SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR SECTION 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 28, 2002

OR

(  ) TRANSITION REPORT PURSUANT TO SECTION 13 OR SECTION 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 0-21577

WILD OATS MARKETS, INC.
(Exact name of registrant as specified in its charter)

(303) 440-5220
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Title of Each Class

Common Stock, $.001 par value

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       (   )

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K: (   )

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2):

  Yes       ( X )       No       (   )

As of June 28, 2002, the aggregate market value of the voting common stock held by non-affiliates (as defined by the regulations of the Securities and Exchange Commission) of the Registrant was $16.10, based upon the closing sale price of such stock on such date as reported on the NASDAQ National Market.

As of March 3, 2003, the total number of shares outstanding of the Registrant’s common stock, $.001 par value, was 29,705,475 shares.

Portions of the definitive Proxy Statement for the Registrant’s Annual Meeting of Stockholders to be held on May 5, 2003, have been incorporated by reference into Part III of this report.

PART I.

Introduction

Wild Oats Markets, Inc. ("Wild Oats") is one of the largest natural foods supermarket chains in North America. As of March 3, 2003, we operated 102 natural foods stores in 25 states and British Columbia, Canada under several names, including:

• Wild Oats Natural Marketplace (nationwide)
• Henry’s Marketplace (San Diego and Orange County, CA)
• Nature’s - A Wild Oats Market (metropolitan Portland, OR)
• Sun Harvest Farms (Texas)
• Capers Community Market (British Columbia, Canada)

We are dedicated to providing a broad selection of high-quality natural, organic and gourmet foods, environmentally friendly household products and complete line of natural vitamins, supplements, herbal and homeopathic remedies and body care products at competitive prices, in an inviting and educational store environment that emphasizes customer service. Our stores feature natural alternatives for virtually every product category found in conventional supermarkets. Wild Oats provides its customers with a one-stop, full-service shopping alternative to both conventional supermarkets and traditional health food stores, with a differentiated concept that appeals to a broader, more mainstream customer base than the traditional natural foods store. Our comprehensive selection of natural and organic products appeals to health-conscious shoppers while we also offer virtually every product category found in a conventional supermarket, including grocery, produce, meat, poultry, seafood, dairy, frozen, food service, bakery, vitamins and supplements, health and body care and household items. Our unique positioning, coupled with industry data that states that the natural products industry comprises less than 5% of the total grocery industry, offers significant potential for us to continue to expand our customer base.

Wild Oats’ sales grew from $893.2 million during fiscal 2001 to $919.1 million in 2002, an increase of 2.9%, even though we closed nine underperforming stores in 2002. Our improvements in sales, despite a significant decrease in overall store count, resulted largely from improvements in marketing, including the completion of the rollout of our national flyer program, in merchandising and operations improvements in our stores, as well as the opening of our first prototype Wild Oats Natural Marketplace store in Long Beach, California.

We added 1, 4, 13, 25 and 16 new and acquired stores to our store base in fiscal years 2002, 2001, 2000, 1999 and 1998, respectively. We also added 24 stores to our store base in 1999 through the completion of two pooling-of-interest transactions. As a result of our aggressive growth over the last five years, we have increased our penetration of existing markets, entered new geographic markets and created a stronger platform for future growth. We believe our growth has resulted in operating efficiencies created by:

• warehousing, distribution and administrative economies of scale
• improved volume purchasing discounts
• coordinated merchandising and marketing strategies

At the end of fiscal 2002, we had 99 stores located in 23 states and Canada, as compared to 107 stores in 23 states and Canada as of the end of fiscal 2001. A summary of store openings, acquisitions, closures and sales is as follows:

As part of the strategic repositioning announced by the Company in the second and fourth quarters of fiscal 2000, the Company identified 22 natural foods stores for closure or sale due to weak performance. In fiscal 2000, we closed ten and sold three of those identified stores. In the second quarter of fiscal 2001, as part of additional evaluation of the Company’s operations by new management, we identified an additional three stores for closure in fiscal 2001; in the fourth quarter of fiscal 2001, we extended our evaluation and identified an additional three stores for closure in fiscal 2001 and fiscal 2002. In fiscal 2002, we identified an additional six stores for closure or sale, including two small vitamin stores. In fiscal 2002, the Company closed five of the identified stores, terminated its lease-related obligations as to one of the closed locations and sold four of the identified stores, including one small vitamin store. Two of the stores were sold in related transactions. Due to a change in estimates related to changes in facts and circumstances during the fourth quarter of fiscal 2001, we decided to continue to operate four stores previously identified for closure or sale. As of March 1, 2003, 20 of the 22 stores identified in fiscal 2000 for closure or sale have been closed or sold and the remaining two stores have been removed from our closure or sale list due to changes in facts and circumstances. Of those stores identified in fiscal 2001, four have been closed or abandoned and the remaining two stores have been removed from our closure or sale list due to changes in facts and circumstances. Of those stores identified in fiscal 2002, three have been sold or closed, and three remain to be closed or sold. A summary of restructuring activity by store count is as follows:

Total store count, as well as the number of stores identified for closure or sale and stores closed or sold, include two small vitamin stores previously operated by us in El Paso, Texas.

Natural products industry

Retail sales of natural products have grown from $7.6 billion in 1994 to $16.24 billion in fiscal 2001, an 11.45% compound annual growth rate, and total sales of natural products (including over the internet, by practitioners, by multi-level marketers and through mail order) reached $34.0 billion in fiscal 2001 (Natural Foods Merchandiser, June 2002). Sales growth in the traditional grocery industry has remained relatively flat over the same period. We believe that this growth reflects a broadening of the natural products consumer base, which is being propelled by several factors, including healthier eating patterns, increasing concern regarding food purity and safety and greater environmental awareness. While natural products generally have higher costs of production and correspondingly higher retail prices, we believe that more of the population now attributes added value to high-quality natural products and is willing to pay a premium for such products, although overall industry growth may slow slightly due to the softening economy. The increase in the availability of natural products in conventional supermarkets, whose sales of natural products increased by 5.5% in fiscal 2001, demonstrates the increase in consumer acceptance of natural products. Despite the increase in natural foods sales within conventional supermarkets, we believe that conventional supermarkets still lack the total shopping experience that natural foods stores offer. Many natural foods stores develop a more personal relationship with increased interaction between store staff and customers than that of conventional supermarkets. Conventional supermarkets may also have less appeal for natural foods shoppers because they are largely dependent on commercial brand names, resulting in a more limited selection of natural products from which to choose. In addition, conventional supermarkets may not be able to match our pricing in many categories because of the greater volume purchase discounts we receive on natural products. As a result, while conventional supermarkets may carry a limited selection of natural foods products, they do not duplicate the inventory of our natural foods stores, which carry a more comprehensive selection of natural products sourced from a large number of independent vendors.

Operating strategy

Our objective is to become the grocery store of choice both for natural foods shoppers and quality-conscious consumers in each of our markets by emphasizing the following key elements of our operating strategy:

Destination format. Our stores are one-stop, full-service supermarkets for customers seeking high-quality natural and gourmet foods and related products. In most of our stores, we offer between 12,000 and 35,000 stock-keeping units of natural foods products in virtually every product category found in a conventional supermarket. Our stores carry a much broader selection of natural and gourmet foods and related products than those offered by typical independent natural foods stores or conventional supermarkets.

High-quality, unique products. We seek to offer the highest quality products throughout our merchandise categories and emphasize unique products and brands not typically found in conventional supermarkets. Each of our stores tailors its product mix to meet the preference of its local market, and where cost of goods and distribution logistics allow, sourcing produce from local organic growers. We also operate regional commissary kitchens and bakeries that provide our stores with fresh bakery items and a unique assortment of prepared foods for the quality- and health-conscious consumer.

Educational and entertaining store environment. Each store strives to create a fun, friendly and educational environment that makes grocery shopping enjoyable, encouraging shoppers to spend more time in the store and to purchase new products. In order to enhance our customers’ understanding of natural foods and how to prepare them, we train our store staff to educate customers as to the benefits and quality of our products and prominently feature educational brochures, newsletters and in-store demonstrations, as well as an in-store consumer information department. In 2003 we will be implementing a new "active sampling" program to emphasize certain perishable products in our stores and to encourage customers to try new products. In addition, many stores offer cafe seating areas, espresso and fresh juice bars and in-store massage therapists, all of which emphasize the comfortable, relaxed nature of the shopping experience. We believe our knowledgeable store staff and high ratio of store staff to customers results in significantly higher levels of customer service than in a conventional supermarket.

Extensive community involvement. We seek to engender customer loyalty by demonstrating our high degree of commitment to the local communities in which we operate. Each store makes significant monetary and in-kind contributions to local not-for-profit organizations through programs such as "5% Days," where a store may, once each calendar quarter, donate 5% of its net sales from one day to a local not-for-profit group, and a "Charity Work Benefit" where we pay employees for time spent working for local charities. In 2002, we added a new charitable option for customers called eScrip(R), which administers a wholly electronic charitable giving program. Under the eScrip program, Wild Oats will donate a sliding percentage of the customer’s purchases to a customer’s selected charity when the customer uses a credit card registered with eScrip to purchase at Wild Oats.

Multiple store formats. We operate two store formats: natural foods supermarkets, which emphasize natural and organic products and high-quality service; and farmers market stores, which emphasize fresh produce, natural living products and price value. Our two store formats enable us to customize our stores to specific site characteristics and to meet the unique needs of a variety of markets. We believe that this multiple store format strategy allows us to operate successfully in a diverse set of markets, enabling us to reach a broader customer base and to increase our market penetration.

Competitive pricing. We seek to offer products at prices that are competitive with those of other natural foods stores and conventional markets. In fiscal 2001 and throughout fiscal 2002, we introduced a new merchandising and marketing program in our natural foods supermarket format stores, and as part of such program reduced everyday prices on up to 2,500 items per store and implemented a weekly flyer program, with an expanded selection of sale items and emphasis on our perishable departments (meat/seafood, produce, prepared foods and dairy). We believe these pricing programs broaden our consumer appeal and encourage our customers to fill more of their shopping needs at our stores.

Motivated staff. We have developed a unique culture by encouraging active participation and communication among all staff members, advocating store-level participation in a variety of marketing, merchandising and operating decisions and rewarding staff based upon the achievement of targeted store-level sales, profitability and other financial performance criteria. In addition, we seek to hire individuals dedicated to the concept of natural foods and a healthy lifestyle. We believe that these practices translate into a satisfied and motivated staff and a high level of customer service.

Growth strategy

Our growth strategy is to increase total year-over-year comparable store sales growth, sales and income through:

• improved guest service and store execution
• opening of new stores
• increased consumer awareness of Wild Oats

We intend to continue our expansion strategy by increasing penetration in existing markets and expanding into new regions that we believe are currently underserved by natural foods retailers. While we believe that most of our store expansion will result from new store openings, we may continue to evaluate acquisition opportunities in both existing and new markets.

We currently have leases and letters of intent signed for 18 new stores to be opened or relocated in the remainder of fiscal 2003 or fiscal 2004. The proposed sites are in metropolitan Los Angeles (six) and Palm Springs, California; Denver and Colorado Springs, Colorado; Indianapolis, Indiana; Lexington, Kentucky; Omaha, Nebraska; Cincinnati, Ohio; metropolitan Nashville, Tennessee; and metropolitan Salt Lake City, Utah (three).

Changes in store base. In fiscal 2002, we opened one new store in Long Beach, California. We closed three underperforming natural foods stores in Boca Raton, Florida; Chesterfield, Missouri; and Cleveland, Ohio; we closed one store in Serra Mesa, California when the lease expired, and we negotiated the early termination of the lease for one small vitamin store in El Paso, Texas. We sold four stores: two in Berkeley and Sunnyvale, California to the purchaser of two other northern California stores in 2001; one in Victoria, British Columbia, Canada; and one small vitamin store in El Paso, Texas. In fiscal 2001, we opened four new stores, closed one underperforming natural foods stores and sold two stores in related transactions.

In fiscal 2001, we stopped construction on several stores then in design, in order to incorporate consumer research and feedback into a prototype design for our natural foods supermarket format stores. The new prototype, unveiled in our new store in Long Beach, California in April of 2002, features an expanded produce department; a relocated natural living department with lower shelving, softer flooring and reading areas to encourage customers to take advantage of the health and nutrition literature available; liquid and dry bulk goods in the same merchandising area; an expanded deli area redesigned to focus the staffs’ attention on the customer, even when working on food preparation; and a warm and inviting new decor.

Year-over-year comparable store sales growth. Comparable store sales (sales of a store we deemed comparable commencing in the 13^th full month of operations) increased 5.2% in fiscal 2002, as compared to a 4.0% increase for fiscal 2001, primarily due to operational improvements and the completion of the implementation of our comprehensive marketing program for our natural foods supermarket format stores. We also have remerchandised a significant number of our natural foods supermarket format stores to emphasize perishables and reset certain product categories according to item movement. We made a commitment in fiscal 2001 to improve customer service through aggressive training programs for new and existing employees, rolled out several new programs in fiscal 2002, and will continue and expand this commitment in fiscal 2003 and beyond.

In fiscal 2003, we will continue to refine our merchandising and marketing programs to reach a broader group of potential customers, to strengthen our awareness amongst our communities as a place to shop for natural, organic and gourmet/specialty foods, to build charitable giving programs that are meaningful to our communities and to bring excitement and entertainment into our stores. These programs will include an expansion of our "grass roots" marketing programs, targeting direct mail, active sampling programs and other initiatives currently being prepared for implementation.

Products

We offer our customers a broad selection of unique, high-quality products that are natural alternatives to those found in conventional supermarkets. We generally do not offer well-known national conventional brands and focus instead on a comprehensive selection of natural branded products within each category. Although the core merchandise assortment is similar at each of our stores, individual stores adapt the product mix to reflect local and regional preferences. Our stores source produce from local organic growers whenever possible and typically offer a variety of local products unique to the region. In addition, in certain markets, our stores may offer more food service, gourmet and ethnic items, as well as feature more value-added services such as gift baskets, catering and home delivery, while in other markets, a store may focus more on bulk foods, produce and staple grocery items. We regularly introduce new high-quality and locally-grown products in our merchandise selection to minimize overlap with products carried by conventional supermarkets. In fiscal 2003, we plan to add up to 1,500 new stock-keeping units, or "SKUs," of natural, organic and gourmet products in each of our stores.

In fiscal 2002, we completed an SKU rationalization program pursuant to which we phased out a large number of SKUs of slower-moving products from our stores to make room for new items and faster moving products. We attribute a certain amount of the decrease in customer traffic experienced in the fourth quarter of fiscal 2002 to the disruptions caused by out-of-stocks of products created by the SKU rationalization program as well as disruptions resulting from the Company’s switch to Tree of Life, Inc. as its new primary distributor.

We intend to continue to expand and enhance our prepared foods, value-added items (such as marinated or stuffed meats and seafood) and in-store cafe environment. We believe that consumers are increasingly seeking convenient, healthy, "ready-to-eat" meals and that by increasing our commitment to this category we can provide an added service to our customers, broaden our customer base and further differentiate us from conventional supermarkets and traditional natural foods stores.

Quality standards. Our objective is to offer products that meet the following standards:

• free of preservatives, artificial colors, chemical additives and added hormones
• organically grown, whenever possible
• minimally processed
• not tested on animals

We continually evaluate new products, quality issues and controversial ingredients. Before new product can be placed on our approved product list for purchase by the stores, our standards committee reviews each new product for compliance with the following, amongst other criteria:

• rBGH (recombinant bovine growth hormone) free
• GMO ("genetically modified organism") free
• cruelty-free

Private label. The natural foods industry is highly fragmented and characterized by many small independent vendors. As a result, we believe that our customers do not have strong loyalty to particular brands of natural foods products. In contrast to conventional supermarkets whose private label products are intended to be low-cost alternatives to name-brand products, we developed our "Wild Oats(R)" private label program in order to build brand loyalty to specific products based on our relationship with our customers and our reputation as a natural foods authority. Through this program, we have successfully introduced a number of high-quality, unique private label products, such as cereals, breads, salad dressings, vitamins, chips, salsa, pretzels, cookies, juices, pasta, pasta sauces, oils, frozen products such as pizza and veggie burgers, and pet foods. In fiscal 2000, we introduced a new line of "Wild Oats(R)" imported and organic goods. In fiscal 2001, we expanded this private label line with the introduction of baking mixes, imported peppers, capers, pickles and cherries, canned tomatoes, preserves, tuna, cookies and teas. In fiscal 2003, we intend to roll out a new private label strategy that will include a new brand name and look for our private label products. We intend to continue to eliminate slow-moving private label product and to expand our private label product offerings on a selected basis.

Pricing. In general, natural and gourmet foods and related products have higher costs of production and correspondingly higher retail prices than conventional grocery items. Our pricing strategy has been to maintain prices that are at or below those of our natural foods competitors while educating our customers about the higher quality and added value of our products to differentiate them from conventional products. As part of the merchandising and marketing programs introduced in fiscal 2001, we reduced prices on a large number of products throughout participating stores. After analysis of results from those stores implementing our merchandising and marketing program in fiscal 2001, and additional customer research, we determined that some pricing reductions on certain items were overly aggressive, resulting in greater margin erosion without corresponding customer recognition and item movement, and we implemented a modest price increase on selected products. Like most conventional supermarkets, we regularly feature dozens of sale items, and we implemented a weekly flyer program featuring a broad selection of sale items from all departments. Our flyers feature strong sale pricing on selected perishable products, as well as advertised sales on a broad selection of grocery, frozen foods, vitamins, supplements and body care products. In-store unadvertised "Wild Buys" add variety and encourage frequent shopping trips by our customers. Sale items are promoted through a variety of media, including direct mail, newspapers and in-store flyers. We regularly monitor the prices at natural foods and conventional supermarket competitors to ensure our prices remain competitive.

Company culture and store operations

Company culture. Our culture is embodied in our mission statement:

"Wild Oats was founded on the vision of enhancing the lives of our customers and
our people with products and education that support health and well-being.

Wild Oats is committed to providing the highest quality, fresh and natural food,
and health and wellness products in vibrant stores with people who are
friendly, eager and ready to educate.

At Wild Oats, we sell food that remembers its roots." (TM)

Our values of service, integrity, quality, giving back to our communities, increasing value for our stakeholders (which include our stockholders, our employees and our communities) and accountability were adopted to support our mission statement. As part of our values, we believe that knowledgeable, satisfied and motivated staff members have a positive impact on store performance and overall profitability. In fiscal 2001, we implemented aggressive new training programs, with an emphasis on customer service, for all new employees. In fiscal 2002, we implemented product knowledge training programs for certain departments to ensure that staff receive consistent training on issues affecting the products they sell. We will continue to focus on customer service in the coming years, with training for existing staff as well as new employees.

Management and employees. Our stores are organized into geographic regions, each of which has a regional director who is responsible for the store operations within his or her region and who reports to our senior management. The regional directors are responsible for, and frequently visit, their cluster of stores to monitor financial performance and ensure adherence to our operating standards. We maintain a staff of corporate level department specialists including natural living, food service, produce and floral, meat/poultry/seafood and grocery merchandising directors who manage centralized buying programs and formulate store-level merchandising, pricing and staff training to ensure company-wide adherence to product standards and store concept.

Staff members at the store and regional levels participate in incentive plans that tie compensation awards to the achievement of specified store-level or region-wide sales, profitability and other performance criteria. We also seek to foster enthusiasm and dedication in our staff members through comprehensive benefits packages, including health and disability insurance, an employee stock purchase plan and an employer-matching 401(k) plan.

Purchasing and distribution

We have centralized merchandising departments for each major product category. These departments set product standards, approve products and negotiate volume purchase discount arrangements with distributors and vendors. The wholesale segment of the natural foods industry provides a large and growing array of product choices across the full range of grocery product categories. On June 14, 2002, we entered into a new primary distribution agreement with Tree of Life, Inc. ("Tree of Life") as distributor. The distribution arrangement commenced effective September 1, 2002, the date upon which our existing primary distribution contract with United Natural Foods, Inc. expired. The new agreement has no specified term, although either party can terminate the agreement after three years upon 120 days’ prior written notice to the other party. Either party also may terminate the agreement for defaults by the other party of certain provisions of the agreement. Under the terms of the new agreement, we are obligated to purchase 90% of our total cost of goods from specified categories of goods for sale in our U.S. stores from Tree of Life, except in certain defined circumstances when such percentage-purchasing obligation is excused. We believe Tree of Life has sufficient warehouse capacity and distribution technology to service our existing stores’ distribution needs for natural foods and products as well as the needs of new stores in the future. We received, as part of the new agreement, a 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 support fee received was used in each of the second, third and fourth quarters to defray transition expenses incurred. As part of the agreement with Tree of Life, we prepared an approved product list from which our stores may order. We also took this opportunity to eliminate from our approved products list certain slow-moving products and products that do not meet our quality and product standards.

In fiscal 1999, we entered into a supply agreement with Nutricia (formerly GNP), under which Nutricia manufactured for us certain private label vitamins and supplements. We terminated the agreement in fiscal 2002 and negotiated a buyout of all remaining inventory. We have no supply contracts with the majority of our smaller vendors, who could discontinue selling to us at any time. Although we believe that we could develop alternative sources of supply, any such termination may create a short-term disruption in store-level merchandise selection.

Most products are delivered directly to our stores by vendors and distributors. We currently operate three warehouse facilities in Los Angeles and San Diego, California and San Antonio, Texas, which receive and distribute purchases of produce and grocery items that cannot currently be delivered cost effectively directly to the stores by outside vendors. We maintain a small fleet of local delivery vans. As we enter new markets, we will evaluate the need for additional warehouse and distribution facilities.

We operate commissary kitchens in Phoenix, Arizona; Denver, Colorado; Portland, Oregon and Vancouver, British Columbia, Canada, as well as a bakery in San Diego, California. These facilities produce deli food, take-out food, bakery products and certain private label items for sale in our stores. Each kitchen can make deliveries to stores within a hundred-mile radius of the facility. We will evaluate the need for new commissary kitchens as we expand into new markets.

Marketing

We recognize the importance of building brand awareness within our trade areas and advertise in traditional media outlets such as radio, newspapers, outdoor and direct mail to gain new customer trial and repeat business. As part of our marketing strategy, we have increased our use of direct mail and newspaper inserts to increase our market exposure to a broader base of customers. Our farmers market format stores primarily use flyers and "weekly specials" advertising to generate consumer interest and increase customer traffic. In fiscal 2001, we introduced eight-page weekly flyers for a select group of our natural foods supermarket format stores, with a significant number of weekly specials and an expanded flyer distribution. In fiscal 2002, this program was introduced in the majority of our natural foods supermarket format stores. We are formulating additional marketing strategies for fiscal 2003, and may modify the flyer program as other marketing strategies are implemented.

We also focus on in-store consumer education through the use of a variety of media, including in-store flyers, informational brochures and signage that promote the depth of our merchandise selection, benefits of natural products and competitive prices. When we first enter a new market, we execute an intense marketing and public relations campaign to build awareness of our new store and its selection of natural products. After the initial campaign, this advertising is supplemented by the marketing strategies described above. Our public relations department promotes the Company and its achievements, manages a consistent flow of internal and external communications and assists in educating consumers about our position on issues of importance, such as genetically modified foods and the use of antibiotics in livestock production. This group also plans and implements media coverage and community events as part of our grand opening celebrations at our new stores.

Our advertising costs prior to the implementation of the expanded marketing program historically were 1.5% of sales. Advertising costs for stores on the expanded marketing program on average have increased to 2.0% of sales. We offset a certain amount of such costs through a promotional program with our vendors, which allows for different degrees of promotional participation in our weekly flyers.

Management information systems

Our management information systems have been designed to provide detailed store-level financial data, including sales, gross margin, payroll and store contribution, to regional directors and store directors and to our headquarters on a timely basis. We determined that our ability to control costs would be increased by capital improvements in technology and software. In fiscal 2002, we implemented a number of information management initiatives intended to make us more competitive in the marketplace, including the following:

• centralized pricing for the majority of our items in all of our natural foods supermarket format stores and item movement tracking in all of our stores (exclusive of our Canadian stores). The farmers market format stores host their own pricing structure, although we currently are examining hosting all pricing for all stores centrally;
• a data warehouse that allows us to perform rapid analyses of disparate data relating to financial performance, item movement, comparable store sales results, customer traffic and other data generated by our operations;
• a promotion management system that links our item information database to our marketing and merchandising systems to facilitate the approval and creation of marketing and merchandising flyers. This enables us to create our flyers more quickly by minimizing printing modifications from flyer to flyer, and increases the accuracy of graphic and text descriptions of items. This program allows us to map and manage shelf space from store to store to ensure consistency of item placement and track item movement to allow us to determine appropriate shelf inventory of various SKUs of product;
• in-store signage and shelf tag printing controlled by our home office departments;
• scale hosting to standardize pricing by weight, product descriptions, cooking instructions and other printed material on weighed items; and
• a front end auditing program that tracks cashier activity and identify anomalies in cash handling, enables us to identify cashier training issues and improper cash handling procedures.

In fiscal 2003, we commenced implementation of a back door replenishment program, a structured and integrated technology-based process for product ordering, vendor electronic data interchange, vendor replenishment and store back door receiving and accounting. The back door replenishment program will improve verification of the accuracy of deliveries and increase the efficiency of our warehouse and in-store receiving departments. We expect to receive the benefits of complete implementation of this program in the natural foods supermarket format stores in the third quarter of fiscal 2004. In fiscal 2003, we intend to commence implementation of an improved labor scheduling program that should increase the accuracy of our labor needs forecast.

Competition

Our competitors currently include other independent and multi-unit natural foods supermarkets, smaller traditional natural foods stores, conventional supermarkets and specialty grocery stores. While certain conventional supermarkets, smaller traditional natural foods stores and small specialty stores do not offer as complete a range of products as we do, they compete with us in one or more product categories. In recent years, several of the larger conventional grocers have added or expanded specialty sections in their stores devoted specifically to natural and organic foods and body care products, and have expanded their offerings of vitamins and supplements. Some feature a "store-within-a-store" concept where the fixtures, lighting and flooring in the natural foods and products section are modified to provide a different, more upscale ambiance, such as that provided in our stores. We believe that these specialty sections do not offer the customer service, product selection and depth of product knowledge that we offer in our stores.

A number of other natural foods supermarkets offer a range of natural foods products similar to those offered in our stores. We believe that the principal competitive factors in the natural foods industry include customer service, quality and variety of selection, store location and convenience, price and store atmosphere. We believe that our primary natural foods competitor is Whole Foods Market, Inc., a company based in Texas, with whom we currently compete directly in California, Colorado, Florida, Illinois, Massachusetts, New Mexico and Texas (a total of 70% of our current markets). We believe our natural foods supermarket concept is differentiated from Whole Foods through our higher product standards and more competitive pricing. Our physical stores are smaller in size, and less expensive to build, which gives us access to markets that may not have the diversity believed necessary to support large box stores. We do not believe we have any true competitors for our farmers market format stores.

Employees

As of March 3, 2003, we employed approximately 6,557 full-time individuals and 1,554 part-time individuals. Approximately 7,721 of our employees are engaged at the store-level and 390 are devoted to regional administrative and corporate activities. We believe that we maintain a good relationship with our employees. We anticipate that in the future one or more of our stores may be the subject of attempted organizational campaigns by labor unions representing grocery industry workers, and that from time to time certain of our stores may be picketed by local labor unions relating to area wage and benefit standards. Four of our stores (including two Henry’s stores in metropolitan San Diego, California) are currently being picketed relating to area standards.

In fiscal 2002, we modified certain features of our benefits plans and introduced additional plans to provide our employees with a broad range of competitive benefits. All of our store employees also participate in an incentive program that provides periodic payments based on achieving certain store-level performance targets and operations standards.

Available Information

Our internet website is http://www.wildoats.com, where we make available, free of charge on our website, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports as soon as reasonably practicable after we electronically file or furnish such materials to the SEC. These reports are also maintained by the SEC on their website at http://www.SEC.gov. Additionally, the public may read and copy any materials the Company files with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. Information on the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330.

PROPERTIES

We currently lease approximately 54,000 square feet for our corporate headquarters in Boulder, Colorado. The lease has three and one-half years remaining on the term, with one three-year renewal option.

We lease all of our currently operating stores. We currently have letters of intent or leases signed for 18 sites projected to be opened in the remainder of fiscal 2003 and fiscal 2004, including seven farmers market format store sites in southern California, and eleven natural foods supermarket format store sites in Colorado, Indiana, Kentucky, Nebraska, Ohio, Tennessee and Utah. Our leases typically provide for a 10- to 15-year base term and generally have several renewal periods. The rental payments are generally fixed base rates, although many of our older leases called for payment of minimum base rent with additional rent calculated on a percentage of sales over a certain break point. All of the leases are accounted for as operating leases. The majority of leases signed in fiscal 2002, fiscal 2003 and beyond is or will be negotiated on a turnkey basis, which substantially reduces our capital expenditures, with modest increases in long-term rent.

Store locations

The following map and store list show, as of March 3, 2003, the natural foods grocery stores that Wild Oats operates in each state and Canadian province and the cities in which our stores are located:

LEGAL PROCEEDINGS

Wild Oats Markets Canada, Inc., as successor to Alfalfa’s Canada, Inc., a Canadian subsidiary of the Company, is a defendant in Helen Fakhri and Ady Aylon, as Representative Plaintiffs v. Alfalfa’s Canada, Inc., a class action suit brought in the Supreme Court, British Columbia, Canada by representative plaintiffs alleging to represent two classes of plaintiffs - those who contracted Hepatitis A allegedly through the consumption of food purchased at a Capers Community Market in the spring of 2002, and those who were inoculated against Hepatitis A as a result of news alerts by Capers and the Vancouver Health Authority. The Company intends to vigorously defend both class certification and the suit itself. The Company is not able to estimate the potential outcome of the suit at this time.

In April 2000, the Company was named as defendant in S/H -Ahwatukee, LLC and YP- Ahwatukee LLC v. Wild Oats Markets, Inc., Superior Court of Arizona, Maricopa County, by a landlord alleging Wild Oats breached a continuous operations clause arising from the closure of a Phoenix, Arizona store. The landlord dismissed the same suit, filed in 1999, without prejudice in 1999, after the Company presented a possible acceptable subtenant, but subsequently rejected the subtenant. Plaintiff claimed $1.5 million for diminution of value of the shopping center plus accelerated rent, fees and $360,000 in attorneys’ fees and costs. After trial in November 2001, the judge awarded the plaintiff $326,000 in damages and $210,000 in attorneys’ fees. We have appealed the judgment. Execution on the judgment is stayed pending the outcome of the appeal by the Company’s payment to the Superior Court of $625,000 (an amount equal to the amount of the judgment and the parties’ agreed estimate of accrued interest thereon). A hearing on the appeal has been requested and will be scheduled by the Appellate Court.

In October 2000, the Company was named as defendant in 3601 Group Inc. v. Wild Oats Northwest, Inc., Wild Oats, Inc. and Wild Oats Markets, Inc., a suit filed in Superior Court for King County, Washington, by a property owner who claims that Alfalfa’s Inc., our predecessor on interest, breached a lease in 1995 related to certain property in Seattle, Washington. After trial, a jury awarded $0 in damages to the plaintiffs, and the Company was subsequently awarded $190,000 in attorneys’ fees. The plaintiff filed for bankruptcy and the Company is currently pursuing our claim as a secured creditor.

In September 2002, the Company filed suit against Michael Gilliland and Elizabeth Cook, former officers and directors and greater than 5% stockholders of the Company, together with two individuals and three limited liability corporations, for a temporary restraining order and damages related to a breach of Mr. Gilliland’s noncompetition covenant, contained in his 1996 employment agreement, arising from the opening of a competitive grocery store in New Mexico. The lawsuit is captioned Wild Oats Markets, Inc. v. Michael C. Gilliland, Elizabeth C. Cook, Mark R. Clapp; Patrick Gilliland, Westside Farmer’s Market LLC, Westside Liquors LLC and Milagro Cafe LLC. Mr. Gilliland and Ms. Cook have counterclaimed, claiming that Ms. Cook was entitled to severance payments, and that both were undercompensated in the receipt of option grants. After a hearing, the court issued a temporary restraining order against Mr. Gilliland, prohibiting him from engaging in the operation of the competing grocery store. The temporary restraining order was subsequently vacated at the Company’s request and the Company dropped its claims for injunctive relief as it did not believe the injunctive relief granted made any material difference in Mr. Gilliland’s behavior. The Company discontinued severance payments made to Mr. Gilliland based on his material breach of his employment contract. The Company continues to pursue its suit for damages. A date for trial of the remaining claims has not been set.

The Company also is named as defendant in various actions and proceedings arising in the normal course of business. In all of these cases, the Company is denying the allegations and is vigorously defending against them and, in some cases, has filed counterclaims. Although the eventual outcome of the various lawsuits cannot be predicted, it is management’s opinion that these lawsuits will not result in liabilities that would materially affect the Company’s consolidated results of operations, financial position, or cash flows.

None.

The Company’s common stock is traded on the NASDAQ National Market under the symbol "OATS".

The following are the quarterly high and low sales prices for each quarter of the past two years:

As of March 3, 2003, Wild Oats’ common stock was held by 627 stockholders of record. No cash dividends have been declared previously on our common stock, and we do not anticipate declaring a cash dividend in the near future. Our Second Amended and Restated Credit Agreement for our $75.0 million credit facility contains restrictions on the payment of cash dividends without lender consent for so long as amounts remain unpaid under the facility.

This report on Form 10-K 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 timing and execution of new store openings, relocations, remodels, sales and closures; the timing and impact of promotional and advertising campaigns; 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. In fiscal 2000 and early fiscal 2001, the Company posted net losses, comparable sales and customer counts were flat to negative, and the Company had no strategy for reversing the negative trends. The Company also was in default under its $125.0 million credit facility and required additional capital to expand its store base. In March of 2001, Perry Odak was hired as our CEO and President, and throughout fiscal 2001, the majority of the Company’s management was replaced with executives with extensive and successful backgrounds in retail sales, operations, merchandising, marketing and finance. This new management team recognized that we had major operational issues to correct in order to reverse the then-current negative trends, including but not limited to:

• poorly integrated acquisitions
• underperforming real estate and no growth strategy
• weak infrastructure
• huge numbers of SKUs and vendors on file
• pricing inconsistencies across the store base
• lack of operational controls
• large percentage of out-of-stocks
• ineffective marketing and merchandising strategies

In the third quarter of fiscal 2001, we began to address these issues, with the testing of an aggressive new merchandising and marketing strategy that was rolled out in the fourth quarter of fiscal 2001 and throughout fiscal 2002. In fiscal 2002, we focused on building operational controls, reducing our SKU count through a SKU rationalization program, implementing centralized buying and pricing, and creating a comprehensive and defensible real estate strategy. We also entered into a new primary distribution agreement with Tree of Life, Inc. ("TOL") and in the third and fourth quarters of fiscal 2002, switched to TOL as primary distributor for all U.S. stores. In September of 2002, we completed an equity offering that resulted in net proceeds of $48.3 million for use in expansion plans.

In the fourth quarter of fiscal 2002, we implemented centralized scale hosting to bring consistency and control to the pricing of our perishable products. We also began executing on our real estate strategy, and to the date of this report have signed leases or letters of intent for 18 new sites opening in fiscal 2003 and fiscal 2004, including eleven Wild Oats locations selected for the excellence of the projects, the position in new segments of existing markets and their defensibility from competitive attack, and seven Henry’s Marketplace locations in easily accessible and highly visible locations in densely populated metropolitan Los Angeles.

Throughout fiscal 2002, we continued to focus on improving the customer experience through new product demonstration programs, staff training on customer service and product knowledge, and resetting and remerchandising a significant number of our older stores. The shift to centralized buying and pricing refocused store staff energies on customer service.

We believe all these programs contributed to overall operational improvements that increased store sales, customer count and average transaction size in fiscal 2002. The sheer magnitude of the changes we implemented in fiscal 2002, coupled with disruptions in product supply caused by our SKU rationalization program and primary distributor switch, and a continued slow economy, contributed to declines in customer counts and comparable store sales in the fourth quarter of fiscal 2002, although per customer basket size increased in the fourth quarter. Road construction adjacent to a number of our stores also contributed, in part, to a 70 basis point decline in comparable store sales.

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 Oats(R) Natural Marketplace and Nature’s(R) - 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 Marketplace(R) and Sun Harvest(TM)> 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 fiscal 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, with subsequent new store openings using the prototype design in Portland, Maine and Louisville, Kentucky in the first quarter of fiscal 2003. We have also redesigned the prototype for our farmers market store format, and opened our first prototype store in Costa Mesa, California 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. We currently have seven signed letters of intent or leases for farmers market format stores slated to open in fiscal 2003 and fiscal 2004.

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 nine weaker stores, comparable store sales chain-wide increased by 5.2% in fiscal 2002, as compared to 4.0% in fiscal 2001. Due to the disruptions already mentioned, however, comparable store sales for the fourth quarter of fiscal 2002 declined to 2.9%, as compared to 5.6% in the third quarter of fiscal 2002, 5.2% in the second quarter of fiscal 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. 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 fiscal 2002, we opened one new store in Long Beach, California. We closed three natural foods supermarket stores in Boca Raton, Florida; Chesterfield, Missouri; and Cleveland, Ohio; one farmers market store in Serra Mesa, California when the lease expired; as well as one small vitamin store in El Paso, Texas. During fiscal 2002, we sold natural foods supermarket stores in Berkeley and Sunnyvale, California (two stores) in related transactions, and Victoria, British Columbia, Canada, as well as one small vitamin store in El Paso, Texas.

At December 28, 2002, we had 99 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:

We currently have an inventory of 13 vacant sites comprising closed store and office 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. In fiscal 2002, we sublet, assigned or negotiated the termination of 9 excess properties from an inventory of vacant sites, the lease for one site on the inventory list expired and we added two former store sites, closed in fiscal 2002, to our inventory. 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 September 2002, we concluded an offering of 4.45 million shares of our common stock for total gross proceeds of $51.2 million. In February of 2003, we completed a refinancing of $75.0 million under our existing credit facility with a group of banks led by the lead bank in our former credit facility. The proceeds from the equity offering and the funds available under the credit facility will be used to finance proposed growth of ten to 13 new stores in fiscal 2003, 15 to 20 stores in fiscal 2004 and 20 to 25 stores in fiscal 2005. 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 fourth quarter of fiscal 2002, management made certain decisions relating to our operations that changed estimates of prior restructuring and asset impairment charges and resulted in net restructuring and asset impairment income of $6,000. During the third quarter of fiscal 2002, management made certain decisions relating to our operations that 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 that 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 that also changed estimates of prior restructuring and asset impairment charges and resulted in restructuring and asset impairment income of $652,000. See "Notes to Consolidated Financial Statements - Note 13 - Restructuring and Asset Impairment Charges."

Critical Accounting Policies and Estimates. Our discussion and analysis of the Company’s 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:

• goodwill valuation
• 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

We believe the following critical accounting policies affect our most significant judgments and estimates used in the preparation of our consolidated financial statements:

Goodwill and Other Intangible Assets. Effective December 30, 2001, the Company implemented SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 was issued in July 2001, supersedes Accounting Principles Bulletin No. 17, Intangible Assets, and is effective for fiscal years beginning after December 15, 2001. SFAS No. 142 primarily addresses the accounting for goodwill and intangible assets subsequent to their initial recognition. SFAS No. 142 (1) prohibits the amortization of goodwill and indefinite-lived intangible assets, (2) requires testing of goodwill and indefinite-lived intangible assets on an annual basis for impairment (and more frequently if the occurrence of an event or circumstance indicates an impairment), (3) requires that reporting units be identified for the purpose of assessing potential future impairments of goodwill and (4) removes the 40-year limitation on the amortization period of intangible assets that have finite lives.

We monitor the carrying value of our long-lived assets, including intangible assets, for potential impairment at the store level. Goodwill, previously recognized at the store level, is now recorded at the enterprise level and monitored accordingly. The Company anticipates an annual decrease in amortization of goodwill of approximately $3.0 million and a corresponding annual increase to net income of $1.8 million. The Company will test goodwill for impairment annually in the second quarter of each fiscal year or more frequently if the occurrence of an event or circumstance indicates potential impairment.

The triggering events for such evaluations include a significant decrease in the market value of an asset, acquisition and construction costs in excess of budget, or current period losses combined with a history of losses or a projection of continuing losses. See "Notes to Consolidated Financial Statements - Note 1 - Organization and Summary of Significant Accounting Policies, Goodwill and Other Intangible Assets." The Company records an asset impairment charge when an impairment is identified. Future adverse changes in asset market values or store operating results could result in an inability to recover the carrying value of the assets, thereby requiring an asset impairment charge in the future. See "Notes to Consolidated Financial Statements - Note 13 - Restructuring and Asset Impairment Charges", for an additional discussion of our policies regarding the calculation of asset impairments.

The Company plans to complete store closures or sales within a one-year period following the commitment date. Costs related to store closures and sales are reflected in the income statement as "Restructuring and Asset Impairment Charges." For stores the Company intends to sell, the Company actively markets the stores to potential buyers. Stores held for disposal are reduced to their estimated net realizable value. For stores the Company intends to close, a lease-related liability is recorded for the present value of the estimated remaining noncancelable lease payments after the anticipated closing date, net of estimated subtenant income, or for estimated lease settlement costs. In addition, the Company records a liability for costs to be incurred after the store closing which are required under leases or local ordinances for site preservation during the period before lease termination. The value of equipment and leasehold improvements related to a closed store is reduced to reflect recoverable values based on the Company’s previous efforts to dispose of similar assets and current economic conditions. Severance costs incurred in connection with store closings are recorded when the employees have been identified and notified of the termination benefits to be made to the employees. Lease-related liabilities and the recoverability of assets to be disposed of are reviewed quarterly, and changes in previous estimates are reflected in operations. Significant cash payments associated with closed stores relate to ongoing payments of rent, common area maintenance, insurance charges, and real property taxes as required under continuing lease obligations.

SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, was issued on July 30, 2002. SFAS No. 146 will require companies to recognize costs associated with exit or disposal activities when they occur rather than at the date of a commitment to an exit or disposal plan. SFAS No. 146 is effective for the Company on January 1, 2003 and management believes it will have no material effect on the Company’s historical financial results.

The Company maintains allowances for bad debt for estimated losses resulting from the inability of third parties to make required payments or ship product upon which credits are due. If the financial condition of such third parties were to deteriorate, resulting in an impairment of their ability to make payments or provide credits, additional allowances may be required.

The Company maintains allowances for excess or unsaleable inventory as a percentage of its gross inventory balance based on historical experience and assumptions about market conditions. If actual market conditions are less favorable than those projected by management, or if the Company expands its forward buying of inventory, which will increase its inventory levels, then additional inventory write-downs may be required.

The Company is self-insured for certain losses relating to workers’ compensation claims and employee medical and dental benefits. The Company has purchased stop-loss coverage to limit its exposure to any significant levels of claims. Self-insured losses are accrued based upon the Company’s estimates of the aggregate insured claims incurred using certain actuarial assumptions followed in the insurance industry and the Company’s historical experiences. If the Company experiences an increase in claims, if actuarial assumptions are inaccurate, or if insurance industry costs increase beyond current expectations, then additional reserves may be required.

The Company maintains reserves for contingencies and litigation based on management’s best estimates of potential liability in the event of a judgment against the Company, and possible settlement costs, as well as existing facts and circumstances. Future adverse changes related to current contingencies and litigation could necessitate additional reserves in the future.

During the second quarter ended June 29, 2002, the Company adopted the provisions of SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. SFAS No. 145, among other things, rescinds SFAS No. 4, which required that gains and losses from extinguishment of debt be classified as an extraordinary item, net of related income tax effects. SFAS No. 145 is to be applied in fiscal years beginning after May 15, 2002 and encourages early application of the rescission of SFAS No. 4. During the twelve months ended December 28, 2002, and December 29, 2001, there were no gains or losses on early extinguishment of debt. In connection with the refinancing of our credit facility, the Company will incur a non-cash charge to write off the remaining unamortized debt issuance cost in the first quarter of fiscal 2003 of approximately $186,000.

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
• 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 and performance by suppliers, distributors and manufacturers
• unavailability of product
• aggregate results of a store fixture and equipment inventory project
• 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 experience operating losses for the first six to 12 months of operation, in accordance with historical trends; however, given the continued weakening of the U.S. economy, operating losses may be extended for additional periods of time.

We substantially completed the remodeling of five of our older stores in fiscal 2002, and remerchandised a number of our stores in the second, third and fourth quarters of fiscal 2002, with the goal of eliminating slower-selling products, reducing excess SKU counts in certain categories of products, and giving greater emphasis to produce, meat and seafood and grocery departments. We plan to remodel an additional 25 stores in fiscal 2003. 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, cash generated from operations, bank debt and equity financing proceeds has funded our capital expenditures. These sources of capital may not be available to us in the future. In addition, our new credit agreement contains limitations on our ability to make capital expenditures that may constrain future growth without additional equity financing. See "Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources."

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 or any future programs will be successful in fiscal 2003 in those stores, nor that the cost of future program rollouts will be at or below the costs incurred in fiscal 2002.

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.

Based upon our current distribution agreement, the Company plans to purchase 30.0% of our total goods from TOL. There is no assurance that we may not experience significant disruption in our operations through shortages of goods and services. Any significant disruption in the supply of goods could have a material impact on our overall sales volume and cost of goods. Inability of Tree of Life to fully fill orders by our stores may result in lower sales and loss of customers.

We received a transition fee as a part of our June 2002 distribution agreement with TOL. We are using the transition fee to offset the transition costs incurred during the transition of our primary distribution relationship to TOL. 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, third and fourth quarters and had no material impact on the results of operations for the twelve months ended December 28, 2002.

From time to time, we may experience product shortages due to the impact of adverse weather conditions, such as drought or flood, or disruptions in the supply chain from product shortages, transportation disruptions or other conditions. Product shortages may result in a material impact to our sales volume, cost of goods or customer counts.

We are currently completing an inventory of all fixtures and equipment in our stores. If the results of such inventory are materially less than the assets currently shown on our balance sheet, such results may negatively impact the value of assets on our balance sheet as well as results of operations.

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.

Our net income for fiscal 2002 was $6.9 million, or $0.26 per diluted share, compared with a net loss of $43.9 million, or $1.80 per diluted share, in fiscal 2001. The following table sets forth, for the periods indicated, certain selected income statement data expressed as a percentage of sales:

Fiscal 2002 Compared to Fiscal 2001

Sales. Sales for the fiscal year ended December 28, 2002, increased 2.9% to $919.1 million from $893.2 million in fiscal 2001. The increase was primarily due to the opening of one new store in the second quarter of fiscal 2002, operational improvements implemented throughout fiscal 2002, as well as the rollout in the first half of fiscal 2002 of our new marketing and merchandising program in 30 of our natural foods supermarket format stores. Comparable store sales increased 5.2% for fiscal 2002, as compared to an increase of 4.0% for fiscal 2001. Some of the comparable store sales increases are attributable to the continued strong performance of the farmers market format stores. We expect sales to increase at a slightly faster rate in fiscal 2003, due to the proposed opening of up to 13 new stores, three of which were opened in the first quarter of fiscal 2003, and the majority of which will open in the third quarter of fiscal 2003.

Gross Profit. Gross profit for the fiscal year ended December 28, 2002, increased 6.1 % to $274.3 million from $258.5 million in fiscal 2001. As a percentage of sales, gross profit increased to 29.8% in fiscal 2002 from 28.9% in fiscal 2001 due to more disciplined pricing strategies, a new category management structure, vendor consolidation and the completion of our SKU rationalization program, which eliminated large numbers of slow-moving items from our stores to make room for new, higher-margin or faster-moving items.

Direct Store Expenses. Direct store expenses for the fiscal year ended December 28, 2002, decreased 4.8% to $198.4 million from $208.3 million in fiscal 2001. As a percentage of sales, direct store expenses decreased to 21.6% in fiscal 2002 from 23.3% in fiscal 2001. Direct store expenses decreased as a result of better expense management at store-level, as well as the centralization of certain non-retail contracts for items such as supplies, as well as maintenance, in-store music, linens and other service contracts. We anticipate that we will see increases in fiscal 2003 and beyond in the area of employee-related insurance and general liability insurance costs. On an absolute basis, we expect direct store expenses to increase with the addition of new stores, but on a percentage-of-sales basis to be consistent with fiscal 2002.

Selling, General and Administrative Expenses. Selling, general and administrative expenses for the fiscal year ended December 28, 2002, increased 3.8% to $55.2 million from $53.2 million in fiscal 2001. The increases are attributable to investments in information systems to support centralized purchasing and pricing, store level signage production and a new data warehouse, as well as increases in advertising and merchandising expenses related to the implementation of our marketing and merchandising program and expenses for expanded infrastructure at the Company’s headquarters to support new store growth and centralized purchasing and pricing. As a percentage of sales, selling, general and administrative expenses increased to 6.0% in fiscal 2002 from 5.9% in fiscal 2001. As part of the Company’s fiscal 2003 evolution of our marketing strategies, we expect to spend additional funds on marketing at the local and community level, as well as a slight increase in corporate and regional support staffs to support the opening of the new stores in the second half of fiscal 2003. As a result of these increased expenditures, we expect that selling, general and administrative expenses will increase in fiscal 2003 over fiscal 2002 levels in both absolute and percentage terms.

Pre-Opening Expenses. Pre-opening expenses for the fiscal year ended December 28, 2002, increased 21.4% to $1.9 million from $1.6 million in fiscal 2001. As a percentage of sales, pre-opening expenses remained constant at 0.2% for fiscal 2002 compared to fiscal 2001. As part of the Company’s increase in marketing efforts, we anticipate that pre-opening expenses for new natural foods supermarket stores will increase from an estimated $250,000 historically to an estimated $400,000 per new store, and those of the farmers market format will increase from $150,000 historically to an estimated $250,000 in the future.

Interest Income. Interest income for the fiscal year ended December 28, 2002, decreased 21.4% to $778,000 from $1.0 million in fiscal 2001. The decrease was attributable to lower interest rates and reduced levels of invested cash.

Interest Expense. Interest expense for the fiscal year ended December 28, 2002, decreased 16.1% to $8.8 million from $10.4 million in fiscal 2001, due to higher average borrowings in fiscal 2001 and higher swap-related interest rates on the term portion of the credit facility in fiscal 2001. Under our Second Amended and Restated Credit Facility, effective February 26, 2003 interest rates have decreased from LIBOR plus 5.25% (the rate under our prior credit facility through February 25, 2003) to LIBOR plus 2.25%. We expect interest expense to remain flat or decrease slightly as total borrowings increase throughout fiscal 2003 but at a substantially lower interest rate than paid in fiscal 2002. Due to the current state of the U.S. economy, management believes that the variable interest rates will remain constant 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. As part of the strategic repositioning announced in the second and fourth quarters of fiscal 2000, we identified 22 natural foods stores for closure or sale due to weak performance. In fiscal 2000, we closed 10 and sold three of those identified stores. In the second quarter of fiscal 2001, as part of additional evaluation of the Company’s operations by new management, we identified an additional three stores for closure in fiscal 2001; in the fourth quarter of fiscal 2001, we extended our evaluation and identified an additional three stores for closure in fiscal 2001 and fiscal 2002. In fiscal 2002, we identified six additional stores for closure or sale, for a total of 34 stores identified for closure or sale in fiscal 2000, fiscal 2001 and fiscal 2002. Through the date of this report, we have closed 18 of the 34 identified stores, and sold nine stores, four in related transactions. Due to a change in estimates related to changes in facts and circumstances during the fourth quarter of fiscal 2001, we decided to continue to operate four stores previously identified for closure or sale. We have three remaining stores previously identified and remaining to be closed or sold.

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

Restructuring and Asset Impairment Charges - Fiscal 2002 and Fiscal 2001. The following tables summarize the components of restructuring and asset impairment charges and income for fiscal 2002 and fiscal 2001, respectively, by quarter (in thousands):

The following details the significant components of restructuring and asset impairment charges and income for fiscal 2002 by quarter:

During the fourth quarter of fiscal 2002, the Company recorded restructuring and asset impairment income of $6,000. Details of the significant components are as follows:

• Gain on sale of assets during the fourth quarter of fiscal 2002 ($130,000 of asset disposal income). During the fourth quarter of fiscal 2002, the Company sold a liquor license for a closed location in Mission Viejo, California for a higher price than originally estimated. Additionally, the Company received an insurance settlement for a claim relating to the location in Madison, New Jersey, where the assets had previously been written off. Therefore, the Company recognized asset disposal income of $130,000 during the fourth quarter of fiscal 2002.

• Change in estimate related to lease-related liabilities for sites previously identified for closure or sale ($3.4 million of restructuring income). During the fourth quarter of fiscal 2002, the Company negotiated the early termination of leases in West Hollywood, California and San Antonio, Texas. The Company also secured viable subtenants for locations in Vancouver, Washington and Boulder, Colorado. Additional information received in fiscal 2002 resulted in a revision in the total rent allocated to one vacant location in Albuquerque, New Mexico, previously included within a restructuring charge; therefore, the Company revised the estimate for future lease obligations. Based on these changes in facts and circumstances and the related changes in estimates, the Company adjusted or reversed the remaining lease-related liabilities previously recorded for these locations and therefore recognized restructuring income of $3.4 million during the fourth quarter of fiscal 2002.

• Lease-related liabilities for three additional stores identified during the fourth quarter of fiscal 2002 to be closed or sold by the end of fiscal 2003 ($3.6 million of restructuring expense). During the fourth quarter, the Company decided to close or sell three additional locations due to lower than anticipated operational performance. The lease-related liabilities for these locations represent the Company’s estimate to dispose of these lease obligations based on current disposition efforts, and is attributable to deteriorating real estate markets in certain regions, existing lease obligations at above-market rates, and unattractive site characteristics. The charge for exit costs assumes, based on the Company’s current results of disposition efforts, that the Company will be successful in disposing of these long-term lease obligations within the next five years. Facts and circumstances can change in the future with respect to the above attributes affecting the ultimate resolution of these exit costs. The Company will make appropriate adjustments to the restructuring liabilities contemporaneous with the change in facts and circumstances.

• Severance for employees terminated during the fourth quarter of fiscal 2002 ($9,000 of restructuring expense). During the fourth quarter of fiscal 2002, two employees were terminated with the sale of one Vitamin Expo location during the fourth quarter of fiscal 2002. The employees were notified of their involuntary termination during the fourth quarter of fiscal 2002. As of December 28, 2002, all $9,000 of involuntary termination benefits had been paid to terminated employees.

During the third quarter of fiscal 2002, the Company recorded restructuring and asset impairment income of $174,000. Details of the significant components are as follows:

• 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 were disposed in 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, the Company recorded restructuring and asset impairment expense of less than $1,000. Details of the significant components are as follows:

• Fixed asset impairments for sites previously identified for closure or sale ($35,000 of asset impairment expense). During the second quarter of fiscal 2002, the Company 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, the Company determined it 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 were disposed in fiscal 2002. Additionally, during the second quarter of fiscal 2002, the Company determined that it could partially recover the carrying value of certain fixed assets used in store front-end operations that were previously written off; therefore, the Company 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, the Company negotiated the early termination of a lease of property at which the Company had operated a kitchen in Los Angeles, California. Also during the quarter, the Company 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, the Company 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 the Company’s operating store in West Hartford, Connecticut, the Company 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; the Company reversed the excess lease-related liabilities previously recorded. Due to these changes in facts and circumstances and the related changes in estimates, the Company 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, the Company 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.

• Fixed asset impairments for store construction project discontinuation ($370,000 of asset impairment expense). During the second quarter of fiscal 2002, the Company 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). The Company determined that it 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 December 28, 2002, all $142,000 of the involuntary termination benefits had been paid to terminated employees.

During the first quarter of fiscal 2002, the Company 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, the Company 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, the Company 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, the Company also completed payment obligations 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, the Company 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, the Company sold one store in Victoria, British Columbia, Canada. The sale agreement included payment for fixed assets. Based on this change in facts and circumstances, the Company 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, the Company determined the likelihood of securing a subtenant for certain space in Tempe, Arizona was now remote due to the Company’s obligation being at above-market rates, the unattractive site characteristics, and increasingly difficult real estate market conditions. With this change in facts and circumstances, the Company decided to fully reserve 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 December 28, 2002, all $269,000 of the involuntary termination benefits had been paid to terminated employees.

Restructuring and Asset Impairment Charges - Fiscal 2001. A total of $54.9 million of restructuring and asset impairment charges were taken in fiscal 2001.

As a result of hiring a new chief executive officer just prior to the beginning of the second quarter of fiscal 2001, and a comprehensive review conducted by the new chief executive officer of our business and strategic repositioning efforts during the second quarter of fiscal 2001, we identified and committed to a restructuring plan during the second quarter of fiscal 2001 and recorded a restructuring and asset impairment charge of $54.8 million (such asset impairments were recorded in accordance with SFAS 121, Accounting for the Impairment of Long-lived Assets and for Assets to be Disposed of). See "Notes to Consolidated Financial Statements - Note 13 - Restructuring and Asset Impairment Charges" for details of the significant components of the charge.

Restructuring Accruals. The material changes in the liability balances of each significant type of exit cost included in the restructuring charges in the second and fourth quarters of fiscal 2000 were related to changes in estimates for lease defeasance costs and for the net realizable value of fixed assets. The changes in estimates during the second quarter of fiscal 2001 for lease defeasance costs in the restructuring charges during the second and fourth quarters of fiscal 2000 resulted from the economic downturn during fiscal 2001, which has made it more difficult to find sublease tenants and settle lease terminations with landlords (particularly in the case of leases with above-market rents). In the second quarter of fiscal 2001, we received updated estimates from various external sources (i.e., landlords and real estate brokers) of the costs to exit certain lease obligations. Due to the economic downturn that worsened during the second quarter of fiscal 2001, we revised our estimates of the costs associated with subleasing properties or settling lease terminations with landlords. Due to changes in facts and circumstances during the fourth quarter of fiscal 2001, we determined that four stores previously identified as sites held for disposal would continue to operate in their existing locations. Three of the stores were expected to be closed in conjunction with the Company’s opening of new stores in the respective trade areas; however, during the fourth quarter of fiscal 2001, the Company decided to abandon the new store sites and continue to operate the existing stores. With regard to the fourth store, management decided in the fourth quarter of fiscal 2001 to continue to operate the store in its existing location after completing a competitive analysis of the market area and a reevaluation of the operations of the store in the fourth quarter of fiscal 2001, which showed that the store was achieving acceptable performance levels and demonstrating positive performance trends following the implementation of our marketing program late in the third quarter of fiscal 2001. As a result, we reversed the restructuring accruals previously recorded for the long-term lease obligations related to these four stores.

The material cash outlays associated with the Company’s exit plans are primarily for lease-related obligations. As of December 28, 2002, the components of the accruals related to the Company’s restructuring activities are accrued liabilities ($4.5 million) and other long-term obligations ($13.6 million). As of December 28, 2002, $3.1 million of involuntary termination benefits accrued during fiscal 2002 and fiscal 2001 had been paid to terminated employees.

Income Tax Expense (Benefit). The effective tax rate for the fiscal year ended December 28, 2002 was 40.7% as compared to 36.5% for fiscal 2001. The increase primarily relates to limitations on the Company’s ability to utilize foreign tax credits due to net operating losses. The remainder of the change is attributable to an increase in state franchise taxes.

For the fiscal year ended December 29, 2001, we recorded a $25.2 million income tax benefit, primarily as a result of the loss before taxes of $69.1 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.

Fiscal 2001 Compared to Fiscal 2000

Sales. Sales for the fiscal year ended December 29, 2001, increased 6.6% to $893.2 million from $838.1 million in fiscal 2000. The increase was primarily due to the opening of four new stores in the first quarter of fiscal 2001, as well as the inclusion of the 16 stores opened or acquired in fiscal 2000, offset by three stores closed or sold in fiscal 2001 and 20 stores closed or sold in fiscal 2000. Higher comparable store sales from existing stores contributed slightly more than half of the fiscal 2001 sales increase, with new stores contributing the balance. Comparable store sales increased 4.0% for fiscal 2001, as compared to a 2.6% decrease for fiscal 2000. Some of the comparable store sales increases are attributable to the phased roll-out of a number of strategic initiatives as part of the our aggressive merchandising and marketing program, which are projected to increase overall sales gradually in those regions in which the initiatives are implemented, through increased advertising, more frequent advertised specials and modified pricing.

Gross Profit. Gross profit for the fiscal year ended December 29, 2001, increased 0.9% to $258.5 million from $256.2 million in fiscal 2000. The smaller percentage increase in gross profit is due primarily to lower merchandise margins resulting from the implementation of pricing reductions as part of the merchandising and marketing program, as well as a shift in the sales mix between store formats. As a percentage of sales, gross profit decreased to 28.9% in fiscal 2001 from 30.6% in fiscal 2000 due primarily to lower merchandise margins resulting from the implementation of the merchandising and marketing program, as well as a shift in the sales mix between store formats, increases in inventory reserves for slow-moving goods, lower margins on certain categories of products sold in the stores, higher utilities expenses and higher-than-expected coupon activity during the fourth quarter of fiscal 2001.

Direct Store Expenses. Direct store expenses for the fiscal year ended December 29, 2001, increased 11.3% to $212.6 million from $191.0 million in fiscal 2000. As a percentage of sales, direct store expenses increased to 23.8% in fiscal 2001 from 22.8% in fiscal 2000. The increases are primarily due to increased payroll associated with an increase in the number of stores in operation, enhanced customer service efforts, additional benefit days due to a change in vacation policy in fiscal 2001, increased health and dental, workers’ compensation, and general liability insurance costs related to general market conditions, and an increase in repairs and maintenance costs.

Selling, General and Administrative Expenses. Selling, general and administrative expenses for the fiscal year ended December 29, 2001, increased 50.4% to $48.9 million from $32.5 million in fiscal 2000. The increases are attributable to consulting and professional fees resulting from the comprehensive review of our business and strategic position ($1.7 million), severance costs for former senior executives ($1.3 million), recruiting and relocation costs ($500,000), and expenses associated with the October 2001 amendment to our $125.0 million credit facility ($300,000), as well as increases in advertising and merchandising expenses related to the implementation of the marketing and merchandising initiatives program and expenses for expanded infrastructure at the Company’s headquarters to support the new advertising, merchandising and pricing initiatives. As a percentage of sales, selling, general and administrative expenses increased to 5.4% in fiscal 2001 from 3.9% in fiscal 2000.

Pre-Opening Expenses. Pre-opening expenses for the fiscal year ended December 29, 2001, decreased 52.5% to $1.6 million from $3.3 million in fiscal 2000. As a percentage of sales, pre-opening expenses decreased to 0.2% in fiscal 2001 from 0.4% in fiscal 2000, due to the opening of four new stores in fiscal 2001 as compared to the opening of 14 new and relocated stores in fiscal 2000.

Interest Expense, Net. Net interest expense for the fiscal year ended December 29, 2001, increased 6.7% to $9.4 million from $8.9 million in fiscal 2000, due to higher average borrowings in fiscal 2001 and higher swap-related interest rates on the term portion of the credit facility in fiscal 2001. As part of the October 2001 amendment to our prior credit facility, the interest rate on the facility was amended to either prime plus 2.25% or one-month LIBOR plus 3.75%, at our election, and the rates increase by 0.5% starting January 1, 2002 and each six months thereafter through January 1, 2003.

Restructuring and Asset Impairment Charges - Fiscal 2000. The following tables summarize the components of restructuring and asset impairment charges and income for fiscal 2001 and fiscal 2000, respectively, by quarter (in thousands):

A total of $42.1 million in restructuring and asset impairment charges were taken in fiscal 2000. See "Notes to Consolidated Financial Statements - Note 13 - Restructuring and Asset Impairment Charges" for details of the significant components of restructuring and asset impairment charges for fiscal 2001 and fiscal 2000, by quarter.

Restructuring and Asset Impairment Charges - Fiscal 2000. During the second quarter of fiscal 2000, we made certain decisions relating to the strategic repositioning of the Company’s operations, which resulted in a restructuring and asset impairment charge of $20.6 million. These decisions included the closure of three natural foods stores during the second quarter of fiscal 2000 ($4.7 million); the planned sale or closure of seven stores during the remainder of fiscal 2000 ($9.9 million); exit costs of previously closed or abandoned sites ($5.6 million); and the discontinuance of e-commerce activities ($400,000). The $5.6 million charge related to changes in estimates for previously closed or abandoned sites. The significant components of the $5.6 million charge were (a) $3.6 million of additional lease-related liabilities, and (b) $2.0 million of fixed asset impairments for 15 previously closed stores. Components of the restructuring and asset impairment charge consist of impairment of fixed ($8.9 million) and intangible assets ($6.4 million); and non-cancelable lease obligations and liabilities ($5.3 million). Substantially all of the restructuring charges are non-cash expenses when initially recorded.

Restructuring Accruals. The material changes in the liability balances of each significant type of exit cost included in the restructuring charges in the second and fourth quarters of fiscal 2000 were related to changes in estimates for lease defeasance costs and for the net realizable value of fixed assets. The changes in estimates during the second quarter of fiscal 2001 for lease defeasance costs in the restructuring charges during the second and fourth quarters of fiscal 2000 resulted from the economic downturn during fiscal 2001, which has made it more difficult to find sublease tenants and settle lease terminations with landlords (particularly in the case of leases with above-market rents). In the second quarter of fiscal 2001, we received updated estimates from various external sources (i.e., landlords and real estate brokers) of the costs to exit certain lease obligations. Due to the economic downturn that worsened during the second quarter of fiscal 2001, we revised our estimates of the costs associated with subleasing properties or settling lease terminations with landlords. Due to changes in facts and circumstances during the fourth quarter of fiscal 2001, we determined that four stores previously identified as sites held for disposal would continue to operate in their existing locations. Three of the stores were expected to be closed in conjunction with the Company’s opening of new stores in the respective trade areas; however, during the fourth quarter of fiscal 2001, the Company decided to abandon the new store sites and continue to operate the existing stores. With regard to the fourth store, management decided in the fourth quarter of fiscal 2001 to continue to operate the store in its existing location after completing a competitive analysis of the market area and a reevaluation of the operations of the store in the fourth quarter of fiscal 2001, which showed that the store was achieving acceptable performance levels and demonstrating positive performance trends following the implementation of our aggressive merchandising and marketing program late in the third quarter of fiscal 2001. As a result, we reversed the restructuring accruals previously recorded for the long-term lease obligations related to these four stores.

The material cash outlays associated with the Company’s exit plans are primarily for lease-related obligations. As of December 29, 2001, the components of the accruals related to the Company’s restructuring activities are accrued liabilities ($6.6 million) and other long-term obligations ($16.4 million). Employee severance benefits are another cash outlay that will be paid out during the next five months. As of December 29, 2001, $2.4 million of the $2.5 million of involuntary termination benefits accrued during the second quarter of fiscal 2001 had been paid to terminated employees. The employee severance benefits relate to the termination of employment of 104 of our 9,000 employees.

Income Tax Benefit. For the fiscal year ended December 29, 2001, we recorded a $25.2 million income tax benefit, primarily as a result of the loss before taxes of $69.1 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.

Off-Balance Sheet Arrangements

The Company has no off-balance sheet arrangements to disclose as required by Item 303(a)(4) of Regulation S-K.

Liquidity and Capital Resources

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

Net cash provided by operating activities was $36.2 million during fiscal 2002 as compared to $25.7 million during fiscal 2001. Cash from operating activities increased during this period primarily due to pre-tax income, partially offset by 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 $14.5 million during fiscal 2002 as compared to $19.9 million during fiscal 2001. The decrease is due to a reduction in capital expenditures for the construction of new stores (fewer stores and lower cost per store).

Net cash used in financing activities was $29.2 million during fiscal 2002 as compared to net cash provided of $1.0 million during fiscal 2001. The change reflects lower incremental borrowings under our credit facility.

We have a net deferred tax asset of $20.3 million on our balance sheet, primarily as a result of the $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 following is a summary of our lease and debt obligations, construction commitments and outstanding letters of credit as of December 28, 2002:

SUMMARY OF OBLIGATIONS AND COMMERCIAL COMMITMENTS
(in thousands)

Refinancing of Credit Facility. Our former credit facility had two separate lines of credit, a revolving line and a term loan facility, both expiring August 1, 2003. As of December 28, 2002, there were $14.3 in borrowings under the revolving line, and $28.8 in borrowings outstanding under the term loan. Interest at December 28, 2002 primarily accrued at a rate of LIBOR plus 4.75%, or 11.35% per annum after adjusting for the impact of the swap agreement required by our credit facility.

In February of 2003, we completed the refinancing of our credit facility with Wells Fargo Bank N.A., our former administrative agent, again acting as lead bank and administrative agent. Our new facility has a $75.0 million limit, which we believe to be adequate for our current borrowing needs, with a three-year term with a one-year renewal option. Under the new facility, we have the option to increase the total facility to $135.0 million through the addition of new lenders and through the agreement of the current lending group to increase their total commitments.

As part of the new facility, we have given our lenders collateral in the form of cash, equipment and fixtures, inventory and other assets. We have also granted leasehold mortgages in those leasehold interests previously mortgaged to secure our former credit facility, although we have no obligation to provide an interest in any new leaseholds. The new facility contains limitations on capital expenditures and the signing of new leases, although we believe such limitations will not restrict our previously announced growth plans of 10 to 13 stores in fiscal 2003, 15 to 20 stores in fiscal 2004 and 20 to 25 stores in fiscal 2005. The interest rate on the facility is currently either prime plus 1.0% or one-month LIBOR plus 2.25%, at our election, and the rates modify depending on the ratio of average total funded debt, as defined under the credit facility, plus six times rent expense, to EBITDAR for the four fiscal quarter periods then ended, as calculated on our quarterly compliance certificate. Additionally, we are charged a commitment fee on the unused portion of the line ranging from 0.25% to 0.5% based on performance objectives as defined in the credit agreement. We believe that cash generated from operations and available under our credit facility will be sufficient to meet our capital expenditure requirements in fiscal 2003.

We maintain an interest rate risk-management strategy, which was required by our former 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 former credit facility, the Company entered into a swap agreement to hedge the interest rate on $32.5 million of its borrowings. The swap agreement locks in a one-month LIBOR rate of 6.7% and expires in August 2003. Under our new facility, we are not obligated to enter into any such rate contracts; however, we may choose to do so if we believe such to be appropriate and in line with our risk-management strategy.

Capital Expenditures. We spent approximately $14.8 million during fiscal 2002 for new store construction, development, remodels and other capital expenditures, exclusive of acquisitions. Capital expenditures originally planned for certain of the stores rescheduled to open in fiscal 2002 were incurred commencing in the fourth quarter of fiscal 2001. 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. As part of our reexamination of our operating strategies, we anticipate that the average capital expenditures to open a natural foods supermarket format store will be $2.5 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; however, our ability to negotiate turnkey leases in the future will result in a substantially lower capital expenditure per store, in return for a slightly higher rent rate over the lease term. Our average capital expenditures to open a farmers market format store are estimated at $1.5 million to $2.0 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.

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 currently are approximately $250,000 to $350,000 per store and are expensed as incurred. Pre-opening costs for natural foods supermarket format stores in the future are projected to increase from $250,000 to $400,000 per store, and pre-opening costs for farmers market format stores are projected to increase from $150,000 to $250,000, as a result of increased advertising 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 available under our existing credit facility will be sufficient to satisfy our budgeted cash requirements through fiscal 2003.

Cautionary Statement Regarding Forward-Looking Statements

This Report on Form 10-K contains "forward-looking statements," within the meaning of the Private Securities Litigation Reform Act of 1995, which involve known and unknown risks. Such forward-looking statements include statements as to the Company's plans to open, acquire or relocate additional stores; the anticipated performance of such stores; the impact of competition and current economic uncertainty; the sufficiency of funds to satisfy the Company's cash requirements through the remainder of fiscal 2003, our expectations for comparable store sales; the impact of changes resulting from our merchandising, advertising and pricing programs; levels of cannibalization; expected pre-opening expenses and capital expenditures; and other statements containing words such as "believes," "anticipates," "estimates," "expects," "may," "intends" and words of similar import or statements of management's opinion. These forward-looking statements and assumptions involve known and unknown risks, uncertainties and other factors that may cause the actual results, market performance or achievements of the Company to differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. Important factors that could cause differences in results of operations include, but are not limited to, the timing and execution of new store openings, relocations, remodels, sales and closures; the impact of competition; changes in product supply or suppliers and supplier performance levels; 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. 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.

In the normal course of business, the Company is exposed to fluctuations in interest rates and the value of foreign currency. The Company employs various financial instruments to manage certain exposures when practical.

The Company is exposed to foreign currency exchange risk. The Company owns and operates three natural foods supermarkets and a commissary kitchen in British Columbia, Canada. The commissary supports the three Canadian stores and does not independently generate sales revenue. Sales made from the Canadian stores are made in exchange for Canadian dollars. To the extent that those revenues are repatriated to the United States, the amounts repatriated are subject to the exchange rate fluctuations between the two currencies. The Company does not hedge against this risk because of the small amounts of funds at risk.

The Company's exposure to interest rate changes is primarily related to its variable rate debt issued under its credit facility. As of December 28, 2002, there was $43.1 million in borrowings outstanding under our former credit facility. The interest rate under the former credit facility at December 28, 2002 was either prime plus 3.25% or one-month LIBOR plus 4.75%, at our election. Because the interest rate on the former facility was variable, the Company's interest expense and net income were affected by interest rate fluctuations. If interest rates were to increase or decrease by 100 basis points, the result under the former facility, based upon the existing outstanding non-hedged variable rate debt as of December 28, 2002, would be an annual increase or decrease of approximately $106,000 in interest expense and a corresponding decrease or increase of approximately $63,000 in the Company's net income after taxes.

On February 26, 2003, the Company refinanced the credit facility and reduced the total commitment available to a $75.0 million revolving line of credit, with a three-year term expiring February 25, 2006. The interest rate on the amended facility is currently either prime plus 1.0% or one-month LIBOR plus 2.25%, at our election, and the rates modify depending on the ratio of average total funded debt, as defined under the credit facility, plus six times rent expense, to EBITDAR for the four fiscal quarter periods then ended, as calculated on our quarterly compliance certificate. Because the interest rate on the facility is variable, based upon the prime rate or LIBOR, the Company's interest expense and net income are affected by interest rate fluctuations. If interest rates were to increase or decrease by 100 basis points, the result, based upon the existing outstanding non-hedged variable rate debt as of March 6, 2003, would be an annual increase or decrease of approximately $74,000 in interest expense and a corresponding decrease or increase of approximately $45,000 in the Company’s net income after taxes.

In September 2000, as required by the Company’s former credit facility, the Company entered into an interest rate swap to hedge its exposure on variable rate debt positions. Variable rates are predominantly linked to LIBOR as determined by one-month intervals. The interest rate provided by the swap fixed one-month LIBOR at 6.7%. At December 28, 2002, the notional principal amount of the interest rate swap agreement was $32.5 million, expiring in August 2003. There is no obligation to renew the swap under the refinanced facility. The notional amount is the amount used for the calculation of interest payments that are exchanged over the life of the swap transaction on the amortized principal balance. In fiscal 2002, the loss, net of taxes, included in other comprehensive loss for this cash flow hedge was approximately $1.2 million.

REPORT OF MANAGEMENT

We are responsible for the preparation and integrity of the consolidated financial statements and all related information appearing in our Annual Report. The consolidated financial statements and notes were prepared in conformity with generally accepted accounting principles appropriate in the circumstances and, accordingly, include certain amounts based on our best judgments and estimates of current conditions and circumstances.

Management maintains a system of accounting and other controls to provide reasonable assurance that assets are safeguarded against loss from unauthorized use or disposition and that accounting records are reliable for preparing financial statements. Even an effective internal control system, no matter how well designed, has inherent limitations, including the possibility of circumvention or overriding of controls, and therefore can provide only reasonable assurance with respect to financial statement presentation. The system of accounting and other controls is modified in response to changes in business conditions and operations and recommendations made by the independent accountants.

The Audit Committee of the Board of Directors, which is composed of directors who are not employees, meets periodically with management and the independent accountants to review the manner in which these groups are performing their responsibilities and to carry out the Audit Committee’s oversight role with respect to auditing, internal controls and financial reporting matters. The Audit Committee reviews with the independent accountants the scope and results of the audit. The independent accountants periodically meet privately with the Audit Committee and have access to its individual members.

We engaged PricewaterhouseCoopers LLP, independent accountants, to audit the consolidated financial statements in accordance with generally accepted auditing standards, which include consideration of the internal control structure. The opinion of the independent accountants, based upon their audits of the consolidated financial statements, is contained in this Annual Report.

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders of Wild Oats Markets, Inc.

In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Wild Oats Markets, Inc. and its subsidiaries (the "Company") at December 28, 2002 and December 29, 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 28, 2002 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

As discussed in Note 1 to the consolidated financial statements, effective December 30, 2001, the Company changed its method of accounting for goodwill and other intangible assets.

PricewaterhouseCoopers LLP

Denver, Colorado

February 25, 2003

The accompanying notes are an integral part of these consolidated financial statements.