Whole Foods Market Q1 Earnings Call Transcript

123jump.com Staff
22 Feb, 2010
New York City

The natural and organic foods supermarket reported quarterly sales rose 7% to $2.6 billion on comparable store sales increase of 3.5% on a two-year stacked basis. Net income surged 79% to $49.7 million in the quarter. Earnings per share soared to 32 cents from 20 cents in the year-ago quarter.

Whole Foods Market, Inc. ((WFMI))
Q1 2010 Earnings Call Transcript
February 16, 2010, 5:00 p.m. ET

Executives

John P. Mackey – Chief Executive Officer
A.C. Gallo – Co-President and Chief Operating officer
Walter Robb – Co-President and Chief Operating Officer
Glenda J. Chamberlain – Executive Vice President and Chief Financial Officer
Jim P. Sud – Executive Vice President of Growth and Development
Cindy McCann – Vice President of Investor Relations

Analysts

Charles Grom – J.P. Morgan
Scott Mushkin - Jefferies & Co.
Edward Kelly – Credit Suisse
Karen Short – BMO Capital Markets
Mark Wiltamuth – Morgan Stanley
Meredith Adler – Barclays Capital
Neil Currie – UBS
Edward Aaron – RBC Capital Markets

Presentation

Operator

Good day. Welcome to today’s program. At this time, all participants are in a listen-only mode. Later, you will have an opportunity to ask questions during the question-and-answer session. It is now my pleasure to turn the conference over to Mr. John Mackey. Please go ahead.

John P. Mackey

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

First, the legalities. The discussion we are having will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and these statements involve risks and uncertainties that may cause actual events, results and/or performance to differ materially from those indicated by such statements. These risks and uncertainties include those outlined in today’s call as well as any other risks identified from time to time in the company’s public statements and reports filed with the SEC.

I hope you’ve had a chance to read our press release which is available on our website along with the scripted portion of this call. We are very pleased with our first quarter results. On a 7% increase in sales we produced, a 116 basis point improvement in operating margin to 3.9% of sales, a 26% increase in EBITDA to $186 million, a 62% increase in diluted earnings per share to $0.32, a 14% increase in cash flow from operations to $161 million and free cash flow of $79 million.

Average weekly sales per store for all stores increased approximately 4% to $572,000 translating to sales per square foot of approximately $800. We are seeing much better results in our new stores, due in part to the overall rebound in our sales, but also reflecting a positive impact of smaller less expensive stores. Compared to the class of 21 new stores in the first quarter of last year, our class of 17 new stores this year was approximately 9% smaller in size averaging 47,000 square feet.

The smaller new stores produced 27% higher average weekly sales per store of $650,000 or a 37% increase in sales per square foot to approximately $707 and produced a 418 basis point higher store contribution as a percentage of sales, due primarily to lower occupancy costs and direct store expenses as a percentage of sales.

We are also seeing significant reductions in certain areas of our development costs, which are driving healthy improvements in EBITDA as well. The percent of sales from new stores declined year-over-year and sequentially to 6% of total sales in the quarter. This combined with our overall performance resulted in less of a drag on overall results.

As we hold our square footage growth relatively steady over the next few years, we expect the average age of our store base to increase, which should help drive improved store contribution as a percentage of sales. If and when we accelerate our square footage growth, the growth paradox will likely resurface once again.

Our comparable store and identical store sales trends improved for the third quarter in a row and both are now back to positive territory. Comparable store sales increased 3.5%, identical store sales increased 2.5% and for the first time since 2005, our comparable and identical store sales on a two-year stacked basis improved sequentially.

The recovery we have seen is fairly broad based, with every region in almost every department producing positive identical store sales growth and sequential improvements. We are particularly pleased with the double digit comps we are generating at the former Wild Oats stores and at our Kensington store in London. The improvement in comparable and identical store sales continues be driven by increases in transaction count.

Our average basket size was down only slightly year-over-year, a significant improvement from the 2% decrease we saw in Q4. The improvement in basket size trends was driven by an increase in the number of items per transaction with the average price per item down slightly.

In general, we are seeing customers celebrate holidays and special events, such as the recent Super Bowl in a bigger way than they did in 2009. We are also seeing a shift in buying patterns around bad weather. Last year customers didn’t stock up as they had historically, this year not only are customers stocking up, they’re restocking afterward as well.

And comparing Q1 to Q4, we saw a slight shift in sales to higher priced tiers which we attribute in part to the holidays and to a lesser degree to customers trading down less. We are still seeing strong redemption rates for coupons featured in our Whole Deal newsletter. Excluding LIFO, gross profit for quarter increased 84 basis points to 34.3% of sales.

We are continuing to see lower cost of goods sold, driven by better purchasing and distribution disciplines as well as improved store level execution, particularly, in terms of shrink control and inventory management. For the second quarter in a row, we saw year-over-year declines in inventory levels of approximately 5%, which drove improvements in inventory turns.

Year-over-year, the margin improvements more than offset slightly higher occupancy costs as a percentage of sales. Early last year, we made the shift from being fairly reactionary on pricing to being much more strategic. We have seen this strategy successfully play out over the last several quarters as we have produced strong year-over-year improvement in gross margin and comps.

While many of our competitors have gone back and forth on their pricing strategies, we are sticking with our goal of offering competitive prices on known value items day in and day out. Our internal benchmarking shows that we maintained our price competitiveness relative to our national competitors during the quarter.

We remain focused on continuing to strike the right balance between driving sales improving our value offerings and maintaining margin. We produced diluted earnings per share of $0.32. We beat our own internal forecast due primarily to higher than expected sales, driving better gross margin results in leverage of G&A expenses. There was still some conservatism in our spending in Q1, resulting in some new G&A expenses being pushed to Q2.

Our results included $10.1 million or $0.04 per diluted share in store closure reserve adjustments. During the quarter we opened six stores in San Francisco, California; Santa Barbara, California; Milford, Connecticut; Portland, Oregon; Plymouth Meeting, Pennsylvania and Seattle, Washington ranging in size from 25,000 to 50,000 square feet and we closed one former Wild Oats store.

Since the fourth quarter, we terminated two leases for stores in development and today announced three new leases averaging 40,000 square feet in size. We are committed to producing positive free cash flow on an annual basis, including sufficient cash flow to fund the 51 stores in our current development pipeline.

In other news, we were extremely pleased to move up four spots to number 18 on Fortune’s list of the 100 best companies to work for. To be of only 13, companies ranked 13 years in a row validates our commitment to our core value of supporting team member happiness and excellence.

We are very happy about this achievement and want to commend our regional and store leadership teams for the great job they did in staying focused on team member morale in what was a very challenging year last year. We also want to take a moment to thank our customers and team members for their generosity in the wake of the tragedy in Haiti.

Our customers donated $1.7 million toward the relief and rebuilding efforts in Haiti. And our team members contributed more than $93,000 to support our Haitian team members whose friends and family have been affected by the earthquake. Through the Whole Planet Foundation, Whole Foods Market has provided $1 million to a micro credit organization that is providing banking services to the people in Haiti, following the earthquake. While not surprised by the outpouring of cash donation, we are humbled and grateful our customers and team members contributed to help so many others in need right now.

Looking back on why we started this business over 30 years ago, one of the things we were most passionate about was the idea of providing customers with healthier alternatives to heavily processed foods produced through industrial agricultural and sold in conventional supermarkets. While we fulfill a part of our mission everyday through selling the highest quality natural and organic foods available, I believe, we have the opportunity and the obligation to do more in terms of educating our stake holders about the benefits of healthy lifestyle choices.

To underscore our renewed focus, we created a new core value last summer, promoting the health of our stake holders through healthy eating education. On January 20th, we announced the official companywide launch of our Health Starts Here Initiative, created to support this new core value. As part of this initiative, our stores are now offering free information, recipes in-store lectures, events and support groups with a selection of educational books and cookbooks offered along side materials from our two partner programs, Dr Joel Fuhrman’s Eat for Health Program and Rip Esselstyn’s, Engine 2 Diet.

In-store signage is focused on education about nutrients in foods through Dr Fuhrman’s aggregate nutrient density index or ANDI scores, including how to prepare and incorporate these foods into our everyday life. Our prepared foods teams are now offering a selection of specially branded health starts here items and the self serve food bars and chef [ph] cases which are generating considerable customer interest.

For more information, visit any of our stores, or check out the video on our website, featured on the front page of the press room. Our Health Starts Here Initiative includes two internal programs as well, The Team Member Healthy Discount Incentive where team members can earn a higher store discount for achieving certain biometric testing scores in the areas of nicotine, blood pressure, cholesterol and body mass index and the Total Health Immersion Program, a voluntary incentive health and wellness education program offered biannually at no cost to our higher health risk team members.

So far, we have had a tremendous response to these programs. We believe the upfront investments we are now making will deliver strong returns over time in terms of healthier team members and lower health care costs. We have a loyal core customer base that is aligned with our mission and core values.

We expect our Health Starts Here Initiative will grow and evolve over time to become a key competitive advantage for us. And by offering an informed approach to food as a source for improved health and vitality, we will help change many more lives for the better.

We believe our passion of support of causes and leadership in areas important to our customers reinforces our position as the authentic retailer of natural and organic foods making us the preferred choice for customers aspiring to a healthier life style. I will now turn to the rationale behind our raised outlook for the fiscal year.

Please refer to our press release for detailed guidance. Last quarter, we guided flat operating margins for fiscal year 2010 excluding unusual items last year. At that point, we had just reported 1.6% comps and 0.4% idents for the first five weeks of Q1. Our results for the last 11 weeks of Q1 were significantly better than this at 4.3% and 3.3% respectively.

We did not forecast this level of improvement and our first quarter results exceeded our own expectations on both the top and the bottom line. For three quarters, we have produced sequential improvement in comparable and identical store sale trends driven by improving transaction count trends. We are now seeing increasing transaction counts year-over-year and sequential improvement in identical store sales growth on a two year basis as well.

Second quarter to date, our results are better still at 7.0% and 6.0% respectively with 0.6% two year identical store sales growth. We are very pleased to see our comps moving closer to the ranges we produced prior to acquiring Wild Oats and the onset of the recession. And we believe there are many reasons to be bullish about our future results. It is relatively early in our recovery; however, and there is still a lot of uncertainty regarding where the economy, the consumer and competition go from here.

Our new ranges for comparable store sales growth of 3.5% to 5.5% and identical store sales growth of 2.9% to 4.9% encompass our cautiousness on the low end and our optimism on high end. We also want to point out that our idents improved 224 basis points from the first half to the second half of 2009. So while we continue to face easier comparisons over the remainder of Q2, we face a significantly higher hurdle in the back half of the year.

Our operating margin guidance range of 4.3% to 4.5% for the year assumes lower year-over-year improvement in gross margin excluding LIFO than we have produce on average over the last three quarters. We do not expect to sustain those higher levels of improvement once we anniversary the shift in our pricing strategy that occurred in the first half of last year.

Additionally, we have been taking advantage of buying opportunities to pass through values to our customers, but it is difficult to predict to what extent these opportunities will continue. We are committed to maintaining our relative price positioning and this might mean a higher level of price investments going forward. We also expect slightly higher G&A of 2.9% of sales for the fiscal year.

Our expense discipline is continuing and even with stronger comps, the lessons we have learned over the last two years are not going to be forgotten. That said, spending last year was limited to must haves and certain costs from 2009 were deferred. So we expect some increases in our cost structure now that we feel more confident about our sales momentum continuing.

In the first quarter, we beat Street estimates by $0.06. Currently, the Street consensus for the remainder of the year is $0.84. Our new EPS range of $1.20 to $1.25 implies $0.88 to $0.93 for the remainder of the year which at the midpoint is $0.07 above the Street’s $0.84 consensus. As currently reflected in Street estimates, we typically see higher weekly sales in our second and third quarters, which drives stronger bottom line results and then sales tend to drop in the fourth quarter which is seasonally our weakest quarter.

Our business model clearly has been highly successful with our company ranked number 324 on the Fortune 500 list of the largest U.S. public corporations. In 2009, we were one of the top 20 best performing stocks on the S&P 500 index. As the world moves out of this recession, our positive sales momentum combined with our continued expense and capital disciplines should produce strong returns for our shareholders with fewer than 300 stores remain incredibly excited about the future growth opportunities for Whole Foods Market.

We are well positioned to take advantage of changing demographic trends and I expect our renewed emphasis on healthy eating to help further differentiate us and solidify our unique position within the food retailing universe. We will now take your questions, but ask that you limit your questions so that everyone has an opportunity too. Operator?

Question-and-Answer Session

Operator

At this time, if you would like to ask a question, please press the star and one on your touchtone phone. You may withdraw your question at any time by pressing the pound key. Once again to ask a question, please press the star and one on your touchtone phone. We will take our first question from Charles Grom with J.P. Morgan. Please go ahead.

Charles Grom – J.P. Morgan

Thanks. Good afternoon. Just on the ID improvement from 1Q to 2Q, pretty big uptick on tier like you spoke to. Just wonder, if we can dig a little deeper into that and how much of that is coming from traffic versus ticket and then also if you could speak to any color regionally on year-to-date results? Thank you.

A.C. Gallo

Hi, this is AC. It is a short period of time. So, it is a little difficult to project how, but what we can say is what we started to see in Q2 was in addition to the strong increasing pattern in our transaction count, we started to see an actual up tick in our basket size which is driven mostly by an increase in the number of items in the basket as our average price per item is still flat to slightly negative. That has been -- that was a big change. So people are putting more items in their basket and it is increasing our basket size.

Walter Robb

And this is Walter. Just to add to that, I think it is pretty clear that the transaction count or the customer count is driving this gain. We are gaining customers back. If last year we were losing, we are gaining them back now and they’re doing the thing that AC just mentioned. So.

Charles Grom - J.P. Morgan

Anything…

Walter Robb

We also had some tremendous, we had some holidays, great holidays that we referenced in the script. But we have got -- two years ago, we got -- we were negative on the holidays. This year, we were had nice incremental improvement on the holidays in terms of lift and had that in Super Bowl and had that in Valentine’s. So those are the things, all of those things seem to be working differently this year than last.

Charles Grom - J.P. Morgan

Okay. Anything regionally you can share?

Walter Robb

It is like the script said. It was end to end. It was strong across the board. It is really very heartening for all of us.

Charles Grom - J.P. Morgan

Okay. And, then one more for me, regarding our gross profit outlook, you spoke to quote unquote taking advantages of buying opportunities, wondering if you can shed some examples for us and what would preclude you from getting those opportunities over the next couple of quarters?

A.C. Gallo

Well, one of the big things we saw this past year was there was a kind of a flood in the market of organic fruit as some different stores pulled back on it and a lot of supply was coming on to the market. We have had a lot of buying opportunities like organic apples in the past year and another thing that we had was there’s also was a large supply of natural meats on the market. So we have been able to purchase a lot of, especially meat and produce and very good prices and be able to pass those along to our customers.

We don’t know, I mean, some of that will still come along. Our projections going forward is that some of that over supply will start to dry up and that we won’t have as many opportunities for some of that same pricing. So, that is why we think that it might not, it might not be some of the same opportunities there.

Charles Grom - J.P. Morgan

Okay. Great. Thanks very much.

Operator

We will take our next question from Scott Mushkin with Jefferies. Please go ahead.

Scott Mushkin - Jefferies & Co.

Hi. Thank you. Hopefully, you guys can hear me. I am on a cell. So just a clarification, that $0.04 adjustment since I haven’t seen the whole release, is that -- would that have been a positive earnings or negative to earnings if we adjust? And I have another question.

Glenda J. Chamberlain

Are you talking about the store closure reserve adjustments, that would have been a negative to earnings.

Scott Mushkin - Jefferies & Co.

So you would subtract out just -- Glenda, earnings would be $0.04 or less with that or $0.04 higher with that adjustment?

John P. Mackey

Higher.

Scott Mushkin - Jefferies & Co.

Of course, that’s higher. Okay. Thanks.

Glenda J. Chamberlain

We had an expense in the quarter of about $10 million or $0.04 related to store closure reserve adjustments. That is included in the $0.32 that we reported.

Scott Mushkin - Jefferies & Co.

Right. So it is even better than you reported. The second thing is in…

Glenda J. Chamberlain

I just want to clarify that that is an ongoing expense for us. We have about $1 million of cash that we actually pay on those leases every quarter and we will continue every quarter to evaluate the reserves. And so it is possible that there may be more adjustments in the future. So, we don’t think of that as a one-time item that needs to be added back.

Scott Mushkin - Jefferies & Co.

Okay. So, just not to beat this to death, but was the adjustment a non-cash or was it some cash and some non-cash?

Glenda J. Chamberlain

We pay out about $1 million in cash every quarter. The amount in excess of that was an adjustment to the reserve balance to increase the number, the estimate of the number of months that we believe it will take to sublease those properties.

John P. Mackey

Non-cash.

Scott Mushkin - Jefferies & Co.]

Great. Then my second question I think maybe I asked something similar, but in our store walking we have noticed that some of the prepared foods sections have had some adjustments and New York area with more being done as the Everett Commissary and obviously your gross margins were pretty nice this quarter. Is there still more opportunities as you look at the prepared food offering to get the shrink down or slash, get the margins up to where you guys want them to be or is that really not a large opportunity going forward?

Walter Robb

I don’t think that’s a meaningful opportunity. I mean, the shrink is always an opportunity. We talked about that on the last couple of calls, Scott. Where we think we have opportunities to improve in that area, but if I was looking at the big picture I wouldn’t say that’s one of the biggest opportunities. So --

A.C. Gallo

And also -- You mentioned that you saw more items from commissary and one of New York stores, that’s a changing thing. There’s a certain amount of, a certain percentage of products that we provide from our commissaries and a certain percentage that comes from the stores and it really varies. Some times they shift it around but the percentage stays fairly constant. We have not been increasing the amount overall of goods in stores from our commissaries versus what’s produced in the store.

Walter Robb

I think the bigger story really is the gross margin is just the ability that the balance we are striking between the price investments, the pricing competitiveness and the gross margins that we’re realizing through the improved disciplines, inventory control which is a form of shrink control and those sorts of things. That balance is extraordinary right now and I think that is the bigger story right now, Scott, in this quarter.

Scott Mushkin - Jefferies & Co.

I just have one follow up. It is just, are you seeing any -- I notice that the amount of prepared foods and perishable foods have been going down for a couple years as a percentage of your sales. Are you seeing that trend reverse and then I will hand off the mic?

John P. Mackey

I don’t know why you say that. We don’t report that number.

Scott Mushkin - Jefferies & Co.]

It was in the K I think last…

John P. Mackey

We report in out percentages.

Walter Robb

Well, I’ll add something and then AC can add to this. Essentially in the last year and a half the numbers show that customers are eating more meals at home than they were eating out for the first time, that went below 50%. We have seen some drift toward the center store. We talked about that in the last couple of calls that’s true as people prepare their meals. Although I will tell you that we are seeing in this uptick, we are seeing such strength in produce in particular, that we will watch those numbers. I’m not sure we can say where that’s going to land. We are seeing extraordinary strength in produce right now.

A.C. Gallo

I think we can say that at the beginning of the recession, we definitely saw a shift toward center store. And what we have been seeing a rebound now in the perishable departments, a lot of strength in the perishable departments we have seen in the last quarter or so.

Scott Mushkin - Jefferies & Co.]

All right. Thanks very much. Thanks for taking my questions.

Operator

We will take our next question from Ed Kelly with Credit Suisse. Please go ahead.

Edward Kelly - Credit Suisse

Hi. Good afternoon. Could you provide more color on just specifically the adjustments that you made in the gross margin strategy of reactionary versus strategic? And then as we think about the gross margin going forward, it sounds like the back half of this year, maybe you can see some deterioration because you are cycling gate buys and along those lines, but how do we think about the gross margin over the next couple of years? Is the goal flat or is there a modest deterioration? How should we think about that line item?

Glenda J. Chamberlain

I just want to start by clarifying our guidance does reflect continued year-over-year improvement in gross margin, just not to the same extent that we saw in the first quarter. So I want to clarify that since you said gross margin deterioration and I will let Walter and AC answer the rest of the question.

Walter Robb

Well, we talk about having a change from the reactionary pricing to a more strategic pricing. I think again last year, in the first and second quarter last year, no one knew where the economy was going. Lots of people were cutting prices. It was a lot of reaction to what we thought customers might be looking for, what other competitors were doing and so a lot of our pricing was, was in reaction to what we thought was going on in the marketplace.

As we went through this past year and especially as we started to see things picking up last summer and then into the fall, we realized that we could set a strategy for -- we could set a strategy -- we got to the point where we felt like we had adjusted ourself to be competitive with in the market place and each marketplace we were in. Then we can start setting a strategy for where we thought we could really make our mark.

And so we adopted and each region is a little bit different, because we really are, we let each region really determine what is the best mix for pricing in their area and we kind of adopted a strategy that has been working for us, obviously. And we feel pretty good about it and don’t feel like we are having to make a lot of adjustments in that strategy at this point.

A.C. Gallo

Your second part of the question was about the outlook for gross margin for the back half of the year and that is -- gross margin is always dynamic in the market place. Right now we are seeing, we actually, we do -- we serve a 63 competitors on 400 items across the country to stay on track of where we are and right now we are seeing, some of the competitors are actually taking back some gross margin. So the market is, except for a couple of isolated metros, has been easing up a little bit.

That would argue for some stability in gross margins. We have already talked about the discount window for buying, it is slightly closing. We will have to see how that plays out and what I think will continue is our disciplines throughout inventory management, order sales, those sorts of things which have served us well. I think it is pretty clear that all the operators feel they will not forget those lessons and disciplines that are in place. So I think argues for stability, in terms of how much we will have to see how those other dynamic factors play out on the back half of the year.

Edward Kelly - Credit Suisse

And by sort of less promotional and the environment you are seeing out there, is that on a conventional side, or is that across the board?

A.C. Gallo

Well, it is across the board. We check all of the competitors. It is everything from Sunflower Sprouts all the way up to Wal-Mart. We are checking them all.

Edward Kelly - Credit Suisse

Last question for you is on the whole cost side, you did a great job of controlling costs last year when you had to. Historically, the growth has been pretty high. But now it sounds like this discipline will continue going forward. I guess the question really is how do we think about growth in both direct store expenses in G&A because I know you have some catch up this year, but is direct store expenses really a function of square footage growth plus inflation now? And is G&A somewhat less than that? I am just wondering how to think about the line items over the next couple of years.

John P. Mackey

I don’t think you should expect to get, to see much leverage in those categories. There may be marginal leverage if we have very strong comp sales growth. But, in general, we expect our growth in sales will drive our growth in earnings, so in modeling it out, I don’t think you should expect to see -- it may slowly get better over time but it won’t be something that, it won’t be that noticeable, I don’t think. So it is going to be the growth in sales that is going to grow our earnings not leveraging direct store expenses of G&A significantly.

Edward Kelly - Credit Suisse

Just…

A.C. Gallo

So that -- that’s it. We got very, we got marginal leverage, marginal leverage this time even in the ident stores because we are recycling over such deep leverage last year, but I think John is right. We will have to go forward and see how we deal with that given these new disciplines.

Walter Robb

We hope to see some. But we don’t want you to model it in because it is going to be a hard fight to create it over the next few years.

Glenda J. Chamberlain

The disciplines that we put in place last year in areas of purchasing, inventory management, spending on new stores, overall CapEx spending and overall spending still exists and are still remain a focus for us. 2.9% G&A that we are guiding to for fiscal year 2010 is a great number for us relative to most of our history. And we do expect to produce continuing leverage in ident stores, most likely although not significant but for our total company basis it is very difficult to.

John P. Mackey

And what you will see over time is the expense discipline we have in terms of new stores will be probably what affects overtime getting leverage in direct store expenses. We’re going to be opening smaller stores and we’re going to be spending less money to open them. That’s going result in less depreciation and higher profitability and better cash flow. So as we open more and more relatively smaller stores that is going to have a long term positive impact. But I don’t expect you should see that much occur in the next year or two. It will take time for that narrative to play out.

Edward Kelly - Credit Suisse

Just a follow up. Is that assuming the same type of comp growth you are talking about now?

John P. Mackey

We don’t know what’s going to happen with comps. I mean, we are in such a discontinuous world right now. We had high single digit, low double digit comp growth for like 30 years, then we went into this recession. What we don’t know is we don’t know what’s going to happen with the economy and we don’t know whether or not we are returning to our historical pattern or whether this is -- we just don’t know what’s going to happen with comps. We really can’t predict it.

We are as interested to find out as you, what’s going to happen. So a year from now, we will have a better indication of what our comp trends are going to be. We are certainly excited right now after being wondering around lost in the wilderness for two years to see our comps moving in the right direction. So we are very excited about that and we feel like we are building momentum again, but we are not prepared to make any predictions about where comps are going to level out at. We hope it will level out for many quarters, but we are not making my predictions of that.

Edward Kelly - Credit Suisse

Fair enough. Thank you.

Operator

We’ll take our next question from Karen Short with BMO Capital. Please go ahead

Karen Short - BMO Capital Markets

Hey, congratulations on a great quarter.

Glenda J. Chamberlain

Thank you very much.

Karen Short - BMO Capital Markets

A couple of questions. Just on your -- well like a big picture question and then the quarter related question, your new store productivity seemed to improve sequentially, wondering if you could share some thoughts on what drove that and then on your guidance which is also near-term, your original guidance. I think you had said specifically it included 170 million shares which I didn’t understand if you were doing a weighted average by quarter. But what do you assume in the new guidance in terms of total annual share counts and then I had one big picture question.

Glenda J. Chamberlain

I will answer the share count question. We think it is about 168 million for the year because it was lower in the first quarter obviously and will be higher in Q2, Q3 and Q4 subsequent to the conversion of the series I preferred.

Karen Short - BMO Capital Markets

Okay.

Walter Robb

Karen, your second question was about store productivity?

Karen Short - BMO Capital Markets

Yeah. It was my first but that’s okay.

Walter Robb

All right. Could you say again just to make sure…

Karen Short - BMO Capital Markets

I’m just curious, if you look -- if you do the math on new store productivity this quarter you definitely saw a sequential improvement. I’m just wondering if you could add some color as to location specific, anything you are doing differently?

Walter Robb

Probably, the biggest shift is slightly smaller stores, the stores we open in this class is in the script went down to 47,000 square feet and produced higher sales, average weekly sales and it costs less to build the stores. So all of those things added. We actually got leverage on depreciation for the first time in a long time, right, I think in the ident stores. I think it is a combination of smaller stores producing a better result costing less to build.

A.C. Gallo

We are also opening stores in a slightly better economic time than last year. And we saw a lot of our store openings were very -- the customers were very excited and we had very large initial sales in a lot of stores and they have maintained. So it is just a very different environment for opening up a store this year than it was a year ago.

Walter Robb

This one is definitely an intangible, Karen, but there’s short of a feeling I think in the company that the company is in a good place and an excitement with the team members and customers about where Whole Foods is right now and I think that translates at some pixie dust that is settling in on the stores right now.

Karen Short - BMO Capital Markets

So looking at the 20,000 class, a little plus, I guess square foot opportunity, you talked about the fact that your Oat stores are now at I think you said $542 in sales per square foot. Do you think if you were to look forward and evaluate the 20,000 plus opportunity, what do you think the sales per square foot would be if you were opening your own stores? Obviously, I am guessing you’d pick slightly better locations.

Glenda J. Chamberlain

Be higher than…

John P. Mackey

It would be higher than -- it would be higher, but we haven’t really tried to project out what sales per square foot would be, but it would be higher for sure. I mean, our smaller stores have higher sales per square foot on average than our larger stores do. But we just haven’t -- we haven’t done that calculation so I can’t say. We are excited to have the Wild Oats stores are comping extremely strongly and well into double digits across the country and their sales per square foot are going up accordingly. We haven’t invested very much capital in them.

We have improved the product selection and the team members are -- feel like they’re doing a great job, but we still haven’t invested very much capital in those Wild Oats stores. We think that as we begin to do so in 2010. We expect to see strong comp growth in those ex Wild Oats stores, actually for many years to come. As we do, we do expect the sales per square foot in those stores to reach Whole Foods Market averages in the next few years.

A.C. Gallo

Over the years, when we have made different acquisitions, we have purchased quite a few companies that have small stores and a lot of those stores that are still around are some of our higher productivity stores. But they weren’t at the time and when we took over the Wild Oats stores I think, it seems like they took a little longer to get going. And some of it was that some of them were in very bad shape and needed a lot of tender care to bring them up to the quality we wanted them to be. But also we were doing it in the middle of a recession when the economy was really slowing down.

I think what we have seen now, now that we’ve had time to operate them for a couple years and the economy is getting better, we are seeing the kind of growth in those stores now that -- as John was saying, I believe that a lot of those stores at some point in the future will be very high productivity stores, very similar to a lot of other stores we have acquired over the years.

Karen Short - BMO Capital Markets

Looking at bigger picture, kind of five years out, do you have any ability to project long-term goals in terms of total number of stores or total sales five years from now? I don’t think you have talked about that number for a while.

John P. Mackey

We have that ability. We do it internally and we are not going to tell you.

Karen Short - BMO Capital Markets

Okay. Fair enough. Thanks.

Operator

We will take our next question from Mark Wiltamuth with Morgan Stanley. Please go ahead.

Mark Wiltamuth - Morgan Stanley

Hi. Good afternoon. I wanted to ask about the London store. You said that was comping double digits and I know this was highlighted as an area that was going to be an earnings drag a couple of quarters ago and can you let us know what’s going on the profitability side there also?

A.C. Gallo

Yeah. We are excited to see the Kensington store move into double-digit comps and also the other small stores in the U.K. have all shown steadily improving comps as well. And I think it is a combination of this past year, about 10 months ago, we separated the U.K. as its own region and moved over Jeff Turnas to be the regional President over there and then also David Doctorow moved over, a long time veteran of our north Atlantic region, moved over to work with Jeff as the Vice President. And those guys have just made steady improvements and the customers are really reacting to it. It is a good time because the economy is also picking up over there. So, it has been really exciting to see and yes as to -- as the sales continue to pick up over there, the profitability is as well.

Mark Wiltamuth - Morgan Stanley

So is it still in the red, or is it turning the corner?

John P. Mackey

It is still in the red. It will be in the red for a while because of the high depreciation. Until some of that depreciation comes off and sales continue to go up, it has high rent. But we see a light at the end of the tunnel and the power of compounding, if you are able to grow those comps say double digits for the next several years, I will be on a call someday in the future and announce the profitability of -- first I will announce the positive cash flow from the store and then I will announce the profitability. But, I am not announcing it right now.

Mark Wiltamuth - Morgan Stanley

Okay. And just to get back to the gross margin discussion on the broader company, you did mention you were doing very well on your buys because of all of the product that was out there with the organics. Were you passing all of that through and really just the margin positive here was from being more disciplined on price relative to last year or were you pocketing some of the cost of goods saving for yourselves?

A.C. Gallo

I would say that the majority of the increase in margin has come through better -- through better disciplines. One things that happened in the first quarter of last year was that we had a lot of the holiday ordering was done before we were clear on how much a problem the sales were going to be. And so when we moved into the holidays expecting our normal bump last year it didn’t happen. We were stuck with a fair amount of inventory and we had a lot of significant shrink in the perishables and then we had lots of holiday items in our Whole Body department.

So that really depressed last year’s gross margin and with better sales this year, better holidays, much better discipline, we did much better through the holidays. So some of that -- a good chunk of that improvement over -- over first quarter of last year was because of that. As far as your question of these better buys we have, I would say that most of it was passed on to the customer, a few places where maybe it helped the margin a little bit, but I think the majority of that margin improvement was we faced some better disciplines and a much better holiday.

Mark Wiltamuth - Morgan Stanley

If you look at the PPI numbers which is a little bit of a crude measure, but we are starting to see some turn in dairy and some of the vegetables. Are you seeing that also?

Walter Robb

The inflation question. We started looking to PPI as well as CPI and we are not completely gathered to those numbers since it reflects primarily commodity conventional agriculture and we have a mix of natural organic as well as conventional. But we saw a slight upturn in, in the last three to the quarter. We still continue to look at the balance of this year. We don’t see inflation being meaningful. So more than 1.5% to 2% range at the Cap is what we our internal projections and so yes we did see a little bit. We still don’t think that for our business it is going to be a meaningful factor. If anything it will be a slight, a slight tailwind, but still not that meaningful.

Mark Wiltamuth - Morgan Stanley

You are still in deflation mode right now versus a year ago?

Walter Robb

Not deflation. The CPI was slightly deflationary, but I don’t think that’s where we are. I don’t think it is going to be a major factor in thinking about the business for the balance of this fiscal year.

Mark Wiltamuth - Morgan Stanley

Okay. Thank you very much.

Operator

We will take our next question from Meredith Adler with Barclays Capital. Please go ahead.

Meredith Adler - Barclays Capital

Hi. Thanks for taking my question. I was wondering just talking a little bit following on Mark’s question, you talked about very strong volumes in produce and I don’t know whether we have a lot of, you have a lot of experience with the kind of inflation and deflation we have seen recently in produce. But is some of it people responding to the lower prices, just generally, the people are buying more produce because there are lower prices?

A.C. Gallo

Yes. I think, last year when we started to have price deflation in produce and we wound up lowering a lot of prices, initially we saw produce volume actually dropping because we were -- initially saw a drop in average transaction because of lower price and not enough tick in volume. But then over the course of time we started to see that, started to see the volume pick up and we have held -- at this point now, our pricing versus a year ago, is staying fairly steady and the increase in tonnage that we are selling in produce is really what’s adding to the -- to the volume.

Meredith Adler - Barclays Capital

Okay. Do you think the customers are proceeding better pricing or that’s just really not it?

A.C. Gallo

Yes. I do believe our customers are perceiving better pricing. We have done -- We have done a lot of -- we have been doing a lot of promotions each region again slightly different. For instance, our North Atlantic region has a program they call Madness Specials that they run two weeks out of every month. They also run weekend Madness Specials and on perishables and those stores have very large dramatic displays of whatever the hot produce item is right now and the sales have been tremendous on it.

So the feedback we are getting from our customers is that they -- we have this feedback a lot over the last year. It was visible to them, that we were really reacting to the different economic times and they really appreciated it. They saw we were really making an effort to make, to increase the value and make it easier for them to continue to shop with us, to shop with us more and again we got a lot of positive comments from our customers about that.

Meredith Adler - Barclays Capital

That’s great. Just a follow up question, when I look at your comp numbers, it looks like the stores two to four years old, which is also the biggest group in terms of the average store size is the biggest, are the stores that are probably struggling the most. Any thoughts about what you do to give those stores a boost or get them back on track or I don’t know how well they’re performing from a bottom line perspective? But is there anything you do if you are not happy with that performance to make it better?

John P. Mackey

We think it will look different next quarter. This is a common problem because stores move in and out of those categories every quarter and I wouldn’t, I wouldn’t read too much into that. So, I don’t think, for example you said the average size, but if you look at that chart Meredith you will see that actually the stores that are less than two years old are actually bigger in size at 52,900 square feet to the stores that are two to five years of age, may have significantly better comps.

So, there’s lots of factors and some times a new cohort of stores each year -- we don’t have as many good stores and they don’t comp as well or they have cannibalized by other stores that have opened up for competitive entries, I wouldn’t read too much into it. It is next quarter, we could see that number to be much higher. So, I don’t think -- maybe Walter you will want to add something to it.

Glenda J. Chamberlain

I will add to it. Actually, what you are talking about the two to five year old category.

Meredith Adler - Barclays Capital

I said two to four, but I meant two to five.

Glenda J. Chamberlain

The comps in that category were negative, slightly negative in Q4. So now we are at 4.4% for this quarter.

John P. Mackey

We are showing some progress and…

Glenda J. Chamberlain

We made a lot of progress.

John P. Mackey

… more progress in Q2.

Walter Robb

In terms of what we are doing to create that movement, I can tell you in that group of stores there are some that are underperforming and we have -- we have been pretty disciplined about using best practices within our individual regions to compare the metrics and try to drill down on the P&L and also work aggressively to build sales. There’s no stone being unturned with respect to comparing stores and looking for ways to keep their costs down and to build their sales and that is happening on an ongoing basis.

Meredith Adler - Barclays Capital

Okay. Thank you very much.

Operator

We will take our next question from Neil Currie with UBS. Please go ahead.

Neil Currie - UBS

Thanks. I think most of my questions have been asked, but maybe I can ask one about where you have seen improvement in sales and it seems that you really have turned the corner in the last quarter and particularly the last four weeks. Is there any particular segment of your customer base where you think the turn around has been most pronounced, whether it is the food customer versus the natural foods customer or whether it’s the high end customer relative to maybe the middle income customer who may still be under some financial pressure?

John P. Mackey

I think we are seeing a little bit of change in each category. We have seen, as you saw our transaction counts up quite a bit. And we definitely are seeing a lot of new faces. We saw especially over the holidays, had a lot of regional Presidents tell me that the stores reporting a lot of, either a lot of customers that are new, comments like I usually came here and bought my Thanksgiving turkey, but last year I didn’t because I didn’t think I could afford it and I realize it was a mistake. I am back here this year again. So we think we have had some returning customers or maybe people who stopped shopping with us at the beginning of the recession. They were afraid of what was happening, not sure if they can afford it.

We also have some of our -- we know that a large majority of our customers only spend a certain amount of their basket at our stores. So with our improved value offerings this year we think we have gotten even our regular customers to buy more than what they had before. And then, the other thing I think that is happening especially in the -- since the beginning of the year, we started this new healthy eating initiative and we have had really a lot of positive response to our -- from our customers and team members on this. And we are seeing a lot of excitement.

We credit some of our -- of our strong produce comps to the fact that people are really focusing in on our produce. We put these ANDI scores up in the stores and we have noticed a dramatic increase in the amount of green vegetables that we are selling. Customers are really reacting to it. It is just a lot -- a combination of a lot of things and a lot of different customers.

Walter Robb

I want to add. This is Walter. I want to add something. Some of you have asked over time about a more definable metric. We have engaged Nielsen and we have got to get a, what we are calling, a positivity metric, positive sentiment drivers for Whole Foods value and this is attracting from October to the end of January. And we saw almost a 10% lift in peoples perception on that sentiment driver as well as a similar decline in the negative.

So I think the perception has shifted in terms of because of the work that we have done, we have done good work on increasing the value offerings and I think we are getting some credit for that. People are beginning to look at us differently and as we make this shift toward healthy eating, which I think John mentioned we can do, I think uniquely well among food retailers, we are getting a differentiation from that effort as well.

John P. Mackey

Hey, Neil, John here. Let me just add that over the past three weeks I have toured three of our regions, our northern California region, our southern California region and our southwest region and what I found in common in all three regions, talked to customers, I have talked to team members, I talked to suppliers while I was in the stores. And there’s some excitement level right now in our team member base and with our customers that I haven’t seen in many years.

I am not sure exactly -- maybe that sources back to our healthy eating initiative. But it is noticeable the company is gaining a lot of positive momentum right now and I am seeing it even in places you don’t expect to see it like our suppliers are generally excited because they’re seeing their sales go up. But having been in three different regions and seeing the same kind of positive energy, it has got us all pretty excited. So I know that is sort of intangible and subjective, but it is -- it is definitely happening. We don’t exactly know why? We are just speculating, but we are hopeful we will see it continue.

Neil Currie - UBS

That’s interesting color. Thanks. The other thing you alluded to and Meredith’s question, that the big turn around seems to be in the stores between two and five years old which tend to be some of your biggest stores with some of the biggest service areas. That would imply to me that maybe perhaps there has been a more exaggerated improvement in some of these service counter areas and food to go, hot food. Should I read that into it?

John P. Mackey

No. I wouldn’t read that into that. We are opening smaller stores. So we do have quite a few 50,000 plus stores that are perhaps not producing the same level of profitability mostly due to their high depreciation in cash flow production is pretty strong that our smaller stores have produced. So they’re acting a bit of a drag, but as they comp and as they grow, they’re acting as less of a drag. So one of the things we are hopeful about and perhaps even optimistic about, is that as our comps continue to hopefully accelerate the bigger stores that due to the recession didn’t comp at historical levels that we used to see are going to begin to return to historical type of comps.

And as that happens, that is going to have a strong impact, positive impact we think on the bottom line. I want to emphasize that our comp improvement has been across the board. It has been at all age stores and all sizes of stores. So, I think that’s something to support for people to understand.

Walter Robb

With that being said, I think historically we do see a larger comp gain in this category as the stores are younger, they have more comp to go. So some of that, potentially could help this category just because, there’s more comp to get earlier in the store life. But the main thing is the comps are strong across the board. Yes.

Neil Currie - UBS

Well. Thank you very much for taking my questions.

John P. Mackey

You’re welcome.

Operator

We will take our last question from Ed Aaron with RBC Capital Markets. Please go ahead.

Edward Aaron - RBC Capital Markets

Hi. Good afternoon. Thank you for squeezing me in. We first talked just in the past year about vendors maybe shifting in some cases products back down to natural versus organic. Just to bring the price point down, just curious to know how organic is changing, if at all, in terms of your mix of business. And to the extent that organic might still be holding up better than the industry on a relative basis, would you draw any conclusions about the market share trends you might be seeing in term of the share you perhaps gaining and the environment where your competition might have pulled back the last couple of years?

Walter Robb

Organic -- this is Walter. Organic remains a strong part of our business and I think the Trade Association just released new data on the size of the organic industry at $26 billion with a growth rate of 5% to 6%. Our own internal numbers show very clearly that and you can look at the Nielsen numbers too, that organic dollars and units while they’re down from historical double digit results are still well ahead of conventional growth rates.

And, that tells us and we see it in our own data, that organic continues to be a lifestyle choice or a choice that people will continue to make even in the darkest of times. Ant that’s a real -- as you point out, some of the competitors have in fact pulled back from some of that selection and that has been a real positive for us. We continue to be an authentic organic retailer and offer those choices and that’s what the numbers show.

John P. Mackey

One thing we haven’t really talked about, but maybe this is a good place to do it at the close of the call, we are seeing our meat departments right now undergoing an evolution in that. We are selling more and more, for example in beef, we are selling a lot more 100% grass fed organic beef. We are finding that from local sources with high animal welfare standards, we are seeing that garner a larger and larger share.

In that sense in the meat department, we are seeing organic as the category growth. We are seeing, we will be seeing similar things in chicken, in our pork sales and lamb as we get more local, more organic, more 100% grass fed or pasture raised. We are starting to see some good share shifts into that category. In that area at least, organic is definitely, I think is growing Whole Foods and we anticipate it will continue to grow in the future.

Edward Aaron - RBC Capital Markets

Thanks. One follow up if I can on the guidance provision, earnings guidance is coming up about $0.15, about a 200 basis point revision to the comp guidance. That implies just a little bit of a higher marginal profit rate, if you will, than what we have historically thought your business would do on an additional point or two of higher comp. And so I am wondering how to reconcile that and would you attribute the difference to the new store productivity being better and the profitability of those stores being higher than what you might have thought when you first provided your guidance for the year?

Glenda J. Chamberlain

Well, the new store profitability certainly helps, but the operating margins that are implied for the rest of the year are 4.5% to 4.8% which is very much in line with and still below what we have produced historically. So that seems to be a reasonable number.

Edward Aaron - RBC Capital Markets

Okay. Thanks. Well congrats on the quarter and if this momentum continues we will start asking when you will start opening bigger stores again.

John P. Mackey

We expect that to happen.

Glenda J. Chamberlain

Thank you, Ed.

Walter Robb

Appreciate it.

John P. Mackey

Okay. Thanks for listening in. As we stated we believe there are many reasons to be bullish about where are our results will go from here, but it is early in our recovery. We have tougher identical store sales growth comparisons as we move into the second half of the year and there’s still a lot of uncertainty regarding the economy. We look forward to updating you on our progress in May on our second quarter earnings call. The transcript of the scripted portion of this call along with a recording of the call is available on our website at www.wholefoodsmarket.com. Thank you for listening in. We will take to you next quarter. Bye.

Operator

This concludes your teleconference. Thank you for your participation. You may now disconnect.