PriceSmart, Inc. (PSMT) Q2 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. Welcome to PriceSmart, Inc’s Earnings Release Conference Call for the second quarter of fiscal year 2013, the three-month period ending on February 28, 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 Wednesday, April 10, 2013. A digital replay of this call will be available through Tuesday, April 30, 2013 by dialling 888-203-1112 for domestic callers, or 719-457-0820 for international callers. The passcode is 1318246. I would now like to turn the conference over to Mr. John Heffner. Please go ahead, sir.

Thank you, Lisa, and welcome to our Q2 earnings call for fiscal year 2013. I hope you'll find this to be a useful forum to review the information that we provided in our earnings press release and 10-Q filing which we released yesterday, April 9, 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 will turn this over to Jose Luis Laparte, PriceSmart’s President and Chief Executive Officer.

Thank you, John. Good morning to all of you and thank you for joining us in our conference call for the results of our second quarter of fiscal year 2013. Starting with sales for the quarter, we ended with $592 million in net warehouse sales resulting in a 10.1% total growth versus last year. Comparable sales growth for the 13 weeks ending March 3 was 9.3%. Latin American markets, which include Central America and Colombia, finished with a 13.2% total growth, and the Caribbean region had a growth of 4.2%. No question that as I explained on other calls, the more diversified and larger Latin American markets reflect better economic conditions compared to some of the Canadian countries. In addition, Latin America had the benefit of three months of sales from the opening of our new Cali, Colombia warehouse club which opened on October 19, 2012, and the sales figures are part of the whole second quarter. The second quarter of this year in the countries where we have presence is an important quarter for two reasons. First, obviously December is one of the months of this quarter and we were very pleased with the performance we had in our seasonal department which include not only the food departments but also a lot of the non-food departments. Second, the months of January and February are transition months to new seasons of business in the different countries, from carnival celebrations that occur in some Caribbean countries and Barranquilla, Colombia and also (indiscernible) celebrations that happened to be at the end of March this year, but a lot of momentum for those sales starts in the first two months of the calendar year. We are very pleased to see that the sales on the different seasonal territories for those important events were…

Thank you, Jose Luis. I hope you've all 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 second quarter before we take your questions. Let me begin by reminding you the change we made last quarter in Q1 with respect to product demonstrations which occur in our warehouse clubs. Prior to Q1, we attributed the cash consideration received from vendors for these product demonstrations as other income in our P&L which flows to total revenues. The expenses associated with these demos were in our cost of goods sold and warehouse operating expenses. Beginning in Q1, and containing this quarter and beyond, we have reclassified that income, reduced by the associated expenses, as a reduction in cost of sales. This had the effect of reducing other income and total revenue by $1.1 million to $1.3 million on a quarterly basis and increased warehouse gross profit margin as a percent of sales by 10 to 13 basis points. It also reduced warehouse operations expenses as a percentage of sales by 11 to 17 basis points. There is no impact on operating income or net income from this change. Prior periods have been adjusted to reflect this with a full disclosure of the change in our 10-Q. I mentioned this again as a reminder as it may impact some of the comparisons you may have as you analyze our results.. Jose Luis has already talked about warehouse sales and membership but I wanted to add one item with respect to the growth in membership income which we recognized in the quarter. Membership income grew 30% from Q2 of last year. While much of that is indeed driven by the growth in accounts…

Thank you. (Operator Instructions) Our first question today will come from Dave King, Roth Capital. David King – Roth Capital: I guess first off, your excellent sales were very strong this quarter, can you talk about the relationship you have with that retailer in the Philippines and how it's been trending and how we should think about that revenue line item going forward?

Dave, so the only relation we have is a sales relation. In the past, those used to be our warehouse clubs, they are now owned and operated completely by this group, and the only thing we do is provide them with I guess warehouse club type merchandise, and it is a growing business. In the last couple of years, they have opened additional warehouses and I'm not sure we can determine how much more that is going to grow because we don't really have any control on their future as far as how many locations and how they are doing on sales. So far, our feeling is that they are definitely doing good because we keep increasing our exports to that market, but that's as much control as we really have on those export sales.

I would add, Jose Luis and Dave, the margin we get on this business is fairly low, about 5%. So while it might have an impact on our total revenue line, as a company it doesn't have much impact on our income or profits.

That's correct.

I think just in terms of strategically, it does probably help us leverage some costs with our suppliers probably, so that is the hidden delta in this offering. David King – Roth Capital: Okay, that's helpful. Then, it looks [in total] (ph) the renewal rate dropped a little bit again this quarter but not as much as last quarter, and then as we think about this as a 12 month number, is it fair to assume then that we're seeing sort of a bottoming in that case of renewals after the fee increase you guys had a while back or how should we think about that now?

I think as Jose Luis mentioned, (indiscernible) is I think we tend to see the reduction in our renewal rates really in those markets that are having some economic struggles, and I would sort of highlight the Jamaica, Aruba, Honduras, and it was due to some difficulties either political or economic, and I think we're seeing that in our renewal rates. In some of our larger markets in Central America, we're seeing renewal rates of 87%, 88% even today. So it's a bit of a mixture. So attributing it to the $5 membership increase, while that might have had some impact, I think we see it correlate more towards some of the economic conditions in some of our specific markets.

Next up we'll hear from Greg Garner, Singular Research.

Thank you and nice quarter, gentleman. A question on the comment about the same four-week comparison on the comp sales for the four weeks leading up to Easter this year versus last year, as I remember last year, Easter was early April, so essentially I just want to make sure I understand this correctly, are you saying the four weeks last year leading up to that early April versus the four weeks in this year early April or this year in March were up 8.6%? I'm just trying to make sure I understand that.

Sure. It was the four weeks ending on whatever Easter Sunday was. So, actually if you take the four-week period that ended on Easter Sunday last year and the four-week period that ended on Easter Sunday this year, this year happened to be March 31, which was the four-week comp period that we were using, then you get that comparison. It was just to I think underscore the fact that there's some question always as to the timing of Easter could impact these things, it didn't impact necessarily much is I think the bottom line.

And another clarification question on your membership growth explanation, being up 30% overall and 6% was related to adjustments to last year's data, is there anything you can tell us about what was the amount of the membership increase, is it totally attributed just to the price change of the membership fee?

I think Jose Luis mentioned, the increase in membership accounts was 14%.

Yes, it's 12%.

12%, I think if you average it, because membership income – I think a 12% point-to-point from February 28 or 29 last year to 28th this year, but since membership income is sort of a rolling number, if you look at the average membership over this 12 month period, it's 14%. So I guess you can (indiscernible) to be about 10% membership fee increase on average.

Okay, I just wanted to make sure my numbers were right in doing that. And I guess might be for more Jose or perhaps you John, so the Colombia store opening here, I mean this amounts to be two in this fiscal year and then it appears if you're on line to open up two next year, I mean this is a great ongoing opening program here, store opening program. But the next two next year not have to do with Colombia, so I'm just wondering, is it difficult to find that next location in Colombia, and if perhaps you were to find it in the next whatever few months or so, would it be – do you have resources to actually put a third store in the next fiscal year, fiscal year '14, or would that have to be pushed out to '15?

Let me tell you, Greg, I guess we didn't highlighted it this time, but I believe we mentioned it in the last earnings call or two earnings calls ago that it has been a challenge definitely to find the good sites in Colombia. That doesn't mean obviously we are not going to find them. We definitely believe there is an opportunity to find the appropriate sites for us in the major cities where we don't have presence yet. So we are working very hard on doing that. And as far as the resources, I don't see any reason. Probably the biggest challenge once you find the site, sometimes in these bigger cities, Greg, is the fact that you have to go through permitting and very complicated and slow permitting process. It's hard to say if we will be able to open something in 2013. If we find a site and the permitting process goes well, we don't have anything else that will limit, I mean we have the people, we have the construction, resources, we have everything that we need to put in place to open as fast as we can, but it will definitely depend on how soon we close on a site and how soon we get the permitting to get that construction up and running. That as I mentioned in Colombia, obviously the major cities, (indiscernible), Menga, where we know members are asking for PriceSmart, definitely will be the priority, so they are the priorities for us now.

(Operator Instructions) Next is Jon Braatz with Kansas City Capital.

Quick question, obviously your operating philosophy is to pass the savings on to the customer and you've been able to leverage your operating expenses very nicely in the quarter and the last couple of quarters, do you see that being passed on and for that operating leverage ratio to rise again, how do you look at that?

Jon, definitely we have been experiencing good operating expense leverage, that combined with good membership income obviously provides the opportunity to reduce prices and warehouse margins consistent obviously with our business model. Now as much as we can keep this kind of a cycle, as much as we can keep reducing our costs and obviously growing in membership income, we're going to continue reducing prices and get much more competitive out there in the market. That's the secret of this business of warehouse clubs.

John, are you still – on the platinum card, are you still fully accruing what is that $500 rebate or something like that?

We do for any purchases made by a platinum member, and this excludes some merchandise that they don't get it on liquor and taco, but for other items, we set aside 2% of the sales or reduce our sales by 2% and up to a maximum of $500 on an annual basis for that member. So our sales are impacted as a result of that.

So you're fully accruing it?

Absolutely, no penalty.

Alright, when do you think you might review it? I assume it doesn't have much of an impact at all at this point, but when would you review that?

Review that in what sense, Jon?

Well, I guess they would fully take advantage of that 2% rebate?

Right, so you're reducing the price by 2% for those.

Okay. And then lastly, the membership rolls in the South Cali store, I know it's not opened yet but you're taking memberships, are they sort of tracking consistent with what you saw in North Cali?

Yes, definitely. It gets a little bit tricky because we already have members from the north that are shopping in the south because it's been open for a while, but as we have seen…

Because that is open, Jon, just to be clear. It's not that's opened in the north and we're opening now.

Okay, I'm sorry.

But again a lot of the members from that north are already shopping in the south location, and in the last two weeks, obviously we have seen that growth in the membership sign-ups in the north location and obviously the key is the next three weeks. So, so far we feel that it is going to probably behave very familiar to the club in the south. The acceptance in the city of Cali has been very good for our concept and we have done that drive and it's probably 40, 45 minutes driving sometimes from one point to the other of the city. So we believe there is very good separation and the demographics are as good in both parts of the city. So we don't have any reason to not to believe that the performance is going to be as good in the north as it has been in the south of the city.

(Operator Instructions) Our next question is from David Strasser with Janney Capital Markets.

I have two clarifications and one question if you don't mind. First, on March, when you see the pattern of sales, if I'm not mistaken, you're closed on Easter Sunday, and you would see sort of a lift heading into Easter Sunday and that a lot of that kind of is given back when you're talking about the shift by being closed in this month versus last, versus April?

Let me comment on that. There's actually one day – one of the only two days of the year that all of our warehouse clubs are closed, and that's Good Friday.

Good Friday, yes, not Easter Sunday.

No, we are open, the clubs are open on Easter Sunday. And so when we looked at this comp period which is offset by one week, what we're looking at is ending a four-week comp period on Easter Sunday but that included a closed day on Friday, and the year before, that Friday and that weekend before (indiscernible) is a pretty big weekend. So, now that gets offset when you go this year because – so we decided to, since we always have these conversations about Easter, are usually a little further apart than one week, we say it was only one week apart, let's see if we can normalize it and see if it's different, and the result as we indicated is not significant in aligning for the weeks.

I just wanted to make sure I understood it, okay, thank you. And then when you look at, sort of when you talk about the weaker markets, the ones that have the lower renewal rates, I don't think you have raised prices everywhere, are the weaker markets you talked about, and those the ones that happen to actually seeing the price increase as well?

We did raise them in Honduras, we did in Aruba, and we did in Jamaica. So there was an increase in those markets. It's probably just a perfect storm in some of those markets. We don't really think the $5 increase is (indiscernible) discourage a lot of members to renew, but when you put that together with the economic, it's hard to tell if the reason they are not renewing is because they don't want to pay the $5 or just because the economic conditions are very rough in some of these markets and there's so much we can do with that. Now we keep obviously trying to be the best price leader out there in those markets to become even a better player. We know that in difficult situations the club business is actually one of the best form (indiscernible) when people are looking at saving money that's the place where they want to go. So sooner or later, we believe there is going to be some recovery in these markets and we're going to be there well-positioned to continue serving those members.

One other question, I mean a little bit about distribution in Colombia, you guys look to probably move anywhere, or move inland and add more quality, so at what point do you feel the need to build a lot of distribution centers? And also with the cost of infrastructure that you essentially built today, how many clubs do you think you could work off with the current infrastructure before there's any more CapEx?

First on distribution, I will say that we're already starting that, David, we are trying to determine obviously where is the best place in the future to try to look at our distribution center in this country. It is a little bit more complex than other countries for sure, it's a much, much bigger country, and we're just at the beginning of making some studies to really determine where is it that you put in and what's the impact that we'll have in the whole operation of Colombia. So far, before the Cali and Barranquilla locations, we are working very well with the (indiscernible) on the Pacific Ocean. So those things are well under control right now but we definitely are looking at what we can do to improve our logistics in that country. We do have already some experience on things we are doing in other countries, in Costa Rica, in Panama, where we have more locations where we are already integrating some of that format of let's call them kind of regional distribution centers that help obviously serve those countries where we're having incremental volume in just one country. I'm not sure I follow the second question, can you repeat that one again, David?

Yes, I'll try to be a little clear this time too. So, with the infrastructure that you have built in Colombia, how many clubs you thank that could serve before you probably need to have some more CapEx or just some more costs to kind of rebuild or increase the infrastructure in the country? So basically how many clubs before there's another big spending on infrastructure in the country?

Since day one, we setup an infrastructure in Colombia to support obviously the size of the country. So we don't really see a lot of additional expenses I guess once we have locations. We feel obviously a little here or there probably adjustments that we will have to do, Colombia is very regulated, and we actually have been doing already some of the adjustments. We started probably even a little later following the concept or the format of other countries and as we have been operating in Barranquilla and Cali, we have learned that there's been, since there are more regulations, we have been adding a little here or little there, but again we don't think it's going to have a huge impact on our expenses in that country.

So the growth on the expense side should be pretty leverageable as you grow, just add more warehouses out there?

That's correct, yes, no question.

Next we'll go to a follow-up from David King. David King – Roth Capital: Just a couple of quick ones actually on mind. I guess Jose Luis, you talked a bit about e-commerce becoming more important (indiscernible), can you talk about some initiatives you have planned along those lines or what specifically you're looking at doing that's different on the e-commerce side as you move forward?

Well, it's kind of R&D area in e-commerce for us now. Obviously we have been operating with e-commerce for more than three years, we started in Costa Rica a couple of years ago or almost three years ago, and we are pleased with the results. I think there's a lot that still needs to happen in the areas of e-commerce for our business and even for the countries where we make business to get more used to using e-commerce. One of the challenges we have been, our retailer, that street merchandise from the U.S., one of the challenges for sure is delivery times. We're trying to look at different ways to reduce the delivery time so that the members don't have to wait two or three weeks before they get their merchandise. So that's one challenge that we recognize on our e-commerce business. The other challenge, believe it or not, there is still a lot of, in some of the cultures where we're operating, there's still a lot of fear of providing the credit card information and things like that. So we're looking at different ways to make sure that the members have the confidence to provide, to make e-commerce purchases. I think that's going to get better also as e-commerce starts growing or Internet business starts growing in all the different countries, but in a few countries, it has been a challenge. Now we even have members that go to the club and make a transaction and order there in presence, we have a kiosk in some of our buildings and some members rather go and make the transaction right there in the club so that they kind of keep contact of their credit card information, it's just cultural challenges. Other than that, it's just a matter of obviously…

I think if you look seasonally at the last year, probably last two years, we do probably 26% to 27% of our sales in the second quarter. So that certainly has a impact on the leverage for our operating expenses and we get the benefits of those operating margin when we get that. So I think it will be consistent with what we've seen in the past years. It's just the nature of the way our sales flow I think and how our operating expenses that we add to that. David King – Roth Capital: Okay, so is it fair to still kind of assume kind of high 5s range on operating margin over the course of the year or is it going to come down a little bit from there?

We don't provide guidance as you know, so I will leave that one with you. David King – Roth Capital: Sounds good. And then I wanted to be careful to not go into guidance I guess maybe on the tax rate last question, I think you talked in the past about a 32% or 33% rate just kind of generally, but I know you've had (indiscernible) sales factor achieving the recognition methodology, some of those kinds of things that has helped to benefit in recent quarters, so is it still fair to assume kind of 32% to 33% rate or do you think it's closer to 30% or below or how should we think about that?

Well, I think it's going to be below 30% sort of (indiscernible) generally. As our profits grow, our profits tend to grow more outside the U.S. and in the U.S. just by nature of how the Company is set up and our foreign subsidiaries have generally lower tax rates in the U.S. So I think there's probably, 29.5% we had this period, I wouldn't want to suggest that that's what's our new reality is, we're probably in the 31% to 32% going forward, I would guess. David King – Roth Capital: Fantastic.

Next we have a question from [Scott walker] (ph), an investor.

I was wondering if you could comment generally about other warehouse club competitors in your market area, specifically Colombia market, are they there, are they coming?

There is not another warehouse club competitor, Scott, in the same, with the same nature of our business. (indiscernible) we're the only warehouse club in that country that charges a membership fee. There is a concept called [Macro] (ph) but they don't have a membership fee and they probably have a different business model, they carry much more local merchandise, they don't have a lot of selection in imported merchandise. So I don't think there is a direct competitor. There are very good retailers in Colombia. Part of group casino, (indiscernible), has a lot of presence with hypermarkets and smaller markets, smaller supermarkets, (indiscernible) was just sold to a Chilean company and they are operating there in more than 90 hypermarkets also in that area. So there are a lot of hypermarket competitors in that area with department stores but there is not a club competitor in Colombia and the same applies for Central America. There isn't just any other club competitors, except for Guatemala where there is (indiscernible) which is an initiative from Wal-Mart that has been around for probably more than 10 years also in Guatemala and we operate in that market, we compete with them in that market, that's the only one where we know. And the last one will be in the Caribbean in terms of warehouse clubs, there is a similar concept with no membership also, that this (indiscernible) is the company owned by a Canadian company and they operate in two markets, in Barbados and Saint Thomas. We got similar concept in terms of the warehouse club but they don't have a membership and they don't have the same selection that we carry. So there's not really right now that we see a direct club competitor.

I was just thinking if there is opportunities if there were any with the site selection being the big challenge looking at some of these existing companies and see if they would be potential acquisitions, and if they had good sites already, in essence you were buying the site and change the format to match what you're doing but if you got the infrastructure in place to support more than like your three stores in Colombia, the faster you get to 10 stores the better?

That's a good suggestion but we haven't found anyone like that yet.

Got you, thank you.

Someone where we can just find good sites is not there yet, no.

If it was easy, everybody would do it, right?

Absolutely.

Everyone at this time, there are no further questions. I'll turn the call back to Mr. Heffner for any additional or closing remarks.

Well, I don't really have any closing remarks, so I will leave it with, thanking you Lisa for your help on our call and thank you all for participating with us today.

Thank you, everyone. Thank you, Lisa.

Thank you. Ladies and gentlemen, that does conclude today's conference. Thank you all for your participation and have a great day.