PriceSmart, Inc.
Q4 2012 Earnings Call Transcript

Published: 31 Oct 2012

[Operator:]

Good day and welcome to PriceSmart Incorporated Earnings Release Conference Call for the Fourth Quarter and Full Year of Fiscal Year 2012, The Three and 12-Month Period Ending On August 31, 2012. All participants are currently in a listen-only mode. After remarks from Jose 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, if time permits. (Operator Instructions) As a reminder, this conference call is being recorded on Wednesday, October 31, 2012. A digital replay of this call will be available through Friday, November 30, 2012 by dialing 888-203-1112 for domestic callers or 719-457-0820 for international callers. The pass code is 7308094. I would now like to turn the conference over to John Heffner. Please go ahead, sir.

[John Heffner:]

Thank you and welcome to our Q4 and full year 2012 earnings call. I hope you will find this to be a useful forum to review the information that we provided in our earnings press release and 10-K filing, which we released yesterday, October 30, 2012. You can find both the filing as well as the earnings press release on our website, www.pricesmart.com. Please note that 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 statements 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 Laparte, PriceSmart’s President and Chief Executive Officer.

[Jose Laparte:]

Good morning to everyone and thank you for joining us in our conference call for the fourth quarter and fiscal year 2012 results. We here at PriceSmart have been closely following the events of Hurricane Sandy and the impact that it has had on the northeast. We hope that all of your families and friends who may have been affected by this storm are well and we would like to send our sincere best wishes for a speedy recovery from the event. Let me begin with warehouse sales for the fourth quarter. We did $499 million resulting in a 14.4% total sales growth versus last year. In terms of comparable warehouse sales, the growth for the quarter was 10.1%. Comparable sales exclude the Barranquilla Colombia club. The Latin America region show a better performance with 11.7% comp and the Caribbean finished with a 7% comp. These have been – it has been a trend for a few quarters, which we believe reflects the larger and more diversified economics of the Latin American countries compared to the Caribbean. The comp sales growth in this last fourth quarter are about 10% is lower than the 13% on Q3, 17% on Q2 or 19% on Q1. We attribute that to general economic conditions in some markets that may be causing a reduction in the growth of consumer spending. In addition, we also believe it is harder to keep growing consistently double digit growth in some clubs year after year. Even with that growth we feel it is a good reflection of a growing business in competitive and challenging environment. Membership accounts in the fourth quarter increased 16% driven by strong new membership sign-ups in Barranquilla Colombia and our 12 month renewal rate at 88%. I would like now to spend a few minutes with some of the highlights for the fiscal year 2012 that we ended on August 31 2012. As a company we are pleased to report that we accomplished a milestone with our sales results of $2 billion. It was only four years ago in fiscal year 2008 that we passed the $1 billion milestone and now in 2012 we were able to double that number of sales. Back in 2008, our average sales per club was $40 million and this past fiscal year the average sales per club is at $68.9 million. That accomplishment has been possible with good merchandise, with growth in our member base that year after year gives us their vote of confidence either by signing up as a new member or renewing every year. And last but not least, the hard work of our team in the offices, distribution centers and warehouse clubs. In terms of membership, we finished the year with more than 965,000 accounts and membership income of $27 million, an increase of 18% compared to fiscal year 2011. During the fourth quarter, on June 1, we raised our membership fee in 10 of our countries after eight years of not adjustment in fees. In U.S. dollars, we moved it from $30 to $35. As a reminder to all of you on the call, the annual membership fees are a fundamental part of our business model and are applied to margin as a way of reducing prices on merchandise. In other words, our goal is to channel the fee increase back into lowering prices. We don’t believe that the fee increase has had an identifiable impact on our renewal rates at this point. Our members appreciate and recognize our efforts to bring them good value, savings, and quality on our merchandise and we work very hard every day to earn this business and loyalty. We ended fiscal year 2012 with operating income of $107.9 million, an increase of 21.9% from prior year. Net income for the year was $67.6 million or $2.24 per share compared to $61.8 million or $2.07 per share the year before. Now, fiscal year 2013 has started and we have been very busy. On October 19, 2012, we opened our second warehouse club in Colombia, in the south parts of the City of Cali, in an area called Cañasgordas. The initial results of that club are encouraging and indicate to us that the warehouse club model is being accepted in this city just as it was in Barranquilla where we recently completed our first year of operation with good results. In the same city of Cali, but in the North, we plan to open our third club in the country in the spring of 2013. Construction is well underway and we’re making good progress to have this new club ready in that area. Another important event to highlight for this fiscal year is that tomorrow, November 1, we will launch for the very first time a new type of membership in our Costa Rica market. This will be called the Platinum membership. Our new Platinum membership is a $75 annual membership card compared with our current $35 card for our business and Diamond members. Platinum members will earn a 2% rebate on their purchases with a maximum annual rebate of $500. Similar to Costco’s Executive Membership, Platinum membership will provide more savings to PriceSmart’s highest volume members, thereby building greater member loyalty and hopefully incentivizing these members to increase their purchases. Combined with our co-branded PriceSmart credit card rewards program that offers a 2% rebate on PriceSmart credit card purchases, our members in Costa Rica will now have the opportunity to earn up to 4% rebate on their purchases. At this time, we’re limiting the Platinum membership to our Costa Rica market in order to assess the effectiveness of this membership category before introducing it to our other markets. Just to finish, we are looking forward to the holiday season. Our clubs are ready for what we expect to be a busy holiday season and our buyers did a good job on finding a lot of exciting merchandise to be able to serve the needs of our members in all the different countries. Thanks again for joining us today. And before we take your questions, let me turn things back to John Heffner for a few additional comments about the financial results.

[John Heffner:]

Thank you, Jose Luis. You all have the numbers from our release and filing yesterday. So, I will not go over them in detail. However, I would like to highlight a few items in our financial results specific to the fourth quarter. Warehouse gross profit margins were up from Q4 of last year by 67 basis points and up sequentially from the third quarter by 44 basis points. We realized efficiencies in our distribution of imported merchandise in the period and we also benefited from vendor rebates and promotional income, which we apply as a reduction to cost of sales. As you know, our general practice is to utilize cost reductions to lower prices and these results provide a good opportunity for us to do so going forward. For the full-year, warehouse gross profit margins were 16 basis points below fiscal year 2011 about a third of that decrease related to incremental importation costs for merchandise in our first six months of operation in Colombia. We did not experience any similar issue with the importation of merchandise for our new Cali club. Warehouse club operations expenses for the quarter were 9.48% of sales, a 52 basis point improvement from Q4 of last year. Nearly all of that reduction can be attributed to a $2.3 million depreciation charge we took in Q4 of last year to correct an error to accumulated depreciation for warehouse clubs in certain countries. The cost associated with our country headquarters, related to our Colombia expansion continue to have an impact on the company’s total warehouse club operations cost as a percent of sales by about 20 basis points, but this has improved somewhat with the sales we now have in Barranquilla and will continue to do so through the year with the new warehouse club in Cali that we opened on October 19 and with the addition of Colombia club planned for opening later this fiscal year. Operating income grew $10.2 million over the fourth quarter of last year to $26.9 million. Operating profit grew 57% and net income grew 40%. Two items of note, currency, which we no longer report in gross margin, but in other income and expense, had a small impact in the quarter than in the recent past, and we recorded a net gain in the fourth quarter of $210,000. However, this is $953,000 less than the benefit we took in the fourth quarter of last year. In Q4 of last fiscal year, we recorded a one-time tax benefit of $3.1 million reducing the effective tax rate in that period to below 30%. In the current period, we have a more normalized tax rate of 34% resulting in a tax provision increase year over year of $4.1 million in the quarter. From a balance sheet perspective, we ended the quarter with $91 million in consolidated cash and equivalents. Inventory ended the year at $201 million and is expected to grow through the quarter in advance of the holidays. For the fiscal year, we generated $89 million in cash from operations and have used $53 million for capital additions including land purchases, mostly in Colombia, and we made two $9 million dividend payments, one at the end of February and the other on October 31. With that, Jose Luis and I would be happy to take your questions. Operator?

[Operator:]

Thank you. (Operator Instructions). We’ll go first to Dave King with ROTH Capital.

[Dave King:]

Thanks, good morning, guys. I guess first off on the gross margin this quarter, can you maybe provide some color around how those different things that you cited, John, benefited the gross margin this quarter in terms of basis points between distribution efficiencies and rebates, et cetera?

[John Heffner:]

Dave, no I’m not going to break down the pieces of it. Those are, I don’t have that information here and I don’t want to go into that level of detail, but I guess rest assured that the company is always reducing prices to provide value to our members. And in the current period, we did get some cost benefits in a couple of areas some as I mentioned distribution efficiencies, we did see some good end cap and promotional activities from our vendors. I think our strategy – so we got the benefit in Q4 – our strategy is to push those benefits and lower prices and I would expect to do that as we go forward.

[Dave King:]

Okay. So I guess what I’m really trying to get out is just how we should think about the gross margin on a go-forward basis. And just how different it will be from kind of the fourth quarter number as you look out maybe over the next couple of quarters and specifically around....

[John Heffner:]

I think generally speaking over the last few quarters our margins are sort of in the 14%, mid-14%, I think that’s sort of target margins that we operate to. And we got some benefits here in this fourth quarter, but our approach is to operate in what I think you’ve seen in recent past quarters.

[Dave King:]

Okay, that’s helpful. And then it sounds like the results or the initial results out of South Cali are really encouraging. Maybe could you help us put that in context versus if I remember Barranquilla just kind of knocks the cover off the ball in terms of productivity right at the outset. Is that, should we expect the kind of same thing out of this store, is it any different than that? Maybe you could just compare and contrast at least based on everything you’ve seen early on today.

[Jose Laparte:]

Yes, Dave, this is Jose Luis. And that, yes, well obviously we are happy with the opening of Cali. We do not provide individual warehouse club information, but we hope to continue seeing positive results in this second club in Colombia. Definitely, we are encouraged with the first two weeks, as I mentioned in my comments, and probably the results are very similar to what we saw in Barranquilla to start. So we are definitely up for a good start and we feel very positive about the acceptance of our warehouse club concept in a new city now like this one, Cali. And obviously you all know we are ready for spring 2013 to open the one in the north. Cali is a big city and we believe there is market for those two warehouses. We don’t have anything else on the – I guess announced as far as other openings right now in Colombia although being a big country we have always said that there is a good opportunity for multiple club locations in a country with 40 million to 45 million people.

[Dave King:]

Absolutely. All right. Thanks so much.

[Jose Laparte:]

Thank you, Dave.

[Operator:]

We’ll go next to David Strasser with Janney Capital Markets.

[David Strasser:]

Thank you very much. I appreciate it. I just wanted to touch base on the renewal rates. You said that they have been – that the price increase didn’t really impact them at all. I guess it dropped a little bit, but I just want to make sure I understand it because, you said 12 months renewal rates had dropped from 89% to 88%, would that mean now that the average or the most recent quarter would be lower than that would be mid-80%s, if the math is right or am I thinking about that correct?

[John Heffner:]

I am not sure we do it that way. It is a 12-month renewal rate, David, and you’re right 88% is where we ended. The comment about the fee increase is we’ve – we didn’t increase the fee in every market. As we mentioned it was I think 10 markets?

[Jose Laparte:]

10 markets.

[John Heffner:]

And so it wasn’t in every location and we’ve done a study to see that the renewal rate has a different profile in those markets where we did raise the fee versus the one’s we didn’t and we didn’t see a distinction on that basis. So that was the basis for that. So the 88% is our renewal rate and I’m not sure I can do the – I’m not sure the math you used refer to holds.

[David Strasser:]

All right. So basically what you’re just basically saying now is that, you saw that the price went up and you didn’t really see anything that changed renewal rate-wise from consumers?

[John Heffner:]

Not enough. We’ve been in it for three months now, so, yes.

[David Strasser:]

Fair enough. Okay, that’s cool. I appreciate it. Thank you.

[John Heffner:]

Okay.

[Operator:]

We will go next to Ronald Bookbinder with The Benchmark Company.

[Ron Bookbinder:]

Good afternoon and congratulations on another quarter of strong execution. On the gross margin, you just had one quarter of these great distribution efficiencies and then the rebates. Why not hold on to that before you pass it on to the consumers to make sure that it’s a trend and it’s not any sort of one-time event?

[John Heffner:]

Sorry not our model, Ron, as we operate at some target margins and as we get those efficiencies, we’ll pass them through the lower prices.

[Jose Laparte:]

Yes, that’s just the concept of the business model. We keep looking at opportunities of lowering our prices and distribution is a big piece and we will continue looking for efficiencies on distribution and, as we find them, obviously we want to be more competitive, we want to keep lowering our prices and as a result of that we hope we will see increase on sales. And it’s just the cycle that we have in this business model now for the warehouse clubs.

[Ron Bookbinder:]

So, in other words, you are confident that these distribution efficiencies will carry forward and then the rebates?

[John Heffner:]

Yes, we would expect them to.

[Ron Bookbinder:]

Okay. On SG&A you talked last quarter about that your payroll cost had been running higher than you’ve liked and you were looking to control a lot of SG&A costs a little bit better and getting some leverage on SG&A. How is that proceeding?

[John Heffner:]

Well, it’s certainly our plans and it’s a big focus of the company to do that. Our operators are very focused in that area in how they operate the warehouse clubs and our plan going forward is to be on track with the type of leverage that this business can generate and should generate. So I would say we are on track with our plans to see leverage going forward, but we’ll see as the results go forward.

[Ron Bookbinder:]

Okay, and just lastly one more on SG&A. How much SG&A is involved in a store opening – SG&A expense that is involved in the store opening, and that you are still planning three store openings this year versus zero last year?

[John Heffner:]

Well, I think the specific question might be, we do have preopening expenses, which we incur before a store opens, and that is the initial hiring of the people and training. It could include the membership activity that we do before a club opens. And some marketing activity potentially in a new area like in Cali. I think in our most recent quarter, or in the fourth quarter, which would have contained a fair amount – or certainly some fair amount of spending associated with Cali, we spent about $360,000 probably some more of that we would spend in the Q1 before we opened on October 19. So I think for Barranquilla, as I recall, it was something in the neighborhood of $700,000 or something like that for...

[Jose Laparte:]

That’s correct. You can think that $750,000 for preopening expenses in the new warehouse club.

[John Heffner:]

Right. But then once it opens, the expense of operating the warehouse club should be similar to the expense we see in other warehouse clubs.

[Ron Bookbinder:]

Okay. And you are still planning three store openings this year versus zero last year?

[John Heffner:]

Well, we just opened Cali South. Then..

[Jose Laparte:]

We will open Cali North. And that’s pretty much the other opening we have announced. In the past that we enter an agreement for another site in Costa Rica, but we don’t necessarily see that being completed as an opening in this fiscal year 2013, nowhere. We haven’t started construction, we’ve haven’t finalized the deal. So we just entered into an agreement and we’re working on the due diligence at this point.

[Ron Bookbinder:]

Okay. So Costa Rica actually might fall into the Q1 of next year, is that what you’re saying?

[Jose Laparte:]

Yes, that’s correct.

[John Heffner:]

Yes.

[Jose Laparte:]

Yes. More like it, yes.

[Ron Bookbinder:]

Okay, thank you very much and congratulations once again.

[Jose Laparte:]

Thank you.

[Operator:]

We will go next to Jon Braatz with Kansas City Capital.

[Jon Braatz:]

Good morning, gentlemen.

[Jose Laparte:]

Hi, Jon.

[Jon Braatz:]

Jose, you mentioned in your prepared remarks about sort of a general softening of economic conditions in a couple markets where it might be challenging to sustain your historical growth rates. And you also mentioned that in the 10-K. I guess my question is, how pervasive do you see the “softness” and maybe how many of your markets might be a little bit more challenged in terms of keeping those growth rates in the upper – I mean in the double-digit area? Can you give us a little color on that?

[Jose Laparte:]

Yes, well, I would say that probably the Caribbean is particularly one of the markets where we have been seen more I guess economic issues. I will say that in general the Central America region is a lot more stronger or at least it was for the past year. Hopefully, the holiday season, we are very positive about the results and that we can see this holiday season. But definitely in terms of highlighting the Caribbean would be a little softer than the Central America region. There is less activity, I guess, economical connectivity in general in some of these smaller islands. And Central America is fortunately having a good growth in general.

[Jon Braatz:]

Okay. John, if I’m not mistaken obviously the Barranquilla store is doing very well, but the south – I mean the Colombian subsidiary is operating in the red, I believe, still. With the opening of the Cali stores, do you see Colombia moving into the black next year?

[John Heffner:]

Well, John, we don’t provide individual subsidiary financial information. But from an operating perspective, and let me speak to that because operating in the black or in the red has a lot of tax implications and intercompany activity, transfer pricing things, but I really think the focus is on from an operating perspective. From an operating perspective, the country headquarters cost we have in place is equivalent to that which we have in countries that have three or four clubs. So, although depending on a number of factors, including the growth of sales in the new clubs, once they open, as well as the pace of adding new clubs and the cost of financing those new clubs, all these things could have an impact on the level of profitability within Colombia in any given period.

[Jon Braatz:]

Okay. All right. And then you increased the membership fee in 10 of your markets. How many members would that be? What percent of your membership base might have been affected by that increase?

[Jose Laparte:]

I will say probably 80%.

[Jon Braatz:]

Okay.

[Jose Laparte:]

Yes, 80% to 85% probably, Jon, easily.

[Jon Braatz:]

Okay. And then one last question. If you were to strip out the new memberships in Barranquilla, what would your membership growth have been in the let’s say the non- Barranquilla markets? Happen to have that handy?

[John Heffner:]

Well, if I did that, then you’d know the number of members in Barranquilla, so I’m not going to mention that.

[Jon Braatz:]

All right. I appreciate that, John. Thank you very much.

[Jose Laparte:]

Thank you, Jon.

[Operator:]

We will go next to Patricio Danziger with Everest Capital.

[Patricio Danziger:]

Hi. My questions were answered already, so thank you very much.

[Jose Laparte:]

Thank you, Patricio.

[Operator:]

We’ll go next to Mark Litwin with Remington Partners.

[Mark Litwin:]

Hi, good morning. You’ve touched on the fact that you don’t really have any specifics on growing – opening new stores in Colombia, but do you have any projections about the number of stores that Colombia could absorb?

[John Heffner:]

I think we’ve opened two and we got one more under construction.

[Mark Litwin:]

No, I know, but I mean, in a bigger – in a broader kind of projection, just your thoughts about how big the country really is for you.

[John Heffner:]

Well, the country is 46 million people.

[Mark Litwin:]

Right.

[John Heffner:]

It has the economic size and its GDP of all of Central America added together I think is the order of magnitude. And in Central America we have quite a few a number of clubs. So, while we don’t know what the exact number is and if we can secure the right sites and continue to experience the kind of success we have seen in Barranquilla and hopefully we’re starting to see in Cali, then we’ll see what that number will allow us to get to. Jose Luis...

[Jose Laparte:]

I will only add that definitely the potential is there with the big cities in Colombia, either Bogotá, Medellín, Bucaramanga, and we have studied a lot of those series. But the key is going to be finding the right sites, the real estate. These are very competitive markets and obviously we’re busy working on that, Mark, but the key will be finding definitely good sites, good real estate locations for those markets.

[Mark Litwin:]

And one other question. Apart from Panama and Costa Rica, are you seeing any impact on – by gang activity in Central America on store sales, store activity?

[Jose Laparte:]

Not really.

[John Heffner:]

I think we do have – yes, there is a concern about security in the Northern Central America, Honduras, Guatemala...

[Mark Litwin:]

Yes, now those are the countries I’m alluding to as outside of Panama and Costa Rica.

[Jose Laparte:]

Yes. But I mean things are I guess normal right now in terms of our business and we haven’t really experienced – fortunately there hasn’t been that much activity around our areas now...

[Mark Litwin:]

I see.

[Jose Laparte:]

...in those markets.

[Mark Litwin:]

Okay. Thank you.

[Jose Laparte:]

Thank you, Mark.

[Operator:]

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

[Ron Bookbinder:]

Hi. I was just wondering did you see the presidential election having an impact one way or another on your business, whether it’s the repatriation of capital or taxation or anything?

[John Heffner:]

My perspective, Ron, is I wouldn’t want to speculate on either the outcome of the election or tax policy that would follow from there, so it’s not something I’d choose to speculate on.

[Ron Bookbinder:]

Okay. Thank you.

[Operator:]

We’ll go next from Dave King with ROTH Capital.

[Dave King:]

All right, thanks. Just a quick follow-up. I guess taking a step back and thinking big picture, maybe somewhat as a follow-up with a prior question on how big Colombia could be, I guess just given the success you’ve had there, any thoughts on the pace of store growth going forward and whether or not that could accelerate somewhat, or if you’d willing to accelerate it? I mean, I understand that it takes time to find the right sites and all those things, so you have to be really methodical in your approach, but at the same time there is advantages to having somewhat of a critical mass, so just any help or color around that would be helpful.

[John Heffner:]

Dave, and I will let Jose Luis chime in on this one as well, I think our focus is to find good sites and that’s probably at this point the most I won’t say limiting factor, but the thing that is defining the rate at which we are opening warehouse clubs at this point in Colombia is finding those good sites and securing those sites.

[Jose Laparte:]

Yes, I would just add there’s a complete relation on our speed and obviously the availability of sites at a reasonable cost for our warehouse club business, but that’s a complete relation on those two variables, not the speed and we will be opening and ultimately finding the reasonable cost sites in these big cities.

[Dave King:]

Right. Now, that’s fair. I mean have you thought about putting – I mean is it a function of also just having more people may be allocated to – if Colombia is an opportunity that it seems like it is, I mean is it a question of allocating more people to doing that, doing site selection or I mean just – what is the limiting factor there in that process?

[Jose Laparte:]

No, it’s, I guess it’s – I don’t think it’s a matter of putting more resources, I think we believe we have the right resources with the attention that that market requires and it’s just challenging probably in some respect. But I guess we are very pleased with what we have done finding these three great locations so far, the two that are open and one that we also believe is going to be a good one. And we’re really trying to find in these new cities or other cities the same quality sites and be successful on that. We’re actively working on evaluating sites in all these cities to find the right one.

[Dave King:]

Okay. That’s helpful. Thanks, again.

[Jose Laparte:]

Thank you, Dave.

[Operator:]

We’ll go next to Matthew Handorf with Graham Partners.

[Matthew Handorf:]

Hi, congratulations on a great quarter. Just one quick question. If I calculate average sales per average member in the last two quarters, it seems to have flattened a bit or maybe even gone slightly negative. So just trying to understand – or any explanations for this or have you reached any sort of kind of limit in wallet share or spend? Any explanation would be great. Thank you.

[John Heffner:]

I am not sure I have a good answer to that. I think our rate of growth of members, since a member can join at any given period and their spending – sales that I think would accrue from that member would happen over a future period. So I think membership might – number of members might always be sort of a leading indicator of sales as opposed to a lagging indicator or it would be hard to make that connection in a current period. Our membership growth has I think been a little higher in the last two quarters than our sales growth. So the math I think would give you that answer, but I’m not sure it’s – I haven’t drawn any conclusions from that for the business.

[Matthew Handorf:]

Great. Thank you.

[Jose Laparte:]

Thank you, Matthew.

[Operator:]

And that will conclude today’s question-and-answer session. I would like to turn the call back over to John Heffner for any additional or closing remarks.

[John Heffner:]

Well, thank you very much for joining us on our call today and wish you a good day and especially those of you who might be still feeling the effects of Hurricane Sandy, best of luck to you and to your families. So that will end our call for today, thank you.

[Jose Laparte:]

Thank you.

[Operator:]

And that does conclude this conference. We thank you for your participation.