Whole Foods Market, Inc.
Notes to Consolidated Financial Statements (unaudited)
January 14, 2007
(1) Basis of Presentation
The accompanying unaudited consolidated financial statements of Whole Foods Market, Inc. (“Whole Foods Market,” “Company,” or “We”) have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial statements and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. The information included in this Form 10-Q should be read in conjunction with Management’s Discussion and Analysis, the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 24, 2006. In the opinion of management, the accompanying consolidated financial statements reflect all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation. Interim results are not necessarily indicative of results for any other interim period or for a full fiscal year. The Company reports its results of operations on a fifty-two or fifty-three week fiscal year ending on the last Sunday in September. The first fiscal quarter is sixteen weeks, the second and third quarters each are twelve weeks and the fourth quarter is twelve or thirteen weeks. Fiscal year 2007 is a fifty-three week fiscal year and 2006 was a fifty-two week fiscal year. We operate in one reportable segment, natural and organic food supermarkets. Where appropriate, we have reclassified prior year financial statements to conform to current year presentation.
(2) Goodwill and Other Intangible Assets
Goodwill and indefinite-lived intangible assets are reviewed for impairment annually or more frequently if impairment indicators arise. We allocate goodwill to one reporting unit for goodwill impairment testing. There were no impairments of goodwill or indefinite-lived intangible assets during the sixteen week period ended January 14, 2007.
Definite-lived intangible assets are amortized over the useful life of the related agreement. We acquired definite-lived intangible assets totaling approximately $6.2 million, consisting primarily of acquired leasehold rights, during the sixteen week period ended January 14, 2007. During the first quarter of fiscal year 2007 and fiscal year 2006, we reclassified approximately $0.1 million of contract-based intangible assets to common stock as the result of bondholders voluntarily converting approximately 3% and 2%, respectively, of our zero coupon convertible debentures. Amortization associated with intangible assets totaled approximately $0.5 million and $1.0 million for the sixteen weeks ended January 14, 2007 and January 15, 2006, respectively. The components of intangible assets were as follows (in thousands):
| | January 14, 2007 | | September 24, 2006 | |
| | Gross carrying | | Accumulated | | Gross carrying | | Accumulated | |
| | amount | | amortization | | amount | | amortization | |
Indefinite-lived contract-based | | $ | 774 | | $ | — | | $ | 774 | | $ | — | |
Definite-lived contract-based | | 51,674 | | (12,481 | ) | 45,579 | | (11,833 | ) |
Definite-lived marketing-related and other | | 1,941 | | (1,741 | ) | 2,242 | | (1,995 | ) |
| | $ | 54,389 | | $ | (14,222 | ) | $ | 48,595 | | $ | (13,828 | ) |
Amortization associated with the net carrying amount of intangible assets at January 14, 2007 is estimated to be $1.9 million for the remainder of fiscal year 2007, $2.6 million in fiscal year 2008, $2.6 million in fiscal year 2009, $2.6 million in fiscal year 2010, $2.5 million in fiscal year 2011, $2.5 million in fiscal year 2012.
(3) Long-Term Debt
During the first quarter of fiscal years 2007 and 2006, approximately 10,000 and 7,000 of the Company’s zero coupon convertible subordinated debentures, respectively, were converted at the option of the holders to approximately 215,000 and 145,000 shares, respectively, of Company common stock. The zero coupon convertible subordinated debentures had a carrying amount of approximately $2.6 million and $8.3 million at January 14, 2007 and September 24, 2006, respectively.
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(4) Comprehensive Income
Our comprehensive income was comprised of net income, unrealized gains and losses on marketable securities, and foreign currency translation adjustments, net of income taxes. Comprehensive income, net of related tax effects, was as follows (in thousands):
| | Sixteen weeks ended | |
| | January 14, | | January 15, | |
| | 2007 | | 2006 | |
Net income | | $ | 53,755 | | $ | 58,318 | |
Unrealized gains (losses), net | | (61 | ) | 382 | |
Foreign currency translation adjustment, net | | (1,501 | ) | 251 | |
Comprehensive income | | $ | 52,193 | | $ | 58,951 | |
(5) Investments
We had short-term cash equivalent investments totaling approximately $11.1 million and $10.1 million at January 14, 2007 and September 24, 2006, respectively.
As of January 14, 2007 and September 24, 2006 we also had short-term available-for-sale securities, generally consisting of state and local government obligations totaling approximately $104.4 million and $193.8 million, respectively. Gross unrealized gains on the securities totaled approximately $16,000 and $76,000 as of January 14, 2007 and September 24, 2006, respectively.
(6) Earnings per Share
The computation of basic earnings per share is based on the number of weighted average common shares outstanding during the period. The computation of diluted earnings per share includes the dilutive effect of equity share options or other equity instruments, consisting of common shares deemed outstanding from the assumed exercise of stock options and the assumed conversion of zero coupon convertible subordinated debentures. A reconciliation of the numerators and denominators of the basic and diluted earnings per share calculations follows (in thousands):
| | Sixteen weeks ended | |
| | January 14, | | January 15, | |
| | 2007 | | 2006 | |
Net income (numerator for basic earnings per share) | | $ | 53,755 | | $ | 58,318 | |
Interest on 5% zero coupon convertible subordinated debentures, net of income taxes | | 40 | | 102 | |
Adjusted net income (numerator for diluted earnings per share) | | $ | 53,795 | | $ | 58,420 | |
Weighted average common shares outstanding (denominator for basic earnings per share) | | 140,267 | | 137,532 | |
Potential common shares outstanding: | | | | | |
Assumed conversion of 5% zero coupon convertible subordinated debentures | | 160 | | 428 | |
Assumed exercise of stock options | | 2,491 | | 7,357 | |
Weighted average common shares outstanding and potential additional common shares outstanding (denominator for diluted earnings per share) | | 142,918 | | 145,317 | |
| | | | | |
Basic earnings per share | | $ | 0.38 | | $ | 0.42 | |
| | | | | |
Diluted earnings per share | | $ | 0.38 | | $ | 0.40 | |
The computations of diluted earnings per share for sixteen week periods ended January 14, 2007 and January 15, 2006 does not include options to purchase approximately 10.9 million shares and 9,100 shares of common stock, respectively, due to their antidilutive effect.
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(7) Dividends
On September 27, 2006, the Company’s Board of Directors approved a quarterly dividend of $0.15 per share, totaling approximately $21 million that was paid on October 23, 2006 to shareholders of record on October 13, 2006. On November 2, 2006, the Company’s Board of Directors approved a 20% increase in the Company’s quarterly dividend to $0.18 per share, totaling approximately $25.3 million that was paid subsequent to the end of the first quarter on January 22, 2007 to shareholders of record on January 12, 2007. During the first quarter of fiscal year 2006, the Company announced a 20% increase in the Company’s quarterly dividend to $0.15 per share and a special dividend of $2.00 per share. The quarterly dividend and special dividend, totaling approximately $298.8 million, were paid on January 23, 2006 to shareholders of record on January 13, 2006. The Company will pay future dividends at the discretion of our Board of Directors. The continuation of these payments and the amount of such dividends depend on many factors, including the results of operations and the financial condition of the Company. Subject to such factors and a determination that cash dividends continue to be in the best interest of our shareholders, the current intention of our Board of Directors is to pay a quarterly dividend on an ongoing basis.
(8) Share-Based Compensation
Our Company maintains several stock based incentive plans. We grant options to purchase common stock under our 1992 Stock Option Plans, as amended. Under these plans, options are granted at an option price equal to the market value of the stock at the grant date and are generally exercisable ratably over a four-year period beginning one year from grant date and have a five-year term. The market value of the stock is determined as the closing stock price at the grant date. At January 14, 2007 and September 24, 2006 there were approximately 6.8 million and 6.5 million shares, respectively, of our common stock available for future stock option grants.
Total unrecognized stock-based compensation expense related to nonvested stock options was approximately $22.7 million as of the end of the first quarter of fiscal year 2007, related to approximately 1.6 million shares with a per share weighted average fair value of $13.78. We anticipate this expense to be recognized over a weighted average period of approximately two years.
Share-based compensation expense recognized during the sixteen week periods ended January 14, 2007 and January 15, 2006 totaled approximately $4.8 million and $1.1 million, respectively and consisted of stock option expense of approximately $4.7 million and $1.0 million, respectively and team member stock purchase plan discounts of approximately $0.1 million. Included in total share-based compensation expense for the first quarter of fiscal year 2007 is a $2.4 million charge related to the acceleration of stock options in September 2005, to adjust for actual experience. Share-based compensation was included in the following line items on the Consolidated Statements of Operations for the periods indicated (in thousands):
| | Sixteen weeks ended | |
| | January 14, | | January 15, | |
| | 2007 | | 2006 | |
Cost of goods sold and occupancy costs | | $ | 193 | | $ | 5 | |
Direct store expenses | | 2,571 | | 94 | |
General and administrative expenses | | 2,009 | | 1,032 | |
Share-based compensation before income taxes | | 4,773 | | 1,131 | |
Income tax benefit | | 1,332 | | 302 | |
Net share-based compensation expense | | $ | 3,441 | | $ | 829 | |
(9) Recent Accounting Pronouncements
In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No.108 (“SAB No. 108”), “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in the Current Year Financial Statements.” SAB No. 108 addresses how the effects of prior-year uncorrected misstatements should be considered when quantifying misstatements in current-year financial statements. SAB No. 108 requires an entity to quantify misstatements using a balance sheet and income statement approach and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative and qualitative factors. The requirements of SAB No. 108 are effective for fiscal years ending after November 15, 2006. We do not expect the adoption of SAB No. 108 will have a significant effect on our future consolidated financial statements.
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measures.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and requires additional disclosures about fair value measurements. SFAS No. 157 applies to fair value measurements that are already required or permitted by other accounting standards, except for measurements of share-based payments and
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measurements that are similar to, but not intended to be, fair value and does not change existing guidance as to whether or not an instrument is carried at fair value. The provisions of SFAS No. 157 are effective for the specified fair value measures for financial statements issued for fiscal years beginning after November 15, 2007. We are currently evaluating the impact, if any, that the adoption of SFAS No. 157 will have on our consolidated financial statements.
In July 2006, the FASB issued Interpretation 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes,” an interpretation of SFAS No. 109, “Accounting for Income Taxes.” FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109. The interpretation applies to all tax positions accounted for in accordance with Statement 109 and requires a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken, or expected to be taken, in an income tax return. Subsequent recognition, derecognition, and measurement is based on management’s best judgment given the facts, circumstances and information available at the reporting date. FIN 48 is effective for fiscal years beginning after December 15, 2006. Early adoption is permitted as of the beginning of an enterprise’s fiscal year, provided the enterprise has not yet issued financial statements, including financial statements for any interim period, for that fiscal year. We are currently evaluating the effect, if any, that the adoption of FIN 48 will have on our consolidated financial statements.
In March 2006, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (that is, Gross versus Net Presentation).” Taxes within the scope of EITF Issue No. 06-3 include any taxes assessed by a governmental authority that are directly imposed on a revenue-producing transaction between a seller and a customer and may include, but are not limited to, sales taxes, use taxes, value-added taxes, and some excise taxes. The EITF concluded that the presentation of these taxes on either a gross (included in revenues and costs) or a net (excluded from revenues) basis is an accounting policy decision that should be disclosed. For any such taxes that are reported on a gross basis, a company should disclose the amounts of those taxes in interim and annual financial statements. The Company’s policy is to exclude all such taxes from revenue. EITF 06-3 is effective for interim and annual reporting periods beginning after December 15, 2006. The adoption of EITF 06-3 will not have any effect on our consolidated financial statements.
(10) Subsequent Event
On February 21, 2007, the Company and Wild Oats Markets announced they signed a definitive merger agreement under which the Company will acquire Wild Oats Markets’ outstanding common stock in a cash tender offer at a price of $18.50 per share, or approximately $565 million based on fully diluted shares. The Company will also assume Wild Oats Markets’ existing net debt, which totaled approximately $106 million on September 30, 2006. The Company expects to fund the transaction at closing using $700 million in new senior term loan facilities. Additionally, in conjunction with the transaction, the Company intends to expand its existing long-term senior revolving credit facility to $250 million. The Company has agreed in the merger agreement to commence a tender offer on February 27, 2007 for all of Wild Oats Markets’ outstanding common stock. The tender offer is conditioned upon at least a majority of the outstanding Wild Oats Markets’ shares being tendered, as well as customary regulatory and other closing conditions. Wild Oats Markets’ board of directors has unanimously recommended that Wild Oats Markets’ stockholders tender their shares in the offer. The Yucaipa Companies, Wild Oats Markets’ largest shareholder with approximately 18% ownership, has committed to tendering its shares. Approval of the transaction by Whole Foods Market shareholders is not required. The tender offer will expire within 30 days, subject to extension and to the receipt of customary regulatory approvals. The Company currently expects to close the transaction in April 2007.
Wild Oats Markets is one of the leading natural and organic foods retailers in North America with annual sales of approximately $1.2 billion. Wild Oats Markets was founded in Boulder, Colorado in 1987 and listed on the NASDAQ National Market in 1996. Wild Oats Markets currently operates 110 stores in 24 states and British Columbia, Canada under four banners: Wild Oats Marketplace (nationwide), Henry’s Farmers Market (Southern California), Sun Harvest (Texas), and Capers Community Market (British Columbia).
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
General
Whole Foods Market, Inc. owns and operates the largest chain of natural and organic foods supermarkets. Our Company mission is to promote vitality and well-being for all individuals by supplying the highest quality, most wholesome foods available. Through our growth, we have had a large and positive impact on the natural and organic foods movement throughout the United States, helping lead the industry to nationwide acceptance. We opened our first store in Texas in 1980 and, as of January 14, 2007, have expanded our operations both by opening new stores and acquiring existing stores from third parties to 189 stores: 180 stores in 31 U.S. states and the District of Columbia; three stores in Canada; and six stores in the United Kingdom. We operate in one reportable segment, natural and organic foods supermarkets.
Our results of operations have been and may continue to be materially affected by the timing and number of new store openings. Stores typically open within 12 to 24 months after entering the store development pipeline. New stores generally become profitable during their first year of operation, although some new stores may incur operating losses for the first several years of operation.
The Company reports its results of operations on a fifty-two or fifty-three week fiscal year ending on the last Sunday in September. The first fiscal quarter is sixteen weeks, the second and third quarters each are twelve weeks, and the fourth quarter is twelve or thirteen weeks. Fiscal year 2007 is a fifty-three week year and fiscal year 2006 was a fifty-two week fiscal year.
Subsequent to the end of the Company’s first fiscal quarter, on February 21, 2007, the Company and Wild Oats Markets announced they signed a definitive merger agreement under which the Company will acquire Wild Oats Markets’ outstanding common stock in a cash tender offer at a price of $18.50 per share. The Company has agreed in the merger agreement to commence a tender offer on February 27, 2007 for all of Wild Oats Markets’ outstanding common stock. The tender offer is conditioned upon at least a majority of the outstanding Wild Oats Markets’ shares being tendered, as well as customary regulatory and other closing conditions. This transaction is discussed further in Note 10 to the consolidated financial statements, “Subsequent Event” in “Item 1. Financial Statements.” Management’s Discussion and Analysis and the accompanying financial statements exclude any impact from the pending merger with Wild Oats Markets as the transaction has not closed.
Executive Summary
Sales for the first quarter of fiscal year 2007 increased approximately 12% to approximately $1.9 billion over approximately $1.7 billion in the prior year, driven by 9% square footage growth and comparable store sales growth of 7.0%. Identical store sales, which exclude three relocated stores and three major expansions, increased 6.2% for the quarter.
Net income for the first quarter totaled approximately $53.8 million and diluted earnings per share was $0.38.
Cash flows from operating activities for the first quarter totaled approximately $112.4 million compared to $88.2 million in the prior year. Our capital expenditures for the quarter totaled $153.0 million, of which approximately $100.9 million was for new store development. During the first quarter, we opened three new stores in West Orange, NJ, Tigard, OR and Seattle, WA and relocated a store in Dallas, TX, ending the quarter with 189 stores.
Cash and cash equivalents, including restricted cash, totaled approximately $118.1 million at the end of the first quarter of fiscal year 2007, and short-term investments totaled approximately $104.4 million. Total long-term debt was approximately $2.9 million at the end of the first quarter of fiscal year 2007.
On September 27, 2006, the Company’s Board of Directors approved a quarterly dividend of $0.15 per share, totaling approximately $21 million that was paid on October 23, 2006 to shareholders of record on October 13, 2006. On November 2, 2006, the Company’s Board of Directors approved a 20% increase in the Company’s quarterly dividend to $0.18 per share, totaling approximately $25.3 million that was paid subsequent to the end of the first quarter on January 22, 2007 to shareholders of record on January 12, 2007.
On November 6, 2006, the Company’s Board of Directors approved a $100 million increase in the Company’s stock repurchase program, bringing the total remaining authorization to approximately $200 million over the next three years.
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Results of Operations
The following table sets forth the Company’s statements of operations data expressed as a percentage of sales:
| | Sixteen weeks ended | |
| | January 14, | | January 15, | |
| | 2007 | | 2006 | |
Sales | | 100.0 | % | 100.0 | % |
Cost of goods sold and occupancy costs | | 65.7 | | 65.5 | |
Gross profit | | 34.3 | | 34.5 | |
Direct store expenses | | 25.8 | | 25.5 | |
General and administrative expenses | | 3.0 | | 3.1 | |
Pre-opening and relocation costs | | 0.9 | | 0.5 | |
Operating income | | 4.6 | | 5.5 | |
Investment and other income, net | | 0.2 | | 0.4 | |
Income before income taxes | | 4.8 | | 5.8 | |
Provision for income taxes | | 1.9 | | 2.3 | |
Net income | | 2.9 | % | 3.5 | % |
Figures may not add due to rounding.
Sales increased approximately 12.2% for the sixteen weeks ended January 14, 2007 over the same period of the prior fiscal year. This increase was driven by comparable store sales growth of approximately 7.0% and year-over-year square footage growth of approximately 9% for the sixteen weeks ended January 14, 2007. Sales of a store are deemed to be comparable commencing in the fifty-third full week after the store was opened or acquired. Sales in identical stores, which exclude relocated stores and major store expansions, increased approximately 6.2% for the sixteen weeks ended January 14, 2007 over the same period of the prior fiscal year. The Company believes its comparable store sales growth and the ability to open successful stores in diverse markets are due to the broad appeal of our stores, natural and organic products entering the mainstream consciousness, improvements in overall store execution and the growing awareness of our brand.
Gross profit consists of sales less cost of goods sold and occupancy costs plus contribution from non-retail distribution and food preparation operations. The Company’s gross profit as a percentage of sales for the sixteen weeks ended January 14, 2007 was approximately 34.3% compared to approximately 34.5% for the same period of the prior fiscal year. Our gross profit may increase or decrease slightly depending on the mix of sales from new stores, seasonality, the impact of weather or a host of other factors, including inflation. Due to seasonality, the Company’s gross profit margin is typically lower in the first quarter than the remaining three quarters of the fiscal year. Gross profit margins tend to be lower for new stores and increase as stores mature, reflecting lower shrink as volumes increase, as well as increasing experience levels and operational efficiencies of the store teams. We continue to find many opportunities to lower our cost of goods sold, and we selectively pass on those savings to our customers through lower prices. While our customers are not primarily focused on price, our value image is important in terms of appealing to a broader customer base, especially as select natural and organic products are becoming more available through various retail formats. Our strategy is to be competitively priced on a market-by-market basis on commodity-type products and on identical product brands in grocery and Whole Body; however, our perishables may be priced at a premium to reflect the higher quality, broader selection, and better customer service available in our produce, meat, seafood, bakery, specialty and prepared foods departments. One way we have improved our value to customers is through our private label products, which give us an opportunity to lower our prices through our scale and buying practices. We are committing additional resources to our private label team and expect private label to grow to a much higher percentage of our sales over time.
Direct store expenses as a percentage of sales were approximately 25.8% for the sixteen weeks ended January 14, 2007 compared to approximately 25.5% for the same period of the prior fiscal year. Direct store expenses as a percentage of sales tend to be higher for new stores and decrease as stores mature, reflecting increasing operational productivity of the store teams.
General and administrative expenses as a percentage of sales were approximately 3.0% for the sixteen weeks ended January 14, 2007 compared to approximately 3.1% for the same period of the prior fiscal year.
Pre-opening costs include rent expense incurred during construction of new stores and other costs related to new store openings, which include costs associated with hiring and training personnel, supplies and other miscellaneous costs. Rent expense is generally incurred for six to 12 months prior to a store’s opening date. Other pre-opening costs are incurred primarily in the 30 days prior to a new store opening. Relocation costs consist of moving costs, remaining lease payments,
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accelerated depreciation costs and other costs associated with replaced stores or facilities. Pre-opening and relocation costs as a percentage of sales were approximately 0.9% for the sixteen weeks ended January 14, 2007 compared to approximately 0.5% for the same period of the prior fiscal year due primarily to the increased number of leases tendered. This significant year-over-year increase is due primarily to the anticipated acceleration in leases tendered and square footage opening in fiscal years 2007 and 2008, including the opening of 18 to 20 new stores in fiscal year 2007.
The numbers of stores opened and relocated were as follows:
| | Sixteen weeks ended | |
| | January 14, | | January 15, | |
| | 2007 | | 2006 | |
New stores | | 3 | | 5 | |
Relocated stores | | 1 | | — | |
The Company began recognizing share-based compensation expense in the first quarter of fiscal year 2006. During the fourth quarter of fiscal year 2005, the Company accelerated the vesting of all outstanding stock options, except options held by the members of the executive team and certain options held by team members in the United Kingdom, in order to prevent past option grants from having an impact on future results. Share-based compensation expense recognized during the sixteen week periods ended January 14, 2007 and January 15, 2006 totaled approximately $4.8 million and $1.1 million, respectively and consisted of stock option expense of approximately $4.7 million and $1.0 million, respectively and team member stock purchase plan discounts of approximately $0.1 million. Included in total share-based compensation expense for the first quarter of fiscal year 2007 is a $2.4 million charge related to the acceleration of stock options in September 2005, to adjust for actual experience. Share-based compensation was included in the following line items on the Consolidated Statements of Operations for the periods indicated (in thousands):
| | Sixteen weeks ended | |
| | January 14, | | January 15, | |
| | 2007 | | 2006 | |
Cost of goods sold and occupancy costs | | $ | 193 | | $ | 5 | |
Direct store expenses | | 2,571 | | 94 | |
General and administrative expenses | | 2,009 | | 1,032 | |
Share-based compensation before income taxes | | 4,773 | | 1,131 | |
Income tax benefit | | 1,332 | | 302 | |
Net share-based compensation expense | | $ | 3,441 | | $ | 829 | |
The Company expects share-based compensation of approximately $2 million to $3 million in the second quarter and $3 million to $4 million per quarter in the second half of the year following the Company’s annual grant date early in the third quarter, when the majority of options are granted.
The Company’s current intention is to keep its broad-based stock option program in place but, going forward, limit the number of shares granted in any one year so that annual earnings per share dilution from share-based compensation expense will ramp up but not exceed 10% over time. The Company believes this strategy is best aligned with its stakeholder philosophy because it limits future earnings per share dilution from options and at the same time retains the broad-based stock option plan, which the Company believes is important to team member morale, its unique corporate culture and its success.
Net investment and other income for the sixteen weeks ended January 14, 2007 totaled approximately $4.0 million compared to approximately $6.1 million, respectively, for the same period of the prior fiscal year due primarily to lower interest income earned based on lower average short-term investment balances.
Liquidity and Capital Resources and Changes in Financial Condition
We generated cash flows from operating activities of approximately $112.4 million during the sixteen weeks ended January 14, 2007 compared to approximately $88.2 million during the same period of the prior fiscal year. Cash flows from operating activities resulted primarily from our net income plus non-cash expenses and changes in operating working capital.
Net cash used in investing activities was approximately $84.2 million for the sixteen weeks ended January 14, 2007 compared to approximately $82.1 million for the same period of the prior fiscal year. Our principal historical capital requirements have been the funding of the development or acquisition of new stores and acquisition of property and equipment for existing stores. The required cash investment for new stores varies depending on the size of the new store, geographic location, degree
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of work performed by the landlord and complexity of site development issues. Capital expenditures for the sixteen weeks ended January 14, 2007 totaled approximately $153.0 million, of which approximately $100.9 million was for new store development and approximately $52.1 million was for remodels and other additions. Capital expenditures for the sixteen weeks ended January 15, 2006 totaled approximately $69.1 million, of which approximately $35.3 million was for new store development and approximately $33.7 million was for remodels and other additions.
Capital expenditures are expected to be in range of $525 million to $575 million. Of this amount, approximately 70% to 75% is related to new stores opening in fiscal year 2007 and beyond.
The following table provides additional information about the Company’s store openings in fiscal year 2006 and fiscal year-to-date through February 21, 2007, leases currently tendered but not opened, and total leases signed for stores scheduled to open through fiscal year 2010:
| | Stores | | Stores | | Leases | | Total Leases | |
| | Opened | | Opened | | Tendered | | Signed | |
| | During | | Through | | as of | | as of | |
| | Fiscal Year | | February 21, | | February 21, | | February 21, | |
| | 2006 | | 2007 | | 2007 | | 2007 | |
Number of stores (including relocations) | | 13 | | 7 | | 16 | | 88 | |
Number of relocations | | 2 | | 2 | | 2 | | 16 | |
New markets | | 4 | | — | | 2 | | 21 | |
Average store size (gross square feet) | | 50,000 | | 54,000 | | 54,000 | | 56,000 | |
As a percentage of existing store average size | | 147 | % | 153 | % | 154 | % | 159 | % |
Total square footage | | 653,000 | | 378,000 | | 870,000 | | 4,972,000 | |
As a percentage of existing square footage | | 10 | % | 6 | % | 13 | % | 74 | % |
Average pre-opening expense per store (incl. rent) | | $ | 1.9 million | | | | | | | |
Average pre-opening rent per store | | $ | 0.7 million | | | | | | | |
Average tender period | | 7.8 months | | | | | | | |
The Company expects total pre-opening and relocation costs for fiscal year 2007 to be in the range of $68 million to $74 million, compared to a total of approximately $37.4 million for fiscal year 2006. Approximately $18 million to $24 million of the estimated total relates to stores expected to open in fiscal year 2008. These ranges are based on estimated tender dates which are subject to change. The Company expects significantly higher-than-average pre-opening expense in fiscal year 2007 of approximately $7 million related to its first Whole Foods Market store in London. Excluding this store, the Company expects total pre-opening and relocation expense for stores opening in fiscal year 2007 to average approximately $2.4 million per store, above the Company’s average for stores opened in fiscal year 2006 due primarily to higher accelerated depreciation related to relocations.
The Company expects its materially higher pre-opening and relocation costs resulting primarily from the anticipated acceleration in leases tendered and square footage opening in fiscal years 2007 and 2008 to significantly impact fiscal year 2007 diluted earnings per share growth.
At January 14, 2007, the Company had short-term investments in available-for-sale securities totaling approximately $104.4 million. These investments are generally tax-free municipal obligations with effective maturities of less than 90 days.
Net cash provided by financing activities was approximately $13.1 million for the sixteen weeks ended January 14, 2007 compared to approximately $143.8 million for the same period of the prior fiscal year. Net proceeds to the Company from the exercise of team members’ stock options for the sixteen weeks ended January 14, 2007 totaled approximately $28.8 million compared to approximately $129.6 million for the same period of the prior fiscal year.
We have a $100 million revolving line of credit available through October 1, 2009. At January 14, 2007 and September 24, 2006, no amounts were drawn under the agreement.
We expect to fund our pending merger transaction with Wild Oats Markets at closing using $700 million in new senior term loan facilities. Additionally, in conjunction with the transaction, the Company intends to expand its existing long-term senior revolving credit facility to $250 million.
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We have outstanding zero coupon convertible subordinated debentures which had a carrying amount of approximately $2.6 million and $8.3 million at January 14, 2007 and September 24, 2006, respectively. During the sixteen week period ended January 14, 2007, approximately 10,000 of the Company’s zero coupon convertible debentures were converted at the option of the holders into approximately 215,000 shares of Company common stock.
The following table shows payments due by period on contractual obligations as of January 14, 2007 (in thousands):
| | | | Less than 1 | | 1-3 | | 3-5 | | More than 5 | |
| | Total | | Year | | Years | | Years | | Years | |
Convertible debt | | $ | 2,630 | | $ | — | | $ | 2,630 | | $ | — | | $ | — | |
Capital lease obligations (including interest) | | 336 | | 94 | | 182 | | 56 | | 4 | |
Operating lease obligations | | 4,886,089 | | 170,036 | | 471,492 | | 503,492 | | 3,741,069 | |
| | | | | | | | | | | | | | | | |
Although the timing of any potential redemption is uncertain, the above table reflects the assumption that convertible debentures will be redeemed at the option of the holder on March 2, 2008. The following table shows expirations per period on commercial commitments as of January 14, 2007 (in thousands):
| | | | Less than 1 | | 1-3 | | 3-5 | | More than 5 | |
| | Total | | Year | | Years | | Years | | Years | |
Credit facilities | | $ | 100,000 | | $ | — | | $ | 100,000 | | $ | — | | $ | — | |
| | | | | | | | | | | | | | | | |
We periodically make other commitments and become subject to other contractual obligations that we believe to be routine in nature and incidental to the operation of the business. Management believes that such routine commitments and contractual obligations do not have a material impact on our business, financial condition or results of operations.
On September 27, 2006, the Company’s Board of Directors approved a quarterly dividend of $0.15 per share, totaling approximately $21 million that was paid on October 23, 2006 to shareholders of record on October 13, 2006. On November 2, 2006, the Company’s Board of Directors approved a 20% increase in the Company’s quarterly dividend to $0.18 per share, totaling approximately $25.3 million that was paid subsequent to the end of the first quarter on January 22, 2007 to shareholders of record on January 12, 2007. During the first quarter of fiscal year 2006, the Company announced a 20% increase in the Company’s quarterly dividend to $0.15 per share and a special dividend of $2.00 per share. The quarterly dividend and special dividend, totaling approximately $298.8 million, were paid on January 23, 2006 to shareholders of record on January 13, 2006. The Company will pay future dividends at the discretion of the Board of Directors. The continuation of these payments, the amount of such dividends, and the form in which the dividends are paid (cash or stock) depend on many factors, including the results of operations and the financial condition of the Company. Subject to these qualifications, the Company currently expects to pay dividends on a quarterly basis.
On November 8, 2005, the Company’s Board of Directors approved a stock repurchase program of up to $200 million. During the fourth quarter of fiscal year 2006, the Company repurchased on the open market approximately 2.0 million shares of Company common stock that were held in treasury at January 14, 2007 and September 24, 2006 for a total of approximately $100 million. On November 6, 2006, the Company’s Board of Directors approved a $100 million increase in the Company’s stock repurchase program, bringing the total remaining authorization to $200 million over the next three years. The specific timing and repurchase amounts will vary based on market conditions, securities law limitations and other factors and will be made using the Company’s available cash resources. The repurchase program may be suspended or discontinued at any time without prior notice.
Our principal historical sources of liquidity have been cash generated by operations, available unrestricted cash and cash equivalents, and short-term investments. Absent the pending merger transaction with Wild Oats Markets, any other significant cash acquisition or a significant change in market condition, we expect planned expansion and other anticipated working capital and capital expenditure requirements for the next twelve months will be funded by cash generated from the expected results of operations, available unrestricted cash and cash equivalents, and short-term investments. Our revolving line of credit also is available should additional working capital be required. There can be no assurance, however, that we will continue to generate cash flows at or above current levels or that our revolving line of credit or other sources of capital will be available to us in the future. We continually evaluate the need to establish other sources of working capital and will seek those considered appropriate based upon the Company’s needs and market conditions.
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Critical Accounting Policies
The preparation of our financial statements in conformity with generally accepted accounting principles requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures of contingent assets and liabilities. Actual results may differ from these estimates. We base our estimates on historical experience and on various other assumptions and factors that we believe to be reasonable under the circumstances. On an ongoing basis, we evaluate the continued appropriateness of our accounting policies and resulting estimates to make adjustments we consider appropriate under the facts and circumstances.
We have chosen accounting policies that we believe are appropriate to report accurately and fairly our operating results and financial position, and we apply those accounting policies in a consistent manner. As discussed in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of the Company’s Annual Report on Form 10-K for the fiscal year ended September 24, 2006, we consider our policies on accounting for insurance and self-insurance reserves, inventory valuation, goodwill and intangible assets, income taxes and share-based compensation to be the most critical in the preparation of our consolidated financial statements because they involve the most difficult, subjective or complex judgments about the effect of matters that are inherently uncertain.
Recent Accounting Pronouncements
In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No.108 (“SAB No. 108”), “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in the Current Year Financial Statements.” SAB No. 108 addresses how the effects of prior-year uncorrected misstatements should be considered when quantifying misstatements in current-year financial statements. SAB No. 108 requires an entity to quantify misstatements using a balance sheet and income statement approach and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative and qualitative factors. The requirements of SAB No. 108 are effective for fiscal years ending after November 15, 2006. We do not expect the adoption of SAB No. 108 will have a significant effect on our future consolidated financial statements.
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measures.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and requires additional disclosures about fair value measurements. SFAS No. 157 applies to fair value measurements that are already required or permitted by other accounting standards, except for measurements of share-based payments and measurements that are similar to, but not intended to be, fair value and does not change existing guidance as to whether or not an instrument is carried at fair value. The provisions of SFAS No. 157 are effective for the specified fair value measures for financial statements issued for fiscal years beginning after November 15, 2007. We are currently evaluating the impact, if any, that the adoption of SFAS No. 157 will have on our consolidated financial statements.
In July 2006, the FASB issued Interpretation 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes,” an interpretation of SFAS No. 109, “Accounting for Income Taxes.” FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109. The interpretation applies to all tax positions accounted for in accordance with Statement 109 and requires a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken, or expected to be taken, in an income tax return. Subsequent recognition, derecognition, and measurement is based on management’s best judgment given the facts, circumstances and information available at the reporting date. FIN 48 is effective for fiscal years beginning after December 15, 2006. Early adoption is permitted as of the beginning of an enterprise’s fiscal year, provided the enterprise has not yet issued financial statements, including financial statements for any interim period, for that fiscal year. We are currently evaluating the effect, if any, that the adoption of FIN 48 will have on our consolidated financial statements.
In March 2006, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (that is, Gross versus Net Presentation).” Taxes within the scope of EITF Issue No. 06-3 include any taxes assessed by a governmental authority that are directly imposed on a revenue-producing transaction between a seller and a customer and may include, but are not limited to, sales taxes, use taxes, value-added taxes, and some excise taxes. The EITF concluded that the presentation of these taxes on either a gross (included in revenues and costs) or a net (excluded from revenues) basis is an accounting policy decision that should be disclosed. For any such taxes that are reported on a gross basis, a company should disclose the amounts of those taxes in interim and annual financial statements. The Company’s policy is to exclude all such taxes from revenue. EITF 06-3 is effective for interim and annual reporting periods beginning after December 15, 2006. The adoption of EITF 06-3 will not have any effect on our consolidated financial statements.
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Risk Factors
We wish to caution you that there are risks and uncertainties that could cause our actual results to be materially different from those indicated by forward-looking statements that we make from time to time in filings with the Securities and Exchange Commission, news releases, reports, proxy statements, registration statements and other written communications, as well as oral forward-looking statements made from time to time by representatives of our Company. These risks and uncertainties include, but are not limited to, those listed in the Company’s Annual Report on Form 10-K for the year ended September 24, 2006. These risks and uncertainties and additional risks and uncertainties not presently known to us or that we currently deem immaterial may cause our business, financial condition, operating results and cash flows to be materially adversely affected. Except for the historical information contained herein, the matters discussed in this analysis are forward looking statements that involve risks and uncertainties, including but not limited to general business conditions, the timely development and opening of new stores, the impact of competition, and other factors which are often beyond the control of the Company. The Company does not undertake any obligation to update forward-looking statements except as required by law.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
There have been no material changes in the Company’s market risk exposures from those reported in our Annual Report on Form 10-K for the year ended September 24, 2006.
Item 4. Controls and Procedures
The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act.
There have been no changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
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Part II. Other Information
Item 1. Legal Proceedings
The Company is subject to various legal proceedings and claims arising in the ordinary course of business. The Company’s management does not expect that the outcome in the current proceedings, individually or collectively, will have a material adverse effect on the Company’s financial condition, operating results or cash flows.
Item 6. Exhibits
Exhibit | 10.1 | Second Amendment, dated December 15, 2006, to the Third Amended and Restated Credit Agreement, dated October 1, 2004, by and among Registrant, the subsidiaries of the Registrant, JPMorgan Chase Bank; Wells Fargo Bank National Association; Wachovia Bank, National Association; and Fleet National Bank |
Exhibit | 31.1 | Certification of Chief Executive Officer Pursuant to 17 CFR 240.13a - 14(a) |
Exhibit | 31.2 | Certification of Chief Financial Officer Pursuant to 17 CFR 240.13a - 14(a) |
Exhibit | 32.1 | Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 |
Exhibit | 32.2 | Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 |
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