UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR SECTION 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JULY 3, 1999
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR SECTION 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________ TO _________
Commission file number 0-21577
WILD OATS MARKETS, INC.
(Exact name of registrant as specified in its charter)
Delaware 84-1100630
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
3375 Mitchell Lane
Boulder, Colorado 80301-2244
(Address of principal executive offices, including zip code)
(303) 440-5220
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes (X) No ( )
As of August 9, 1999, there were 13,278,724 shares outstanding of the
Registrant's Common Stock (par value $0.001 per share).
TABLE OF CONTENTS
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheet
July 3, 1999 (Unaudited) and January 2, 1999 3
Consolidated Statement of Operations (Unaudited)
Three and Six Months Ended July 3, 1999 and June 27, 1998 4
Consolidated Statement of Cash Flows (Unaudited)
Six Months Ended July 3, 1999 and June 27, 1998 5
Notes to Consolidated Financial Statements (Unaudited) 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 8
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 13
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 13
Item 2. Changes in Securities 13
Item 3. Defaults Upon Senior Securities 13
Item 4. Submission of Matters to a Vote of Security Holders 13
Item 5. Other Information 13
Item 6. Exhibits and Reports on Form 8-K 14
SIGNATURES 15
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
WILD OATS MARKETS, INC.
Consolidated Balance Sheet
(In thousands, except share data)
July 3, January 2,
1999 1999
(Unaudited)
Assets
Current assets:
Cash and cash equivalents $ 13,881 $ 11,255
Accounts receivable (less allowance
for doubtful accounts of $211 and
$159, respectively) 1,892 1,762
Inventories 37,925 28,464
Prepaid expenses and other current assets 1,452 1,956
Deferred income taxes 3,663 812
-------- --------
Total current assets 58,813 44,249
-------- --------
Property and equipment, net 138,481 97,878
Intangible assets, net 109,354 55,827
Deposits and other assets 1,299 886
-------- --------
$307,947 $198,840
======== ========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 37,372 $ 29,022
Accrued liabilities 20,126 12,432
Notes payable 3,400 3,150
Current portion of obligations in capital leases 552
-------- --------
Total current liabilities 61,450 44,604
Long-term debt 85,979
Obligations in capital leases 1,031
Deferred income taxes 2,021 1,958
Other liabilities 2,674 1,334
-------- --------
153,155 47,896
-------- --------
Stockholders' equity:
Preferred stock, $0.001 par value; 5,000,000
shares authorized; no shares
issued and outstanding
Common stock, $0.001 par value; 20,000,000
shares authorized; 13,266,502 and
13,077,884 shares issued and outstanding 13 13
Additional paid-in capital 144,126 140,778
Retained earnings 10,340 10,262
Accumulated other comprehensive income (loss) 313 (109)
-------- --------
Total stockholders' equity 154,792 150,944
-------- --------
$307,947 $198,840
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
3
WILD OATS MARKETS, INC.
Consolidated Statement of Operations and Comprehensive Income
(In thousands, except per-share data)
(Unaudited)
Three Months Ended Six Months Ended
July 3, June 27, July 3, June 27,
1999 1998 1999 1998
Sales $135,337 $98,663 $257,846 $190,266
Cost of goods sold and occupancy costs 93,150 67,877 178,006 130,824
-------- ------- -------- --------
Gross profit 42,187 30,786 79,840 59,442
Operating expenses:
Direct store expenses 29,712 21,948 56,819 42,249
Selling, general and administrative expenses 4,888 3,856 9,269 7,627
Pre-opening expenses 937 432 1,600 981
Non-recurring expenses 393 10,894 393
-------- ------- -------- --------
Income from operations 6,650 4,157 1,258 8,192
Interest expense (income), net 551 (140) 641 (524)
-------- ------- -------- --------
Income before income taxes 6,099 4,297 617 8,716
Income tax expense 2,723 1,693 258 3,408
-------- ------- -------- --------
Net income before cumulative effect of change 3,376 2,604 359 5,308
in accounting principle
Cumulative effect of change in accounting principle,
net of tax 281
-------- ------- -------- --------
Net income 3,376 2,604 78 5,308
-------- ------- -------- --------
Other comprehensive income:
Foreign currency translation adjustment, net 257 8 424 30
-------- ------- -------- --------
Comprehensive income $ 3,633 $ 2,612 $ 502 $ 5,338
======== ======= ======== ========
Basic net income per common share $0.26 $0.20 $0.01 $0.41
======== ======= ======== ========
Diluted net income per common share $0.25 $0.19 $0.01 $0.39
======== ======= ======== ========
Average common shares outstanding 13,184 12,997 13,138 12,954
Dilutive effect of stock options 393 491 371 486
-------- ------- -------- --------
Average common shares outstanding assuming dilution 13,577 13,488 13,509 13,440
======== ======= ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
4
WILD OATS MARKETS, INC.
Consolidated Statement of Cash Flows
(In thousands)
(Unaudited)
Six Months Ended
July 3, June 27,
1999 1998
Cash Flows From Operating Activities
Net income $ 78 $ 5,308
Adjustments to reconcile net
income to net cash provided
by operating activities:
Depreciation and amortization 8,567 5,985
Non-recurring expenses 10,794
Loss (gain) on disposal of property and equipment 14 (106)
Deferred tax provision (benefit) (1,462) 426
Change in assets and liabilities (net of acquisitions):
Inventories (4,066) (1,149)
Receivables and other assets 604 (1,017)
Accounts payable 8,342 (494)
Accrued liabilities 1,730 1,526
-------- --------
Net cash provided by operating activities 24,601 10,479
-------- --------
Cash Flows From Investing Activities
Capital expenditures (30,799) (27,138)
Payment for purchase of acquired
entities, net of cash acquired (64,995) (9,585)
-------- --------
Net cash used by investing activities (95,794) (36,723)
-------- --------
Cash Flows From Financing Activities
Net borrowings under line-of-credit agreement 75,500
Repayments on short-term debt (3,150) (705)
Proceeds from issuance of common stock 1,255 1,128
-------- --------
Net cash provided by financing activities 73,605 423
-------- --------
Effect of exchange rate changes on cash 214 30
-------- --------
Net increase (decrease) in cash and cash equivalents 2,626 (25,791)
Cash and cash equivalents at beginning of period 11,255 46,686
-------- --------
Cash and cash equivalents at end of period $ 13,881 $ 20,895
======== ========
Supplemental disclosure of cash flow information:
Cash paid for interest $ 633 $ 6
======== ========
Cash paid for income taxes $ 1,240 $ 2,575
======== ========
Supplemental schedule of noncash investing and
financing activities:
Short-term note receivable for sale of property $ 365
========
Non-cash adjustment to purchase price for Nature's
acquisition $ 2,090
========
The accompanying notes are an integral part of the consolidated financial
statements.
5
WILD OATS MARKETS, INC.
Notes to Consolidated Financial Statements
(Unaudited)
1. Accounting Policies
The consolidated balance sheet as of July 3, 1999, the consolidated
statement of operations for the three and six months ended July 3, 1999 and
June 27, 1998, as well as the consolidated statement of cash flows for the
six months ended July 3, 1999 and June 27, 1998, have been prepared without
an audit. In the opinion of management, all adjustments, consisting only of
normal, recurring adjustments necessary for a fair presentation thereof,
have been made.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted. It is suggested that these
consolidated financial statements be read in conjunction with financial
statements and notes thereto included in the Company's 1998 Annual Report
to Stockholders. The results of operations for interim periods presented
are not necessarily indicative of the operating results for the full year.
2. New Accounting Pronouncements
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") 98-1, Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use. SOP 98-
1, which is effective for transactions in fiscal years beginning after
December 15, 1998, provides guidance on accounting for the costs of
computer software developed or obtained for internal use. The Company
adopted SOP 98-1 in fiscal 1999 with no material effect on its reported
financial results.
In April 1998, the AICPA issued SOP 98-5, Accounting for the Costs of
Start-Up Activities. SOP 98-5 provides guidance on how entities should
account for pre-opening costs, pre-operating costs, organization costs and
start-up costs. SOP 98-5 requires that the costs of start-up activities be
expensed as incurred. SOP 98-5 is effective for fiscal years beginning
after December 15, 1998, and the initial application should be reported as
a cumulative effect of a change in accounting principle. The Company
adopted SOP 98-5 in fiscal 1999 and recorded approximately $281,000 as a
cumulative effect of a change in accounting principle, net of taxes, during
the first quarter of 1999. The impact on basic and diluted earnings per
share of this adoption was $(0.02) for the six months ended July 3, 1999.
The Company expects SOP 98-5 to have no material effect on its ongoing
results of operations.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("FAS") No. 133, Accounting for Derivative
Instruments and Hedging Activities. FAS No. 133, as amended is effective
for fiscal years beginning after June 15, 2000, and requires all
derivatives to be recognized in the balance sheet as either assets or
liabilities and measured at fair value. In addition, all hedging
relationships must be reassessed and documented pursuant to the provisions
of FAS No. 133. The Company will adopt FAS No. 133 for the 2000 fiscal
year, but does not expect such adoption to materially affect its financial
statement presentation due to the Company's limited use of such
instruments.
3. Business Combinations
On April 30, 1999, the Company acquired the operations of three existing
natural foods supermarkets in Norwalk and Hartford, Connecticut and
Melbourne, Florida. The purchase price for this acquisition aggregated
$6.5 million in cash. The acquisition was accounted for using the purchase
method, and the excess of cost over the fair value of the assets acquired
and liabilities assumed of $6.1 million was allocated to goodwill, which is
being amortized on a straight-line basis over 40 years.
On May 29, 1999, the Company acquired all of the outstanding stock of
Nature's Fresh Northwest, Inc. ("Nature's"), a Delaware corporation that
owned seven operating nature foods stores, with one new store and one
relocation in development in metropolitan Portland, Oregon. The purchase
price for this acquisition aggregated $40.0 million in cash, including the
assumption by the Company of a $17.0 million promissory note owed by
Nature's to General Nutrition, Incorporated, its parent corporation. The
acquisition was accounted for using the purchase method, and the excess of
cost over the fair value of the assets acquired and liabilities assumed of
$32.1 million was allocated to goodwill, which is being amortized on a
straight-line basis over 40 years.
4. Earnings Per Share
The Company reports both basic earnings per share, which is based on the
weighted-average number of common shares outstanding, and diluted earnings
per share, which is based on the weighted-average number of common shares
outstanding and all dilutive potential common shares outstanding, except
where the effect of their inclusion would be antidilutive (i.e., in a loss
period).
5. Non-Recurring Expenses
During the first quarter of 1999, the Company's management made certain
decisions relating to the Company's operations and selected store closures,
which resulted in approximately $10.9 million of non-recurring expenses
being recorded. These decisions included (1) a change in the Company's
strategic direction, resulting in the closure in the second quarter of 1999
of its two "Farm to Market" stores located in Buffalo Grove, Illinois, and
Tempe, Arizona ($4.5 million), and (2) a decision by the Company's
management to allocate corporate resources to servicing new and existing
stores, rather than closed sites
6
($6.4 million). Components of the non-recurring charge consist primarily of
non-cancelable lease obligations through the year 2000 ($1.2 million) and
abandonment of fixed and intangible assets ($9.7 million). At July 3, 1999,
the remaining accrued liabilities related to the non-recurring charge
totaled approximately $785,000.
6. Subsequent Events
Subsequent to July 3, 1999, the Company signed an agreement to acquire all
of the outstanding stock of Henry's Marketplace, Inc. ("Henry's"), which
operates 11 natural food markets in the metropolitan San Diego area, in a
stock-for-stock exchange valued at approximately $46.0 million. The number
of shares issued by the Company will be based on the average price of the
Company's common stock in the 10 trading days preceding closing, subject to
a pricing collar between $26 and $32 per share. The Federal Trade
Commission has cleared the acquisition. The completion of the acquisition,
which is scheduled to close on September 1, 1999, is subject to certain
conditions to closing, and is intended to qualify as a pooling of interests
for financial accounting purposes. Accordingly, following the completion
of the transaction, the Company's consolidated financial statements for
1999, 1998, 1997, and 1996 will be restated to include Henry's financial
results for the respective periods, adjusted to conform with the Company's
accounting policies and presentation.
7
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Form 10-Q contains forward-looking statements within the context of Section
21E of the Securities Exchange Act of 1934, as amended. Each and every forward-
looking statement involves a number of risks and uncertainties, including the
Risk Factors specifically delineated and described in the Company's 1998 Annual
Report to Stockholders and those Risk Factors that have been specifically
expanded or modified below. The actual results that the Company achieves may
differ materially from any forward-looking statements due to such risks and
uncertainties. Words such as "believes", "anticipates", "expects", "intends",
and similar expressions are intended to identify forward-looking statements, but
are not the exclusive means of identifying such statements. The Company
undertakes no obligation to update any forward-looking statements in order to
reflect events or circumstances that may arise after the date of this report.
Certain of the Risk Factors are hereby restated, modified and expanded in
accordance with the following section references that correlate to the
corresponding sections of the Company's 1998 Annual Report to Stockholders:
Uncertain Ability to Execute Growth Strategy
The Company's business has grown considerably in size and geographic scope,
increasing from 14 stores in 1994 to its current size of 78 stores in 20 states
and Canada. In the second quarter of 1999, the Company acquired ten operating
natural foods stores, opened one new store, closed two stores and relocated
three stores. The Company has also entered into a stock purchase agreement for
the acquisition of 11 operating natural foods stores, with the proposed
acquisition scheduled to close September 1, 1999. The Company's ability to
implement its growth strategy depends to a significant degree upon its ability
to open, relocate or acquire stores in existing and new markets and to integrate
and operate those stores profitably. While the Company plans to expand
primarily through the opening of new stores, it will continue to pursue
acquisitions of natural foods retailers where attractive opportunities exist.
The Company's growth strategy is dependent upon a number of factors, including
its ability to:
. access adequate capital resources;
. expand into regions where it has no operating experience;
. identify markets that meet its site selection criteria;
. locate suitable store sites and negotiate acceptable lease terms;
. locate acquisition targets and negotiate acceptable acquisition
terms;
. hire, train and integrate management and store employees;
. recruit, train and retain regional pre-opening and support teams;
. complete construction of new stores on time and on budget; and
. expand its distribution and other operating systems.
In addition, the Company pursues a strategy of clustering stores in each of its
markets to increase overall sales, achieve operating efficiencies and further
penetrate markets. In the past, when the Company has opened a store in a market
where it had an existing presence, the Company has experienced a decline in the
sales and operating results at certain of its existing stores in these markets.
The opening of competing stores may have a similar adverse effect on the
Company's results of operations. The Company intends to continue to pursue its
store clustering strategy and expects the sales and operating results trends for
other stores in an expanded market to continue to experience temporary declines
related to the clustering of stores. Further, acquisitions involve a number of
additional risks, such as short-term negative effects on the Company's reported
operating results, diversion of management's attention, unanticipated problems
or legal liabilities, and the integration of potentially dissimilar operations,
some or all of which could have a material adverse effect on the Company's
business, results of operations and financial condition. There can be no
assurance that the Company will achieve its planned expansion in existing
markets, enter new markets, or operate or integrate its existing, newly-opened
or newly-acquired stores profitably. If the Company fails to do so, the
Company's business, results of operations and financial condition will be
materially and adversely affected. In addition, the Company's ability to
execute its growth strategy is partially dependent upon the demographic trends
and market conditions in the natural foods industry. Any change in those trends
and conditions could adversely affect the Company's future growth rate.
Fluctuations in Financial Results
The Company's results of operations may fluctuate significantly from period-to-
period as the result of a variety of factors, including:
. the number, timing, mix and cost of store openings, acquisitions,
relocations, or closings;
. the ratio of stores opened to stores acquired;
. the opening of stores by the Company or its competitors in markets
where the Company has existing stores;
. comparable store sales results;
. the ratio of urban format to supermarket format stores; and
. seasonality in sales volume and sales mix in certain geographic
regions.
The Company incurs significant pre-opening expenses, and new stores typically
experience an initial period of operating losses. As a result, the opening of a
significant number of stores in a single period will have an adverse effect on
the Company's results of operations. Conversely, delays in opening of planned
new stores may result in revenue shortfalls and may adversely affect results of
operations. The opening of competing stores may have a similar adverse effect
on results of operations. Further, the integration of a significant number of
acquired stores may have an adverse effect on the Company's results of
operations due to duplication of expenses and a higher cost structure in the
acquired stores, financing costs, and goodwill arising from the acquisition.
Due to the foregoing factors, the Company believes that period-to-period
comparisons of its operating results are not necessarily meaningful and that
such comparisons cannot be relied upon as indicators of future financial
performance.
8
Impact of the Year 2000 Issue
The Company continually evaluates its management information systems and has
made modifications and upgrades where the Company has believed it to be
necessary to comply with Year 2000 concerns. Although the Company believes that
its internal Year 2000 compliance will be adequate and does not anticipate any
disruption in its operations as a result of its information systems not being
Year 2000 compliant, there can be no assurance that such a disruption will not
occur.
If failures of software systems occur within the operations of the Company's
vendors, distributors or financial centers, the failure could affect the
Company's business, financial condition and results of operations. Such
failures could result in the inability to obtain products for the Company's
stores and the inability to process credit card or electronically processed food
stamp payments from customers.
Although the Company has taken significant steps to address possible Year 2000
problems, there can be no assurance that failure of the Company's primary
vendors, distributors or financial centers to timely attain Year 2000 compliance
will not materially adversely affect the Company's results of operations and
financial condition. Year 2000 compliance problems in other areas such as
failures by telephone, mail, data transfer or other utility or general service
providers or government or private entities could also have a material adverse
effect on the Company. The Company is currently formulating contingency plans
in the event these third-party systems are not Year 2000 compliant and
anticipates having such plans completed by the end of the third quarter of 1999.
Background
Store Openings, Closings, Remodels, Relocations and Acquisitions. During the
second quarter of 1999, the Company opened one new store in Hinsdale, Illinois,
relocated three stores in Ft. Collins, Colorado, Salt Lake City, Utah and
Portland, Oregon, and closed two "Farm to Market" stores in Buffalo Grove,
Illinois and Tempe, Arizona (see "Notes to Consolidated Financial Statements"
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Non-Recurring Expenses"). During the second quarter of 1999, the
Company also acquired seven operating natural foods stores in metropolitan
Portland, Oregon (of which one was subsequently relocated during the second
quarter), and three operating natural foods stores in Norwalk and Hartford,
Connecticut; and Melbourne, Florida. The Company plans to open five new stores
and acquire 11 stores (as described below) during the remainder of 1999.
Further, the Company is actively looking for other acquisition opportunities and
may complete additional acquisitions in the remainder of 1999 and 2000.
Subsequent to July 3, 1999, the Company signed an agreement to acquire all of
the outstanding stock of Henry's Marketplace, Inc. ("Henry's"), which operates
11 natural food markets in the metropolitan San Diego area, in a stock-for-stock
exchange valued at approximately $46.0 million. The number of shares issued by
the Company will be based on the average price of the Company's common stock in
the 10 trading days preceding closing, subject to a pricing collar between $26
and $32 per share. The Federal Trade Commission has cleared the acquisition.
The completion of the acquisition, which is scheduled to close on September 1,
1999, is subject to certain conditions to closing, and is intended to qualify as
a pooling of interests for financial accounting purposes.
The Company's results of operations have been and will continue to be affected
by, among other things, the number, timing and mix of store openings,
acquisitions or closings. New stores build their sales volumes and refine their
merchandise selection gradually and, as a result, generally have lower gross
margins and higher operating expenses as a percentage of sales than more mature
stores. The Company anticipates that the new stores opened in 1999 will
experience operating losses for the first six to 12 months of operation, in
accordance with historic trends. Further, acquired stores, while generally
profitable as of the acquisition date, generate lower gross margins and store
contribution margins than the Company average, due to their substantially lower
volume purchasing discounts. Over time, typically six months, as the Company
sells through the acquired inventories and implements its volume purchase
discounts, the Company expects that the gross margin and store contribution
margin of the acquired stores will approach the Company average. The Company
anticipates that a high concentration of acquired stores, such as the seven-
store Nature's acquisition concluded in the second quarter of 1999, and the
eleven-store Henry's acquisition contemplated to be completed in the third
quarter of 1999, will have a temporary negative impact on the Company's
consolidated results of operations.
The Company is actively upgrading, remodeling or relocating some of its older
stores. Remodels and relocations typically cause short-term disruption in sales
volume and related increases in certain expenses as a percentage of sales, such
as payroll. Remodels on average take between 90 and 120 days to complete. The
Company cannot predict whether sales disruptions and the related impact on
earnings may be greater in time or volume than projected in certain remodeled or
relocated stores. The Company will continue to evaluate the profitability of
all of its stores on an ongoing basis and may, from time to time, make decisions
regarding closures, disposals, relocations or remodels in accordance with such
evaluations. As part of this strategy, the Company closed two stores in Tempe,
Arizona, and Buffalo Grove, Illinois, and relocated three stores in Ft. Collins,
Colorado, Salt Lake City, Utah and Portland, Oregon during the second quarter
and expects to relocate additional stores in the year 2000.
Store Format and Clustering Strategy. The Company operates two store formats:
supermarket and urban. The supermarket format is generally 15,000 to 35,000
square feet, and typically generates higher sales and store contribution than
the 5,000 to 15,000 square foot urban format stores. The Company's results of
operations have been and will continue to be affected by the mix of supermarket
and urban format stores opened or acquired and whether stores are being opened
in markets where the Company has an existing presence. The Company expects to
focus primarily on opening or acquiring supermarket format stores in the future
but will consider additional urban stores when appropriate opportunities exist.
In addition, the Company pursues a strategy of clustering stores in each of its
markets to increase overall sales, achieve operating efficiencies and further
penetrate markets. The Company believes this strategy has resulted in increased
overall sales in each of its markets. In the past, when the Company has opened
a store in a market where it had an existing presence, the Company has
experienced a decline in the sales and operating results at certain of its
existing stores in that market. However, over time, the Company believes the
affected stores generally will achieve store contribution margins comparable to
prior levels on the lower base of sales. The Company intends to continue to
pursue its store clustering strategy and
9
expects the sales and operating results trends for other stores in an expanded
market to continue to experience temporary declines related to the clustering of
stores.
Comparable Store Sales Results. Sales of a store are deemed to be comparable
commencing in the thirteenth full month of operations for new, relocated and
acquired stores. A variety of factors affect the Company's comparable store
sales results, including, among others, the relative proportion of new or
relocated stores to mature stores, the opening of stores by the Company or its
competitors in markets where the Company has existing stores, the timing of
promotional events, the Company's ability to execute its operating strategy
effectively, changes in consumer preferences for natural foods and general
economic conditions. Past increases in comparable store sales may not be
indicative of future performance.
The Company's comparable store sales results have been negatively affected in
the past by planned cannibalization (the loss of sales at an existing store when
the Company opens a new store nearby) resulting from the implementation of the
Company's store clustering strategy. The Company expects that comparable sales
increases will continue to be negatively affected by planned cannibalization
throughout 1999 due to the planned opening of new or relocated stores in several
of the Company's existing markets, including Phoenix, Arizona, Denver, Colorado,
Hartford, Connecticut, Las Vegas, Nevada, Albuquerque, New Mexico, Nashville,
Tennessee and Salt Lake City, Utah. There can be no assurance that comparable
store sales for any particular period will not decrease in the future.
Pre-Opening Expenses. Pre-opening expenses include labor, rent, utilities,
supplies and certain other costs incurred prior to a store's opening. Through
1998, pre-opening costs were deferred during the pre-opening period and expensed
in full when the store opened. Pre-opening expenses have averaged approximately
$250,000 to $350,000 per store over the past 18 months, although the amount per
store may vary depending on the store format and whether the store is the first
to be opened in a market, or is part of a cluster of stores in that market.
In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position ("SOP") 98-5, Accounting for Costs of Start-Up Activities.
SOP 98-5 requires that pre-opening costs be expensed as incurred. SOP 98-5 is
effective for fiscal years beginning after December 15, 1998, and the initial
application should be reported as a cumulative effect of a change in accounting
principle. The Company adopted SOP 98-5 in fiscal 1999 and recorded
approximately $281,000 as a cumulative effect of a change in accounting
principle, net of taxes, during the first quarter of 1999.
Results of Operations
The following table sets forth, for the periods indicated, certain selected
income statement data expressed as a percentage of sales:
Three Months Ended Six Months Ended
July 3, June 27, July 3, June 27,
1999 1998 1999 1998
Sales 100.0% 100.0% 100.0% 100.0%
Cost of goods sold and occupancy costs 68.8 68.9 69.0 68.8
----- ----- ----- -----
Gross margin 31.2 31.1 31.0 31.2
Direct store expenses 22.0 22.1 22.0 22.2
Selling, general and administrative expenses 3.6 4.0 3.6 4.0
Pre-opening expenses 0.7 0.6 0.6 0.5
Non-recurring expenses 4.3 0.2
----- ----- ----- -----
Income from operations 4.9 4.4 0.5 4.3
Interest expense (income), net 0.4 (0.4) 0.2 (0.3)
----- ----- ----- -----
Income before income taxes 4.5 4.8 0.3 4.6
Income tax expense 2.0 1.9 0.1 1.8
----- ----- ----- -----
Net income before cumulative effect
of change in accounting principle 2.5 2.9 0.2 2.8
Cumulative effect of change in accounting 0.1
principle, net of taxes
----- ----- ----- -----
Net income 2.5% 2.9% 0.1% 2.8%
===== ===== ===== =====
Sales. Sales for the three months ended July 3, 1999 increased 37.2% to $135.3
million from $98.7 million for the same period in 1998. Sales for the six
months ended July 3, 1999 increased 35.5% to $257.8 million from $190.3 million
for the same period in 1998. The increase is primarily due to the opening of
two new stores, the acquisition of 13 stores, and the relocation of five stores
in the first six months of 1999, as well as the inclusion of eight stores opened
and seven stores acquired during 1998. Comparable store sales increased 8% for
the second quarter of 1999, based on both new and acquired stores that have been
operating longer than 12 months. The Company expects its comparable store sales
increases to be 5% for the third quarter of 1999. See "Risk Factors-
Fluctuations in Financial Results".
Gross Profit. Gross profit for the three months ended July 3, 1999 increased
37.0% to $42.2 million from $30.8 million for the same period in 1998. Gross
profit for the six months ended July 3, 1999 increased 34.3% to $79.8 million
from $59.4 million for the same period in 1998. The increase in gross profit is
primarily attributable to the increase in the number of stores operated by the
Company. Gross profit as a percentage of sales for the three months ended July
3, 1999 remained relatively constant at 31.2% as compared to 31.1% for the same
period in 1998. Gross profit as a percentage of sales for the six months ended
July 3, 1999 decreased to 31.0% from 31.2% in the same period in 1998. The
decrease is primarily attributable to year-end reward discount coupons issued in
early
10
fiscal 1999 in conjunction with the Company's Wild Shopper Card frequent shopper
program (which was discontinued in the first quarter of 1999) and to lower gross
margin performance in the Company's two "Farm to Market" stores, which were
closed in the second quarter of 1999 (see "Notes to Consolidated Financial
Statements" and "Store Openings, Closings, Remodels, Relocations and
Acquisitions").
Direct Store Expenses. Direct store expenses for the three months ended July 3,
1999 increased 35.4% to $29.7 million from $21.9 million for the same period in
1998. Direct store expenses for the six months ended July 3, 1999 increased
34.5% to $56.8 million from $42.2 million for the same period in 1998. The
increase in direct store expenses is attributable to the increase in the number
of stores operated by the Company. Direct store expenses as a percentage of
sales for the three months ended July 3, 1999 decreased to 22.0% from 22.1% for
the same period in 1998. Similarly, direct store expenses as a percentage of
sales for the six months ended July 3, 1999 decreased to 22.0% from 22.2% for
the same period in 1998. The decreases are primarily attributable to the
matured performance of the new stores opened in 1998, as well as improved
control of direct store expenses, particularly payroll and benefits costs.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the three months ended July 3, 1999 increased 26.8%
to $4.9 million from $3.9 million for the same period in 1998. Selling, general
and administrative expenses for the six months ended July 3, 1999 increased
21.5% to $9.3 million from $7.6 million for the same period in 1998. The
increase is the result of additional central and regional support staff and
infrastructure that the Company has added to support its increased number of
stores. Selling, general and administrative expenses as a percentage of sales
for the three and six months ended July 3, 1999 decreased to 3.6% from 4.0% for
the same periods in 1998. The decreases are the result of greater leverage of
overhead expenses over higher sales volumes.
Pre-Opening Expenses. Pre-opening expenses for the three months ended July 3,
1999 increased 116.9% to $937,000 from $432,000 for the same period in 1998.
Pre-opening expenses for the six months ended July 3, 1999 increased 63.1% to
$1.6 million from $981,000 for the same period in 1998. The increase is
attributable to the opening of two new stores and five relocated stores during
the first six months of 1999, as compared to the opening of three new stores and
one relocated store during the same period in 1998. Additionally, in accordance
with SOP 98-5, pre-opening expenses are recognized as incurred during fiscal
1999. Prior to fiscal 1999, pre-opening expenses were deferred until a store's
opening date, at which time such costs were expensed in full. Pre-opening
expenses as a percentage of sales for the three months ended July 3, 1999
increased to 0.7% from 0.6% for the same period in 1998. Similarly, pre-opening
expenses as a percentage of sales for the six months ended July 3, 1999
increased to 0.6% from 0.5% for the same period in 1998. The increases are
primarily due to a higher number of new and relocated stores during the first
six months of 1999.
Non-Recurring Expenses. There were no non-recurring expenses during the three
months ended July 3, 1999, as compared to $393,000 for the same period in 1998.
Non-recurring expenses of approximately $10.9 million were incurred during the
first quarter of 1999, resulting from certain decisions by the Company's
management regarding the Company's operations and selected store closures.
These decisions included (1) a change in the Company's strategic direction with
respect to its two "Farm to Market" stores located in Buffalo Grove, Illinois,
and Tempe, Arizona ($4.5 million), and (2) a decision by the Company's
management to allocate corporate resources to servicing new and existing stores,
rather than closed sites ($6.4 million). Components of the non-recurring charge
consist primarily of non-cancelable lease obligations through the year 2000
($1.2 million) and abandonment of fixed and intangible assets ($9.7 million).
Net Interest Expense (Income). Net interest expense for the three months ended
July 3, 1999 was $551,000 as compared to net interest income of $140,000 for the
same period in 1998. Net interest expense for the six months ended July 3, 1999
was $641,000 as compared to net interest income of $524,000 for the same period
in 1998. The change is attributable to increased borrowing from the Company's
revolving line of credit to fund new store openings and acquisition of 13 stores
in the first six months of 1999, and to lower levels of invested cash in the
first six months of 1999.
Liquidity and Capital Resources
The Company's primary sources of capital have been cash flow from operations,
trade payables, bank indebtedness, and the sale of equity securities. Primary
uses of cash have been the financing of new store development, new store
openings, acquisitions and purchases of real property.
Net cash provided by operating activities was $24.6 million during the six
months ended July 3, 1999 as compared to $10.5 million during the same period in
1998. Cash provided by operating activities increased during this period
primarily due to increases in net income before depreciation and amortization
expense and non-recurring expenses. The Company has not required significant
external financing to support inventory requirements at its existing and new
stores because it has been able to rely on vendor financing for most of the
inventory costs, and anticipates that vendor financing will continue to be
available for new store openings.
Net cash used by investing activities was $95.8 million during the six months
ended July 3, 1999 as compared to $36.7 million during the same period in 1998.
The increase is due to the opening of two new stores, the acquisition of 13
stores, the relocation of five stores, and several store remodels in the first
six months of 1999, as well as the construction costs incurred for five new or
relocated stores now under construction which are expected to open in the
remainder of 1999, as compared to three new stores, one relocated store and six
acquired stores in the first six months of 1998 and the construction costs
incurred for new stores in development which opened during the remainder of
1998.
Net cash provided by financing activities was $73.6 million during the six
months ended July 3, 1999 as compared to $423,000 during the same period in
1998. The increase reflects increased borrowing under the Company's revolving
line of credit, as well as the repayment of a $3.2 million note payable.
11
Subsequent to the end of the second quarter, the Company expanded its $80.0
million revolving line of credit to $120.0 million. The facility has a three-
year term and bears interest, at the Company's option, at the prime rate or
LIBOR plus 0.65%. The line of credit agreement includes certain financial and
other covenants, as well as restrictions on payments of dividends. As of August
9, 1999, there were $80.0 million in borrowings outstanding under this facility.
The Company spent approximately $30.8 million during the first six months of
1999 and anticipates that it will spend approximately $20 million during the
remainder of 1999 for new store construction, purchases of real property and
leasehold interests, development, remodels and maintenance capital expenditures,
exclusive of acquisitions.
The Company's average capital expenditures to open a leased store, including
leasehold improvements, equipment and fixtures, have ranged from approximately
$2.0 million to $3.0 million over the past 24 months, excluding inventory costs
and initial operating losses. The Company expects to increase the average size
of its new stores and increase the number of its new store openings over time,
and is using a greater proportion of new and custom equipment in its stores.
Therefore, the Company anticipates that its average capital expenditures per
store will increase over time by approximately $500,000.
The Company owns three parcels of real property on which it has constructed or
relocated certain stores. The Company opened two stores on owned property in
the second quarter of 1999, and acquired a third operating store and the
underlying property in the second quarter as part of the acquisition of the
outstanding stock of Nature's Fresh Northwest, Inc. Construction of stores
requires substantially greater cash outlays than the remodeling of existing
buildings (i.e., $3.5 to $9.0 million as compared to $2.0 to $3.0 million). The
Company has entered into agreements to sell two of the parcels of real
properties in sale-leaseback transactions. If the Company is not successful in
completing the transactions for the sale and leaseback of the properties
currently owned by the Company, this may result in unplanned, long-term uses of
the Company's cash that otherwise would be available to fund operations.
Additionally, unexpected permitting and construction delays could result in
greater or longer-term cash outlays. Delays in opening new stores also may
result in reductions in forecasted sales revenues from projected levels and
increases in pre-opening costs for any given reporting period.
The cost of initial inventory for a new store has historically been
approximately $500,000; however, the Company relies on vendor financing for most
of this cost. Pre-opening costs currently are approximately $250,000 to
$300,000 per store and are expensed as incurred. The amounts and timing of such
pre-opening costs will depend upon the availability of new store sites and other
factors, including the location of the store and whether it is in a new or
existing market for the Company, the size of the store, and the required build-
out at the site. Costs to acquire future stores, if any, are impossible to
predict and could vary materially from the cost to open new stores. There can
be no assurance that actual capital expenditures will not exceed anticipated
levels. The Company believes that cash generated from operations and funds
available under the revolving line of credit will be sufficient to satisfy its
cash requirements, exclusive of additional acquisitions, through 1999.
Year 2000 Readiness Statement
Information Technologies. As the Year 2000 approaches, the Company recognizes
the need to ensure its operations will not be adversely impacted by Year 2000
software or hardware failures. The Company has determined that all of its major
software and hardware systems at its corporate headquarters are Year 2000
compliant. The Company has substantially completed installing Year 2000
compliant point-of-sale hardware (cash registers and scanners) in its stores.
In 1995, the Company began installing new point-of-sale systems to enable its
stores to have scanning capabilities. The Company has not accelerated the
installation schedule for this equipment in response to Year 2000 compliance
issues. All equipment installed since 1995 is Year 2000 compliant. Total
replacement and installation cost to date has been approximately $5.0 million,
with the cost to complete the installation in 1999 in the Company's existing
noncompliant stores estimated at an additional $500,000. This cost may increase
if the Company acquires additional stores with noncompliant point-of-sale
systems. The Company has determined that all major point-of-sale systems at the
metropolitan Portland, Oregon Nature's stores purchased in the second quarter of
1999 are Year 2000 compliant, and that all such systems in the 11 San Diego,
California Henry's stores expected to be acquired on September 1, 1999 are Year
2000 compliant. The Company's existing point-of-sale hardware was and is being
replaced to accommodate a merchandise management system that is Year 2000
compliant and that was previously acquired by the Company for its greater item
movement, tracking, pricing and reporting capabilities. The Company will
continue to make certain investments in its software systems and applications to
ensure that they are Year 2000 compliant. The financial impact of these
investments to the Company is not anticipated to be material in any single year.
Vendors, Suppliers and Service Providers. The Company also is in the process of
verifying whether its major suppliers, service providers, and financial
institutions are Year 2000 compliant. Many of the Company's product vendors are
smaller businesses that have not considered the impact of Year 2000
noncompliance and so are taking no steps to ensure compliance. To the extent
that product vendors' manufacturing or distribution systems fail as a result of
Year 2000 noncompliance, certain products carried by the Company's stores could
become unavailable, resulting in decreases in operating revenues, although in
many circumstances, alternative local vendors' products may be available. The
Company is currently requesting Year 2000 compliance statements from its major
vendors to determine whether such vendors' distribution of product may be
interrupted as a result of Year 2000 compliance problems. The Company will,
based on the responses received, formulate an alternative action plan to ensure
minimal impact on the available supply of products in its stores. One of the
Company's largest distributors recently provided information to its customers
concerning its own Year 2000 compliance. Currently this distributor has
upgraded or replaced the majority of its technology infrastructure and devices
that had embedded computer chips with compliant systems and devices, and is
currently testing its upgrades. At this time, the Company cannot evaluate the
magnitude of the impact that a failure by the distributor to successfully
install compliant systems could have on the Company's operations. A failure in
the distributor's warehouse facilities could affect the Company's ability to
stock product in certain of its stores, resulting in lower sales revenues in
those stores. The Company's stores' operations could be materially adversely
affected if utilities are disrupted. At this time the Company is in the process
of developing contingency plans to address product or utility disruptions.
12
If the Company's financial institutions are not Year 2000 compliant, a failure
in their operating system could result in a temporary inability by the Company
to access necessary cash resources required for operations; however, normal
store operations will generate sufficient revenues to cover daily operating
needs. The Company's credit card processor has confirmed to the Company that it
has adapted its systems to accept credit cards issued with expiration dates of
2000 and beyond and has also completed implementation of the phases of its
compliance program in accordance with guidelines of the Federal Financial
Institutions Examination Council.
Mechanical Systems. The Company has commenced review of the various individual
mechanical systems, such as HVAC, refrigeration and security systems, in its
stores to determine whether any Year 2000 compliance issues exist as to these
systems. The Company has contacted the suppliers of certain store systems with
embedded chips where Year 2000 compliance may be an issue to obtain confirmation
of compliance or instructions for reprogramming in the event of a compliance
problem. Responses received to date to a questionnaire sent to service
providers of mechanical systems indicate there will be little impact on store
operations due to Year 2000 noncompliance in mechanical systems. The Company
does not anticipate that any major store mechanical systems will require
replacement because of Year 2000 compliance concerns or that noncompliance of
any mechanical systems will have any material effect on store operations. The
dollar value of perishable goods that could be affected by a failure in
refrigerated systems is small in comparison to the total inventory of any store.
The estimates and conclusions regarding Year 2000 impact contained above are
forward-looking statements based on the Company's best estimates of future
events. Actual results may differ due to certain risks and uncertainties that
the Company cannot, at this time, predict.
New Accounting Pronouncements
See disclosures in Note 2 of the "Notes to Consolidated Financial Statements".
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not applicable.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Alfalfa's Canada, Inc., the Company's Canadian subsidiary, is a defendant in a
suit brought in the Supreme Court of British Columbia, by one of its
distributors, Waysafer Wholefoods Limited and one of its principals, seeking
monetary damages for breach of contract and injunctive relief to enforce a
buying agreement for the three Canadian stores entered into by a predecessor of
Alfalfa's Canada, Inc. The suit was filed in September 1996. The Company does
not believe its potential exposure in connection with the suit to be material.
There are no other material pending legal proceedings to which the Company or
its subsidiaries are a party. From time to time, the Company is involved in
lawsuits that the Company considers to be in the normal course of its business.
Item 2. Changes in Securities
Not applicable.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
At the Company's Annual Meeting of Stockholders, held on May 5, 1999, the
Company's stockholders elected the following directors for a three-year term:
Elizabeth C. Cook, David Ferguson and James McElwee. The directors were elected
by the following number of votes:
For Withheld
--- --------
Elizabeth C. Cook 9,700,175 21,569
David Ferguson 9,701,290 20,454
James McElwee 9,700,203 21,541
The remaining directors whose terms continue after the meeting date are John
Shields, Brian Devine, Morris Siegel, Michael C. Gilliland and David M.
Chamberlain. Also at such meeting,, PriceWaterhouseCoopers LLP was ratified as
the Company's independent accountants for the fiscal year ending January 1,
2000, by a vote of 9,693,698 for, 8,740 against and 19,306 abstained. There were
no broker non-votes.
Item 5. Other Information
Not applicable.
13
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number Description of Document
------ -----------------------
3(i).1.(a)** Amended and Restated Certificate of Incorporation of
Registrant.(1)
3(i).1.(b)** Certificate of Correction to Amended and Restated
Certificate of Incorporation of the Registrant.(1)
3(i).1.(c)** Certificate of Designations of Series A Junior
Participating Preferred Stock of Registrant (2)
3(ii).1** Amended and Restated By-Laws of Registrant.(1)
4.1** Reference is made to Exhibits 3(i).1 through 3(ii).1.(1)
4.2** Rights Agreement dated as of May 22, 1998 between
Registrant and Norwest Bank Minnesota N.A.(3)
10.1** Employment Agreement dated June, 14, 1999 between Mary
Beth Lewis and the Registrant.
10.2+ Employment Agreement dated June 1, 1999 between James Lee
and the Registrant.
27.1+ Financial Data Schedule.
____________
** Previously filed.
+ Included herewith.
(1) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the year ended December 28, 1996
(File Number 0-21577).
(2) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended April 3, 1999 (File Number 0-21577).
(3) Incorporated by reference to the Registrant's Registration Statement on
Form 8-A dated May 21, 1998.
(b) Reports on Form 8-K.
The Company filed two reports on Form 8-K during the three-month period
ended July 3, 1999. The first report, dated May 28, 1999, reported the
acquisition of the outstanding stock of Nature's Fresh Northwest, Inc,. a
Delaware corporation that owned seven operating natural food stores, with
one new store and one relocation in development. An amendment to such
report on Form 8-K-A was filed on August 16, 1999, to incorporate certain
financial statements of Nature's Fresh Northwest, Inc.
The second report on Form 8-K, dated August 2, 1999, reported the execution
of a stock purchase agreement between the Company, Henry's Marketplace,
Inc. ("Henry's") and the stockholders of Henry's Marketplace, Inc.,
pursuant to which the Company proposed to acquire all of the outstanding
stock of Henry's, which owns and operates 11 natural foods grocery stores
in the metropolitan San Diego, California area. The transaction referenced
in the Form 8-K is contemplated to close on September 1, 1999.
14
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Boulder, County of
Boulder, State of Colorado, on the 17th day of August 1999.
Wild Oats Markets, Inc.
By /s/ Mary Beth Lewis
------------------------------
Mary Beth Lewis
Executive Officer, Vice President of
Finance, Treasurer and Chief Financial Officer
(Principal Financial and Accounting Officer)
15