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Meldungen 14.11.2002

14.11.2002: Meldung: Wild Oats Markets: Quarterly Report (engl.)

Management"s Discussion And Analysis Of Financial Condition And Results Of Operations

 

This report on Form 10-Q contains certain forward-looking statements regarding our future results of operations and performance. Important factors that could cause differences in results of operations include, but are not limited to, the Company"s continued compliance with its credit facility covenants; the timing and execution of new store openings, relocations, remodels, sales and closures; the timing and impact of the marketing, merchandising and advertising programs; the impact of competition; changes in product supply or suppliers; changes in management information needs; changes in customer needs and expectations; governmental and regulatory actions; general industry or business trends or events; changes in economic or business conditions in general or affecting the natural foods industry in particular; and competition for and the availability of sites for new stores and potential acquisition candidates. See Management"s Discussion and Analysis of Financial Condition and Results of Operations - Cautionary Statement Regarding Forward-Looking Statements.

 

Overview

 

Marketing and Merchandising Initiatives and Operational Improvements. During the third quarter of fiscal 2002, we had a 10.5% increase in average weekly sales per store, a 5.7% increase in average weekly customer count per store and a 4.9% increase in average sales per customer chain-wide as compared to the third quarter of fiscal 2001.

 

Over the last 15 months, we have instituted new programs to improve customer service and store-level execution. We also implemented inventory and SKU reduction programs, centralized product ordering and pricing functions to refocus store management energies on store-level operations, and reset store merchandise for customer convenience in many stores. In the third quarter of fiscal 2002, we also transferred our primary distribution business to Tree of Life, Inc., our new distributor. We believe these programs, together with marketing and merchandising initiatives discussed in previous reports on Form 10-Q, contributed to overall operational improvements that increased store sales, customer count and average transaction size in the third quarter of fiscal 2002, as compared to the third quarter of fiscal 2001.

 

Store format. We operate two store formats: the natural foods supermarket and farmers market formats. The natural foods supermarket format store, operated under the Wild OatsRNatural Marketplace and Nature"sR- A Wild Oats Market tradenames, is generally 20,000 to 35,000 gross square feet, and the farmers market store, operated under the Henry"s MarketplaceR and Sun Harvest†† tradenames, is generally 15,000 to 25,000 gross square feet. Our profitability has been and will continue to be affected by the mix of natural foods supermarkets and farmers market stores opened, acquired or relocated and whether stores are being opened in markets where we have an existing presence. In fiscal 2001 and the first half of 2002, we redesigned the natural foods supermarket format store layout and design. In April 2002, we opened the first of our redesigned natural foods supermarket format stores in Long Beach, California. We have also redesigned the prototype for our farmers market store format, and plan to open our first prototype store in the first quarter of fiscal 2003. We also plan to expand the farmers market store format as our second, parallel store format. We believe this format, which is primarily located in metropolitan San Diego, California and Texas, appeals to a more value-conscious customer. This format has historically produced higher comparable store sales results than the natural foods supermarket format stores, although margins are lower. The format also appears to perform better in the face of new competition, whether from conventional or natural foods supermarket competitors.

 

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 our comparable store sales results, including, among others:

- general economic conditions

- the opening of stores by us or by our competitors in markets where we have existing stores

- the relative proportion of new or relocated stores to mature stores

- the timing of advertising and promotional events

- store remodels

- store closures

- our ability to effectively execute our operating plans

- changes in consumer preferences for natural foods products

- availability of produce and other seasonal merchandise.

 

Past increases in comparable store sales may not be indicative of future performance. The farmers market format stores, which depend heavily on produce sales, are more susceptible to sales fluctuations resulting from the availability and pricing of certain produce items. Road construction adjacent to our operating stores, as well as construction within the common areas of the shopping centers in which we operate, may also affect customer traffic and comparable store sales results.

 

As a result of marketing and merchandising initiatives, operational improvements, and the closure of one weaker store, comparable store sales chain-wide increased by 5.6% in the third quarter of fiscal 2002, as compared to 5.2% in the second quarter of 2002, 7.3% in the first quarter of fiscal 2002, 5.7% in the fourth quarter of fiscal 2001, 5.5% in the third quarter of fiscal 2001, 3.9% in the second quarter of fiscal 2001, and 1.0% in the first quarter of fiscal 2001. Comparable store sales are expected to be between 3.5% and 5.5% for the remainder of the year. No new store openings are anticipated until early 2003. There can be no assurance that comparable store sales for any particular period will not decrease in the future.

 

Store openings, closings, sales, remodels, relocations and acquisitions. In the third quarter of fiscal 2002, we opened no new stores, and we closed one farmers market store in San Diego, California when the lease expired, as well as one small vitamin store in El Paso, Texas. In the third quarter of fiscal 2001, we opened no new stores and we closed no stores. Subsequent to the third quarter of fiscal 2002, we sold one other small vitamin store in El Paso, Texas.

 

At September 28, 2002, we had 100 stores located in 23 states and Canada, as compared to 107 stores in 23 states and Canada as of the end of fiscal 2001, and 106 stores in 22 states and Canada as of the end of fiscal 2000. A summary of store openings, acquisitions, closures and sales is as follows:

 

TOTAL STORE

COUNT

Fiscal Year Period

Ending Ending

Sep 28,

2000 2001 2002

Store count at beginning of period 110 106 10 7

Stores opened 14 4 1

Stores acquired 2

Stores closed (17) (1) (5)

Stores sold (3) (2) (3)

Store count at end of period 106 107 100

 

We currently have an inventory of 14 vacant sites, not including those referenced below, comprising closed store, kitchen and warehouse locations and excess unoccupied space acquired during acquisitions or other leasing transactions, for which we have rent obligations; appropriate accruals have been made for such obligations. We are actively seeking subtenants or assignees for the spaces, although many of the sites are difficult to sublease or assign because of unusual site characteristics, surpluses of vacant retail space in the markets in which the sites are located, or because the remaining lease terms are relatively short. In the third quarter of fiscal 2002, we negotiated an early lease termination for one site, sublet one small space adjacent to an existing store, and sold one kitchen facility.

 

In September 2002, we concluded an offering of 4.45 million shares of our common stock for total gross proceeds of $51.2 million. Under the terms of our amended credit facility, as a result of the completion of the equity financing, we will be allowed to increase the number of new leases we may execute and new stores we may open, based on the format of the stores proposed to be opened. See Management"s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.

 

As has been our practice in the past, we will continue to evaluate the profitability, strategic positioning, impact of potential competition, and sales growth potential of all of our stores on an ongoing basis. We may, from time to time, make decisions regarding closures, disposals, relocations or remodels in accordance with such evaluations.

Pre-opening expenses. Pre-opening expenses include labor, rent, advertising, utilities, supplies and certain other costs incurred prior to a store"s opening. The amount per store may vary depending on whether the store is the first to be opened in a market or is part of a cluster of stores in that market. We expect our pre-opening expenses will increase to $400,000 to $500,000 per natural foods supermarket store, and $200,000 to $300,000 per farmers market store, depending on whether the store is the first in a geographic area, the date of rent commencement negotiated under the lease, and the extent of grand opening advertising and staff training activities.

 

Restructuring and Asset Impairment Activity. During the third quarter of fiscal 2002, management made certain decisions relating to our operations which changed estimates of prior restructuring and asset impairment charges and resulted in net restructuring and asset impairment income of $174,000. During the second quarter of fiscal 2002, management made certain decisions relating to our operations which changed estimates of prior restructuring and asset impairment charges and resulted in net restructuring and asset impairment expense of $0. During the first quarter of fiscal 2002, management made certain decisions relating to our operations which also changed estimates of prior restructuring and asset impairment charges and resulted in restructuring and asset impairment income of $652,000. See our 2001 Annual Report filed on Form 10-K for the fiscal year ended December 29, 2001 for a detailed discussion of restructuring and asset impairment charges during the last three years.

 

Critical Accounting Policies and Estimates. Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

 

On an ongoing basis, we evaluate the continued appropriateness of our accounting policies and resulting estimates, including those related to:

 

- asset impairment charges - restructuring charges and store closing costs - allowance for bad debt - inventory valuation and reserves - self-insurance reserves - reserves for contingencies and litigation - goodwill valuation

 

The consolidation in 2002 of our brands to increase synergy and awareness has resulted in a change to our goodwill accounting policy. During the first quarter of fiscal 2002, we recorded goodwill at the enterprise level to recognize goodwill for the brand, as opposed to past practice of recording goodwill at the store level. See Note 2, Notes to Consolidated Financial Statements. See also our 2001 Annual Report filed on Form 10-K for the fiscal period ended December 29, 2001, for disclosures of the remaining critical accounting policies that continue in existence unchanged from that annual period.

 

Factors Impacting Results of Operations

Our results of operations have been and will continue to be affected by, among other things:

- the number, timing and mix of store openings, acquisitions, relocations, remodels or closings

- availability of financing to replace maturing obligations º fluctuations in quarterly results of operations

- impact of merchandising and marketing initiatives on store performance

- economic conditions

- construction adjacent to operating stores

- competition

- labor issues

- loss of key management

- government regulations

- changes in suppliers, distributors and manufacturers

- volatility in our stock price

 

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. We anticipate that the new stores opened in fiscal years 2002 and 2003 will experienceoperating losses for the first six months of operation, in accordance with historical trends.

Occasionally, we will remodel and remerchandize certain of our older stores. Remodels and remerchandising typically cause short-term disruption in sales volume and related increases in certain expenses as a percentage of sales, such as payroll. We cannot predict whether sales disruptions and the related impact on earnings may be greater in time or volume than projected in future remodeled or remerchandised stores.

 

The construction or acquisition of new stores, remodeling of existing stores, as well as completion of capital purchases of new technology systems required for efficient operation of our business require substantial capital expenditures. In the past, our capital expenditures have been funded by cash generated from operations, bank debt and equity financing proceeds. These sources of capital may not be available to us in the future. See Management"s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.

 

Our existing credit facility matures in August 2003. We are currently discussing a new line of credit will several potential lenders. Our results of operations may be impacted by our ability to refinance as well as on the interest rates and covenants negotiated with any new lender.

 

Our quarterly results of operations may differ materially from quarter to quarter for a variety of reasons, including the timing and success of new store openings, overall store performance, changes in the economy, seasonality and the timing of holidays, significant increases or decreases in prices for or availability of goods and services, competitive pressure and labor disturbances, shrink and spoilage, fluctuations in profit margins for discontinued items, as well as other factors mentioned in this section.

 

We have implemented merchandising and marketing initiatives in certain of our natural foods supermarket format stores in fiscal 2002. There can be no assurances that these programs will be successful in those stores, nor that the cost of program roll-out will be at or below the costs incurred in fiscal 2001 for similar programs.

 

Downturns in general economic conditions in communities, states, regions or the nation as a whole can affect our results of operations. While purchases of food generally do not decrease in a slower economy, consumers may choose less expensive alternative sources for food purchases. In addition, downturns in the economy make the disposition of excess properties, for which the Company continues to pay rent and other carrying costs, substantially more difficult as the markets become saturated with vacant space and market rents decrease below our contractual rent obligations.

Construction on roads and in parking lots and shopping center common areas adjacent to our operating stores is an ongoing and unpredictable variable in the operation of our stores. Such activity historically has negatively impacted our results of operations by reducing customer traffic and lowering sales volumes.

 

As mentioned previously, we compete with both natural foods and conventional grocers. As competition in certain markets intensifies, our results of operations may be negatively impacted through loss of sales, reduction in margin from competitive price modifications, and disruptions in our employee base.

 

From time to time, unions will attempt to organize employees or portions of the employee base at stores or our distribution or manufacturing facilities. Responses to organization attempts require substantial management and employee time and are disruptive to operations. In addition, from time to time certain of our stores may be subject to informational picketing, which can discourage customer traffic and lower sales volumes. Our ability to attract, hire and retain qualified employees at store and home-office levels is critical to our continued success.

 

Our future direction and success is dependent in large part on the continued services of certain key executive officers. Loss of any key officer may have an adverse affect on current operations and future growth programs.

 

We are subject to a myriad of local, state and federal regulations governing the operation of our stores and support facilities, including licensing laws governing the sale of particular categories of products, health and sanitation laws, laws governing the manufacture, labeling and importation of private label products, labor laws controlling wages, benefits and employment conditions of our employees and advertising regulations governing the manner in which we may advertise products we sell. In October 2002, the National Organic Standards, a comprehensive program of regulations governing the growing, production, handling and sale of goods labeled as organic, was fully implemented. Consumer and regulatory concerns regarding food safety issues, new technology or competitive pressures may trigger modifications in existing laws and the implementation of new laws governing components of our business operations. Such modifications can have a material impact on our sales volume, costs of goods and direct store expenses. Modification of such laws may also impact the vendors and manufacturers who provide goods and services to us, raising the cost of such items or decreasing their availability. In addition, from time to time we are audited by various governmental agencies for compliance with existing laws, and we could be subject to fines or operational modifications as a result of noncompliance.

 

We received a transition fee as a part of our June 2002 distribution agreement with Tree of Life, Inc. We are using the transition fee to offset the transition costs incurred during the transition of our primary distribution relationship to Tree of Life. These costs include, but are not limited to, the cost of retagging store shelves, modification of product inventory, disposal of discontinued products, resetting of products on store shelves and training of store personnel in new procedures, and legal and consulting expenses. A portion of the transition fee received was used to defray transition expenses incurred in the second and third quarters.

 

Our stock price has been and continues to be fairly volatile. Our stock price is affected by our quarterly and year-end results, results of our major competitors and suppliers, general market and economic conditions and publicity about our competitors, our vendors, our industry or us. Volatility in our stock price may affect our future ability to renegotiate our existing credit agreement or enter into a new borrowing relationship, or affect our ability to obtain new store sites on favorable economic terms.

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 Nine Months Ended

 

Sep 28, Sep 29, Sep 28, Sep 29,

2002 2001 2002 2001

 

Sales 100.0% 100.0 % 100.0% 100.0 %

Cost of goods sold and 70.6 71.4 70.4 70.7

occupancy costs

 

Gross margin 29.4 28.6 29.6 29.3

Direct store expenses 21.3 23.5 21.6 23.7

Selling, general 5.6 5.9 6.0 5.6

and administrative expenses

Pre-opening expenses 0.1 0.0 0.2 0.2

Restructuring and (0.1) 0.4 (0.1) 8.3

asset impairment charges

(income)

Income (loss) from operations 2.5 (1.2) 1.9 (8.5)

Loss on investment 0.0

Interest income 0.1 0.2 0.1 0.1

Interest expense (1.0) (1.1) (1.0) (1.2)

Income (loss) before income 1.6 (2.1) 1.0 (9.6)

taxes

Income tax expense (benefit) 0.6 (0.8) 0.4 (3.5)

Net income (loss) 1.0% (1.3)% 0.6% (6.1)%

 

Sales. Sales for the three months ended September 28, 2002, increased 2.7% to $228.1 million from $222.2 million in the same period in fiscal 2001. Sales for the nine months ended September 28, 2002, increased 3.9% to $697.3 million from $671.1 million in the same period in fiscal 2001. The increases were primarily attributed to improvements in same-store sales resulting from the positive impact of marketing and merchandising initiatives and overall operational improvements. The increases were achieved despite the sale or closure of eight stores during the first nine months of fiscal 2002. For the most part, these store sales or closures were part of the Company"s program to divest under-performing stores. Comparable store sales increased 5.6% for the third quarter of fiscal 2002 from a 5.2% increase in the second quarter of fiscal 2002, as compared to a 5.5% increase in the third quarter of fiscal 2001, due to operational improvements in a number of stores; and the continued implementation of merchandising and marketing programs in fiscal 2002.

Gross Profit. Gross profit for the three months ended September 28, 2002, increased 5.6% to $67.1 million from $63.5 million in the same period in fiscal 2001. Gross profit for the nine months ended September 28, 2002 increased 5.0% to $206.1 million from $196.3 million in the same period in fiscal 2001. The increases were primarily attributed to higher sales volumes. As a percentage of sales, gross profit increased to 29.4% for the third quarter of fiscal 2002 from 28.6% for the same period in fiscal 2001. As a percentage of sales, gross profit increased to 29.6% for the nine months ended September 28, 2002 from 29.3% for the same period in fiscal 2001. The increases were due to lower occupancy costs, which were partially offset by lower merchandise margins resulting from a shift in sales mix and aggressive markdowns made in response to weaker-than-expected sales of certain seasonal specialty produce items during the third quarter of fiscal 2002.

 

Direct Store Expenses. Direct store expenses for the three months ended September 28, 2002, decreased 6.7% to $48.6 million from $52.1 million in the same period in fiscal 2001, and for the nine months ended September 28, 2002, decreased 5.2% to $150.6 million from $158.7 million in the same period in fiscal 2001. The decreases were the result of disciplined payroll expense management and operational improvements in the stores. As a percentage of sales, direct store expenses decreased to 21.3% for the third quarter of fiscal 2002 from 23.5% for the same period in fiscal 2001. As a percentage of sales, direct store expenses decreased to 21.6% for the nine months ended September 28, 2002 from 23.7% for the same period in fiscal 2001. The decreases are primarily due to the reduction of store-level payroll and better cost-containment measures. In addition, certain marketing expenses are now included in selling, general and administrative expenses.

Selling, General and Administrative Expenses. Selling, general and administrative expenses for the three months ended September 28, 2002, decreased 3.8% to $12.7 million from $13.2 million for the same period in fiscal 2001. As a percentage of sales, selling, general and administrative expenses decreased to 5.6% for the third quarter of fiscal 2002 from 5.9% for the same period in fiscal 2001. The decrease was attributable to more disciplined cost management, including the deferral of headcount additions, as well as the favorable resolution of a legal matter. Selling, general and administrative expenses for the nine months ended September 28, 2002, increased 10.5% to $41.6 million from $37.7 million in the same period in fiscal 2001. As a percentage of sales, selling, general and administrative expenses increased to 6.0% for the nine months ended September 28, 2002 from 5.6% for the same period in fiscal 2001. The increase was primarily due to our ongoing investments in marketing and advertising to improve sales performance. Based on the first nine months" results, we expect selling, general and administrative expenses as a percentage of sales to return to approximately 6.0% as we scale up for new store openings in fiscal 2003. We currently are evaluating the nature, frequency and reach of our advertising activities. Changes in our advertising strategy could affect future levels of selling, general and administrative expenses in both absolute dollars and as a percentage of sales.

 

Pre-Opening Expenses. Pre-opening expenses for the three months ended September 28, 2002 increased to $237,000 compared to $1,000 during the same period in fiscal 2001, and for the nine months ended September 28, 2002, decreased 17.5% to $1.3 million from $1.5 million in the same period in fiscal 2001. As a percentage of sales, pre-opening expenses increased to 0.1% for the three months ended September 28, 2002, from 0.0% for the same period in fiscal 2001, as a result of pre-opening rent expense for stores scheduled to open in the first quarter of fiscal 2003. As a percentage of sales, pre-opening expenses remained constant at 0.2% in the first nine months of fiscal 2002 and fiscal 2001, due to the acceleration of the rent commencement date and higher-than-expected rent payments related to the opening of one new store in the first nine months of fiscal 2002, as compared to the opening of four new stores with lower pre-opening expenses in the first nine months of fiscal 2001. As part of the Company"s increase in marketing and staff training efforts nationwide, we anticipate that pre-opening expenses for new natural foods supermarket stores will increase to an estimated $400,000 to $500,000 per new store, depending on the store"s location, and those of the farmers market format will increase to an estimated $200,000 to $300,000 in the future.

 

Interest Income. Interest income for the three months ended September 28, 2002, decreased 51.9% to $234,000 from $486,000 for the same period in fiscal 2001, and for the nine months ended September 28, 2002, decreased 20.1% to $603,000 from $755,000 for the same period in fiscal 2001. The decreases were attributable to lower interest rates and reduced levels of invested cash. See Management"s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources below.

 

Interest Expense. Interest expense for the three months ended September 28, 2002, decreased 6.4% to $2.4 million from $2.5 million in the same period in fiscal 2001, and for the nine months ended September 28, 2002, decreased 11.0% to $7.1 million from $8.0 million in the same period in fiscal 2001 due to decreased borrowings during the nine-month period. As part of the October 2001 amendment to our credit facility, our revolving line of credit accrues interest on prime-based and LIBOR-based loans at prime plus 3.25% and one-month LIBOR plus 4.75% (6.6% at September 28, 2002), respectively, both increasing by 0.5% on January 1, 2003; thereafter, the rate will remain constant through the maturity date of August 1, 2003. Due to the current state of the U.S. economy, management believes that the variable interest rates will remain constant or decrease slightly during the next six to 12 months. See Management"s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources below.

 

Restructuring and Asset Impairment Charges (Income). During the third quarter of fiscal 2002, the Company recorded restructuring and asset impairment income of $174,000 consisting of the following components:

- Gain on sale of assets for a site sold during the third quarter of fiscal 2002 ($85,000 of asset disposal income). During the third quarter of fiscal 2002, the Company sold a closed kitchen facility in Santa Fe, New Mexico for a higher price than originally estimated. Therefore, the Company recognized asset disposal income of $85,000 during the third quarter of fiscal 2002.

- Change in estimate related to lease-related liabilities for sites previously identified for closure or sale ($100,000 of restructuring income). During the third quarter of fiscal 2002, the Company negotiated the early termination of a lease in Tempe, Arizona. During the third quarter of fiscal 2002, the Company also terminated lease obligations for a site in Denver, Colorado. Based on these changes in facts and circumstances and the related changes in estimates, the Company reversed the remaining lease-related liabilities previously recorded for these locations and therefore recognized restructuring income of $100,000 during the third quarter of fiscal 2002.

- Fixed asset impairments for one additional store identified and closed in the third quarter of fiscal 2002 ($6,000 of asset impairment expense). During the third quarter of fiscal 2002, the Company decided to close one small vitamin store operated under the Vitamin Expo tradename as part of brand consolidation. The assets will be disposed by the end of fiscal 2002.

- Lease-related liabilities for one additional store identified and closed in the third quarter of fiscal 2002 ($5,000 of restructuring expense). During the third quarter of fiscal 2002, the Company exercised the right of early lease termination with 90 days" notice to the landlord for a small vitamin store in El Paso, Texas. The lease-related liabilities for this location represent the remaining lease cost through termination in the fourth quarter of fiscal 2002.

 

During the second quarter of fiscal 2002, we recorded restructuring and asset impairment expense of $0, consisting of the following significant components:

- Fixed asset impairments for sites previously identified for closure or sale ($35,000 of asset impairment expense). During the second quarter of fiscal 2002, we determined that certain fixed assets were not compatible with the Company"s new store design. Due to the implementation of the new store design, such assets could not be relocated as contemplated under the original restructuring plan. As a result, we determined we could not recover the previously estimated carrying value of these assets, and therefore recognized an asset impairment charge of approximately $170,000 during the second quarter of fiscal 2002. The assets will be fully disposed by the end of fiscal 2002. Additionally, during the second quarter of fiscal 2002, we determined that we could partially recover the carrying value of certain fixed assets used in store front-end operations that were previously written off; therefore, we recognized asset disposal income of approximately $135,000 during the second quarter of fiscal 2002.

- Change in estimate related to lease-related liabilities for sites previously identified for closure or sale ($678,000 of restructuring income). During the second quarter of fiscal 2002, we negotiated the early termination of a lease of property at which we had operated a kitchen in Los Angeles, California. Also during the quarter, we subleased a closed location in Hartford, Connecticut for the remaining lease term and provided a subsidy for the sublessee; the previously estimated lease-related liabilities in excess of the subsidy were reversed. Additionally, we subleased a site in Vancouver, British Columbia, Canada, for the remaining lease term and consequently reversed the previously estimated lease-related liabilities. For space adjacent to our operating store in West Hartford, Connecticut, we negotiated a lease amendment with the landlord during the second quarter of fiscal 2002 and, as a result, will be removed from the lease in the first quarter of fiscal 2003; we reversed the excess lease-related liabilities previously recorded. Due to these changes in facts and circumstances and the related changes in estimates, we recorded restructuring income during the second quarter of fiscal 2002.

- Fixed asset impairments for one additional store identified in the second quarter of fiscal 2002 to be closed during the third quarter of fiscal 2002 ($131,000 of asset impairment expense). During the second quarter of fiscal 2002, we decided to close one store in the third quarter of fiscal 2002 due to failure to extend the lease term with the landlord. The assets were disposed during the third quarter of fiscal 2002.

º Fixed asset impairments for store construction project discontinuation ($370,000 of asset impairment expense). During the second quarter of fiscal 2002, we determined that a new store design was required and construction of new stores based on the previously developed designs would be abandoned to incorporate the new store design changes. Assets in this charge included abandoned construction in progress (primarily leasehold improvements). We determined that we could not recover the carrying value of these fixed assets, and therefore recognized an asset impairment charge and disposed of the assets during the second quarter of fiscal 2002.

- Severance for employees terminated during the second quarter of fiscal 2002 ($142,000 of restructuring expense). During the second quarter of fiscal 2002, 65 employees were terminated in conjunction with the closure of one store in Cleveland, Ohio and the closure of the bakery operations within one support facility in Denver, Colorado during the quarter. The employees were notified of their involuntary termination during the second quarter of fiscal 2002. As of September 28, 2002, all $142,000 of the involuntary termination benefits had been paid to terminated employees.

During the first quarter of fiscal 2002, we recorded restructuring and asset impairment income of $652,000. Details of the significant components are as follows:

 

- Change in estimate related to lease-related liabilities for sites previously identified for closure or sale that were closed, sold or disposed of during the first quarter of fiscal 2002 ($761,000 of restructuring income). During the first quarter of fiscal 2002, we sold one store in Victoria, British Columbia, Canada. The purchaser assumed the lease-related obligations associated with this store. Based on this change in facts and circumstances, we reversed the remaining lease-related liabilities previously recorded for this store and therefore recognized restructuring income of $649,000 during the first quarter of fiscal 2002. During the first quarter of fiscal 2002, we also concluded payments for terminated lease obligations for sites in Boca Raton, Florida; Santa Fe, New Mexico and Framingham, Massachusetts; based on this change in facts and circumstances, we reversed the remaining lease-related liabilities previously recorded for these stores and therefore recognized restructuring income of $112,000 during the first quarter of fiscal 2002.

 

- Gain on sale of assets for a site sold during the first quarter of fiscal 2002 ($253,000 of asset disposal income). During the first quarter of fiscal 2002, we sold one store in Victoria, British Columbia, Canada. The sale agreement included payment for fixed assets. Based on this change in facts and circumstances, we recorded the gain on the sale of the fixed assets and therefore recognized asset disposal income of $253,000 during the first quarter of fiscal 2002.

 

- Change in estimate related to lease-related liabilities for sites previously identified for closure ($93,000 of restructuring expense). During the first quarter of fiscal 2002, we determined the likelihood of securing a subtenant for certain space in Tempe, Arizona was now remote due to our obligation being at above-market rates, the unattractive site characteristics, and increasingly difficult real estate market conditions. With this change in facts and circumstances, we decided to fully reserve for the remaining lease obligations of the site and therefore recognized a restructuring charge of $93,000 during the first quarter of fiscal 2002. There was a related change in estimate during the third quarter of fiscal 2002 following the negotiation of an early lease termination that resulted in the recognition of $91,000 in restructuring income.

 

- Severance for employees terminated during the first quarter of fiscal 2002 ($269,000 of restructuring expense). During the first quarter of fiscal 2002, 103 employees were terminated in conjunction with the closure of two stores in Boca Raton, Florida and Chesterfield, Missouri during the first quarter of fiscal 2002. The employees were notified of their involuntary termination during the first quarter of fiscal 2002. As of September 28, 2002, all $269,000 of the involuntary termination benefits had been paid to terminated employees.

A summary of restructuring activity by store count is as follows:

 

RESTRUCTURING

STORE COUNT

Fiscal Year Period

Ending Ending

Sep 28,

2000 2001 2002

Stores remaining at commencement of period 9 6

Stores identified in fiscal 2000 for closure or sale 22

Stores identified in fiscal 2001 for closure or sale 6

Stores identified in fiscal 2002 for closure or sale 2

Identified stores closed or abandoned (10) (3) (5)

Identified stores sold (3) (2) (3)

Reversal of stores identified for closure or sale (4)

Identified stores remaining at period end 9 6 0

 

Income Tax Expense. The Company has a $20.9 million net deferred tax asset, primarily as a result of the $54.9 million of restructuring and asset impairment charges recorded during fiscal 2001. For the three months ended September 28, 2002, we recorded $1.4 million of income tax expense, primarily as a result of income before income taxes of $3.5 million during the period. For the nine months ended September 28, 2002, we recorded $2.6 million of income tax expense, primarily as a result of income before income taxes of $7.0 million during the period. The recoverability of the net deferred tax asset is primarily dependent upon the Company generating sufficient taxable income in the future. Although realization of the net deferred tax asset is not assured, we believe it is more likely than not that the Company will generate sufficient taxable income in the future to realize the full amount of the deferred tax asset. Our assessment is based on projections that assume that the Company can maintain its current store contribution margin. Furthermore, we expect to maintain the sales growth experienced over the past five years that would generate additional taxable income. The primary uncertainty related to the realization of the deferred tax asset is the Company"s ability to achieve its four-year business plan and generate future taxable income to realize the full amount of the deferred tax asset. We believe that the sales, gross margin, store contribution margin, and selling, general and administrative expenses assumptions in our four-year business plan are reasonable and, more likely than not, attainable. We will continue to assess the recoverability of the net deferred tax asset and to the extent it is determined in the future that a valuation allowance is required, it will be recognized as a charge to earnings at that time.

 

Liquidity and Capital Resources

 

Our primary sources of capital have been cash flow from operations (which includes inventory and 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, relocations, remodels and acquisitions and repayment of debt.

 

We have a current credit facility that matures in August 2003, and we have commenced discussions with a number of lending institutions regarding a new credit facility of $100.0 million to $125.0 million. Our current facility has two separate lines of credit, a revolving line of up to $86.2 million and a term loan of up to $38.8 million, each with a three-year term expiring August 1, 2003. As part of the October 2001 amendment of the credit facility, which had an original credit capacity of $157.5 million, borrowings under the credit facility have been limited to $125.0 million. As of September 28, 2002, there were $59.5 million in borrowings outstanding under the $86.2 million revolving line of this facility and $31.3 million in borrowings outstanding under the $38.8 million term note. The interest rate on the facility is currently prime plus 3.25% or one-month LIBOR plus 4.75%, at our election (6.6% at September 28, 2002), and the rates increase by 0.5% on January 1, 2003, and thereafter, remain constant through the maturity of August 1, 2003. We currently do not have sufficient funds to pay all outstanding indebtedness. The Company is in the process of refinancing its debt and negotiating a new credit facility. If we are not successful in negotiating a new credit facility prior to the August 1, 2003 maturity date of the existing credit facility, our liquidity and ability to fund operations will be negatively impacted, and we may not have sufficient funds to repay all outstanding indebtedness. Although no assurances can be given, we expect that we will be successful in securing a new credit facility prior to August 1, 2003.

 

Net cash provided by operating activities was $24.6 million during the first nine months of fiscal 2002 as compared to $25.6 million during the same period in fiscal 2001. Cash from operating activities decreased during this period primarily due to changes in working capital items. We have not required significant external financing to support inventory requirements at our existing and new stores because we have been able to rely on vendor financing for most of the inventory costs, and we anticipate that vendor financing will continue to be available for new store openings.

Net cash used in investing activities was $6.7 million during the first nine months of fiscal 2002 as compared to $18.8 million during the same period in fiscal 2001. The decrease is due to a reduction in capital expenditures related to new store construction and remodels.

 

Net cash provided by financing activities was $20.6 million during the first nine months of fiscal 2002 as compared to $5.3 million used in financing activities during the same period in fiscal 2001. The change reflects $51.2 million of gross equity offering proceeds, offset by $31.5 million in debt repayments and $590,000 in partial repayment of a related-party note.

 

We have a net deferred tax asset of $20.9 million on our balance sheet, primarily as a result of $54.9 million of restructuring and asset impairment charges recorded during fiscal 2001. The net deferred tax asset will reduce cash required for payment of federal and state income taxes, as we believe we will generate sufficient taxable income for realization of the asset in the future. The Company has determined that it must amend its 1999, 2000 and 2001 tax returns to correct the reporting of deemed dividend income from a foreign subsidiary. Such determination was the result of an internal self-review and not the result of any tax audit by the Internal Revenue Service or other tax authority. The Company believes that such amended tax returns will not materially affect the consolidated results, liquidity or financial position of the Company, or have any impact on tax expense reported in financial statements for 1999, 2000 and 2001. The Company believes that it has sufficient net operating loss carryovers to carry back to such tax years in order to eliminate any additional tax liability, but expects that it will have liability for interest and potential penalties. Current estimates of total tax liability, interest and potential penalties is not more than approximately $400,000. The Company believes that it has sufficient reserves to cover any interest and potential penalties that may result from the amended returns. The Company currently is in the process of amending the returns and intends to seek a waiver from the Internal Revenue Service for certain penalties; however, no assurance can be given that such waiver will be granted.

 

In September 2002, the Company raised $51.2 million in an offering of the Company"s equity to provide additional liquidity. The Company filed a registration statement on Form S-3 to register 3.25 million shares of the Company"s common stock in connection with such placement, in addition to 1.2 million shares previously registered. The Company engaged JP Morgan Securities Inc. to act as the advisor to the Company in the equity financing, for which JP Morgan Securities received a fee of approximately $2.4 million. JP Morgan Securities Inc. is affiliated with J.P. Morgan Partners (SBIC), LLC, which holds approximately 7.9% of our outstanding common stock.

 

We maintain an interest rate risk management strategy, required by our amended credit facility terms, that uses derivative instruments to minimize significant, unanticipated earnings fluctuations that may arise from volatility in interest rates. The Company"s specific goals are to (1) manage interest rate sensitivity by modifying the repricing or maturity characteristics of some of its debt and (2) lower (where possible) the cost of its borrowed funds. In accordance with the Company"s interest rate risk management strategy, and in accordance with the requirements of our credit facility, the Company has entered into a swap agreement to hedge the interest rate on $35.0 million of its borrowings. The swap agreement locks in a one-month LIBOR rate of 6.6% and expires on August 1, 2003.

 

Capital Expenditures. We spent approximately $6.9 million during the first nine months of fiscal 2002 for new store construction, development, remodels and other capital expenditures, exclusive of acquisitions. Capital expenditures during the first nine months of fiscal 2002 were less than previously estimated due to abandonment of one new store site and the deferral of three new store openings until the first quarter of fiscal 2003, in part due to landlord delays in completion of construction. The aggregate amount to construct all five originally scheduled stores was originally estimated at $15.0 million to $20.0 million, but we terminated one store"s lease obligations and opened one store in April 2002. Our average capital expenditures to open a leased store, including leasehold improvements, equipment and fixtures, have ranged from approximately $2.0 million to $5.0 million historically, excluding inventory costs and initial operating losses. We anticipate that the average capital expenditures to open a natural foods supermarket format store will be $3.0 million to $4.0 million in the future, partly because of our decision to reduce the size or simplify the format of our food service department in new stores, as well as our decision not to increase store size in the majority of geographic areas. Our average capital expenditures to open a farmers market format store are estimated at $2.0 million to $2.5 million in the future. Delays in opening new stores may result in increased capital expenditures and increased pre-opening costs for the site, as well as lower than planned sales for the Company. Under our amended credit facility, we are limited in our new store capital expenditures to a cumulative $3.2 million from the fourth quarter of fiscal 2001 through the third quarter of fiscal 2002; however, proceeds from the equity offering completed in September 2002 may be used to increase our total allowable level of capital expenditures by the net cash proceeds of $48.3 million. We plan to use the equity proceeds to complete the construction of three stores to be opened during the first quarter of fiscal 2003 and execute leases for and commence capital expenditures for up to 15 new stores through fiscal 2003. Although there can be no assurance that actual capital expenditures will not exceed anticipated levels, we believe that cash generated from operations and the recent equity offering, and available under our existing credit facility will be sufficient to satisfy our budgeted capital expenditure requirements through the remainder of fiscal 2002.

 

The cost of initial inventory for a new store is approximately $300,000 to $800,000 depending on the store format; however, we obtain vendor financing for most of this cost. Pre-opening costs are expensed as incurred. Pre-opening costs for natural foods supermarket format stores in the future are projected at $400,000 to $500,000 per store, depending on the store"s location, and pre-opening costs for farmers market format stores are projected at $200,000 to $300,000, as a result of increased grand opening advertising and staff training for new stores. 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 us, 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, although our amended credit facility contains aggregate limits on the amounts of capital expenditures we may make. We believe that cash generated from operations and the recent equity offering and available under our existing credit facility will be sufficient to satisfy our budgeted cash requirements through fiscal 2002.

 

Contact:

Whole Foods Market, Inc.

601 N. Lamar Suite 300

Austin, Texas 78703

Corporate office phone: (512) 477-4455

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