PriceSmart, Inc. (PSMT) Q3 2013 Earnings Report, Transcript and Summary

Good day and welcome to PriceSmart, Inc’s Earnings Release Conference Call for the Third Quarter of Fiscal Year 2013, the three-month period ending on May 31, 2013. All participants are currently in a listen-only mode. After remarks from Jose Luis Laparte, PriceSmart’s President and Chief Executive Officer; and John Heffner, PriceSmart’s Executive Vice President and Chief Financial Officer, you will be given an opportunity to ask questions as time permits. (Operator Instructions) As a reminder, this conference call is being recorded on Thursday July 11, 2013. A digital replay of this call will be available through Wednesday, July 31, 2013 by dialing 888-203-1112 for domestic callers or 719-457-0820 for international callers. The passcode is 9596291. I’d now like to turn the conference over to Mr. John Heffner. Please go ahead, sir.

Thank you and welcome to our Q3 call for fiscal year 2013. Jose Louis and I are conducting this call from Costa Rica and I hope the call quality is good. Q3 financial information was provided in our earnings press release and 10-Q filing which we released yesterday, July 10, 2013. You can find both the filing as well as the earnings press release on our website, www.pricesmart.com. Please note that the statements made during this call may contain forward-looking statements concerning the Company’s anticipated future plans, revenues, and related matters. These forward-looking statements include, but are not limited to, statements containing the words expect, believe, will, may, should, estimate and similar expressions. These statements are subject to risks and uncertainties that could cause actual results to differ materially, including the risks detailed in the Company’s Annual Report on Form 10-K for the fiscal year ended August 31, 2012 filed with the Securities and Exchange Commission on October 30, 2012. We assume no obligation and expressly disclaim any duty to update any forward-looking statement to reflect the occurrence of events or circumstances which may arise after the date of this call. Now, I’ll turn this over to Jose Luis Laparte, PriceSmart’s President and Chief Executive Officer.

Good morning to all of you and thank you for joining us in our conference call for the results of our third quarter of fiscal year 2013. Starting with sales for the quarter, we ended with $556 million in net warehouse sales resulting in 12.3% total for our growth as compared to this quarter last year. Comparable sales growth for the 13 weeks ending June 2nd was 9.2%. That compares of 9.2% compared with 9.3% in Q2 and 8.3% in Q1, giving us a comparable growth of 8.9% for the 39 week period of this fiscal year 2013. Latin American markets, which include Central America and Colombia, finished with 15.4% total growth, and the Caribbean region had a growth of 6.4% compared to the third quarter of fiscal year 2012. Latin America has a benefit of the two clubs, which we opened in Cali, Colombia. The Cali South location, which opened in October of 2012, therefore have sales for the whole third quarter and the Cali North location which opened at the beginning of May 2013 only the third month of third quarter. Later on I will talk more about these most recent opening. In the last two conference calls I have been making a reference about the fact that Latin American region reflects better economic conditions compared to some of the Caribbean countries. That statement is still valid, although – this last third quarter we saw the Caribbean region, which I now speak to 6.4 comp growth versus the 4.2% in the second quarter and 5.8% in the first quarter of this fiscal year. Hopefully this is a sign of some improvement in the underlying economic conditions. The third quarter in our countries, especially in the Latin America region, includes sales for the Easter season and the Semana Santa…

Thank you, Jose Luis. I hope you all have had a chance to access our earnings release and 10-Q, both of which were made available yesterday. Let me highlight a few items in our financial results specific to the third quarter, before we take your questions. Warehouse gross profit margin as a percent of net warehouse sales declined 55 basis points in the quarter compared to Q3 of last year at 14.4%. Sequentially merchandise margins have declined 30 basis points in Q1 to Q2 and then again in the current quarter. This planned reduction is consistent with the Company’s business model of lowering prices on merchandise as we leverage our operating expenses and thereby providing ongoing value to our members. The margin reduction is also consistent with our goal to ensure that our members receive increased value resulting from the increased membership fee. Warehouse club operations expenses for the quarter 8.9% of sales, a 31 basis points improvement in our expense rate in Q3 last year, despite the addition of expenses related to the two new Cali clubs, one of which was a only a partial quarter’s worth of expenses. (Indiscernible) cost factors showed leverage with increases in spending growing at a slower rate in the sales growth. In addition, we experienced a year-over-year of benefit resulting from a charge taken last year related to past debit card fees. Operating income grew 13% over the third quarter of last year to $28.7 million. As a percent of sales, operating income was 5.2% of sales. We experienced some year-over-year positive effect of higher interest income related to the level of cash deposits in some of our foreign subsidiaries. Currency devaluations, particularly in Honduras and Jamaica and Colombia, including hedging costs contributed to foreign exchange related losses of $785,000 in the quarter.…

(Operator Instructions) We will take our first question from David Strasser with Janney Capital Markets.

Thank you very much. I had a few questions. The first on the gross margin, it seems that this quarter you – although there is a bit of a change in strategy into get more aggressive on pricing, something I would have – I think makes a lot of sense, do you – I mean is that something that we should be modeling in going forward, sort of this the lower prices going forward and as you did that, were you able to see any pick up in sales or how do you think that would manifest itself on the sales line over time? Would it take some time – is there a lag to seeing that impact sales on a positive way or do you see it right away?

Yes. First of all, this is Jose Luis. We don’t provide any guidance, I guess on margins or I guess going forward. We don’t really want to set any different expectation. We do have – the only thing I will say is we react to whatever competition we have. If there is pressure in any specific market, we had a commitment with our members and that’s why you may probably see some variations from quarter-to-quarter on our margins, depending on which countries we make the changes or which countries we react to those margin, I guess conditions. That’s our goal at the end of the day to keep providing good value to the members. It’s hard to tell what we can expect going forward.

Because what – it seemed though at least from the verbiage in the Q that at least this time you were pretty – it was across the board of across categories and across geographies, is there any thought differential in thought process in sort of the way that, that was described in the – going after the – with the lower – with the more greater investment in price? Because it just seemed that you’re very adamant that it was – it seemed like a more strategic decision Company wide this quarter than it had been in the past, am I misreading that?

Well clearly – David this is – it’s our business model to continue to reduce prices, which has particularly as it relates to when we can leverage our operating expenses, which will have the margin percent impact. As it was also indicated in some of our past quarterly calls when asked about the membership fee increase that we’d expect to move that – some of that back into lower prices and lower margins as part of the whole value proposition for our members.

Okay. Actually you are in Costa Rica right now and I know that a year-ago or so, you had talked about Walmart opening a Sam’s Club site in Costa Rica. They weren’t as forthcoming about it. It seems that, since then, there is recently been sort of an environmental approval. As you're there, do you see any ground breaking or anything going on with that site that you had talked about a year-ago with respect to that Sam’s Club?

Yeah to our knowledge, there isn’t anything going on. Again, we don’t know anything and it seems that it’s pretty quiet down here from that perspective.

Okay.

And they haven’t announced anything officially. So, I’d say so far things continue as they were last year. There is still a [rumor], but that’s all we have [currently].

Rumors, I know them well. And one last question, on Colombia you sounded like you are moving along, you are not ready to give any guidance, but it did sound like you were moving along a bit on a couple of sites in Colombia, just the way you were talking at the beginning of the call. Am I reading too much into that, do you think or you seemed more optimistic than perhaps past calls?

No, I guess there was – we have always been optimistic David. It's a permitting process can be very complicated in all these countries. And we’d like to move a little faster sometimes, so it was subject to all the conditions that we need to meet on the permit process. So we’re pretty optimistic that just because of the fact that we believe there is a good opportunity and the fact that we’re not in some of the main cities like Bogota, Medellin, two examples. So hopefully very soon, we will be able to narrow those opportunities and realize some sites for those – for that country.

Thank you very much. Enjoy it down in Costa Rica.

Thank you, David. We’re excited.

We’ll take our next question from Dave King with Roth Capital.

Thanks, good morning guys. I guess my – sorry, good afternoon I guess okay. I guess my main questions have to do with the recent dollar appreciation versus some of the currencies you guys are exposed to and I know, John, you touched on it a little bit in your prepared remarks. But, I guess, I’m just trying to get a better understanding of, as we think about your [guided] long-term strategy of trying to keep warehouse club gross margins and say that 14% to 14.5% range and to keep prices low for your members, with the dollar appreciating and a good amount of your goods coming from the U.S., can you just walk me through how that affects your ability to keep prices low? Could you possibly have margins that are below target for a while in order to keep those prices for members or is it where you – just can’t keep the prices as low as you want and then arguably, that could incrementally hurt unit volumes? I guess, just help us better understand that if you can.

Well David, I will try to explain that. David, I will try to do update with that – with the devaluation so to speak, there is an impact as we see a devaluation in our prices it’s not a direct impact or it doesn’t happen the day after the devaluation because obviously we have the inventory and we don’t really adjust that inventory to a new pricing. But as we bring new merchandise obviously we have to, we make decisions on how to impact that and depending on how big the devaluation is, we’ll have to probably raise our prices. It happens fortunately or I guess everybody who imports merchandise will have the same effect. So I guess we’re all into this game of increasing sometimes the prices when we have that pressure of the devaluation, which is completely out of our control. But again it will depend, we don’t really have a target for all especially I guess it will vary by item depending how much inventory we own and what are the conditions for the items and we just try to do as best as we can. Maintain our price leadership among anything and that obviously continue to drive value with our members. Not we stay – sometimes the prices will go up even in those conditions. I don’t know if I – if you have anything else to add John on that.

No I think you covered that. I think the only comment I would make is that it – that can certainly impact demand maybe not so much as Jose Luis said. And from a competition standpoint, we’re probably subject to – our competitors were subject to some of that same activity, but it probably has – it could impact demand in some of those countries where those the prices are going up in local currency, but we could – that’s how we probably follow the economic conditions of that country.

Absolutely, okay, fair enough. And then, that’s extremely helpful guys. And then just kind of following up on David’s question, it sounds like some of that, then could be offset though based on the fact that you kind of lowered prices across the board recently. Is there a thought looking back in history at how long it takes to flow through when you kind of lower prices across the board, how long it takes to flow through into higher unit volumes or is it just kind of does it just vary?

It's really based, it depends on the – I guess the type of items once you start working on lowering prices. Our experience tells us that the members are very smart. They do recognize obviously they know the prices they pay especially on commodities or items like that, and I think it takes some time to get the volume on sales. But I really think that our members appreciate that we operate under that philosophy and I think after so many years operating in this market they do understand how we operate and they have the loyalty to our business knowing that we always try to do the best on keep our prices low. That will continue being our business philosophy and well probably not a lot of retailers have the same philosophy of trying to achieve where else they can reduce expenses to keep lowering the prices, but definitely keep that one and believe in that – either it will come through sales volume or more members joining our warehouse clubs or even increasing our membership renewal, as there are a lot of effects I think we don’t always see it on merchandise, hopefully we’ll see that also in better membership renewal, more I guess word of mouth getting out about our prices and having more members join our club. So I think its – low prices will give us good result in different lines of our business most of them.

Fantastic. All right. Thanks so much guys.

Thank you, Dave.

(Operator Instructions) We’ll go next to Ronald Bookbinder with the Benchmark Company.

Good morning and thank you for taking my question. Only, in the queue you talked about that the merchandise mix had a small positive impact on gross margin. Are people shifting to more discretionary items and do you expect that to continue?

I guess the comment there is – that I think we indicated that some of the hard lines and soft lines had a little bit of higher growth I think which had an impact on the margins. But the other thing is our amount of imported merchandise is up a little bit as a percent of the total and our U.S. that include all the imported things from U.S. which pretty much is consumable. So that our U.S. food and that sort of thing. So I think the combination of the different kinds of merchandise we’re bringing in had a small positive impact in the period compared to a year-ago.

Do you think that shows an improving economy especially in the Caribbean area as people are moving to more imported merchandise?

Yes, I'll say Ronald that there is definitely that. As soon as we see improvement in the economies – in the economies in the countries we get a little bit of shift I mean it’s not dramatic obviously because there is not anything driving – anything big driving those changes. But I would say that little by little people obviously; they probably look more at import or probably more discretionary items at the non-food items not as we get into these type of conditions. Hopefully, the improvement will continue in the Caribbean location and the Caribbean markets in general and we would be able to keep in those type of moves. But I am not sure there was a big shift, it's more of what John explained now as far as I guess even in our U.S. mix there is a good quantity of basic consumables knowing our mix from detergents to basic cereals and things like that, you know that people will still have the preference for those type of items, Ronald.

Ronald let me add one more thing, thanks for reading the 10-Q. I am glad you read it already.

Okay. Also in there, it talked about sales up 12.3% with hard lines and soft lines growing 16% and 15% respectively; what are the lines that are lagging and is there anything going on there causing that shift?

I wouldn’t say anything lagging, I just highlighted the one that are little higher than the average, I guess.

Yes, a little higher and I don’t think we have any specific concerns on categories, obviously we do a lot of those things are sometimes special programs that we do in certain categories that fortunately cause an impact for those two reflects a better performance in a specific quarter. We were pretty pleased in most of the categories or departments. I don’t think there is a special area where we’re concerned that we’re not driving increases. I think for the most part we’re seeing decent increases. There are some obviously that are important highlighted, I don’t think there is an area of concern in our business of categories that are lagging here and there we see sometimes a couple of departments that is troubled, but they’re probably not that significant in our total sales volume. So I'll say that I am not concerned on a specific department at this point, one that would be lagging or will not have any growth at all. Now fortunately everything seems to be pretty much growing at a similar pace and there are some obviously outliers out there, but other than that it's pretty good to see just consistent growth amongst different categories and departments in the countries.

And while a small export sales increased to a fair amount, is the retailer in the Philippines is he doing anything different or is it just lumpy?

He is ordering some more from us, so we have – so we must be doing some good things there. I don’t have a specific insight into their business other than what I see from what they order from us.

Okay. And lastly tax rate for 2014, is there anything that should be driving it up or down from this year?

In any given quarter we have some tax adjustments that impact the quarter’s rate, but all things being equal, the effective tax rates of our countries and the mix of taxable profits across our subsidiaries would suggest sort of a normalized rate of about 32%.

32%. Okay. Thank you very much and good luck going forward.

Thank you, Ronald.

We’ll take our next question from Jon Braatz with Kansas City Capital.

Good morning, John, Jose Luis.

Hello Jon.

Good morning.

Couple of questions, going back to gross margins; was the broad reduction of prices, was that effective for the full quarter?

Like on the first day that we changed all the price?

Well, I mean roughly, John.

I think it's a trend over time. I mean its always changing, it was changing during Q2, changing in the Q3. So I think it's a strategic direction we have as a Company.

Okay. Have you ever – has the Company ever taken such a broad – seen such a broad reduction in prices or it's been sort of a little bit here and there. Was this as broad as you’ve seen in the past?

No, I don’t think – I think it’s part of our business model. Jon, I don’t think we specifically drive that changes in a quarter or anything and we just keep trying to get the lower prices and any opportunity we see there by negotiating with vendors, lower costs or by improving our logistics costs or at any given time that we see an opportunity to keep lowering prices. It might even be duties some of these countries as we go through year after year where there are trade agreements, not every item went to zero tax or zero duty in – when trade agreements are in place, usually it takes up some – for some items it takes some time. I mean it may be an item that was at 20% goes down 5% on duty we get that 5% and we use it to lower prices. So, there are so many variables, so it's not a – it's not a strategy that we have in place. I guess as what – I guess we still have it in place in our basic business philosophy and that’s how we operate, it’s in our blood to keep trying to lower our margin front.

Okay. John, do you think we’ll continue to see from last couple of quarters that high rate of interest expense being capitalized?

To a degree that we continue to build clubs, the accounting rules allow us to capitalize interest expense. So it will be based upon the investments that we have going forward will drive that how much we will capitalize.

So for the two stores that you’re planning currently …

There will be some capital – yes, there will be some capital raised in those clubs that are under construction right now, the one we saw yesterday in – here in Costa Rica and the one that we will begin building in the new fiscal year for Honduras. So yes, we will see some capitalized interest for those clubs.

Do you think it would be as significant as it was this quarter?

I don’t have it right now.

Okay. All right, John. Thank you very much.

Thank you, Jon.

And it appears there are no further questions at this time.

Okay. Well, if that’s the case, then I would like to thank everyone for being on the call and I hope you all have a good day. Bye-bye.

Thank you.

And this does conclude today’s conference. We thank you for your participation.