TO BE CREAM OF THE CROP

DAVID GHITELMAN

BOULDER, Colo. -- Spring was a season of milestones for Wild Oats Markets here.

In April, the company opened a well-received store in Long Beach, Calif., that it said will serve as a template for future development.

In May, it reported the results of its first profitable quarter since new management assumed the helm last year.

Then last month, Wild Oats answered two longstanding questions -- regarding equity funding and distribution -- that earlier in the spring fueled industry speculation that the company was grooming itself to be a takeover candidate rather than a stand-alone player in the expanding natural and organic niche.

And yet, despite agreeing that the company has made impressive gains, analysts told SN Wild Oats still has not fully proven itself.

"They've clearly made progress," said Carole Buyers, equity analyst, RBC Dain Rauscher, Denver, "but the company's not out of the woods yet.

"They have to improve their profitability stance in a big way. The same problems they faced six months ago are still there."

Jonathan Ziegler, San Francisco-based managing director for Deutsche Banc Alex. Brown, New York, used remarkably similar language in his assessment of the company.

"I don't think Wild Oats is completely out of the woods yet," he told SN. "They still have to show a decent recurring profit. They still have to get more stores like Long Beach open."

Analysts also mentioned the challenge posed by Wild Oats' much larger and considerably faster-growing rival, Whole Foods Market, Austin, Texas. Last year, Wild Oats had 109 stores and sales of $893.2 million, in contrast to Whole Foods' 126 stores and sales of $2.3 billion.

Noted Buyers, "In Boulder and Denver, which is Wild Oats' core market of origin, they laid the groundwork for Whole Foods to come and open its larger stores."

Wild Oats' current management told SN it is confident it will continue to rise to all these challenges.

While Perry Odak, who was named Wild Oats' president and chief executive officer in March 2001, declined to be interviewed for this story (and has not been interviewed by the press since joining Wild Oats), the company did make available two top executives for SN to interview. Both joined Wild Oats within the last year, following extensive retail careers elsewhere.

Ed Dunlap, Wild Oats' chief financial executive, spent five years with The Gap, San Francisco, leaving the clothing company as vice president, finance and operations, for Europe.

Terry Malloy, Wild Oats' chief marketing officer, is a veteran of 25 years at Chicago-area, food-and-drug chain Jewel-Osco, now a subsidiary of Albertson's, Boise, Idaho. His final position there was as senior vice president, marketing, for drug stores.

Both told SN they are strongly optimistic about Wild Oats' prospects. Commented Dunlap, "We addressed our biggest strategic challenge last year and did so successfully in turning the corner on rejuvenating our top line. We've now had five successive quarters of positive comparable-store sales growth. That will continue."

Growing Pains

Founded in 1987 as a single natural/organic store here, Wild Oats grew at accelerating pace through the 1990s, largely through acquisition, with the growth peaking in 1999 when the company acquired or opened 25 stores.

The growth came at a considerable price. A net income of $12.5 million for fiscal 1999 turned into a net loss of $15 million in fiscal 2000. This ballooned into a net loss of $43.9 million last year and put a brake on expansion. In fiscal 2000, it opened 14 new stores, acquired two more, but closed 17 and sold three. In fiscal 2001, the company opened four new units, closed one and sold two. So far in 2002, Wild Oats has opened one store, closed three and sold three.

Wild Oats' mistake, according to Scott Van Winkle, equity analyst for Boston-based Adams, Harkness & Hill, was that its acquisitions were too scattered.

"There was no focus on density," he told SN. "The history of Wild Oats was making acquisitions without a geographic focus, and that's what caused a lot of problems."

Dunlap admitted that lack of geographic focus had been a cause of the company's woes. "The company was built largely through acquisition," he said. "There was some organic growth, but its growth from 1997 through early 2000 was through acquisitions. Those acquisitions created a store base that is geographically thin.

"One of our strategic challenges now is to densify the store base in those markets we believe provide the greatest potential. That is the cornerstone to our real-estate strategy."

Dunlap noted that Wild Oats' plans for growth start in Southern California, where, he said, its Henry's Marketplace banner enjoys wide recognition, particularly in the Los Angeles and San Diego markets. After filling in Southern California, he added that the company will likely be "expanding eastward through the Southwest."

Wild Oats' goal, according to Dunlap, is to operate 150 stores by 2005, although 200 stores "within five years is definitely within the realm of possibility. In terms of profitability, we hope to get a 2% after-tax return on sales. We're looking at growing our sales in the area of 15% to 20% over this [three-year] time frame. A lot is going to be driven by new stores."

At the moment, it appears likely that these new stores will be paid for from the proceeds of a stock offering. In June, Wild Oats filed papers with the Securities and Exchange Commission requesting permission to issue up to 3.25 million additional shares of its common stock (on top of the nearly 25 million shares already in circulation). With Wild Oats trading on NASDAQ late last week at roughly $14.50 per share, such an offering would produce more than $47 million, which would be enough to meet the company's stated equity need of $30 to $50 million to pay for new stores.

Earlier this year, the company's still unresolved search for new sources of equity led some analysts, including Buyers, to speculate that Wild Oats might be grooming itself to be a takeover candidate. "The company for the last nine months had been talking about raising money," she said. "We saw such a delay [that] it was possible it was [preparing itself for] a strategic acquisition." However, she told SN that she had changed her mind after the offering plan was filed.

Speculation about a takeover may also have been fueled by the presence of Odak at the helm of Wild Oats. In his previous job as president and CEO of Ben & Jerry's Homemade, South Burlington, Vt., he oversaw the takeover of that entrepreneurial product of the counterculture by the massive Anglo-Dutch consumer packaged goods manufacturer Unilever.

In addition, according to Buyers, Odak's contract entitles him to a $9.2 million bonus if the company is sold and its stock reaches $20. She noted that he could also receive a $9.2 million bonus if the stock price closes at $30 or more for 120 days.

Along with the potential stock offering, the news that last month Wild Oats reached a new distribution agreement well before its current agreement expires in September also helped quash rumors of an impending takeover. Wild Oats' primary distributor will become Tree of Life, St. Augustine, Fla., a subsidiary of Netherlands-based Koninklijke Wessanen, succeeding United Natural Foods, Dayville, Conn.

Learning Curves

If the Wild Oats store that opened this spring in Long Beach was a Broadway show, it would be well on its way to being a hit.

Certainly, it has received rave reviews from the critics -- in this case, industry analysts -- who have visited it. "I thought it was a great store," said Buyers. "It was crowded. It seemed well-merchandised. The focus on customer service was there."

Ziegler offered a similar assessment. "It's pretty darn impressive," he said. "The location was good.

"It was abuzz with customer traffic. It has a strong perishables department. It was a brightly lit store with great fixtures, a little bit more weighted to the perimeter with less space devoted to the gondolas in the center of the store."

The store, Ziegler added, appeared to show that Wild Oats had realized it needs to serve both the committed devotees of natural and organic products as well as attract mainstream shoppers curious about trying alternatives.

"In the old days, I thought Wild Oats did not succeed because they were focused on the Birkenstocks-and-socks set," he said. "Whole Foods recognized that there was a whole demographic out there that wants to eat healthier, but it's not someone who necessarily wants to eat organic.

"Wild Oats now is coming back and saying maybe we were too focused on the Birkenstocks and socks. Whole Foods was right. We want to go broader into the market."

Broadening the market while continuing to serve the faithful, Malloy explained, is precisely what Wild Oats is trying to do in its new stores, which will be modeled after the Long Beach unit, and in its Fresh Look campaign, launched last year at 12 stores in Colorado and currently in almost half the chain's stores. The program, as explained by Odak in an October conference call, features more competitive pricing throughout the store, weekly advertising flyers highlighting sales items, and a consolidation of store banners from roughly a dozen to, at present, five.

"When we began our new marketing program," Malloy said, "our first goal was not to alienate our core customers, and we are retaining our most loyal customers. In addition, we are expanding our customer base, attracting the conventional customer. Not only are we attracting them, but we are getting a bigger share of their food purchases."

The pricing aspect of the program has been modified over the last year. Pricing, said Dunlap, "was an issue about 12 months ago. Based upon competitive pricing surveys, we felt that our pricing had gotten out of line relative to the competition. That spawned an adjustment of our prices in a number of areas as part of the Fresh Look campaign. We continue to monitor prices and survey our customers, and we found as we got into the fourth quarter that we had pushed the pricing pedal too much, so we readjusted our prices."

Both the Long Beach store and the Fresh Look program show how Wild Oats has been learning from the example of conventional supermarkets.

Explained Malloy, "We're going to stay true to the natural and organic category. At the same time, there are a lot of best practices that conventional stores have been using for quite a while that we certainly can put to good use here.

"We're rolling out a data warehouse, and we're starting to get some great information, not only about what's selling but where it's selling and what kind of customers are buying it.

"We've centralized our buying. We've centralized our marketing so we can be more consistent and leverage our business as a group of 100-plus stores rather than acting individually. Definitely, we're moving toward more consistency, more standardization."

The Long Beach store will be a template not only with its emphasis on perimeter items and modern fixtures, but also in its size. The store is a compact 26,000 square feet.

Commented Dunlap, "We're staying true to our beginnings. We're going to stay in smaller footprints, around the mid-20,000s in terms of selling square footage. We're going to stay with those smaller boxes because, in our opinion, [they] create more of an intimate shopping feel. There is a lot more customer interaction, which to us is a point of differentiation from other food retailers. Also, it gives us real-estate flexibility."

Analysts, however, noted that the small box not only differentiates Wild Oats from the general trend in conventional supermarkets but also from its principal natural/organic rival, Whole Foods, whose newest and most successful stores have been measuring close to 50,000 square feet.

"Whole Foods has shown the bigger the store, the better the improvement [in sales]," said Buyers.

Ziegler also said he was not yet sold on Wild Oats' small-box strategy. "Their idea is to do smaller stores, cluster them and go more densely into markets," he observed. "I need to really go out and see the company and see if that strategy makes sense, vs. the strategy that Whole Foods has, which is just to go to the right demographic and go for the primo location."

Van Winkle noted that Whole Foods has managed to build larger stores and maintain a "high-touch, high-service orientation. One of the things Whole Foods has done very successfully is keep their corporate culture while opening large-format supermarket stores."

Still, the analysts added that the natural/organic segment can probably accommodate two national contenders.

"I certainly think the category is large enough for both [Whole Foods and Wild Oats]," said Van Winkle. "Wild Oats has a very good business today at a 100-plus stores. To be really successful, they probably want good density in all their markets."

Ziegler noted, "I think Wild Oats is on to something. There's room for two players. I think Wild Oats' approach is significantly different from Whole Foods'. Probably both can make it work."