calculate financial ratios and interpret against company history and industry benchmark

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ListOfAllRatios

Liquidity, or short-term solvency ratios
Current ratio CA/CL
Quick ratio (CA-INV)/CL
Cash ratio Cash/CL
Leverage, or long-term solvency ratios
Total debt ratio TL/TA
Debt/equity ratio D/E
Equity multiplier A/E = 1 + D/E
Times interest earned ratio EBIT/Interest
Cash coverage ratio EBDIT/Interest or EBITDA/Interest
Asset turnover, or utilization ratios
Total asset turnover Sales/Assets
Capital intensity Assets/Sales
Inventory Turnover COGS/INV
Days’ sales in inventory 365/Inventory Turnover
Receivables turnover Sale/AR
Days’ sales in receivables 365/Receivables turnover
AP Turnover COGS/AP
Days until pay 365/Profitability ratios
Operating Cycle in Days 365/Inventory Turnover + 365/Receivables turnover
Cash Cycle in Days Operating Cycle in Days - 365/Profitability ratios
Profitability ratios
Profit margin NI/Sales
Return on assets NI/Assets = NI/Sales*Sales/Assets
Return on equity NI/Equity = NI/Sales*Sales/Assets*Assets/Equity
Du Pont Identity (Operating Efficiency = Profit Margin)*(Asset Use Efficiency = Total Asset Turnover)*(Financial Leverage = Equity Multiplier)
Market value ratios
EPS = NI/Shares outstanding
Dividends per share = Div/Shares outstanding
Price-earnings ratio (MV per share)/EPS
Market-to-book ratio (MV per share)/(Book value per share)
Growth Ratios
b (add to RE)/NI
Internal Growth Rate (ROA*b)/(1-ROA*b)
Sustainable Growth Rate (ROE*b)/(1-ROE*b)
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ratio

TIME WARNER INC 2014 2013 2012 2011 BENCHMARK
CONSOLIDATED BALANCE SHEET Current Ratio CA/CL 1.48 1.49 1.35 1.51 0.71
(in millions) Quick Ratio (CA-INV)/CL 1.27 1.30 1.15 1.29
2014 2013 2012 2011 Cash Ratio Cash/CL 0.37 0.22 0.29 0.39
Assets
Current assests
Cash and equivalents 3,210 1,816 2,841 3,476
Account Receivable 7,005 7,305 7,385 6,922
Inventory 1,776 1,648 2,036 1,890
Deferred income taxes 181 369 474 663
Prepaid expenses and other current assets 721 559 528 481
Current assests of discontinued operations 0 834 0 0
Total Current Assets 12,893 12,531 13,264 13,432
Noncurrent inventories 6779 7016 6675 6594
Investments 2336 2009 1966 1820
Property, plan and equipment, net 2678 3291 3942 3963
Intangible assets subject to amortization, net 1225 1338 2108 2232
Intangible assets not subject to amortization 7034 7043 7642 7805
Goodwill 27587 27401 30446 30029
Other assets 2563 2458 2046 1926
Noncurrent asses of discontinued operations 0 4,912 0 0
Total Assets 63,095 67,999 68,089 67,801
LIABILITIES AND EQUITY
Current Liabilities
Accounts Payable and accrued liabilities 7,052 6,754 8,039 7,815
Deferred revenue 504 542 1,011 1,084
Debt due within one year 1,168 66 749 23
Current Liabilities of discontinued operations 0 1,026 0 0
Total Current Liabilities 8,724 8,388 9,799 8,922
Long Term Debt 21,389 20,061 19,122 19,501
Deferred income taxes 1,797 2,287 2,127 2,541
Deferred revenue 349 351 523 549
Other noncurrent liabilities 5,606 6,324 6,721 6,334
Noncurrent liabilities of discontinued operations 0 684 0 0
Total Liabilities 37,865 38,095 38,292 37,847
Equity
Common stock 17 17 17 17
Additional pai-in capital 149,549 153,410 154,577 156,114
Treasury stock (41,563) (37,630) (35,077) (33,651)
Accumulated other comprehensive loss, net (841) (852) (989) (852)
Accumulated deficit (81,932) (85,041) (88,732) (91,671)
Total Time Warner Inc shareholders' equity 25,230 29,904 29,796 29,957
Noncontrolling interests 0 0 1 -3
Total Equity 25,230 29,904 29,797 29,954
Total liabilities and equity 63,095 67,999 68,089 67,801

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WhyFS

Why Work With Financial Statements?
Financial statements convey information from within the firm controlled by managers to outside the firm (owners, investors, bankers, suppliers, customers, other constituents)
Internal managers also use the information internally to guide the firm to a profitable future
Financial managers would like to have market value information, but often times this is not possible so financial managers rely on financial statements
“Accounting numbers are just pale reflections of economic reality, but they frequently are the best available information”
Internal uses
Performance evaluation – compensation and comparison between divisions
Planning for the future – guide in estimating future cash flows
External uses
Creditors
Suppliers
Customers
Stockholders
Stock Brokers
Investment bankers
Research Analysts
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ProblemsFS

Problems with Financial Statement Analysis
It’s accounting!
Not market value
Some conglomerates do not have parallel peers or industries
International and National firms may use different accounting standards and procedures than others
Making financial statements difficult to compare
Analysts often calculate ratios in different manners
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WhyCommonSize

Why Common Size
Standardized statements make it easier to compare financial information:
As the company grows, comparing one year to the next
For comparing different companies of different sizes, particularly within the same industry
For comparing companies when the statements are in different currencies
Standardized statements use % instead of dollars
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CommonSizeHow (an)

Common-Size Balance Sheet. Compute all accounts as a percent of total assets. Common-Size Income Statement. Compute all line items as a percent of sales. Assumptions
Name RAD Corp
RAD Corp RAD Corp RAD Corp Year 1 12/31/04
Balance Sheet Income Statement Income Statement Year 2 12/31/05
As of 12/31/2005 For The Year Ended 12/31/2005 For The Year Ended 12/31/2005 Statements Balance Sheet
Cash 6,489 A/P 340,220 Revenues 3,991,997 Revenues 100.00% Income Statement
A/R 1,052,606 N/P 86,631 Cost of Goods Sold 1,738,125 Cost of Goods Sold 43.54% Outstanding Shares 166735
Inventory 295,255 Other CL 1,098,602 Expenses 1,269,479 Expenses 31.80% Dividends paid 143392
Other CA 199,375 Total CL 1,525,453 Depreciation 308,355 Depreciation 7.72%
Total CA 1,553,725 LT Debt 871,851 EBIT 676,038 EBIT 16.93%
Net FA 2,535,072 Total Liability 2,397,304 Interest Expense 42,013 Interest Expense 1.05%
C/S 1,691,493 Taxable Income 634,025 Taxable Income 15.88%
Total Assets 4,088,797 Total Liab. & Equity 4,088,797 Taxes 272,210 Taxes 6.82%
Net Income 361,815 Net Income 9.06%
RAD Corp EPS $2.17 EPS $2.17
Balance Sheet Dividends per share $0.86 Dividends per share $0.86
As of 12/31/2005
Cash 0.16% A/P 8.32%
A/R 25.74% N/P 2.12%
Inventory 7.22% Other CL 26.87%
Other CA 4.88% Total CL 37.31%
Total CA 38.00% LT Debt 21.32%
Net FA 62.00% Total Liability 58.63%
C/S 41.37%
Total Assets 100.00% Total Liab. & Equity 100.00%
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CommonSizeHow

Common-Size Balance Sheet. Compute all accounts as a percent of total assets. Common-Size Income Statement. Compute all line items as a percent of sales. Assumptions
Name RAD Corp
RAD Corp RAD Corp RAD Corp Year 1 12/31/04
Balance Sheet Income Statement Income Statement Year 2 12/31/05
As of 12/31/2005 For The Year Ended 12/31/2005 For The Year Ended 12/31/2005 Statements Balance Sheet
Cash 6,489 A/P 340,220 Revenues 3,991,997 Revenues Income Statement
A/R 1,052,606 N/P 86,631 Cost of Goods Sold 1,738,125 Cost of Goods Sold Outstanding Shares 166735
Inventory 295,255 Other CL 1,098,602 Expenses 1,269,479 Expenses Dividends paid 143392
Other CA 199,375 Total CL 1,525,453 Depreciation 308,355 Depreciation
Total CA 1,553,725 LT Debt 871,851 EBIT 676,038 EBIT
Net FA 2,535,072 Total Liability 2,397,304 Interest Expense 42,013 Interest Expense
C/S 1,691,493 Taxable Income 634,025 Taxable Income
Total Assets 4,088,797 Total Liab. & Equity 4,088,797 Taxes 272,210 Taxes
Net Income 361,815 Net Income
RAD Corp EPS $2.17 EPS $2.17
Balance Sheet Dividends per share $0.86 Dividends per share $0.86
As of 12/31/2005
Cash A/P
A/R N/P
Inventory Other CL
Other CA Total CL
Total CA LT Debt
Net FA Total Liability
C/S
Total Assets Total Liab. & Equity
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WFMI SEC Financials

http://finance.yahoo.com/q?s=wfmi http://biz.yahoo.com/f/g/g.html
Whole Foods Market, Inc.
Consolidated Balance Sheets
(In thousands)
September 24, 2006 and September 25, 2005
     2006     2005
Assets     
Current assets:     
Cash and cash equivalents    $ 2,252     $ 308,524
Short-term investments – available-for-sale securities      193,847       —  
Restricted cash      60,065       36,922
Trade accounts receivable      82,137       66,682
Merchandise inventories      203,727       174,848
Prepaid expenses and other current assets      33,804       45,965
Deferred income taxes      48,149       39,588
  
Total current assets      623,981       672,529
Property and equipment, net of accumulated depreciation and amortization      1,236,133       1,054,605
Goodwill      113,494       112,476
Intangible assets, net of accumulated amortization      34,767       21,990
Deferred income taxes      29,412       22,452
Other assets      5,209       5,244
  
Total assets    $ 2,042,996     $ 1,889,296
  
     2006     2005
Liabilities and Shareholders’ Equity     
Current liabilities:     
Current installments of long-term debt and capital lease obligations    $ 49     $ 5,932
Trade accounts payable      121,857       103,348
Accrued payroll, bonus and other benefits due team members      153,014       126,981
Dividends payable      —         17,208
Other current liabilities      234,850       164,914
  
Total current liabilities      509,770       418,383
Long-term debt and capital lease obligations, less current installments      8,606       12,932
Deferred rent liability      120,421       91,775
Other long-term liabilities      56       530
  
Total liabilities      638,853       523,620
  
Shareholders’ equity:     
Common stock, no par value, 300,000 shares authorized;      1,147,872       874,972
142,198 and 136,017 shares issued, 139,607 and 135,908 shares
outstanding in 2006 and 2005, respectively
Common stock in treasury, at cost      (99,964 )     —  
Accumulated other comprehensive income      6,975       4,405
Retained earnings      349,260       486,299
  
Total shareholders’ equity      1,404,143       1,365,676
  
Commitments and contingencies     
  
Total liabilities and shareholders’ equity    $ 2,042,996     $ 1,889,296
  
The accompanying notes are an integral part of these consolidated financial statements.
 
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Whole Foods Market, Inc.
Consolidated Statements of Operations
(In thousands, except per share amounts)
Fiscal years ended September 24, 2006, September 25, 2005 and September 26, 2004
     2006     2005     2004  
Sales    $ 5,607,376     $ 4,701,289     $ 3,864,950  
Cost of goods sold and occupancy costs      3,647,734       3,052,184       2,523,816  
  
Gross profit      1,959,642       1,649,105       1,341,134  
Direct store expenses      1,421,968       1,223,473       986,040  
General and administrative expenses      181,244       158,864       119,800  
Pre-opening and relocation costs      37,421       37,035       18,648  
  
Operating income      319,009       229,733       216,646  
Other income (expense):       
Interest expense      (32 )     (2,223 )     (7,249 )
Investment and other income      20,736       9,623       6,456  
  
Income before income taxes      339,713       237,133       215,853  
Provision for income taxes      135,885       100,782       86,341  
  
Net income    $ 203,828     $ 136,351     $ 129,512  
  
Basic earnings per share    $ 1.46     $ 1.05     $ 1.06  
  
Weighted average shares outstanding      139,328       130,090       122,648  
  
Diluted earnings per share    $ 1.41     $ 0.99     $ 0.99  
  
Weighted average shares outstanding, diluted basis      145,082       139,950       135,454  
  
Dividends declared per share    $ 2.45     $ 0.47     $ 0.3  
  
The accompanying notes are an integral part of these consolidated financial statements.
 
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Whole Foods Market, Inc.
Consolidated Statements of Shareholders’ Equity and Comprehensive Income
(In thousands)
Fiscal years ended September 24, 2006, September 25, 2005 and September 26, 2004
     Shares     Common    Common     Accumulated     Retained     Total  
Outstanding Stock Stock in Other Earnings Shareholders’
Treasury Comprehensive Equity
Income (Loss)
Balances at September 28, 2003    120,140     $ 423,297    $ —       $ 1,624     $ 320,055     $ 744,976  
     
Net income    —         —        —         —         129,512       129,512  
Foreign currency translation adjustments    —         —        —         856       —         856  
Reclassification adjustments for losses included in net income    —         —        —         88       —         88  
Change in unrealized gain (loss) on investments, net of income taxes    —         —        —         (515 )     —         (515 )
     
Comprehensive income    —         —        —         429       129,512       129,941  
Dividends ($0.30 per share)    —         —        —         —         (37,089 )     (37,089 )
Issuance of common stock pursuant to team member stock plans    4,184       59,518      —         —         —         59,518  
Issuance of common stock in connection with acquisition    478       16,375      —         —         —         16,375  
Tax benefit related to exercise of team member stock options    —         35,583      —         —         —         35,583  
Other    12       334      —         —         —         334  
     
Balances at September 26, 2004    124,814       535,107      —         2,053       412,478       949,638  
     
Net income    —         —        —         —         136,351       136,351  
Foreign currency translation adjustments    —         —        —         1,893       —         1,893  
Reclassification adjustments for losses included in net income    —         —        —         1,063       —         1,063  
Change in unrealized gain (loss) on investments, net of income taxes    —         —        —         (604 )     —         (604 )
     
Comprehensive income    —         —        —         2,352       136,351       138,703  
Dividends ($0.47 per share)    —         —        —         —         (62,530 )     (62,530 )
Issuance of common stock pursuant to team member stock plans    5,042       110,293      —         —         —         110,293  
Tax benefit related to exercise of team member stock options    —         62,643      —         —         —         62,643  
Share-based compensation    —         19,135      —         —         —         19,135  
Conversion of subordinated debentures    6,052       147,794      —         —         —         147,794  
     
Balances at September 25, 2005    135,908       874,972      —         4,405       486,299       1,365,676  
     
Net income    —         —        —         —         203,828       203,828  
Foreign currency translation adjustments    —         —        —         2,494       —         2,494  
Change in unrealized gain (loss) on investments, net of income taxes    —         —        —         76       —         76  
     
Comprehensive income    —         —        —         2,570       203,828       206,398  
Dividends ($2.45 per share)    —         —        —         —         (340,867 )     (340,867 )
Issuance of common stock pursuant to team member stock plans    5,510       199,450      —         —         —         199,450  
Purchase of treasury stock    (2,005 )     —        (99,964 )     —         —         (99,964 )
Excess tax benefit related to exercise of team member stock options    —         59,096      —         —         —         59,096  
Share-based compensation    —         9,432      —         —         —         9,432  
Conversion of subordinated debentures    194       4,922      —         —         —         4,922  
     
Balances at September 24, 2006    139,607     $ 1,147,872    $ (99,964 )   $ 6,975     $ 349,260     $ 1,404,143  
     
The accompanying notes are an integral part of these consolidated financial statements.
 
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Whole Foods Market, Inc.
Consolidated Statements of Cash Flows
(In thousands)
Fiscal years ended September 24, 2006, September 25, 2005 and September 26, 2004
     2006     2005     2004  
Cash flows from operating activities       
Net income    $ 203,828     $ 136,351     $ 129,512  
Adjustments to reconcile net income to net cash provided by operating activities:       
Depreciation and amortization      156,223       133,759       115,157  
Loss on disposal of fixed assets      6,291       15,886       5,769  
Share-based compensation      9,432       19,135       —    
Deferred income tax expense (benefit)      (15,521 )     (27,873 )     (682 )
Tax benefit related to exercise of team member stock options      —         62,643       35,583  
Excess tax benefit related to exercise of team member stock options      (52,008 )     —         —    
Interest accretion on long-term debt      460       4,120       7,551  
Deferred rent      26,607       16,080       11,109  
Other      693       1,317       (1,133 )
Net change in current assets and liabilities:       
Trade accounts receivable      (17,720 )     (2,027 )     (19,158 )
Merchandise inventories      (32,200 )     (21,486 )     (27,868 )
Prepaid expenses and other current assets      (7,849 )     (4,151 )     (2,940 )
Trade accounts payable      18,509       12,597       12,515  
Accrued payroll, bonus and other benefits due team member      26,033       26,445       29,646  
Other accrued expenses      129,886       38,023       35,279  
  
Net cash provided by operating activities      452,664       410,819       330,340  
  
Cash flows from investing activities       
Development costs of new store locations      (208,588 )     (207,792 )     (156,728 )
Other property, plant and equipment expenditures      (131,614 )     (116,318 )     (109,739 )
Proceeds from hurricane insurance      3,308       —         —    
Acquisition of intangible assets      (16,332 )     (1,500 )     —    
Change in notes receivable      —         13,500       (13,500 )
Purchase of available-for-sale securities      (555,095 )     —         —    
Sale of available-for-sale securities      362,209       —         —    
Increase in restricted cash      (23,143 )     (10,132 )     (26,790 )
Payment for purchase of acquired entities, net of cash acquired      —         —         (18,873 )
Other investing activities      —         —         1,332  
  
Net cash used in investing activities      (569,255 )     (322,242 )     (324,298 )
  
Cash flows from financing activities       
Dividends paid      (358,075 )     (54,683 )     (27,728 )
Issuance of common stock      222,030       85,816       59,518  
Purchase of treasury stock      (99,964 )     —         —    
Excess tax benefit related to exercise of team member stock options      52,008       —         —    
Payments on long-term debt and capital lease obligations      (5,680 )     (5,933 )     (8,864 )
  
Net cash provided by (used in) financing activities      (189,681 )     25,200       22,926  
  
Net change in cash and cash equivalents      (306,272 )     113,777       28,968  
Cash and cash equivalents at beginning of year      308,524       194,747       165,779  
  
Cash and cash equivalents at end of year    $ 2,252     $ 308,524     $ 194,747  
  
Supplemental disclosures of cash flow information:       
Interest paid    $ 607     $ 1,063     $ 2,127  
Federal and state income taxes paid    $ 70,220     $ 74,706     $ 60,372  
Non-cash transactions:       
Common stock issued in connection with acquisition    $ —       $ —       $ 16,375  
Conversion of convertible debentures into common stock, net of fees    $ 4,922     $ 147,794     $ 293  
Whole Foods Market, Inc.
Notes to Consolidated Financial Statements
Fiscal years ended September 24, 2006, September 25, 2005 and September 26, 2004
(1) Description of Business
Whole Foods Market, Inc. and its consolidated subsidiaries (collectively “Whole Foods Market,” “Company,” or “We”) own and operate the largest chain of natural and organic foods supermarkets. Our Company mission is to promote vitality and well-being for all individuals by supplying the highest quality, most wholesome foods available. Through our growth, we have had a large and positive impact on the natural and organic foods movement throughout the United States, helping lead the industry to nationwide acceptance over the last 25 years. We opened our first store in Texas in 1980 and, as of September 24, 2006, have expanded our operations both by opening new stores and acquiring existing stores from third parties to 186 stores: 177 stores in 31 U.S. states and the District of Columbia; three stores in Canada; and six stores in the United Kingdom.
(2) Summary of Significant Accounting Policies
Definition of Fiscal Year
We report our results of operations on a 52- or 53-week fiscal year ending on the last Sunday in September. Fiscal years 2006, 2005 and 2004 were 52-week years.
Principles of Consolidation
The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles. All significant majority-owned subsidiaries are consolidated on a line-by-line basis, and all significant intercompany accounts and transactions are eliminated upon consolidation.
Cash and Cash Equivalents
We consider all highly liquid investments with an original maturity of 90 days or less to be cash equivalents.
Investments
We classify as available-for-sale our cash equivalent investments and our short-term and long-term investments in debt and equity securities that have readily determinable fair values. Available-for-sale investments are recorded at fair value. Unrealized holding gains and losses, net of the related tax effect, on available-for-sale investments are excluded from earnings and are reported as a separate component of shareholders’ equity until realized. A decline in the fair value of any available-for-sale security below cost that is deemed to be other-than-temporary or for a period greater than two fiscal quarters results in a reduction in carrying amount to fair value. The impairment is charged to earnings and a new cost basis of the security is established. Cost basis is established and maintained utilizing the specific identification method.
Restricted Cash
Restricted cash primarily relates to cash held as collateral to support projected workers’ compensation obligations.
Inventories
We value our inventories at the lower of cost or market. Cost was determined using the last-in, first-out (“LIFO”) method for approximately 94% of inventories in fiscal years 2006 and 2005. Under the LIFO method, the cost assigned to items sold is based on the cost of the most recent items purchased. As a result, the costs of the first items purchased remain in inventory and are used to value ending inventory. The excess of estimated current costs over LIFO carrying value, or LIFO reserve, was approximately $13.2 million and $10.7 million at September 24, 2006 and September 25, 2005, respectively. Costs for remaining inventories are determined by the first-in, first-out (“FIFO”) method.
Cost was determined using the retail method for approximately 54% of inventories in fiscal years 2006 and 2005. Under the retail method, the valuation of inventories at cost and the resulting gross margins are determined by applying a cost-to-retail ratio for various groupings of similar items to the retail value of inventories. Inherent in the retail inventory method calculations are certain management judgments and estimates, including shrinkage, which could impact the ending inventory valuation at cost as well as the resulting gross margins. Cost was determined using the item cost method for approximately 46% of inventories in fiscal years 2006 and 2005. This method involves counting each item in inventory, assigning costs to each of these items based on the actual purchase costs (net of vendor allowances) of each item and recording the actual cost of items sold. The item-cost method of accounting allows for more accurate reporting of periodic inventory balances and enables management to more precisely manage inventory and purchasing levels when compared to the retail method of accounting.
 
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Our largest supplier, United Natural Foods, Inc., accounted for approximately 22%, 22% and 20% of our total purchases in fiscal years 2006, 2005 and 2004, respectively.
Property and Equipment
Property and equipment is stated at cost, net of accumulated depreciation and amortization. We provide depreciation of equipment over the estimated useful lives (generally three to 15 years) using the straight-line method. We provide amortization of leasehold improvements on the straight-line method over the shorter of the estimated useful lives of the improvements or the terms of the related leases. Terms of leases used in the determination of estimated useful lives may include renewal periods at the Company’s option if exercise of the option is determined to be reasonably assured at the inception of the lease. We provide depreciation of buildings over the estimated useful lives (generally 20 to 30 years) using the straight-line method. Costs related to a projected site determined to be unsatisfactory and general site selection costs that cannot be identified with a specific store location are charged to operations currently. The Company recognizes a liability for the fair value of a conditional asset retirement obligation when the obligation is incurred. Repair and maintenance costs are expensed as incurred. Interest costs on significant projects constructed or developed for the Company’s own use are capitalized as a separate component of the asset. Upon retirement or disposal of assets, the cost and related accumulated depreciation are removed from the balance sheet and any gain or loss is reflected in earnings.
Operating Leases
The Company leases stores, distribution centers, bakehouses and administrative facilities under operating leases. Store lease agreements generally include rent holidays, rent escalation clauses and contingent rent provisions for percentage of sales in excess of specified levels. Most of our lease agreements include renewal periods at the Company’s option. We recognize rent holiday periods and scheduled rent increases on a straight-line basis over the lease term beginning with the date the Company takes possession of the leased space for construction and other purposes. We record tenant improvement allowances and rent holidays as deferred rent liabilities and amortize the deferred rent over the terms of the lease to rent. We record rent liabilities for contingent percentage of sales lease provisions when we determine that it is probable that the specified levels will be reached during the fiscal year.
Goodwill
Goodwill consists of the excess of cost of acquired enterprises over the sum of the amounts assigned to identifiable assets acquired less liabilities assumed. Goodwill is reviewed for impairment annually, or more frequently if impairment indicators arise, on a reporting unit level. We allocate goodwill to one reporting unit for goodwill impairment testing. We determine fair value utilizing both a market value method and discounted projected future cash flows compared to our carrying value for the purpose of identifying impairment. Our annual impairment review requires extensive use of accounting judgment and financial estimates. Application of alternative assumptions and definitions, such as reviewing goodwill for impairment at a different organizational level, could produce significantly different results.
Intangible Assets
Intangible assets include acquired leasehold rights, liquor licenses, license agreements, non-competition agreements and debt issuance costs. Indefinite-lived intangible assets are reviewed for impairment annually, or more frequently if impairment indicators arise. We amortize definite-lived intangible assets on a straight-line basis over the life of the related agreement, currently one to 48 years for contract-based intangible assets and one to five years for marketing-related and other identifiable intangible assets.
Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of
We evaluate long-lived assets and identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. When the Company commits to relocate a location, a charge to write down the related assets to their estimated net recoverable value is included in the “Pre-opening and relocation costs” line item in the Consolidated Statements of Operations.
Fair Value of Financial Instruments
The carrying amounts of cash and cash equivalents, trade accounts receivable, trade accounts payable, accrued payroll, bonuses and team member benefits, and other accrued expenses approximate fair value because of the short maturity of those instruments. Investments are stated at fair value with unrealized gains and losses included as a component of shareholders’ equity until realized.
 
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The fair value of convertible subordinated debentures is estimated using quoted market prices. The fair value of senior unsecured notes is estimated by discounting the future cash flows at the rates currently available to us for similar debt instruments of comparable maturities. Carrying amounts and estimated fair values of our financial instruments other than those for which carrying amounts approximate fair values as noted above are as follows (in thousands):
     2006    2005
     Carrying    Estimated Fair    Carrying    Estimated Fair
Amount Value Amount Value
Convertible subordinated debentures    $ 8,320    $ 19,298    $ 12,850    $ 34,635
Senior unsecured notes      —        —        5,714      5,828
Insurance and Self-Insurance Reserves
The Company uses a combination of insurance and self-insurance plans to provide for the potential liabilities for workers’ compensation, general liability, property insurance, director and officers’ liability insurance, vehicle liability and employee health care benefits. Liabilities associated with the risks that are retained by the Company are estimated, in part, by considering historical claims experience, demographic factors, severity factors and other actuarial assumptions. While we believe that our assumptions are appropriate, the estimated accruals for these liabilities could be significantly affected if future occurrences and claims differ from these assumptions and historical trends.
Revenue Recognition
We recognize revenue for sales of our products at the point of sale. Discounts provided to customers at the point of sale are recognized as a reduction in sales as the products are sold.
Cost of Goods Sold and Occupancy Costs
Cost of goods sold includes cost of inventory sold during the period, net of discounts and allowances, contribution from non-retail distribution and food preparation operations, shipping and handling costs and occupancy costs. The Company receives various rebates from third party vendors in the form of quantity discounts and payments under cooperative advertising agreements. Quantity discounts and co-operative advertising discounts in excess of identifiable advertising costs are recognized as a reduction of cost of goods sold when the related merchandise is sold.
Advertising
Advertising and marketing expense for fiscal years 2006, 2005 and 2004 was approximately $24.0 million, $20.1 million and $17.4 million, respectively. These amounts are shown net of vendor allowances received for co-operative advertising of approximately $1.2 million, $1.2 million and $1.0 million in fiscal years 2006, 2005 and 2004, respectively. Advertising costs are charged to expense as incurred and are included in the “Direct store expenses” line item in the Consolidated Statements of Operations.
Pre-opening and Relocation Costs
Pre-opening costs include rent expense incurred during construction of new stores and costs related to new store openings including costs associated with hiring and training personnel, smallwares, supplies and other miscellaneous costs. Rent expense is generally incurred approximately nine months prior to a store’s opening date. Other pre-opening costs are incurred primarily in the 30 days prior to a new store opening. Pre-opening costs are expensed as incurred. Relocation costs, which consist of moving costs, remaining lease payments, accelerated depreciation costs, asset impairment costs, other costs associated with replaced facilities and other related expenses, are expensed as incurred.
Share-Based Compensation
Our Company maintains several share-based incentive plans. We grant options to purchase common stock under our 1992 Stock Option Plans, as amended. Under these plans, options are granted at an option price equal to the market value of the stock at the grant date and are generally exercisable ratably over a four-year period beginning one year from grant date and have a five-year term. The grant date is established once the Company’s Board of Directors approves the grant and all key terms have been determined. The exercise prices of our stock option grants are the closing price on the grant date. Stock option grant terms and conditions are communicated to team members within a relatively short period of time. Our Board of Directors generally approves one primary stock option grant annually with a grant date that occurs during a trading window. Our Company offers a team member stock purchase plan to all full-time team members with a minimum of 400 hours of
 
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service. Under this plan, participating team members may purchase our common stock each calendar quarter through payroll deductions. Participants in the stock purchase plan may elect to purchase unrestricted shares at 100 percent of market value or restricted shares at 85 percent of market value on the purchase date.
Prior to the effective date of revised Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based Payment,” the Company applied Accounting Principles Board Opinion No. 25 (“APB No. 25”), “Accounting for Stock Issued to Employees” and related interpretations for our stock option grants. APB No. 25 provides that the compensation expense relative to our team member stock options is measured based on the intrinsic value of the stock option at date of grant.
Effective the beginning of the first quarter of fiscal year 2006, the Company adopted the provisions of SFAS No. 123R using the modified prospective transition method. Under this method, prior periods were not restated. The Company’s methods used to determine share-based compensation, which includes the utilization of the Black-Scholes option pricing model, requires extensive use of accounting judgment and financial estimates, including estimates of the expected term team members will retain their vested stock options before exercising them, the estimated volatility of the Company’s common stock price over the expected term, and the number of options that will be forfeited prior to the completion of their vesting requirements. The related share-based compensation expense is recognized on a straight-line basis over the vesting period. Application of alternative assumptions could produce significantly different estimates of the fair value of share-based compensation and consequently, the related amounts recognized in the Consolidated Statements of Operations. The provisions of SFAS No. 123R apply to new stock options and stock options outstanding, but not yet vested, on the effective date.
SFAS No. 123R requires the Company to value unvested stock options granted prior to its adoption of SFAS No. 123 under the fair value method and expense these amounts in the income statement over the stock option’s remaining vesting period. In the fourth quarter of fiscal year 2005, the Company accelerated the vesting of all outstanding stock options, except options held by the members of the executive team and certain options held by team members in the United Kingdom, in order to prevent past option grants from having an impact on future results. The Company intends to keep its broad-based stock option program in place, but also intends to limit the number of shares granted in any one year so that annual earnings per share dilution from equity-based compensation expense will not exceed 10%.
Prior to the adoption of SFAS No. 123R, the Company presented the tax savings resulting from tax deductions resulting from the exercise of stock options as an operating cash flow, in accordance with Emerging Issues Task Force (“EITF”) Issue No. 00-15, “Classification in the Statement of Cash Flows of the Income Tax Benefit Received by a Company upon Exercise of a Nonqualified Employee Stock Option.” SFAS No. 123R requires the Company to reflect gross tax savings resulting from tax deductions in excess of expense reflected in its financial statements, including pro forma amounts, as a financing cash flow.
In November 2005, the FASB issued Staff Position No. FAS 123R-3, “Transition Election Related to Accounting for the Tax Effects of the Share-Based Payment Awards” (“FSP FAS 123R-3”). The Company has elected to adopt the transition guidance for the additional paid-in-capital pool (“APIC pool”) pool in paragraph 81 of SFAS No. 123R. The prescribed transition method is a detailed method to establish the beginning balance of the APIC pool related to the tax effects of share-based compensation, and to determine the subsequent impact on the APIC pool and Consolidated Statement of Cash Flows of the tax effects of share-based compensation awards that are outstanding upon adoption of SFAS No. 123R.
Income Taxes
We recognize deferred income tax assets and liabilities by applying statutory tax rates in effect at the balance sheet date to differences between the book basis and the tax basis of assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to reverse. Deferred tax assets and liabilities are adjusted to reflect changes in tax laws or rates in the period that includes the enactment date. Significant accounting judgment is required in determining the provision for income taxes and related accruals, deferred tax assets and liabilities. In the ordinary course of business, there are transactions and calculations where the ultimate tax outcome is uncertain. In addition, we are subject to periodic audits and examinations by the IRS and other state and local taxing authorities. Although we believe that our estimates are reasonable, actual results could differ from these estimates.
Earnings per Share
Basic earnings per share is based on the weighted average number of common shares outstanding during the fiscal period. Diluted earnings per share is based on the weighted average number of common shares outstanding plus, where applicable, the additional common shares that would have been outstanding as a result of the conversion of dilutive options and convertible debt.
 
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Comprehensive Income
Comprehensive income consists of net income, foreign currency translation adjustments, and unrealized gains and losses on marketable securities, net of income taxes. Comprehensive income is reflected in the Consolidated Statements of Shareholders’ Equity and Comprehensive Income. At September 24, 2006, accumulated other comprehensive income consisted of foreign currency translation adjustment gains of approximately $6.9 million and unrealized gains on marketable securities of approximately $0.1 million. At September 25, 2005, accumulated other comprehensive income consisted of foreign currency translation adjustment gains of approximately $4.4 million.
Foreign Currency Translation
The Company’s Canadian and United Kingdom operations use their local currency as their functional currency. Assets and liabilities are translated at exchange rates in effect at the balance sheet date. Income and expense accounts are translated at the average monthly exchange rates during the year. Resulting translation adjustments are recorded as a separate component of accumulated other comprehensive income.
Segment Information
We operate in one reportable segment, natural foods supermarkets. We currently have three stores in Canada and six stores in the United Kingdom. All of our remaining operations are domestic.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the period reported. Actual results could differ from those estimates. We use estimates when accounting for depreciation and amortization, allowance for doubtful accounts, inventory valuation, long-term investments, team member benefit plans, team member health insurance plans, workers’ compensation liabilities, share-based compensation, store closure reserves, income taxes and contingencies.
Reclassifications
Where appropriate, we have reclassified prior years’ financial statements to conform to current year presentation.
Recent Accounting Pronouncements
In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No.108 (“SAB No. 108”), “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in the Current Year Financial Statements.” SAB No. 108 addresses how the effects of prior-year uncorrected misstatements should be considered when quantifying misstatements in current-year financial statements. SAB No. 108 requires an entity to quantify misstatements using a balance sheet and income statement approach and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative and qualitative factors. The requirements of SAB No. 108 are effective for fiscal years ending after November 15, 2006. We are currently evaluating the effect, if any, that the adoption of SAB No. 108 will have on our consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measures.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and requires additional disclosures about fair value measurements. SFAS No. 157 applies to fair value measurements that are already required or permitted by other accounting standards, except for measurements of share-based payments and measurements that are similar to, but not intended to be, fair value and does not change existing guidance as to whether or not an instrument is carried at fair value. The provisions of SFAS No. 157 are effective for the specified fair value measures for financial statements issued for fiscal years beginning after November 15, 2007. We are currently evaluating the impact, if any, that the adoption of SFAS No. 157 will have on our consolidated financial statements.
In July 2006, the FASB issued Interpretation 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes,” an interpretation of SFAS No. 109, “Accounting for Income Taxes.” FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109. The interpretation applies to all tax positions accounted for in accordance with Statement 109 and requires a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken, or expected to be taken, in an income tax return. Subsequent recognition, derecognition, and measurement is based on management’s best judgment given the facts, circumstances and information available at the reporting date. FIN 48 is effective for fiscal years beginning after December 15, 2006. Early adoption is permitted as of the beginning of an enterprise’s fiscal year, provided the enterprise has not yet issued financial statements, including financial statements for any interim period, for that fiscal year. We are currently evaluating the effect, if any, that the adoption of FIN 48 will have on our consolidated financial statements.
 
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In March 2006, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (that is, Gross versus Net Presentation). Taxes within the scope of EITF Issue No. 06-3 include any taxes assessed by a governmental authority that are directly imposed on a revenue-producing transaction between a seller and a customer and may include, but are not limited to, sales taxes, use taxes, value-added taxes, and some excise taxes. The EITF concluded that the presentation of these taxes on either a gross (included in revenues and costs) or a net (excluded from revenues) basis is an accounting policy decision that should be disclosed. For any such taxes that are reported on a gross basis, a company should disclose the amounts of those taxes in interim and annual financial statements. The Company’s policy is to exclude all such taxes from revenue. The provisions of EITF 06-3 are effective for interim and annual reporting periods beginning after December 15, 2006. The adoption of EITF 06-3 will not have any effect on our consolidated financial statements.
In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections, a Replacement of Accounting Principles Board Opinion No. 20 and FASB Statement No. 3.” SFAS No. 154 requires retrospective application to prior periods’ financial statements for changes in accounting principles, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS No. 154 also requires that retrospective application of a change in accounting principle be limited to the direct effects of the change. Indirect effects of a change in accounting principle, such as a change in non-discretionary profit-sharing payments resulting from an accounting change, should be recognized in the period of the accounting change. SFAS No. 154 also requires that a change in depreciation, amortization, or depletion method for long-lived, non-financial assets be accounted for as a change in accounting estimate affected by a change in accounting principle. The provisions of SFAS No. 154 are effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Early adoption is permitted for accounting changes and corrections of errors made in fiscal years beginning after the date this Statement was issued. The Company is required to adopt the provisions of SFAS No. 154, as applicable, beginning in fiscal year 2007. We do not expect the adoption of SFAS No. 154 will have a significant effect on our future consolidated financial statements.
(3) Natural Disaster Costs
The Company has two stores in the New Orleans area which were damaged by and closed due to Hurricane Katrina during the fourth quarter of fiscal year 2005, and accordingly the Company recorded expenses totaling approximately $16.5 million for related estimated net losses. The main components of the $16.5 million expense were estimated impaired assets totaling approximately $12.2 million, estimated inventory losses totaling approximately $2.5 million, salaries and relocation allowances for displaced Team Members and other costs totaling approximately $3.4 million, and a $1.0 million special donation from the Company to the American Red Cross, net of accrued estimated insurance proceeds totaling approximately $2.6 million. In fiscal year 2005, approximately $13.4 million of net natural disaster costs is included in “Direct store expenses” in the Consolidated Statements of Operations, approximately $1.0 million is included in “General and administrative expenses,” and approximately $2.1 million is included in “Cost of goods sold and occupancy costs.” In fiscal year 2006, the Company recognized approximately $7.2 million in pre-tax credits for insurance proceeds and other adjustments related to previously estimated Hurricane Katrina losses, of which approximately $4.2 million is included in “Direct store expenses,” approximately $0.9 million is included in “Cost of goods sold and occupancy costs,” and approximately $2.1 million is included in “Investment and other income.”
(4) Property and Equipment
Balances of major classes of property and equipment are as follows (in thousands):
     2006    2005
Land    $ 39,993    $ 34,396
Buildings and leasehold improvements      955,130      784,000
Fixtures and equipment      779,050      692,403
Construction in progress and equipment not yet in service      168,105      133,061
     
     1,942,278      1,643,860
Less accumulated depreciation and amortization      706,145      589,255
     
   $ 1,236,133    $ 1,054,605
     
Depreciation and amortization expense related to property and equipment totaled approximately $152.4 million, $129.8 million and $111.2 million for fiscal years 2006, 2005 and 2004, respectively. Property and equipment included accumulated
 
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accelerated depreciation and other asset impairments totaling approximately $13.1 million and $5.9 million at September 24, 2006 and September 25, 2005, respectively. Property and equipment includes approximately $0.9 million, $3.0 million and $2.1 million of interest capitalized during fiscal years 2006, 2005 and 2004, respectively. Development costs of new store locations totaled approximately $208.6 million, 207.8 million and $156.7 million in fiscal years 2006, 2005 and 2004, respectively. As of November 2, 2006, we had signed leases for 88 stores under development.
(5) Business Combinations
Fresh & Wild Holdings Limited
On January 31, 2004, we acquired all of the outstanding stock of Fresh & Wild Holdings Limited (“Fresh & Wild”) for a total of approximately $20 million in cash and approximately $16 million in Company common stock, totaling 477,470 shares. The acquisition of Fresh & Wild, which owned and operated seven natural and organic food stores in London and Bristol, England, provided a platform for expansion of the Whole Foods Market brand in the United Kingdom. This transaction was accounted for using the purchase method and, accordingly, the purchase price has been allocated to tangible and identifiable intangible assets acquired based on their estimated fair values at the date of acquisition. Total costs in excess of tangible and intangible assets acquired of approximately $30.5 million have been recorded as goodwill. Fresh & Wild results of operations are included in our consolidated income statements for the period beginning February 1, 2004 through September 26, 2004 and all subsequent periods. John Mackey and Walter Robb, executive officers of the Company, each owned approximately 0.2% of the outstanding stock of Fresh & Wild and received proceeds totaling approximately $54,000 and $78,000, respectively, in consideration for their ownership interest.
Select Fish LLC
On October 27, 2003, we acquired certain assets of Select Fish LLC (“Select Fish”) in exchange for approximately $3 million in cash plus the assumption of certain liabilities. All assets acquired relate to a seafood processing and distribution facility located in Seattle, Washington. This transaction was accounted for using the purchase method. Accordingly the purchase price was allocated to tangible and identifiable intangible assets acquired based on their estimated fair values at the date of the acquisition. Total costs in excess of tangible and intangible assets acquired of approximately $1.1 million have been recorded as goodwill. Select Fish results of operations are included in our consolidated income statements beginning October 27, 2003.
-6 Goodwill and Other Intangible Assets
Goodwill and indefinite-lived intangible assets are reviewed for impairment annually, or more frequently if impairment indicators arise. We allocate goodwill to one reporting unit for goodwill impairment testing. During fiscal year 2006, we acquired goodwill totaling approximately $1.1 million, primarily related to the acquisition of one small store in Portland, Maine. We acquired indefinite-lived intangible assets totaling approximately $50,000 and $0.7 million during fiscal years 2006 and 2005, respectively, consisting primarily of liquor licenses. There was no impairment of goodwill or indefinite-lived intangible assets during fiscal years 2006, 2005 or 2004.
Definite-lived intangible assets are amortized over the useful life of the related agreement. We acquired definite-lived intangible assets totaling approximately $15.7 million and $1.5 million during fiscal years 2006 and 2005, respectively, consisting primarily of acquired leasehold rights. Amortization associated with intangible assets totaled approximately $2.5 million, $2.8 million, and 3.0 million during fiscal years 2006, 2005 and 2004, respectively. The components of intangible assets were as follows (in thousands):
     2006     2005  
     Gross carrying    Accumulated     Gross carrying    Accumulated  
amount amortization amount amortization
Indefinite-lived contract-based    $ 774    $ —       $ 723    $ —    
Definite-lived contract-based      45,579      (11,833 )     32,597      (11,827 )
Definite-lived marketing-related and other      2,242      (1,995 )     2,921      (2,425 )
        
   $ 48,595    $ (13,828 )   $ 36,241    $ (14,252 )
        
Amortization associated with the net carrying amount of intangible assets is estimated to be approximately $2.4 million in fiscal year 2007, $2.3 million in fiscal year 2008, $2.3 million in fiscal year 2009, $2.2 million in fiscal year 2010 and $2.2 million in fiscal year 2011.
 
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(7) Long-Term Debt
We have long-term debt and obligations under capital leases as follows (in thousands):
     2006    2005
Obligations under capital lease agreements for equipment, due in monthly installments through 2012    $ 335    $ 300
Senior unsecured notes      —        5,714
Convertible debentures, including accreted interest      8,320      12,850
     
Total Long-term debt      8,655      18,864
Less current installments      49      5,932
     
Long-term debt, less current installments    $ 8,606    $ 12,932
     
On October 1, 2004, we amended our credit facility to extend the maturity of our $100 million revolving line of credit to October 1, 2009. The credit agreement contains certain affirmative covenants including maintenance of certain financial ratios and certain negative covenants including limitations on additional indebtedness as defined in the agreement. At September 24, 2006 and September 25, 2005, we were in compliance with the applicable debt covenants. All outstanding amounts borrowed under this agreement bear interest at our option of either the defined base rate or the LIBOR rate plus a premium. Commitment fees of 0.15% of the undrawn amount are payable under this agreement. At September 24, 2006 and September 25, 2005 no amounts were drawn under the agreement. The amount available to the Company under the agreement was effectively reduced to $88.4 million by outstanding letters of credit totaling approximately $11.6 million at September 25, 2005. On November 7, 2005, we amended our credit facility to delete negative covenants related to the repurchase of Company stock and payment of dividends.
We have outstanding zero coupon convertible subordinated debentures which had a carrying amount of approximately $8.3 million and $12.9 million at September 24, 2006 and September 25, 2005, respectively. The debentures have an effective yield to maturity of 5 percent and a scheduled maturity date of March 2, 2018. The debentures are convertible at the option of the holder, at any time on or prior to maturity, unless previously redeemed or otherwise purchased. The debentures may be redeemed at the option of the holder on March 2, 2008 or March 2, 2013 at the issue price plus accrued original discount to the date of redemption. Subject to certain limitations, at our option, we may elect to pay this purchase price in cash, shares of common stock or any combination thereof. The debentures may also be redeemed in cash at the option of the holder if there is a change in control at the issue price plus accrued original discount to the date of redemption. The Company may redeem the debentures for cash, in whole or in part, at redemption prices equal to the issue price plus accrued original discount to the date of redemption. The debentures are subordinated in the right of payment to all existing and future senior indebtedness. The debentures have a conversion rate of 21.280 shares of Company common stock per $1,000 principal amount at maturity, or approximately 311,000 shares and 505,000 shares at September 24, 2006 and September 25, 2005, respectively. Approximately $5.0 million and $150.1 million of the carrying amount of the debentures were voluntarily converted by holders to shares of Company common stock during fiscal years 2006 and 2005, respectively.
We also had outstanding senior unsecured notes that bear interest at 7.29% payable quarterly with a carrying amount of approximately $5.7 million at September 25, 2005. The Company made the final principal payment totaling approximately $5.7 million to retire its senior notes on May 16, 2006.
(8) Leases
The Company is committed under certain capital leases for rental of equipment and certain operating leases for rental of facilities and equipment. These leases expire or become subject to renewal clauses at various dates from 2006 to 2038. Amortization of equipment under capital lease is included with depreciation expense.
 
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Rental expense charged to operations under operating leases for fiscal years 2006, 2005 and 2004 totaled approximately $153.1 million, $124.8 million and $99.9 million, respectively. Minimum rental commitments required by all non-cancelable leases are approximately as follows (in thousands):
     Capital    Operating
2007    $ 58    $ 162,827
2008      93      227,490
2009      89      247,284
2010      74      246,028
2011      39      243,331
Future fiscal years      25      3,636,926
     
     378    $ 4,763,886
     
Less amounts representing interest      43   
     
Net present value of capital lease obligations      335   
Less current installments      49   
     
Long-term capital lease obligations, less current installments    $ 286   
     
During fiscal years 2006, 2005 and 2004, we paid contingent rentals totaling approximately $9.6 million, $7.6 million and $4.8 million, respectively. No asset retirement obligations have been incurred associated with operating leases. Sublease rental income totaled approximately $1.6 million, $1.3 million and $1.4 million during fiscal years 2006, 2005 and 2004, respectively. John Mackey and Glenda Chamberlain, executive officers of the Company, own approximately 51% and 2%, respectively, of BookPeople, Inc., a retailer of books and periodicals that is unaffiliated with the Company, which leases retail space in Austin, Texas from the Company. The lease provides for an aggregate annual minimum rent of approximately $0.4 million which the Company received in rental income in fiscal years 2006, 2005 and 2004.
(9) Income Taxes
Components of income tax expense are as follows (in thousands):
     2006     2005     2004  
Current federal income tax    $ 120,774     $ 106,087     $ 70,750  
Current state income tax      30,632       22,568       16,272  
  
Total current tax      151,406       128,655       87,022  
  
Deferred federal income tax      (13,350 )     (22,462 )     284  
Deferred state income tax      (2,171 )     (5,411 )     (965 )
  
Total deferred income tax      (15,521 )     (27,873 )     (681 )
  
Total income tax expense    $ 135,885     $ 100,782     $ 86,341  
  
Actual income tax expense differed from the amount computed by applying statutory corporate income tax rates to income before income taxes as follows (in thousands):
     2006     2005     2004  
Federal income tax based on statutory rates    $ 118,900     $ 82,997     $ 75,548  
Increase (reduction) in income taxes resulting from:       
Change in valuation allowance      (31 )     1,639       2,310  
Tax exempt interest      (1,352 )     —         —    
Share-based compensation      (462 )     3,310       —    
Deductible state income taxes      (9,962 )     (6,005 )     (5,357 )
Other, net      331       1,684       (1,467 )
  
Total federal income taxes      107,424       83,625       71,034  
State income taxes      28,461       17,157       15,307  
  
Total income tax expense    $ 135,885     $ 100,782     $ 86,341  
  
 
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Current income taxes payable as of September 24, 2006 and September 25, 2005 totaled approximately $27.2 million and $5.2 million, respectively. The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows (in thousands):
     2006     2005  
Deferred tax assets:     
Compensation-related costs    $ 43,303     $ 34,009  
Insurance-related costs      16,889       14,380  
Inventories      —         2,879  
Lease and other termination accruals      18       359  
Rent differential      41,717       31,434  
Net domestic and international operating loss carryforwards      10,461       16,606  
Capital loss carryforwards      2,810       7,231  
  
Gross deferred tax assets      115,198       106,898  
Valuation allowance      (13,271 )     (17,364 )
  
     101,927       89,534  
  
Deferred tax liabilities:     
Financial basis of fixed assets in excess of tax basis      (21,858 )     (24,673 )
Inventories      (313 )     —    
Capitalized costs expensed for tax purposes      (1,290 )     (1,841 )
Other      (905 )     (980 )
  
     (24,366 )     (27,494 )
  
Net deferred tax asset    $ 77,561     $ 62,040  
  
Deferred taxes have been classified on the consolidated balance sheets as follows:     
     2006     2005  
Current assets    $ 48,149     $ 39,588  
Noncurrent assets      29,412       22,452  
  
Net deferred tax asset    $ 77,561     $ 62,040  
  
As of September 24, 2006, we had international operating loss carryforwards totaling approximately $32.5 million, of which approximately $11.8 million will begin to expire in fiscal year 2008 and approximately $20.7 million has an indefinite life. During fiscal year 2006, approximately $31,000 of the valuation allowance related to the utilization of certain operating and capital loss carryforwards was released. Additionally, the valuation allowance decreased by approximately $4.1 million due to the expiration of capital loss carryforwards for which no benefit was realized. We have provided a valuation allowance of approximately $13.3 million for deferred tax assets associated with international operating loss carryforwards and domestic capital loss carryforwards for which management has determined it is more likely than not that the deferred tax asset will not be realized. Management believes that it is more likely than not that we will fully realize the remaining domestic deferred tax assets in the form of future tax deductions based on the nature of these deductible temporary differences and a history of profitable operations.
(10) Investments
We had short-term cash equivalent investments totaling approximately $10.1 million and $325.7 million at September 24, 2006 and September 25, 2005, respectively.
As of September 24, 2006, we also had short-term available-for-sale securities, generally consisting of state and local government obligations totaling approximately $193.8 million. Gross unrealized gains on the securities totals approximately $77,000 as of September 24, 2006.
 
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(11) Shareholders’ Equity
Dividends
The Company’s Board of Directors approved the following dividends during fiscal years 2006 and 2005 (in thousands, except per share amounts):
Date of Declaration    Dividend    Date of Record    Date of Payment    Total
per Share Amount
Fiscal year 2006:            
November 9, 2005    $ 0.15    January 13, 2006    January 23, 2006    $ 20,918
November 9, 2005      2    13-Jan-06    23-Jan-06      277,904
March 6, 2006      0.15    14-Apr-06    24-Apr-06      21,004
June 13, 2006      0.15    14-Jul-06    24-Jul-06      21,186
Fiscal year 2005:            
November 10, 2004    $ 0.1    7-Jan-05    17-Jan-05    $ 12,088
April 5, 2005      0.13    15-Apr-05    25-Apr-05      16,345
June 7, 2005      0.13    15-Jul-05    25-Jul-05      16,834
September 14, 2005      0.13    October 14, 2005    October 24, 2005      17,063
On September 27, 2006, the Company’s Board of Directors approved a quarterly dividend of $0.15 per share that was paid on October 23, 2006 to shareholders of record on October 13, 2006. On November 2, 2006, the Company’s Board of Directors approved a 20% increase in the Company’s quarterly dividend to $0.18 per share payable on January 22, 2007 to shareholders of record on January 12, 2007. The Company will pay future dividends at the discretion of the Board of Directors. The continuation of these payments, the amount of such dividends, and the form in which the dividends are paid (cash or stock) depend on many factors, including the results of operations and the financial condition of the Company. Subject to these qualifications, the Company currently expects to pay dividends on a quarterly basis.
On November 9, 2005, the Company’s Board of Directors approved a two-for-one stock split to be distributed on December 27, 2005 to shareholders of record at the close of business on December 12, 2005. The stock split was effected in the form of a stock dividend. Shareholders received one additional share of Whole Foods Market common stock for each share owned. All share and per share amounts in these financial statements have been adjusted to reflect the effect of the stock split. All shares reserved for issuance pursuant to the Company’s stock option and stock purchase plans were automatically increased by the same proportion. In addition, shares subject to outstanding options or other rights to acquire the Company’s stock and the exercise price for such shares were adjusted proportionately.
Treasury Stock
On November 8, 2005, the Company’s Board of Directors approved a stock repurchase program of up to $200 million over the next four years. During the fourth quarter of fiscal year 2006, the Company repurchased on the open market approximately 2.0 million shares of Company common stock that were held in treasury at September 24, 2006. The average price per share paid was $49.85, for a total of approximately $100 million. At September 25, 2005, we had no shares of Company common stock in treasury.
On November 6, 2006, the Company’s Board of Directors approved a $100 million increase in the Company’s stock repurchase program, bringing the total remaining authorization to $200 million over the next three years. The specific timing and repurchase amounts will vary based on market conditions, securities law limitations and other factors and will be made using the Company’s available cash resources and line of credit availability. The repurchase program may be suspended or discontinued at any time without prior notice.
(12) Earnings per Share
The computation of basic earnings per share is based on the number of weighted average common shares outstanding during the period. The computation of diluted earnings per share includes the dilutive effect of common stock equivalents consisting of common shares deemed outstanding from the assumed exercise of stock options and the assumed conversion of zero coupon convertible subordinated debentures.
 
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A reconciliation of the numerators and denominators of the basic and diluted earnings per share calculations follows (in thousands, except per share amounts):
     2006    2005    2004
Net income (numerator for basic earnings per share)    $ 203,828    $ 136,351    $ 129,512
Interest on 5% zero coupon convertible subordinated debentures, net of income taxes      283      2,539      4,697
        
Adjusted net income (numerator for diluted earnings per share)    $ 204,111    $ 138,890    $ 134,209
        
Weighted average common shares outstanding (denominator for basic earnings per share)      139,328      130,090      122,648
        
Potential common shares outstanding:         
Assumed conversion of 5% zero coupon convertible subordinated debentures      363      3,414      6,562
Assumed exercise of stock options      5,391      6,446      6,244
        
Weighted average common shares outstanding and potential additional common shares outstanding (denominator for diluted earnings per share)      145,082      139,950      135,454
        
Basic earnings per share    $ 1.46    $ 1.05    $ 1.06
        
Diluted earnings per share    $ 1.41    $ 0.99    $ 0.99
        
The computation of diluted earnings per share does not include options to purchase approximately 4.3 million, 158,000 shares and 6,000 shares of common stock at the end of fiscal years 2006, 2005 and 2004, respectively, due to their antidilutive effect.
(13) Share-Based Compensation
Total share-based compensation expense recognized during fiscal year 2006 and fiscal year 2005 was approximately $9.4 million and $19.9 million, respectively. Of these totals, approximately $3.6 million and $10.1 million was included in “Direct store expenses”, $5.5 million and $8.6 million was included in “General and administrative expenses”, and $0.3 million and $1.2 million was included in “Cost of goods sold and occupancy costs” in the Consolidated Statements of Operations in fiscal year 2006 and fiscal year 2005, respectively. The related total tax benefit was approximately $2.7 million and $4.5 million in fiscal year 2006 and fiscal year 2005, respectively. Our Company maintains several share-based incentive plans.
Stock Option Plan
We grant options to purchase common stock under our 1992 Stock Option Plans, as amended. Under these plans, options are granted at an option price equal to the market value of the stock at the grant date and are generally exercisable ratably over a four-year period beginning one year from grant date. Options granted in fiscal year 2006 expire five years from the date of grant and options granted in fiscal years 2005 and 2004 expire seven years from date of grant. Certain options granted during fiscal year 2005 were granted fully vested. Our Company has, in connection with certain of our business combinations, assumed the stock option plans of the acquired companies. All options outstanding under our Company’s previous plans and plans assumed in business combinations continue to be governed by the terms and conditions of those grants. The market value of the stock is determined as the closing stock price at the grant date. At September 24, 2006, September 25, 2005 and September 26, 2004 approximately 6.5 million, 7.7 million and 11.2 million shares of our common stock, respectively, were available for future stock option grants.
 
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The following table summarizes option activity (in thousands, except per share amounts):
     Number     Weighted    Weighted    Aggregate
of Options Average Average Intrinsic
Outstanding Exercise Price Remaining Value
Contractual Life
Outstanding options September 28, 2003    15,728     $ 17.53      
Options granted    5,240       39.54      
Options exercised    (4,154 )     14.13      
Options expired    (674 )     23.9      
        
Outstanding options at September 26, 2004    16,140     $ 25.69      
Options granted    12,112       59.82      
Options exercised    (4,996 )     21.64      
Options expired    (711 )     37.33      
        
Outstanding options at September 25, 2005    22,545     $ 44.58      
Options granted    1,444       69      
Options exercised    (5,466 )     36      
Options expired    (202 )     56.57      
Options forfeited    (46 )     64.52      
        
Outstanding options at September 24, 2006    18,275     $ 48.82    4.74    $ 243,726
        
Vested/expected to vest at September 24, 2006    18,031     $ 48.55    4.75    $ 243,691
        
Exercisable options at September 24, 2006    16,551     $ 47.11    4.75    $ 239,831
        
The weighted average fair values of options granted during fiscal years 2006, 2005 and 2004 were $17.04, $15.19 and $14.69, respectively. The aggregate intrinsic value of stock options at exercise, represented in the table above, was approximately $180.0 million during fiscal year 2006. Total gross unrecognized share-based compensation expense related to nonvested stock options was approximately $25.2 million as of the end of fiscal year 2006, related to approximately 1.5 million shares. We anticipate this expense to be recognized over a weighted average period of approximately two years.
A summary of options outstanding and exercisable at September 24, 2006 follows (share amounts in thousands):
        Options Outstanding   Options Exercisable
Range of   Number   Weighted Average   Weighted   Number   Weighted
Exercise Prices Remaining Average Average
From   To   Outstanding   Life (in Years)   Exercise Price   Exercisable   Exercise Price
$10.47   $ 20.48   1,554   1.19   $ 11.38   1,554   $ 11.38
  21.76     38.31   2,721   3.17     26.16   2,683     26.13
  39.61     39.61   2,632   4.61     39.61   2,596     39.61
  41.05     54.17   4,753   5.57     53.56   4,588     53.77
  54.75     66.81   5,206   5.97     66.69   5,130     66.74
  68.96     73.14   1,409   4.62     69   —       n/a
Total     18,275   4.74   $ 48.82   16,551   $ 47.11
Share-based compensation expense related to vesting stock options recognized during fiscal year 2006 totaled approximately $4.6 million.
During fiscal year 2005, the Company accelerated the vesting of all outstanding stock options, except options held by the members of the executive team and certain options held by team members in the United Kingdom, in order to prevent past option grants from having an impact on future results. The Company recognized a share-based compensation charge totaling approximately $17.4 million related to this acceleration, which was determined by measuring the intrinsic value on the date of the acceleration for all options that would have expired in the future unexercisable had the acceleration not occurred. The calculation of this charge required that management make estimates and assumptions concerning future team member turnover. In the fourth quarter of fiscal year 2006 the Company recognized an additional $3.0 million share-based compensation charge related to this acceleration to adjust for actual experience. Additional adjustments in future periods may be necessary as actual results could differ from these estimates and assumptions.
 
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The Company also recognized share-based compensation totaling approximately $1.2 million and $2.5 million for modifications of terms of certain stock option grants and other compensation based on the intrinsic value of the Company’s common stock during fiscal years 2006 and 2005, respectively.
The fair value of stock option grants has been estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:
     2006     2005     2004  
Expected dividend yield    1.26 %   0.84 %   0.76 %
Risk-free interest rate    5.04 %   4.14 %   4.72 %
Expected volatility    29.4 %   48.3 %   49.48 %
Expected life, in years    3.22     2.1     3.3  
Risk-free interest rate is based on the US treasury yield curve for a three and a half-year term and the seven-year zero coupon treasury bill rate on the dates of the annual grant in fiscal year 2006 and fiscal year 2005, respectively. Expected volatility is calculated using a ratio of implied volatility based on comparable Long-Term Equity Anticipation Securities (“LEAPS”) and four-year historical volatility for fiscal year 2006. The Company determined the use of implied volatility versus historical volatility represents a more accurate calculation of option fair value. In fiscal year 2005, expected volatility was calculated using the daily historical volatility over the last seven years. Expected life is calculated in two tranches based on weighted average percentage of unexpired options and exercise-after-vesting information over the last five years, in fiscal year 2006. During fiscal year 2005, expected life was calculated in five salary tranches based on weighted average exercise-after-vesting information over the last seven years. The assumptions used to calculate the fair value of options granted are evaluated and revised, as necessary, to reflect market conditions and experience.
Prior to the effective date of revised Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based Payment,” the Company applied Accounting Principles Board Opinion No. 25 (“APB No. 25”), “Accounting for Stock Issued to Employees” and related interpretations for our stock option grants. APB No. 25 provides that the compensation expense relative to our team member stock options is measured based on the intrinsic value of the stock option at date of grant.
In accordance with SFAS No. 123R, the Company adopted the provisions of SFAS No. 123R in the first quarter of fiscal year 2006 using the modified prospective approach. Under this method, prior periods are not restated. As a result of adoption, the Company’s income before income taxes and net income for fiscal year 2006, are $6.4 million and $3.8 million lower, respectively, than if we had continued to account for share-based compensation under APB No. 25. Basic and diluted earnings per share for fiscal year 2006 are $0.03 lower than if we had continued to account for share-based compensation under APB No. 25. Had we previously recognized compensation costs as prescribed by SFAS No. 123, previously reported net income, basic earnings per share and diluted earnings per share would have changed to the pro forma amounts shown below (in thousands, except per share amounts):
     2005     2004  
Reported net income    $ 136,351     $ 129,512  
Share-based compensation expense, net of income taxes      15,309       —    
Pro forma expense, net of income taxes      (179,616 )     (23,888 )
  
Pro forma net income (loss)    $ (27,956 )   $ 105,624  
  
Basic earnings per share:     
Reported    $ 1.05     $ 1.06  
Share-based compensation expense      0.12       —    
Pro forma adjustment      (1.38 )     (0.20 )
  
Pro forma basic earnings (loss) per share    $ (0.21 )   $ 0.86  
  
Diluted earnings per share:     
Reported    $ 0.99     $ 0.99  
Share-based compensation expense      0.12       —    
Pro forma adjustment      (1.31 )     (0.17 )
  
Pro forma diluted earnings (loss) per share    $ (0.20 )   $ 0.82  
  
Pro forma disclosures for fiscal year 2006 are not presented because the amounts are recognized in the Consolidated Statement of Operations.
 
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Team Member Stock Purchase Plan
Our Company also offers a team member stock purchase plan to all full-time team members with a minimum of 400 hours of service. Under this plan, participating team members may purchase our common stock each fiscal quarter through payroll deductions. Participants in the stock purchase plan may elect to purchase unrestricted shares at 100 percent of market value or restricted shares at 85 percent of market value on the purchase date. Participants are required to hold restricted shares for two years before selling them. In fiscal year 2006, we recognized approximately $0.6 million of share-based compensation expense related to team member stock purchase plan discounts. We issued approximately 51,000, 40,000 and 32,000 shares under this plan in fiscal years 2006, 2005 and 2004, respectively. At September 24, 2006, September 25, 2005 and September 26, 2004 approximately 369,000, 420,000, and 460,000 shares of our common stock, respectively, were available for future issuance.
(14) Team Member 401(k) Plan
Our Company offers a team member 401(k) plan to all team members with a minimum of 1,000 services hours in one year. In fiscal years 2006 and 2005, the Company made a matching contribution to the plan of approximately $2.3 million in cash. The Company did not make a matching contribution to the plan in fiscal year 2004.
(15) Quarterly Results (unaudited)
The Company’s first quarter consists of 16 weeks, and the second, third and fourth quarters consist of 12 weeks. Because the first quarter is longer than the remaining quarters, it typically represents a larger share of our annual sales from existing stores. Quarter to quarter comparisons of results of operations have been and may be materially impacted by the timing of new store openings. The Company believes that the following information reflects all normal recurring adjustments necessary for a fair presentation of the information for the periods presented. The operating results for any quarter are not necessarily indicative of results for any future period.
The Company accelerated the vesting of all outstanding stock options on September 22, 2005 in order to prevent past option grants from having an impact on future results. The Company incurred a share-based compensation charge totaling approximately $18.2 million in the fourth quarter of fiscal year 2005, primarily a non-cash charge related to this accelerated vesting of options. The Company’s effective tax rate for the fourth quarter and fiscal year 2005 was higher than its historical rate primarily due to the non-deductible portion of the expense recognized for the accelerated vesting of stock options. In the fourth quarter of fiscal year 2006, the Company recorded additional $3.0 million non-cash share-based compensation charge to adjust the estimate related to accelerated vesting for actual experience.
The Company has two stores in the New Orleans area which were damaged by and closed due to Hurricane Katrina during the fourth quarter of fiscal year 2005, and accordingly the Company recorded expenses totaling approximately $16.5 million for related estimated net losses.
 
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The following tables set forth selected quarterly unaudited consolidated statements of operations information for the fiscal years ended September 24, 2006 and September 25, 2005 (in thousands except per share amounts):
     First     Second     Third     Fourth  
Quarter Quarter Quarter Quarter
Fiscal Year 2006         
Sales    $ 1,666,953     $ 1,311,520     $ 1,337,886     $ 1,291,017  
Cost of goods sold and occupancy costs      1,092,018       848,020       866,260       841,436  
  
Gross profit      574,935       463,500       471,626       449,581  
Direct store expenses      424,438       330,470       335,555       331,505  
General and administrative expenses      50,889       43,421       43,955       42,979  
Pre-opening and relocation costs      8,491       7,324       7,860       13,746  
  
Operating income      91,117       82,285       84,256       61,351  
Other income (expense)         
Interest expense      (3 )     —         (8 )     (21 )
Investment and other income      6,082       4,068       5,581       5,005  
  
Income before income taxes      97,196       86,353       89,829       66,335  
Provision for income taxes      38,878       34,542       35,931       26,534  
  
Net income    $ 58,318     $ 51,811     $ 53,898     $ 39,801  
  
Basic earnings per share    $ 0.42     $ 0.37     $ 0.38     $ 0.29  
  
Diluted earnings per share    $ 0.4     $ 0.36     $ 0.37     $ 0.28  
  
Dividends declared per share    $ 2.15     $ 0.15     $ 0.15     $ —    
  
     First     Second     Third     Fourth  
Quarter Quarter Quarter Quarter
Fiscal Year 2005         
Sales    $ 1,368,328     $ 1,085,158     $ 1,132,736     $ 1,115,067  
Cost of goods sold and occupancy costs      895,486       697,686       733,931       725,081  
  
Gross profit      472,842       387,472       398,805       389,986  
Direct store expenses      348,380       276,313       285,804       312,976  
General and administrative expenses      40,401       34,773       39,618       44,072  
Pre-opening and relocation costs      6,599       10,265       8,777       11,394  
  
Operating income      77,462       66,121       64,606       21,544  
Other income (expense)         
Interest expense      (1,708 )     (342 )     (163 )     (10 )
Investment and other income      1,194       2,113       2,868       3,448  
  
Income before income taxes      76,948       67,892       67,311       24,982  
Provision for income taxes      30,778       27,158       26,924       15,922  
  
Net income    $ 46,170     $ 40,734     $ 40,387     $ 9,060  
  
Basic earnings per share    $ 0.37     $ 0.31     $ 0.31     $ 0.07  
  
Diluted earnings per share    $ 0.34     $ 0.29     $ 0.29     $ 0.06  
  
Dividends declared per share    $ 0.1     $ 0.13     $ 0.13     $ 0.13  
  
(15) Commitments and Contingencies
The Company uses a combination of insurance and self-insurance plans to provide for the potential liabilities for workers’ compensation, general liability, property insurance, director and officers’ liability insurance, vehicle liability and employee health care benefits. Liabilities associated with the risks that are retained by the Company are estimated, in part, by considering historical claims experience, demographic factors, severity factors and other actuarial assumptions. While we believe that our assumptions are appropriate, the estimated accruals for these liabilities could be significantly affected if future occurrences and claims differ from these assumptions and historical trends.
From time to time we are a party to legal proceedings including matters involving personnel and employment issues, personal injury, intellectual property and other proceedings arising in the ordinary course of business which have not resulted in any material losses to date. Although not currently anticipated by management, our results could be materially impacted by the decisions and expenses related to pending or future proceedings.
The Company has entered into Retention Agreements with certain executive officers of the Company or its subsidiaries which provide for certain benefits upon an involuntary termination of employment other than for cause after a “Triggering Event.” A Triggering Event includes a merger of the Company with and into an unaffiliated corporation if the Company is not the surviving corporation or the sale of all or substantially all of the Company’s assets. The benefits to be received by the executive officer whose employment is terminated after a Triggering Event occurs include receipt of his or her annual salary through the one-year period following the date of the termination of employment and the immediate vesting of any outstanding stock options granted to such executive officer.
 
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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act.
Changes in Internal Control over Financial Reporting
There have been no changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Management’s Report on Internal Control over Financial Reporting
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Under the supervision and with the participation of the Company’s management, including our principal executive officer and principal financial officer, the Company conducted an evaluation of the effectiveness of its internal control over financial reporting based on criteria established in the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, the Company’s management concluded that its internal control over financial reporting was effective as of September 24, 2006.
The Company’s independent registered public accounting firm, Ernst & Young LLP, audited management’s assessment of internal control over financial reporting and also independently assessed the effectiveness of our internal control over financial reporting. Ernst & Young LLP has issued their attestation report which is included in Part II, Item 8 of this Report on Form 10-K.
Item 9B. Other Information.
Not applicable.
 
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PART III
Item 10. Directors and Executive Officers of the Registrant.
The information required by this item about our Company’s Executive Officers is included in Part I, “Item 1. Business” of this Report on Form 10-K under the caption “Executive Officers of the Registrant.” All other information required by this item is incorporated herein by reference from the registrant’s definitive Proxy Statement for the Annual Meeting of Shareholders to be held March 5, 2007 to be filed with the Commission pursuant to Regulation 14A.
The Company has adopted a Code of Conduct and Ethics for Team Members and Directors pursuant to section 406 of the Sarbanes-Oxley Act. A copy of our Code of Conduct and Ethics is publicly available on our Company website at http://www.wholefoodsmarket.com/investor/corporategovernance/codeofconduct.pdf. The information contained on our Web site is not incorporated by reference into this Report on Form 10-K.
Item 11. Executive Compensation.
The information required by this item is incorporated herein by reference from the registrant’s definitive Proxy Statement for the Annual Meeting of Shareholders.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required by this item about our Company’s securities authorized for issuance under equity compensation plans as of September 24, 2006 is included in Part I, “Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” of this Report on Form 10-K. All other information required by this item is incorporated herein by reference from the registrant’s definitive Proxy Statement for the Annual Meeting of Shareholders.
Item 13. Certain Relationships and Related Transactions.
The information required by this item is incorporated herein by reference from the registrant’s definitive Proxy Statement for the Annual Meeting of Shareholders.
Item 14. Principal Accounting Fees and Services.
The information required by this item is incorporated herein by reference from the registrant’s definitive Proxy Statement for the Annual Meeting of Shareholders.
 
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Ratios

Ratio Analysis
*** Ratios also allow for better comparison through time, between companies that of different sizes or have different currencies
Ratios are used both internally and externally
*** Ratios are computed differently by different people
The ones we see in this book are only one of many possible ways to compute them!
Hints About Financial Ratios
In calculating any ratio, we mean the ratio of one thing to something else
When we write the ratio as a fraction, we put the of part in the numerator and the to part in the denominator
Example:
Current ratio: find the ratio of current assets to current liabilities
(Current Assets)/(Current Liabilities) = $45,000/$30,000 = 1.5
If you keep the unit of measure (dollars) in both the numerator and denominator, the answer will hint at what the ratio means
*** (Current Assets)/(Current Liabilities) = $45,000/$30,000 = $1.50/$1.00
In this case the ratio indicates that for every $1.00 of current liabilities, there is $1.50 worth of current assets to use to pay off the current liabilities
In general, this trick can be used with all ratios
Who uses them? Why we might be interested?
Stock analysts
Should I buy/sell this stock?
Auditors
Are the financial statements free from material misstatement?
Internal Managers
How is the firm doing?
Investors
Should I sell/buy this stock?
Banks
Will the borrower be able to pay back the loan?
Basically: almost everyone
Questions To Ask When You Use Ratios:
How is it computed?!
Not everyone agrees about how to calculate a given ratio
What is it intended to measure and why might we be interested?
What is the unit of measure?
What might a high or low value be telling us?
How might such values be misleading?
Accounting behind the numbers…?
Does a low CA/CL mean trouble for a large firm?
How could the measure be improved?
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LiquidityR

Liquidity Ratios
Liquidity = How quickly an asset can be converted to cash
Bankers, Auditors, Managers, Employees, Investors, and everyone else needs to know if they have cash in the short-term
Current Ratio = CA/CL
Measure of short term liquidity
Example: $2/$1 = $2 CA for every $1 of CL
If you were to sell all CA and pay off all CL, you would have $2 for every $1 of CL
Above 1, in general is good
Less than 1, in general is not so good
High ==> could mean firm saving up cash to make acquisition, or it could mean that they do not see profitable fixed assets to purchase
Low ==> could mean that they may have a hard time paying short-term debt
CA/CL is often used in debt contracts as indicator of short term liquidity
If you incur long-term debt, CA↑/CL, (CA/CL) ↑
If you pay off short-term creditors: 5/2 = 2.5 → (5-1)/(2-1) = 4/1 = 4
Firms may do these things before the report their numbers at the end of the period
An apparent low CA/CL may not be bad for a company with a large reserve of untapped borrowing power
Firm buys inventory with $, CA/CL stays same
Firm sells inventory for more than they have it on the books for, (CA/CL) ↑
Quick Ratio = (CA-INV)/CL = (Quick Assets)/CL
Measure of immediate short-term liquidity
Why take out inventory?
Inventory may not be at market value
May be hard to sell
May be obsolete
Using cash to buy inventory reduces the Quick Ratio
People who are interested in whether firm can pay bills or purchase assets in the short term may use this ratio:
Creditors, internal managers, investors
Cash Ratio = Cash/CL
Do we even need to define this?
Summary:
Current Ratio = CA/CL
Quick Ratio = (CA-INV)/CL
Cash Ratio = Cash/CL
What does it mean when these ratios are greater than 1? A: More CA than CL
What does it mean when these ratios are less than 1? A: More CL than CA
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LeverageR (1)

Leverage, Or Long-term Solvency Ratios
Capital Structure = Relationship Between Debt & Equity
A = L + E
10 = 2 + 8
Solvency = “the position of having enough money to cover expenses and debts”
Banks, Investors look at these ratios
Variables:
Equity = TE = E
Liability = Debt = TL = D
Assets = TA = A
Total Debt Ratio
Total Debt Ratio = TL/TA = (TA–TE)/TA
Amount of debt for every $1 of assets
How much of every $1 of assets is financed with debt
Debt/Equity Ratio
Debt/Equity Ratio = TL/TE = D/E
Amount of debt for every $1 of equity
Equity Multiplier = Leverage = TA/TE = (1+D/E)
For every $1 of equity how many dollars of assets are there
Shows us the amount of leverage
Times Interest Earned Ratio =EBIT/Interest
How many times over interest can be paid
Who might be interested in this ratio? A: Creditors.
Cash Coverage Ratio = (EBIT+Depr.)/Interest =EBDIT/Interest
One possible measure of cash flow to meet financial obligations
If the company has a great deal of non-cash deprecation expense, then it makes sense to use this one
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LeverageR (2)

TL/TA TL/TE TA/TE
Same Capital Structure 0.20 = 2/10 then ==> 2/(10-2) = 2/8 = 0.25 then ==> 10/8 = 1.25
Same Capital Structure 0.25 = 2.5/10 then ==> 2.5/(10-2.5) = 2.5/7.5 = 0.33 then ==> 10/7.5 = 1.3333333333
Same Capital Structure 0.50 = 5/10 then ==> 5/(10-5) = 1 = 1 then ==> 2 = 2
Same Capital Structure 0.80 = 8/10 then ==> 8/(10-8) = 4 = 4 then ==> 5 = 5
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EfficencyR

Turnover or Efficiency Ratios COGS $5,000.00 Sales $10,000.00 COGS $5,600.00
Measures how efficently we manage our Inventory, Receivables, Assets, and Cash Cycle INV. $1,000.00 AR $1,000.00 AP $800.00
COGS/INV. 5 Sales/AR 10 COGS/AP 7
Inventory Turnover =COGS/Inv. 365 365 365
Alternative = COGS/((Beg.Inv.+EndInv.)/2) Days to sell 73 Days to collect 36.5 Days to pay 52
How many times we run inventory down to zero and then immediately restock
How many times did we buy and sell our inventory during the year Operating Cycle = Days to sell + Days to collect = = 73 + 36.5 + 109.5
"As long as we are not running out of stock and foregoing sales, the higher the ratio, the more efficient we are at managing inventory" Cash Cycle = Operating Cycle - Payables Period = 109.5 - Days to pay = 57.5
Example: COGS/Inv.=5,000/1,000 = 5
Days’ Sales In Inventory = 365/Inv. Turn Operating cycle = days inventory sits + days to collect after selling
How long inventory sits before it is sold Cash cycle = operating cycle – payables period
Example:
If Inv. Turn = 5
Days’ Sales In Inventory = 365days/5 = 73 days
Receivables Turnover = Sales/AR
Alternative = (Credit_Sales)/((Beg.AR+EndAR)/2)
How fast we collect our receivable
# of times we collect and reloan the $ per year
Example: 10,000/1,000 = 10
Days’ Sales In Receivables = 365/(Days’ Sales In Receivables)
Average time it takes to collect the AR
Example: 365days/10 = 36.5 days
Payables Turnover = COGS/AP
Example:
COGS/AP = 5,600/800 = 7
365 days/7 = 52 days to pay bill
Total Asset Turnover = Sales/TA
Alternative = (Total_Operating_Revenue)/((Beg.TA+EndTA)/2)
Measure of asset use efficiency
How many sales do we generate from $1 of assets
The higher, the better, or the more efficient
Sales/TA goes up, more efficient use of assets!
If a firm has newer assets that have not been depreciated, book value for assets may be high and may temporarily lower the ratio
Not unusual for TAT < 1, especially if a firm has a large amount of fixed assets
If firm has many old assets (fully depreciated), the Asset Turnover will be high, but not necessarily a good sign because it might have to use a lot of cash to buy new assets).
Capital Intensity = TA/Sales
For every $1 of sales how many $ of assets did it take to generate that $1
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ProfitabilityR

Profitability Ratios
Are we getting a good return?
Profit Margin = NI/Sales
For every $1 of sales, what is the profit?
Example: $60/$400 = .15
High PM corresponds to low expense ratios relative to sales
High PM:
Internal managers could be managing cost efficiently
Product/service could be superior to others and could thus demand a high price
Low Profit Margin may be fine if volume is high (SUCH AS Grocery Stores)
Return On Assets = NI/TA = ROA (also known as ROI (ROInvestment))
Profit per $1 of asset
ROA = NI/Sales*Sales/TA
ROA = Profit Margin*Asset Turnover = Operating Efficiency*Asset Use Efficiency
Return On Equity = ROE = NI/Equity
Return to shareholders
What is the profit per $1 of equity?
The key:
When there is no debt, ROE = ROA
When there is debt this should happen: ROE > ROA
Why? Because the assets must earn a return for both the creditors and owners
The more debt there is, the higher (ROE – ROA) must be!
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ROAandROE (1)
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Du Pont (1)

ROE = Profitability x Efficiency x Leverage
ROE = Operating efficiency Asset Efficiency Financial leverage
ROE = Profit Margin x Asset Turnover x Equity Multiplier
NI/Equity = NI/Sales x Sales/Assets x Assets/Equity
ROE = Profits generated from $1 of sales, are expenses being kept low? x Sales generated by $1 of assets, efficient utilization of assets? x For every $1 of owner investment, how many $ of assets were purchased?
ROE = NI/Assets x Assets/Equity
ROE = ROA x Equity Multiplier
ROE = ROA x (1 + D/E)
ROE = ROA x (1/(1-D/TA))
"Leverage up" ROE by increasing the amount of debt
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ROA
ROE

Du Pont (2)

Assumptions
Year 1 1998
NI 200
Sales 6,000
Assets 2,000
Equity 1,000
NI/Equity = 20.00%
ROE = 20.00%
Year 2 1999
NI 200
Sales 5,600
Assets 2,400
Equity 1,400
NI/Equity = 14.29%
ROE = 14.29%
1998 ROE = NI/Equity = $200/$1,000 = 20.00%
1999 ROE = NI/Equity = $200/$1,400 = 14.29%
ROE = Profitability x Efficiency x Leverage
ROE = Profit Margin x Asset Turnover x Equity Multiplier
NI/Equity = NI/Sales x Sales/Assets x Assets/Equity
1998 ROE =20.00% = $200/$6,000 x $6,000/$2,000 x $2,000/$1,000
20.00% = 3.33% x 3.00 x 2.00
1999 ROE =14.29% = $200/$5,600 x $5,600/$2,400 x $2,400/$1,400
14.29% = 3.57% x 2.33 x 1.71
ROE went down, not because of a decrease in profitability of sales, but:
Assets are used less efficiently to generate sales!
Firm is less effective at leveraging stockholders' investment in the firm.
In 1998 the financial managers were able to turn each $1 of invested funds into $2.00 of assets.
In 1999 the financial managers only managed to turn $1 of equity into $1.71 of assets.
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MarketValueR

Market Value Ratios (For publicly traded companies)
Price-Earnings Ratio = (Market Price per Share)/EPS)
Note: EPS = NI/(# Shares Outstanding)
$ paid for $1 of earnings
“Surrogate for growth”
Market-To-Book Ratio (also known as Tobin's Q)
Note: Book Value per Share = TE/(# Shares Outstanding)
(Market Value per Share)/(Book Value per Share)
>1, stock market believes that firm is worth more than the book value of equity
<1, stock market believes that firm is worth less than the book value of equity
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GrowthR (1)

Firm Growth
In the long run if firm wants to increase Net Income, they must increase Sales, which in turn means they must buy more Assets
Assets cost $
The $ come from E, D, or Retained Earnings
Remember: Net Income gets divided up:
Paid out as dividends
Dividends/NI = Dividend payout rate = DPR
Kept as retained earnings
(Retained earnings)/NI = plowback rate = b
The internal growth rate tells us how much the firm can grow assets using retained earnings as the only source of financing
They won’t go issue new equity or debt
D/A will go down over time
Firm gets funds to buy assets from retained earnings
The sustainable growth rate tells us how much the firm can grow by using internally generated funds and issuing debt to maintain a constant debt ratio (issues no new equity)
Firm gets funds to buy assets from retained earnings and debt
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GrowthR (2)
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InternalSustainable Growth

Assumptions: Q Corp Q Corp ROA*b 0.07517
Name Q Corp Balance Sheet ($ in millions) Income Statement t ($ in millions) (1-ROA*b) 0.92483
Year 1 12/31/02 As of December 31, 2002 and December 31, 2002 For The Year Ended December 31, 2002 ROA*b/(1-ROA*b) 0.08128
Year 2 12/31/03 2002 2003 Sales $2,354 ROE*b 0.10558
Statements: Balance Sheet ($ in millions) Assets COGS 1387 (1-ROE*b) 0.89442
Income Statement Income Statement t ($ in millions) Current assets Depreciation $276 ROE*b/(1-ROE*b) 0.11805
Tax rate 34% Cash $127 $141 EBIT $691 ROA = $377/$3,760 = 0.1002287234
Accounts receivable 208 231 Interest Paid $120 ROE = $377/$2,677 = 0.1407769892
Inventory 436 465 Taxable income $571 Div. Payout Rate (DPR) = $94/$377 = 1/4
Total current assets $771 $837 Taxes (34%) $194 b = $283/$377 = 3/4
Fixed assets Net Income $377 SUM = 1
Net plant and equipment 2774 2923 Dividends $94 Internal Growth Rate = ROA*b/(1-ROA*b) = 0.08128
Total assets $3,545 $3,760 Addition to RE $283 Sustainable Growth Rate = ROE*b/(1-ROE*b) = 0.11805
Liabilities and Owners' Equity
Current liabilities ROA = $377/$3,760 =
Accounts payable 355 387 ROE = $377/$2,677 =
Notes payable 274 239
Total current liabilities $629 $626 Div. Payout Rate (DPR) = $94/$377 =
Long-term debt 531 457 b = $283/$377 =
Total liabilities $1,160 $1,083 SUM =
Owners' equity
Common stock and paid-in surplus 543 593 Internal Growth Rate = ROA*b/(1-ROA*b) =
Retained earnings 1842 2084 Sustainable Growth Rate = ROE*b/(1-ROE*b) =
Total owners' equity $2,385 $2,677
Total liabilities and owners' equity $3,545 $3,760
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Benchmarks

Choosing a Benchmark
Time trend:
Over time, have things changed?
Management by exception:
Directing attention to deviations
Peer group:
Firms that compete in the same markets
Have similar assets
Operate in similar ways
Standard Industrial Classification code = SIC page 69
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ROA*b

Internal Growth Rate

1 - ROA*b

=

ROA*bInternal Growth Rate 1 - ROA*b

ROE*b

Sustainable Growth Rate

1-ROE*b

=

ROE*bSustainable Growth Rate 1-ROE*b

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