but it seems to me that wouldn’t make them feel too good and then I know you use options a lot and it goes way down into your employee base and clearly over the last few years those haven’t done so well and top of it if the people actually own some stock, they now aren’t getting the dividend. So I was just wondering why wouldn’t that have some morale implications at the store levels and do you think you will need to increase compensation to kind of offset some of these factors.

John Mackey

I think the answer is that yes everybody likes it better when the comps are higher and the company is growing and stock options are worth more money and everybody likes that better. I think that people, the team members (a) understand Whole Foods Market is a mission driven company, secondly they understand we’re being impacted with forces that are really beyond our control and that we’re being as proactive as we can in the difficult economic environment we find ourselves in but I don’t think that they are blaming the company for the fact that our sales are slowing down and I think that when you have a company that has as strong a morale as Whole Foods and its been one of the best 100 companies to work for for 11 years in a row.

We have a great culture, people like their jobs, fun to work in our stores, and we’re not like Starbucks closing down 600 stores and laying off 1,000s and 10’s of 1,000s of people, that we have a philosophy of shared fate and yes we all like it when times are better. But that doesn’t mean that just because there’s a slowdown that the morale of Whole Foods Market is going to collapse. I think we’re far more resilient then most people apparently realize and so I don’t predict there’s going to be any massive loss of morale in our organization. In fact what I expect, Whole Foods Market team members have a lot of character and I expect them to rally behind the company.

We’re going through a tough time here and again I’ve never seen our comps this low in the 30 years since I started the company. I give our team members a lot of credit for their passion and their commitment to our company I expect them to rally behind us and help us get through the difficult time we’re in and we are going to get through this difficult time and we’re going to be a far stronger better positioned company as the economy turns back up again. When that will be I can’t know. I’m not a soothsayer but it will, the long-term trend of the American economy is up. It’s been that way ever since the Republic was founded and this time is no exception.

So we’re down a little bit now but we’re going to be back up again. We’re going to take this opportunity of a weak economy to position our company stronger. We’re going to renew our balance sheet. We’re going to make sure that we grow no faster then we have the cash available to grow and we’re positioning ourselves for long-term success and I think our team members are behind us on that. I think they support Whole Foods’ mission and our values and what the company stands for. So that’s what I think.

Scott Mushkin – Jeffries & Company

Distribution, I know there’s been some speculation there, any thoughts about bringing more of that in-house and is there an ability to do that? And then a partner in the UK, would you ever consider getting a partner there to help you grow but also mitigate some of the expenses and then you have the highest gross margins in the industry and I was wondering what you attribute that to?

John Mackey

We don’t anticipate getting a partner in the UK. Taking more distribution in-house, well we already do. Our produce distribution in-house, we do our seafood, we have our own seafood, we do our perishables, what we think the key area to control distribution on is in our perimeter, that that’s a competitive advantage for us so we do have control of that, from our prepared foods to our bake houses to our kitchens to our in-store kitchens, seafood distribution, produce distribution so we’re really talking about the center of the store and we think we have a great relationship with [UNFI] and we think they’re a great company. They’re doing well for us and we don’t have any plans to, we don’t want to put the capital into building distribution centers at this time. We’d rather save the capital we have to open new stores.

We’ve got a lot of reasons to be positive about 2009 particularly in terms of the Wild Oats integration is coming along very nicely. We always say it takes 24 months and we’re still a little bit, we’re almost half way. We’re seeing 7% comps over the last four weeks. We’ve closed the stores that are losing money or most of the stores at Wild Oats that are losing money. We’ve upgraded the remaining stores. They’re going to enter our comp base.

Two of the things that are positive for comps; Oats is going to enter or comp base at the end of this month and they’re reporting 7% comps right now. Secondly the cannibalization, the cannibalization is a factor and it is a few hundred basis points negative on our comps and as we get into fiscal 2009 we’re going to anniversary those stores that are cannibalizing and we have so fewer openings that are going to occur in 2009 that cannibalization is going to be slowly taken out of the picture, steadily taken out of the picture at Whole Foods so between cannibalization and Oats those are two very positive things that are going to help lift our comps up in fiscal year 2009.

Its never pleasant going through a difficult downtime but there’s opportunities in that and you can run around, you can throw your hands up in despair of it all or you can see what’s the opportunity that’s being given to us right now. And the opportunity that’s been given to Whole Foods is to get our G&A expense line under better control, to have more discipline in our capital expenditure line to get our stores opened, spending less money to ratchet down the store development costs, the size of the stores, and to focus on getting our return on invested capital up for our investors.

So it’s not necessarily pleasant but there are opportunities that are here for us. And this management team is very, we’ve all been around here a long time and we’re very committed to Whole Foods’ mission, to our values and we believe that we have a very dynamic and resilient company and we can adapt to whatever conditions the economy throws at us, the competitors throw at us, the federal government throws at us. Whole Foods Market is going to adapt and we’re going to come out a much stronger company as a result of this.

So that’s going to be the close of this call and I’ll conclude it by saying we remain very bullish on the long-term growth prospects of Whole Foods as the market continues to grow and our company continues to improve. So we look forward to speaking with everyone again in November on our fourth quarter earnings call. Thanks very much, we’ll talk to you soon. Goodbye.

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Source: Whole Foods Markets, Inc. F3Q08 (Qtr End 07/06/08) Earnings Call Transcript
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