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WFM > SEC Filings for WFM > Form 10-K on 21-Nov-2012All Recent SEC Filings

Show all filings for WHOLE FOODS MARKET INC

Form 10-K for WHOLE FOODS MARKET INC


21-Nov-2012

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Overview
Whole Foods Market, Inc. is the world's leading retailer of natural and organic foods and America's first national "Certified Organic" grocer. Our Company mission is to promote the vitality and well-being of all individuals by supplying the highest quality, most wholesome foods available. Through our growth, we have had a significant and positive impact on the natural and organic foods movement throughout the United States, helping lead the industry to nationwide acceptance. The Company was formed in 1980 and, as of September 30, 2012, operated 335 stores: 322 stores in 39 U.S. states and the District of Columbia; 7 stores in Canada; and 6 stores in the United Kingdom. We have one operating segment, natural and organic foods supermarkets.

Our continued growth depends on our ability to increase sales in our identical stores and open new stores. New stores generally become profitable within their first year of operation; although some new stores may incur operating losses for the first several years of operation. The Company's average weekly sales and gross profit are typically highest in the second and third fiscal quarters, and lowest in the fourth fiscal quarter. Average weekly sales and gross profit are typically lower in the first fiscal quarter due to the product mix of holiday sales, and in the fourth fiscal quarter due to the seasonally slower sales during the summer months.

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

The Company reports its results of operations on a 52- or 53-week fiscal year ending on the last Sunday in September. Fiscal year 2012 was a 53-week year and fiscal years 2011 and 2010 were 52-week years.

Economic and Industry Factors
Food retailing is a large, intensely competitive industry. Our competition varies across the Company and includes but is not limited to local, regional, national and international conventional and specialty supermarkets, natural foods stores, warehouse membership clubs, online retailers, smaller specialty stores, farmers' markets and restaurants, each of which competes with us on the basis of store ambiance and experience, product selection, quality, customer service, price or a combination of these factors. Natural product sales through retail channels continue to experience significant growth, increasing 10% over the prior year, according to Natural Foods Merchandiser.

We offer a broad and differentiated selection of high-quality natural and organic products with a strong emphasis on perishable foods. We aspire to become an international brand synonymous with not just natural and organic foods, but also with being the highest quality food retailer in every community in which we are located.

Highlights for Fiscal Year 2012
We ended fiscal year 2012 with strong sales growth and record fourth quarter results, delivering the best year in our Company's 32-year history. The pace of new store openings and lease signings continues to increase, and our accelerated growth plans are on track. Our commitment to natural and organic products, local products, high quality standards, emphasis on perishable product sales, healthy eating products and education, range of choices based on price, and empowered team members who focus on unparalleled customer service differentiate us from the competition and have created a loyal customer base. We continue to evaluate and strengthen our value offerings, providing a clear range of choices in every category. We believe our focus in these areas has played a key role in driving our sales growth, and we are committed to maintaining our unique positioning. In fiscal year 2012, a 53-week year:

Sales increased 15.7% over the prior year to $11.70 billion driven by an 8.7% comparable store sales increase and identical store sales increased 8.4% over the prior year;

Net income increased 35.9% over the prior year to $465.6 million;

Diluted earnings per share increased 30.6% over the prior year to $2.52;

EBITDA totaled $1.06 billion, an increase of 26.4% over the prior year;

We produced $919.7 million in cash flow from operations and invested $456.2 million in capital expenditures, of which $261.7 million related to new locations;

We made four dividend payments to common shareholders totaling $94.5 million; and

We had cash, restricted cash, and investments totaling $1.54 billion at the end of the fiscal year.


Table of Contents

Outlook for Fiscal Year 2013
The following table provides guidance for fiscal year 2013:
Sales growth                                                     10% - 12%
Comparable store sales growth                                  6.5% - 8.5%
Identical store sales growth                                   6.0% - 8.0%
General and administrative expenses as a percentage of sales          3.1%
Operating income as a percentage of sales                      6.6% - 6.7%
Diluted earnings per share                                   $2.83 - $2.87
Diluted earnings per share growth                                12% - 14%
Tax rate                                                     38.6% - 39.0%
Ending square footage growth                                            8%

Fiscal year 2013 will be a 52-week year, with twelve weeks in the fourth fiscal quarter. On a 52-week to 52-week basis, the Company expects total sales growth of 12% to 14% and diluted earnings per share growth of 14% to 16%.

The Company expects capital expenditures for fiscal year 2013 to be in the range of approximately $565 million to $615 million, which includes the opening of approximately 32 to 34 new stores. The Company is committed to producing cash flows from operations in excess of its capital expenditure requirements on an annual basis, including sufficient cash flow to fund the 79 stores in its current development pipeline.

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

                                                       2012       2011       2010
Sales                                                 100.0  %   100.0  %   100.0  %
Cost of goods sold and occupancy costs                 64.5       65.0       65.2
Gross profit                                           35.5       35.0       34.8
Direct store expenses                                  25.5       26.0       26.4
General and administrative expenses                     3.2        3.1        3.0
Pre-opening expenses                                    0.4        0.4        0.4
Relocation, store closure and lease termination costs   0.1        0.1        0.1
Operating income                                        6.4        5.4        4.9
Interest expense                                          -          -       (0.4 )
Investment and other income                             0.1        0.1        0.1
Income before income taxes                              6.4        5.5        4.6
Provision for income taxes                              2.4        2.1        1.8
Net income                                              4.0        3.4        2.7
Preferred stock dividends                                 -          -        0.1
Income available to common shareholders                 4.0  %     3.4  %     2.7  %


Figures may not sum due to rounding.

Sales
Sales totaled approximately $11.70 billion, $10.11 billion and $9.01 billion in fiscal years 2012, 2011 and 2010, respectively, representing increases of 15.7%, 12.2% and 12.1% over the previous fiscal years, respectively. Sales increases for all years are due to comparable store sales increases and stores open or acquired less than one fiscal year, plus an additional week of sales in fiscal year 2012. Comparable store sales increased approximately 8.7%, 8.5% and 7.1% in fiscal years 2012, 2011 and 2010, respectively. Identical store sales increased approximately 8.4%, 8.4% and 6.5% in fiscal years 2012, 2011 and 2010, respectively. The sales increase contributed by stores open or acquired less than one fiscal year totaled approximately $293.8 million, $222.0 million and $251.8 million for fiscal years 2012, 2011 and 2010, respectively.


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Comparable stores, relocated stores and remodels excluded from the identical store base, identical stores, and stores open less than one fiscal year were as follows:

                                      2012     2011     2010
Comparable stores                      311      298      281
Relocated stores                        (7 )     (6 )     (6 )
Remodels with major expansions          (3 )     (1 )     (2 )
Identical stores                       301      291      273

Stores open less than one fiscal year   25       18       18

We believe our efforts around value and differentiation continue to be a significant contributor to our momentum. Our customers have shifted their buying toward branded and organic products, higher priced tiers, and to several discretionary categories. With the moderation of inflation, we saw our identical store sales breakout move toward approximately 80% transaction count and 20% basket size. During fiscal year 2012, our transaction count in identical stores increased 6.7%, continuing to accelerate from the 5.7% increase we experienced in fiscal year 2011. The increase in transaction growth helped to offset the slower increase in basket size year-over year. Basket size is partially impacted by our growth in new customers, who tend to have a smaller average basket size. During fiscal year 2012, our basket size increased 1.7% compared to the 2.4% increase for fiscal year 2011.

Gross Profit
Gross profit totaled approximately $4.16 billion, $3.54 billion and $3.14 billion in fiscal years 2012, 2011 and 2010, respectively. Net LIFO inventory reserves increased approximately $0.1 million and $10.3 million in fiscal years 2012 and 2011, respectively. During fiscal year 2010, net LIFO inventory reserves decreased approximately $7.7 million due primarily to lower average inventory balances and net deflation in product costs. Moderation of inflation during the fiscal year ended September 30, 2012 resulted in an almost flat net LIFO inventory reserve, as compared to rising product costs in the prior year. Excluding the LIFO charge, gross profit increased 43 basis points, driven by improvement in occupancy costs and costs of goods sold. During fiscal year 2011, despite the 19 basis point impact from the LIFO charge, the Company maintained healthy gross margins by balancing rising product costs while maintaining our relative value position. The Company realized sequentially lower cost of goods sold during fiscal year 2010 by taking advantage of buying opportunities and improving our distribution, shrink control and inventory management.

We have maintained our commitment to offering highly competitive prices on known value items in addition to implementing targeted pricing and promotional strategies. The success of this ongoing strategy is reflected in our continued sales momentum and the results from our most recent competitive survey. The survey indicates we dramatically improved our pricing position versus our competitors during fiscal year 2012, resulting in our most competitive position in more than three years.

To the extent changes in costs are not reflected in changes in retail prices or changes in retail prices are delayed, our gross profit will be affected. Our gross profit may increase or decrease slightly depending on the mix of sales from new stores or the impact of commodity costs or a host of other factors, including possible supply shortages, and extreme weather-related disruptions. Relative to existing stores, 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.

Direct Store Expenses
Direct store expenses totaled approximately $2.98 billion, $2.63 billion and $2.38 billion in fiscal years 2012, 2011 and 2010, respectively. The 51 basis point decrease in direct store expenses as a percentage of sales in fiscal year 2012 primarily reflects leverage of 25 basis points in wages, 16 basis points in depreciation expense, and 8 basis points in healthcare costs. During fiscal year 2011, the 38 basis point decrease in direct store expenses as a percentage of sales primarily reflects leverage of 28 basis points in wages and 19 basis points in depreciation expense, partially offset by an increase in costs, including worker's compensation expense of 5 basis points as a percentage of sales.

General and Administrative Expenses
General and administrative expenses totaled approximately $372.1 million, $310.9 million and $272.4 million in fiscal years 2012, 2011 and 2010, respectively. Higher wages and share-based payment expense, resulting primarily from our higher stock price, drove the 10 basis point increase in general and administrative expenses as a percentage of sales during fiscal year 2012. During fiscal year 2011, the increase in general and administrative expenses as a percentage of sales was primarily driven by higher wages, including wage costs associated with new strategic initiatives, totaling 6 basis points as a percentage of sales.


Table of Contents

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

                                                    2012         2011         2010
Cost of goods sold and occupancy costs          $  1,874     $  1,396     $    862
Direct store expenses                             22,647       14,121       10,140
General and administrative expenses               17,767       11,742       11,892
Share-based payment expense before income taxes   42,288       27,259       22,894
Income tax benefit                               (15,759 )    (10,072 )     (9,170 )
Net share-based payment expense                 $ 26,529     $ 17,187     $ 13,724

Pre-opening Expenses
Pre-opening expenses totaled approximately $46.9 million, $40.9 million and $38.0 million in fiscal years 2012, 2011 and 2010, respectively. The Company opened 25, 18 and 16 new store locations during fiscal years 2012, 2011 and 2010, respectively. Average pre-opening expense per new store opened in the year indicated, including pre-opening rent, totaled approximately $1.7 million, $2.5 million and $2.6 million in fiscal years 2012, 2011 and 2010, respectively.

Relocation, Store Closure and Lease Termination Costs Relocation, store closure and lease termination costs totaled approximately $9.9 million, $8.3 million and $11.2 million in fiscal years 2012, 2011 and 2010, respectively. The Company relocated or closed one, six and one store locations during fiscal years 2012, 2011 and 2010, respectively. Relocation, store closure and lease termination costs for fiscal years 2012, 2011 and 2010 include charges totaling approximately $2.4 million, $1.6 million and $6.9 million, respectively, to increase store closure reserves for increased estimated net lease obligations for closed stores. During fiscal year 2010, the Company recorded a gain totaling approximately $3.2 million related to the sale of a non-operating property.

Interest Expense
Interest expense, net of amounts capitalized, was approximately $0.4 million, $3.9 million and $33.0 million in fiscal years 2012, 2011 and 2010, respectively. Interest expense for fiscal years 2011 and 2010 consists principally of interest expense on the $700 million term loan we entered into to finance the acquisition of Wild Oats Markets. The reductions in interest expense are primarily due to the repayment of $490 million and $210 million of the term loan during fiscal years 2011 and 2010, respectively. The Company had no long-term debt amounts outstanding during fiscal year 2012, and its revolving line of credit expired in August 2012.

Investment and Other Income
Investment and other income which includes interest income, investment gains and losses, rental income and other income totaled approximately $8.9 million, $8.0 million and $6.9 million in fiscal years 2012, 2011 and 2010, respectively. The Company held higher average investment balances during fiscal years 2012 and 2011.

Income Taxes
Income taxes resulted in an effective tax rate of approximately 38.1%, 37.9% and 40.3% in fiscal years 2012, 2011 and 2010, respectively. The lower effective tax rates for fiscal years 2012 and 2011 reflect the tax effects of a reduction of reserves for uncertain tax positions and increased state tax credits in fiscal year 2012, and the tax effects of certain initiatives and investments in both fiscal years.

Non-GAAP measures
In addition to reporting financial results in accordance with generally accepted accounting principles, or GAAP, the Company provides information regarding Earnings Before Interest, Taxes, Depreciation and Amortization ("EBITDA") and Return on Invested Capital ("ROIC") as additional information about its operating results. These measures are not in accordance with, or an alternative to, GAAP. We believe that these presentations provide useful information to management, analysts and investors regarding certain additional financial and business trends relating to its results of operations and financial condition. In addition, management uses these measures for reviewing the financial results of the Company as well as a component of incentive compensation.


Table of Contents

The following is a tabular reconciliation of the non-GAAP financial measure EBITDA to GAAP net income, which the Company believes to be the most directly comparable GAAP financial measure. EBITDA was as follows (in thousands):

                                     2012          2011          2010
Net income                    $   465,573     $ 342,612     $ 245,833
Provision for income taxes        286,471       209,100       165,948
Interest expense                      354         3,882        33,048
Investment and other income        (8,892 )      (7,974 )      (6,854 )
Operating income                  743,506       547,620       437,975
Depreciation and amortization     311,550       287,109       275,589
EBITDA                        $ 1,055,056     $ 834,729     $ 713,564

The Company defines ROIC as annualized adjusted earnings divided by average invested capital. Earnings are annualized on a 52-week basis. Adjustments to earnings are defined in the following tabular reconciliation. Invested capital represents a trailing four-quarter average. ROIC was as follows (in thousands):

                                                       2012            2011            2010
Net income                                      $   465,573     $   342,612     $   245,833
Interest expense, net of taxes                          219           2,411          19,730
Adjusted earnings                                   465,792         345,023         265,563
Total rent expense, net of taxes (1)                211,344         193,609         175,542
Estimated depreciation on capitalized operating
leases, net of tax (2)                             (140,896 )      (129,073 )      (117,028 )
Adjusted earnings, including interest related
to operating leases                                 536,240         409,559         324,077

Annualized adjusted earnings                    $   457,115     $   345,023     $   265,563
Annualized adjusted earnings, including
interest related to
operating leases                                $   526,204     $   409,559     $   324,077

Average working capital, excluding current
portion of long-term debt                       $   955,973     $   493,187     $   450,827
Average property and equipment, net               2,090,103       1,950,435       1,891,750
Average other assets                                954,899         872,117         878,341
Average other liabilities                          (460,155 )      (389,198 )      (349,101 )
Average invested capital                        $ 3,540,820     $ 2,926,541     $ 2,871,817
Average estimated asset base of capitalized
operating leases (3)                              2,740,419       2,501,264       2,355,315
Average invested capital, adjusted for
capitalization of operating leases              $ 6,281,239     $ 5,427,805     $ 5,227,132

ROIC                                                  12.9%           11.8%            9.2%
ROIC, adjusted for capitalization of operating
leases                                                 8.4%            7.5%            6.2%

(1) Total rent includes minimum base rent of all tendered leases
(2) Estimated depreciation equals two-thirds of total rent expense
(3) Estimated asset base equals eight times total rent expense

Liquidity and Capital Resources and Changes in Financial Condition The following table summarizes the Company's cash and short-term investments as of the dates indicated (in thousands):

                                                             September 30,       September 25,
                                                                 2012                2011
Cash and cash equivalents                                  $        89,016     $       212,004
Short-term investments - available-for-sale securities           1,131,213             442,320
Total                                                      $     1,220,229     $       654,324

Additionally, the Company held long-term investments in available-for-sale securities totaling approximately $221.4 million and $52.8 million at September 30, 2012 and September 25, 2011, respectively.

We generated cash flows from operating activities of approximately $919.7 million, $754.8 million and $585.3 million in fiscal years 2012, 2011 and 2010, respectively. Cash flows from operating activities resulted primarily from our net income plus non-cash expenses and changes in operating working capital.


Table of Contents

Net cash used in investing activities totaled approximately $1.34 billion, $450.7 million and $715.4 million for fiscal years 2012, 2011 and 2010, respectively. Net purchases of available-for-sale securities totaled approximately $871.3 million, $73.1 million and $425.6 million for fiscal years 2012, 2011 and 2010, respectively. 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 of landlord incentives and complexity of site development issues. Capital expenditures for fiscal years 2012, 2011 and 2010 totaled approximately $456.2 million, $365.0 million and $256.8 million, respectively, of which approximately $261.7 million, $203.5 million and $171.4 million, respectively, was for new store development and approximately $194.5 million, $161.5 million and $85.4 million, respectively, was for remodels and other property and equipment expenditures.

The following table provides information about the Company's store development activities:

                                                       Stores
                                                       opened
                               Stores      Stores      during                    Total
                               opened      opened    fiscal year  Properties    leases
                               during      during    2013 as of  tendered as   signed as
                             fiscal year fiscal year   Nov. 7,    of Nov. 7,  of Nov. 7,
                                2011        2012        2012         2012      2012 (1)
Number of stores (including
relocations)                        18          25           7           12          79
Number of relocations                6           1           -            4          10
New markets                          -           8           4            4          18
Average store size (gross
square feet)                    39,400      35,500      33,500       37,600      36,600
Total square footage           708,700     887,400     234,800      450,800   2,896,300
Average tender period in
months                            12.5         7.9         5.9
Average pre-opening expense       $2.5        $1.7
per store                      million     million
Average pre-opening rent per      $1.2        $0.6
store                          million     million

(1) Includes leases for properties tendered

The following table provides information about the Company's estimated store openings for fiscal years 2013 and 2014:

                                           Average
                 Estimated                new store    Ending square
                 openings  Relocations square footage  footage growth

Fiscal year 2013 32 - 34 5 34,000 8% Fiscal year 2014 33 - 38 2 - 3 38,000 8% - 9%

On October 26, 2012, the Company announced plans to purchase six leases, averaging 31,000 square feet in size, from Johnnie's Foodmaster. Johnnie's Foodmaster will close the stores prior to the anticipated November 30, 2012 transaction closing date. The Company plans to remodel and reopen the locations as Whole Foods Market stores before the end of September 2013. The leases related to this transaction are included in the current development pipeline in the tables above.

We believe we will produce operating cash flows in excess of the capital expenditures needed to open the 79 stores in our current development pipeline.

Over the long term, the Company considers 1,000 stores to be a reasonable indication of its market opportunity in the United States as the Whole Foods Market brand continues to strengthen, consumer demand for natural and organic products continues to increase, and the Company's flexibility on new store size opens up additional market opportunities. The Company believes significant opportunities exist in Canada and the United Kingdom as well. Our growth strategy is to expand primarily through new store openings, with the majority of our new stores to fall in the range of 35,000 to 45,000 square feet going forward.

Net cash provided by financing activities totaled approximately $297.2 million in fiscal year 2012. Net cash used in financing activities totaled approximately $223.6 million and $168.9 million in fiscal years 2011 and 2010, respectively.

During fiscal year 2007, the Company entered into a $700 million, five-year term . . .

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