Whole Foods Market Q3 Earnings Call Transcript

123jump.com Staff
01 Aug, 2011
New York City

The natural and organic foods supermarket said quarterly sales increased 11% to $2.4 billion. Comparable store sales rose 8.4% or 17.2% on a two-year stacked basis. Net quarterly income surged 35% to $88.5 million. Earnings per share grew to 50 cents versus 38 cents per share a year-ago quarter.

Whole Foods Market, Inc. ((WFM))
Q3 2011 Earnings Call Transcript
July 27, 2011 5 p.m. ET

Executives

Cindy McCann – Vice President, Investor Relations
Walter Robb – Co-Chief Executive Officer
John P. Mackey – Co-Chief Executive Officer
Glenda Flanagan – Executive Vice President and Chief Financial Officer
James P. Sud – Executive Vice President, Growth and Business Development

Analysts

John Heinbockel – Guggenheim Securities
Karen Short – BMO Capital Markets
Mark Miller – William Blair & Company
Scott Mushkin – Jefferies & Company
Edward Aaron – RBC Capital Markets
Stephen Grambling – Goldman Sachs
Robert Summers – Susquehanna Financial Group

Presentation

Operator

Good day ladies and gentlemen. All sites are now online in a listen-only mode. Please note there will be a question-and-answer session later on in today’s program. At that time, you can press star and one on your telephone, if you would like to ask a question. I’ll now turn the program over to our moderator for today, Cindy McCann, Vice President of Investor Relations. Please go ahead.

Cindy McCann

Good afternoon and thank you for joining us for the Whole Foods Market third quarter earnings conference call. On the call today are John Mackey and Walter Robb, Co-Chief Executive Officers, Glenda Flanagan, Vice President and Chief Financial Officer, Jim Sud, Executive Vice President of Growth and Development.

As a reminder, all forward-looking statements on this call are subject to risks and uncertainties that could cause the company’s actual results to differ materially from the expectations and assumptions discussed today. This may be due to a variety of factors that affect the company, including the risks specified in the company’s most recently filed Form 10-Q and 10-K. Please note our press release and scripted remarks are available on our website. We assume you have read our press release, so we will use this time to focus on highlights from the quarter and our initial outlook for next year.

I will now turn the call over to Walter Robb.

Walter Robb

Thank you Cindy. Good afternoon everybody. We are verve proud of the consistency of our third quarter results, which were once again near peak levels. We produced 8.4% comparable store sales growth; average weekly sales per store of $653,000 translating to $896 of sales per square foot; 9.5% store contribution; 5.9% operating margin, which we are proud to say is our ninth consecutive quarter of year-over-year operating margin improvement; 8.6% EBITDA margin; a 30% increase in diluted earnings per share to $0.50 and 38% NOPAT ROIC for all stores.

Our solid execution, combined with our capital discipline is generating strong, consistent cash flow. Over the last four quarters, we have produced 720 million in cash flow from operations and received 214 million of proceeds from stock option exercises.

We have used our cash to invest 329 million in new and existing stores, pay off the remaining 490 million of our term loan and to date return $53 million in quarterly dividends to our shareholders. We are pleased to be in a position where we can maintain a healthy cash balance and still have the capacity to internally fund our accelerated growth plans, increase our dividend and repurchase stock. We expect we will be using all three of these strategies over time.

Turning to sales, we’re very pleased to be reporting 8.4% comps or 7.8% excluding the positive impact of the Easter shift. This was our sixth consecutive quarter of comp growth of 7.8% or higher. We believe our efforts around value continue to be a significant contributor to our momentum, helping drive a 5% increase in our transaction counts.

We’ve worked very hard over the last couple of years to successfully improve our price image, particularly in perishables and we remain focused on maintaining our relative price positioning in the marketplace. With the return of inflation, we’re seeing our comp breakout move towards our historical pattern of 60% transaction count and 40% basket size.

In Q3, our basket size increased 3%, slightly higher than the 2% increase in Q2. This is driven entirely by a higher average price per item as we selectively pass through some product cost increases and customers continue trading up. Year-over-year, sales continue to shift toward branded and organic products, higher-priced tiers and to several discretionary categories. We also saw strong increases in the $50-plus size baskets.

We are hopeful we can continue to strike the right balance between rising product costs and our retails based on our contracts, our distribution network and our tools to manage value. We anticipate incremental increases in inflation in Q4, but our pricing studies show that our competitors have been passing through product cost increases and we don’t have any reason to believe that’s going to change.

Our comparable store sales increased 8.5% year-to-date through Q3 and 9.5% for the first three weeks of Q4. We are proud that we are continuing to gain market share at a faster rate than most public food retailers and attribute much of our success to our visible value efforts, which have positively impacted our price image and are continuing to raise the bar in areas that matter to our customers, particularly quality standards in health and wellness. For example, we recently announced our new Whole Kids Foundation, a charitable organization that will provide children with access to healthy food choices through partnerships with schools, educators and organizations.

We believe our new foundation is a natural extension of our role as America’s healthiest grocery store and hope that, through collaborating with schools and parents, we can increase fruit and vegetable consumption both at schools and at home and make a significant contribution in the fight against childhood obesity. The Foundation’s first major initiative is the Whole Kids Garden Grant project, a program designed for schools to help build healthy relationships between children and food through the power of gardening.

Turning to new store growth, during the quarter, we opened four new stores in Lafayette, California; Encinitas, California; Fairfield, Connecticut and Houston, Texas, as well as relocated three stores in Rockville, Maryland; Franklin, Tennessee and Charlottesville, Virginia.

In the fourth quarter to date, we have opened one new store, actually today, in Marietta, Georgia, temporarily relocated our store in upper Arlington Ohio, and we expect to open three new additional stores, including one relocation, over the remainder of the fiscal year. We’d encourage you to visit the Beyond the Numbers section of our Investor Relations webpage for more information about our newest Houston, Texas store, our Whole Kids Foundation, our Wellness Club website and more, including the now infamous Whole Foods Parking Lot Wrap.

I will now give you some additional color on our updated outlook for fiscal year 2011 and the initial outlook for 2012. Please refer to our press release for more detailed information.

Based on our Q3 results, recent comp trends and updated assumptions for Q4, we’ve raised our diluted EPS range for fiscal 2011 to $1.91 to $1.92, which implies a range of $0.40 to $0.41 in diluted EPS for Q4. Please note that our fourth quarter is seasonally our weakest quarter of the year in terms of average weekly sales and store contribution.

For fiscal 2012, which is a 53-week year, our initial outlook is for diluted EPS of $2.21 to $2.26, a year-over-year increase of 16% to 18% on the 13% to 15% total sales growth. On a 52-week to 52-week basis, this translates to diluted EPS growth of 13% to 15% and total sales growth of 11% to 13%.

Since our second-quarter earnings release, we have signed eight new leases averaging 30,000 square feet in size in Tucson, Arizona; Fremont, California; Newport Beach, California; Basalt, Colorado; Detroit, Michigan; Columbia, South Carolina; Virginia Beach, Virginia and Cheltenham, United Kingdom. We have now signed 31 new leases over the last 12 months and believe we are on track to open between 24 and 27 new stores in fiscal ‘12 and 28 to 32 new stores in fiscal 2013.

As reflected in our outlook, even though we are projecting to open a record number of new stores, we are not expecting a meaningful impact on our earnings growth from this acceleration of new store openings. While new stores produce lower store contribution than mature stores, we estimate new stores will account for only 5% of our total sales in fiscal 2012 and thus should not have a material negative impact on our results. In addition, our new stores are performing well. On average, they are smaller, less expensive to build and are expected to achieve higher returns on invested capital than the larger stores we opened in the recent past.

From a cash and infrastructure perspective, we are well-positioned to internally fund and execute the acceleration in our new store growth. Our fiscal 2012 guidance reflects strong comparable store sales growth, a record number of new store openings, EBITDA approaching $1 billion, significant operating margin improvement and earnings growth in excess of sales growth.

We are very pleased to be producing consistently strong results that are in line with our historical operating ranges and expect the lessons we learned during the Great Recession will drive even higher levels of both operating performance and returns on invested capital over time.

Our business has been highly successful, producing industry-leading comparable store sales growth, average weekly sales and sales per square foot. We see a new era of possibility for Whole Foods Market as customers increasingly embrace healthier lifestyles and we look forward to accelerating our growth in the coming years.

Over the longer term, we consider 1000 stores to be a reasonable indication of our market opportunity in the United States. Our brand continues to strengthen. Consumer demand for natural and organic products continues to increase. America’s healthcare crisis is creating a new frontier for health and wellness and our flexibility on new store size has opened up additional market opportunities.

We believe Canada and the U.K. hold great promise as well. We will now take your questions. Please limit your questions to one at a time so that everyone has an opportunity to participate. Our call will be ending today at 4:45 central time. Thanks so much.

Question-and-Answer Session

Operator

You can begin with star and one on your telephone, if you would like to ask a question. First, we’ll go to the site of John Heinbockel from Guggenheim Securities. Please go ahead.

John Heinbockel – Guggenheim Securities

Hey guys. A couple of things, two things as it relates to your consumer. Obviously, the sales have been very good. You’ve got the right demographic. When you think about what your customer would be concerned about and then whatever work you do with regard to consumer research, what would that be that might weaken confidence in your particular customer? Is there any -- it doesn’t sound like there’s any reason for that to happen anytime soon. And then as a follow-up, what are your thoughts, current thoughts, on price elasticity as it relates to inflation pass-through?

John P. Mackey

Hi. John Mackey here. I mean, over our 30-plus year history, we’ve seen consistently strong same-store sales growth in a variety of different economic environments. If you ask what could deflate it, I mean, at one time that we didn’t see strong same-store sales growth in our 30-year history was back in, when the panic hit in 2008 and 2009. So if such a panic was to occur again where people just stop spending money because they’re frightened and -- obviously that would be bad for everyone, including Whole Foods.

But generally, even in up times or bad times or just average times, we’ve sort of seen strong same-store sales growth. So unless there is some type of crisis, we anticipate, going forward, that’s why we are accelerating our growth. Whole Foods is going to flourish in a variety of different economic environments.

Walter Robb

So I’m just going to add to that, John, that what the research has shown us is that customers are -- they are concerned about value and they appreciate the visible value efforts that we’ve been doing, that is clearly resonating with folks. But they’re also thinking about their health and it seems like our America’s Healthiest Grocery Store, people are really realizing that that’s important to them and that’s translating into their purchasing decisions. So both of those things are showing up pretty strongly in the research we’re doing.

With respect to your inflation, look, it’s incremental, it’s manageable. Everything I see is that -- and from all the other reports that the elasticity is there to continue to pass on as long as it stays incremental and manageable. And I think that’s where we are for the next three to six months. So obviously, have to see how it plays out but right now, pretty good elasticity.

John Heinbockel – Guggenheim Securities

Then just finally, cash is building. Given how you’re building stores today, that’s not going to change even if you step up expansion. So when you think about putting to work the cash balance that you’ve got and not having that dilute return on capital, are there things you can -- and I’m not thinking about acquisitions per se because I’m not sure that there’s that many opportunities out there. But from a financial instrument perspective, are there things you can invest in that give you a better return than maybe what you’re investing in today or it will just be highly liquid kind of low-return instruments that give you more flexibility to use as you need it?

John P. Mackey

We’re thinking about plunging it all into gold.

John Heinbockel – Guggenheim Securities

Social networking stocks.

John P. Mackey

Yes, exactly. We’re taking a flyer on a Facebook IPO.

I mean, yes. We’re going to be conservative, that’s the shareholders cash and it’s going to be in short-term instruments that don’t produce a whole lot of interest at this point. But we have a lot of uses for our cash besides just piling it up. For one thing, we’re really celebrating our growth, so we do think a more rapid growth over the next several years is going to soak up more capital than we’ve seen the last few years as our growth slowed down a bit. So that’s going to take part of it. We anticipate growing our dividends as well.

Thirdly we’ve done stock repurchases in the past and we would certainly consider doing that again in the future as well. We paid off our debt. So we are not going to be doing any of that. But I do not anticipate we’re going to be speculative in any way regarding the cash reserves. I floated that idea by our Board several years ago and it got shot down, so I’m not looking to do that again.

Walter Robb

By the way, piling it up feels -- a little bit feels pretty good right about now. So it’s nice to have a margin of error. Thanks, John, for your questions. Thank you for your questions, John.

Operator

Next, we’ll go to the site of Karen Short from BMO Capital Markets. Please go ahead.

Karen Short – BMO Capital Markets

Hi. Congratulations on a good quarter. Just one housekeeping and then bigger picture. Your pre-opening and relocation expenses or at least through your guidance in ‘12 seem fairly low given that ramp in new stores, anything noteworthy there?

Glenda Flanagan

Hi, Karen, Glenda here. Actually, the one thing that’s not as apparent just looking at that is that the number of relocations in any year can have a bigger-than-average impact on that number. We had six relos in the current year and we’re only planning for two next year. So that’s the reason that it turns out flat even though we have a higher number of stores.

Karen Short – BMO Capital Markets

Got it. Okay. And then I guess I was wondering, thinking about the natural and organic space in general, as you guys said, there’s obviously growing demand for healthier eating and manufacturers are responding accordingly. I guess I’m just curious kind of bigger picture how do think about balancing your offering and your strategy so that you continue to carry some of the more mainstream products, because that’s where the demand is, but also maintaining your differentiation and kind of continuing to distance yourself from the competition? Can you maybe just talk about that a little bit?

Walter Robb

I think our philosophy is to continue to offer a range of choices, but I think we’re moving decidedly in the favor of differentiating ourselves across the board in every department through our -- just continuing to set the standards. I mean, you’ve seen what we’ve done in seafood; you’ve seen what we’ve done in meat; we talked about it. You’ve seen how we set the bar in Whole Body area and the Health Starts Here program, which is -- there’s just not another program out there like that in the supermarket industry.

So I think we’re less concerned about the mainstream products and more concerned about continuing to have a range of choices, a range of price points within those categories according to our standards and continuing to raise the bar on the quality standards. I don’t know if I’m getting exactly at your question, but do you want to rephrase it or…?

Karen Short – BMO Capital Markets

No, no, I think that’s -- I think it’s just more as products go more mainstream that your stance is to try to not be mainstream. So how do you balance that a little bit?

Walter Robb

The other thing is we’re investing in the farm system. We have been aggressively developing local products in all parts of the country, loaning them money. We have a very nice local loan program. We have continued to nurture the next generation of products and product suppliers that are creating a lot of excitement in all parts of the country in the company. And so I actually think that we will continue to set our own stream, so to speak, in the product quality going forward and the differentiation is going to be a big part of that effort.

Karen Short – BMO Capital Markets

Then last, do you have an up-to-date on the Wellness Centers in terms of what cost associated with it and how it’s kind of shaping in terms of how you think about it strategically?

John P. Mackey

Karen, John here. Well, we’ve got our first one open and that’s in Boston, a Devon store has opened. It’s a soft opening. We haven’t started marketing it yet. But we do have one actually opened and the rest of them should be -- I think the next one opens in early September and we should have them all open before November is out.

But the cost for opening them, it will vary tremendously between the different locations. Some are more expensive on a construction basis, but remember these are only a couple thousand square feet, so it’s not a major capital investment in any case. But it’s too early and premature to give out that data, but rest assured, as the prototypes, once you make the decision to move forward and more aggressively, we can provide some basic economics. But it’s premature to do that at this point.

Glenda Flanagan

Karen, you can check out on the Beyond the Numbers, we actually have a link to the new Wellness Club Web site and I think the Devon store and the individual stores are going to have websites as well.

Walter Robb

Thank you for the compliment on the quarter Karen. We appreciate it.

Karen Short – BMO Capital Markets

Thanks.

Operator

Next, we’ll go to Mark Miller from William Blair. Please go ahead.

Mark Miller – William Blair & Company

Hi. Good afternoon. The company’s had a great improvement in the new store sales over the last two years and this quarter, though, the non-comp store sales came down a little bit, and so I’m wondering. Is that due to the timing of openings in the quarter or the mix of locations and then for the fiscal fourth quarter it looks like your guidance has it back up again a little bit.

John P. Mackey

Mark, we’re rustling through some papers here to be accurate, but one thing we are pleased about, we’re opening smaller stores. One thing we see is our sales per square foot are up substantially as well as our profits for new stores is much higher than we’ve seen in the past. So, we are a little bit less concerned about lower sales and we’re focusing on the net profits that we are generating out of the new stores, plus the sales per square foot are much higher than historically we’ve seen over the last few years.

So we’re -- we actually think we opened a good crop of stores in 2011. And that’s one of the reasons our earnings are so strong, that new stores are acting less of a drag on overall earnings than they have in some previous years. Our new stores are doing very well for us. So we think really all the news on good -- all the news on new stores is pretty good.

Walter Robb

If I could add a little color to John’s comment, I think that the strategy we’ve been talking about the right size store for the right community, this is starting to really bear some fruit for us now. As these stores open stronger, the right size, the right amount of capital is a nice little addition to the earnings this quarter.

Mark Miller – William Blair & Company

I think you had talked about the cost to build coming down, feeling like you could be in the 250 range, maybe a little lower. I guess as you’ve gotten more visibility on the stores your opening into fiscal ‘12, how do you feel about that range?

John P. Mackey

We’re going to continue to report. We think it’s an important metric to report our cost to build on a per square foot basis. But it’s important to understand, that can vary from quarter to quarter and year to year because there are so many things that can influence that, like if we’re opening stores in an expensive city like New York where basically you have to use unionized labor, you just can’t even get a store open without it, you’re going to have a higher cost to build that if you’re doing something in the Midwest or the South or the Southwest.

So I think it’s important to just realize that we are really focused on those. But from quarter to quarter, even year to year, they might see some variances and that doesn’t necessarily -- you’ve got to look through the noise and look at the long-term trend. So, we think we’re going to produce good numbers on the long-term trend but we do want to manage expectations a little bit. There could be some variance from quarter to quarter or year to year.

Walter Robb

But I don’t want to hedge that answer too much because I think we’re going to continue to make progress in this area. We’ve said that quarter to quarter over the last couple of years we are going to continue to make progress. Like John said, it may bounce around a little bit, but ultimately, absolutely, I think that’s a reasonable number, but it may bounce around a little bit but depending on stores size and the complexity of the projects. But we are only in the middle innings of that effort to improve our capital efficiency on new stores and we’re going to make more progress.

Mark Miller – William Blair & Company

Okay. That makes sense, thanks. And then my last question is as the average ticket increase is accelerating, does that make it easier for you to leverage your store operating expenses or do those begin to rise at a faster pace as well?

John P. Mackey

The answer is yes. It does make it easier to leverage them. Something like rent is largely fixed, so that gets leveraged. Your depreciation, certainly in the short run, gets leveraged while cost of replacement will rub that over the long term, but it’s a lagging indicator. I also might indicate that wages tend to be a lagger as well. So a little bit of inflation initially is probably good for a retailer.

In the medium term, it’s neutral because the stuff starts to catch up. In the long term, it’s bad because it’s -- once inflationary expectations get built in, you don’t have a stable environment anymore and you go in to negotiate rents. So your wages are constantly in flux and the uncertainty that is there affects both your employees and your customers. So -- but in the short run, it feels kind of good, kind of like having a drink feels pretty good, the first one. But you take more drinks, you get diminishing returns.

Mark Miller – William Blair & Company

I’m sure we’ll be chatting about this in the future as well. Thanks.

John P. Mackey

Thank you.

Operator

Next, we’ll go to Scott Mushkin from Jefferies. Please go ahead.

Scott Mushkin – Jefferies & Company

Hey guys. Thanks for taking my question. So I was wondering if you can give us -- I know you’re trying to drive growth into markets not necessarily on the coast but open up new opportunities. I was wondering if you can give us any insights specifically on that Omaha, Nebraska store, maybe some learnings there and what you think the opportunity is to really get into some greenfield markets.

Walter Robb

Hey, Scott, Walter here. I’ll go first. I think John might add or Jim. We talked about Omaha. The big learning there for us is that looking ahead to how many stores can a market support. I think in Omaha for example we’re centrally located whereas if we did it again, we might have two or even three stores in that market. So the learning has been, okay, now that we’ve got a little more flexibility on stores size, we can take a little broader approach to the market and that opens up more opportunities for us. Did you want to add to that Jim?

James P. Sud

No, that was (inaudible).

John P. Mackey

I’ll add something to it. The fascinating thing about Omaha was the store did not start -- it started kind of slow for us. It’s been a very strong comp since it really opened up and now it’s a very good performer for us overall. So the interesting thing about some of the secondary markets is they start a little slower, but sometimes we have -- we don’t have as robust competition in some of those markets and those stores can produce very strong returns for us.

So we’re actually very excited and now that we’re going to be varying our size of stores considerably, depending on the market, it gives us a lot more flexibility. We’re actually really excited about what we would think of a secondary market opportunity. We’ve seen some very good returns on capital on a lot of those stores, Omaha being a good example of that. Birmingham, Alabama is another good example.

Scott Mushkin – Jefferies & Company

So if I were to look at the return on invested capital in that particular store, even though it started slow, is it above the average?

John P. Mackey

Don’t know that off the top of our head.

Walter Robb

You don’t have that book right here (inaudible).

Scott Mushkin – Jefferies & Company

Okay. The second question is I think, if I look to your guidance, margin guidance is 5.7% to 5.8%. I think that if that’s not the top of what you guys have ever done, it’s pretty darn close. So I think I actually almost ask this every call at this stage. But maybe you can just -- if you have a sense, where your thoughts are as far as you talked a little bit about efficiency and trying to get the cost-to-build down, but how about on the operating level? Where do you think you are on gaining efficiencies at the store and kind of driving that to a higher level?

Glenda Flanagan

We made great progress this year and last year, over the last few years, in gaining efficiencies in the stores. It’s something that we focus on across the company on a regular basis. We don’t think we’re there yet, that we’ll ever get there really because as long as we continue to see sales growth that we have seen over our history, we should continue to see expense leverage.

John P. Mackey

Scott, One thing to realize is that there were to drags that brought down those store operating margins. We got it to our historical high and then two things happened. One, we acquired Wild Oats, although we had to go through a lengthy process to make that acquisition and that acted as a drag because those stores had far less favorable operating metrics when we first acquired them.

Now, we’ve brought those stores way up as we promised that we would. We are seeing -- in fact, on average, we doubled the sales of the Wild Oats stores since we acquired them four years ago. So that should give you an indication of how much we’ve increased the productivity of those stores.

Secondly, we saw the economy collapse and our sales collapsed right along with it. That brought down our operating metrics. But our comps have been strong now for a couple of years and so -- and Wild Oats has been well integrated. So in some ways, we are returning or have returned to near the top of the range (inaudible) producing. But I don’t think we necessarily will stop there.

I think we’ll continue to -- assuming our same-store sales continue to increase, we expect to see Wild Oats continue to improve. We are opening -- again, new stores are having higher productivity numbers than they used in the past and we are continuing to -- with the strong same sales growth, we expect our operating margins to continue to improve. So we are hopeful we can do better than we’ve done historically in the past. Although we’re not promising that, we’re certainly shooting for that internally.

Walter Robb

I would affirm that, Scott. I really feel like the Great Recession was the Great Teacher, and I think we really shout out to the regional presidents and their teams. I think they’ve done an outstanding job delivering consistency in leverage and greater efficiency. At this point now, we have a couple year track record of being I think more consistent than we even were historically in terms of doing that on incremental gain. So I would affirm that that’s our goal to make progress from this point forward.

Scott Mushkin – Jefferies & Company

Is there any particular lever you would look to that stands out as an opportunity versus others? Then I’ll give the floor up. I thank you for answering my questions.

Walter Robb

Sales is the big item. You’ve got to have the sales, so you’ve got to be getting that mix right to continue to have transaction count and growth in sales. That gives you the room to move. But…

John P. Mackey

We’re doing a lot of things. Walter, sales is very important. We’re constantly trying to evolve our labor mix, what we call Smart Service, so you put service in where it’s something the customer values. But in areas where the customer value it less, you don’t necessarily have the same degree of service. So we are evolving that in a lot of our stores. Since we are having more discipline in our capital investments, you’ll see depreciation as we’re leveraging that. That’s a lower percentage than it’s historically been (inaudible) a lot of our new stores, so labor as sales continue to go up. I also might add that we’re seeing favorable rents at this point.

A lot of the new stores we’ve signed have very -- more favorable rent than we had four or five years ago. So that’s something that’s going to pay off in the long term in terms of store operating metrics.

Walter Robb

On the gross margin line, the better inventory management, we continue to reduce incrementally days on hand. We’re working aggressively on shrink and that’s come down a lot. We’re still early to middle innings on our distribution side. We started out as a retail company. We started out focusing on building the great stores and the great store experience. We just backed into the distribution and the support of that because we have stores everywhere and we are -- there’s a lot for us to gain.

We’ve got a good handle on that now on the perishable side where we have our own -- our distribution network pretty well build out for ourselves and we have an outstanding contract with Unifi on the dry side of things, which promises incremental benefits to Whole Foods as we grow. So there’s gains all those areas for us to continue to work on as we move forward.

John P. Mackey

I’m going to underscore what Walter said. It’s kind of like Whole Foods’ competitive advantage for most of our history has been in store experience, service levels, differentiated product mix, et cetera. That’s how we’ve become so successful and that’s what’s driven our growth. But what we’re getting much better at now is we’re getting better at being more efficient. We’re becoming a more efficient retailer and as Walter said, we are kind of in the early innings on that. I think that’s where Whole Foods Market, assuming we don’t therefore dilute our service levels or the store experience for our customers, we’ve got a lot of efficiency gains ahead of us.

And I think that’s going to help drive direct-store expenses down as a percentage and increase the operating margins. So that’s I think the good news, is that we’ve still got a long way to go before we are generating Wal-Mart-type efficiencies in our company. We’ll probably never generate Wal-Mart-type efficiencies, but we’ve still got a lot of progress and improvement we can realize over the next several years that will benefit our shareholders.

Walter Robb

I think this team would like to give a special shout out to Bart Beilman, our VP of Distribution and Global VP of Distribution, and his team here in Austin has just done a phenomenal job over the last couple years helping us to begin to realize those things.

Glenda is making the point again to -- that around this cost-to-build is we’re doing a better job designing the stores now, a lot rationalizing the choices we’re making in designing them and building them for less, the cost-to-build in addition to the cost per square foot. You start watching this cost to actual build the stores coming down. It’s come down from 15 million in sort of the 10 million range now. It’s huge progress. When you put less capital upfront to get a nice store experience, your returns are going to continue to grow. We have more progress we can make in that area as well. So that was a long-winded answer, but hopefully you got a feel for our enthusiasm for that topic.

Scott Mushkin – Jefferies & Company

That was a lot of great color. Thank you very much.

Operator

We’ll go to the site of Ed Aaron from RBC Capital Markets. Please go ahead.

Edward Aaron – RBC Capital Markets

Thanks for taking the question. When I look at your recent comp trends, they’re not only very good but they’re remarkably consistent relative to history. They’ve basically been within 100 basis points span for like six quarters. I was just wondering, when you think about the business, what do think explains that? Is it just a function of a bigger store base or do you think there is maybe kind of somewhat of a behavioral change happening from your consumer?

John P. Mackey

We’ve been studying how Bernie Madoff managed his funds. No, seriously, it’s kind of puzzling to us. We’ve had these long-term comp trends that have just been there sort of consistently and then other than the aberration of the Great Recession, we seem to be back on track for that. We are comping the comps so to speak (inaudible) years. And I think it’s just kind of the normalized state of things for Whole Foods. As long as we continue to improve customer experience and evolve our concept and create more value for customers, (inaudible) these kind of numbers. So I don’t think it’s automatic. I think it’s something we have to work to do, but I think our business model is just basically -- produces these kind of results the way we manage our business.

Walter Robb

So I’m going to give you a complementary view to John’s point, which is I think that I don’t want for us to take a bunch of credit for ourselves, but I think that a lot of serious focus on going back and looking at the store experience, the store design, and I think that has translated into a new group of stores that are feeling really good to the customer. I think our work on valuable -- and not just value but visible value, one-day sales, we’re getting huge returns on those sorts of efforts. People appreciate that and they feel like we’re accessible and part of their lives.

I think this focus on healthy eating, it’s a big idea for this new generation of time and we are there. We’re leading it and at a time when healthcare costs have been higher, people are realizing that this is a way they can move forward in a healthy lifestyle. I think all those things have combined to give us a nice bit of what feels like on this end a whole new generation of momentum for what we’re doing.

John P. Mackey

Yes, I mean, I’ll pile onto that as well. If you consider the remarkable success Trader Joe’s has also had in the marketplace, you can kind of view the marketplace as evolving, and the conventional supermarket chains who try to be all things to all people continue to sort of gradually lose share and the alternative formats are continuing to gain share. So it’s the evolution of the marketplace. Whole Foods is extremely well positioned with our -- we’re America’s Healthiest Grocery Store and we’re uniquely positioned to gain and benefit from the sea-change that’s undergoing in people’s conception of healthy living and healthy lifestyle and wanting to eat natural and organic foods and to live longer and avoid crippling diseases. I think Whole Foods is positioned perfectly for what I think have been and will continue to be major demographic evolution.

Edward Aaron – RBC Capital Markets

The results speak for themselves. Thank you.

John P. Mackey

Thank you. I appreciate that.

Operator

And now, we’ll go ahead and take our last question from the site of Stephen Grambling from Goldman Sachs. Please go ahead.

Stephen Grambling – Goldman Sachs

Hi. Thank you for taking my question. Just to follow up on some of the comments from earlier, you referenced that you’ve been checking pricing at conventionals. Now, as you see better supply chain efficiencies, you’re nurturing the farmers and suppliers within it. Do you feel like your gap with them is narrowing even further as they pass through inflation? Are your costs of goods actually rising at a smaller rate do you think?

Walter Robb

This is Walter. From what I see from reading their numbers and so forth, we’re not trying to outpace the gap. We are trying to price the market and do our own thing in terms of value and differentiation. And so I think what -- the comments we made earlier, just we have more ability to do that, more flexibility to do that because of the gains we’re making on the supply side and those things that we talked about earlier.

But yes, we are tracking that; we’re tracking internally our inflation every month, 8000-plus items. We’re tracking every month all the major competitors on a major basket, 600, 800 items and we’re watching that and so our ability to stay competitive, to be competitive and stay competitive is -- it just gets stronger from here.

Stephen Grambling – Goldman Sachs

Okay. Thank you.

Walter Robb

Did that answer your question?

Stephen Grambling – Goldman Sachs

Yes, I think that does. I guess a follow-up to that would be just -- maybe it’s been asked a little bit before -- is just kind of in terms of innings or however you want to make the metaphor, what’s the runway on the supply side, in the supply chain, going forward?

John P. Mackey

It’s huge, Steve. Whole Foods is -- we’re continuing to gain economies of scale. There’s tremendous -- just on the distribution side, we were talking to Bart who heads up our distribution efforts just yesterday about this very matter. We have the distribution in place right now. The United States is (inaudible) stores without having to add additional distribution centers. So there’s tremendous leverage that we can realize through distribution alone.

And as our purchasing continues to increase, on the buy side, there’s tremendous -- probably the biggest reason our gross margins are stronger is even though we’ve been more competitive on our pricing, we’ve been able to pass through on the buy side a lot of the savings our scale is giving us and that’s resulted in better prices for our customers as well as higher gross margins for our investors.

And we think that -- again, we think we are in the early innings of that. As we continue to grow and to accelerate our growth, we think there is going to be continued scale that we’re going to gain and we’re going to probably do the same thing. We’re going to hopefully realize some of that in a little bit higher gross margins and the rest we’re going to pass onto our customers with more competitive prices. Right now Whole Foods is kind of in an increasing return cycle, which should continue as long as we’re able to continue our growth.

Walter Robb

I just want to add to that. I want to make sure to go back to the foundation of your question. I don’t think there is a gap between Whole Foods. Like for like with the competitors, we’re competitive, that’s the way it is. I’m watching those numbers every 30 days and even more frequent than that, so I don’t think there is a gap. We just have -- we’re in a very good competitive position right now; I like our position. I think we’ve got the information to back that up. Also, we want to thank you for spending the time -- spending additional time writing about our company. I appreciate that.

Stephen Grambling – Goldman Sachs

Thank you. That’s very helpful. Congrats on a great quarter.

Walter Robb

Thank you.

John P. Mackey

Thank you.

Operator

It looks like we do have time for one more question. It will come from the site of Bob Summers from Susquehanna. Please go ahead.

Robert Summers – Susquehanna Financial Group

Good afternoon guys. Just one quick thing, just digging into the basket a little bit and I think you talked about it being driven by higher price per item but then right after that, you talked about trading up, which is something I think we haven’t heard about for a while. So I guess two things. One, just how much of that was driven by inflation, then what was the impact from trading up? Then as you’re starting to see that, any thoughts on where it could go? Because it feels like, again, this is something we haven’t really heard constructive comments on in a while.

Walter Robb

Hi, Bob. This is Walter. Of the 3% basket, we said inflation is somewhere in the 1.75 to 2 range, so 100 basis points from the other, but we didn’t really break it out and that’s kind of a rough thing. But it’s really true, the uptick went from -- it’s a result of both the inflation but also we’ve studied this behavior. We saw -- we see branded product actually outpacing -- the rate of growth in branded product actually outpacing private label growth, which as you remember during the downturn that thing got (inaudible) on the growth rate was kind of proxy for value.

We see the branded products growing nicely right now. We see people making incremental trade-ups from $3 to $4, $4 to $5, $5 to $6. We’ve seen that in several areas like they might trade a private-label shampoo for a branded shampoo or a cheese and we’re seeing that in several areas across. We also have seen -- we’re doing the quintile -- we are breaking our basket $10, $20, $30, $40, $50 and we saw obviously, as we mentioned in the script, the greatest growth in the $50 plus basket; that grew both in dollars and units. But we didn’t see any degradation in the other baskets either. So it’s kind of this -- it’s a new time with a new set of things happening here that we haven’t seen before. The basket is definitely a result of both of those.

Robert Summers – Susquehanna Financial Group

And then correct me if I’m wrong, but I think that the way, like your private label pricing philosophy, as you get that shift into brand, not only is it going to be an aid comp but it should also be gross margin enhancing. Is that right?

Walter Robb

I’ll just take you back to our overall guidance on gross margin. It all blends into kind of where we think we can continue to maintain the sort of historical range of margins that we’ve been, even though it’s getting tougher to do with a little bit more incremental inflation. We think we’ve also dialed up our tools and ability to do that. So we’re just going to take you back to kind of the overall blend where we think we can be going forward. Right now, that’s what we’re affirming.

Robert Summers – Susquehanna Financial Group

Okay. Great.

Walter Robb

Okay. Great. So thank you all for listening in. We appreciate it. Join us in November for our fourth quarter earnings when John will be in the chair. A transcript of the scripted portion of this call, along with a recording of the call, is available now on our website at www.wholefoodsmarket.com. Talk to you all next quarter.