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Whole Foods Market 10-Q 2010

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

 

FORM 10-Q

 

x      Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

for the period ended July 4, 2010;

 

or

 

o         Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

for the transition period from                                    to                                   .

 

Commission File Number:  0-19797

 

WHOLE FOODS MARKET, INC.

(Exact name of registrant as specified in its charter)

 

Texas

 

74-1989366

(State of

 

(IRS employer

incorporation)

 

identification no.)

 

550 Bowie St.

Austin, Texas 78703

(Address of principal executive offices)

 

512-477-4455

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act).

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.)  Yes o  No x

 

The number of shares of the registrant’s common stock, no par value, outstanding as of July 4, 2010 was 171,898,661 shares.

 

 

 



Table of Contents

 

Whole Foods Market, Inc.

Form 10-Q

Table of Contents

 

 

Page

 

Number

 

 

Part I. Financial Information

 

 

 

Item 1. Financial Statements

 

Consolidated Balance Sheets (unaudited), July 4, 2010 and September 27, 2009

3

 

 

Consolidated Statements of Operations (unaudited), for the twelve and forty weeks ended July 4, 2010 and July 5, 2009

4

 

 

Consolidated Statements of Shareholders’ Equity and Comprehensive Income (unaudited), for the forty weeks ended July 4, 2010 and fiscal year ended September 27, 2009

5

 

 

Consolidated Statements of Cash Flows (unaudited), for the forty weeks ended July 4, 2010 and July 5, 2009

6

 

 

Notes to Consolidated Financial Statements (unaudited)

7

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

16

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

22

 

 

Item 4. Controls and Procedures

22

 

 

Part II. Other Information

 

 

 

Item 1. Legal Proceedings

23

 

 

Item 5. Other Information

23

 

 

Item 6. Exhibits

24

 

 

Signature

25

 

2



Table of Contents

 

Part I. Financial Information

 

Item 1. Financial Statements

 

Whole Foods Market, Inc.

Consolidated Balance Sheets (unaudited)

July 4, 2010 and September 27, 2009

(In thousands)

 

 

 

2010

 

2009

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

136,144

 

$

430,130

 

Short-term investments — available-for-sale securities

 

294,926

 

 

Restricted cash

 

86,814

 

71,023

 

Accounts receivable

 

122,421

 

104,731

 

Merchandise inventories

 

333,554

 

310,602

 

Prepaid expenses and other current assets

 

44,940

 

51,137

 

Deferred income taxes

 

103,508

 

87,757

 

Total current assets

 

1,122,307

 

1,055,380

 

Property and equipment, net of accumulated depreciation and amortization

 

1,888,310

 

1,897,853

 

Long-term investments — available-for-sale securities

 

57,364

 

 

Goodwill

 

665,210

 

658,254

 

Intangible assets, net of accumulated amortization

 

69,363

 

73,035

 

Deferred income taxes

 

76,525

 

91,000

 

Other assets

 

9,586

 

7,866

 

Total assets

 

$

3,888,665

 

$

3,783,388

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Current installments of long-term debt and capital lease obligations

 

$

402

 

$

389

 

Accounts payable

 

203,294

 

189,597

 

Accrued payroll, bonus and other benefits due team members

 

235,934

 

207,983

 

Dividends payable

 

 

8,217

 

Other current liabilities

 

281,371

 

277,838

 

Total current liabilities

 

721,001

 

684,024

 

Long-term debt and capital lease obligations, less current installments

 

513,196

 

738,848

 

Deferred lease liabilities

 

284,950

 

250,326

 

Other long-term liabilities

 

69,600

 

69,262

 

Total liabilities

 

1,588,747

 

1,742,460

 

 

 

 

 

 

 

Series A redeemable preferred stock, $0.01 par value, 425 shares authorized,
zero and 425 shares issued and outstanding in 2010 and 2009, respectively

 

 

413,052

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Common stock, no par value, 300,000 shares authorized, 171,899 and 140,542 shares
issued and outstanding in 2010 and 2009, respectively

 

1,763,559

 

1,283,028

 

Accumulated other comprehensive loss

 

(4,713

)

(13,367

)

Retained earnings

 

541,072

 

358,215

 

Total shareholders’ equity

 

2,299,918

 

1,627,876

 

Commitments and contingencies

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$

3,888,665

 

$

3,783,388

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

3



Table of Contents

 

Whole Foods Market, Inc.

Consolidated Statements of Operations (unaudited)

(In thousands, except per share amounts)

 

 

 

Twelve weeks ended

 

Forty weeks ended

 

 

 

July 4,

 

July 5,

 

July 4,

 

July 5,

 

 

 

2010

 

2009

 

2010

 

2009

 

Sales

 

$

2,163,181

 

$

1,878,338

 

$

6,908,400

 

$

6,202,391

 

Cost of goods sold and occupancy costs

 

1,402,847

 

1,218,029

 

4,499,421

 

4,074,047

 

Gross profit

 

760,334

 

660,309

 

2,408,979

 

2,128,344

 

Direct store expenses

 

567,191

 

499,830

 

1,821,702

 

1,654,196

 

General and administrative expenses

 

68,153

 

52,592

 

206,629

 

192,024

 

Pre-opening expenses

 

8,692

 

10,763

 

33,137

 

38,616

 

Relocation, store closure and lease termination costs

 

728

 

18,209

 

10,452

 

27,937

 

Operating income

 

115,570

 

78,915

 

337,059

 

215,571

 

Interest expense

 

(7,421

)

(7,688

)

(25,757

)

(28,964

)

Investment and other income

 

1,543

 

1,326

 

5,236

 

2,528

 

Income before income taxes

 

109,692

 

72,553

 

316,538

 

189,135

 

Provision for income taxes

 

43,963

 

29,746

 

128,203

 

78,741

 

Net income

 

65,729

 

42,807

 

188,335

 

110,394

 

Preferred stock dividends

 

 

7,839

 

5,478

 

20,306

 

Income available to common shareholders

 

$

65,729

 

$

34,968

 

$

182,857

 

$

90,088

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

0.38

 

$

0.25

 

$

1.11

 

$

0.64

 

Weighted average shares outstanding

 

171,653

 

140,439

 

164,529

 

140,385

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per share

 

$

0.38

 

$

0.25

 

$

1.10

 

$

0.64

 

Weighted average shares outstanding, diluted basis

 

172,601

 

140,439

 

171,395

 

140,385

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

4



Table of Contents

 

Whole Foods Market, Inc.

Consolidated Statements of Shareholders’ Equity and Comprehensive Income (unaudited)

Forty weeks ended July 4, 2010 and fiscal year ended September 27, 2009

(In thousands)

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

other

 

 

 

Total

 

 

 

Shares

 

Common

 

comprehensive

 

Retained

 

shareholders’

 

 

 

outstanding

 

stock

 

income (loss)

 

earnings

 

equity

 

Balances at September 28, 2008

 

140,286

 

$

1,266,141

 

$

422

 

$

239,461

 

$

1,506,024

 

Net income

 

 

 

 

146,804

 

146,804

 

Foreign currency translation adjustments

 

 

 

(8,748

)

 

(8,748

)

Reclassification adjustments for amounts included in income, net of income taxes

 

 

 

8,440

 

 

8,440

 

Change in unrealized losses, net of income taxes

 

 

 

(13,481

)

 

(13,481

)

Comprehensive income

 

 

 

 

 

 

 

 

 

133,015

 

Redeemable preferred stock dividends

 

 

 

 

(28,050

)

(28,050

)

Issuance of common stock pursuant to team member stock plans

 

256

 

4,286

 

 

 

4,286

 

Excess tax benefit related to exercise of team member stock options

 

 

54

 

 

 

54

 

Share-based payment expense

 

 

12,795

 

 

 

12,795

 

Other

 

 

(248

)

 

 

(248

)

Balances at September 27, 2009

 

140,542

 

1,283,028

 

(13,367

)

358,215

 

1,627,876

 

Net income

 

 

 

 

188,335

 

188,335

 

Foreign currency translation adjustments

 

 

 

(1,009

)

 

(1,009

)

Reclassification adjustments for amounts included in income, net of income taxes

 

 

 

10,019

 

 

10,019

 

Change in unrealized losses, net of income taxes

 

 

 

(356

)

 

(356

)

Comprehensive income

 

 

 

 

 

 

 

 

 

196,989

 

Redeemable preferred stock dividends

 

358

 

5,195

 

 

(5,478

)

(283

)

Conversion of preferred stock

 

29,311

 

413,052

 

 

 

413,052

 

Issuance of common stock pursuant to team member stock plans

 

1,688

 

43,953

 

 

 

43,953

 

Excess tax benefit related to exercise of team member stock options

 

 

2,960

 

 

 

2,960

 

Share-based payment expense

 

 

15,371

 

 

 

15,371

 

Balances at July 4, 2010

 

171,899

 

$

1,763,559

 

$

(4,713

)

$

541,072

 

$

2,299,918

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

5



Table of Contents

 

Whole Foods Market, Inc.

Consolidated Statements of Cash Flows (unaudited)

(In thousands)

 

 

 

Forty weeks ended

 

 

 

July 4,

 

July 5,

 

 

 

2010

 

2009

 

Cash flows from operating activities

 

 

 

 

 

Net income

 

$

188,335

 

$

110,394

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

211,073

 

204,291

 

Loss (gain) on disposition of fixed assets

 

(756

)

2,138

 

Impairment of long-lived assets

 

2,020

 

22,164

 

Share-based payment expense

 

15,371

 

8,829

 

LIFO benefit

 

(6,519

)

(2,177

)

Deferred income tax expense (benefit)

 

(7,178

)

32,488

 

Excess tax benefit related to exercise of team member stock options

 

(2,817

)

 

Deferred lease liabilities

 

31,322

 

39,338

 

Other

 

(1,679

)

5,141

 

Net change in current assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(17,613

)

8,912

 

Merchandise inventories

 

(14,558

)

14,165

 

Prepaid expenses and other current assets

 

7,610

 

24,711

 

Accounts payable

 

13,722

 

(9,495

)

Accrued payroll, bonus and other benefits due team members

 

27,771

 

9,728

 

Other current liabilities

 

12,023

 

(270

)

Net change in other long-term liabilities

 

2,803

 

4,364

 

Net cash provided by operating activities

 

460,930

 

474,721

 

Cash flows from investing activities

 

 

 

 

 

Development costs of new locations

 

(143,379

)

(196,949

)

Other property and equipment expenditures

 

(56,388

)

(55,182

)

Purchase of available-for-sale securities

 

(888,947

)

 

Sale of available-for-sale securities

 

536,794

 

 

Increase in restricted cash

 

(15,791

)

(70,397

)

Payment for purchase of acquired entities, net of cash acquired

 

(14,450

)

 

Other investing activities

 

(1,075

)

(884

)

Net cash used in investing activities

 

(583,236

)

(323,412

)

Cash flows from financing activities

 

 

 

 

 

Preferred stock dividends paid

 

(8,500

)

(19,833

)

Issuance of common stock

 

43,896

 

2,705

 

Excess tax benefit related to exercise of team member stock options

 

2,817

 

 

Proceeds from issuance of redeemable preferred stock, net

 

 

413,052

 

Proceeds from long-term borrowings

 

 

123,000

 

Payments on long-term debt and capital lease obligations

 

(210,228

)

(320,980

)

Net cash provided by (used in) financing activities

 

(172,015

)

197,944

 

Effect of exchange rate changes on cash and cash equivalents

 

335

 

(2,752

)

Net change in cash and cash equivalents

 

(293,986

)

346,501

 

Cash and cash equivalents at beginning of period

 

430,130

 

30,534

 

Cash and cash equivalents at end of period

 

$

136,144

 

$

377,035

 

 

 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

Interest paid

 

$

38,494

 

$

42,059

 

Federal and state income taxes paid

 

$

136,195

 

$

27,647

 

Non-cash transaction:

 

 

 

 

 

Conversion of redeemable preferred stock into common stock

 

$

418,247

 

$

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

6



Table of Contents

 

Whole Foods Market, Inc.

Notes to Consolidated Financial Statements (unaudited)

July 4, 2010

 

(1) Basis of Presentation

 

The accompanying unaudited consolidated financial statements of Whole Foods Market, Inc. and its consolidated subsidiaries (collectively “Whole Foods Market,” “Company,” or “We”) have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial statements and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. The information included in this Form 10-Q should be read in conjunction with Management’s Discussion and Analysis, the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 27, 2009. In the opinion of management, the accompanying consolidated financial statements reflect all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation. Interim results are not necessarily indicative of results for any other interim period or for a full fiscal year. The Company reports its results of operations on a fifty-two or fifty-three week fiscal year ending on the last Sunday in September. The first fiscal quarter is sixteen weeks, the second and third quarters each are twelve weeks, and the fourth quarter is twelve or thirteen weeks. Fiscal years 2010 and 2009 are fifty-two week fiscal years. We have one operating segment and a single reportable segment, natural and organic foods supermarkets. The following is a summary of percentage sales by geographic area for the periods indicated:

 

 

 

Twelve weeks ended

 

Forty weeks ended

 

 

 

July 4,

 

July 5,

 

July 4,

 

July 5,

 

 

 

2010

 

2009

 

2010

 

2009

 

Sales:

 

 

 

 

 

 

 

 

 

United States

 

97.0

%

97.1

%

97.0

%

97.3

%

Canada and United Kingdom

 

3.0

%

2.9

%

3.0

%

2.7

%

Total sales

 

100.0

%

100.0

%

100.0

%

100.0

%

 

The following is a summary of the percentage of net long-lived assets by geographic area:

 

 

 

July 4,

 

September 27,

 

 

 

2010

 

2009

 

Long-lived assets, net:

 

 

 

 

 

United States

 

96.6

%

96.5

%

Canada and United Kingdom

 

3.4

%

3.5

%

Total long-lived assets, net

 

100.0

%

100.0

%

 

(2) Summary of Significant Accounting Policies

 

Fair Value Measurements

 

The Company records its financial assets and liabilities at fair value in accordance with the framework for measuring fair value in generally accepted accounting principles. This framework establishes a fair value hierarchy that prioritizes the inputs used to measure fair value:

 

·                  Level 1: Observable inputs that reflect unadjusted quoted prices for identical assets or liabilities traded in active markets.

·                  Level 2: Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.

·                  Level 3: Inputs that are generally unobservable. These inputs may be used with internally developed methodologies that result in management’s best estimate of fair value.

 

The Company holds money market fund investments that are classified as cash equivalents or restricted cash and available-for-sale securities generally consisting of state and local government obligations that are measured at fair value on a recurring basis based on quoted prices in active markets for identical assets. Investments are stated at fair value, based on quoted prices in active markets for identical assets, with unrealized gains and losses included as a component of shareholders’ equity until realized. The carrying amount of the Company’s interest rate swap agreement is measured at fair value on a recurring basis using a standard valuation model that incorporates inputs other than quoted prices that are observable, including interest rate curves. Declines in fair value below the Company’s carrying value deemed to be other than temporary are charged against net earnings.

 

The carrying amounts of trade and other accounts receivable, trade accounts payable, accrued payroll, bonuses and team member benefits, and other accrued expenses approximate fair value because of the short maturity of those instruments. Store

 

7



Table of Contents

 

closure reserves and estimated workers’ compensation claims are recorded at net present value to approximate fair value. The carrying amount of our five-year term loan approximates fair value because it has a variable interest rate which reflects market changes to interest rates and contains variable risk premiums based on the Company’s corporate ratings.

 

Effective September 28, 2009, the Company adopted the provisions of Accounting Standards Codification (“ASC”) 820, “Fair Value Measurements and Disclosures,” for nonfinancial assets and liabilities. Specifically, the Company measures certain property and equipment and intangible assets at fair value resulting from impairment as applicable. The fair value is determined using management’s best estimate based on a discounted cash flow model based on future store operating results using internal projections. When the Company determines assets related to an operating location are impaired, a charge to write down the related assets to fair value is included in the “Direct store expenses” line item on the Consolidated Statements of Operations. When the Company commits to relocate, close, or dispose of a location, a charge to write down the related assets is included in the “Relocation, store closure and lease termination costs” line item on the Consolidated Statements of Operations.

 

Effective January 18, 2010, the Company adopted the provisions of Accounting Standards Update (“ASU”) No. 2010-06, “Improving Disclosures about Fair Value Measurements.” Specifically, the Company updated the determination of a class of assets or liabilities for which separate fair value measurement should be disclosed and the need to disclose valuation techniques used to measure both recurring and nonrecurring Level 2 or Level 3 fair value measurements, based on clarified guidance. Expanded disclosures related to significant transfers in and out of Level 1 and Level 2, and the requirement related to the presentation of the Level 3 reconciliation are not applicable to the Company at July 4, 2010 as we had no transfers in valuation levels or Level 3 financial assets and liabilities.

 

Details on the fair value of the Company’s assets and liabilities recorded at fair value are included in Note 3 to the consolidated financial statements, “Fair Value Measurements.”

 

Recent Accounting Pronouncements

 

In December 2007, the Financial Accounting Standards Board (“FASB”) issued new guidance within ASC 805, “Business Combinations,” which replaces previous guidance on this topic and applies to all transactions or other events in which an entity obtains control of one or more businesses, including those sometimes referred to as “true mergers” or “mergers of equals” and combinations achieved without the transfer of consideration. The new provisions establish principles and requirements for how the acquirer recognizes and measures identifiable assets acquired, liabilities assumed, any noncontrolling interest and goodwill acquired, and also provide for disclosures to enable users of the financial statements to evaluate the nature and financial effects of the business combination. Additional amendments address the recognition and initial measurement, subsequent measurement, and disclosure of assets and liabilities arising from contingencies acquired as part of a business combination. The newly issued guidance is effective for fiscal years beginning after December 15, 2008 and is applied prospectively to business combinations completed on or after that date. The provisions are effective for the Company’s fiscal year ending September 26, 2010. We do not expect the adoption of these provisions to have a significant effect on our consolidated financial statements.

 

In April 2008, the FASB issued amendments to ASC 350, “Intangibles — Goodwill and Other.” These provisions amend the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. The intent of the position is to improve the consistency between the determination of the useful life of a recognized intangible asset and the period of expected cash flows used to measure the fair value of the asset. The amended guidance is effective for fiscal years beginning after December 15, 2008. These provisions are effective for the Company’s fiscal year ending September 26, 2010. We do not expect the adoption of these provisions to have a significant effect on our consolidated financial statements.

 

In March 2010, the FASB issued ASU No. 2010-11, “Derivatives and Hedging,” which amends ASC 815, “Derivatives and Hedging.” The amended guidance clarifies the scope exception for embedded credit derivative features related to the transfer of credit risk in the form of subordination of one financial instrument to another. The amendments address how to determine which embedded credit derivative features, including those in collateralized debt obligations and synthetic collateralized debt obligations, are considered to be embedded derivatives that should not be analyzed for potential bifurcation and separate accounting as well as under which circumstances embedded credit derivative features would not qualify for the scope exception and would be subject to potential bifurcation and separate accounting. The guidance provided in ASU No. 2010-11 is effective at the beginning of the Company’s first fiscal quarter beginning after June 15, 2010. ASU No. 2010-11 is effective for the Company’s fourth quarter of fiscal year ending September 26, 2010. We do not expect the adoption of this provision to affect our future consolidated financial statements.

 

8



Table of Contents

 

(3) Fair Value Measurements

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

The Company holds money market fund investments that are classified as either cash equivalents or restricted cash and available-for-sale marketable securities generally consisting of state and local government obligations that are measured at fair value on a recurring basis, based on current market prices. The Company’s interest rate swap agreement is measured at fair value on a recurring basis using a standard valuation model that incorporates expected interest rate curves. The Company held the following financial assets and liabilities at fair value, based on the hierarchy input levels indicated, on a recurring basis (in thousands):

 

July 4, 2010

 

Level 1 Inputs

 

Level 2 Inputs

 

Level 3 Inputs

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

Money market fund investments

 

$

112,701

 

$

 

$

 

$

112,701

 

Marketable securities — available-for-sale

 

352,290

 

 

 

352,290

 

Total

 

$

464,991

 

$

 

$

 

$

464,991

 

Liabilities:

 

 

 

 

 

 

 

 

 

Interest rate swap

 

$

 

$

5,177

 

$

 

$

5,177

 

 

September 27, 2009

 

Level 1 Inputs

 

Level 2 Inputs

 

Level 3 Inputs

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

Money market fund investments

 

$

509,395

 

$

 

$

 

$

509,395

 

Liabilities:

 

 

 

 

 

 

 

 

 

Interest rate swap

 

$

 

$

20,588

 

$

 

$

20,588

 

 

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

 

During the twelve and forty weeks ended July 4, 2010, the Company recorded fair value adjustments totaling approximately $0.1 million and $2.0 million, respectively, reducing the carrying value of related property and equipment to zero. Fair value adjustments were included in the following line items on the Consolidated Statements of Operations for the periods indicated (in thousands):

 

 

 

Twelve weeks ended

 

Forty weeks ended

 

 

 

July 4,

 

July 5,

 

July 4,

 

July 5,

 

 

 

2010

 

2009

 

2010

 

2009

 

Direct store expenses

 

$

127

 

$

125

 

$

1,106

 

$

14,494

 

Relocation, store closure and lease termination costs

 

18

 

5,782

 

914

 

6,483

 

Total impairment of fixed assets

 

$

145

 

$

5,907

 

$

2,020

 

$

20,977

 

 

(4) FTC Settlement Agreement

 

The Federal Trade Commission (“FTC”) challenged the Company’s August 28, 2007 acquisition of Wild Oats Markets, Inc. The Company reached a settlement agreement with the FTC and received final approval of the settlement agreement by the FTC Commissioners on June 1, 2009 after a 30-day public comment period. Under the terms of the agreement, a third-party divestiture trustee was appointed to market for sale until September 8, 2009:  leases and related assets for 19 non-operating former Wild Oats stores; leases and related fixed assets (excluding inventory) for 12 operating acquired Wild Oats stores and one operating Whole Foods Market store; and Wild Oats trademarks and other intellectual property associated with the Wild Oats stores.

 

Pursuant to the settlement agreement, the divestiture period was extended by the FTC until March 8, 2010 to allow for good faith offers that were not finalized for six operating and two non-operating former Wild Oats stores as well as Wild Oats trademarks and other intellectual property associated with the Wild Oats stores. At the conclusion of the divestiture period, the divestiture trustee submitted buyers awaiting FTC approval for a total of two operating and one non-operating former Wild Oats stores, as well as the Wild Oats trademarks and intellectual property. The FTC approved the sale of those properties and related intangible on June 18, 2010. These transactions were completed during the twelve weeks ended July 4, 2010. The 11 remaining operating stores and 18 non-operating stores have been retained by the Company without further obligation to attempt to divest.

 

Pursuant to the FTC’s approval of the final consent order, the Company recorded adjustments during the second half of fiscal year 2009 totaling approximately $4.8 million to measure long-lived assets and certain lease liabilities related to certain of the operating stores for which sale and transfer of the assets was determined to be probable or more likely than not at the lower of carrying amount or fair value less costs to sell. Additionally, the Company recorded adjustments totaling approximately $0.2 million and $3.0 million during the twelve and forty weeks ended July 4, 2010, respectively, to measure the disposed assets and liabilities at fair value.

 

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(5) Business Combination

 

Greenlife Grocery

 

On May 24, 2010, we completed the acquisition of certain assets of Greenlife Grocery, LLC (“Greenlife”) in exchange for approximately $14.5 million in cash plus the assumption of certain liabilities. The transaction has been recorded in accordance with ASC 805, “Business Combinations.” The assets acquired are all assets related to two natural foods supermarkets in Chattanooga, Tennessee and Asheville, North Carolina. Assets acquired included, but were not limited to, inventory, fixed assets, and the Greenlife trade name. The purchase price has been preliminarily allocated to tangible and identifiable intangible assets totaling approximately $5.4 million based on their estimated fair values at the date of acquisition. Total costs in excess of tangible and identifiable intangible assets acquired of approximately $9.5 million have been recorded as goodwill. Results of these acquired operations are included in our consolidated statements of operations for the period beginning May 25, 2010 through July 4, 2010.

 

(6) Property and Equipment

 

Balances of major classes of property and equipment are as follows (in thousands):

 

 

 

July 4,

 

September 27,

 

 

 

2010

 

2009

 

Land

 

$

48,928

 

$

48,928

 

Buildings and leasehold improvements

 

1,792,856

 

1,687,103

 

Capitalized real estate leases

 

24,874

 

24,874

 

Fixtures and equipment

 

1,299,582

 

1,187,195

 

Construction in progress and equipment not yet in service

 

80,334

 

130,068

 

 

 

3,246,574

 

3,078,168

 

Less accumulated depreciation and amortization

 

(1,358,264

)

(1,180,315

)

 

 

$

1,888,310

 

$

1,897,853

 

 

Depreciation expense related to property and equipment totaled approximately $61.8 and $203.1 million for the twelve and forty weeks ended July 4, 2010, respectively. During the same periods of the prior fiscal year, depreciation expense related to property and equipment totaled approximately $59.2 million and $195.6 million, respectively. Property and equipment included accumulated accelerated depreciation and other asset impairments totaling approximately $7.8 million and $9.6 million at July 4, 2010 and September 27, 2009, respectively. During the second quarter of fiscal year 2010, the Company sold certain land and idle buildings that had been held for sale totaling approximately $4.8 million at September 27, 2009. Total proceeds, net of closing costs, were approximately $8.0 million, resulting in a gain on the sale of assets of approximately $3.2 million. The gain was included in the “Relocation, store closure and lease termination costs” line item on the Consolidated Statements of Operations. Additionally, at July 4, 2010, the Company held approximately $1.8 million, net of accumulated depreciation, primarily related to certain leasehold improvements and fixtures held for sale included in the pending United Natural Foods, Inc. asset purchase agreement. These amounts are included in the “Prepaid expenses and other current assets” line item on the Consolidated Balance Sheets.

 

(7) Goodwill and Other Intangible Assets

 

Goodwill is reviewed for impairment annually at the beginning of the fourth fiscal quarter, or more frequently if impairment indicators arise. We allocate goodwill to one reporting unit for goodwill impairment testing. There were no impairments of goodwill during the forty weeks ended July 4, 2010 or July 5, 2009. During the twelve weeks ended July 4, 2010, the Company acquired goodwill totaling approximately $9.5 million related to the Greenlife acquisition. The Company recorded goodwill adjustments of approximately $2.6 million and $2.3 million, primarily related to actual exit costs of certain restructuring reserves related to the Wild Oats acquisition, during the forty weeks ended July 4, 2010 and July 5, 2009, respectively.

 

Indefinite-lived intangible assets are evaluated for impairment quarterly, or whenever events or changes in circumstances indicate the carrying amount may not be recoverable. There were no impairments of indefinite-lived intangible assets during the forty weeks ended July 4, 2010. During the forty weeks ended July 5, 2009, the Company recognized impairment charges totaling $0.4 million for liquor licenses related to locations included in the FTC settlement.

 

Definite-lived intangible assets are amortized over the useful life of the related agreement. We acquired definite-lived intangible assets totaling approximately $0.4 million, primarily consisting of intangibles associated with the Greenlife acquisition, and $0.9 million, primarily consisting of acquired leasehold rights, during the twelve and forty weeks ended July 4, 2010, respectively. During the twelve and forty weeks ended July 5, 2009 we acquired definite-lived intangible assets totaling approximately $0.9 million and $1.4 million, respectively, primarily consisting of acquired leasehold rights. There were no impairments of definite-lived intangible assets during the forty weeks ended July 4, 2010. The Company recorded

 

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Table of Contents

 

impairment charges related to certain definite-lived intangible assets during the twelve and forty weeks ended July 5, 2009 totaling approximately $0.5 million and $0.8 million, respectively. Asset impairment charges of approximately $0.5 million were related to the FTC settlement and included in the “Relocation, store closure and lease termination costs” line item on the Consolidated Statements of Operations, while approximately $0.3 million related to certain favorable lease assets and were included in the “Direct store expenses” line item on the Consolidated Statements of Operations. Amortization associated with intangible assets totaled approximately $1.4 million and $4.6 million for the twelve and forty weeks ended July 4, 2010, respectively, and approximately $2.4 million and $6.1 million for the same periods in the prior fiscal year, respectively.

 

The components of intangible assets were as follows (in thousands):

 

 

 

July 4, 2010

 

September 27, 2009

 

 

 

Gross carrying

 

Accumulated

 

Gross carrying

 

Accumulated

 

 

 

amount

 

amortization

 

amount

 

amortization

 

Indefinite-lived contract-based

 

$

1,646

 

$

 

$

1,566

 

$

 

Definite-lived contract-based

 

96,767

 

(29,430

)

96,515

 

(25,105

)

Definite-lived marketing-related and other

 

591

 

(211

)

225

 

(166

)

 

 

$

99,004

 

$

(29,641

)

$

98,306

 

$

(25,271

)

 

Amortization associated with the net carrying amount of intangible assets at July 4, 2010 is estimated to be $1.4 million for the remainder of fiscal year 2010, $5.8 million in fiscal year 2011, $5.8 million in fiscal year 2012, $4.9 million in fiscal year 2013, $4.8 million in fiscal year 2014, and $4.5 million in fiscal year 2015.

 

(8) Reserves for Closed Properties

 

Following is a summary of store closure reserves activity during the forty weeks ended July 4, 2010 and fiscal year ended September 27, 2009 (in thousands):

 

 

 

July 4,

 

September 27,

 

 

 

2010

 

2009

 

Beginning balance

 

$

69,228

 

$

69,269

 

Additions

 

4,148

 

8,276

 

Usage

 

(14,645

)

(17,841

)

Adjustments

 

4,990

 

9,524

 

Ending balance

 

$

63,721

 

$

69,228

 

 

Additions to store closure reserves relate to the accretion of interest on existing reserves and new closures. During the forty weeks ended July 4, 2010, the Company did not record any additional reserves related to new closures. The Company recorded reserves totaling approximately $2.7 million related to five new closures during the fiscal year ended September 27, 2009. Usage included approximately $4.6 million and $4.2 million in termination fees related to certain idle properties, and approximately $10.1 million and $13.7 million in ongoing cash rental payments during the forty weeks ended July 4, 2010 and fiscal year ended September 27, 2009, respectively. During the forty weeks ended July 4, 2010 and fiscal year ended September 27, 2009, the Company recognized charges for net adjustments of approximately $7.6 million and $12.9 million, respectively, related to increases in reserves primarily due to changes in certain subtenant income estimates related to the continued depression in the commercial real estate market, which are included on the accompanying Consolidated Statements of Operations under the caption “Relocation, store closure and lease termination costs.” Additionally, the Company recorded goodwill adjustments of approximately $2.6 million during the forty weeks ended July 4, 2010 and fiscal year ended September 27, 2009.

 

(9) Long-Term Debt

 

The Company entered into a $700 million, five-year term loan agreement that expires in 2012. During the twelve weeks ended July 4, 2010 the Company repaid the $210 million portion of the term loan that was not subject to an interest rate swap agreement. At July 4, 2010, the Company has outstanding $490 million under this agreement. The loan bears interest at our option of the alternative base rate (“ABR”) plus an applicable margin, currently 0.75%, or LIBOR plus an applicable margin, currently 1.75%, based on the Company’s Moody’s and S&P rating. These applicable margins are currently the maximum allowed under these agreements. The interest period on LIBOR borrowings may range from one to six months at our option. The participating banks hold security interests in certain of the Company’s assets to collateralize amounts outstanding under the term loan. The term loan agreement contains certain affirmative covenants including maintenance of certain financial ratios and certain negative covenants including limitations on additional indebtedness and payments as defined in the agreement. At July 4, 2010 we were in compliance with all applicable debt covenants.

 

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The Company also has outstanding a $350 million revolving line of credit that extends to 2012. All outstanding amounts borrowed under this agreement bear interest at our option of the ABR plus an applicable margin, currently 0.875%, or LIBOR plus an applicable margin, currently 1.875%, based on the Company’s Moody’s and S&P rating. These applicable margins are currently the maximum allowed under these agreements. The participating banks hold security interests in certain of the Company’s assets to collateralize amounts outstanding under the revolving credit facility. The credit agreement contains certain affirmative covenants including maintenance of certain financial ratios and certain negative covenants including limitations on additional indebtedness and payments as defined in the agreement. Commitment fees on the undrawn amount, reduced by outstanding letters of credit, are payable under this agreement. At July 4, 2010 and September 27, 2009 the Company had no amounts drawn under this agreement. The amount available to the Company under the agreement was effectively reduced to approximately $341.4 million and $335.2 million by outstanding letters of credit totaling approximately $8.6 million and $14.8 million at July 4, 2010 and September 27, 2009, respectively.

 

During fiscal year 2008, the Company entered into an interest rate swap agreement, which expires in October 2010, with a notional amount of $490 million to effectively fix the interest rate on $490 million of the term loan at 4.718%, excluding the applicable margin and associated fees, to help manage cash flow exposure related to interest rate fluctuations. The interest rate swap was designated as a cash flow hedge. Hedge ineffectiveness was not material during the forty weeks ended July 4, 2010 or the same period of the prior fiscal year.

 

The interest rate swap agreement does not contain a credit-risk-related contingent feature. The carrying amount of the Company’s interest rate swap totaled approximately $5.2 million and $20.6 million at July 4, 2010 and September 27, 2009, respectively. The Company had accumulated net derivative losses of approximately $3.1 million and $12.6 million, net of taxes, in accumulated other comprehensive income as of July 4, 2010 and September 27, 2009, respectively, related to this cash flow hedge. These losses are being recognized as an adjustment to interest expense over the same period in which the interest costs on the related debt are recognized. During the twelve and forty weeks ended July 4, 2010 the Company had reclassified approximately $5.0 million and $16.9 million, respectively, from accumulated other comprehensive income related to ongoing interest payments that was included in the “Interest expense” line item on the Consolidated Statements of Operations. During the twelve and forty weeks ended July 5, 2009 the Company had reclassified approximately $4.1 million and $9.7 million, respectively, from accumulated other comprehensive income related to ongoing interest payments. The Company expects to reclass approximately $5.2 million from accumulated other comprehensive income to interest expense over the remaining life of the agreement.

 

(10) Equity

 

Redeemable Preferred Stock

 

During the first quarter of fiscal year 2009, the Company issued 425,000 shares of Series A 8% Redeemable, Convertible Exchangeable Participating Preferred Stock, $0.01 par value per share (“Series A Preferred Stock”) to affiliates of Leonard Green & Partners, L.P., for approximately $413.1 million, net of approximately $11.9 million in closing and issuance costs. The Series A Preferred Stock was classified as temporary shareholders’ equity at September 27, 2009 since the shares were (i) redeemable at the option of the holder and (ii) had conditions for redemption which are not solely within the control of the Company. The holders of the Series A Preferred Stock were entitled to an 8% dividend, payable quarterly on the first day of each calendar quarter in cash. The Company paid cash dividends on the Series A Preferred Stock totaling zero and $8.5 million during the twelve and forty weeks ended July 4, 2010. During the twelve and forty weeks ended July 5, 2009 the Company paid cash dividends on the Series A Preferred Stock totaling $8.5 million and approximately $19.8 million, respectively.

 

On October 23, 2009 the Company announced its intention to call all 425,000 outstanding shares of the Series A Preferred Stock for redemption on November 27, 2009 in accordance with the terms governing such Series A Preferred Stock. On November 26, 2009 the holders converted all 425,000 outstanding shares of the Series A Preferred Stock. The Series A Preferred Stock was converted to common stock based on the quotient of (i) the liquidation preference plus accrued dividends and (ii) 1,000, multiplied by the conversion rate of 68.9655. At the conversion date, the liquidation preference of the Series A Preferred Stock of $425 million and accrued dividends of approximately $5.2 million converted into approximately 29.7 million shares of common stock of the Company.

 

Restricted Stock Issuance

 

On May 14, 2010 the Company awarded approximately 98,000 shares of restricted common stock pursuant to the Whole Foods Market 2009 Stock Incentive Plan. Fair value of the restricted share issuance on grant date totaled approximately $4.0 million. The stock will fully vest and all restrictions will lapse on August 14, 2010. The Company recorded approximately $2.3 million of share-based payment expense related to this transaction during the twelve weeks ended July 4, 2010. For further information, see Note 13 to the consolidated financial statements, “Share-Based Payments.”

 

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Table of Contents

 

(11) Comprehensive Income

 

Our comprehensive income was comprised of net income; unrealized gains and losses on investments; unrealized gains and losses on cash flow hedge instruments, including reclassification adjustments of unrealized losses to net income related to ongoing interest payments; and foreign currency translation adjustments, net of income taxes. Comprehensive income, net of related tax effects, was as follows (in thousands):

 

 

 

Twelve weeks ended

 

Forty weeks ended

 

 

 

July 4,

 

July 5,

 

July 4,

 

July 5,

 

 

 

2010

 

2009

 

2010

 

2009

 

Net income

 

$

65,729

 

$

42,807

 

$

188,335

 

$

110,394

 

Foreign currency translation adjustments, net

 

(2,803

)

6,113

 

(1,009

)

(9,588

)

Reclassification adjustments for amounts included in net income

 

2,994

 

2,391

 

10,019

 

5,674

 

Unrealized gains (losses), net

 

277

 

(1,669

)

(356

)

(11,667

)

Comprehensive income

 

$

66,197

 

$

49,642

 

$

196,989

 

$

94,813

 

 

Unrealized gains on investments, net of tax, totaled approximately $230,000 and $280,000 for the twelve and forty weeks ended July 4, 2010, respectively. Unrealized losses on investments, net of tax, totaled approximately $60,000 and $170,000 over the same periods. At July 4, 2010, accumulated other comprehensive loss consisted of foreign currency translation adjustment losses of approximately $1.7 million and unrealized losses on cash flow hedge instruments and investments of approximately $3.0 million, net of related income tax effect of approximately $2.1 million.

 

(12) Earnings per Share

 

The computation of basic earnings per share is based on the number of weighted average common shares outstanding during the period. The computation of diluted earnings per share for the twelve and forty weeks ended July 4, 2010 includes the dilutive effect of common stock equivalents consisting of incremental common shares deemed outstanding from the assumed exercise of stock options. Additionally, the computation of diluted earnings per share for the forty weeks ended July 4, 2010 includes the assumed conversion of Series A Preferred Stock.

 

A reconciliation of the numerators and denominators of the basic and diluted earnings per share calculations follows (in thousands, except per share amounts):

 

 

 

Twelve weeks ended

 

Forty weeks ended

 

 

 

July 4,

 

July 5,

 

July 4,

 

July 5,

 

 

 

2010

 

2009

 

2010

 

2009

 

Income available to common shareholders
(numerator for basic earnings per share)

 

$

65,729

 

$

34,968

 

$

182,857

 

$

90,088

 

Preferred stock dividends

 

 

 

5,478

 

 

Adjusted income available to common shareholders
(numerator for diluted earnings per share)

 

$

65,729

 

$

34,968

 

$

188,335

 

$

90,088

 

Weighted average common shares outstanding
(denominator for basic earnings per share)

 

171,653

 

140,439

 

164,529

 

140,385

 

Potential common shares outstanding:

 

 

 

 

 

 

 

 

 

Incremental shares from assumed exercise of stock options

 

948

 

 

690

 

 

Assumed conversion of redeemable preferred stock

 

 

 

6,176

 

 

Weighted average common shares outstanding and potential additional common shares outstanding
(denominator for diluted earnings per share)

 

172,601

 

140,439

 

171,395

 

140,385

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

0.38

 

$

0.25

 

$

1.11

 

$

0.64

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per share

 

$

0.38

 

$

0.25

 

$

1.10

 

$

0.64

 

 

The computation of diluted earnings per share for the twelve and forty weeks ended July 4, 2010 does not include options to purchase approximately 13.6 million shares and 12.7 million shares of common stock, respectively, due to their antidilutive effect. For the twelve and forty weeks ended July 5, 2009, the computation of diluted earnings per share does not include options to purchase approximately 16.0 million shares and 16.7 million shares of common stock, respectively, or the conversion of Series A Preferred Stock to approximately 29.3 million shares and 22.5 million shares of common stock, respectively, due to their antidilutive effect.

 

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Table of Contents

 

(13) Share-Based Payments

 

Our Company maintains several stock based incentive plans. We grant options to purchase common stock under our Whole Foods Market 2009 Stock Incentive Plan. Under this plan, options are granted at an option price equal to the closing price of the Company’s common stock on the grant date and generally vest ratably over a four-year period beginning one year from grant date and have a five or seven year term. During the twelve weeks ended July 4, 2010, the Company also granted options that vest over a nine-year period beginning one year from grant date, and have a ten year term. On July 4, 2010 and September 27, 2009 there were approximately 12.7 million and 15.4 million shares of our common stock, respectively, available for future stock option grants.

 

Our Company also offers a team member stock purchase plan to all full-time team members with a minimum of 400 hours of service. Participating team members may purchase Company common stock through payroll deductions. The plan provides for a 5% discount from the shares market value on the share purchase date which meets the share-based payment “Safe Harbor” provisions, and therefore is non-compensatory.

 

As of July 4, 2010 there was approximately $65.9 million of unrecognized share-based payment expense related to nonvested stock options, net of estimated forfeitures, related to approximately 5.7 million shares. We anticipate this expense to be recognized over a weighted average period of 3.44 years. To the extent the forfeiture rate is different than what we have anticipated, share-based payment expense related to these awards will differ from our expectations.

 

Share-based payment expense recognized during the twelve and forty weeks ended July 4, 2010 totaled approximately $6.2 million and $15.4 million, respectively, which included approximately $3.9 million and $13.1 million, respectively, related to stock options. Share-based payment expense for the twelve and forty weeks ended July 4, 2010 also included approximately $2.3 million associated with awards of restricted common stock and is included in the “General and administrative expenses” line item on the Consolidated Statements of Operations. Share-based payment expense recognized during the twelve and forty weeks ended July 5, 2009 totaled approximately $2.7 million and $8.8 million, respectively, and related entirely to stock options. Share-based payment expense was included in the following line items on the Consolidated Statements of Operations for the periods indicated (in thousands):

 

 

 

Twelve weeks ended

 

Forty weeks ended

 

 

 

July 4,

 

July 5,

 

July 4,

 

July 5,

 

 

 

2010

 

2009

 

2010

 

2009

 

Cost of goods sold and occupancy costs

 

$

194

 

$

102

 

$

579

 

$

274

 

Direct store expenses

 

2,047

 

1,416

 

7,342

 

4,883

 

General and administrative expenses

 

3,957

 

1,169

 

7,450

 

3,672

 

Share-based payment expense before income taxes

 

6,198

 

2,687

 

15,371

 

8,829

 

Income tax benefit

 

(2,547

)

(1,121

)

(6,202

)

(3,612

)

Net share-based payment expense

 

$

3,651

 

$

1,566

 

$

9,169

 

$

5,217

 

 

On May 14, 2010, the Company issued its annual grant of options to team members and directors. The following table summarizes option activity during the first three quarters of fiscal year 2010:

 

 

 

 

 

 

 

Weighted

 

 

 

 

 

Number

 

 

 

average

 

Aggregate

 

 

 

of options

 

Weighted

 

remaining

 

intrinsic

 

 

 

outstanding

 

average

 

contractual life

 

value

 

 

 

(in thousands)

 

exercise price

 

(in years)

 

(in thousands)

 

Outstanding options at September 27, 2009

 

18,317

 

$

45.24

 

 

 

 

 

Options granted

 

3,128

 

40.80

 

 

 

 

 

Options exercised

 

(1,501

)

27.49

 

 

 

 

 

Options forfeited

 

(238

)

28.08

 

 

 

 

 

Options expired

 

(379

)

55.68

 

 

 

 

 

Outstanding options at July 4, 2010

 

19,327

 

$

45.91

 

3.21

 

$

53,455

 

Options vested and expected to vest

 

18,670

 

$

46.31

 

3.09

 

$

47,811

 

Exercisable options at July 4, 2010

 

12,967

 

$

52.71

 

1.91

 

$

14,855

 

 

The weighted average fair value of options granted during fiscal year 2010 was $16.60. The aggregate intrinsic value of stock options at exercise, represented in the table above, for the forty weeks ended July 4, 2010 was approximately $12.3 million.

 

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Table of Contents

 

The fair value of stock option grants has been estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:

 

 

 

2010

 

2009

 

Expected dividend yield

 

0.00

%

0.00

%

Risk-free interest rate

 

2.26

%

1.56

%

Expected volatility

 

46.19

%

52.31

%

Expected life, in years

 

4.56

 

3.97

 

 

Risk-free interest rate is based on the US Treasury yield curve on the date of the grant for the time period equal to the expected term. Expected life is calculated in tranches based on weighted average percentage of unexpired options and exercise-after-vesting information over the last four years. Unvested options are included in the term calculation using the “mid-point scenario” which assumes that unvested options will be exercised halfway between vest and expiration date. Expected volatility is calculated using a ratio of implied volatility, derived through the Newton-Raphson method of bisection, and four or six-year historical volatilities based on the expected life of each tranche of options. The Company determined the use of both implied volatility and historical volatility represents a more consistent and accurate calculation of option fair value. The assumptions used to calculate the fair value of options granted are evaluated and revised, as necessary, to reflect market conditions and experience.

 

In addition to the above valuation assumptions, the Company is required to estimate an annual forfeiture rate for unvested options and true up fair value expense accordingly. The Company monitors actual forfeiture experience and adjusts the rate from time to time as necessary.

 

(14) Commitments and Contingencies

 

The Company uses a combination of insurance and self-insurance plans to provide for the potential liabilities for workers’ compensation, general liability, property insurance, director and officers’ liability insurance, vehicle liability, and employee health care benefits. Liabilities associated with the risks that are retained by the Company are estimated, in part, by considering historical claims experience, demographic factors, severity factors and other actuarial assumptions. While we believe that our assumptions are appropriate, the estimated accruals for these liabilities could be significantly affected if future occurrences and claims differ from these assumptions and historical trends.

 

From time to time we are a party to legal proceedings including matters involving personnel and employment issues, personal injury, intellectual property, real estate and other proceedings arising in the ordinary course of business. The Company has established loss provisions for matters in which losses are probable and the amount of loss can be reasonably estimated. The Company does not believe that any of these proceedings arising in the ordinary course of business, either alone or in the aggregate, will have a material adverse effect on the Company’s results of operations, cash flows or financial condition. Although management does not expect that the outcome in these proceedings will have a material adverse effect on our financial condition or results of operations, litigation is inherently unpredictable. Therefore, we could incur judgments or enter into settlements of claims that could materially impact our results.

 

On October 27, 2008, Whole Foods Market was served with the complaint in Kottaras v. Whole Foods Market, Inc., a putative class action filed in the United States District Court for the District of Columbia, seeking treble damages, equitable, injunctive, and declaratory relief and alleging that the acquisition and merger between Whole Foods Market and Wild Oats violates various provisions of the federal antitrust laws. This case is in the preliminary stages. Whole Foods Market cannot at this time predict the likely outcome of this judicial proceeding or estimate the amount or range of loss or possible loss that may arise from it. The Company has not accrued any loss related to the outcome of this case as of July 4, 2010.

 

(15) Subsequent Events

 

The Company evaluated subsequent events and transactions for potential recognition or disclosure in the financial statements through the date the financial statements were issued.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

We wish to caution you that there are risks and uncertainties that could cause our actual results to be materially different from those indicated by forward-looking statements that we make from time to time in filings with the Securities and Exchange Commission (“SEC”), news releases, reports, proxy statements, registration statements and other written communications, as well as oral forward-looking statements made from time to time by representatives of our Company. These risks and uncertainties include those listed in the Company’s Annual Report on Form 10-K for the fiscal year ended September 27, 2009. These risks and uncertainties and additional risks and uncertainties not presently known to us or that we currently deem immaterial may cause our business, financial condition, operating results and cash flows to be materially adversely affected. Except for the historical information contained herein, the matters discussed in this analysis are forward-looking statements that involve risks and uncertainties, including general business conditions, changes in overall economic conditions that impact consumer spending, including fuel prices and housing market trends, the impact of competition, and other factors which are often beyond the control of the Company. The Company does not undertake any obligation to update forward-looking statements except as required by law.

 

General

 

Whole Foods Market, Inc. is the leading natural and organic foods supermarket and America’s first national “Certified Organic” grocer. Our Company mission is to promote vitality and well-being for all individuals by supplying the highest quality, most wholesome foods available. Through our growth, we have had a significant and positive impact on the natural and organic foods movement throughout the United States, helping lead the industry to nationwide acceptance. We opened our first store in Texas in 1980 and, as of July 4, 2010, we operated 298 stores: 287 stores in 38 U.S. states and the District of Columbia; six stores in Canada; and five stores in the United Kingdom. We have one operating segment, natural and organic foods supermarkets.

 

Our results of operations have been and may continue to be materially affected by the timing and number of new store openings. Stores typically open within two years after entering the store development pipeline. New stores generally become profitable during their first year of operation; although some new stores may incur operating losses for the first several years of operation. The Company historically has experienced lower average weekly sales in the fourth quarter, which typically results in lower gross profit and higher direct store expenses as a percentage of sales.

 

Sales of a store are deemed to be comparable commencing in the fifty-third full week after the store was opened or acquired. Identical store sales exclude sales from relocated stores and remodeled stores with changes in square footage greater than 20% from the comparable calculation to reduce the impact of square footage growth on the comparison. Stores closed for eight or more days are excluded from the comparable and identical store base from the first fiscal week of closure until re-opened for a full fiscal week.

 

The Company reports its results of operations on a fifty-two or fifty-three week fiscal year ending on the last Sunday in September. Fiscal years 2010 and 2009 are fifty-two week years.

 

Economic and Industry Factors

 

Food retailing is a large, intensely competitive industry. Our competition varies across the Company and includes but is not limited to local, regional, national and international conventional and specialty supermarkets, natural foods stores, warehouse membership clubs, smaller specialty stores, farmers’ markets, and restaurants, each of which competes with us on the basis of product selection, quality, customer service, price or a combination of these factors. Natural and organic food continues to be one of the fastest growing segments of food retailing today.

 

Our 8.4% identical store sales growth for the twelve weeks ended July 4, 2010 was driven primarily by transaction count along with a 1% increase in basket size. We believe our transaction count increases are being driven by a combination of our loyal customers shopping with us more frequently, prior customers returning to shop with us, and an increasing number of new customers entering our doors. Our increase in basket size was driven entirely by customers putting more items in their baskets. We have worked hard to improve our value image and believe our success in this regard has played a large role in the sales momentum we are seeing. The pass-through of select product cost increases was more than offset by our continued strategic price investments. Customers are still seeking value as demonstrated by continued strong sales growth in promotional and private label items; however, branded product sales growth is outpacing private label growth, and customers are selectively trading up to higher-priced items in certain areas.

 

Our internal benchmarking research indicates continued improvement in our price competitiveness during the twelve weeks ended July 4, 2010 relative to our regional and national competitors. Whole Foods Market is being looked at differently in

 

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this area according to our Nielsen study which shows improving trends in consumer sentiment around our value efforts and, even more importantly, as reflected in our continued strong sales growth relative to most other food retailers.

 

Outlook for Fiscal Year 2010

 

The following table provides additional information on the Company’s results through July 4, 2010 and expectations for the fourth quarter and fiscal year 2010:

 

 

 

 

 

Estimated

 

 

 

 

 

Forty weeks ended

 

fourth quarter

 

Estimated

 

 

 

July 4, 2010

 

fiscal year 2010

 

fiscal year 2010

 

Sales growth

 

11.4%

 

12.8% — 13.8%

 

11.7% — 11.9%

 

Comparable store sales growth

 

6.7%

 

6.5% — 7.5%

 

6.6% — 6.8%

 

Identical store sales growth

 

5.9%

 

6.5% — 7.5%

 

6.0% — 6.2%

 

General and administrative expenses excluding FTC-related legal costs

 

2.9%

 

3.2%

 

3.0%

 

Pre-opening and relocation costs

 

$43.6 million

 

$8.0 — $9.5 million

 

$51 — $53 million

 

Diluted earnings per share

 

$1.10

 

$0.27 — $0.29

 

$1.37 — $1.39

 

Capital expenditures

 

$199.8 million

 

$50 — $60 million

 

$250 — $260 million

 

 

Results of Operations

 

The following table sets forth the Company’s statements of operations data expressed as a percentage of sales:

 

 

 

Twelve weeks ended

 

Forty weeks ended

 

 

 

July 4,

 

July 5,

 

July 4,

 

July 5,

 

 

 

2010

 

2009

 

2010

 

2009

 

Sales

 

100.0

%

100.0

%

100.0

%

100.0

%

Cost of goods sold and occupancy costs

 

64.9

 

64.8

 

65.1

 

65.7

 

Gross profit

 

35.1

 

35.2

 

34.9

 

34.3

 

Direct store expenses

 

26.2

 

26.6

 

26.4

 

26.7

 

General and administrative expenses

 

3.2

 

2.8

 

3.0

 

3.1

 

Pre-opening expenses

 

0.4

 

0.6

 

0.5

 

0.6

 

Relocation, store closure and lease termination costs

 

 

1.0

 

0.2

 

0.5

 

Operating income

 

5.3

 

4.2

 

4.9

 

3.5

 

Interest expense

 

(0.3

)

(0.4

)

(0.4

)

(0.5

)

Investment and other income

 

0.1

 

0.1

 

0.1

 

 

Income before income taxes

 

5.1

 

3.9

 

4.6

 

3.0

 

Provision for income taxes

 

2.0

 

1.6

 

1.9

 

1.3

 

Net income

 

3.0

 

2.3

 

2.7

 

1.8

 

Preferred stock dividends

 

 

0.4

 

0.1

 

0.3

 

Income available to common shareholders

 

3.0

%

1.9

%

2.6

%

1.5

%

 

Figures may not sum due to rounding.

 

Sales increased approximately 15.2% and 11.4% for the twelve and forty weeks ended July 4, 2010, respectively, over the same periods of the prior fiscal year. Comparable store sales increased 8.8% and 6.7% for the twelve and forty weeks ended July 4, 2010, respectively, and identical store sales increased 8.4% and 5.9%, respectively. As of July 4, 2010, there were 280 locations in the comparable store base. Identical store sales for the twelve weeks ended July 4, 2010 exclude three relocated stores from the comparable calculation to reduce the impact of square footage growth on the comparison. Identical store sales for the forty weeks ended July 4, 2010 exclude five relocated stores and two major expansions. The number of stores open or acquired fifty-two weeks or less equaled 20 at July 4, 2010. The sales increase contributed by stores open or acquired fifty-two weeks or less totaled approximately $164.0 million and $244.8 million for the twelve and forty weeks ended July 4, 2010, respectively.

 

The Company’s gross profit as a percentage of sales for the twelve and forty weeks ended July 4, 2010 was approximately 35.1% and 34.9%, respectively, compared to approximately 35.2% and 34.3% for the same periods of the prior fiscal year, respectively. For the twelve and forty weeks ended July 4, 2010, the Company recognized LIFO credits totaling approximately $3.7 million and $6.5 million, respectively, compared to credits totaling approximately $5.8 million and $2.2 million for the same periods of the prior fiscal year, respectively. Excluding the impact of LIFO, gross margin increased 13 basis points for the twelve weeks ended July 4, 2010 compared to the same period of the prior fiscal year due to an

 

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improvement in occupancy costs which helped offset slightly higher cost of goods sold as a percentage of sales. Now that we have fully cycled over the shift in our pricing strategy that occurred in the first half of 2009, we are not generating the same level of year-over-year improvement in gross margin as we saw in the first half of the year. In addition, we made strategic pricing decisions on select teams during the twelve weeks ended July 4, 2010 to position ourselves competitively in the marketplace. Our gross profit may vary throughout the year depending on the mix of sales from new stores, seasonality, the impact of weather or a host of other factors, including inflation or deflation.

 

Direct store expenses as a percentage of sales for the twelve and forty weeks ended July 4, 2010 were approximately 26.2% and 26.4%, respectively, compared to approximately 26.6% and 26.7% for the same periods of the prior fiscal year, respectively. The decrease in direct store expenses as a percentage of sales for the twelve weeks ended July 4, 2010 was driven by reductions in salaries and benefits and depreciation expense as a percentage of sales. During the forty weeks ended July 5, 2009 the Company recorded impairment charges on long-lived assets related to operating locations totaling approximately $14.5 million.

 

General and administrative expenses as a percentage of sales for the twelve and forty weeks ended July 4, 2010 were approximately 3.2% and 3.0%, respectively, compared to approximately 2.8% and 3.1% for the same periods of the prior fiscal year, respectively. FTC-related legal costs incurred during the twelve and forty weeks ended July 4, 2010 totaled approximately $1.4 million and $3.0 million, respectively, compared to approximately $0.4 million and $14.2 million for the same periods of the prior fiscal year, respectively.

 

Share-based payment expense was included in the following line items on the Consolidated Statements of Operations for the periods indicated (in thousands):

 

 

 

Twelve weeks ended

 

Forty weeks ended

 

 

 

July 4,

 

July 5,

 

July 4,

 

July 5,

 

 

 

2010

 

2009

 

2010

 

2009

 

Cost of goods sold and occupancy costs

 

$

194

 

$

102

 

$

579

 

$

274

 

Direct store expenses

 

2,047

 

1,416

 

7,342

 

4,883

 

General and administrative expenses

 

3,957

 

1,169

 

7,450

 

3,672

 

Share-based payment expense before income taxes

 

6,198

 

2,687

 

15,371

 

8,829

 

Income tax benefit

 

(2,547

)

(1,121

)

(6,202

)

(3,612

)

Net share-based payment expense

 

$

3,651

 

$

1,566

 

$

9,169

 

$

5,217

 

 

Pre-opening expenses as a percentage of sales for the twelve and forty weeks ended July 4, 2010 were approximately 0.4% and 0.5%, respectively, compared to approximately 0.6% for each of the same periods of the prior fiscal year. Currently, rent expense generally has been incurred beginning approximately 11 months prior to a store’s opening date as compared to approximately 13 months for stores opened during fiscal year 2009.

 

Relocation, store closure and lease termination costs as a percentage of sales for the twelve and forty weeks ended July 4, 2010 were approximately 0.0% and 0.2%, respectively, compared to approximately 1.0% and 0.5% for the same periods of the prior fiscal year, respectively. During the twelve weeks ended July 4, 2010, the Company recorded credit adjustments to reduce expected future lease termination costs totaling approximately $0.8 million due to lower estimated future lease-related costs on certain properties. During the forty weeks ended July 4, 2010, the Company recorded net adjustments to lease termination costs totaling approximately $7.6 million. Adjustments totaling approximately $9.7 million and $13.5 million were recorded for the twelve and forty weeks ended July 5, 2009, respectively, to increase reserves for closed properties due to the downturn in the real estate market and actual exit costs. During the forty weeks ended July 4, 2010 the Company recognized a gain of approximately $3.2 million from the sale of a non-operating property and a reduction in store closure reserve liabilities of approximately $2.5 million related to two stores to be sold under the FTC settlement and one early lease termination. During the twelve and forty weeks ended July 5, 2009, the Company recorded non-cash asset impairment charges included in store closure costs totaling approximately $6.7 million and $7.4 million, respectively, including approximately $5.2 million during the third quarter related to the potential sale of certain operating store assets under the FTC settlement agreement. The Company continues to evaluate store closure reserve adjustments primarily related to changes in certain subtenant income estimates driven by the outlook for the commercial real estate market.

 

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The number of stores opened and relocated were as follows:

 

 

 

Twelve weeks ended

 

Forty weeks ended

 

 

 

July 4,

 

July 5,

 

July 4,

 

July 5,

 

 

 

2010

 

2009

 

2010

 

2009

 

New stores

 

6

 

1

 

15

 

6

 

Relocated stores

 

 

3

 

 

6

 

 

Interest expense for the twelve and forty weeks ended July 4, 2010 totaled approximately $7.4 million and $25.8 million, respectively, compared to approximately $7.7 million and $29.0 million for the same periods of the prior fiscal year, respectively. The decrease in interest expense for the forty weeks ended July 4, 2010 compared to the same period of the prior year is due primarily to interest expense related to amounts outstanding on the Company’s revolving line of credit during the first quarter of fiscal year 2009 as well as the repayment of the $210 million portion of the Company’s $700 million term loan during the twelve weeks ended July 4, 2010. The Company had no amounts outstanding on its revolving line of credit during the forty weeks ended July 4, 2010.

 

Investment and other income, which includes investment gains and losses, interest income, rental income and other income, totaled approximately $1.5 million and $5.2 million for the twelve and forty weeks ended July 4, 2010, respectively, compared to approximately $1.3 million and $2.5 million for the same periods of the prior fiscal year, respectively. The increases were due primarily to investment income earned on investments in available-for-sale securities during fiscal year 2010.

 

Income taxes for the twelve and forty weeks ended July 4, 2010 resulted in an effective tax rate of approximately 40.1% and 40.5%, respectively, compared to approximately 41.0% and 41.6% for the same periods of the prior fiscal year, respectively.

 

Liquidity and Capital Resources and Changes in Financial Condition

 

The following table summarizes the Company’s cash and short-term investments (in thousands):

 

 

 

July 4,

 

September 27,

 

 

 

2010

 

2009

 

Cash and cash equivalents

 

$

136,144

 

$

430,130

 

Short-term investments – available-for-sale securities

 

294,926

 

 

Restricted cash

 

86,814