Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

**FORM 10-Q**

 

| (**X**)QUARTERLY REPORT PURSUANT TO SECTION 13 OR    SECTION 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED     MARCH 27, 2004OR
( )TRANSITION REPORT PURSUANT TO SECTION 13 OR    SECTION 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM     __________ TO __________
 

 

Commission file number 0-21577

 

**WILD OATS MARKETS, INC.**

*(Exact name of registrant as specified in its charter)*

**Delaware***(State or other jurisdiction of    Incorporation or organization)*
**84-1100630***(I.R.S. Employer Identification Number)*****
 

 

**3375 Mitchell LaneBoulder, Colorado 80301***(Address of principal executive offices, including zip code)*

 

 

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

 

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirements for the past 90days:

  Yes       ( **X** )       No      (  )

 

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

  Yes       ( **X** )       No      (  )

 

As of May 3, 2004 there were 30,329,808 shares outstanding of theRegistrant's Common Stock (par value $.001 per share).

 

 

 

**TABLE OF CONTENTS**
**PART I.****FINANCIAL    INFORMATION**
Item 1.
Financial Statements:

Consolidated Balance Sheets,      March 27, 2004 (unaudited) and December 27, 2003

3
Consolidated Statements of      Income (unaudited), Three Months Ended March 27, 2004 and March 29, 2003

4
Consolidated      Statements of Comprehensive Income (unaudited), Three Months Ended March 27, 2004 and      March 29, 2003

5
Consolidated Statements      of Cash Flows (unaudited), Three Months Ended March 27, 2004 and March 29, 2003

6
Notes to      Consolidated Financial Statements (unaudited)

7
Item 2.
Management’s Discussion and Analysis      of Financial Condition and Results of Operations

13
Item 3.
Quantitative and Qualitative Disclosures About      Market Risk

21
Item 4.
Controls and Procedures

21**PART II.**
**OTHER INFORMATION**

Item 1.
Legal Proceedings

23
Item 2.
Changes in Securities

23
Item 3.
Defaults      Upon Senior Securities

24
Item 4.
Submission of Matters to a Vote of Security Holders

22
Item 5.
Other Information

24
Item 6.
Exhibits      and Reports on Form 8-K

24
**SIGNATURES AND CERTIFICATIONS**

Signatures

25
**PARTI.  FINANCIAL INFORMATION**

**Item1.  Financial Statements**

 

**WILD OATS MARKETS, INC.**

**ConsolidatedBalance Sheets**

*(in thousands, except share data)*

 

**March 27,**
**December 27,**
**2004**
**2003**
*(unaudited)***ASSETS**Current assets:Cash and cash equivalents
$ 12,901 
$ 17,400 Inventories, net of reserves 
45,837 
46,621 Accounts receivable, net of    allowance for doubtful accounts 
4,175 
4,038 Income tax receivable
90 
261 Prepaid expenses and other current    assets
1,847 
2,192 Deferred tax asset
6,928 
6,340 Total current assets
71,778 
76,852 Property and equipment, net
136,350 
130,989 Goodwill, net
106,084 
106,404 Other intangible assets, net
6,912 
6,976 Deposits and other assets
3,020 
2,932 Deferred tax asset
10,735 
12,438 
$ 334,879 
$ 336,591 **LIABILITIES AND    STOCKHOLDERS’ EQUITY**Current liabilities:Accounts payable
$ 52,039 
$ 47,529 Book overdraft
22,747 
26,727 Accrued liabilities
41,930 
42,998 Current portion of debt and    capital leases
64 
14 Total current liabilities
116,780 
117,268 Long-term debt and capital leases
24,221 
30,179 Other long-term obligations
14,271 
14,058 
155,272 
161,505 Commitments and contingencies Stockholders’ equity:Preferred stock, $0.001 par value;    5,000,000 sharesauthorized; no shares issued and outstandingCommon stock, $0.001 par value;    60,000,000 sharesauthorized; 30,266,778 and 30,063,421 sharesissued and outstanding, respectively
30 
30 Additional paid-in capital
219,803 
217,400 Note receivable, related party
(10,962)
(10,815)Accumulated deficit
(29,420)
(31,777)Accumulated other comprehensive    income
156 
248 Total stockholders’ equity
179,607 
175,086 
$ 334,879 
$ 336,591 
*The accompanying notes are an integral part of theconsolidated financial statements.*

 

**WILD OATS MARKETS, INC.**

**ConsolidatedStatements of Income**

*(in thousands, except per-share data) (unaudited)*

 

**THREE MONTHS    ENDED**
**March 27,**
**March 29,**
**2004**
**2003**Sales
$ 263,795 
$ 235,987 Cost of goods sold and occupancy    costs
186,681 
165,128 Gross profit
77,114 
70,859 Operating expenses:Direct store expenses
57,043 
50,864 Selling, general and    administrative expenses 
15,521 
15,977 Loss (gain) on disposal of assets
(70)
1,468 Pre-opening expenses
475 
922 Restructuring expense (income),    net
264 
(1,736)Income from operations
3,881 
3,364 Loss on early extinguishment of    debt 
(186)Interest income
186 
176 Interest expense
(267) 
(993)Income before income taxes
3,800 
2,361 Income tax expense
1,443 
921 Net income
$ 2,357 
$ 1,440 Net income per common share:Basic
$ 0.08 
$ 0.05 Diluted
$ 0.08 
$ 0.05 Weighted average common shares    outstanding, basic
30,194 
29,704 Dilutive effect of stock options
840 
212 Weighted average common shares    outstanding, assuming dilution
31,034 
29,916 
 

*The accompanying notes are an integral part of theconsolidated financial statements.*

 

**WILD OATS MARKETS, INC.**

**ConsolidatedStatements of Comprehensive Income**

*(in thousands) (unaudited)*

 

**THREE MONTHS    ENDED**
**March 27,**
**March 29,**
**2004**
**2003**Net income
$ 2,357 
$ 1,440 Other comprehensive income (loss):Foreign currency translation    adjustments arisingduring the period
(92) 
218 Recognition of hedge results to    interest expenseduring the period, net of tax of    $163
272 Change in market value of cash    flow hedge duringthe period, net of tax of $13
(21)Other comprehensive income (loss)
(92)
469 Comprehensive income
$ 2,265 
$ 1,909 
 

*The accompanying notes are an integral part of theconsolidated financial statements*

 

**WILD OATS MARKETS, INC.**

**ConsolidatedStatements of Cash Flows**

*(in thousands) (unaudited)*

 

**THREE MONTHS    ENDED**
**March 27, 2004**
**March 29, 2003****CASH FLOWS FROM OPERATING    ACTIVITIES**Net income
$ 2,357 
$ 1,440 Adjustments to reconcile net    income to net cash from   operating    activities:Depreciation and amortization
6,749 
5,570 Loss (gain) on disposal of    property and equipment
(70) 
1,468 Deferred tax expense
1,341 
885 Non-cash restructuring expense    (income), net
227 
(1,736)Other
199 
263 Change in assets and liabilities:Inventories, net
549 
(1,921)Receivables, net, and other assets
211 
(1,591)Accounts payable
5,939 
3,997 Accrued liabilities
(1,077)
855 Net cash provided by operating activities
16,425 
9,230 **CASH FLOWS FROM INVESTING    ACTIVITIES**Capital expenditures
(13,649)
(6,129)Proceeds from sale of property and    equipment
964 Net cash used in investing activities
(12,685)
(6,129)**CASH FLOWS FROM FINANCING    ACTIVITIES**Net repayments under    line-of-credit agreement
(6,000)
(5,100)Net increase (decrease) in book    overdraft
(3,980)
763Repayments on long-term debt and    capital leases
(13)
(37,094)Proceeds from long-term debt
37,879 Payment of debt issuance costs
(721)Proceeds from issuance of common    stock, net
1,780 
485 Net cash used in financing activities
(8,213)
(3,788)Effect of exchange rate changes on    cash
(26)
(28)Net decrease in cash and cash    equivalents
(4,499)
(715)Cash and cash equivalents at    beginning of period
17,400 
11,367 Cash and cash equivalents at end    of period
$ 12,901 
$ 10,652 **SUPPLEMENTAL DISCLOSURE OF    NON-CASH INVESTING AND FINANCING ACTIVITIES**Equipment acquired through capital    lease
$ 105 
 

*The accompanying notes are an integral part of theconsolidated financial statements.*

 

 

**WILD OATS MARKETS, INC.**

**Notesto Consolidated Financial Statements**

*(unaudited)*

 
**1.****Nature of Operations and Basis of    Presentation**
Wild Oats Markets, Inc. ("Wild Oats" or the"Company"), headquartered in Boulder, Colorado, owns and operates natural andorganic foods supermarkets in the United States and Canada. The Company also operatesbakeries, commissary kitchens and a distribution center that supply the stores. TheCompany’s operations are concentrated in one market segment, grocery stores, and aregeographically concentrated in the western and central parts of the United States.

The consolidated balance sheet as of March 27, 2004, and theconsolidated statements of income, cash flows, and comprehensive income for the threemonths ended March 27, 2004 and March 29, 2003, have been prepared without an audit. Inthe opinion of management, all adjustments, consisting only of normal, recurringadjustments necessary for a fair statement thereof, have been made.

The financial statements have been prepared by the Company in accordance withthe rules and regulations of the Securities and Exchange Commission ("SEC").Certain information and footnote disclosures normally included in financial statementsprepared in accordance with accounting principles generally accepted in the United Stateshave been condensed or omitted pursuant to SEC regulations, therefore, these consolidatedfinancial statements should be read in conjunction with financial statements and notesthereto included in the Company's 2003 Annual Report on Form 10-K. The preparation offinancial statements requires management to make estimates and assumptions that affect thereported amounts of assets, liabilities, revenue, expenses and related disclosures ofcontingent assets and liabilities. Examples include accounting for self-insurancereserves, restructuring charges and store closing costs, asset impairment charges,goodwill and inventory valuation, and contingencies. Actual results may differ from theseestimates. The results of operations for interim periods presented are not necessarilyindicative of the operating results for the full year.

Certain prior period information has been reclassified to conform to thecurrent presentation.

The unaudited information included in the consolidated financialstatements for the three months ended March 27, 2004 includes the results of operations ofthe Company for the 13 weeks then ended.

 
**2.****Stock-Based Compensation**
At March 27, 2004, the Company has seven stock-based employeecompensation plans, which are described more fully in *Note 9 – Stock Plans andOptions* in our fiscal 2003 Annual Report filed on Form 10-K for the period endedDecember 27, 2003. The Company accounts for those plans in accordance with the intrinsicvalue based method in APB Opinion No. 25, *Accounting for Stock Issued to Employees*,and related interpretations. Some stock-based compensation cost is reflected in net incomefor options issued at a discount as Board of Directors compensation. All other optionsgranted under the plans had an exercise price equal to the market value of the underlyingcommon stock on the date of grant; therefore, no stock-based compensation cost isreflected in net income for these grants. Also reflected in results of operations for thefirst quarter of fiscal 2004 and 2003 is compensation expense of $315,000 and $182,000,respectively, relating to the extension of the option exercise period beyondCompany-imposed blackout periods for previously granted stock options held by retiringmembers of the Board of Directors. 

As required by Financial Accounting Standards Board Statement Nos. 123,Accounting for Stock-Based Compensation ("SFAS 123"), and 148, Accounting forStock-Based Compensation-Transition and Disclosure ("SFAS 148"), the followingtable illustrates the effect on net income and earnings per share if stock-basedcompensation costs were to be calculated based on the fair value of the options grantedand recognized ratably over the vesting period as prescribed in SFAS No. 123 (inthousands):

**THREE MONTHS    ENDED**
**March 27, 2004**
**March 29, 2003**Net income, as reported
$ 2,357 
$ 1,440 Add: Stock-based compensation    expense included in reported net income, net of tax
226 
132 Deduct: Total stock-based    compensation expense determined under fair value based    method for all awards, net of tax
(587)
(638)Pro forma net income
$ 1,996 
$ 934 Earnings per share:Basic – as reported
$ 0.08 
$ 0.05 Basic – pro forma
$ 0.07 
$ 0.03 Diluted – as reported
$ 0.08 
$ 0.05 Diluted – pro forma
$ 0.06 
$ 0.03 
 
**3.****Property and Equipment**
As a result of the significant store closures, remodels and resets, infiscal 2003 the Company undertook a review of all fixtures and equipment in its stores,including a physical inventory in conjunction with an asset tagging exercise. During thefirst quarter of fiscal 2003, the Company substantially completed the review and recordeda $1.5 million loss on disposal of fixtures and equipment that will no longer be used inthe stores. 

 
**4.****Debt Covenant Compliance and Liquidity**
In February of 2003, the Company completed the refinancing of its creditfacility with Wells Fargo Bank N.A. The Company’s new facility at inception had a$75.0 million limit, with a three-year term and a one-year renewal option. Under the newcredit facility, the Company has the option to increase the total facility to $135.0million through the addition of new lenders and through the agreement of the currentlending group to increase their total commitments. In December 2003, an additional lenderwas added to the syndicate under the existing terms, increasing the credit facility limitto $95 million.

As part of the new credit facility, the Company gave the lenderscollateral in the form of cash, equipment and fixtures, inventory and other assets. TheCompany has also granted a leasehold mortgage in those leasehold interests previouslymortgaged to secure our former credit facility, although it has no obligation to provide asecurity interest in any new leaseholds. The new credit facility contains limitations oncapital expenditures and the signing of new leases. The interest rate on the facility iscurrently either prime plus 1.0% or one-month LIBOR plus 2.25%, at the Company’selection, and the rates are subject to adjustment depending on the ratio of average totalfunded debt, as defined under the credit facility, plus six times rent expense, toEarnings Before Interest, Income Taxes, Depreciation, Amortization and Restructuring("EBITDAR") for the four fiscal quarter periods then ended, as calculated on ourquarterly compliance certificate. The Company believes that cash generated from operationsand available under its credit facility will be sufficient to meet its capital expenditurerequirements in fiscal 2004.

The Company is currently, and expects to continue to be, in compliancewith the monthly and quarterly financial covenants in the credit agreement. In the eventthat business conditions worsen, management has identified contingency actions to enablethe Company to remain in compliance with the financial covenants. Even if the Companyremains in compliance with its monetary covenants, a technical default could result due toa breach of the financial covenants. In the absence of a waiver or amendment to suchfinancial covenants, such non-compliance would constitute a default under the creditagreement, and the lenders would be entitled to accelerate the maturity of theindebtedness outstanding thereunder. In the event that such non-compliance appears likely,or occurs, the Company will seek approval, as it has in the past, from the lenders torenegotiate financial covenants and/or obtain waivers, as required. However, there can beno assurance that future amendments or waivers will be obtained.

 
**5.****Derivatives and Hedging Activities**
In accordance with the Company’s interest rate risk-managementstrategy and as required by the terms of the Company’s credit facility at the time,in September 2000, the Company entered into a swap agreement to hedge the interest rate on$30.0 million of its borrowings as of March 29, 2003. The swap agreement locked in aone-month LIBOR rate of 6.7% and expired in August 2003. The fair value of the swap atMarch 29, 2003 was ($547,000), which has been recorded in the accompanying balance sheetin accrued liabilities. There is no obligation to renew the swap under the refinancedfacility. No interest rate swap agreements are outstanding as of March 27, 2004.

 
**6.****Earnings Per Share**
Earnings per share are calculated in accordance with the provisions ofSFAS No. 128, *Earnings Per Share ("SFAS 128").*SFAS 128 requires theCompany to report both basic earnings per share, which is based on the weighted-averagenumber of common shares outstanding, and diluted earnings per share, which is based on theweighted-average number of common shares outstanding and all dilutive potential commonshares outstanding, except where the effect of their inclusion would be anti-dilutive.Anti-dilutive stock options for 354,259****and 2,113,188 shares for the three monthsended March 27, 2004 and March 29, 2003, respectively, were not included in the earningsper share calculations.

 
**7.****Goodwill and Finite Lived Intangible Assets**
During the first quarter of fiscal 2004, no goodwill was recognized as aresult of acquisitions and, no goodwill was impaired. In January 2004, the Company sold aretail store located in New York City that did not fit the Company’s real estatestrategy or format for $900,000 in cash. The goodwill associated with this store of$320,000 was written off and included in the calculation of the gain on disposal of thisbusiness. No other changes in the carrying amount of goodwill occurred.

Other intangible assets consist of the following (in thousands):

**March 27,**
**December 27,**
**2004**
**2003**Leasehold interests
$ 8,985 
$ 9,045 Less accumulated amortization
(2,291)
(2,240)
6,694 
6,805 Liquor licenses
218 
171 
$ 6,912 
$ 6,976 
Amortization expense related to finite lived intangible assets was$129,000 and $120,000 for the three months ended March 27, 2004 and March 29, 2003,respectively. The estimated amortization of finite lived intangible assets for each of thefive fiscal years ending in fiscal 2008 is as follows (in thousands):

**FISCAL     YEAR**
**AMORTIZATION EXPENSE**
2004
$ 496
2005
$ 491
2006
$ 474
2007
$ 470
2008
$ 461
 

 
**8.****Restructuring Expense (Income)**
During the first quarter of fiscal 2004, the Company recordedrestructuring expense of $264,000 consisting of the following components:
Change in estimate related to    lease-related liabilities for sitespreviously identified for closure or sale
$     236,000 Severance for employees notified    of termination during the firstquarter
       28,000 Total restructuring expense
$     264,000 

 

Details of the significant components are as follows:- *Change in estimate related to lease-related liabilities for sites    previously identified for closure or sale ($236,000 of restructuring expense)* –    During the first quarter, the Company determined that additional time will be needed to    dispose of certain lease obligations for vacant sites in Pinecrest, Florida and Memphis,    Tennessee, resulting in restructuring expense of $236,000. 
- *Severance for employees notified of termination during the first    quarter ($28,000 of restructuring expense) -*During the first quarter, 26 employees    were terminated in conjunction with the closing of a store in West Palm Beach, Florida.    The employees were notified of their involuntary termination during the first quarter of    fiscal 2004. As of March 27, 2004, $15,000 of involuntary termination benefits had been    paid to terminated employees. 

The following table summarizes accruals related to the Company’srestructuring activities during the first three months of fiscal 2004 (in thousands):
**EXIT PLANS**
**2000 AND PRIOR**
**Q2 2001**
**Q4 2002**
**Q3 2003**
**Q1 2004**
**TOTAL**Balance, 12/27/03
$ 5,783 
$ 4,949 
$ 458 
$ 181 
$11,371 New accruals -  Severance
$ 28 
28   Lease-related    liabilities
(16)
216 
36 
236 Cash paid -   Severance
(13)
(26)
(15)
(54)  Lease-related    liabilities
(151)
(95)
(476)
(35)
(757)Balance, 3/27/04
$ 5,6161
$ 5,0701
$ 52
$ 1202
$ 132
$10,824 *1**The restructuring accrual    balance consists of lease-related liabilities.**2**The restructuring accrual    balance consists of lease related liabilities and a total of $32,000 of employee    termination benefits.*
As of March 27, 2004, the components of the accruals related to theCompany’s restructuring activities are accrued liabilities ($2.3 million) and otherlong-term obligations ($8.5 million).

 
**9.****Income Taxes**
For the three months ended March 27, 2004, the Company recorded $1.4million of income tax expense, as a result of income before income taxes of $3.8 millionduring the period. The Company has a $17.7 million net deferred tax asset, primarily as aresult of net operating loss carry-forwards and temporary differences relating torestructuring and asset impairment charges. The recoverability of the net deferred taxasset is primarily dependent upon the Company generating sufficient taxable income in thefuture. The Company has established a valuation allowance for certain state net operatingloss carry-forwards which the Company believes will not result in a future realizable taxbenefit based upon projected taxable income in those states during the carry forwardperiod. Although realization of the remaining net deferred tax asset is not assured, theCompany has concluded that a valuation allowance is not required, as it is more likelythan not that the Company will be able to realize a tax benefit through the generation offuture taxable income. The Company's assessment is based upon projections, which assumethe Company will at least maintain its current store contribution margin, and aggregatesales growth experienced over the past five years, which would generate sufficient taxableincome to realize the full amount of the deferred tax asset. The Company believes that thesales, gross margin, store contribution margin, and selling, general and administrativeexpenses assumptions in its financial projections are reasonable and, more likely thannot, attainable. The Company will continue to assess the recoverability of the remainingnet deferred tax asset, and to the extent it is determined in the future that anadditional valuation allowance is required, it will be recognized as a charge to earningsat that time.

 
**10.****Change in Primary Distributor**During the fourth quarter of 2003, the Company    and Tree of Life, Inc. ("TOL") agreed to terminate their primary distribution    relationship, and in January 2004, the Company signed a five year primary distribution    agreement with United National Foods, Inc. ("UNFI"). The transition to UNFI was    fully completed in March 2004. The agreement states that UNFI will pay the Company a    conversion fee to cover the costs of the transition to UNFI, which is payable over the    period of the contract, subject to the Company meeting certain minimum purchase    requirements.**11.****Related Party Transactions**
The Company and Perry D. Odak, the Company’s Chief ExecutiveOfficer and President, and a director of the Board, entered into an employment agreementin March 2001. As part of Mr. Odak’s employment agreement, the Company agreed topurchase his home in York, Pennsylvania if he was unable to sell it within a specificperiod of time. In July 2001, the Company arranged for a relocation service to purchasethe home from Mr. Odak for $1.6 million. Despite substantial marketing efforts, therelocation service was unable to sell the house for a reasonable price. In November 2002,Mr. Odak offered to repurchase the house for the original $1.6 million he had received. AtDecember 28, 2002, Mr. Odak had remitted $1.35 million to the Company as partialconsideration to fund the purchase and the remaining consideration was funded by Mr.Odak’s fiscal 2002 bonus of $250,000 to which he was contractually entitled. On March6, 2003, the Company remitted the $1.6 million to the relocation service.

 
**12.****Contingencies**
Wild Oats Markets Canada, Inc., as successor to Alfalfa’s Canada,Inc., a Canadian subsidiary of the Company, is a defendant in Helen Fakhri and AdyAylon, as Representative Plaintiffs v. Alfalfa’s Canada, Inc., a class actionsuit brought in the Supreme Court, British Columbia, Canada by representative plaintiffsalleging to represent two classes of plaintiffs – those who contracted Hepatitis Aallegedly through the consumption of food purchased at a Capers Community Market in thespring of 2002, and those who were inoculated against Hepatitis A as a result of newsalerts by Capers and the Vancouver Health Authority. In the fourth quarter of 2003, theaction was certified as a class action by the court. The Company is appealing that ruling.The Company intends to vigorously defend both class certification and the suit itself. TheCompany is not able to estimate the potential outcome of the suit at this time.

In April 2000, the Company was named as defendant in S/H –Ahwatukee, LLC and YP - Ahwatukee LLC v. Wild Oats Markets, Inc., Superior Court ofArizona, Maricopa County, by a landlord alleging Wild Oats breached a continuousoperations clause arising from the closure of a Phoenix, Arizona store. Plaintiff claimed$1.5 million for diminution of value of the shopping center plus accelerated rent, feesand $360,000 in attorneys’ fees and costs. After trial in November 2001, the judgeawarded the plaintiff an aggregate $536,000 in damages and attorneys’ fees. TheCompany’s appeal of judgment was denied in the first quarter of fiscal 2004, and theCompany filed a motion for reconsideration, which was denied. The Company plans to seekcertification of the decision to the Arizona Supreme Court. The Company has recognized acharge to restructuring expense during the fourth quarter of 2003 in the amount of$705,000, including estimated attorney’s fees and estimated interest accrued on thejudgment.

In September 2002, the Company filed suit against Michael Gilliland andElizabeth Cook, former officers and directors and greater than 5% stockholders of theCompany, together with two individuals and three limited liability corporations, for atemporary restraining order and damages related to a breach of Mr. Gilliland’snon-competition covenant, contained in his 1996 employment agreement, arising from theopening of a competitive grocery store in New Mexico. The lawsuit is captioned WildOats Markets, Inc. v. Michael C. Gilliland, Elizabeth C. Cook, Mark R. Clapp; PatrickGilliland, Westside Farmer’s Market LLC, Westside Liquors LLC and Milagro Cafe LLC.Mr. Gilliland and Ms. Cook have counterclaimed, claiming that Ms. Cook was entitled toseverance payments, and that both were under-compensated during their employment by theCompany. After a hearing, the court issued a temporary restraining order against Mr.Gilliland, prohibiting him from engaging in the operation of the competing grocery store.The temporary restraining order was subsequently vacated at the Company’s request andthe Company dropped its claims for injunctive relief as it did not believe the injunctiverelief granted made any material difference in Mr. Gilliland’s behavior. The Companydiscontinued severance payments made to Mr. Gilliland based on his material breach of hisemployment contract. The Company continues to pursue its suit for damages. A related suitwas filed against Mr. Gilliland and his brother, Patrick Gilliland, for misappropriationof trade secrets and insider trading related to Patrick Gilliland’s postings on afinancial chat board that he was receiving and trading upon confidential information ofthe Company. A motion to consolidate the two related suits was denied by the BoulderCounty District Court in April 2004.

We continue our audit of past administrative practices of one of ourbenefit plans, and expect to complete such audit by the end of the second fiscal quarterof 2004. At this time, the Company cannot estimate whether such audit results willdisclose any corrections that will result in material liability to the Company.

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

 

 

 

**Item 2.  Management'sDiscussion And Analysis Of Financial Condition And Results Of Operations**

This report on Form 10-Q contains certain forward-looking statementsregarding our future results of operations and performance. Important factors that couldcause differences in results of operations include, but are not limited to, the timing andexecution of new store openings, relocations, remodels, sales and closures; the timing andimpact of promotional and advertising campaigns; the impact of competition; changes inproduct supply or suppliers and disruption caused by such change; changes in managementinformation needs; changes in customer needs and expectations; governmental and regulatoryactions; general industry or business trends or events; changes in economic or businessconditions in general or affecting the natural foods industry in particular; andcompetition for and the availability of sites for new stores and potential acquisitioncandidates. See *"Management's Discussion and Analysis of Financial Condition andResults of Operations - Cautionary Statement Regarding Forward-Looking Statements."*

 

**Overview**

Wild Oats Markets, Inc. is one of the largest natural food supermarketchains in North America, with 101 stores in 24 states and British Columbia, Canada, as ofMarch 27, 2004. Our stores are differentiated from other grocers, both conventional andnatural, by our uncompromising commitment to natural and organic products and to ourcustomers’ education in the areas of health and wellness. 

*Quarterly Results, Marketing and Merchandising Initiatives andOperational Improvements*. Company performance in the first quarter of fiscal 2004reflected overall growth in store sales, customer count and average transaction sizenationwide. We attribute the growth to overall improvements in operational execution atstore level and marketing and merchandising programs, as well as the positive impact ofthe California grocery strike in the first two months of the year on our 22 southernCalifornia stores. Throughout fiscal 2004, we will continue to focus on improving ourbusiness and value to our stakeholders through investment in infrastructure needed foroperational improvements and growth. We also will continue strengthening our brandpositioning. The initiatives we will focus on include: - Re-engineering of key departments in our stores to improve product    selection, shop-ability and customer service 
- Continued expansion of our private label product lines
- Investment in new store signage and merchandising to improve consumer    understanding of food safety, nutrition and diet 
- Continued training of staff to ensure detailed product knowledge and an    ability to educate consumers on health and wellness issues
- Integration of our new produce and frozen food distribution facility into    the distribution chain for our stores in the western United States
- Development of brand marketing programs by region and community

In the first quarter of fiscal 2004, we introduced new strategies tocommunicate information on certain food safety concerns and dietary trends, such as ourintroduction of "Are You Counting Carbs?" signage for lower carbohydrateproducts, "trans-fat-free" signage educating our customers on the role of transfats in health problems as part of our removal of products containing hydrogenated oilsfrom our stores, and meat and seafood information signage on a variety of topics,including our "worry-free" grass-fed beef. We consolidated our warehousefacilities in the western United States into one new state-of-the-art distributionfacility and largely completed our transition to a new primary distributor, UNFI. 

Strikes by grocery store workers in conventional grocery stores insouthern California commencing in October 2003 and continuing through February 2004resulted in increased sales and customer counts in our 17 Henry’s Marketplace andfive Wild Oats Natural Marketplace stores in that region. The strike accounted for anestimated 4.9% of our total quarterly comparable store sales of 8.5%. We developedstrategies to service conventional customers during the strikes, including modification ofsome product mix, and increased customer service, with the goal of customer retentionafter the strike concluded. Through the date of this report, average sales and customerretention in the 22 affected stores equaled or exceeded our historic retention rates.

We continue to execute our real estate strategy, and through the date ofthis report, have signed leases or letters of intent for 31 proposed new sites opening infiscal 2004 and fiscal 2005. New stores expected to open in the remainder of fiscal 2004include sites in metropolitan Phoenix, Arizona; metropolitan San Diego and Los Angeles,California; Superior, Colorado; Indiana; Nebraska; Ohio; metropolitan Portland, Oregon andSalt Lake City, Utah.  The expansion of the credit facility to $95 million inFebruary 2003, together with cash generated from operations, ensures that we havesufficient capital resources to fund our projected new store growth over the next severalyears.

*Store Openings, Closings and Remodels.* At March 27, 2004, we had101 stores located in 24 states and Canada, as compared to 102 stores in 25 states andCanada at the end of the first quarter of fiscal 2003. 

**TOTAL STORE    COUNT**

**Period**
**Fiscal Year    Ending**
**Ending**
**March 27,**
**2002**
**2003**
**2004**Store count at beginning of period
107     
99     
103     Stores opened
1     
8     
1     Stores closed
(5)    
(4)    
(2)*  Stores sold
(4)    
     
(1)    Store count at end of period
99     
103     
101     
* *Includes the closure of one store in Phoenix, Arizona for format    conversion.*

 

In the first quarter of fiscal 2004, we sold one store that did not fitour real estate strategy or formats in New York City, and we closed one store in West PalmBeach, Florida, where the lease was expiring and the store had incurred weather-relatedroof damage. We also closed one natural foods supermarket store in Phoenix, Arizona toconvert that store to our farmers market format, which store is scheduled to reopen latein the second quarter of 2004. One new store was opened in Colorado Springs, Colorado. Inthe first quarter of fiscal 2004 and through the date of this report, we have commencedand completed major remodeling and/or major resetting projects in seven of our stores. Wehave also consolidated the operation of two warehouse facilities into our new Riverside,California distribution center. In the second quarter of fiscal 2004, we plan to close oneremaining warehouse facility as a part of the consolidation of our distribution facilitiesin the western United States.

At the end of the first fiscal quarter of 2004, we had an inventory of11 vacant sites comprising closed store and office locations and excess unoccupied spaceacquired during acquisitions or other leasing transactions, for which we have rentobligations. Appropriate accruals have been made for such obligations. We are activelyseeking subtenants or assignees for the majority of the spaces, although many of the sitesare difficult to sublease or assign because of unusual site characteristics, surpluses ofvacant retail space in the markets in which the sites are located, or because theremaining lease terms are relatively short. 

*Comparable Store Sales Results.* Sales of a store are deemed to becomparable commencing in the thirteenth full month of operations for new, relocated andacquired stores. Comparable store sales increased by 8.5% in the first quarter of fiscal2004 as a result of operational improvements and the continued positive impact of theCalifornia conventional grocery store strikes in the first two months of the quarter(estimated at 4.9%). Sales growth in our perishable departments (specifically meat andproduce), as a result of improved product selection, marketing programs targeting lowcarbohydrate diets and food safety concerns around meat and seafood, also contributed tothe sales increase. Comparable store sales for fourth quarter 2004 will be lower incomparison to the robust comparable stores sales in the fourth quarter of fiscal 2003,during which we saw substantial positive comparable store sales impact in 22 of our storesas a result of the California grocery strikes. 

*Critical Accounting Policies and Estimates*. Our discussion andanalysis of our financial condition and results of operations are based upon ourconsolidated financial statements, which have been prepared in accordance with accountingprinciples generally accepted in the United States of America. The preparation of thesefinancial statements requires us to make estimates and judgments that affect the reportedamounts of assets, liabilities, revenues and expenses, and related disclosures ofcontingent assets and liabilities. We base our estimates on historical experience and onvarious other assumptions that are believed to be reasonable under the circumstances, theresults of which form the basis for making judgments about the carrying values of assetsand liabilities that are not readily apparent from other sources. Actual results maydiffer from these estimates. 

On an ongoing basis, we evaluate the continued appropriateness of ouraccounting policies and resulting estimates, including those related to:- Goodwill valuation
- Asset impairment charges
- Restructuring charges and store closing costs
- Inventory valuation and reserves
- Self-insurance reserves
- Reserves for contingencies and litigation

We believe the following critical accounting policies affect our mostsignificant judgments and estimates used in the preparation of our consolidated financialstatements. There have been no changes during the first quarter of 2004 in the selectionor application of these policies.

*Goodwill.* Goodwill consists of the excess cost of acquiredcompanies over the sum of the fair market value of their underlying tangible andidentifiable intangible assets acquired and liabilities assumed. Prior to 2002, goodwillwas recorded at the store-level, and amortized over 40 years. With adoption of Statementof Financial Accounting Standards No. 142, "Goodwill and Other IntangibleAssets", we record goodwill at the enterprise level. It is no longer amortized but istested for impairment annually, or more frequently if certain indicators of impairmentexist. Our annual evaluation for impairment requires management to exercise a high degreeof judgment in developing assumptions and fair value estimates used in the calculation,which have the potential of significantly impacting the results.

*Impairment of Long-Lived Assets.*We monitor the carrying value ofour long-lived assets, including finite-lived intangible assets, for potential impairmentwhenever changes in circumstances indicate a potential for impairment may exist. Thetriggering events for evaluations of finite lived intangible assets include a significantdecrease in the market value of an asset, acquisition and construction costs in excess ofbudget, or current store operating losses combined with a history of losses or aprojection of continuing losses. If an impairment is identified, based on undiscountedfuture cash flows, management compares the asset’s future cash flows, discounted topresent value using a risk-adjusted discount rate, to its current carrying value andrecords a provision for impairment as appropriate. With respect to equipment and leaseholdimprovements associated with closed stores, the value of these assets is adjusted toreflect recoverable values estimated based on our previous efforts to dispose of similarassets, with consideration for current economic conditions. 

*Restructuring and Asset Impairment Costs.*We plan to completestore closures or sales within a one-year period following the commitment date. Costsrelated to store closures and sales are reflected in the income statement as"Restructuring and Asset Impairment Charges." For stores we intend to sell, weactively market the stores to potential buyers. Stores held for disposal are reduced totheir estimated net realizable value. Prior to 2003, when we committed to close a store, alease-related liability was recorded for the present value of the estimated remainingnon-cancelable lease payments after the anticipated closing date, net of estimatedsubtenant income, or for estimated lease settlement costs. In addition, we recorded aliability for costs to be incurred after the store closing which are required under leasesor local ordinances for site preservation during the period before lease termination. Thevalue of equipment and leasehold improvements related to a closed store was reduced toreflect recoverable values based on our previous efforts to dispose of similar assets andcurrent economic conditions. In accordance with the new requirements of SFAS No. 146 (See *"Notesto Consolidated Financial Statements – Note 1 – Organization and Summary ofSignificant Accounting Policies -New Accounting Pronouncements"*in our fiscal2003 Annual Report on form 10-K for a discussion of SFAS No. 146), as of fiscal 2003, werecognized such lease related costs at the time of the actual store closing. As of thedate of the commitment to close or relocate a store, depreciation of store assets isaccelerated over the remaining months of operation as necessary in order to bring theirnet carrying cost down to net realizable value as of the date of closure. 

Severance costs incurred in connection with store closings are recordedwhen the employees have been identified and notified of the termination benefits to bemade to the employees. 

Lease-related liabilities and the recoverability of assets to bedisposed of are reviewed quarterly, and changes in previous estimates are reflected inoperations. Significant cash payments associated with closed stores relate to ongoingpayments of rent, common area maintenance, insurance charges, and real property taxes asrequired under continuing lease obligations.

*Inventories.*Store inventories are valued principally at thelower of cost or market, with cost primarily determined under the retail method on aFirst-in, First-out ("FIFO") basis. FIFO cost is determined using the retailmethod for approximately 80% of inventories and using the item cost method for highlyperishable products representing approximately 20% of inventories. Under the retailinventory method, the valuation of inventories at cost and the resulting gross margins aredetermined by applying a cost-to-retail ratio for various categories of similar items tothe retail value of inventories. Inherent in the retail inventory method calculations arecertain management judgments and estimates, including shrinkage, which could impact theending inventory valuation at cost as well as the resulting gross margins. 

We maintain allowances for excess or unsaleable inventory as apercentage of our gross inventory balance based on historical experience and assumptionsabout market conditions. If actual market conditions are less favorable than thoseprojected by management, or if we expand our forward buying of inventory, which willincrease our inventory levels, then additional inventory write-downs may be required.

*Self-Insurance*. We are self-insured for certain losses relatingto worker’s compensation claims, general liability and employee medical and dentalbenefits. We have purchased stop-loss coverage in order to limit its exposure to anysignificant levels of claims. Self-insured losses are accrued based upon our estimates ofthe aggregate uninsured claims incurred using certain actuarial assumptions followed inthe insurance industry and our historical experiences. A high degree of managementjudgment is required in developing these estimates and assumptions, which have thepotential for significantly impacting the required reserve amounts.

*Contingencies and Litigation.*We maintain reserves forcontingencies and litigation based on management’s best estimates of potentialliability in the event of a judgment against us, possible settlement costs, as well asexisting facts and circumstances. Future adverse changes related to current contingenciesand litigation could necessitate additional reserves in the future.

 

 

 

 

 

**Results of Operations**

Our net income for the first quarter of fiscal 2004 was $2.4 million, or$ 0.08 per diluted share, compared with a net income of $1.4 million, or $0.05 per dilutedshare, in the same period in fiscal 2003. The following table sets forth, for the periodsindicated, certain selected income statement data expressed as a percentage of sales andin dollars (*in thousands - percentages may not add due to rounding):*
**FISCAL YEAR**
**THREE MONTHS    ENDED**
**THREE MONTHS    ENDED**
**$**
**%**
**$**
**%**
**March 27,**
**March 27,**
**March 29,**
**March 29,**
**2004**
**2004**
**2003**
**2003**Sales
$263,795 
100.0%  
$235,987 
100.0%Cost of goods sold and occupancy costs
186,681 
70.8     
165,128 
70.0   Gross profit 
77,114 
29.2     
70,859 
30.0   Direct store expenses
57,043 
21.6     
50,864 
21.6   Selling, general and administrative    expenses
15,521 
5.9     
15,977 
6.8   Loss (gain) on disposal of assets,
(70)
0.0     
1,468 
0.6   Pre-opening expenses
475 
0.2     
922 
0.3   Restructuring expense (income)
264 
0.1     
(1,736)
(0.7)  Income from operations
3,881 
1.5     
3,364 
1.4   Loss on early extinguishment of debt
(186)
(0.1)  Interest income
186 
0.1     
176 
0.1   Interest expense
(267)
(0.1)    
(993)
(0.4)  Income before income taxes
3,800 
1.4     
2,361 
1.0   Income tax expense
1,443 
0.5     
921 
0.4   Net income
$ 2,357 
0.9%  
$ 1,440 
0.6%
 

*Sales.* Sales are generated primarily from the retail sale ofproducts in our stores. Net sales for the three months ended March 27, 2004, were $263.8million, an increase of 11.8% over the same period in fiscal 2003, driven primarily by the8.5% increase in comparable store sales for the quarter, as well as a full quarter ofsales for three new stores opened during the first quarter of 2003. The sales increase wasprimarily attributed to operational improvements, increased sales at 22 stores positivelyimpacted by the labor strikes in California conventional grocery stores during the firsttwo months of the first quarter of fiscal 2004, and improvements in marketing andmerchandising programs. There is no assurance that we will continue to retain theincreased sales that resulted from the California grocery strikes. 

Comparable stores’ customer traffic increased 2.7% and the averagetransaction size per customer in those stores increased 5.8%. We deem sales of a storecomparable commencing in the 13th full month of operations. 

*Gross Profit.* Gross profit consists of sales less cost of goodssold and store occupancy costs. As a percentage of sales, gross profit margins decreasedto 29.2% in the first quarter of fiscal 2004 from 30.0% in the same period in fiscal 2003,due primarily to accelerated depreciation of $1.7 million related to projected store andwarehouse closures, start-up costs for our Riverside, California distribution facility,lower margins associated with the opening of new stores, and disruptions in private labelproduct supply resulting from our transition to a new primary distributor. We expect theseimpacts to continue into the second quarter of fiscal 2004.

*Direct Store Expenses.* As a percentage of sales, direct storeexpenses remained constant at 21.6% in the first quarter of fiscal 2004 compared to thesame period in fiscal 2003. Improvements made in labor management were offset by higherbenefit costs for health and dental insurance, among others.

*Selling, General and Administrative Expenses.*Selling, generaland administrative expenses for the three months ended March 27, 2004 decreased 2.9% to$15.5 million, as compared to $16.0 million, in the same period in fiscal 2003. Firstquarter selling, general and administrative expenses included costs of an ongoingadministrative practices audit of one of our benefit plans and the costs necessary toensure our compliance with Section 404 of the Sarbanes-Oxley Act of 2002 ("SOX")prior to its effective date. We expect that the benefit plan audit will be completed inthe second quarter of fiscal 2004, and that SOX compliance costs will continue throughoutthe year. As a percentage of sales, selling, general and administrative expenses decreasedto 5.9% in the first quarter of fiscal 2004 from 6.8% in the same period in fiscal 2003.The decrease is attributable to the timing of various marketing programs as compared to2003, as well as the leveraging of existing support costs against higher sales for thequarter. Commencing in the second quarter of fiscal 2004, we expect to see an increase incompensation expense as a result of a change in the type of compensation, from stockoptions to Restricted Stock Units ("RSU"), received by Board members formembership and participation on the Board of Directors, such expense to be equal to thefair market value of stock underlying the RSU on the date granted or vested. 

*Loss (Gain) on Disposal of Assets.*We recorded a $70,000 net gainon disposal of assets for the three months ended March 27, 2004, including a net gain of$161,000 (after adjustment for write-off of goodwill) from the sale of a retail store inNew York City in January 2004. During the same period in fiscal 2003, we substantiallycompleted a physical inventory of all fixtures and equipment in our stores, an exerciseundertaken in response to significant store closings, remodels and resets, and recorded a$1.5 million loss on disposal of fixtures and equipment that we no longer used in ourstores. 

*Pre-Opening Expenses*. Pre-opening expenses include labor, rent,advertising, utilities, supplies and certain other costs incurred prior to a store’sopening. Pre-opening expenses for the three months ended March 27, 2004, decreased to$475,000, as compared to $922,000 during the same period in fiscal 2003. As a percentageof sales, pre-opening expenses decreased to 0.2% in the first quarter of fiscal 2004 from0.3% in the same period in fiscal 2003, due to the number and timing of new store openingsin the period. One new store opened in the first quarter of fiscal 2004 as compared tothree openings during the same period in 2003. Pre-opening expenses will be higher duringthe remainder of fiscal 2004 as we prepare to open up to 12 additional new stores.

*Restructuring Expense (Income).*During the first quarter offiscal 2004, we recorded restructuring expense of $264,000. Details of the significantcomponents are as follows:- *Change in estimate related to lease-related liabilities for sites    previously identified for closure or sale ($236,000 of restructuring expense)* –    During the first quarter, we determined that additional time will be needed to dispose of    certain lease obligations for vacant sites in Pinecrest, Florida and Memphis, Tennessee,    resulting in restructuring expense of $236,000. 
- *Severance for employees notified of termination during the first    quarter ($28,000 of restructuring expense) -*During the first quarter, 26 employees    were terminated in conjunction with the closing of a store in West Palm Beach, Florida.    The employees were notified of their involuntary termination during the first quarter of    fiscal 2004. As of March 27, 2004, $15,000 of involuntary termination benefits had been    paid to terminated employees. 

*Loss on Early Extinguishment of Debt*. Loss on earlyextinguishment of debt for the three months ended March 29, 2003 was due to therefinancing of the credit facility, which required the write-off of the unamortized debtcosts associated with the old facility.

*Interest Income*. Interest income for the three months ended March27, 2004 remained relatively constant at $186,000 as compared to $176,000 for the sameperiod in fiscal 2003.

*Interest Expense.* Interest expense for the three months endedMarch 27, 2004 decreased 73.1% to $267,000 from $1.0 million in the same period in fiscal2003, due to an overall decrease in borrowings under our credit facility as well as theexpiration of the interest rate swap in August 2003 which increased first quarter 2003interest expense by $435,000. 

*Income Tax Expense.*For the three months ended March 27, 2004, werecorded $1.4 million of income tax expense, as a result of income before income taxes of$3.8 million during the period. We expect the effective tax rate on income from continuingoperations will be in the range of 38.0% to 38.5% for fiscal 2004. See *"Management’sDiscussion and Analysis of Financial Conditions and Results of Operations – Liquidityand Capital Resources"*below.

 

**Liquidity and Capital Resources**

Our primary sources of capital have been cash flow from operations(which includes trade payables), bank indebtedness, and the sale of equity securities.Primary uses of cash have been the financing of new store development, new store openings,relocations, remodels and acquisitions and repayment of debt.

Net cash provided by operating activities was $16.4 million during thefirst three months of fiscal 2004 as compared to $9.2 million during the same period infiscal 2003. Increases in cash from operating activities during this period wereattributable to higher pretax income adjusted for non-cash items as well as significantimprovements in inventory and payables management. Accounts payable balances as of March27, 2004 increased to $52.0 million from $39.3 million as of March 29, 2003. This increasewas primarily attributable to improved vendor terms and higher capital spending. Accruedliabilities increased to $41.9 million from $38.6 million as of March 29, 2003, primarilydue to normal increases in self insurance reserves.

Net cash used in investing activities was $12.7 million during the firstthree months of fiscal 2004 as compared to $6.1 million during the same period in fiscal2003. The increase is due to increased capital spending related to new store growth.

Net cash used in financing activities was $8.2 million during the firstthree months of fiscal 2004 as compared net cash used of $3.8 million during the sameperiod in fiscal 2003. The increased use of cash is due primarily to the timing of checksclearing our central disbursement account. 

For the three months ended March 27, 2004, we recorded $1.4 million ofincome tax expense, as a result of income before income taxes of $3.8 million during theperiod. We have a $17.7 million net deferred tax asset, primarily as a result of netoperating loss carry-forwards and temporary differences relating to restructuring andasset impairment charges. The recoverability of the remaining net deferred tax asset isprimarily dependent upon us generating sufficient taxable income in the future. We haveestablished a valuation allowance for certain state net operating loss carry-forwardswhich we believe will not result in a future realizable tax benefit based upon projectedtaxable income in those states during the carry forward period. Although realization ofthe net deferred tax asset is not assured, we have concluded that a valuation allowance isnot required, as it is more likely than not that we will be able to realize a tax benefitthrough the generation of future taxable income. Our assessment is based upon projectionswhich assume we will at least maintain its current store contribution margin, andaggregate sales growth experienced over the past five years, which would generatesufficient taxable income to realize the full amount of the deferred tax asset. We believethat the sales, gross margin, store contribution margin, and selling, general andadministrative expenses assumptions in its financial projections are reasonable and, morelikely than not, attainable. We will continue to assess the recoverability of theremaining net deferred tax asset, and to the extent it is determined in the future that anadditional valuation allowance is required, it will be recognized as a charge to earningsat that time.

*Refinancing of Credit Facility.*In February 2003, we completedthe refinancing of our credit facility with Wells Fargo Bank N.A., our formeradministrative agent, again acting as lead bank and administrative agent. Our new facilityinitially had a $75.0 million limit, which was increased to $95 million in December 2003with the addition of one new bank to the lending group, and has a three-year term with aone-year renewal option. Under the new facility, we have the option to increase the totalfacility to $135.0 million through the addition of new lenders and through the agreementof the current lending group to increase their total commitments. 

As part of the credit facility, we have given our lenders collateral inthe form of cash, equipment and fixtures, inventory and other assets. We have also grantedleasehold mortgages in those leasehold interests previously mortgaged to secure our formercredit facility, although we have no obligation to provide a security interest in any newleaseholds. The facility contains limitations on capital expenditures and the signing ofnew leases, although we believe such limitations will not restrict our announced growthplans of up to 15 stores in fiscal 2004 and up to 20 stores in fiscal 2005. The interestrate on the facility is currently either prime plus 1.0% or one-month LIBOR plus 2.25% atour election, and the rates modify depending on the ratio of average total funded debt, asdefined under the credit facility, plus six times rent expense, to EBITDAR for the fourfiscal quarter periods then ended, as calculated on our quarterly compliance certificate.Additionally, we are charged a commitment fee on the unused portion of the line rangingfrom 0.25% to 0.5% based on performance objectives as defined in the credit agreement.Outstanding borrowings under the new facility were $24.2 million as of March 27, 2004, ascompared to $38.9 million as of the end of the first quarter of fiscal 2003. The decreasein the amount of outstanding borrowings from the same period in fiscal 2003 isattributable to improved working capital management and increased sales volume. As our newstore growth accelerates, we expect that our borrowings under the credit facility willincrease to fund capital expenditures. We believe that we will have sufficient capitalresources to fund our projected new store growth through 2005 due to the expansion of thecredit facility, together with cash generated from operations.

*Capital Expenditures*. We spent approximately $13.6 million duringthe first three months of fiscal 2004 for new store construction, development, remodelsand other capital expenditures, exclusive of acquisitions. Our average capitalexpenditures to open a leased store, including leasehold improvements, equipment andfixtures, have ranged from approximately $2.0 million to $5.0 million historically,excluding inventory costs and initial operating losses. We anticipate that the averagecapital expenditures to open a natural foods supermarket format store will be $2.1 millionto $3.9 million in the future; however, our ability to negotiate turnkey leases in thefuture will result in substantially lower capital expenditure per store, in return for aslightly higher rent rate over the lease term. Our average capital expenditures to open afarmers market format store are estimated at $1.6 million to $3.0 million in the future.Delays in opening new stores may result in increased capital expenditures and increasedpre-opening costs for the site, as well as lower than planned sales for the Company. 

The cost of initial inventory for a new store is approximately $300,000to $600,000 depending on the store format; however, we obtain vendor financing for most ofthis cost. Pre-opening costs for natural foods supermarket format stores currently arebetween $300,000 and $400,000 per store, and pre-opening costs for farmers market formatstores are between $250,000 and $350,000, and are expensed as incurred. The amounts andtiming of such pre-opening costs will depend upon the availability of new store sites andother factors, including the location of the store and whether it is in a new or existingmarket for us, the size of the store, and the required build-out at the site. Costs toacquire future stores, if any, are impossible to predict and could vary materially fromthe cost to open new stores. There can be no assurance that actual capital expenditureswill not exceed anticipated levels, although our amended credit facility containsaggregate limits on the amounts of capital expenditures we may make. We believe thatcash generated from operations and available borrowings under our existing credit facilitywill be sufficient to satisfy our budgeted cash requirements, including capital needs to execute our store growth plansover the next two years. In the past, we have primarily used cash flows generated fromoperations, improvements in working capital and equity proceeds to fund store growth andhave used any excess cash to reduce debt. As our store development plan accelerates, weexpect that a greater proportion of our capital needs will be funded through borrowings onthe line of credit than we have utilized in the past. We will continually evaluate othersources of capital and will seek those considered appropriate for future acquisition oraccelerated store growth opportunities.

 

**Cautionary Statement Regarding Forward-Looking Statements**

This Report on Form 10-Q contains "forward-lookingstatements," within the meaning of the Private Securities Litigation Reform Act of1995, which involve known and unknown risks. Such forward-looking statements includestatements as to the Company's plans to open, acquire or relocate additional stores; theanticipated performance of such stores; the impact of competition and current economicuncertainty; the sufficiency of funds to satisfy the Company's cash requirements throughthe remainder of fiscal 2004, our expectations for comparable store sales; expectedpre-opening expenses and capital expenditures; and other statements containing words suchas "believes," "anticipates," "estimates,""expects," "may," "intends" and words of similar import orstatements of management's opinion. These forward-looking statements and assumptionsinvolve known and unknown risks, uncertainties and other factors that may cause the actualresults, market performance or achievements of the Company to differ materially from anyfuture results, performance or achievements expressed or implied by such forward-lookingstatements. Important factors that could cause differences in results of operationsinclude, but are not limited to, the timing and execution of new store openings,relocations, remodels, sales and closures; the impact of competition; changes in productsupply or suppliers and supplier performance levels; changes in management informationneeds; changes in customer needs and expectations; governmental and regulatory actions;general industry or business trends or events; changes in economic or business conditionsin general or affecting the natural foods industry in particular; and competition for andthe availability of sites for new stores and potential acquisition candidates. The Companyundertakes no obligation to update any forward-looking statements in order to reflectevents or circumstances that may arise after the date of this Report.

 

**Item 3.  Quantitative andQualitative Disclosures About Market Risk**

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

The Company is exposed to foreign currency exchange risk. The Companyowns and operates three natural foods supermarkets and a commissary kitchen in BritishColumbia, Canada. The commissary supports the three Canadian stores and does notindependently generate sales revenue. Sales made from the Canadian stores are made inexchange for Canadian dollars. To the extent that those revenues are repatriated to theUnited States, the amounts repatriated are subject to the exchange rate fluctuationsbetween the two currencies. The Company does not hedge against this risk because of thesmall amounts of funds at risk.

The Company's exposure to interest rate changes is primarily related toits variable rate debt issued under its credit facility. In 2003, the Company refinancedthe credit facility and reduced the total commitment available to a $95.0 millionrevolving line of credit, with a three-year term expiring February 25, 2006. The interestrate on the amended facility is currently either prime plus 1.0% or one-month LIBOR plus2.25%, at our election, and the rates modify depending on the ratio of average totalfunded debt, as defined under the credit facility, plus six times rent expense, to EBITDARfor the four fiscal quarter periods then ended, as calculated on our quarterly compliancecertificate. Because the interest rate on the facility is variable, based upon the primerate or LIBOR, the Company's interest expense and net income are affected by interest ratefluctuations. If interest rates were to increase or decrease by 100 basis points, theresult, based upon the existing outstanding variable rate debt as of March 27, 2004, wouldbe an annual increase or decrease of approximately $242,000 in interest expense and acorresponding decrease or increase of approximately $150,000 in the Company’s netincome after taxes.

In September 2000, as required by the Company’s former creditfacility, the Company entered into an interest rate swap to hedge its exposure on variablerate debt positions. Variable rates are predominantly linked to LIBOR as determined byone-month intervals. The interest rate provided by the swap fixed one-month LIBOR at 6.7%.At March 29, 2003, the notional principal amount of the interest rate swap agreement was$30.0 million, and expired in August 2003. There is no obligation to renew the swap underthe refinanced facility. The notional amount is the amount used for the calculation ofinterest payments that are exchanged over the life of the swap transaction on theamortized principal balance. 

**Item 4. Controls and Procedures**

*Evaluation of Disclosure Controls and Procedures.*We maintain asystem of controls and procedures designed to provide reasonable assurance as to thereliability of the financial statements and other disclosures included in this report, aswell as to safeguard assets from unauthorized use or disposition. We evaluated theeffectiveness of the design and operation of our disclosure controls and procedures asdefined in the Exchange Act Rule 13a-14 under supervision and with the participation ofmanagement, including our Chief Executive Officer and Chief Financial Officer, as of theend of the period covered by this report. Based upon that evaluation, our Chief ExecutiveOfficer and Chief Financial Officer concluded that our disclosure controls and proceduresare effective in timely alerting them to material information required to be included inour periodic Securities and Exchange Commission filings. 

*Changes in Internal Control Over Financial Reporting.* During thefiscal quarter ended March 27, 2004, there have been no changes in our internal controlover financial reporting that have materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting.****

 

 

 

**PartII.  OTHER INFORMATION**

**Item1.  Legal Proceedings**

 

Wild Oats Markets Canada, Inc., as successor to Alfalfa’s Canada,Inc., a Canadian subsidiary of the Company, is a defendant in Helen Fakhri and AdyAylon, as Representative Plaintiffs v. Alfalfa’s Canada, Inc., a class actionsuit brought in the Supreme Court, British Columbia, Canada by representative plaintiffsalleging to represent two classes of plaintiffs – those who contracted Hepatitis Aallegedly through the consumption of food purchased at a Capers Community Market in thespring of 2002, and those who were inoculated against Hepatitis A as a result of newsalerts by Capers and the Vancouver Health Authority. In the fourth quarter of 2003, theaction was certified as a class action by the court. The Company is appealing that ruling.The Company intends to vigorously defend both class certification and the suit itself. TheCompany is not able to estimate the potential outcome of the suit at this time.

In April 2000, the Company was named as defendant in S/H –Ahwatukee, LLC and YP- Ahwatukee LLC v. Wild Oats Markets, Inc., Superior Court ofArizona, Maricopa County, by a landlord alleging Wild Oats breached a continuousoperations clause arising from the closure of a Phoenix, Arizona store. Plaintiff claimed$1.5 million for diminution of value of the shopping center plus accelerated rent, feesand $360,000 in attorneys’ fees and costs. After trial in November 2001, the judgeawarded the plaintiff an aggregate $536,000 in damages and attorneys’ fees. TheCompany’s appeal of judgment was denied in the first quarter of fiscal 2004, and theCompany filed a motion for reconsideration, which was denied. The Company plans to seekcertification of the decision to the Arizona Supreme Court. The Company has recognized acharge to restructuring expense during the fourth quarter of 2003 in the amount of$705,000, including estimated attorney’s fees and estimated interest accrued on thejudgment.

In September 2002, the Company filed suit against Michael Gilliland andElizabeth Cook, former officers and directors and greater than 5% stockholders of theCompany, together with two individuals and three limited liability corporations, for atemporary restraining order and damages related to a breach of Mr. Gilliland’snon-competition covenant, contained in his 1996 employment agreement, arising from theopening of a competitive grocery store in New Mexico. The lawsuit is captioned WildOats Markets, Inc. v. Michael C. Gilliland, Elizabeth C. Cook, Mark R. Clapp; PatrickGilliland, Westside Farmer’s Market LLC, Westside Liquors LLC and Milagro Cafe LLC.Mr. Gilliland and Ms. Cook have counterclaimed, claiming that Ms. Cook was entitled toseverance payments, and that both were under-compensated during their employment by theCompany. After a hearing, the court issued a temporary restraining order against Mr.Gilliland, prohibiting him from engaging in the operation of the competing grocery store.The temporary restraining order was subsequently vacated at the Company’s request andthe Company dropped its claims for injunctive relief as it did not believe the injunctiverelief granted made any material difference in Mr. Gilliland’s behavior. The Companydiscontinued severance payments made to Mr. Gilliland based on his material breach of hisemployment contract. The Company continues to pursue its suit for damages. A related suitwas filed against Mr. Gilliland and his brother, Patrick Gilliland, for misappropriationof trade secrets and insider trading related to Patrick Gilliland’s postings on afinancial chat board that he was receiving and trading upon confidential information ofthe Company. A motion to consolidate the two related suits was denied by the BoulderCounty District Court in April 2004.

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

 

**Item 2.  Changes in Securities and Use of Proceeds and IssuerPurchases of Equity Securities**

None. 

 

**Item3.  Defaults Upon Senior Securities**

None.

 

**Item 4.  Submission of Matters to a Vote of Security Holders**

Not applicable.

 

**Item5.  Other Information**

None.

 

**Item6.  Exhibits and Reports on Form 8-K**

 

(a)Exhibits:Exhibit 10.1** - 
Agreement    for Distribution of Product between Wild Oats Markets, Inc. and United Natural Foods, Inc.    dated January 9, 2004. Portions have been omitted pursuant to a request for    confidential treatment (1)Exhibit 31.1+ – CEO    Certification under Section 302 of Sarbanes-Oxley Act of 2002Exhibit 31.2+ – CFO    Certification under Section 302 of Sarbanes-Oxley Act of 2002Exhibit 32.1+ – CEO    Certification under Section 906 of Sarbanes-Oxley Act of 2002Exhibit 32.2+ – CFO    Certification under Section 906 of Sarbanes–Oxley Act of 2002
(b)Reports on Form 8-K:(1)Report    dated January 30, 2004 on Form 8-K, reported under Item 4, "Changes in    Registrant’s Accountant" announcing change in Registrant’s independent    accountants.(2)Report dated January 30, 2004 on Form 8-K/A, reported under Item 4, "Changes    in Registrant’s Accountant" announcing engagement of Registrant’s new    independent accountant.(3)Report dated February 24, 2004 on Form 8-K, reported under Item 12, "Results    of Operations and Financial Conditions" regarding Registrant’s results of    operations and financial condition for the period ended December 27, 2003.** Previously filed.+ Included herewith.
(1) Incorporated by reference from the Registrant’s Form      10-K for the year ended December 27, 2003  (File No. 0-21577).

**SIGNATURES**

Pursuant to the requirements of the Securities Exchange Act of 1934, theRegistrant has duly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized, in the City of Boulder, County of Boulder, State of Colorado,on the 6th day of May 2004.

 
Wild Oats Markets, Inc.(Registrant)By: /s/ Edward F. DunlapEdward F. DunlapExecutive Officer and Chief Financial Officer(Principal Financial and Accounting Officer)
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