Event Details

1st Quarter Earnings Script

February 8, 2017 04:01 PM CST

Cindy:

Good afternoon and thank you for joining us.  On today’s call are John Mackey, Chief Executive Officer; A.C. Gallo, President; Glenda Flanagan, Executive Vice President and Chief Financial Officer; Jim Sud, Executive Vice President of Growth & Development; David Lannon and Ken Meyer, Executive Vice Presidents of Operations, and Jason Buechel, Executive Vice President and Chief Information Officer.

As a reminder, all forward-looking statements on this call are subject to risks and uncertainties that could cause actual results to differ materially from the expectations and assumptions discussed today. This may be due to a variety of factors, including the risks outlined in our company’s most recently filed Form 10-K.  For easier comparisons, we will discuss our results excluding the charges we announced today.  In addition, our remarks include references to non-GAAP measures. For a reconciliation of our non-GAAP measures to the GAAP figures, please see the tables in our earnings release. Please note our press release and scripted remarks are available on our website.  I will now turn the call over to John Mackey. 

John:  Thank you, Cindy.  Good afternoon everyone. 

As we have announced today, we are setting a new strategic direction for Whole Foods Market in order to deliver improved performance and higher returns over the long term.  While our nine-point plan is still very much intact, we are resetting and refining our growth strategy and moving faster in fully implementing category management, which is such an integral part of our go-forward merchandising, pricing, marketing and affinity strategies. 

Over the past 38 years, Whole Foods Market has played a leadership role in fresh, healthy, natural and organic foods becoming mainstream.  Now that they have, we must revisit the question of how to best serve all of our stakeholders.  What has become clear is that we don’t want to compete in a race to the bottom, as consumers have ever-increasing choices for how and where they shop.

Through our affinity work, we know that our core customers represent our largest customer segment and account for a majority of our sales.  They are dedicated to the high quality, fresh, healthy foods and transparency we offer.  While they are already highly engaged with our brand, there is still significant opportunity for growth and, if these customers add just one more item per trip, the sales potential is significantly greater than with any other segment.  Going forward, Whole Foods Market will focus on serving this growing niche of customers better than ever before.  This is a win win as delighting our most committed and informed customers – our “Whole Foodies” – results in a better experience for all our shoppers.  

We see tremendous opportunities in applying this new, targeted approach to all aspects of our business from marketing to merchandising to real estate.  Examples of some steps we are already taking include our recently launched “Eat Real Food” brand campaign, the acceleration of our category management initiative, and the resetting of our growth strategy.  

We kicked off the new year with our “Eat Real Food” brand campaign, which targets our core customers with its “eating well and living well” theme.  While the campaign has been on air for just a short time, we are pleased with early indicators that show positive trends on ad recall and purchase intent, and we look forward to establishing an on-going customer dialogue through our new always-on paid media plan. 

Today we announced plans to accelerate our timeline for fully implementing category management and have partnered with dunnhumby to help lead our efforts.  Evolving our purchasing operating model while developing data-rich, customer-centric category management capabilities are critical steps - steps that are integral to our go-forward merchandising, pricing, marketing and affinity strategies, particularly with regard to supplier support.  dunnhumby has a proven track record of using data-driven, customer-led insights to create relevant shopping experiences for customers on a market-to-market basis, and this strategic partnership will help us go faster, do more and do it better.  We do not have specifics to share on timing today, but we do expect our shorter pilot phase and rollout timeline to meaningfully accelerate the sales and margin benefits.

We will continue to grow but no longer have a goal of 1200+ stores.  We remain optimistic about the future growth potential for our 365 format but want to see how this next round of stores perform before getting more aggressive.  As we work to position Whole Foods Market for long-term success, we have carefully evaluated our portfolio of stores and have made the difficult but prudent decision to close nine stores in the second quarter.  We believe our more targeted and disciplined site selection and continued moderation in ending square footage growth will result in a healthier bottom line, increased free cash flow and higher returns as we minimize the negative impact from cannibalization and redirect our energy and capital on improving comps, EBITDA, and ROIC. 

I will now turn to our quarterly results.  For the quarter, sales increased 2% to a record $5 billion.  In what continues to be a challenging sales environment, we maintained our expense disciplines, delivering 7.6% EBITDA margin, $0.39 in earnings per share, and $284 million in operating cash flow.  In keeping with our capital allocation strategy, we invested $245 million in capital expenditures and returned $43 million to our shareholders through dividends and share repurchases, ending the quarter with $1.1 billion of total debt and $1.2 billion in total available capital. 

We have seen stability in our comps over the last three quarters, with some modest traffic improvement from Q4 to Q1.  During the quarter, we saw wide swings in comps on a weekly basis, as is frequently the case in Q1 due to weather and holiday shifts.  After a strong start for the first five weeks, comps dropped off sharply in the pre- and post-election weeks, and then showed nice lifts over Thanksgiving and Christmas weeks.  We want to appreciate our Team Members across the company for all of their hard work in making our stores a preferred shopping destination for those important holiday meals.  Many stores broke weekly sales records, and more than 100 stores surpassed the $1 million mark during each of those holiday weeks!   

We welcomed 13 new stores in the quarter, including two relocations in Philadelphia and Winter Park, Florida.  In Philadelphia, we relocated a 20-year old, 37,000 square foot store to a new 63,000 square foot location with a Food Hall that can seat 140 customers.  In addition, customers can enjoy lunch or an evening out in four fast casual dining venues run by favorite local chefs, the Parkway Pub or the Parkway Perch upstairs, which offers a spectacular view of the Philly skyline.  And, in Winter Park, after being a part of the community for 18 years, we were excited to provide our customers with a new store that is nearly twice the size, has more parking and includes exciting new culinary offerings such as self-serve Japanese mochi ice-cream bites and sushi burritos.  In markets where our brand is well established, relocating older, smaller stores to larger locations offering more parking and an elevated shopping experience offers low risk and high returns.  We expect three more relocations this year, with another 12 in our pipeline, and will continue to seek additional opportunities.  

Over the last two years, we have moderated our lease signings, ending square footage growth, and capital expenditures as a percent of sales.  We have terminated four leases in development to date and are continually evaluating our pipeline.  We are also continually evaluating stores on a case-by-case basis, balancing the age, size and performance trends of the store with the potential returns from additional capital investments, monitoring lease renewals, and taking into account how each store fits into our longer-term strategy for that particular market.  As a result of our evaluation, today we announced plans to close nine stores in Q2.  In keeping with our ongoing efforts to increase efficiencies and better leverage our size and scale, we are also closing our last three remaining commissary kitchens.  These closures were all prudent but difficult decisions, and we are working closely with all affected team members to find other positions within our Company. 

Turning now to our thoughts on the remainder of the fiscal year, we have updated our outlook primarily to reflect year-to-date sales and comp trends, lost sales related to store closures, and $14 million of estimated costs related to accelerating category management.  We now expect sales growth of 1.5% or greater and EPS of $1.33 or greater for the fiscal year.  Please see our press release for more detailed information. 

We are pleased comps have shown stability over the last three quarters and are hopeful they will improve as our always-on brand messaging and other sales-building initiatives gain traction and comparisons get easier.  Our two-year comps have continued to moderate, however, and while it has only been three weeks, we have seen further moderation in the second quarter to date.  Given the competitive landscape continues to be very dynamic, and it is uncertain how long the deflationary environment will continue, we believe it is appropriate to reset comp expectations at this time.  Please note Easter was in the second quarter last year and will fall in the third quarter this year, negatively impacting comps in Q2 and positively impacting comps in Q3.  Historically, the impact has been approximately 50 basis points.  

We covered a lot of ground today but before we turn it over for questions, I want to say I have never felt more energized and inspired to lead Whole Foods Market and strongly believe that refocusing our efforts on how to best serve our core customers, while pursuing a more targeted and disciplined growth strategy, will result in improved comps, a healthier bottom line, increased free cash flow and higher returns.