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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED SEPTEMBER 27, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM_____________ TO______________.
Commission file number: 0-19797
WHOLE FOODS MARKET, INC.
(Exact name of registrant as specified in its charter)
Texas 74-1989366
(State of (IRS employment
incorporation) identification no.)
601 North Lamar Suite 300
Austin, Texas 78703
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code:
512-477-4455
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to section 12(g) of the Act:
Common Stock, no 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. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
registrant on November 30, 1998 was approximately $1.2 billion.
The number of shares of the registrant's common stock, no par value, outstanding
as of November 30, 1998 was approximately 26,555,000.
The following document is incorporated by reference into the part of this annual
report on Form 10-K as indicated: Portions of the registrant's definitive proxy
statement for the annual meeting of shareholders to be held on March 29, 1999
are incorporated into Part III to the extent indicated herein.
1
PART I
Item 1. BUSINESS
Whole Foods Market owns and operates the country's largest chain of natural
foods supermarkets. The Company opened its first store in Austin, Texas in 1980
and operated 87 stores in 19 states and the District of Columbia as of September
27, 1998. As a result of both acquisitions and internal expansion, the Company
has grown rapidly from sales of approximately $92.5 million in fiscal 1991 to
approximately $1.4 billion in fiscal 1998. In fiscal 1998, the Company's stores
had average sales per square foot of $670, which the Company believes is higher
than most conventional supermarkets or food retailers, including competitors in
the large-store segment of the natural foods industry.
Through Amrion, its subsidiary acquired in September 1997, the Company is
engaged in developing, producing and marketing high quality nutriceuticals and
nutritional supplements. Amrion's products include nutriceuticals, herbs, herbal
formulas, vitamins, minerals and homeopathic medicinals.
Financial information about industry segments is included under the caption
"Segment Information" in the Notes to Consolidated Financial Statements.
The Natural Foods Industry
The Company's product offerings include natural foods and nutritional
supplements. Natural foods can be defined as foods which are minimally
processed, largely or completely free of artificial ingredients, preservatives
and other non-naturally occurring chemicals and in general are as near to their
whole, natural state as possible. According to a leading trade publication for
the industry, natural products sales have grown to approximately $14.8 billion
in 1997. This growth is being propelled by several factors, including increasing
consumer concern over the purity and safety of food due to the presence of
pesticide residues, artificial ingredients and other chemicals; environmental
concerns due to the degradation of water and soil quality; and healthier eating
patterns due to a better educated populace whose median age is increasing each
year. While organic and natural food products have higher costs of production,
the Company believes that due to changes in demographics and buying habits a
significant segment of the population now attributes added value to high quality
natural food and accordingly is willing to pay higher prices for such food
items.
According to a leading trade publication for the industry, there were 12,800
natural products retail stores in 1997 in the United States. While
natural/health food stores have historically provided only a limited selection
of products, the natural foods supermarket-size formats provide a complete
grocery shopping alternative to conventional supermarkets. The Company believes
that besides its own stores there are fewer than 100 other natural foods stores
larger than 10,000 square feet throughout the country. Whole Foods Market also
believes that the growth of larger supermarket-size natural foods stores has
increased consumer awareness of and demand for natural foods.
According to a leading trade publication for the industry, the retail market for
vitamin and nutritional supplements is estimated to have grown to approximately
$9.3 billion in 1997. This growth has resulted from an increased national
interest in preventative health choices, favorable consumer attitude shifts
toward natural health care, increased consumer willingness toward self-care in
resistance to rising health care costs and a rapidly growing demographic segment
of the population over 40 years old concerned with aging and disease.
Additionally, public awareness of the positive effects of vitamins and other
nutritional supplements on health has been heightened by widely publicized
reports of favorable research findings. Recent estimates indicate that
approximately 40% of the U.S. population use nutritional supplements in some
form.
Business Strategy
Whole Foods Market owns and operates the country's largest chain of natural
foods supermarkets. The Company believes its success to date is the result of
its ability to differentiate itself from other retailers competing for
consumers' food dollars by tailoring its product mix, customer service attitude
and store environment to satisfy the needs of the natural foods shopper and to
appeal to the broader market of quality-oriented consumers. Each element of the
Company's strategy is designed to enhance and build the Whole Foods Market brand
name and to engender a high degree of loyalty among the Company's customers.
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Product Offerings
o High Quality Standards. The Company is committed to offering its
customers the highest quality products. It has developed quality goals
and features products that are free of artificial flavors, sweeteners,
colors, preservatives and added chemicals. To better ensure quality
and to enhance merchandising, the Company has acquired or developed
businesses that manufacture and distribute significant product
categories. For instance, Whole Foods Market operates regional
bakehouses and commissaries, a seafood wharf, a nutritional supplement
manufacturer and a coffee roaster.
o Broad Product Assortment. The Company provides its customers the
convenience of one-stop shopping by offering not only a broader
product selection than is available in typical natural foods stores
but also by having a full range of merchandise categories comparable
to those available in conventional supermarkets. The Company's stores
carry approximately 10,000 to 18,000 SKUs and feature categories such
as prepared foods, vitamins and nutriceuticals, bakeries and specialty
wines and cheeses which the Company believes differentiate it from
many other natural foods retailers.
o Private Label Products. Under the premium "Whole Foods" label and the
value-priced "365" label, the Company offers its customers unique,
high quality goods available only at Whole Foods Market stores. The
Company developed its private label products to enhance its offering
of natural food brands which are typically not as well known as larger
national brands found in conventional supermarkets. The Company
believes that customers trust the Whole Foods Market name because of
its position as the industry leader and reputation for quality.
o Competitive Pricing. The Company seeks to price its products at or
below comparable products in its geographic markets.
Company Culture
o Decentralized, Team Approach. The Company promotes a decentralized,
team approach to store operations in which many personnel,
merchandising and operating decisions are made by employee teams at
the individual store level. This approach allows the Company to better
tailor its store environment and product offering to local markets and
customers.
o Employees (Team Members) as "Stakeholders." The Company believes it
has been successful in motivating its team members by making them
stakeholders in the organization through its "gainsharing" programs,
which reward specifically targeted performance such as team labor
productivity, and through its stock option and purchase plans.
o Customer Service Attitude. Due to the Company's distinctive company
culture which creates a sense of personal responsibility among its
team members, Whole Foods Market team members' self interest and job
satisfaction are closely tied to ensuring customer satisfaction.
o Sense of Purpose. The Company believes that by promoting healthy,
nutritious and environmentally safe products it helps inspire its team
members by providing them with a greater sense of purpose and mission
in their work.
The Shopping Experience
o Large Format Stores. Averaging approximately 24,000 square feet, the
Company's stores are significantly larger than typical natural foods
stores, more closely resembling the size of some conventional
supermarkets.
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o Information Orientation. To familiarize customers with natural food
products and to inform them about developments in the natural foods
industry, the Company provides a significant amount of product
information throughout each store. Each store also contains a
centrally located, fully staffed information booth. In addition, the
Company trains store team members to be knowledgeable about its
products and to provide information and assistance to customers.
o Appealing Shopping Environment. In order to overcome the common
attitude that grocery shopping is a chore, the Company has designed
its stores to create a sense of warmth, fun and informality. Many
stores feature juice and coffee bars, in-store massage therapists and
other amenities which provide convenience and service to its
customers.
Growth Strategy
Whole Foods Market's growth strategy is to expand through a combination of new
store openings and the acquisition of existing stores. The Company seeks to open
or acquire stores in existing regions and in metropolitan areas where the
Company believes it can become a leading natural foods supermarket. The Company
primarily seeks to open large format stores which range between 30,000 to 50,000
square feet, located on premium real estate sites, often in urban, high
population locales. The Company has also grown through acquisitions, as the
natural foods retailing industry is extremely fragmented and comprised of many
smaller local and regional chains. The Company believes that the acquisition of
smaller chains may provide access to desirable locations and markets and pursues
such acquisitions on an opportunistic basis. The Company is continually in
discussions with third parties regarding potential acquisitions.
Historical store growth is summarized below:
Fiscal Year (1)
1994 1995 1996 1997 1998
------------------------------------------------------------
Beginning of year................... 30 35 41 68 75
New and acquired stores............. 5 9 32 9 15
Relocations and closures............ (0) (3) (5) (2) (3)
------------------------------------------------------------
End of year......................... 35 41 68 75 87
------------------------------------------------------------
Total square footage (end of year).. 702,000 862,000 1,563,000 1,724,000 2,092,000
------------------------------------------------------------
(1) Stores acquired in pooling transactions are reflected as acquired in the
period in which the applicable transaction closed.
As of November 30, 1998 the Company had signed leases for an additional 29
stores in development ranging from 24,000 to 53,000 square feet in total store
size. The Company expects to open approximately ten stores in fiscal year 1999
and 15 to 20 stores in fiscal year 2000.
Products
The Company offers its customers approximately 10,000 to 18,000 SKUs of food and
non-food products. The Company's broad product selection is designed to meet the
needs of natural foods shoppers as well as gourmet customers. The Company has
been able to expand the breadth of its product offerings by carefully monitoring
the market for new products and by responding to customer input. Many national
brands featured in conventional supermarkets are not available at Whole Foods
Market because they do not meet the Company's product standards. The Company's
product line consists primarily of products from natural food vendors which
typically do not have the resources to build brand recognition with consumers.
Quality Standards. The Company's objective is to sell its customers the highest
quality foods available. The Company defines quality in terms of nutrition,
freshness, appearance and taste and has the following product quality goals:
o Whole Foods. The Company evaluates each and every product that is
sold.
o Natural. The Company features foods that are free from artificial
preservatives, colors, flavors and sweeteners.
o Taste. The Company is passionate about great tasting food and the
pleasure of sharing it with others.
o Freshness. The Company is committed to foods that are fresh, wholesome
and safe to eat.
o Organic. The Company seeks out and promotes organically grown foods.
o Wellness. The Company provides foods and nutritional products that
support health and well-being.
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Product Categories. The Company's product offerings include organic and high
quality conventional produce; convenient and tasty prepared foods; high quality
natural and conventional meats; a variety of wild and natural farm-raised
seafood; a bakery featuring Whole Foods Market brand crusty breads; choice
selections of specialty cheeses, beer and wine; a mixture of natural, organic,
gourmet and ethnic grocery products; numerous value priced items in the bulk
department; and a nutrition area offering a complete alternative pharmacy with
holistic remedies, herbs, vitamins and supplements.
Private Label Products. The Company has expanded its private label offerings
over the last several years and has developed two different lines of products.
The "Whole Foods" label program began in 1992 and markets "best of the class"
premium and super premium products. The Company seeks artisan food producers,
small batch production and hand-tested recipes for inclusion in this program.
Products marketed under the "Whole Foods" label include organic pasta sauces,
pear and plum butters, organic kalamata olives, jams, organic olive oil, salsa,
honey and organic chocolate bars. In 1998, the Company has added to this private
label program items such as butter cookies imported from France, smoked salmon,
organic hot chocolate, organic water crackers imported from England and French
soap. In 1997, the Company introduced a new line of products under the "365"
label which emphasizes every day value products. The goal of this program is to
find products that meet the Company's quality standards but are less expensive
than alternative products available to the Company. The Company markets these
products to its customer through special displays and distinctive packaging.
Products marketed under this private label program include expeller pressed
canola oil, several cuts of imported Italian pasta, pasta sauces, extra virgin
olive oil, frozen fruit bars, dolphin-safe canned tuna, spring water and two
flavors of macaroni and cheese. Additional "365" items include dry and canned
pet food, dry breakfast cereals, 100% recycled paper towels, bathroom tissues
and paper napkins, frozen waffles, baked tortilla chips, tomatoes, frozen
vegetables, frozen fruits, fruit spreads, whole bean coffees, sorbet, ice cream,
cookies, soft drinks and 100% fruit juices.
Nutritional Supplements. Amrion currently markets and sells more than 900
products, including nutriceuticals, herbs, herbal formulas, vitamins, minerals
and homeopathic products. Amrion products are dietary nutritional supplements
and not pharmaceutical or medicinal products, and these products are sold under
Company-owned trademarks primarily through direct marketing. Three product
groups collectively comprise a significant portion of Amrion's net sales. These
product groups are known as Coenzyme Q10, Ginkgo Biloba and Bilberry. To reduce
the potential adverse effect of a decreased demand for any of these products,
Amrion continually adds new products to its existing line.
Whole Foods Market introduced private label nutritional supplements and
nutriceuticals manufactured by Amrion in its retail stores during fiscal 1998.
Additionally, the Company plans to redesign its nutritional departments to be
more accessible and customer friendly.
Store Operations
Team Approach to Store Operations. The Company has promoted a strong company
culture featuring a team approach to store operations which the Company believes
is distinctly more empowering of employees than that of the traditional
supermarket. Each store employs between 34 and 342 people, organized into up to
nine teams, each led by a team leader. Each team is responsible for a different
aspect of store operations, such as produce; grocery; meat, poultry and seafood;
prepared foods; bakery goods; beer/wine/cheese; nutrition products (nutritional
supplements, herbs and body care); customer service; and the front-end section
which runs the customer check-out counters. The Company promotes a
decentralized, team approach to store operations in which many personnel,
merchandising and operating decisions are made by employee teams at the
individual store level.
The Company strives to create a company-wide consciousness of "shared fate" by
uniting the self-interests of team members as closely as possible to the
self-interests of customers and of shareholders. One way the Company reinforces
this concept is through its various gainsharing programs, which reward
specifically targeted performance such as team labor productivity. There is also
a team member incentive program which currently rewards team members for sales
increases of private label products. The Company also reinforces the shared fate
concept by offering team members three programs which encourage stock ownership.
Team members are eligible for stock options under the Team Member Stock Option
Plan either through seniority or promotion. Team members can also purchase
restricted stock at a discount through payroll deductions under the Team Member
Stock Purchase Plan. In addition, since 1996 the Company has made its employer's
match in the Company's 401(k) plan in Company stock. The Company believes
encouraging team members to become shareholders aligns the interests of team
members with the interests of its shareholders for the betterment of both
stakeholders.
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The Company believes that it helps to inspire its team members by providing them
with a greater sense of purpose and mission in their work. For many team
members, their job is an extension of their personal philosophy and lifestyle.
Team members can feel they are contributing to the good of others by selling
clean and nutritious foods, by contributing to long-term sustainable agriculture
and by promoting a pesticide-free and healthier environment. Additionally, the
Company has a program which provides paid time off to team members for working
with qualified community service organizations. Because of the Company's
decentralized management structure, an effective store team leader (store
manager) is critical to the success of the store. Store team leaders are paid a
salary plus a bonus based on store profit contribution. The store team leader
works closely with the associate store team leader, as well as with all the team
leaders, to operate the store as efficiently and profitably as possible.
Store Description. The Company has no prototype store. Each store's layout is
customized to the actual size and configuration of the particular location. The
Company emphasizes strong visual presentations in all key traffic areas of its
stores. Merchandising displays are changed frequently and often incorporate
seasonal themes. The stores also sponsor a variety of organized in-store
activities, such as store tours, samplings, taste fairs and other special
events. To further a sense of community and interaction with customers, the
stores typically include sit-down eating areas, customer comment boards and
centrally located information booths. In addition, some stores offer special
services such as home delivery.
Site Selection. Each of the stores are generally located in high-traffic
shopping areas and are either freestanding or in strip centers. In selecting
store locations, the Company uses an internally-developed model to analyze
potential markets on such criteria as income levels, population density and
educational levels. After the Company has selected a target site, it retains an
independent third party consultant to project sales. The Company primarily seeks
to open large format stores which range between 30,000 to 50,000 square feet,
located on premier real estate sites, often in urban, high population locales.
Stores currently under development average approximately 34,000 square feet. In
addition, the Company will also opportunistically pursue smaller store sites
which it believes can achieve management's sales and return on investment
targets.
The Company typically opens a new store approximately 12 to 24 months after a
store site is selected and the lease is signed. The Company estimates that its
cash requirements to open a new store will range (depending on the size of the
new store, geographic location, degree of work performed by the landlord, and
complexity of site development issues) from $3 million to $12 million, excluding
new store inventory (approximately $500,000). The Company incurred in fiscal
1998 on average approximately $530,000 in pre-opening expenses for new stores
other than relocated stores. Pre-opening expenses are currently expensed in the
quarter in which the store is opened.
Purchasing and Distribution
The Company's buyers purchase products for retail sale from regional wholesale
suppliers and vendors. Over the last few years, the Company has shifted some of
its purchasing operations from the store to the regional and national level. By
purchasing on a regional and national level, the Company is able to negotiate
better volume discounts with major vendors and distributors. The Company expects
planned upgrades to its information systems to improve the Company's purchasing
leverage by providing product and quantity information by supplier on a regional
and company-wide basis. The Company owns and operates seven distribution centers
across the country. The largest of the Company's distribution centers, Texas
Health Distributors in Austin, Texas, distributes natural products to the
Company's stores in Texas and Louisiana as well as to other food retailers.
The other six distribution centers primarily distribute produce and the
Company's private label products to Company stores in their respective regions.
In addition, the Company owns a seafood wharf, a produce procurement center, a
specialty coffee roaster and distributor and has established regional
commissaries and bakehouses, all of which distribute products to the Company's
stores.
Amrion currently imports approximately 75% of its raw materials from various
foreign countries. Due to the increase in demand for Amrion's products from the
overall growth in the natural products industry, Amrion has developed strategic
partnerships with key domestic and international raw material suppliers. These
written supply contracts between Amrion and principal raw material suppliers are
negotiated each year and provide reasonable assurance that Amrion's supply of
raw materials will not be interrupted. However, alternative sources of Amrion's
materials are available in the event a supplier is unable to deliver as
specified in the written supply contract. The termination of supply by one or
more of its vendors could have a temporary adverse effect on Amrion's sales. The
cost incurred by Amrion for its raw materials could rise in the event of a
deterioration of the value of the U.S. Dollar against the foreign currencies of
Amrion's suppliers. Further cost increases could result due to the increase in
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demand relative to the supply of these products from the overall growth in the
natural products industry. The Company intends to utilize Amrion's expertise to
develop a direct marketing distribution of Whole Foods Market private label
products through catalogue and internet-based sales.
Marketing
The Company spends less on advertising than conventional supermarkets, instead
relying primarily on word-of-mouth recommendations from its customers. The
Company allocates about half of its marketing budget to region-wide programs and
the remainder to the individual store's marketing efforts. The stores spend most
of their own marketing budgets on store events such as taste fairs, classes,
store tours and product samplings. Each store also has a separate budget for
making contributions to a variety of philanthropic and community activities,
creating goodwill and maintaining a high profile in the community. The Company
presently contributes approximately 5% of its after tax profits in the form of
cash or products to not-for-profit organizations.
Amrion utilizes direct mail of Company designed catalogs, brochures and
individual mail pieces which highlight product lines and current promotional
activities. Amrion complements its direct mail activities with print
advertising, free standing inserts and package insert programs. Additionally,
Amrion's retail and health care professional divisions, which target health food
stores, health care providers and mass merchandisers, utilize marketing
strategies which include direct mail, telemarketing contact, personal visits
from sales representatives, consumer and trade advertising, point of sale
materials, free standing inserts with coupons in newspapers and radio
advertising.
Competition
The Company's natural foods competitors currently include other natural foods
supermarkets, conventional and specialty supermarkets, other natural foods
stores and small specialty stores. Although the Company historically has
encountered limited competition in its geographic markets with other stores
operating in the natural foods supermarket format, it has faced increased
competition in recent years from such stores, particularly in new markets, and
expects to encounter additional competition from such stores in its existing
markets and in new markets. When the Company faces such direct competition,
there can be no assurance that the Company will be able to compete effectively
or that increased competition will not adversely impact the Company's results of
operations. In addition, conventional and specialty supermarkets compete with
the Company in one or more product categories and may expand more aggressively
in marketing a broad range of natural foods and thereby compete more directly
with the Company for products, customers and locations. Some of the Company's
competitors have been in business longer or have greater financial or marketing
resources than the Company and may be able to devote greater resources to
securing suitable locations and to the sourcing, promotion and sale of their
products.
The business of developing, manufacturing and marketing vitamins, minerals and
other nutritional supplements is highly competitive. It is not possible to
accurately assess the number and size of competitors, as the nutritional
supplement industry is composed of many small companies, many of which are
privately-held and do not publish sales and marketing figures. The Company
believes that Amrion's competitive pricing, quality of advertising,
comprehensive lines of quality products and customer service commitment enable
it to compete favorably with other vitamin and nutritional supplement companies.
Government Regulation
The Company's stores are subject to various federal, state and local laws,
regulations and administrative practices affecting its business and must comply
with provisions regulating health and sanitation standards, food labeling, equal
employment, minimum wages and licensing for the sale of food and, in some
stores, alcoholic beverages. Difficulties or failures in obtaining or
maintaining required licenses or other required approvals could delay or prevent
the opening of new stores or adversely affect the operations of existing stores.
The manufacturing, processing, formulating, packaging, labeling and advertising
of products, particularly the nutriceutical and nutritional supplement products
developed, produced and marketed by Amrion, are subject to regulation by one or
more federal agencies, including the FDA, FTC, CPCS, USDA and EPA. Amrion's
activities are also regulated by various agencies of the states, localities and
foreign countries to which Amrion's products are distributed and in which
Amrion's products are sold.
The composition and labeling of nutritional supplements and nutriceuticals,
which comprise a significant majority of Amrion's products, is most actively
regulated by the FDA under the provisions of the Federal Food, Drug, and
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Cosmetic Act ("FFDC Act"). The FFDC Act has been revised in recent years by the
Nutrition Labeling and Education Act of 1990 ("NLEA") and by the Dietary
Supplement Health and Education Act of 1994 ("DSHEA"). Final rules establishing
labeling and notification requirements for dietary supplements were promulgated
by the FDA on September 23, 1997, and the labeling portion of the regulations
will take effect on March 23, 1999. Amrion is in the process of implementing the
labeling and notification provisions. Additionally, on April 29, 1998, the FDA
published a proposed rule regarding claims for dietary supplements concerning
the effects of the product on the structure or function of the body. The FTC
also issued a guidance document for dietary supplement advertisement in November
1998.
Employees
As of September 27, 1998, the Company had approximately 14,200 employees,
including approximately 12,300 full-time and 1,900 part-time employees. The
Company sponsors a partially self-insured health care benefits plan for
participating employees. The Company does not subscribe to any workers'
compensation insurance program with respect to its employees in Texas and
instead maintains a reserve for job-related injury claims. The employees of the
Company are not represented by a labor union or collective bargaining agreement.
Certain of the Company's stores have been, and certain stores continue to be,
subjected to informational pickets by the local retail clerks' and butchers'
unions.
Trademarks
Registered service marks of the Company include the names "Whole Foods Market,"
"Wellspring," "Bread & Circus," "Fresh Fields," "Good for You Foods," "Organic
Coffee Company," "Allegro Coffee Company" and the Company's stylized logos. The
Company also owns common law trademarks and trademark registrations including
those used on certain product names used by Amrion.
Risk Factors
The Company wishes to caution readers that the following important factors,
among others, could cause the actual results of Whole Foods Market to differ
materially from those indicated by forward-looking statements made from time to
time in news releases, reports, proxy statements, registration statements and
other written communications, as well as oral forward-looking statements made
from time to time by representatives of the Company. Except for historical
information, the matters discussed in such oral and written communications are
forward-looking statements that involve risks and uncertainties, including but
not limited to general business conditions, the timely and successful
development and opening of new stores, the impact of competition and other risks
detailed below. "Forward-looking statements" within the meaning of Section 21E
of the Securities Exchange Act of 1934, as amended, can be identified by the use
of predictive, future-tense or forward-looking terminology, such as "believes,"
"anticipates," "expects," "estimates," "may," "will" or similar terms.
Forward-looking statements also include projections of financial performance,
statements regarding management's plans and objectives and statements concerning
any assumptions relating to the foregoing. All subsequent written or oral
forward-looking statements attributable to the Company or persons acting on its
behalf are expressly qualified by these factors.
Growth Dependent on Expansion. The Company's strategy is to expand through a
combination of new store openings and acquisitions of existing stores as well as
the possible acquisition or development of businesses with complementary product
lines and related lines of business. Successful implementation of this strategy
is contingent on numerous conditions, some of which are described below, and
there can be no assurance that the Company's expansion strategy can be
successfully executed.
Continued growth of Whole Foods Market will depend to a significant degree upon
its ability to open or acquire new stores in existing and new markets and to
operate these stores on a successful basis. Further, the Company's expansion
strategy is dependent on finding suitable locations, and Whole Foods Market
faces intense competition with other retailers for such sites. There can be no
assurance that Whole Foods Market will be able to open or acquire new stores in
a timely manner and to operate them on a successful basis. In addition, there
can be no assurance that Whole Foods Market can successfully hire and train new
employees and integrate them into the programs and policies of Whole Foods
Market or adapt its distribution, management information and other operating
systems to the extent necessary to operate new or acquired stores in a
successful and profitable manner and adequately supply natural foods products to
these stores at competitive prices.
There can be no assurance that Whole Foods Market will continue to grow through
acquisitions. To the extent Whole Foods Market further expands by acquiring
existing businesses, there can be no assurance that Whole Foods Market can
successfully integrate the acquired businesses into its operations and support
systems, and that the operations of acquired businesses will not be adversely
affected as the Company's decentralized approach to operations is introduced.
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Capital Needed for Expansion. The acquisition of existing stores, the opening of
new stores and the development of new production and distribution facilities
requires significant amounts of capital. In the past, the Company's growth has
been funded primarily through proceeds from public offerings, bank debt, private
placements of debt, and internally generated cash flow. These and other sources
of capital may not be available to Whole Foods Market in the future.
Quarterly Fluctuations. The Company's quarterly operating results could be
adversely affected by losses from new stores, variations in the mix of product
sales, price changes in response to competitive factors, increases in
merchandise costs, possible supply shortages and the timing of acquisitions. In
addition, the Company's quarterly results of operations may fluctuate
significantly as the result of the timing of new store openings and the range of
operating results which may be generated from newly opened stores. The Company
currently expenses pre-opening costs associated with a new store opening during
the quarter in which the store is opened. Accordingly, quarter to quarter
comparisons of results of operations have been and may be materially impacted by
the timing of new store openings. Information on future requirements for
pre-opening costs is included in "Adoption of Accounting Standards" in
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
Competition. The Company's competitors include other natural foods stores, large
and small traditional and specialty supermarkets and grocery stores. These
stores compete with Whole Foods Market in one or more product categories. In
addition, traditional and specialty supermarkets are expanding more aggressively
in marketing a broad range of natural foods and thereby competing directly with
Whole Foods Market for products, customers and locations. Some of these
potential competitors have been in business longer or have greater financial or
marketing resources than Whole Foods Market and may be able to devote greater
resources to the sourcing, promotion and sale of their products. Increased
competition may have an adverse effect on profitability as the result of lower
sales, lower gross profits, and/or greater operating costs such as marketing.
The sales of nutritional supplements, nutricueticals and other fitness and
health-related products are highly competitive, and the Company expects to face
such continued competitive pressure in the future. Amrion's nutritional
supplement products, which are its largest source of revenue, compete on a
national and regional basis directly with other specialty health retailers,
nutritional supplement manufacturers and mass merchandisers such as drug stores
and supermarkets. Many of these competitors are substantially larger and have
greater resources than Whole Foods Market.
Food Safety. There is increasing governmental scrutiny of and public awareness
regarding food safety. The Company believes that many customers choose to shop
at Whole Foods Market because of their interest in health, nutrition and food
safety. Although the Company has intensified its food safety procedures for
perishables, it anticipates that its customers will hold it to a higher standard
than conventional supermarkets. The sale of contaminated food products, or the
perception of such sale, by the Company could have a material adverse effect on
its operations.
Personnel Matters. Whole Foods Market is dependent upon a number of key
management and other personnel. The loss of the services of a significant number
of key personnel within a short period of time could have a material adverse
effect upon Whole Foods Market. The Company's continued success is also
dependent upon its ability to attract and retain qualified employees to meet
Whole Foods Market's future needs. The Company faces intense competition for
qualified personnel, many of whom are subject to offers from competing
employers, and there can be no assurance that Whole Foods Market will be able to
attract and retain such personnel. Whole Foods Market does not maintain key
person insurance on any employee.
Integration of Acquired Operations. By acquiring many new stores and certain
manufacturing type businesses in the last several years, the Company has
materially increased the scope of its operations by (i) increasing the number of
its stores and entering new markets and (ii) including the manufacturing of
nutriceuticals and nutritional supplements and the direct marketing of these.
There can be no assurance that comparable store sales of acquired stores will
increase to or be maintained at the level achieved by existing Whole Foods
Market stores. Additionally, there can be no assurance that the operations of
acquired stores will not be adversely affected as a result of the introduction
of the Company's team approach to store operations, or the response of customers
to the changes in operations and merchandising mix made by new ownership. With
respect to the Company's acquisition of manufacturing operations, there can be
no assurance that current retail stores which are customers of the acquired
companies will continue to do business with such companies after they become
subsidiaries of Whole Foods Market, nor can there be any assurance that Whole
Foods Market can realize the expected benefits from the acquisition of these
companies. The integration of acquired operations into Whole Foods Market will
require the dedication of management resources which may temporarily detract
from attention to day-to-day business of the Company.
9
Negative Impact of Litigation Possible. From time to time the Company is the
subject of various lawsuits arising in the ordinary course of business.
Additionally, like other retailers, distributors and manufacturers of products
that are ingested, the Company faces an inherent risk of exposure to product
liability claims in the event that the use of its products results in injury.
Although not currently anticipated by management, the Company's results could be
materially impacted by legal and settlement expenses related to such lawsuits.
Government Regulation. The manufacturing, processing, formulating, packaging,
labeling and advertising of products, particularly the nutriceutical and
nutritional supplement products, are subject to regulation by one or more
federal agencies, including the FDA, the FTC, the CPSC, the USDA and the EPA.
Amrion's activities are also regulated by various agencies of the states,
localities and foreign countries to which Amrion's products are distributed and
in which Amrion's products are sold.
The composition and labeling of nutritional supplements and nutricueticals is
most actively regulated by the FDA under the provisions of the FFDC Act. The
FFDC Act has been revised in recent years by the NLEA and by the DSHEA. While in
the judgment of Whole Foods Market these regulatory changes are generally
favorable to the nutritional supplements industry, there can be no assurance
that Amrion will not in the future be subject to additional laws or regulations
administered by various regulatory authorities. In addition, there can be no
assurance that existing laws and regulations will not be repealed or be subject
to more stringent or unfavorable interpretation by applicable regulatory
authorities.
Final rules establishing labeling and notification requirements for dietary
supplements were promulgated by the FDA on September 23, 1997 and the labeling
portion of the regulations will take effect on March 23, 1999. Amrion is in the
process of implementing the recent labeling and notification provisions.
Additionally, on April 29, 1998, the FDA published a proposed rule regarding
claims for dietary supplements concerning the effects of the product on the
structure or function of the body. The FTC also issued a guidance document for
dietary supplement advertisement in November 1998.
The Company cannot predict the nature of future laws, regulations,
interpretations or applications, nor can it determine what effect either
additional governmental regulations or administrative orders, when and if
promulgated, or disparate federal, state and local regulatory schemes would have
on its business in the future. They could, however, require the reformulation of
certain products to meet new standards, the recall or discontinuance of certain
products not able to be reformulated, additional record keeping, expanded
documentation of the properties of certain products, expanded or different
labeling and/or scientific substantiation. Any or all of such requirements could
have an adverse effect on the Company's results of operations and financial
condition.
Governmental regulations in foreign countries where Amrion plans to expand sales
may prevent or delay entry into the market or prevent or delay the introduction,
or require the reformulation, of certain of Amrion's products.
Sales Concentrations of Major Products. Three product groups collectively
comprise a significant portion of Amrion's net sales. These product groups are
known as Coenzyme Q10, Ginkgo Biloba and Bilberry. Although historically sales
of these products have increased annually, there can be no assurance this trend
will continue or that current revenues attributed to the products will be
maintained. To the extent customer demand for these product groups declines,
Amrion's sales would be adversely affected. To reduce the potential adverse
effect of a decreased demand for any of these products, Amrion continually adds
new products to its existing line.
Possible Volatility of Convertible Subordinated Debentures and Common Stock
Price. The market price of the Company's convertible subordinated debentures and
common stock could be subject to significant fluctuation in response to various
market factors and events, including variations in the Company's earning
results, changes in earnings estimates by securities analysts, publicity
regarding the Company, its competitors, the health food industry generally, new
statutes or regulations or changes in the interpretation of existing statutes or
regulations affecting the health food industry specifically, sales of
substantial amounts of common stock in the public market or the perception that
such sales could occur and other factors. In addition, in recent years, the
stock market has experienced broad price and volume fluctuations that often have
been unrelated to the operating performance of particular companies. These
market fluctuations also may adversely affect the market price of the debentures
and the common stock. Volatility in the price of the Company's common stock,
changes in prevailing interest rates and changes in perception of the Company's
creditworthiness may in the future adversely affect the price of the debentures.
10
Information System Upgrades and Year 2000 Issues. The Company continually
evaluates and upgrades its management information systems. The Company has
completed a number of acquisitions in recent years, and the information systems
of some of the acquired operations have not been fully integrated with the
Company's information systems. Although the Company does not anticipate any
disruption in its operations or financial reporting as a result of system
upgrades or system integrations, there can be no assurance that such disruption
will not occur or that the desired benefits from the system upgrades will be
realized.
Currently there is significant uncertainty in the software industry and among
software users regarding the impact of the year 2000 on installed software.
Software database modifications and/or implementation modifications will be
required to enable such software to distinguish between 21st and 20th century
dates. The Company uses third-party system software which will need to be
modified or replaced in order to address year 2000 compliance. If the Company is
unsuccessful in completing remediation of non-compliant systems, if the costs to
remediate the Company's Year 2000 issues significantly exceed current estimates,
or if significant third parties upon whom the Company relies cannot resolve
their Year 2000 issues, there could be a material adverse effect on the
Company's business, financial condition, and results of operations. Additional
information on Year 2000 issues is included under the caption "Year 2000 Issues"
in Management's Discussion and Analysis of Financial Condition and Results of
Operations.
Item 2. Properties
The Company owns the New Orleans store location. The Company also owns a
building in Austin, Texas which houses one of its stores, the corporate
headquarters and a bookstore. The underlying property is leased from a third
party under a ground lease which has a base term of twenty years with ten
options to renew for five years each. The Company owns the underlying property
for its stores in development in Atlanta and Santa Fe. The Company owns a
manufacturing, distribution and warehousing facility and an adjacent lot near
Boulder, Colorado, an office building in Boulder and an undeveloped property in
Westminster, Colorado. In October 1998, the Company purchased a 381,000 square
foot manufacturing, distribution, warehousing and administrative facility in
Thornton, Colorado. All other stores, distribution centers, bakehouses and
administrative facilities are leased, with expiration dates ranging from 1 to 25
years. The Company has options to renew most of its leases with renewal periods
ranging from 5 to 50 years.
The Company has a lease with the bookstore at its building in Austin, Texas.
Certain officers of the Company are also shareholders of the bookstore in which
they own a combined 13.4% of the outstanding stock. The Company believes that
the terms of the lease between the Company and the bookstore are on terms no
less favorable to the Company than could have been negotiated with an
independently owned retailer. This is partially based on an appraisal of the
lease by an independent appraisal firm. The income from this lease is not
material to the operations of the Company.
Item 3. Legal Proceedings
From time to time, the Company is involved in lawsuits that the Company
considers to be in the normal course of its business which have not resulted in
any material losses to date.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
11
PART II
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters
The Company's common stock is traded on the Nasdaq Stock Market under the symbol
"WFMI." The following sets forth the high and low sales prices for the Company's
last two fiscal years.
High Low
Fiscal 1997
September 30, 1996 to January 19, 1997 $27.75 $17.50
January 20, 1997 to April 13, 1997 $24.50 $17.50
April 14, 1997 to July 6, 1997 $33.75 $20.50
July 7, 1997 to September 28, 1997 $36.63 $32.38
Fiscal 1998
September 29, 1997 to January 18, 1998 $51.38 $34.63
January 19, 1998 to April 12, 1998 $70.13 $44.50
April 13, 1998 to July 5, 1998 $67.50 $53.00
July 6, 1998 to September 27, 1998 $66.50 $35.50
The Company had approximately 1,500 record holders of its common stock as of
November 30, 1998.
On March 30, 1998, the shareholders of the Company approved an amendment to the
Articles of Incorporation that increased the authorized number of shares of
common stock from 50 million to 100 million.
The Company intends to retain any earnings for use in its business and therefore
does not anticipate paying any cash dividend in the foreseeable future. The
Company's present bank credit agreement contains certain restrictive covenants
that include the unavailability of the payment of dividends on common stock.
In fiscal year 1998 the Company issued the following unregistered securities:
(1) In December 1997, the Company issued 1,013,340 shares of Common Stock
to the former stockholders of commonly controlled companies doing
business as Merchant of Vino as consideration for the Company's
acquisition of Merchant of Vino.
(2) In December 1998, the Company issued 174,878 shares of Common Stock to
the former stockholder of Allegro Coffee Company, Inc. as consideration
for the Company's acquisition of Allegro Coffee Company, Inc.
In issuing such securities, the Company relied on the exemption from the
registration and prospectus delivery requirements of the Securities Act of 1933,
as amended, provided by Section 4(2) of such Act.
In addition, as previously reported on the Company's Form 10-Q for the period
ended January 18, 1998, the Company issued in February 1998 in a private
offering under Rule 144A of the Securities Act of 1933, as amended, zero coupon
convertible subordinated debentures. In issuing such securities, the Company
relied on the exemption from the registration and prospectus delivery
requirements of the Securities Act of 1933, as amended, provided by Rule 144A
promulgated under such Act.
12
Item 6. Selected Financial Data
Whole Foods Market, Inc. and Subsidiaries
Summary Financial Information (In thousands, except per share and operating
data)
Sept 27 Sept 28 Sept 29 Sept 24 Sept 25
1998 1997 1996 1995 1994
- -------------------------------------------------------------------------------------------------------------------
Consolidated Statements of Operations (1)
Sales $ 1,389,768 1,117,346 946,353 748,691 597,294
Cost of goods sold and occupancy costs 921,104 749,551 645,925 504,211 402,471
- -------------------------------------------------------------------------------------------------------------------
Gross profit 468,664 367,795 300,428 244,480 194,823
Selling, general and administrative expenses 385,573 312,703 266,107 225,755 177,850
Pre-opening and relocation costs 3,979 5,243 5,903 6,361 9,145
Merger and reorganization expenses 1,699 4,887 38,516 0 0
- -------------------------------------------------------------------------------------------------------------------
Income (loss) from operations 77,413 44,962 (10,098) 12,364 7,828
Interest expense (7,685) (6,044) (4,671) (2,368) (127)
Investment and other income 2,328 450 650 1,087 1,166
- -------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes 72,056 39,368 (14,119) 11,083 8,867
Provision (credit) for income taxes 26,661 12,724 (1,404) 6,899 7,095
- -------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 45,395 26,644 (12,715) 4,184 1,772
- -------------------------------------------------------------------------------------------------------------------
Basic income (loss) per common share $ 1.74 1.10 (0.54) 0.18 0.08
- -------------------------------------------------------------------------------------------------------------------
Weighted average common shares outstanding 26,159 24,194 23,366 22,724 22,187
- -------------------------------------------------------------------------------------------------------------------
Diluted income (loss) per common share $ 1.64 1.06 (0.54) 0.18 0.08
- -------------------------------------------------------------------------------------------------------------------
Weighted average shares outstanding,
diluted basis 27,744 25,162 23,366 23,404 22,749
- -------------------------------------------------------------------------------------------------------------------
Operating Data:
Number of stores at end of period 87 75 68 61 49
Store sales per square foot 670 638 636 625 639
Average weekly sales per store 291,690 277,141 253,555 238,776 243,520
Comparable store sales increase (2) 11.0% 8.3% 5.4% 6.2% 9.9%
Consolidated Balance Sheet Data (End of Year):
Working capital 93,064 35,427 15,648 871 21,876
Total assets 544,808 398,484 340,819 290,414 221,510
Long-term debt (including current maturities) 159,016 93,844 85,291 53,721 8,389
Shareholders' equity 277,273 205,465 172,024 172,353 167,232
(1) The financial information above for prior periods has not been restated for
the pooling-of-interests acquisitions of Allegro Coffee Company and
Merchant of Vino due to the immateriality of the information of the
acquired entities to the Company's consolidated financial information.
Fiscal years 1998, 1997, 1995 and 1994 are 52-week years and fiscal year
1996 is a 53-week year.
(2) For internal reporting purposes, the Company's fiscal year is comprised of
13 accounting periods generally consisting of four weeks each. Sales of a
store are deemed to be "comparable" commencing in the fifty-third full week
during which the store was open.
13
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
General
Whole Foods Market opened its first store in Texas in 1980 and has expanded its
operations to 87 stores as of September 27, 1998 both by opening new stores and
acquiring existing stores from third parties. The results of the Company's
operations have been and will continue to be materially affected by the timing
and number of new store openings. New stores may incur operating losses for the
first one or two years of operations. The Company's results of operations are
reported on a 52- or 53-week fiscal year ending on the last Sunday in September.
Fiscal years 1998 and 1997 are 52-week years and fiscal year 1996 is a 53-week
year. In December 1997, the Company completed pooling-of-interests mergers with
Allegro Coffee Company, a specialty coffee roaster and distributor based in
Boulder, Colorado and Merchant of Vino, which operated four gourmet/natural food
supermarkets and two specialty wine and gourmet food shops in the greater
Detroit metropolitan area. For fiscal 1998, the financial information contained
herein presents the combined results of operations of Whole Foods Market,
Allegro Coffee Company and Merchant of Vino for the entire fiscal year. Prior
year results of operations have not been restated due to the immateriality of
the financial statements of the acquired entities to the Company's consolidated
financial statements.
Development Activity
The following is a schedule of stores opened, relocated, closed and acquired
during fiscal years 1998, 1997 and 1996:
Store Location Date
- ----- -------- ----
Reston Reston, VA opened 11/95
Oak Street Evanston, IL acquired 12/95
closed 9/96
Sherman Oaks West Sherman Oaks, CA opened 1/96
Tenley Washington, DC opened 1/96
Georgetown Washington, DC opened 1/96
Lakeview Lakeview, IL opened 2/96
Manhasset Munsey Park, NY opened 2/96
Arlington Arlington, VA opened 2/96
Durham Durham, NC relocated 2/96
Mt. Washington Baltimore, MD opened 5/96
Madison Madison, WI opened 6/96
West LA Los Angeles, CA relocated 7/96
Franklin San Francisco, CA opened 7/96
Cupertino Cupertino, CA relocated 8/96
Vienna Vienna, VA opened 11/96
La Jolla La Jolla, CA opened 11/96
Philadelphia Philadelphia, PA opened 1/97
Wheaton Wheaton, IL relocated 2/97
Hillcrest San Diego, CA opened 4/97
San Rafael San Rafael, CA opened 4/97
Federal Ft. Lauderdale, FL acquired 4/97
Plantation Plantation, FL acquired 4/97
Granary Monterey, CA acquired 8/97
Quarry San Antonio, TX relocated 10/97
Brentwood Brentwood, CA opened 10/97
Evanston Evanston, IL relocated 12/97
Birmingham Birmingham, MI acquired 12/97
Farmington Hills Farmington Hills, MI acquired 12/97
Plymouth Ann Arbor, MI acquired 12/97
Rochester Rochester, MI acquired 12/97
Somerset Troy, MI acquired 12/97
Troy Troy, MI acquired 12/97
Pearl Boulder, CO opened 2/98
Tempe Tempe, AZ opened 3/98
14
Store Location Date
- ----- -------- ----
Winter Park Winter Park, FL opened 4/98
Marlton Marlton, NJ opened 5/98
Monterey/Granary Monterey, CA relocated 6/98
Coral Springs Coral Springs, FL opened 9/98
Results of Operations
The following table sets forth the statement of operations data of Whole Foods
Market expressed as a percentage of sales for the fiscal years indicated:
Year Ended 1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------
Sales 100.0% 100.0% 100.0%
Cost of goods sold and occupancy costs 66.3 67.1 68.3
- --------------------------------------------------------------------------------------------------------------------
Gross profit 33.7 32.9 31.7
Selling, general and administrative expenses 27.7 28.0 28.1
Pre-opening and relocation costs 0.3 0.5 0.6
Merger and reorganization expenses 0.1 0.4 4.1
- --------------------------------------------------------------------------------------------------------------------
Income (loss) from operations 5.6 4.0 (1.1)
Interest expense (0.6) (0.5) (0.5)
Investment and other income 0.2 0.0 0.1
- --------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes 5.2 3.5 (1.5)
Provision (credit) for income taxes 1.9 1.1 (0.1)
- --------------------------------------------------------------------------------------------------------------------
Net income (loss) 3.3% 2.4% (1.3)%
- --------------------------------------------------------------------------------------------------------------------
Figures may not add due to rounding.
Sales
Sales for all years shown reflect increases due to new stores opened and
acquired and comparable store sales increases of 11.0%, 8.3%, and 5.4% for
fiscal years 1998, 1997 and 1996, respectively. Sales of a store are deemed to
be comparable commencing in the fifty-third full week after the store was opened
or acquired. The Company expects that comparable store sales increases for
fiscal year 1999 will be lower than for fiscal year 1998. The Company believes
that current comparable store sales increases have been greater than historical
averages due to such factors as increasing sales in stores acquired from Fresh
Fields, the comparison of sales from stores located in Southern California which
were negatively impacted in the prior year by the name change from Mrs. Gooch's
to Whole Foods Market, improvements in overall store execution and increased
sales of newly released private label products. Comparable store sales increases
generally resulted from an increase in the number of customer transactions and
slightly higher average transaction amounts, reflecting an increase in market
share as the stores mature in a particular market. Additionally, net sales by
Amrion increased over the prior year by 20.0%, 25.5%, and 40.0% for fiscal years
1998, 1997 and 1996, respectively. Sales increases by Amrion resulted from
improved customer acquisition programs and expanded retail and mass market
distribution programs. The Company believes that historical sales trends may not
necessarily be indicative of future results of operations.
Gross Profit
Gross profit consists of sales less cost of goods sold and occupancy costs, plus
contribution from non-retail grocery distribution and food preparation
operations. The Company's consolidated gross profit in fiscal year 1998
increased as a percentage of sales to 33.7% from 32.9% in fiscal year 1997 and
from 31.7% in fiscal year 1996. These increases reflect increased national
buying and private label initiatives which continue to lower the cost of product
purchased on a national basis, and continued improvement by new stores with
respect to product procurement and merchandising and controlling spoilage. In
all years, gross profit margins were positively affected by margin improvements
as stores mature. Relative to other stores in a region, gross profit margins
tend to be lower for new stores and increase as stores mature, reflecting lower
spoilage as volumes increase, as well as increasing experience levels and
operational efficiencies of the store teams. Additionally, gross profit margins
were positively affected in all years by the increased percentage of sales in
certain regions and in departments such as prepared foods where the Company
achieves higher gross profits. Gross profits were also positively affected for
all years by reductions in product cost as a percentage of sales at Amrion,
offset by a slight increase in indirect costs in fiscal 1998.
15
Selling, General and Administrative Expenses
Selling, general and administrative expenses in fiscal 1998 decreased as a
percentage of sales to 27.7% from 28.0% in fiscal year 1997 and 28.1% in fiscal
year 1996. These decreases in selling, general and administrative expenses as a
percentage of sales reflect reductions in store labor costs and increases in
store sales without comparable increases in administrative staff. These
decreases were offset by increased market development costs and increased
administrative staff at Amrion. Whole Foods Market has historically been able to
expand without a significant increase in general and administrative costs.
However, in certain circumstances the Company has increased the number of
administrative and support personnel at the regional and national levels in
connection with the implementation of new management information systems and to
support current and planned growth.
Pre-opening and Relocation Costs
Whole Foods Market developed and opened six new stores in fiscal 1998, five new
stores in fiscal 1997, and ten new stores in fiscal 1996. Additionally, the
Company relocated three stores in fiscal 1998, one store in fiscal 1997, and
three stores and the Fresh Fields corporate office in fiscal 1996. Pre-opening
and relocation costs in fiscal 1998, 1997 and 1996 were approximately $4.0
million, $5.2 million and $5.9 million, respectively. Pre-opening costs include
hiring and training personnel, supplies and certain occupancy and miscellaneous
costs related to new store and facility openings and are expensed in the quarter
of the opening. Pre-opening costs are generally higher in locations which are
some distance from an existing base of operations due to higher training, travel
and moving costs. Relocation costs consist of losses on dispositions of fixed
assets and inventories, remaining lease payments and other costs of holding
replaced facilities and other related expenses.
Merger and Reorganization Expenses
Merger expenses in fiscal 1998 include transaction expenses associated with the
acquisitions of Merchant of Vino and Allegro Coffee Company. Merger expenses in
fiscal 1997 include transaction expenses associated with the acquisition of
Amrion. Merger and reorganization expenses in fiscal 1996 include severance,
transaction expenses, duplicate system disposal costs and conforming accounting
adjustments associated with the acquisition of Fresh Fields, and severance and
other costs associated with the restructuring of the Southern California region.
Additionally, fiscal 1996 expenses include losses on the disposition of store
assets, remaining rent and lease termination costs recognized pursuant to a plan
initiated at the time of the Fresh Fields acquisition to close or relocate
duplicate stores. At September 27, 1998 and September 28, 1997, the Company had
remaining merger-related liabilities related to the Fresh Fields acquisition
totaling approximately $3.1 million and $9.8 million, respectively. These
liabilities were reduced primarily as a result of cash payments for rent and
lease termination costs. The Company does not expect the ultimate payment of
these liabilities to materially affect its liquidity.
Interest Expense
In 1996, the Company refinanced a portion of the outstanding balance on its $75
million bank line of credit with $40 million in newly issued senior notes. In
1997, the Company amended and increased its bank line of credit to $100 million.
In 1998, the Company issued $115 million of zero coupon convertible subordinated
debentures, and amended and reduced its bank line of credit to $10 million.
Interest expense related to the Company's borrowings was approximately $7.7
million in fiscal 1998, $6.0 million in fiscal 1997, and $4.7 million in fiscal
1996, net of capitalized interest associated with stores under development.
Investment and Other Income
Investment and other income for fiscal 1998 consists primarily of interest
income earned on a short-term corporate bond portfolio and a prime money market
portfolio. In fiscal 1997 and 1996, investment and other income consists
primarily of interest income generated from U.S. Treasury and agency securities.
Investment and other income was approximately $2.3 million, $450,000 and
$650,000 in fiscal 1998, 1997 and 1996, respectively.
16
Income Taxes
The Company's effective tax rate was 37% and 32.3% in fiscal 1998 and 1997,
respectively, and a credit of 10.0% in fiscal 1996. The income tax rate for
fiscal 1998 reflects the elimination of the approximately $7.8 million valuation
allowance previously provided on net operating loss carryforwards acquired in
the Fresh Fields merger. As of September 27, 1998, the Company had remaining net
operating loss carryforwards of approximately $8.6 million related to net
operating losses incurred by Fresh Fields from its inception until the fiscal
1996 acquisition by Whole Foods Market which are available to offset certain
future taxable income. The fiscal 1996 effective tax rate reflects a pre-tax
loss of $14.1 million and the non-deductibility for federal income tax purposes
of certain merger transaction costs that were expensed for financial accounting
and reporting purposes in that year. The Company expects its effective tax rate
for fiscal 1999 will be higher than its effective rate for fiscal 1998. As of
September 27, 1998, the Company considers it more likely than not that all net
operating loss carryforwards will be utilized.
Business Combinations
In December 1997, the Company completed a merger with Merchant of Vino, which
operated four gourmet/natural foods stores and two specialty wine and gourmet
food shops in the Detroit area, in exchange for approximately 1 million shares
of Company common stock. Also in December 1997, the Company completed a merger
with Allegro Coffee Company, a specialty coffee roaster and distributor based in
Boulder, Colorado, in exchange for approximately 175,000 shares of Company
common stock. These merger transactions were accounted for using the
pooling-of-interests method. Due to the immateriality of Merchant of Vino and
Allegro financial statements to the Company's consolidated financial statements,
financial information for the periods prior to fiscal 1998 was not restated.
In September 1997, the Company completed a merger with Amrion in exchange for
approximately 4.7 million shares of Company common stock, plus the assumption of
approximately 330,000 outstanding options to purchase shares of common stock.
The merger was accounted for using the pooling-of-interests method. Also in
fiscal 1997, the Company completed two acquisitions of three natural foods
markets in exchange for a total of 230,000 shares of Company common stock. These
acquisitions were accounted for using the pooling-of-interests method. Due to
the immateriality of the financial statements of these acquired companies to the
Company's consolidated financial statements, financial information for the
periods prior to the combination was not restated.
On August 30, 1996, the Company completed a merger with Fresh Fields Markets,
which operated 22 natural foods supermarkets, in exchange for approximately 4.8
million shares of Company common stock plus the assumption of approximately
549,000 outstanding options to purchase shares of common stock.
17
Quarterly Results
The first quarter consists of 16 weeks, the second and third quarters each
consist of 12 weeks and the fourth quarter consists of 12 or 13 weeks. Fiscal
year 1998 and 1997 are 52-week years with the fourth quarters consisting of 12
weeks. Because the first quarter is longer than the remaining quarters and
contains both the Thanksgiving and Christmas holidays, it typically represents a
larger share of the Company's annual sales from existing stores.
Quarter-to-quarter comparisons of results of operations may be materially
impacted by the number and timing of new store openings for which related costs
are deferred as incurred and expensed in the quarter the store is opened. The
Company believes that the historical pattern of quarterly sales and income as a
percentage of the annual total may not be indicative of the pattern in future
years. The following table sets forth selected quarterly unaudited financial
information for the fiscal years ended September 27, 1998 and September 28, 1997
(in thousands except per share data):
1st 2nd 3rd 4th
1998 Quarter Quarter Quarter Quarter
- -------------------------------------------------------------------------------------------------------------------
Sales $ 407,788 324,811 330,999 326,170
Gross profit 135,752 110,939 110,832 111,141
Pre-opening and relocation costs 1,065 1,462 1,024 428
Merger and reorganization expenses 1,699 0 0 0
Income from operations 21,084 18,857 18,921 18,551
Income before income taxes 19,092 17,657 17,621 17,686
Net income 12,028 11,124 11,101 11,142
Basic income per share $ 0.46 0.43 0.42 0.42
Weighted average common shares outstanding 25,913 26,094 26,279 26,435
Diluted income per share $ 0.44 0.40 0.40 0.40
Weighted average shares outstanding - diluted basis 27,523 27,824 27,880 27,824
- -------------------------------------------------------------------------------------------------------------------
1st 2nd 3rd 4th
1997 Quarter Quarter Quarter Quarter
- -------------------------------------------------------------------------------------------------------------------
Sales $ 312,584 259,800 274,510 270,452
Gross profit 99,447 85,284 92,021 91,043
Pre-opening and relocation costs 1,604 1,129 0 2,510
Merger and reorganization expenses 0 0 0 4,887
Income from operations 10,778 12,597 14,188 7,399
Income before income taxes 9,195 11,179 12,922 6,072
Net income 5,988 7,218 8,283 5,155
Basic income per share $ 0.25 0.30 0.34 0.21
Weighted average common shares outstanding 24,085 24,155 24,188 24,386
Diluted income per share $ 0.24 0.29 0.33 0.20
Weighted average shares outstanding - diluted basis 24,971 24,841 25,294 25,741
- -------------------------------------------------------------------------------------------------------------------
18
Liquidity and Capital Resources
At September 27, 1998 and September 28, 1997, the Company's working capital was
approximately $93.1 million and $35.4 million, respectively, and the ratio of
current assets to current liabilities was 2.02 to 1 and 1.46 to 1, respectively.
Net cash flow from operating activities was approximately $90.9 million, $54.0
million and $28.8 million in fiscal 1998, 1997 and 1996, respectively. During
1998 the Company issued for approximately $115 million zero coupon convertible
subordinated debentures. The issue price of the debentures results in an
effective yield to maturity of 5 percent. The debentures are convertible at the
option of the holder, at any time on or prior to maturity, unless previously
redeemed or otherwise purchased. Debentures may be redeemed at the option of the
holder on March 2, 2003, March 2, 2008 or March 2, 2013 for a purchase price
equal to issue price plus accrued original issue discount to such dates. Subject
to certain limitations, the Company, at its option, may elect to pay this
purchase price in cash, shares of common stock or any combination thereof.
Debentures may also be redeemed in cash at the option of the holder if there is
a change in control at a purchase price equal to issue price plus original issue
discount to the date of redemption. Subsequent to March 2, 2003, the debentures
are redeemable at the option of the Company for cash, in whole or in part, at
redemption prices equal to issue price plus accrued original issue discount to
date of redemption. The debentures are subordinated in the right of payment to
all existing and future senior indebtedness.
Whole Foods Market also maintains a bank credit agreement which provides for a
revolving line of credit of up to $10 million. Any amount outstanding under this
agreement is convertible into a four year term loan upon the expiration of the
revolving credit term on June 30, 1999. Principal payments are to be made in
quarterly installments beginning September 30, 1999. This credit agreement
contains certain restrictive covenants, including restrictions upon the payment
of dividends on common stock. The credit agreement also contains certain
affirmative covenants, including the maintenance of certain financial ratios as
defined in the agreement. All outstanding amounts borrowed under this agreement
bear interest at the Company's option of either a defined base rate or the
Eurodollar rate plus a premium. All amounts outstanding under the Company's line
of credit agreement were repaid during 1998 with proceeds from the issuance of
the convertible subordinated debentures and no amounts were drawn at September
27, 1998. At September 28, 1997 approximately $52.1 million was drawn under the
Company's line of credit agreement. In May 1996 the Company issued $40 million
of senior unsecured notes, bearing interest at 7.29% and payable in seven equal
annual installments beginning May 16, 2000. The notes contain certain
affirmative and negative covenants, including maintenance of certain financial
ratios. Net cash flow from financing activities was approximately $60.7 million,
$11.8 million and $38.9 million in fiscal 1998, 1997 and 1996, respectively.
Whole Foods Market's principal capital requirements have been the funding of the
development or acquisition of new stores and, to a lesser extent, the resultant
increase in working capital requirements. The Company estimates that cash
requirements to open a new store will range from $3 million to $12 million
(after giving effect to any landlord construction allowance). This excludes new
store inventory of approximately $500,000, a substantial portion of which is
financed by the vendors of Whole Foods Market. In fiscal 1999, Whole Foods
Market plans to open approximately nine new stores, relocate one existing store
and will have under development additional stores that will open in fiscal 2000.
The Company will incur additional capital expenditures in fiscal 1999 in
connection with ongoing equipment upgrades and resets at its existing stores,
purchase and development of new production, distribution and office facilities
for Amrion and Allegro and continued development of its management information
systems. Net cash flow used by investing activities was approximately $128.3
million, $56.4 million and $73.2 million in fiscal 1998, 1997 and 1996,
respectively. The Company expects that cash on hand and cash generated from
operations will be sufficient to fund planned store openings and other cash
needs through the end of fiscal 1999, absent any material cash acquisitions.
Year 2000 Issues
During fiscal 1998, the Company established a project team to coordinate
existing Year 2000 activities and address remaining Year 2000 issues. The team
has focused its efforts in three areas: (1) information systems (IS) software
and hardware; (2) facilities and non-IS equipment with embedded systems; and (3)
third-party relationships.
The Company has adopted a five-phase Year 2000 Plan consisting of: Phase I -
identification and ranking of the components of the Company's systems,
equipment, and suppliers that may be vulnerable to Year 2000 problems; Phase II
- - assessment of items identified in Phase I; Phase III - remediation or
replacement of non-compliant systems and components and determination of
solutions for non-compliant suppliers; Phase IV - testing and implementation of
systems for which remediation is complete; and Phase V - development of
contingency plans to mitigate the potential adverse effects on the Company's
operations of reasonably likely worst case Year 2000 scenarios. The Company has
19
completed Phase I and plans to complete Phase II by January 31, 1999. Phases III
and IV are underway concurrent with Phases I and II. Phase V will begin after
Phase II is completed.
Information Systems Software and Hardware. The Company has assessed its primary
information systems and remediation is in process for those systems that require
remediation. The Company's planned testing completion and implementation dates
for these systems are summarized below:
Planned Testing Planned
Completion Implementation
Date Date
----------------- -----------------
Point of Sale
Northeast May 30, 1999 June 29, 1999
Others December 31, 1998 April 30, 1999
Store Back Office
Mid-Atlantic April 30, 1999 May 3, 1999
Northeast May 30, 1999 June 29, 1999
S. Pacific January 31, 1999 March 29, 1999
Others December 31, 1998 May 3, 1999
Financials
Corporate System March 1, 1999 March 6, 1999
Mid-Atlantic April 30, 1999 May 1, 1999
Distribution
Corporate System March 1, 1999 March 6, 1999
Amrion June 18, 1999 June 27, 1999
Mid-Atlantic April 30, 1999 May 3, 1999
S. Pacific December 31, 1998 December 31, 1998
Other
Bakery/Commissary February 28, 1999 June 27, 1999
Time Keeping February 28, 1999 June 27, 1999
The Company plans to complete all remediation, testing, and implementation of
its individual information systems by June 30, 1999.
Facilities and Non-IS Equipment with Embedded Systems. The Company has completed
an inventory of all non-IS embedded systems. Assessment of these items is
planned to be complete by January 31, 1999. Plans are already in place to
upgrade a variety of devices such as time clocks, scales, fax machines, and HVAC
controls. The Company plans to complete remediation, testing and implementation
for all non-IS embedded systems by June 30, 1999.
Third-party Relationships. The Company has identified significant third parties
upon whom it relies and has sent written requests for representation of their
Year 2000 readiness. The Company is reviewing responses received and will follow
up on those not received. The Company will also be conducting discussions with
its most significant vendors and suppliers to verify their Year 2000 readiness
and review their contingency plans.
Costs to Address the Company's Year 2000 Issues. The Company estimates that the
expense associated with the Year 2000 Plan will be approximately $2 million, of
which approximately $150,000 has been incurred to date. Additionally, the
Company estimates that hardware and software purchases totaling approximately $2
million will be capitalized pursuant to the Year 2000 Plan.
Risks and Contingency Plans. The aforementioned costs and completion dates are
based on plans for work to be performed and management's best estimates, which
have been derived from assumptions about future events including the
availability of certain resources and other factors. The Company believes that
the Year 2000 Plan will address its Year 2000 concerns. However, if the Company
is unsuccessful in completing remediation of non-compliant systems, if the costs
to remediate the Company's Year 2000 issues significantly exceed current
estimates, or if significant third parties upon whom the Company relies cannot
resolve their Year 2000 issues, there could be a material adverse effect on the
Company's business, financial condition, and results of operations. Therefore,
the Company plans to develop by the end of July 1999 contingency plans to
20
address risks that have been determined to be most likely based upon the results
of assessment, testing and verification procedures. There are numerous
uncertainties related to Year 2000 issues including uncertainties related to
third parties upon whom the Company relies, and at this time the Company is
unable to fully determine the consequences of Year 2000 failures on its results
of operations. The Company believes that the successful implementation of its
Year 2000 Plan will mitigate the risk of a material adverse impact on the
Company's results of operations.
Adoption of Accounting Standards
The Financial Accounting Standards Board has issued Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS No. 130),
which is effective for financial statements issued for periods beginning after
December 15, 1997. The Company plans to adopt SFAS No. 130 in fiscal year 1999.
This statement establishes standards for reporting and displaying comprehensive
income and its components in a full set of general-purpose financial statements.
The Company does not expect the adoption of SFAS No. 130 to result in
significant additional disclosures.
The Financial Accounting Standards Board has issued Statement of Financial
Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and
Related Information" (SFAS No. 131), which is effective for financial statements
issued for periods beginning after December 15, 1997. The Company plans to adopt
SFAS No. 131 in fiscal year 1999. This statement establishes standards for
reporting information about operating segments in annual financial statements
and requires selected information about operating segments in interim financial
reports issued to shareholders. It also establishes standards for related
disclosures about products and services, geographic areas and major customers.
The Company is evaluating the impact of the adoption of this new accounting
standard on its consolidated financial statements.
The American Institute of Certified Public Accountants (AICPA) issued Statement
of Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed
or Obtained for Internal Use" in March 1998. SOP 98-1 is effective for fiscal
years beginning after December 15, 1998 and establishes criteria for
capitalizing certain internal use software costs. The Company plans to adopt SOP
98-1 in fiscal year 2000. The adoption of SOP 98-1 will not have a material
impact on the Company's consolidated financial statements.
The AICPA issued SOP 98-5, "Reporting on the Costs of Start-up Activities" in
April 1998. SOP 98-5 requires costs of start-up activities and organization
costs to be expensed as incurred and is effective for financial statements
issued for fiscal years beginning after December 15, 1998. The Company plans to
adopt SOP 98-5 in fiscal year 2000, with the initial application recognized as
the cumulative effect of a change in accounting principle. The Company currently
capitalizes pre-opening costs and expenses such amounts in the quarter of the
location opening. Capitalized pre-opening costs at September 27, 1998 and
September 28, 1997 were $118,000 and $129,000, respectively. The Company does
not expect the adoption of SOP 98-5 to have a material effect on its
consolidated financial statements; however, the ultimate effect of adoption will
depend upon the level of capitalized pre-opening costs at such date.
Disclaimer on Forward Looking Statements
Except for the historical information contained herein, the matters discussed in
this analysis are forward looking statements that involve risks and
uncertainties, including but not limited to general business conditions, the
timely development and opening of new stores, the impact of competition, and the
other risks detailed from time to time in the Company's filings with the
Securities and Exchange Commission.
21
Item 7(a) Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to cash flow and fair value risk from changes in interest
rates, which may affect its financial position, results of operations and cash
flows. In seeking to minimize the risks from interest rate fluctuations, the
Company manages exposures through ongoing evaluation of its investment portfolio
and composition of long-term debt. The Company does not use financial
instruments for trading or other speculative purposes.
The Company's exposure to interest rate risk currently consists of its
investment portfolio, senior notes and subordinated convertible debentures. The
Company's investment portfolio, in the amount of $53.6 million (of which $26.6
million was included in cash equivalents) as of September 27, 1998, had an
average interest rate of approximately 5.7% during fiscal 1998. Subsequent to
the end of the fiscal year the Company sold $15 million of its investment
portfolio. Because of the short-term maturities of this investment portfolio,
the carrying value approximates fair value. The senior notes bear interest at a
fixed rate of 7.29%, with a current outstanding balance of $40.0 million. As of
September 27, 1998, the estimated fair value of the senior notes exceeded the
carrying amount by approximately $2.8 million. The zero coupon subordinated
convertible debentures have an effective yield to maturity of 5%, with a current
outstanding balance of $118.4 million. As of September 27, 1998 the estimated
fair value of the convertible debentures is approximately $105.6 million. Should
interest rates increase or decrease, the estimated fair values of the senior
notes and the zero coupon subordinated debentures would decrease or increase
accordingly.
The impact of the foreign exchange fluctuations on the Company's foreign
subsidiary is immaterial.
Item 8. Financial Statements and Supplementary Data
See Item 14 (a).
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
PART III
Item 10. Directors and Executive Officers of the Registrant
A brief description of each executive officer and director of the Company is
provided below. The Company has a "staggered" board of directors in which only a
portion of the Company's directors stand for reelection each year. The term of
office of Linda A. Mason and Jirka Rysavy will expire at the annual meeting of
shareholders in 1999, the term of office of Avram J. Goldberg, Dr. John B.
Elstrott and Dr. Ralph Z. Sorenson will expire at the annual meeting of
shareholders in 2000 and the term of office of David W. Dupree, Fred "Chico"
Lager and John P. Mackey will expire at the annual meeting of shareholders in
2001. The term of office of the directors elected at this Annual Meeting will
expire at the annual meeting of shareholders in 2002. All officers serve at the
discretion of the Board of Directors.
John P. Mackey, 45, co-founder of the Company, has served as Chairman of the
Board and Chief Executive Officer since 1980.
Peter Roy, 42, has been with the Company since 1988 and served as President
since August 1993. Mr. Roy recently joined the Board of U.S.A. Floral Products,
Inc.
Glenda Flanagan, 45, has served as Vice President and Chief Financial Officer of
the Company since December 1988.
James P. Sud, 46, has served as Vice President and Chief Operating Officer since
May 1997. He had been President of MPS Production Company, an independent oil
and gas company engaged in exploration, production and oil field equipment
services since 1977. He served as a director of the Company from 1980 to March
1997.
Rich Cundiff, 41, has served as President of the Southern Pacific Region since
January 1996. He has held various positions with the Company since 1988,
including President and Vice President of the Southwest Region and store team
leader.
22
A.C. Gallo, 45, has served as President of the Northeast Region since July 1996.
He has held various positions with the Company and with Bread & Circus, Inc.,
which was acquired by the Company in October 1992, including Vice President of
the Northeast Region, Vice President of Perishables and produce coordinator.
Chris Hitt, 49, has served as President of the Mid-Atlantic Region since August
1996. He has held various positions with the Company since 1985 including
President of the Northern California, Northeast, Southeast, and Southwest
Regions.
Juan Nunez, 40, has served as President of the Florida Region since September
1998. He has held various positions with the Company and with Mrs. Gooch's
Natural Food Markets, Inc., which was acquired by the Company in September 1993,
including Vice President of the Southwest Region, Director of Store Operations,
and store team leader.
Walter Robb, 45, has been with the Company since 1991 and served as President of
the Northern California Region since August 1993.
Dan Rodenberg, 43, has served as President of the Midwest Region since January
1997. He has held various positions with the Company since 1989, including Vice
President of the Mid-Atlantic and Midwest Regions and store team leader.
Lee Valkenaar, 43, has served as President of the Southwest Region since January
1996. He has held various store team leader positions with the Company since
1987.
Dr. Cristina G. Banks, 46, has served as a director of the Company since July
1992. Dr. Banks is a principal and co-owner of Terranova Consulting Group, a
full service management consulting firm which was started in December 1996. She
has served as Senior Lecturer on the faculty at the Walter A. Haas School of
Business in Berkeley, California since 1985.
David W. Dupree, 45, has served as director of the Company since August 1996.
Mr. Dupree is a Managing Partner of Halifax Capital Partners, a limited
partnership founded to pursue small and mid cap investment opportunities. He was
the Managing Director of The Carlyle Group, a Washington, D.C. based merchant
banking concern, from 1992 to 1998. Mr. Dupree also serves as a director of
Insight Health Services Corp. and Care Systems, Inc
Dr. John B. Elstrott, 50, has served as a director of the Company since February
1995. Dr. Elstrott is the founding director of the Levy Rosenblum Institute for
Entrepreneurship at Tulane University's A.B. Freeman School of Business which
was started in 1991. He has been on the faculty at Tulane since 1982.
Avram J. Goldberg, 69, has served as a director of the Company since May 1994.
Mr. Goldberg has been the Chairman of the Board of AVCAR Group, Ltd., a
consulting firm specializing in the retail industry, since 1989. Mr. Goldberg
also serves as a director of Ekco Group, Inc.
Mr. Fred "Chico" Lager, 44, has served as a director of the Company since
January 1996. Mr. Lager has been a Trustee of Fenimore Asset Management Trust, a
mutual fund company, since 1997. Mr. Lager has been a self-employed consultant,
working with a select number of emerging small businesses, since 1991.
Linda A. Mason, 44, has served as a director of the Company since July 1992.
Mrs. Mason is the co-founder of Bright Horizons Family Solutions, Inc., which
operates work-site childcare centers, and served as its President from 1982 to
July 1998. Since July 1998, she has served as Chairman of the Board.
Jirka Rysavy, 44, joined the Company's board in November 1998. Mr. Rysavy is the
founder and has served as Chairman of the Board of Corporate Express, Inc., a
global provider of non-production goods and services to large corporations,
since 1986. Mr. Rysavy served as the Chief Executive Officer from the company's
inception until September 1998.
Dr. Ralph Z. Sorenson, 65, has served as a director of the Company since
December 1994. Dr. Sorenson is currently Professor Emeritus of business
administration at the University of Colorado, Boulder and has served in various
capacities at the University of Colorado since July 1992, including Dean of the
College of Business and Graduate School of Business Administration. Dr. Sorenson
serves as a director of the Polaroid Corporation, Houghton Mifflin Company,
Eaton Vance Inc. and Exabyte Corporation.
23
Each non-employee director of the Company receives $3,000 for each Board of
Directors meeting he or she attends and $500 for each telephone meeting called
by the Company which is greater than one hour in length and in which a majority
of directors participate. Each non-employee committee chair receives an annual
retainer of $1,500. Each non-employee director receives $500 for each committee
meeting attended (excluding the Nominating Committee meetings). Each
non-employee director who is a member of the Nominating Committee receives
$2,500 for each new director recruited. In addition, directors are reimbursed
for reasonable expenses incurred in attending Board of Directors meetings.
Directors who are employees of the Company are not paid any separate fees for
serving as directors.
The Board of Directors held five meetings in fiscal 1998. No director attended
fewer than 75% of the meetings of the Board (and any committees thereof) which
they were required to attend.
Section 16(a) Beneficial Ownership Reporting Compliance
Under the securities laws of the United States, the Company's directors and
executive officers, and persons who own more than 10% of the Company's common
stock, are required to report their initial ownership of the Company's common
stock and any subsequent changes in that ownership to the Securities and
Exchange Commission. Specific due dates have been established for these reports,
and the Company is required to disclose in this proxy statement any failure to
file by these dates. Based solely upon a review of Forms 3, 4 and 5 furnished to
the Company, the Company believes that all of its directors, officers and
applicable shareholders timely filed these reports except as follows. A sale of
common stock was not timely reported on a Form 4 filed by Dr. John B.
Elstrott.
In addition, under the Company's option plan for outside directors, each newly
elected director receives an option as of the date of his or her election to
purchase 10,000 shares of the Company's common stock at an exercise equal to the
closing price of the Company's common stock on the date of grant. Incumbent
directors receive an option grant as of the date of the Company's annual meeting
of shareholders to purchase 2,000 shares of the Company's common stock at an
exercise price equal to the closing price of the Company's common stock on the
date of grant if the director attended at least two-thirds of the meeting of the
Company's Board of Directors held in the preceding year.
24
Item 11. Executive Compensation
The following table sets forth information concerning compensation paid or
accrued by the Company during the three-year period ended September 27, 1998 to
or for the Company's Chief Executive Officer and the certain other highest
compensated executive officers of the Company whose total compensation exceeded
$100,000.
Summary Compensation Table
- --------------------------
Other Company
Annual Stock
Name and Principal Position Year Salary(1) Bonus Compensation(2) Options
--------- ----- --------------- -------
John P. Mackey 1998 $185,000 $ 90,000 $500 9,000
CEO 1997 170,000 93,000 500 9,000
1996 145,000 52,500 500 9,000
Peter Roy 1998 $165,000 $110,000 $500 4,000
President 1997 150,000 103,000 500 4,000
1996 130,000 67,900 500 19,000
Chris Hitt 1998 $165,000 $ 94,000 $500 0
Regional President 1997 150,000 68,900 500 3,600
1996 150,000 47,707 8,035(6) 31,100
Glenda Flanagan 1998 $150,000 $125,000 $500 4,000
CFO 1997 135,000 105,000 500 4,000
1996 115,000 78,700 500 9,000
James P. Sud (3) 1998 $150,000 $125,000 $500 4,000
COO 1997(4) 90,000 47,600 ----- 14,000
Carl Morris (5) 1998 $130,000 $145,000 $500 4,000
President, wholefoods.com 1997 130,000 92,000 500 4,000
1996 110,000 47,700 500 9,000
(1) The Company has a policy that limits the cash compensation paid in any one
year to any officer to ten times the average full time salary of all Team
Members. Amounts earned in excess of the salary limitation may be deferred
to the next year, subject to certain restrictions.
(2) Except as otherwise indicated, the amounts indicated reflect the Company's
contributions on behalf of the persons indicated to the Whole Foods Market,
Inc. Savings Plan and Trust. In 1996, 1997 and 1998, the Company's
contribution was a maximum of $500 paid in shares of the Company's common
stock.
(3) Mr. Sud did not earn $100,000 prior to fiscal 1997.
(4) Salary and bonus for 1997 are prorated to reflect May 1, 1997 employment
date.
(5) As of the fiscal year end, Mr. Morris was no longer an executive officer of
the Company.
(6) Of the amount indicated, $7,535 represents reimbursement of moving
expenses.
25
Option Plans
The following table sets forth certain information with respect to the options
granted during the fiscal year ended September 27, 1998 to each executive
officer of the Company listed in the Summary Compensation Table set forth under
the caption "Executive Compensation."
Option Grants in Fiscal Year 1998
- ---------------------------------
Percent of
Total Options Exercise or Potential Realizable Value at
Number of Granted to Base Price Assumed Annual Rates of Stock Price
Options Employees in in Dollars Expiration Appreciation for Option Term (1)
Name Granted Fiscal Year per Share (3) Date 5 % 10 %
- -------------- ------- ----------- ------------- ---- --------- --------
John P. Mackey 5,000 $49.75 01/21/05 $101,266 $235,993
4,000 $69.75 03/31/05 $113,581 $264,692
-----
9,000 (2)
Peter Roy 4,000 (2) $69.75 03/31/05 $113,581 $264,692
Chris Hitt 0 N/A N/A N/A $0 $0
Glenda Flanagan 4,000 (2) $69.75 03/31/04 $113,581 $264,692
James P. Sud 4,000 (2) $69.75 03/31/05 $113,581 $264,692
Carl Morris 4,000 (2) $69.75 03/31/05 $113,581 $264,692
(1) The 5% and 10% assumed annual rates of appreciation are mandated by the
rules of the Securities and Exchange Commission and do not reflect the
Company's estimates or projections of future prices of the shares of the
Company's common stock. There can be no assurance that the amounts
reflected in this table will be achieved.
(2) Less than 1%.
(3) Closing price of common stock at date of grant.
The following table sets forth certain information with respect to the options
exercised by the executive officers named above during the year ended September
27, 1998 or held by such persons at September 27, 1998. The number of options
held at September 27, 1998 includes options granted under the 1992 Option Plan
for Team Members and under the 1987 Option and Incentive Plan (the "1987 Plan").
The 1987 Plan was terminated by the Company in 1992, except as to options
previously granted.
Aggregated Option Exercises in Fiscal Year 1998 and Fiscal Year End Option
Values
- --------------------------------------------------------------------------
Number of Value of Unexercised
Shares Unexercised Options In-the-Money Options (2)
Acquired Value at September 27, 1998 at September 27, 1998
--------------------- ---------------------
Name on Exercise Realized (1) Exercisable Unexercisable Exercisable Unexercisable
---- ----------- ------------ ----------- ------------- ----------- -------------
John P. Mackey 0 0 79,350 24,650 $2,819,350 $370,875
Peter Roy 0 0 48,100 20,900 $1,121,563 $386,813
Chris Hitt 69,815 $3,189,568 22,186 22,250 $568,313 $417,735
Glenda Flanagan 900 $41,625 58,200 15,900 $1,990,963 $273,375
James P.Sud 0 0 10,100 16,700 $260,838 $287,063
Carl Morris 4,800 $186,000 12,150 17,100 $279,356 $302,075
(1) Based upon the market price for the underlying shares of common stock of
Whole Foods Market received upon excercise and the option exercise price.
(2) Based upon the closing price of the common stock of Whole Foods Market on
September 25, 1998, which was $43.625 per share.
26
Compensation Committee Interlocks and Insider Participation
No executive officer of the Company served as a member of the Compensation
Committee (or other board committee performing similar functions or, in the
absence of any such committee, the entire board of directors) of another
corporation, one of whose executive officers served on the Compensation
Committee. No executive officer of the Company served as a director of another
corporation, one of whose executive officers served on the Compensation
Committee. No executive officer of the Company served as a member of the
Compensation Committee (or other board committee performing equivalent functions
or, in the absence of any such committee, the entire board of directors) of
another corporation, one of whose executive officers served as a director of the
Company.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth certain information regarding the beneficial
ownership of the Company's common stock as of November 30, 1998 for (i) each
person who is known by the Company to own beneficially more than 5% of the
outstanding shares of common stock, (ii) each director of the Company, (iii)
each executive officer of the Company listed in the Summary Compensation Table
set forth under the caption "Executive Compensation," and (iv) all of the
directors and officers of the Company as a group. Except pursuant to applicable
community property laws and except as otherwise indicated, each shareholder
identified in the table possesses sole voting and investment power with respect
to its or his shares.
Shares Owned (1)
-------------------------------
Name Number Percent
- ---- ------- --------
FMR Corp. (2) 2,757,200 10.4%
Pilgrim Baxter & Assoc. (3) 2,806,800 10.6%
Dr. Cristina G. Banks (4) 19,500 *
David W. Dupree (5) 7,510 *
Dr. John B. Elstrott 3,600 *
Glenda Flanagan (6) 61,124 *
Avram J. Goldberg (7) 13,700 *
Christopher Hitt (8) 42,210 *
Fred "Chico" Lager (9) 9,817 *
John P. Mackey (10) 328,317 1.2%
Linda A. Mason (11) 16,700 *
Carl Morris (12) 12,174 *
Peter Roy (13) 71,374 *
Jirka Rysavy 0 *
Dr. Ralph Z. Sorenson (14) 9,500 *
James P. Sud (15) 51,675 *
All directors and officers
as a group (20 persons) 809,868 3.0%
* Less than one percent
(1) Includes shares issuable upon exercise of stock options which are vested or
will be vested prior to January 29, 1999.
(2) Based on information contained in Schedule 13G, as amended on February 14,
1998. The amount indicated reflects FMR Corp's beneficial ownership as of
December 31, 1997. Of the shares indicated, FMR Corp. has the sole voting
power of 244,200 shares and the sole power to dispose of all the shares
indicated. The address of such shareholder is 82 Devonshire Street, Boston,
Massachusetts 02109.
(3) Based on information contained in Schedule 13G, as amended on November 5,
1998. Of the shares indicated, Pilgrim Baxter & Associates, Ltd. has the
sole voting power of 2,554,800 shares and the sole power to dispose of all
the shares indicated. The address of such shareholder is 825 Duportail
Road, Wayne, Pennsylvania 19087.
(4) Includes options to purchase 19,300 shares of common stock.
(5) Includes options to purchase 1,541 shares of common stock.
(6) Includes options to purchase 57,200 shares of common stock.
(7) Includes options to purchase 10,700 shares of common stock.
(8) Includes options to purchase 24,186 shares of common stock.
(9) Includes options to purchase 8,000 shares of common stock.
27
(10) Includes options to purchase 63,850 shares of common stock.
(11) Includes options to purchase 16,700 shares of common stock.
(12) Includes options to purchase 12,150 shares of common stock.
(13) Includes options to purchase 49,700 shares of common stock.
(14) Includes options to purchase 9,500 shares of common stock.
(15) Includes options to purchase 10,100 shares of common stock.
Item 13. Certain Relationships and Related Transactions
John P. Mackey, Peter Roy and Glenda Flanagan, executive officers of the
Company, own approximately 13.4% in the aggregate of BookPeople, Inc. which
leases facilities from the Company. During fiscal 1998, the lease was amended to
reduce the size of the leased facility and the aggregate annual minimum rent
from approximately $582,000 to approximately $391,000. In fiscal 1998, the
Company received approximately $456,000 in rental income from this lease.
Retention Agreements
Since November 1991, the Company has entered into Retention Agreements with the
executive officers of the Company or its subsidiaries which provide for certain
benefits upon an involuntary termination of employment other than for cause
after a "Triggering Event." A Triggering Event includes a merger of the Company
with and into an unaffiliated corporation if the Company is not the surviving
corporation or the sale of all or substantially all of the Company's assets. The
benefits to be received by the executive officer whose employment is terminated
after a Triggering Event occurs include receipt of his or her annual salary
through the one-year period following the date of the termination of employment
and the immediate vesting of any outstanding stock options granted to such
executive officer.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) (1) and (2) Financial Statements and Schedules.
Reference is made to the listing on page 29 of all financial statements
filed as a part of this report. No schedules are required.
(b) (3) Exhibits
Reference is made to the Exhibit Index on page 50 for a list of all
exhibits filed as a part of this report.
28
Whole Foods Market, Inc. and Subsidiaries
Index to Consolidated Financial Statements
Page
Number
------
Independent Auditors' Report 30
Consolidated Balance Sheets at September 27, 1998 and September 28, 1997 31
Consolidated Statements of Operations for the fiscal years ended September 27, 1998,
September 28, 1997 and September 29, 1996 32
Consolidated Statements of Shareholders' Equity for the fiscal years ended
September 27, 1998, September 28, 1997 and September 29, 1996 33
Consolidated Statements of Cash Flows for the fiscal years ended September 27, 1998,
September 28, 1997 and September 29, 1996 34
Notes to Consolidated Financial Statements 36
29
Whole Foods Market, Inc. and Subsidiaries
Independent Auditors' Report
The Board of Directors
Whole Foods Market, Inc.
We have audited the accompanying consolidated balance sheets of Whole Foods
Market, Inc. and subsidiaries ("Company") as of September 27, 1998 and September
28, 1997 and the related consolidated statements of operations, shareholders'
equity and cash flows for each of the fiscal years in the three-year period
ended September 27, 1998. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards 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 consolidated financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall consolidated financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Whole Foods Market,
Inc. and subsidiaries as of September 27, 1998 and September 28, 1997, and the
results of their operations and their cash flows for each of the fiscal years in
the three-year period ended September 27, 1998, in conformity with generally
accepted accounting principles.
/s/ KPMG Peat Marwick LLP
- -------------------------
KPMG Peat Marwick LLP
Austin, Texas
November 20, 1998
30
Whole Foods Market, Inc. and Subsidiaries
Consolidated Balance Sheets (In thousands, except share data)
September 27, 1998 and September 28, 1997
Assets
1998 1997
- -------------------------------------------------------------------------------------------------------------------
Current assets:
Cash and cash equivalents $ 36,674 13,395
Marketable securities 27,019 1,089
Trade accounts receivable 15,201 11,468
Merchandise inventories 85,628 64,838
Prepaid expenses and other current assets 8,870 8,945
Deferred income taxes 10,701 12,964
- -------------------------------------------------------------------------------------------------------------------
Total current assets 184,093 112,699
Property and equipment, net of accumulated depreciation and amortization 291,478 228,215
Acquired leasehold rights, net of accumulated amortization 12,150 11,418
Excess of cost over net assets acquired, net of accumulated amortization 35,802 35,577
Other assets, net of accumulated amortization 21,285 10,575
- -------------------------------------------------------------------------------------------------------------------
$ 544,808 398,484
- -------------------------------------------------------------------------------------------------------------------
Liabilities and Shareholders' Equity
1998 1997
- -------------------------------------------------------------------------------------------------------------------
Current liabilities:
Current installments of long-term debt and capital lease obligations $ 343 1,171
Trade accounts payable 32,505 30,900
Accrued payroll, bonus and employee benefits 26,670 21,722
Other accrued expenses 31,511 23,479
- -------------------------------------------------------------------------------------------------------------------
Total current liabilities 91,029 77,272
Long-term debt and capital lease obligations, less current installments 158,673 92,673
Deferred rent liability 7,932 6,407
Other long-term liabilities 6,792 10,091
Deferred income taxes 3,109 6,576
- -------------------------------------------------------------------------------------------------------------------
Total liabilities 267,535 193,019
- -------------------------------------------------------------------------------------------------------------------
Shareholders' equity:
Common stock, no par value, 100,000,000 and 50,000,000 shares authorized
in 1998 and 1997, respectively; 26,500,000 and 24,453,000 shares
issued and outstanding in 1998 and 1997, respectively 219,189 192,514
Unrealized gain (loss) on securities available for sale 211 (125)
Retained earnings 57,873 13,076
- -------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 277,273 205,465
- -------------------------------------------------------------------------------------------------------------------
Commitments and contingencies
- -------------------------------------------------------------------------------------------------------------------
$ 544,808 398,484
- -------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
31
Whole Foods Market, Inc. and Subsidiaries
Consolidated Statements of Operations (In thousands, except per share data)
Fiscal years ended September 27, 1998, September 28, 1997 and September 29, 1996
1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------
Sales $ 1,389,768 1,117,346 946,353
Cost of goods sold and occupancy costs 921,104 749,551 645,925
- -------------------------------------------------------------------------------------------------------------------
Gross profit 468,664 367,795 300,428
Selling, general and administrative expenses 385,573 312,703 266,107
Pre-opening and relocation costs 3,979 5,243 5,903
Merger and reorganization expenses 1,699 4,887 38,516
- -------------------------------------------------------------------------------------------------------------------
Income (loss) from operations 77,413 44,962 (10,098)
Other income (expense):
Interest expense (7,685) (6,044) (4,671)
Investment and other income 2,328 450 650
- -------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes 72,056 39,368 (14,119)
Provision (credit) for income taxes 26,661 12,724 (1,404)
- -------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 45,395 26,644 (12,715)
- -------------------------------------------------------------------------------------------------------------------
Basic income (loss) per common share $ 1.74 1.10 (0.54)
- -------------------------------------------------------------------------------------------------------------------
Weighted average common shares outstanding 26,159 24,194 23,366
- -------------------------------------------------------------------------------------------------------------------
Diluted income (loss) per common share $ 1.64 1.06 (0.54)
- -------------------------------------------------------------------------------------------------------------------
Weighted average shares outstanding, diluted basis 27,744 25,162 23,366
- -------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
32
Whole Foods Market, Inc. and Subsidiaries
Consolidated Statements of Shareholders' Equity (In thousands)
Fiscal years ended September 27, 1998, September 28, 1997 and September 29, 1996
Unrealized
Gain (Loss)
on Securities Retained Total
Shares Common Available Earnings Shareholders'
Issued Stock for Sale (Deficit) Equity
- -------------------------------------------------------------------------------------------------------------------
Balance at September 24, 1995 22,790 $ 174,663 (165) (2,145) 172,353
Adjustment to conform fiscal year
of pooled entity 0 0 0 3,491 3,491
Other acquisition 195 8 0 305 313
Issuance of common stock 807 7,575 0 0 7,575
Tax benefit related to exercise of
employee stock options 0 1,059 0 0 1,059
Change in market value of securities
available for sale 0 0 (52) 0 (52)
Net loss 0 0 0 (12,715) (12,715)
- -------------------------------------------------------------------------------------------------------------------
Balance at September 29, 1996 23,792 183,305 (217) (11,064) 172,024
- -------------------------------------------------------------------------------------------------------------------
Adjustment to conform fiscal year of
pooled entity 0 0 0 (1,268) (1,268)
Other acquisitions 244 2,200 0 (1,236) 964
Issuance of common stock 514 7,907 0 0 7,907
Common stock purchased and retired (97) (2,187) 0 0 (2,187)
Tax benefit related to exercise of
employee stock options 0 1,289 0 0 1,289
Change in market value of securities
available for sale 0 0 92 0 92
Net income 0 0 0 26,644 26,644
- -------------------------------------------------------------------------------------------------------------------
Balance at September 28, 1997 24,453 192,514 (125) 13,076 205,465
- -------------------------------------------------------------------------------------------------------------------
Acquisitions 1,187 2,027 0 (598) 1,429
Issuance of common stock 860 14,925 0 0 14,925
Tax benefit related to exercise of
employee stock options 0 9,723 0 0 9,723
Change in market value of securities
available for sale 0 0 336 0 336
Net income 0 0 0 45,395 45,395
- -------------------------------------------------------------------------------------------------------------------
Balance at September 27, 1998 26,500 $ 219,189 211 57,873 277,273
- -------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
33
Whole Foods Market, Inc. and Subsidiaries
Consolidated Statements of Cash Flows (In thousands)
Fiscal years ended September 27, 1998, September 28, 1997 and September 29, 1996
1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------
Cash flow from operating activities
Net income (loss) $ 45,395 26,644 (12,715)
Adjustments to reconcile net income (loss) to net cash flow
from operating activities:
Depreciation and amortization 42,307 34,456 26,953
Loss on disposal of fixed assets 1,421 523 1,163
Deferred income tax benefit (1,204) (1,390) (7,118)
Change in LIFO reserve 417 800 746
Rent differential 1,525 800 882
Loss provision on disposal of fixed assets 0 1,422 12,477
Loss provision on disposal of other assets 0 923 4,124
Tax benefit related to exercise of employee stock options 9,723 1,289 1,059
Interest accretion on long-term debt 3,337 0 0
Lease termination and other closing cost provisions 0 165 10,476
Adjustment to conform fiscal year of pooled entity 0 (1,268) 3,491
Lease termination and other merger accrual payments (8,497) (2,956) 0
Other 0 449 (5)
Net change in current assets and liabilities:
Trade accounts receivable (1,922) (4,681) (3,117)
Merchandise inventories (14,442) (18,694) (11,191)
Prepaid expenses and other current assets 883 (510) (2,635)
Trade accounts payable (947) 3,934 5,768
Accrued payroll, bonus and employee benefits 4,948 9,671 (3,919)
Other accrued expenses 7,929 2,464 2,408
- -------------------------------------------------------------------------------------------------------------------
Net cash flow from operating activities 90,873 54,041 28,847
- -------------------------------------------------------------------------------------------------------------------
Cash flow from investing activities
Acquisition of property and equipment (41,197) (31,062) (19,812)
Development costs of new store locations (54,521) (24,566) (50,288)
Acquisition of mail lists and other intangible assets (4,984) (6,693) (1,583)
Purchase of marketable securities (25,594) 0 0
Proceeds from sale of marketable securities 0 5,899 988
Payment for purchase of acquired entities, net of cash acquired (1,841) 0 0
Other investing activities (191) 0 (2,480)
- --------------------------------------------------------------------------------------------------------------------
Net cash flow used in investing activities (128,328) (56,422) (73,175)
- --------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. (continued)
34
Whole Foods Market, Inc. and Subsidiaries
Consolidated Statements of Cash Flows (Continued) (In thousands)
Fiscal years ended September 27, 1998, September 28, 1997 and
September 29, 1996
1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------
Cash flow from financing activities
Net proceeds from issuance of convertible debentures $ 111,748 0 0
Net proceeds from long-term borrowings 11,000 24,336 80,000
Payments on long-term debt and capital lease obligations (76,939) (18,277) (48,711)
Issuance of common stock 14,925 7,907 7,575
Purchase and retirement of treasury stock 0 (2,187) 0
Minority interest contributions 0 0 33
- -------------------------------------------------------------------------------------------------------------------
Net cash flow from financing activities 60,734 11,779 38,897
- -------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 23,279 9,398 (5,431)
Cash and cash equivalents at beginning of year 13,395 3,997 9,428
- -------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 36,674 13,395 3,997
- -------------------------------------------------------------------------------------------------------------------
Supplemental disclosure of cash flow information
Interest and income taxes paid:
Interest $ 5,691 6,733 3,649
- -------------------------------------------------------------------------------------------------------------------
Federal and state income taxes $ 16,618 11,221 5,426
- -------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
35
Whole Foods Market, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Fiscal years ended September 27, 1998, September 28, 1997 and September 29, 1996
(1) Corporate Organization
The consolidated financial statements include the accounts of Whole Foods
Market, Inc. and its subsidiaries (Company). All significant majority-owned
subsidiaries are consolidated on a line-by-line basis. All significant
intercompany accounts and transactions are eliminated upon consolidation. Where
appropriate, prior years' financial statements have been reclassified to conform
with the 1998 presentation.
(2) Summary of Significant Accounting Policies
Business
The Company engages in the sale of natural food and nutritional products,
primarily through its natural foods supermarkets and direct marketing of
nutritional supplements. As of September 27, 1998, the Company operated 87
stores, all of which are located in the United States, and engaged in direct
marketing of nutritional supplements primarily in the United States.
Definition of Fiscal Year
The Company reports its results of operations on a 52- or 53-week fiscal year
ending on the last Sunday in September. Fiscal years 1998 and 1997 are 52-week
years, and fiscal year 1996 is a 53-week year.
Cash Equivalents
For purposes of the consolidated statements of cash flows, the Company considers
all highly liquid investments with an original maturity of 90 days or less to be
cash equivalents.
Marketable Securities
Marketable securities at September 27, 1998 consisted of investments in
short-term high quality corporate bond funds and at September 28, 1997 consisted
of U.S. Treasury and agency securities. The Company classifies its debt and
equity securities as available-for-sale. Available-for-sale securities are
recorded at fair value. Unrealized holding gains and losses, net of the related
tax effect, on available-for-sale securities are excluded from earnings and are
reported as a separate component of shareholders' equity until realized.
Realized gains and losses from the sale of available-for-sale securities are
determined on a specific identification basis.
A decline in the fair value of any available-for-sale security below cost that
is deemed to be other than temporary results in a reduction in carrying amount
to fair value. The impairment is charged to earnings and a new cost basis of the
security is established. Dividend and interest income are recognized when
earned.
Fair Value of Financial Instruments
The carrying amounts of cash and cash equivalents, trade accounts receivable,
trade accounts payable, accrued payroll, bonus and employee benefits, and other
accrued expenses approximate fair value because of the short maturity of those
instruments. Marketable securities are stated at fair value with unrealized
gains and losses included as a component of shareholders' equity until realized.
The carrying value of notes payable to banks approximates fair value due to
variable interest rates charged on these notes. The carrying value and fair
value of convertible subordinated debentures at September 27, 1998 was
$118,361,000 and approximately $105,581,000, respectively. The Company estimated
the fair value of convertible subordinated debentures using quoted market
prices. The carrying value and fair value of senior unsecured notes at September
27, 1998 was $40,000,000 and approximately $42,842,000, respectively. The
carrying value and fair value of senior unsecured notes at September 28, 1997
was $40,000,000 and approximately $40,405,000, respectively. The Company
estimated the fair value of senior unsecured notes by discounting the future
cash flows at the rates currently available to the Company for similar debt
instruments of comparable maturities.
(continued)
36
Whole Foods Market, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(2) Summary of Significant Accounting Policies, continued
Inventories
Inventories, both retail and wholesale, are valued at the lower of cost or
market. Cost is principally determined by the last-in, first-out (LIFO) method.
The manufactured inventories of Amrion and Allegro are determined by the
first-in, first-out (FIFO) method. The excess of estimated current costs over
LIFO carrying value was approximately $3,658,000 and $3,241,000 at September 27,
1998 and September 28, 1997, respectively. Balances of inventories are as
follows (in thousands):
1998 1997
- --------------------------------------------------------------------------------
Manufactured inventories:
Raw materials $ 12,445 6,713
Work in process 363 438
Finished goods 10,473 9,138
- --------------------------------------------------------------------------------
Total manufactured inventories 23,281 16,289
- --------------------------------------------------------------------------------
Other inventories, net of LIFO reserve 62,347 48,549
- --------------------------------------------------------------------------------
$ 85,628 64,838
- --------------------------------------------------------------------------------
Property and Equipment
Property and equipment is stated at cost, net of accumulated depreciation and
amortization. Depreciation is provided over the estimated useful lives
(generally 5 to 15 years) using the straight-line method. Leasehold improvements
are amortized on the straight-line method over the shorter of the estimated
useful lives of the improvements or the terms of the related leases. Pre-opening
costs include hiring and training personnel, supplies and certain occupancy and
miscellaneous costs related to new locations, and are expensed in the quarter in
which the location opens. Capitalized pre-opening costs related to stores not
yet open at September 27, 1998 and September 28, 1997 totaled $118,000 and
$129,000, respectively. Costs related to a projected site determined to be
unsatisfactory and general site selection costs which cannot be identified with
a specific store location are charged to operations currently.
Other Assets
Acquired leasehold rights are amortized as rent expense over the remaining lease
term using the straight-line method. Accumulated amortization of acquired
leasehold rights at September 27, 1998 and September 28, 1997 was $2,081,000 and
$1,338,000, respectively. Excess of cost over net assets acquired is amortized
over 40 years using the straight-line method. Accumulated amortization of excess
of cost over net assets acquired at September 27, 1998 and September 28, 1997
was $6,973,000 and $5,820,000, respectively. The carrying value of the excess of
cost over net assets acquired is evaluated periodically in relation to such
factors as the occurrence of a significant event, the operating performance of
each acquired subsidiary and the estimated future undiscounted cash flows of the
underlying business of each subsidiary. Other assets include non-competition
agreements, costs associated with purchased mailing lists and certain costs
associated with the issuance of debt which are capitalized and amortized over
the life of the related agreement using the straight-line method. Total
purchased mailing lists costs included in other assets at September 27, 1998 and
September 28, 1997 was $7,522,000 and $5,442,000 respectively, and accumulated
amortization was $3,647,000 and $2,490,000, respectively. Also included in other
assets at September 27, 1998 and September 28, 1997 was a note receivable of
approximately $2,341,000 and $2,459,000, respectively. Other accumulated
amortization included in other assets at September 27, 1998 and September 28,
1997 totaled $3,559,000 and $1,616,000, respectively.
Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of
The Company evaluates long-lived assets and certain identifiable intangibles for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of an asset
to future undiscounted cash flows expected to be generated by the asset. If such
assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the assets exceeds the
fair value of the assets. Assets to be disposed of are reported at the lower of
the carrying amount or fair value less costs to sell.
(continued)
37
Whole Foods Market, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(2) Summary of Significant Accounting Policies, continued
Advertising
The Company expenses the production costs of advertising when the advertising
first takes place, except for direct-response advertising which is capitalized
and amortized over its expected period of future benefit. Direct response
advertising consists primarily of direct mail advertising, including deferred
promotional mailing costs, of the Company's products. The capitalized costs of
mailed promotional materials are amortized over the expected promotional benefit
period of three months. Advertising expense for fiscal years 1998, 1997 and 1996
was approximately $18,410,000, $13,959,000 and $10,867,000, respectively.
Income Taxes
The Company uses the asset and liability approach which accounts for deferred
income taxes by applying statutory tax rates in effect at the balance sheet date
to differences between the book basis and the tax basis of assets and
liabilities. Deferred tax assets and liabilities are measured using enacted tax
rates expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The deferred tax assets and
liabilities are adjusted in income to reflect changes in tax laws or rates in
the period that includes the enactment date.
Income (loss) per Share
The Financial Accounting Standards Board had issued Statement of Financial
Accounting Standards No. 128 (SFAS No. 128), "Earnings per Share", which is
effective for financial statements issued for periods ending after December 15,
1997, including interim periods. Effective September 29, 1997, the Company
adopted on a retroactive basis SFAS No. 128, which establishes standards for
computing and presenting earnings per share. Earnings per share for all periods
presented has been restated to reflect the adoption of SFAS No. 128. The
adoption of SFAS No. 128 did not have a material effect on the Company's
financial statements. Basic income (loss) per share is based on the weighted
average number of common shares outstanding during the fiscal period. Diluted
income (loss) per share is based on the weighted average number of common shares
outstanding and, where applicable, dilution from options and convertible debt.
A reconciliation of the denominators of the basic and diluted earnings per share
calculations follows (in thousands):
1998 1997 1996
- --------------------------------------------------------------------------------
Denominator for basic income (loss) per
share: weighted average shares 26,159 24,194 23,366
Additional shares deemed outstanding from
the assumed exercise of stock options 1,585 968 0
- --------------------------------------------------------------------------------
Denominator for diluted income (loss) per
share: adjusted weighted average
shares and assumed conversions 27,744 25,162 23,366
- --------------------------------------------------------------------------------
The computation of diluted earnings per share does not include approximately
1,643,000 shares of common stock related to the zero coupon convertible
subordinated debentures at the end of fiscal year 1998 and options to purchase
approximately 1,014,000 shares, 380,000 shares and 2,688,000 shares of common
stock at the end of fiscal years 1998, 1997 and 1996, respectively, because to
do so would be antidilutive.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
revenues and expenses during the period reported. Actual results could differ
from those estimates. Estimates are used when accounting for depreciation and
amortization, allowance for doubtful accounts, employee benefit plans, taxes,
restructuring reserves and contingencies.
38
Whole Foods Market, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(3) Business Combinations
Merchant of Vino
In December 1997, the Company acquired Merchant of Vino, which operated four
gourmet/natural food supermarkets and two specialty wine and gourmet food shops
in the greater Detroit metropolitan area, for approximately 1 million shares of
Company common stock. The acquisition was accounted for using the
pooling-of-interests method. Due to the immateriality of the financial
statements of the acquired entity to the Company's consolidated financial
statements, financial information for the periods prior to fiscal 1998 has not
been restated. An adjustment to decrease retained earnings by approximately $1.8
million was recorded to include results of operations of the acquired entity
prior to the combination in these consolidated financial statements. Revenue and
results of operations of the acquired entity for the period from September 29,
1997 through the date of acquisition are not material to the combined results.
Allegro Coffee Company
In December 1997, the Company acquired Allegro Coffee Company, a specialty
coffee roaster and distributor based in Boulder, Colorado, for approximately
175,000 shares of Company common stock. The acquisition was accounted for using
the pooling-of-interests method. Due to the immateriality of the financial
statements of the acquired entity to the Company's consolidated financial
statements, financial information for the periods prior to fiscal 1998 has not
been restated. An adjustment to increase retained earnings by approximately $1.2
million was recorded to include results of operations of the acquired entity
prior to the combination in these consolidated financial statements. Revenue and
results of operations of the acquired entity for the period from September 29,
1997 through the date of acquisition are not material to the combined results.
Amrion, Inc.
In September 1997, the Company completed the merger with Amrion, Inc., a
Boulder, Colorado-based company engaged in developing, producing and marketing
nutriceuticals and nutritional supplements, in exchange for approximately
4,680,000 shares of Company common stock plus the assumption of approximately
330,000 outstanding options to purchase shares of common stock. The merger was
accounted for using the pooling-of-interests method.
Granary Market
In August 1997, the Company completed the acquisition of Organic Merchants,
Inc., doing business as Granary Market (Granary), which operated a natural foods
market in Monterey, California, in exchange for approximately 33,000 shares of
Company common stock. The acquisition was accounted for using the
pooling-of-interests method. Due to the immateriality of Granary financial
statements to the Company's consolidated financial statements, financial
information for the periods prior to the combination was not restated. An
adjustment to increase retained earnings by approximately $346,000 was recorded
to include results of Granary operations for the periods prior to the
combination in these consolidated financial statements. Revenue and results of
operations of Granary for the period from September 30, 1996 through the date of
acquisition were not material to the combined results.
Bread of Life
In April 1997, the Company completed the acquisition of Bread of Life, Inc.
(Bread of Life), which operated two natural foods markets in South Florida, in
exchange for approximately 200,000 shares of Company common stock. The
acquisition was accounted for using the pooling-of-interests method. Due to the
immateriality of Bread of Life financial statements to the Company's
consolidated financial statements, financial information for the periods prior
to the combination was not restated. An adjustment to decrease retained earnings
by approximately $1,582,000 was recorded to include results of Bread of Life
operations for the periods prior to the combination in these consolidated
financial statements. Revenue and results of operations of Bread of Life for the
period from September 30, 1996 through the date of acquisition were not material
to the combined results.
(continued)
39
Whole Foods Market, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(3) Business Combinations, continued
Fresh Fields Markets, Inc.
In August 1996, the Company completed the merger with Fresh Fields Markets, Inc.
(Fresh Fields), which operated natural foods supermarkets in Washington D.C.,
Chicago, Philadelphia and New York, in exchange for approximately 4,750,000
shares of Company common stock plus the assumption of approximately 549,000
outstanding options to purchase shares of common stock. The merger was accounted
for using the pooling-of-interests method.
Oak Street Market
In December 1995, the Company completed the acquisition of Natural Merchants
Exchange, Inc., doing business as Oak Street Market (Oak Street), which operated
a natural foods market in Evanston, Illinois, in exchange for approximately
195,000 shares of Company common stock. The acquisition was accounted for using
the pooling-of-interests method. Due to the immateriality of Oak Street
financial statements to the Company's consolidated financial statements,
financial information for the periods prior to the combination was not restated.
An adjustment to decrease retained deficit by $305,000 was recorded to include
results of Oak Street operations for the periods prior to the combination in
these consolidated financial statements. Revenue and results of operations of
Oak Street for the period from September 25, 1995 through the date of
acquisition were not material to the combined results.
(4) Merger and Reorganization Expenses
Merger and reorganization expenses for fiscal years 1998 and 1997 consist of
transaction and other merger-related costs associated with the acquisitions of
Merchant of Vino and Allegro Coffee Company in 1998 and of Amrion in 1997.
Merger and reorganization expenses for fiscal year 1996 consist primarily of
transaction and other merger-related costs associated with the acquisition of
Fresh Fields and with the reorganization of the Southern California region.
Merger and reorganization expenses are summarized as follows (in thousands):
1998 1997 1996
- --------------------------------------------------------------------------------
Transaction and other merger-related costs $ 1,699 4,887 8,577
Store closing and relocation costs 0 0 20,907
Duplicate systems disposal costs and
other accounting adjustments 0 0 6,730
- --------------------------------------------------------------------------------
Total merger-related costs 1,699 4,887 36,214
Southern California reorganization costs 0 0 2,144
Other 0 0 158
- --------------------------------------------------------------------------------
Total merger and reorganization expenses $ 1,699 4,887 38,516
- --------------------------------------------------------------------------------
Expenses including losses on the disposition of store assets and lease
termination costs were recognized in fiscal 1996 pursuant to a plan initiated at
the time of the Fresh Fields acquisition to close or relocate duplicate stores.
At September 27, 1998, the terminations of certain operating leases remain under
the plan. Liabilities totaling approximately $12.8 million for remaining rent,
lease termination and other store closing costs were recorded in fiscal 1996 as
part of merger-related costs. These liabilities were reduced by approximately
$6.7 million and $3.0 million during fiscal 1998 and 1997, respectively,
primarily as a result of cash payments for rent and lease termination costs.
Accounting adjustments totaling approximately $2.7 million were made in fiscal
1996 on a retroactive basis to the net assets of Fresh Fields to conform its
fixed asset and operating lease accounting policies to those of Whole Foods
Market in connection with the 1996 merger.
Costs recognized in fiscal 1996 associated with the reorganization of the
Southern California region included severance and relocation payments, costs
associated with changing the names of the stores from Mrs. Gooch's to Whole
Foods Market, systems and process conversion costs and other reorganization
expenses.
40
Whole Foods Market, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(5) Quarterly Results (unaudited)
For fiscal years 1998 and 1997, the first quarter is 16 weeks and the remaining
quarters are each 12 weeks. The following table sets forth selected quarterly
unaudited financial information for the fiscal years ended September 27, 1998
and September 28, 1997 (in thousands except per share data):
1st 2nd 3rd 4th
1998 Quarter Quarter Quarter Quarter
- -------------------------------------------------------------------------------------------------------------------
Sales $ 407,788 324,811 330,999 326,170
Gross profit 135,752 110,939 110,832 111,141
Pre-opening and relocation costs 1,065 1,462 1,024 428
Merger and reorganization expenses 1,699 0 0 0
Income from operations 21,084 18,857 18,921 18,551
Income before income taxes 19,092 17,657 17,621 17,686
Net income 12,028 11,124 11,101 11,142
Basic income per share $ 0.46 0.43 0.42 0.42
Weighted average common shares outstanding 25,913 26,094 26,279 26,435
Diluted income per share $ 0.44 0.40 0.40 0.40
Weighted average shares outstanding - diluted basis 27,523 27,824 27,880 27,824
- -------------------------------------------------------------------------------------------------------------------
1st 2nd 3rd 4th
1997 Quarter Quarter Quarter Quarter
- -------------------------------------------------------------------------------------------------------------------
Sales $ 312,584 259,800 274,510 270,452
Gross profit 99,447 85,284 92,021 91,043
Pre-opening and relocation costs 1,604 1,129 0 2,510
Merger and reorganization expenses 0 0 0 4,887
Income from operations 10,778 12,597 14,188 7,399
Income before income taxes 9,195 11,179 12,922 6,072
Net income 5,988 7,218 8,283 5,155
Basic income per share $ 0.25 0.30 0.34 0.21
Weighted average common shares outstanding 24,085 24,155 24,188 24,386
Diluted income per share $ 0.24 0.29 0.33 0.20
Weighted average shares outstanding - diluted basis 24,971 24,841 25,294 25,741
- -------------------------------------------------------------------------------------------------------------------
(6) Property and Equipment
Balances of major classes of property and equipment are as follows (in
thousands):
1998 1997
- -------------------------------------------------------------------------------------------------------------------
Land $ 11,051 3,906
Buildings and leasehold improvements 190,341 158,729
Fixtures and equipment 207,254 152,014
Vehicles 280 359
Construction in progress and equipment not yet in service 20,196 12,475
- -------------------------------------------------------------------------------------------------------------------
429,122 327,483
Less accumulated depreciation and amortization 137,644 99,268
- -------------------------------------------------------------------------------------------------------------------
$ 291,478 228,215
- -------------------------------------------------------------------------------------------------------------------
Depreciation and amortization expense related to property and equipment was
approximately $37,344,000, $30,725,000 and $24,375,000 for fiscal years 1998,
1997 and 1996, respectively. Leasehold improvements and construction in progress
include approximately $735,000, $769,000 and $1,183,000 of interest capitalized
during 1998, 1997 and 1996, respectively.
41
Whole Foods Market, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(7) Long-Term Debt
The Company has long-term debt and obligations under capital leases as follows
(in thousands):
1998 1997
- -------------------------------------------------------------------------------------------------------------------
Obligations under capital lease agreements for equipment,
due in monthly installments through 2001 $ 590 1,196
Notes payable to banks 0 52,436
Senior unsecured notes 40,000 40,000
Convertible debentures 118,361 0
Other notes payable 65 212
- -------------------------------------------------------------------------------------------------------------------
159,016 93,844
Less current installments 343 1,171
- -------------------------------------------------------------------------------------------------------------------
$ 158,673 92,673
- -------------------------------------------------------------------------------------------------------------------
During the second quarter of fiscal 1998, the Company issued a private offering
under Rule 144A of the Securities Act of 1933, as amended, of zero coupon
convertible subordinated debentures with no sinking fund requirement and a
scheduled maturity date of March 2, 2018. The debentures were subsequently
registered. The offering resulted in gross proceeds to the Company of
approximately $115 million. The issue price of the debentures results in an
effective yield to maturity of 5 percent. The principal amount of the debentures
at maturity is approximately $308.8 million. The debentures are convertible at
the option of the holder, at any time on or prior to maturity, unless previously
redeemed or otherwise purchased. The debentures have a conversion rate of 5.320
shares per $1,000 principal amount at maturity, initially representing a
conversion price of approximately $70 per share of common stock, or
approximately 1,643,000 shares. The debentures may be redeemed at the option of
the holder on March 2, 2003, March 2, 2008 or March 2, 2013 at the issue price
plus accrued original discount to the date of redemption. Subject to certain
limitations, the Company, at its option, may elect to pay this purchase price in
cash, shares of common stock or any combination thereof. The debentures may also
be redeemed in cash at the option of the holder if there is a change in control
at the issue price plus accrued original discount to the date of redemption.
Subsequent to March 2, 2003, the Company, at its option, may redeem the
debentures for cash, in whole or in part, at redemption prices equal to the
issue price plus accrued original discount to the date of redemption. The
debentures are subordinated in the right of payment to all existing and future
senior indebtedness. All amounts outstanding under the Company's line of credit
were repaid during the second fiscal quarter with proceeds from the issuance of
the convertible subordinated debentures. The credit agreement was subsequently
amended to reduce the available line of credit from $100 million to $10 million.
The Company maintains a bank credit agreement which provides for a revolving
line of credit of up to $10 million. Any amount outstanding under this agreement
is convertible into a four-year term loan upon the expiration of the revolving
credit term on June 30, 1999. Principal payments are to be made in quarterly
installments beginning September 30, 1999. This credit agreement contains
certain restrictive covenants, including the unavailability of the payment of
dividends on common stock. The credit agreement also contains certain
affirmative covenants including maintenance of certain financial ratios as
defined in the agreement. All outstanding amounts borrowed under this agreement
bear interest at the Company's option of either a defined base rate or the
Eurodollar rate plus a premium. Commitment fees ranging from 0.1875% to 0.25% of
the undrawn amount are payable under this agreement. At September 27, 1998,
there were no amounts drawn and at September 28, 1997, approximately $52.1
million was drawn under this agreement prior to the aforementioned amendment in
fiscal 1998. The average interest rate on amounts outstanding under this
agreement at September 28, 1997 was approximately 6.62%. The amounts available
to the Company under this line of credit were effectively reduced by outstanding
letters of credit totaling $5.8 million and $6.8 million at September 27, 1998
and September 28,1997, respectively.
In May 1996, the Company issued $40,000,000 of senior unsecured notes payable to
refinance existing indebtedness. The notes bear interest at 7.29% and are
payable in seven equal annual installments beginning May 16, 2000. The notes
contain certain affirmative and negative covenants, including maintenance of
certain financial ratios as defined in the agreement. At September 27, 1998 and
September 28, 1997, the Company was in compliance with the debt covenants.
42
Whole Foods Market, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(8) Leases
The Company is committed under certain capital leases for rental of equipment
and certain operating leases for rental of facilities and equipment. These
leases expire or become subject to renewal at various dates from 1999 to 2024.
Rental expense charged to operations under operating leases for fiscal years
1998, 1997 and 1996 totaled approximately $35,180,000, $29,153,000 and
$24,683,000, respectively. Minimum rental commitments required by all
noncancelable leases are approximately as follows (in thousands):
Capital Operating
- --------------------------------------------------------------------------------
1999 $ 322 42,504
2000 336 42,786
2001 23 42,888
2002 0 42,555
2003 0 41,276
Future years 0 416,608
- --------------------------------------------------------------------------------
681
Less amounts representing interest 91
- ------------------------------------------------------------------
590
Less current installments 258
- ------------------------------------------------------------------
$ 332
- --------------------------------------------------------------------------------
Minimum rentals for operating leases do not include certain amounts of
contingent rentals which may become due under the provisions of leases for
retail space. These agreements provide that minimum rentals may be increased
based on a percent of annual sales from the retail space. During fiscal 1998,
1997 and 1996, the Company paid contingent rentals of approximately $1,456,000,
$1,200,000 and $981,000 respectively. Certain officers of the Company own
approximately 13.4% of a business which leases facilities from the Company under
a lease that commenced in fiscal 1995. The Company's rental income from this
lease totaled approximately $456,000 in fiscal year 1998 and $582,000 in fiscal
years 1997 and 1996.
(9) Income Taxes
Components of total income tax expense (credit) are as follows (in thousands):
1998 1997 1996
- -------------------------------------------------------------------------------
Current federal income tax $ 22,165 11,556 4,548
Current state income tax 5,700 2,558 1,166
- -------------------------------------------------------------------------------
Total current tax 27,865 14,114 5,714
Deferred federal income tax (1,463) 271 (6,842)
Deferred state income tax 259 (1,661) (276)
- -------------------------------------------------------------------------------
Total deferred tax (1,204) (1,390) (7,118)
- -------------------------------------------------------------------------------
Total income tax expense (credit) $ 26,661 12,724 (1,404)
- -------------------------------------------------------------------------------
(continued)
43
Whole Foods Market, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(9) Income Taxes, continued
Actual income tax expense (credit) differed from the amount computed by applying
statutory corporate income tax rates to income (loss) before taxes as follows
(in thousands):
1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------
Federal tax based on statutory rates $ 25,220 13,779 (4,907)
Increase (reduction) in income taxes resulting from:
Tax exempt interest 0 (102) (99)
Net loss of pooled entity 0 0 768
Non-deductible merger transaction costs 2,677 646 1,682
Non-deductible amortization of cost in excess
of net assets acquired 356 354 348
Other, net 2,294 1,131 2,013
Reduction in valuation allowance (7,760) (3,086) (1,676)
Deductible state income taxes (2,085) (895) (319)
- --------------------------------------------------------------------------------------------------------------------
Total federal taxes 20,702 11,827 (2,190)
State income taxes 5,959 897 786
- -------------------------------------------------------------------------------------------------------------------
Total income tax expense (credit) $ 26,661 12,724 (1,404)
- --------------------------------------------------------------------------------------------------------------------
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities are as follows (in
thousands):
Current deferred tax assets (liabilities) 1998 1997
- -------------------------------------------------------------------------------------------------------------------
Compensated absences, principally due to financial reporting accrual $ 4,500 3,303
Lease termination and other merger accruals 197 8,781
Inventories, principally due to additional costs inventoried
for tax purposes pursuant to the Tax Reform Act of 1986 2,843 808
Alternative minimum tax credit 245 106
Acquired net operating loss carryforwards 3,235 3,283
Other (319) (34)
- --------------------------------------------------------------------------------------------------------------------
Total current deferred tax assets (liabilities) 10,701 16,247
Valuation allowance against current assets 0 (3,283)
- --------------------------------------------------------------------------------------------------------------------
Net current deferred tax assets (liabilities) $ 10,701 12,964
- -------------------------------------------------------------------------------------------------------------------
Long-term deferred tax assets (liabilities) 1998 1997
- -------------------------------------------------------------------------------------------------------------------
Lease termination and other merger accruals $ 1,462 0
Rent differential, principally due to financial
reporting of pro rata expense 3,405 2,190
Financial basis of fixed assets in excess of tax basis (7,052) (7,263)
Capitalized costs expensed for tax purposes (1,092) (765)
Acquired net operating loss carryforwards, long-term 0 3,640
Other 168 99
- -------------------------------------------------------------------------------------------------------------------
Total long term deferred tax assets (liabilities) (3,109) (2,099)
Valuation allowance against long-term assets 0 (4,477)
- --------------------------------------------------------------------------------------------------------------------
Net long term deferred tax asset (liability) (3,109) (6,576)
- --------------------------------------------------------------------------------------------------------------------
Net deferred tax asset $ 7,592 6,388
- -------------------------------------------------------------------------------------------------------------------
(continued)
44
Whole Foods Market, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(9) Income Taxes, continued
The valuation allowance decreased by approximately $7,760,000, $3,086,000 and
$1,676,000 in fiscal 1998, 1997 and 1996, respectively. Management believes that
it is more likely than not that the Company will fully realize the total
deferred tax assets based on the nature of these deductible temporary
differences and a history of profitable operations.
As of September 27, 1998, the Company had net operating loss carryforwards
totaling approximately $8,628,000 that will begin to expire in 2003 and are
subject to certain limitations on use.
(10) Employee Benefit Plans
Employee Stock Option Plans
The Company grants options to purchase common stock under its 1992 Stock Option
Plans, as amended. Under these plans, options are granted at an option price
equal to the market value of the stock at the date of grant and are generally
exercisable ratably over a four-year period beginning one year from date of
grant. Options granted in fiscal years 1998, 1997 and 1996 expire seven years
from date of grant. The Company has, in connection with certain of its business
combinations, assumed the stock option plans of the acquired companies. All
options outstanding under the Company's previous plans and plans assumed in
business combinations continue to be governed by the terms and conditions of
those grants. At September 27, 1998, September 28, 1997 and September 29, 1996,
approximately 1,378,000, 1,570,000 and 1,169,000 shares of common stock were
available for option grants.
The following table summarizes option activity (in thousands, except per share
amounts):
Weighted
Number average
of options exercise
outstanding price
- -------------------------------------------------------------------------------------------------------------------
Balance at September 24, 1995 1,893 $12.78
Options granted 679 20.71
Options assumed 549 24.58
Options exercised (334) 11.51
Options canceled (99) 16.97
- -------------------------------------------------------------------------------------------------------------------
Balance at September 29, 1996 2,688 17.19
Options granted 665 22.48
Options assumed 330 9.28
Options exercised (413) 16.13
Options canceled (165) 22.26
- -------------------------------------------------------------------------------------------------------------------
Balance at September 28, 1997 3,105 17.36
Options granted 1,580 68.39
Options exercised (839) 16.70
Options canceled (126) 41.06
- -------------------------------------------------------------------------------------------------------------------
Balance at September 27, 1998 3,720 $38.38
- -------------------------------------------------------------------------------------------------------------------
(continued)
45
Whole Foods Market, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(10) Employee Benefit Plans, continued
A summary of options outstanding and exercisable at September 27, 1998 follows
(in thousands, except per share amounts):
Options Outstanding Options Exercisable
-------------------------------- ---------------------------------
Range of Weighted average Weighted Weighted
exercise prices Number remaining average Number average
From To outstanding life (in years) exercise price exercisable exercise price
--------------------------------------------------------------------------------------------------------------------
$0.90 $11.07 367 3.99 $5.92 256 $5.40
12.50 15.52 419 5.43 13.89 258 14.08
16.09 19.38 449 4.57 17.45 193 17.61
19.50 22.00 738 5.34 21.49 279 21.05
22.51 35.13 232 5.27 29.63 99 29.33
45.00 69.75 1,515 6.48 68.79 6 69.75
- -----------------------------------------------------------------------------------------------------------------------
Total 3,720 5.58 $38.38 1,091 $16.10
- -----------------------------------------------------------------------------------------------------------------------
At September 28, 1997 and September 29, 1996, approximately 1,282,000 and
1,235,000 outstanding options, respectively, were exercisable. The weighted
average exercise price for outstanding exercisable options was $15.36 and $15.51
at September 28, 1997 and September 29, 1996, respectively.
The Company adopted the disclosure provisions of Statement of Financial
Accounting Standards No. 123 (SFAS No. 123), "Accounting for Stock-Based
Compensation," in fiscal 1997. In accordance with SFAS No. 123, the Company
continues to apply Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" and related interpretations in accounting for its
stock option grants. Accordingly, no compensation expense has been recognized
for option grants. As required by SFAS No. 123, the Company has determined pro
forma net income and net income per common share as if compensation costs had
been recognized beginning in fiscal year 1996 based on the fair value of the
options granted. The fair value of stock option grants has been estimated at the
date of grant using the Black-Scholes multiple option pricing model with the
following weighted average assumptions:
1998 1997 1996
- -------------------------------------------------------------------------------
Expected dividend yield 0.00% 0.00% 0.00%
Risk-free interest rate 5.63% 6.79% 6.27%
Expected volatility 53.72% 54.28% 54.83%
Expected life, in years 3.37 3.28 3.28
The weighted average estimated fair values at grant date of employee stock
options granted during fiscal years 1998, 1997 and 1996 were $30.03, $10.46 and
$9.41, respectively. The Black-Scholes option valuation model was developed for
use in estimating the fair value of traded options which have no vesting
restrictions and are fully transferable. In addition, option valuation models
require the input of highly subjective assumptions including expected stock
price volatility. Because the Company's employee stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in the Company's opinion the existing available models do
not necessarily provide a reliable single measure of the fair value of the
Company's employee stock options.
Had the Company recognized compensation cost based on the fair value of stock
options granted at grant date as determined using the Black-Scholes option
valuation model described above consistent with SFAS No. 123, net income (loss)
and diluted income (loss) per common share would have changed to the pro forma
amounts shown below (in thousands, except per share amounts):
(continued)
46
Whole Foods Market, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(10) Employee Benefit Plans, continued
1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------
Net income (loss):
As reported $45,395 26,644 (12,715)
Pro forma $36,437 23,660 (13,639)
- --------------------------------------------------------------------------------------------------------------------
Diluted income (loss) per common share:
As reported $1.64 1.06 (0.54)
Pro forma $1.31 0.94 (0.58)
- -------------------------------------------------------------------------------------------------------------------
The above pro forma disclosures reflect only options granted in fiscal years
1998, 1997 and 1996. Therefore, these disclosures are not likely to be
representative of the effects on net income and net income per common share in
future years because they do not take into consideration pro forma compensation
expense related to grants awarded prior to fiscal year 1996.
Employee Stock Purchase Plan
The Company offers an employee stock purchase plan to all full-time employees
with a minimum of 400 hours of service. Under this plan, participating employees
may purchase common stock of the Company each fiscal quarter through payroll
deductions. Participants in the plan may elect to purchase unrestricted shares
of stock at 100 percent of its market value or restricted shares at 85 percent
of its market value on the purchase date. Participants are required to hold
restricted shares for two years before selling them. Approximately 8,400, 8,700
and 9,100 shares were issued by the Company under this plan in fiscal 1998, 1997
and 1996, respectively.
Employee 401(k) Plan
The Company offers an employee 401(k) plan to all employees with a minimum of
one year of service and 1,000 service hours in the plan year. Company matching
contributions under this plan, determined at the Company's discretion, were
approximately $821,000, $436,000 and $267,000 in fiscal 1998, 1997 and 1996,
respectively. Matching contributions in fiscal 1998 and 1997 were made in
Company common stock totaling approximately 13,000 and 15,000 shares,
respectively.
(11) Segment Information
The Company operates in two business segments, natural foods supermarkets and
direct marketing. The direct marketing segment information below includes all
activities of Amrion other than intercompany transactions, which have been
eliminated. Summary segment information follows (in thousands):
1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------
Sales:
Natural foods supermarkets $ 1,308,070 1,049,283 892,098
Direct marketing 81,698 68,063 54,255
- -------------------------------------------------------------------------------------------------------------------
Total $ 1,389,768 1,117,346 946,353
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
Income (loss) from operations:
Natural foods supermarkets $ 67,811 36,162 (15,984)
Direct marketing 9,602 8,800 5,886
- -------------------------------------------------------------------------------------------------------------------
Total $ 77,413 44,962 (10,098)
- -------------------------------------------------------------------------------------------------------------------
(continued)
47
Whole Foods Market, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
(11) Segment Information, continued
1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------
Total assets:
Natural foods supermarkets $ 500,073 363,538 310,604
Direct marketing 44,735 34,946 30,215
- -------------------------------------------------------------------------------------------------------------------
Total $ 544,808 398,484 340,819
- -------------------------------------------------------------------------------------------------------------------
Depreciation and amortization:
Natural foods supermarkets $ 39,360 32,461 25,525
Direct marketing 2,947 1,995 1,428
- -------------------------------------------------------------------------------------------------------------------
Total $ 42,307 34,456 26,953
- -------------------------------------------------------------------------------------------------------------------
Capital expenditures:
Natural foods supermarkets $ 89,994 50,981 68,524
Direct marketing 5,724 4,647 1,576
- -------------------------------------------------------------------------------------------------------------------
Total $ 95,718 55,628 70,100
- -------------------------------------------------------------------------------------------------------------------
(12) Commitments and Contingencies
The Company provides partially self-insured, voluntary employee benefits plans
which provide, among other benefits, health care benefits to participating
employees. The plans are designed to provide specified levels of coverage, with
excess insurance coverage provided by a commercial insurer. The Company's
exposure related to claims associated with unreported cases or underestimated
future costs associated with known cases for which the Company is partially
self-insured at September 27, 1998 has been estimated based on management's
review of claims outstanding at fiscal year end, claims reported subsequent to
fiscal year end and management's knowledge of the typical length of time from
date of occurrence to date of reported claim.
The Company is a party to certain legal proceedings arising in the ordinary
course of business. After consultation with counsel and a review of available
facts, management believes that damages, if any, arising from litigation will
not be material to the Company's financial position or results of operations.
48
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
WHOLE FOODS MARKET, INC.
Date: December 22, 1998 By: /s/ Glenda Flanagan
-------------------
Glenda Flanagan, Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities indicated on December 22, 1998.
Name Title
/s/ John Mackey
- ---------------
John Mackey Chairman of the Board, Chief Executive
Officer and Director (Principal Executive
Officer)
/s/ Glenda Flanagan
- -------------------
Glenda Flanagan Chief Financial Officer (Principal
Financial and Accounting Officer)
/s/ Dr. Cristina G. Banks
- -------------------------
Dr. Cristina G. Banks Director
/s/ David W. Dupree
- -------------------
David W. Dupree Director
/s/ Dr. John B. Elstrott
- ------------------------
Dr. John B. Elstrott Director
/s/ Avram J. Goldberg
- ---------------------
Avram J. Goldberg Director
/s/ Fred Lager
- --------------
Fred Lager Director
/s/ Linda A. Mason
- ------------------
Linda A. Mason Director
/s/ Jirka Rysavy
- ----------------
Jirka Rysavy Director
/s/ Dr. Ralph Z. Sorenson
- -------------------------
Dr. Ralph Z. Sorenson Director
49
INDEX TO EXHIBITS
2.1 Agreement and Plan of Merger, among the Registrant, WFM Colorado
Acquisition, Inc., Allegro Coffee Company, Inc. and the
shareholders of Allegro Coffee Company, Inc. (4)
2.2 Agreement and Plan of Merger, among the Inc., the Merchant of Vino
companies, and the Registrant, Whole Foods Market Group,
stockholders of the Merchant of Vino Companies. (4)
3.1 Restated Articles of Incorporation of the Registrant, as
amended (2)
3.2 By-laws of the Registrant adopted May 23, 1995 (8)
4.1 Form of Zero Coupon Convertible Subordinated Debentures
Due 2018. (5)
4.2 Indentures between the Company and Chase Bank of Texas, National
Association, as Trustee. (5)
4.3 Registration Rights Agreement by and among the Company and BT Alex
Brown Incorporated
and Morgan Stanley & Co. Incorporated. (5)
10.1 1987 Stock Option and Incentive Plan for Employees (3)
10.2 1987 Stock Option Plan for Outside Directors (3)
10.3 1993 Team Member Stock Ownership Plan (1)
10.5 Form of Retention Agreement between the executive officers of the
Registrant and the Registrant (3)
10.6 Form of amendment to Retention Agreement (1)
10.7 Amended and Restated Loan Agreement, dated December 27, 1994,by
and among the Registrant, the subsidiaries of the Registrant and
Texas Commerce Bank National Association (8)
10.8 First Amendment dated May 16, 1996 to Amended and Restated Loan
Agreement, dated December 27, 1994, by and among Registrant, the
subsidiaries of the Registrant and Texas Commerce Bank National
Association (9)
10.9 Second Amendment dated December 24, 1996 to Amended and Restated
Loan Agreement, dated December 27, 1994, by and among Registrant,
the subsidiaries of the Registrant and Texas Commerce Bank
National Association (10)
10.10 Third Amendment dated March 24, 1997 to Amended and Restated Loan
Agreement, dated December 27, 1994, by and among Registrant, the
subsidiaries of the Registrant and Texas Commerce Bank National
Association (10)
10.11 Fourth Amendment dated September 2, 1997 to Amended and Restated
Loan Agreement, dated December 27, 1994, by and among Registrant,
the subsidiaries of the Registrant and Texas Commerce Bank
National Association (10)
10.12 Fifth Amendment dated December 19, 1997 to Amended and Restated
Loan Agreement, dated December 27, 1994, by and among Registrant,
the subsidiaries of the Registrant and Texas Commerce Bank
National Association (12)
10.13 1992 Stock Option Plan for Team Members, as amended (1)
10.14 1992 Stock Option Plan for Outside Directors (1)
10.15 1993 Team Member Stock Purchase Plan (1)
10.16 Second Amended and Restated 1991 Stock Incentive Plan of Fresh
Fields Markets, Inc. with amendments thereto (6)
10.17 1994 Director Stock Option Plan with amendments thereto (6)
10.18 Non-Qualified Stock Option Plan of Amrion, Inc. (7)
10.19 1994 Non-Employee Director Stock Option Plan of Amrion, Inc. (7)
21.1 Subsidiaries of the Registrant (12)
23.1 Consent of KPMG Peat Marwick LLP (12)
27.1 Financial Data Schedule (12)
99.1 Proxy Statement for Annual Meeting of Shareholders to be held
March 29, 1999. (11)
(1) Filed as an exhibit to Registration Statement on Form S-4 (No. 33-63824)
and incorporated herein by reference.
(2) Filed as an exhibit to Registration Statement on Form S-3 (No.33-69362)
and incorporated herein by reference.
(3) Filed as an exhibit to Registration Statement on Form S-1 (No. 33-44214)
and incorporated herein by reference.
(continued)
50
INDEX TO EXHIBITS, continued
(4) Filed as an exhibit to Registration Statement on Form S-3 (No.
333-43555) and incorporated herein by reference.
(5) Filed as an exhibit to Registration Statement on Form S-3 (No.
333-51419) and incorporated herein by reference.
(6) Filed as an exhibit to Registration Statement on Form S-8 (No. 33-11273)
and incorporated herein by reference.
(7) Filed as an exhibit to Registration Statement on Form S-8 (No. 33-35809)
and incorporated herein by reference.
(8) Filed as an exhibit to Registrant's Form 10-K for year ended September
24, 1995 and incorporated herein by reference.
(9) Filed as an exhibit to Registrant's Form 10-K for year ended September
29, 1996 and incorporated herein by reference.
(10) Filed as an exhibit to Registrant's Form 10-K for year ended September
28, 1997 and incorporated herein by reference.
(11) To be filed with the Securities and Exchange Commission and
incorporated herein by reference.
(12) Filed herewith
51