COMPANY: Whole Foods Market, Inc. I.

Summary
Whole Foods Markets, Inc. is the largest natural foods retailer in the US. The company sells natural and organic foods in over 100 stores and in the following categories: produce, grocery, meat and poultry, seafood, bakery, prepared foods, specialty (beer/wine/cheese), nutritional supplements, body care, pet products, floral, household products, and an alternative pharmacy. WFMI has approximately 20,000 SKUs of food and non-food products All valuation results indicate that it is difficult to justify Whole Foods current stock price. Its historical growth in revenues and profits are quite impressive and the company will continue to grow moderately. However, we believe that its growth will level off over the long-run due to a saturation of the market because of increased competition. We do feel that this company is well managed but we also feel that much of the present stock price has future expansion possibilities already incorporated. We would consider this company a good Buy opportunity if it were trading in the $30 to $45 range as our valuation indicates. However at its current market price of about $54, our recommendation is to Hold.

II. Significant business and industry discussion

The retail grocery market was examined through Michael Porters five forces framework.

1.

Rivalry Among Existing Firms

The range of competitors within the overall industry include chain and independent

supermarkets (Krogers, Safeway, others); mass merchandisers and super centers (Wal-mart, Target); convenience stores; wholesale clubs (Sams); restaurants and fast food chains (who compete for consumer food dollars); natural food stores (Whole Foods, Wild Oats); local farmers markets, and internet grocers. Historically, the concentration of competitors has been fragmented by geography. However, through recent consolidations, the emergence of regional and national chains has started to prevail along with the decline of the independent/local shops. This trend may actually help alleviate some of the price competition in the industry that was previously driven by small, highly fragmented competitors. This consolidation trend will also eliminate any overcapacity in the industry over time. Furthermore, the M&A activity has allowed many companies to spread their fixed costs over a wider range of output, thus creating more efficiency in operations. Often, it is cheaper for a company to acquire an incumbent due to the location of their stores and access to customers rather than to raise the capital for entirely new stores. Also, these

acquisition activities may help companies to gain enough economies of scale to better compete with the Wal-marts and Sams Clubs. The overall industry can be characterized as mature with relatively few options for growth outside of acquisitions. Growth is constrained by the small US population growth and increased consumer spending on food consumed outside the home. Thus, industry growth is likely to come from demand stealing from competitors. However, two of the fastest growing areas within the industry (at the expense of conventional grocery) are organic foods and prepared foods. According to the Food Marketing Institute (FMI), organic food sales are estimated to grow from $6 billion in 1999 to $13 billion by 2003. While the retail grocery industry has been somewhat resistant to the economic downturn in the US economy, there has been a consumer trend towards private label brands rather than national brands. This trend is actually beneficial to retailers for a couple of reasons. First, private labels increase brand identity of the store as well as raise consumer switching costs among stores. Second, private labels are often sold at a 20-40 percent discount over national brands but are higher margin products for retailers (typically 35-40% margin vs. 27% for national brands). In addition, the organic food segment may be further aided by the recent USDA requirements for organic labeling of products. This set of standards, to be in effect as early as October 2002, will educate the consumer on what organic is as well as introduce regulation into the organic market. It is likely that natural food stores will use this informational complexity to promote and educate consumers regarding their products. However, it is unclear whether this organic labeling requirement alone will further help to differentiate natural food stores from their conventional counterparts or whether it will reduce the lines of differentiation between the competitors. Lastly, exit barriers play a role in determining the level of competition among rivals within an industry. Specifically, the location of grocery stores is often one of the most crucial factors in determining the success of the store. Success depends upon how close the store is located to its customer base as well as how close competitor stores are positioned. Thus, competitors are often entrenched in the location of their stores and will likely pursue aggressive tactics to ward off competition into their areas. This creates increased competition in the market. One trend that has developed includes the movement of retail grocers into cities with larger customer bases in order to face less competition from the super centers located in and on the outskirts of suburbia.

2.

Threat of Substitutes
The relative price of substitutes plays a role in determining a companys profitability.

Organic food is priced at a premium to conventional food reflecting the high labor costs in

cultivating the product (Exhibit 1). The price premium may be one reason why organic food has not become mainstream. Another reason is that consumers either lack education about its benefits (or dont care) so that the price premium does not appear to be justified. However, when comparing upscale organic and prepared foods to competitors such as restaurants, the benefit/cost ratio appears more justified. Furthermore, market research conducted by FMI has categorized 11 percent of shoppers as dedicated to healthy eating. These shoppers tend to be better educated, more affluent, couples or singles without children, and generally in better physical shape than the rest of the population. Thus, this target market segment for natural food stores probably has a very low prope nsity for substitution. Another category identified by FMI represents 28 percent of shoppers defined as those who work to change eating habits promoted by health concerns and interest in self-care. These individuals that actively seek out health and nutritional information, are younger to middle aged, and have medium to high household incomes. Thus, this market segment likely has a higher propensity to substitute than the segment above, but still is probably lower than the overall market. In total, the organic segment of the market should look to capture 39 percent of consumers in the future.

3.

Buyer Power
The retail grocery market is typically considered somewhat resistant to economic

downturns, thus, to some degree, consumers food budgets are price ins ensitive. However, there is risk that consumers will switch from high quality / high margin stores to mass merchandisers (Walmart, Shop N Save) to stretch declining incomes further in a downturn market. Furthermore, while individual consumers typically lack significant buyer power to affect the specific prices of products, collectively, they can exert influence on retailers to sell or not sell specific types of products (one example being the GMO debate).

4.

Supplier Power
The organic food suppliers are not highly concentrated, so natural food retailers have

some power over them. Also, the natural food retailers may have the ability to backward integrate with partnerships and joint ventures with local growers. In addition, there is a trend for top conventional food manufacturers to invest in national/organic food companies (examples include HJ Heinz, Kellogg, Kraft & General Mills). Thus, the larger number of suppliers of organic products, the less influence one supplier can have in the market.

5.

Threat of New Entry

Because the retail grocery market is typically low margin, it is critical for companies to have some type of cost advantage over peers. Product costs typically range from 70% to 73% of conventional grocery sales and even more so for organic products. Thus, the larger chains may be able to obtain better and cheaper access to products than the independent stores. Labor is also a significant cost to retail grocers, representing 50% to 53% of total operating costs. Most labor is unionized, thus, a non-unionized labor force could represent a cost advantage. WMFI had a nonunionized labor force until a recent vote in August 2002 by employers to unionize the labor force. Other operating costs (including rent, utilities, transportation, and technology) are controllable by the company. Thus, the company who is best able to control these costs will be the most profitable. Lastly, technology costs are key in the retail grocery industry in order to increase efficiency in operations and aid marketing aids. Point-of-sale systems can help to increase inventory turnover and sales and lead to better targeted customer marketing. Other areas that affect new entry into a market include capital requirements, economies of scale, and brand identity. All of these factors have been discussed to some degree under other forces. Lastly, expected retaliation by incumbent competitors is an important element in determining the threat of new entry. Specifically, Whole Foods faces a threat from conventional supermarkets and mass merchandisers who may move to carry organic products within their stores. The USDA reports that for the first time in 2001, more organic products were purchased in conventional stores than any other venue, including natural food stores. However, it is unclear as to whether rising consumer awareness of organic products and the placement of these products at conventional stores will ultimately cannibalize natural food store sales.

Overview of the firm

Whole Foods Markets, Inc. is the largest natural foods retailer in the US. The company sells natural and organic foods in over 100 stores and in the following categories: produce, grocery, meat and poultry, seafood, bakery, prepared foods, specialty (beer/wine/cheese), nutritional supplements, body care, pet products, floral, household products, and an alternative pharmacy. WFMI has approximately 20,000 SKUs of food and non-food products. The company opened its first store in Austin, Texas and has grown to over 126 stores with $2.3 billion in sales and $0.9 billion in assets at the end of September 2001. WFMI currently employs 17,000 people and has a market capitalization of approximately $2.9 billion. The company has grown through a combination of new store openings and acquisitions. Recently, the company launched its first international store in Toronto, Canada and plans to further expand abroad in the future. WFMI is

considered a premier retailer and is often benchmarked against best in show retailers such as Walmart, Walgreens, Home Depot, Starbucks, Williams-Sonoma and Tiffanys in addition to other retail grocery companies. Its closest competitor in their business description is Wild Oats.

III. Summary of significant financial statement numbers A.) Quality of Accounting Numbers
Overall, Whole Foods has relatively clean financial statements. The Company received an unqualified audit opinion from Ernst & Young in 2001. The Company is growing at a strong rate while debt remains relatively low. Sales growth over the past two years has exceeded 20%. The Company generated positive cash flows from operating activities.

B.)

Significant Accounting Methods

Whole Foods uses stock options as a form of compensation for their employees. As

required by SFAS No. 123, Whole Foods disclosed the pro forma net income impact if the options were treated as compensation cost. The fair values of the stock option grants were estimated using the Black-Scholes multiple option pricing model. For fiscal years, 2001, 2000, and 1999, the impact to earnings per share was $0.22, $0.20, and $.22 respectively. Whole Foods is using stock options as a way to motivate employees and reward them for performance. However, this also is at great expense to the Company. In fiscal year 2000, Whole Foods adopted a formal plan to sell the NatureSmart business of manufacturing and the direct marketing of nutritional supplements. The NatureSmart business had been segregated from continuing operations and reported as discontinued operations in the financial statements. Whole Foods experienced a net loss from discontinued operations of $9.4 million in 2000. Whole Foods made acquisitions in 2000 and 1999. In February 2000, the Company acquired all of the assets of Natural Abilities, Inc., which operated three natural foods supermarkets in the Sonoma County, California area. The transaction was accounted for using the purchase method of accounting and the purchase price was allocated to net assets acquired based on their estimated fair values at the date of acquisition. This allocation resulted in goodwill totaling approximately $23.9 million, which has been amortized on a straight-line basis over 20 years. In April 1999, Whole Foods acquired the outstanding stock of Natures Heartland, Inc., which operated four natural foods supermarkets in the greater Boston metropolitan area. This was

accounted for using the same methodology discussed above and resulted in goodwill of $13.5 million.

C.)

Balance Sheet
It is evident from reviewing the balance sheet that Whole Foods is growing rapidly. Net

receivables and inventory have grown substantially but they have stayed consistent as a percentage of total assets. Property, plant and equipment have also increased as the number of stores operated by Whole Foods has increased every year. Meanwhile, the long-term debt has decreased between 2000 and 2001. Whole Foods is using the cash generated from operations to pay down their debt. Current liabilities have increased slightly year over year, mainly in the other category. The reformula ted balance sheet (Exhibit 2) paints a similar picture. Whole Foods is increasing their total operating assets along with their net operating assets. Increases in property, plant and equipment and other assets caused the largest increase in operating assets while other current liabilities and accounts payable accounted for the largest increases in operating liabilities. The Companys financial obligations have declined due to a decrease in long-term debt. This caused a decrease in net financial obligations and increased common shareholders equity. Overall, Whole Foods appears to have improved their financial condition between 2000 and 2001.

D.)

Income Statement
After reviewing the income statement, Whole Foods has achieved solid sales growth while

maintaining their gross profit. SG&A remained constant over the last three years along with preopening and relocation costs. This shows that the Company is growing at a constant rate year over year and maintaining their strong financial results. Despite the decrease in debt from the balance sheet, interest expense has increased slightly over the past few years. Whole Foods had a gain on disposal of assets in 2001 and a loss in 2000. The reformatted income statement (Exhibit 3) also reveals the strong operating results. The Company has little financial activity except for interest expense and the associated tax benefit from interest expense. Investments and other income are insignificant. Comprehensive income was very strong in 2001 but was negative in 2000. The negative comprehensive income in 2000 was largely due to the loss on disposal of assets and equity in losses of unconsolidated affiliates. The expense relating to stock options has remained relatively constant over the last three years.

E.)

Statement of Stockholders Equity

Total equity increased significantly between 2000 and 2001 largely due to net income. The Company issued $18.3 million of their stock from the treasury in 2001 and received a tax benefit from the exercise of stock options of $9.2 million. From the reformatted statement (Exhibit 4), the changes mentioned above are also visible. Comprehensive income accounts for the majority of the increase in stockholders equity.

F.)

Cash Flow Statement

Whole Foods has grown their cash flow generated from operations over the past three

years. Net income is the main driver of the cash flow from operations along with depreciation and amortization. Cash flows from investing activities became less negative between 2000 and 2001 since there were no cash acquisitions in 2001. Cash flows from financing activities reveal that in 2001, the Company paid down long-term debt and capital lease obligations of $78 million compared to $6 million in 2000. The reformatted cash flow statement (Exhibit 5) revealed the same observations as the GAAP cash flow statement.

G.)

Segment Analysis
Whole Foods operates under only one segment, operating the largest chain of natural and

organic foods supermarkets.

IV. Significant ratio analysis A.) Comparisons to Grocery Industry

We used common-size analysis for fiscal year 2001 to compare profitability, turnover, and leverage and liquidity ratios of Whole Foods to other companies in the grocery industry. We compared Whole Foods to Wild Oats, Winn-Dixie, Albertsons, Safeway, and Kroger. See Exhibits 6-8 for the details. Upon examining the profitability ratios, Whole Foods had the highest return on assets, the highest gross margin, and their P/E ratio was much higher than any other grocery stock. Whole Foods return on assets for 2001 was 8.5%. This shows that Whole Foods earns more income per average total assets than their competitors. Whole Foods is able to charge higher prices for their products, which is one of the advantages of selling organic foods. Whole Foods gross margin was 34.4%, which was again driven by the high profits that are available in the organic market. Whole Foods enjoys the benefits of a customer base that is not concerned about high prices. Grocery stores are known for low profit margins and this is where Whole Foods separates themselves from

the standard grocery chain. Whole Foods has a P/E ratio of 38 for fiscal year 2001. This is due to the high stock price which can be attributed to the strong growth prospects and the best-in-class nature of the company. After completing the turnover ratio analysis, we discovered that Whole Foods had the fastest inventory turnover, the fastest payables turnover, and the lowest days in inventory. We were surprised to learn that Whole Foods had an inventory turnover ratio of 15.48 which was by the far the best in the industry. This number might be slightly slanted since Whole Foods sells only organic foods which have a shorter shelf life. Most grocery stores also sell more toiletry and paper products. While Whole Foods also sells these items, they are a much lower percentage of overall sales. Whole Foods does pay their suppliers faster than any of the comparables that we examined. This is a negative but Whole Foods must have strong relationships with their suppliers since organic foods have to meet certain requirements. Whole Foods wants maintain strong relationships and quick payments are one way to strengthen the relationship. Whole Foods has the lowest days in inventory from the companies that we compared. Once again, this is due to the nature of the organic market and Whole Foods focus on fresh items. Upon examining the leverage and liquidity ratios, Whole Foods had the lowest debt to equity ratio and the lowest assets to equity ratio. The low debt to equity ratio shows that Whole Foods is not saddled with too much debt. Whole Foods has the capability to borrow from financial markets if necessary. They had lower assets as a percentage of equity but they are also much smaller than the other traditional grocery stores used in our analysis.

B.)

Comparisons to Best in Retail Class

We used common-size analysis for fiscal year 2001 to compare profitability, turnover, and

leverage and liquidity ratios of Whole Foods to other Best in Retail Class (BIC) Competitors. We compared Whole Foods to Walgreens, Wal-Mart, Home Depot, and Tiffanys. See Exhibits 9-11 for the details. Upon examining the profitability ratios and leverage and liquidity ratios, Whole Foods does not appear to be very remarkable when compared against the BIC. However, as with the grocery competitors, Whole Foods has the highest PE ratio of all BIC for fiscal year 2001. Again this is due to the perceived strong growth prospects of Whole Foods. After completing the BIC turnover ratio analysis, we again discovered that Whole Foods had the fastest inventory turnover, the fastest payables turnover, and the lowest days in inventory. The fast inventory turnover and lowest days in inventory are believed to be a product of the grocery industry. Exhibit 12 shows the

Profit Margin/Asset Turnover Combination of all competitors. Whole Foods appears to be doing much better than the Grocery competitors but not quite as good as the BIC.

V. Forecasting
We needed to forecast several key operating items in order to perform a valuation analysis employing the DCF, RIM and ReOM models. These are discussed below. We prepared our forecast by consulting various analyst reports, the companys 10K, and industry sources which forecast organic market demand. See Exhibits 13 and 14.

Sales
We used the number of stores, total square feet per store and sales per square feet as the main drivers in our sales forecast. We expect the total number of stores to increase from 135 at 2002 to 200 by year 2007. This is consistent with WFMIs growth strategy and past acquisition strategy. Since the company is currently building new prototype stores with 50,000 sq. ft., we assumed that the average sq. ft per store would increase from over 30,000 in 2002 to 40,000 by year 2007. Lastly, we assumed that the sales per sq. ft. would increase from $656 at 2002 to $750 by 2007 assuming continued price increases and improving efficiencies of operations. We felt this input may be somewhat aggressive. Total dollar sales were forecast by multiplying the (number of stores x sq. ft. per store) x sales per sq. ft. In total, dollar sales were expected to increase at a rate of 23% in 2003 and decline to 12.6% by 2007. For the residual year, we assumed a 3% long-term growth rate. Our sales forecast implies that WFMI will increase its market share in the organic food segment from 24% in 2002 to 38% by 2007 as measured by S&P. We do feel that this sales forecast, while attainable, may be somewhat aggressive.

Gross Margin
Cost of goods sold was assumed to remain at 65% of sales over the forecast period. This projection is in line with historical figures. Thus, WFMIs gross margin was assumed to be 35% over the forecast period.

EBITDA
Operating expenses before depreciation and amortization were assumed to remain at 27% of sales over the forecast period. This projection is below historical figures and assumes that the

company will be able to better control costs/gain efficiencies with expansion in the future. Thus, WFMIs EBITDA was assumed to be 8% over the forecast period.

EBIT
Depreciation expenses were assumed to range from 2.1% to 2.2% of sales over the forecast period. Depreciation is based off of the capital expenditure forecast and takes into account continued depreciation on existing assets. Also, amortization expenses were assumed to stop as these historical expenses related to goodwill amortization are no longer allowed per SFAS 142. Thus, WFMIs EBIT was assumed to range from 5.8% to 5.9% over the forecast period.

Working Capital
Working capital levels were based upon historical days sales outstanding, days in inventory and days payable outstanding ratios. We assumed that WFMIs cash conversion cycle would decline from 14 days in 2002 to 10 days throughout the forecast period. This forecast is based on the assumption that the company will leverage its size on vendors as it grows and manage its cash more efficiently. We feel that this forecast is somewhat aggressive.

Capital Expenditures
We assumed that capital expenditures would grow as a function of sales over the forecast period but that this function would decline from 4.5% to 2.5% by 2007. This assumption may be too aggressive considering the expansion plans that we have assumed in our sales forecast.

VI. Valuation Methods

A.)

Residual Operating Earnings Model

We valued Whole Foods using the residual operating earnings model. See exhibit 15 for

details of the model. Using a WACC of 9%, the model calculated the value per share of Whole Foods of $41. This is far below the current share price of around $53 per share. For this model, we used an operating income growth rate of 16% which was calculated in our sales forecast. We estimated the return on NOA and NOA growth at 17.5%, which was based on asset turnover over the past few years. Since asset turnover was stable over the last few years, we used sales growth as our estimate for return on NOA and NOA growth. We also used a 3% growth rate for the continuing value calculation. Currently, Whole Foods is growing at much faster rates but 20%

growth rates are unsustainable over long periods of time. We performed a WACC sensitivity analysis which resulted in a share price of $68 at 7% versus a value per share of $27 at an 11% WACC. Obviously, all of these models rely heavily on the assumptions and any changes to the assumptions results in large value per share changes.

B.)

Residual Income Model

We also valued Whole Foods using the Residual Income model. See exhibit 16 for details

of the model. Using a Cost of Equity Capital of 10.5%, the model calculated the value per share of Whole Foods at about $26.60. This is far below the current share price of around $53 and well below the $41 share price calculated using the Operating Income Model. For this model, we used an Earnings growth rate of 20% calculated in our sales forecast. We estimated the discount factor to be about 11%. We also used a 3% growth rate for the continuing value calculation. Currently, Whole Foods is growing at the much faster rate of 20%. However growth rates of this magnitude seem to be unsustainable over long periods of time especially in the grocery segment.

C.)

Discounted Cash Flow Model

We valued Whole Foods using a DCF model. See Exhibit 17 for details of the model.

Using a WACC of 9%, the model calculated the value per share of Whole Foods at $38.45. This is below the current share price of around $53 per share. For this model, we used the assumptions outlined under the forecast section and an effective tax rate of 40%. We also used a 3% growth rate for the continuing value calculation and assumed that capital expenditures would equal depreciation by the residual year. We also performed a WACC sensitivity analysis which resulted in a share price of $60.65 at 7% versus a value per share of $27.41 at an 11% WACC. While WFMIs current share price falls within these bounds, we feel that the fundamental value of WFMI falls at the lower end of this range given the aggressive operating assumptions used in the forecast and the low WACC levels used in the sensitivity analysis.

D.)

Multiple Analysis
We conducted two kinds of multiples analysis in order to cross check our valuation results

from the residual income/operating income model and the DCF model. For the first one, we selected comparable companies from the grocery industry (Exhibit 18). Kroger, Safeway, Albertsons and Wild Oats are compared as direct competitors of Whole Foods. The enterprise value of each company is shown to indicate the size of the companie s. We used the average of the peer groups P/E, P/B and P/S ratios and applied to the Whole Foods valuation. In the second

valuation, the comparable companies are selected from the Best in Class in the retail sector (Exhibit 18). Wal-Mart, Walgreen, Home Depot and Tiffanys are selected as category killers in their industry. We repeated the procedure as described above. The results are astonishing. In comparison with its direct competitors in the grocery industry, it is clear that Whole foods is overvalued. All the multiples (P/E, P/B, P/S) for Whole Foods are much higher than those for the peer group. If we apply the average multiples to Whole Foods, its stock will be valued at just $ 18 per share. However, from the second analysis, it also becomes clear that the multiples of Whole Foods are very similar to those of Best in Class or category killers in the retailing sector. Applied valuation by using the Best in Class average indicates that stock of Whole Foods should be worth about $50 per share. This is very close to the current market price.

E.)

Valuation Matrix
Using the assumptions outlined about to create a Valuation Matrix (Exhibit 19) it appears

difficult to justify our present market price. With a Core RNOA of 11.3 % we would need to have an annual growth in NOA of greater than 15%. This seems highly unlikely and reaffirms our believe that the equity is overvalued.

VII. Investment prospects: The current opportunity

A.)

Recent events

Report strong fourth quarter results

Whole Foods Market reported fourth quarter results on Nov 19, 2002. Sales for the quarter increased by 20 % to $638million. Net income for the quarter increased by 38% to $ 22.0 millon from $17.2 million in the prior year. These increases were driven by a combination of internal expansion (weighted average year over year square footage growth), acquisition and alliance (higher comparable sales) and, efficient use of their existing space (higher identical store sales).

Set goals for FY 2003

For FY 2003, the Company maintains its sales growth forecast of 15% to 20%. The Company upwardly revised its EPS forecast for FY2003 from $ 1.62 to $ 1.67 after seeing the strong results of the last quarter of FY2002. This newly forecasted EPS is an increase of 19% from the actual annual EPS $ 1.40 for FY2002.

Continue to open new stores

In order to support its growth target, the Company plans to open 2 new stores in the premier districts of Manhattan. The stores will be the largest food groceries in New York City. The Company has also signed leases for new stores in Colorado and San Francisco.

B.)

Wall street analyst perceptions

In the past 12 months, 7 analysts have recommended Whole Foods as a buy while 6

analyst rank it as a hold. Monica Aggarwal, an analyst at Merrill Lynch, downgraded Whole Foods stock from buy to hold in the end of August and has kept it rated as a hold. She agrees to the Companys better positioning to capture the extra profit and achieve faster growth than the traditional groceries, however, she still expects sales growth to be moderate in the low teens given discretional weaker consumer spending and intensified competition. While still impressive, she said this is likely below expectations and that with the recent 27% rise in the stock price, valuations are stretched.

VIII. Investment risks: What can go wrong? A.) Overview of business risks

New Stores Openings and Acquisitions

The Companys strategy is to expand though a combination of new store openings and acquisition of existing chains. Although the Company declares 15-20% as the sales growth forecast, achievement of the targeted growth is subject to numerous factors. Particularly, the strategy is dependent on finding suitable locations and winning the competition for such cites from other grocers. Also, successful acquisitions depend on Whole Foods not paying too high of a premium as well as completing a smooth integration process.

Increased competition
The Companys competitors include other natural foods supermarkets, conventional and specialty supermarkets, other natural foods stores and restaurants. These businesses compete with the Company in one or more product categories. In addition, traditional and specialty supermarkets are expanding more aggressively in marketing a broad range of natural foods, thereby competing directly with the Company for products, customers, and locations. Increased competition may have

an adverse effect on profitability as the result of lower sales, lower gross margin and higher marketing costs.

Consumer Spending
The Companys results of operation may be sensitive to changes in overall macroeconomic conditions that impact discretionary consumer spending. This may be very true to the Company because of their premium pricing. A general reduction in level of discretionary consumer spending or shifts in consumer discretionary spending to the Companys competitors could adversely affect its growth and profitability.

Product liability claims

Although the Company has intensified its retail food safety procedure, the customers of the Company hold it to a higher standard than conventional supermarkets. The real or perceived sale of contaminated food products could result in serious product liability claims, and also to damage of its brand equity.

B.)

Overview of capital market risks

Category Killer Premium

As multiples analysis shows, the Companys stock has been traded at very high multiples compared with its comparable companies in the grocery industries. This premium as a category killer could quickly disappear if the Company does not meet analysts expectations or they comeup short of their target growth rate.

Employee stock options

The Company has aggressively used stock options as a key incentive plan for its employees. As a result, the authorized stock options represent almost 20% of the total outstanding shares. Some analysts are concerned with the possible dilution and also the change in accounting rules with regards to stock options. It is estimated that the Companys earnings would be reduced by 16% in FY2002 and 13% in FY2003 if the stock option were expensed out. This is compared to 6% and less than 3% respectively, on average for the traditional groceries.

Beta

The Beta for Whole Foods is 0.82. This is 10% higher than the comparables mean of 0.74. Since Wild Oats also has a higher beta (0.91) than its peers, we can conclude that the stocks of natural food retailers tend to be more volatile and that their returns are more closely correlated with the movement of the overall market than stocks of the conventional supermarkets such as Kroger, Safeway, Albertsons etc. This is of course presuming that the capital structure of the companies are similar.