PriceSmart Q2 Earnings Conference Call: Full Transcript

Operator:

Good day and welcome to PriceSmart, Inc.’s Earnings Release Conference Call for the Second Quarter of Fiscal Year 2016, the three months period ending on February 29, 2016. 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.

To do so please press star, one on your phone at any time and you will be placed in the queue.

Also as a reminder, this conference is being recorded on Friday, April 8, 2016. A digital replay of this call will be available through April 31, 2016, by dialing toll free 888-203-1112 for domestic callers or 719-457-0820 for international callers. The passcode for the replay is 120-17-14.

I would now like to turn the conference over to John Heffner. Please go ahead, sir.

John M. Heffner: Executive Vice President and Chief Financial Officer:

Thank you and welcome to our earnings call for the second quarter of fiscal year 2016. We’ll be discussing the information that we provided in our earnings press release which we released yesterday, April 7, 2016 along with our 10-Q. The earnings release also include information about our net warehouse and comp sales for March.

You can find both the press release and the 10-Q filing 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 can 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, 2015 filed with the Securities and Exchange Commission on October 29, 2015.

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 Luis Laparte, PriceSmart’s President and Chief Executive Officer.

Jose Luis Laparte: Chief Executive Officer and President:

Good morning, everyone and thank you for joining us today. I will begin my remarks focused on our second quarter results and will follow that with some comments about March sales which was also included in our press release.

Sales for the quarter were $759 million, an increase in total sales of 3.7% when compared to the second quarter of last fiscal year. We ended the quarter with 38 warehouse clubs compared to 36 a year ago. Net income for the second quarter of fiscal year 2016 was $25.9 million or $0.85 per share compared to $24.8 million or $0.82 a year ago for the same quarter.

I will probably sound a little repetitive as I have been mentioning in the last few calls that the Colombia currency affects many of our comparisons with last year and quarter two was no exception. For example, comparable sales which now includes 38 of our 38 clubs had a decrease of 0.9 for the 13 weeks ended February 28, 2016. Three Colombia warehouse clubs were in that calculation for the full 13 weeks and the other three in Colombia were in the calculation for a portion of that period. Extracting those clubs from the calculation, the 13 week comparable sales for the other 30 warehouse clubs was a positive of 2.7%.

I will speak more about our Colombian business, but let me first touch base on results in our other regions. Our non-Colombia markets performed well in the second quarter. Central America had a total sales growth of 11.5%, which included the positive impact of two additional warehouse clubs: one in Panama opened in June 2015 and one in Nicaragua opened in November 2015. The two new warehouse clubs continue to do well adding members and sales.

We saw positive comp sales in all our Central America countries with a section of Nicaragua which was impacted by the planned cannibalization of sales in the 16 warehouse clubs by the new one. Double-digit sales growth was recorded in Panama, Honduras and Nicaragua.

In the Caribbean, warehouse sales grew 4.4% in the second quarter compared to the year earlier period with the number of warehouse clubs 11. Again, all countries in the region of the Caribbean recorded positive sales growth with Jamaica growing above 10% year-on-year.

On the other hand, we started to see some challenges in Trinidad during the quarter. In February, Trinidad increased the BAT on a large number of products which impacted prices and consumer spending. The country in total a big exporter of oil and natural gas is slipping into a period of its lower economic growth due to low price of those commodities. This is expected to put some pressure on consumer demand which can impact our business in the next few quarters in a market that has been very good for us over that past 2 to 3 years.

In Colombia, net warehouse sales declined by 32% when translated to US dollar, reflecting the impact of a 37.8 devaluation of the peso compared to the US dollar in the same quarter last year. The average exchange rate for translating Colombian peso sales to US dollars in the quarter was 3,283 compared to 2,382 a year ago.

In local currency, net warehouse sales for the quarter declined 6.5%. The prices on important merchandise, which have a US dollar cost basis, is impacting demand which is driving the negative growth for those products. Sales of local products, however, recorded a 9% positive growth when measured in pesos.

It is our goal going forward to come positive in local currency in Colombia. We did not achieve that in the second quarter. The peso has stabilized somewhat at around 3,100 pesos level. A stable currency should help us achieve that goal.

From a merchandise perspective, for the total company, we recorded comp sales growth in the period in liquor, health and beauty, fresh meat, automobile, home furniture, office furniture and fashion apparels.

Moving on to membership, membership income was $11.3 million for the quarter. We finished the quarter with more than 1,000,460 accounts. While this is an increase of 6% compared to a year ago, it is a reduction of approximately 21,000 accounts from the end of fiscal year 2015, driven by renewal activity in Colombia on the anniversaries of the opening for the warehouse clubs in Bogota, Medellin and Pereira.

As discussed in our first quarter earnings call, the combination of generally lower renewal rates for first year members, another factor specific to the three newer clubs in Colombia such as exceptionally large number of pre-opening sign-ups in the Bogota club and the license of the Bogota club to a number of those members resulted in a net reduction of member accounts. We finished the second quarter at an 81% 12-months renewal capture rate for all countries and that will be 88%, excluding Colombia.

While we have seen some improvement in the monthly renewal rate over the past few months in Colombia, we are particularly encouraged by an ongoing stream of new member signups in our Colombian clubs. Our warehouse clubs in Bogota, Medellin and Barranquilla have the highest number of new membership signups of any of our warehouse clubs in the second quarter. We believe this is a good indication of the acceptance of our concept with these new members that despite the current prices on imported merchandise, they are seeing good value in the overall item mix that we now have between imported and local merchandise.

Before I leave the subject of Colombia, let me say a few things about our approach to pricing our imported merchandise during this evaluation that I know I shared a few times already in other earnings calls, but is worth repeating. There is no question that prices of imported merchandise across all retailers in Colombia are going up, which negatively impacts consumers' demand. We have taken margin reductions in that market in an effort to solidify our position for the future and in addition we are pleased with the combination of items to local production that we have been introducing in the last few months. We are making sure that the quality of the locally produced products is at least as good as the imported goods that we have been offering for sale. It has been a good experience working with local vendors that have demonstrated their ability to produce and supply high quality items for us.

Other activities relevant to report as we finished second quarter includes the progress of the construction of our new warehouse club in Chia, municipality in the northern suburb of Bogota. Our plan remains to open that club around September 2016. We believe this new club will serve not only the Chia community, but also residents in the northern portion of Bogota.

Also in Colombia, we are in a parking deck of our Barranquilla location. This is part of an overall expansion program in certain markets. The expansion in Barranquilla will add both more parking spaces and extra sales force space to our club. In other markets we are on the process of planning similar actions and in some cases hove or expect to acquire some adjacent plants to be used or expanded parking at those locations.

Finally, as we reported in our 10-Q, subsequent to the end of the quarter, we enter into a contract to acquire a build-to-suit distribution center in Miami. Once completed, currently expected in the first half of 2017, we will relocate much of our current distribution operations to this new location. Not only will this new center provide improved operating efficiencies by virtue of this design, but it will ensure we have long term control over a strategically critical element of our business.

I know John will have a few comments about Q2, but let me now speak to our March sales. March sales decreased 4.2% to $227.8 million and four-week comp sales ending March 27 decreased 5.4%. Excluding Colombia, comp sales decreased 3.1%. This month in which Semana Santa and Easter fall compared to the year earlier period has a measurable effect on the year to year comparison given the days warehouse clubs are closed and the shopping behavior of members in our markets over the Easter weekend.

Easter Sunday this year fell on the last day of our comp period, March 27, Easter year last year was in April 5th. As such, we believe it is more instructive to view March and April together as we have done in prior years. For example, last year fiscal year 2015 March comps were 7.3 followed by April at 0.2%, all at 3.8% combined.

Before I conclude, I would just like to add one more comment. As I travel and visit our operations in our different countries, I always comeback optimistic from the things I see and the efforts and dedication of our teams. Even though we face very good competitors in our markets, I am reminded that PriceSmart offers a particularly unique and differentiated shopping experience, shopping alternative for the small business members and household members. I also see further opportunities for us to improve our execution of the club philosophy, finding efficiencies in our buying, distribution, operations and all our other functional disciplines to better serve our members.

Thanks again for joining us today. After John's remarks, we will take your question.

John Heffner: Executive Vice President Chief Financial Officer:

Thank you Jose Luis. Let me highlight a few brief additional items with respect to our financial results for the second quarter. Net income in the quarter of $25.9 million resulted in earnings per share of $0.85 compared to $0.82 a year ago. The lower sales and decreased merchandise margins as a percent of sales in the Colombia segment resulted in an operating loss of $1.7 million and a net loss of $2.2 million or approximately $0.07 per share.

While the net was an approximate $0.04 per share improvement over last year, that improvement was largely from reduced foreign exchange losses. Performance in the non-Colombia segments when added together resulted in net income of $28.1 million or approximately $0.92 per share, approximately $0.01 less than last year. Total consolidated warehouse gross profit margins in the first quarter were 14.2% of net warehouse sales, a reduction of 35 basis points from the same period last year. In Colombia, our efforts to reduce the impact of higher peso prices associated with the strong US dollar resulted in a 132 basis point reduction in margins in Colombia compared to the year ago quarter.

Membership income increased 3.6% on total membership account growth of 6.1%. The disparity primarily reflects the impact of the translation of the Colombian peso price membership when translated back to US dollars. The US dollar membership income recognized for a membership in Colombia in Q2 was 27% less than a year ago.

Total SG&A expense as a percent of sales increased 34 basis points with two additional warehouse clubs operating in the quarter compared to a year ago. Higher deferred comp expense associated with stock awards granted in the first quarter hit the G&A line along with additional spending in the buying and information technology areas.

Of the foreign exchange losses incurred in the quarter, $388,000 related to the devaluation of the Honduran lempira, including a one-time adjustment related to the remeasurement of a portion of a bank loan in Honduras not covered by a non-deliverable forward. We recognized income from unconsolidated affiliates of $429,000 related to the sale of land owned by the company's real estate joint venture in Panama.

The effective tax rate for the quarter was 31.7% compared to 35.3% last year. The difference resulted from a reduced loss in Colombia for which no tax benefit is realized and a lower proportion of US taxable income which has a higher statutory rate compared to the tax rates in our foreign jurisdictions.

We ended the quarter with strong balance sheet and a $173 million in cash and equivalents. During the quarter, cash increased $33 million from the end of November. Cash from operations in the quarter contributed $67.7 million, of which $24.5 million was from reductions in inventory net of accounts payable. We used $14.5 million in the quarter for investing activities in the construction of our Chia, Colombia club and other capital projects. And we used another $10.6 million in the payment of a cash dividend to shareholders at the end of February.

With that, Jose Luis and I will be happy to take your questions. Operator, I'll turn things over to you.

Question & Answer

Operator:

Thank you. If you would like to ask a question please signal by pressing star one on your telephone key pad. If you are using a speaker phone please make sure your mute function is turned off to allow your signal to reach our equipment. Again star one to ask a question.

We'll go first to Dave King with ROTH Capital Partners.

Dave King: Roth Capital Partners:

Thanks. Good morning guys. I guess first off, in terms of the warehouse club gross margin and the outlook for that and obviously with Colombia down I think 132 basis points year-on-year, how should we be thinking about how to think about that line and then going forward assuming that you're starting to get some benefits now or at least less of, less pressure I guess is a better way of saying it in Colombia and then given some of the initiatives you have to produce more goods locally, how should we be thinking about that over the near term? Have you seen any improvement maybe since quarter-end and then how do you think about it longer term?

Jose Luis Laparte:

Yes, longer term, Dave, good morning. Longer term obviously we continue to improve our margins in Colombia. At this point we are definitely committed for the long term and we don't really want to start trying to get advantage even with the combination of local items. We are looking at first improving our sales figures and obviously as you said, if we continue to see more stable currency, obviously we will be able to get back some of those margins as we were at some point lowering in Colombia, but at this point we don't really have any drastic change. Our commitment has been really to keep pushing ourselves, and even on the local merchandise, the margins are not that higher compared to our import merchandise. Now it's not that the combination of local gifts has higher margin rate. Definitely , what we are looking at during when we compare items to local, the first priority is to obviously drive incremental sales and keep pushing that line, Dave.

John M. Heffner:

Dave, I will add one more thing to that. I think we are sort of at this point anniversarying when we started really taking the margins down in Colombia. So I think as you've indicate, a 132 basis point change year-over-year in this past quarter, it was a much higher difference in Q1 and I think we are now seeing that -- as we go into Q3 here and compared to Q3 a year ago, we will see even a smaller change on a year-over-year basis. So I think we sort of coming up to that anniversary of the actions we took, the pricing actions we took which really took in the place rate sort of April March, April, May of last year.

Dave King:

Okay. That's great color. Thank you for that. And then maybe switching gears to the G&A increase, John, I think you touched on it a little bit, sounds like it was deferred comp and then some tax spend. Was the deferred comp, was that a catch up or was that -- is that a kind of higher run rate, I guess, how should we be thinking about the level of G&A? Was that out size is sort of the good -- or is the sort of good run rates to be using going forward?

John M. Heffner:

I'd say just in the run rate now, David, it was about grants that we did in Q1 and this will be in the run rate.

Dave King:

Okay. Thanks for that and then one more for me and I'll step back. In terms of the March sales and the Easter closings, obviously that had an impact, so thanks for sharing that Jose Luis. Do you guys have any color on how the weekly sort of trended over the course of the month, was it stronger sort of in the earlier what were sort of the weekly comp served in the earlier part of the month versus the latter part that were the closing sort effect; is there anywhere to kind of guide us towards how to think about the impact so far before we see April?

[Technical Difficulty]

John M. Heffner:

.... some portion of our operation remain in that slide for some time, at least runs for a few more years and so we will do that. So, we are working out how we would then sublet the space that we have and as we focus on our new site as well as utilizing some portion of the other site. So we’re probably a good year, year plus away from that.

Analyst:

Okay, understood. And then just, secondly I mean when we plug in the operating margin rate for Colombia also the EBITDA rate, I mean you turned EBITDA margin negative now in Q2 for Colombia and the operating margin really did a good effort to try and stay positive and trend upwards after your grand opening of the three clubs. But then it really turned around and it's really gone sharply downwards since in the last couple of quarters and on top of that, we clearly notice the negative same-store sales in Colombian peso in Q2. Can you elaborate a little bit on what's, I mean, I guess you're comfortable with situation and at least that's a sense I get from this call and that's clearly good. But can you get a sense of when you will start getting uncomfortable because for the last couple of quarters, I mean, clearly if one same-store sales in Colombian peso to, let's say, exit to the premise public same-store sales figures for their concepts and in Colombia, you've been outperforming them; but now we are looking at a low performance here in Q2. Can you comment a little bit on that, what to expect and maybe it will be helpful if you could say a little bit about your same store sales in the matured Colombian stores. So how much of this negative same-store sales in Colombia in Q2 was driven by the anniversary effect and how much was driven by the pressure on the consumer in Colombia. I know that was an awfully long question, and just to make it a little bit longer, can you add on a little bit of comment on the exit to bringing in the SI format Colombia if that is something you expect an impact from?

Jose Luis Laparte:

Okay. I am going to try to elaborate on the 15 questions, but let me see to start. I guess we said that we are comfortable with that condition in Colombia. I would say we believe we have things under control, we don't like obviously looking at local currency, we are not happy with the decrease that we had in this quarter of 6.5%. Although we see we have a lot of things in place that we believe are going to turn around that number into the positive into the flat numbers hopefully very soon. We're putting all efforts, all our efforts on making that happen. And I think we will be more comfortable when we see that number obviously comping positive in local currency, which is our first goal and again, it doesn't happen overnight. It's been a lot of transition on competition of items getting the items as we want, getting the pricing. I think there is also a lot of adjustment in the Colombian market even in our --. I want to say something that is important for me to highlight, even a lot of that US items that were in open prices, a lot of them continue to be very successful items. So obviously all that consumers and members in Colombia are going through this transition, not only with us, with every item, if you buy a car, if you buy computers, electronics, it doesn't matter wherever you buy them. The increase compared to a year-ago is now about 37%, but if you look at it compared to a year and a half ago, it's more than 70% because of the drastic devaluations they have.

So it's been quite a transition and it's taken a little bit longer. Hopefully and this is something that every day we wake up we hope for the ability of the currency, it's has been kind of the stable, I guess goes along with oil prices to some degree and it's been kind of stable in the last few weeks. So if we continue on that direction, I think we will put a lot things, we have lot of things in place to drive that positive comp. Every other week we have some of our clubs, new clubs, on tour clubs in Colombia reporting individually positive comp sales in local currency. So that is a good indication. For the last few days actually some of our clubs, particularly Medellin has been also tracking positive comp sales in local currency. So I think a lot of the actions were seen the results there in a positive way. Hopefully that answers the first portion of your question.

The other one related to exit on the new format, I guess, we, obviously, like any competitor, we take those things seriously. That's a very successful format for -- in Brazil. It will compete definitely also in the arena for the small business member for the Pendero, for the small shop and the Macro has been actual improving because Macro is also worried about this new format coming into Brazil, into Colombia. I think we are trying to make sure that we're also ready to be able to compete with them as we have been competing with Macro. So, it's going to be an interesting period obviously for Colombia with these guys introducing the new concept. But I believe we have good strategies in place to compete with them as soon as they open. Hopefully that answers all of your questions.

Analyst:

Yeah, thanks a lot Jose Luis. Maybe just two quick more. Just in terms of on the new side or new club openings, can you comment a little bit more specifically on what has been holding it back? You review many sites, is it the fact that the dollar value of land in Colombia hasn't come down or in other markets where you look, or is the fact that the market just dried up or is it just you haven't found the right match? Can you comment a little bit on more specifically what has been holding you, because there has been a decrease in new club opening announcements from your side over the last 18 months?

Jose Luis Laparte:

Yes. Well, it's a combination of things, definitely, we're not waiting on anything to happen on, specifically on the currency, therefore Colombia or other markets. All markets where we're looking at sites, the process just tends to be long because you have to have permits and more and more every country has I guess a lot of processes or a lot of approvals to be completed before you can get on approval for construction. So, it's more about process and we're doing our best trying to accelerate it and also we do recognize that the process has been literally slow in terms of openings. Obviously we're putting a lot of efforts to try to make them faster and for all the markets we're making business realizing that we're really take those opportunities going forward.

So, hopefully we'll be able to announce more of those formats and it's not for our lack of trying, we'll definitely keep trying and trying to get more resources to make things happen in those different markets.

Analyst:

Okay, great. Thanks. Just the final one and I guess you got to bring up and Panama sites and it's everywhere, but you might think I am joking to bring it up. But I mean, you have a substantial part of your operation in Panama and you also have a substantial part of your operation in Costa Rica. And I mean, Panama has been blooming and from the -- sometimes it has been a little bit difficult to understand what has been driving this boom and some of these lease sort of, I mean, put some clarity on what can drive booms in Panama, I don't know. But have you any force in that? And then secondly on the Costa Rican colon, I mean, it's no secret that Costa Rica is pretty sharply tied into to Panama and their currency. I mean, the Costa Rican colon looks probably a little bit more than expensive on many measures and we clearly seen you are taking some of that last quarter in Costa Rican colon, so, to try and mitigate that a little bit. But do you -- any thoughts at all on Panama Costa Rica that will be helpful.

Jose Luis Laparte:

Well, Panama, you're right. It’s been a very good market for us I think since, much as I recall, probably since 2007, 2008 when there was a big crisis in the state. Those guys didn't even feel it. There is a lot of construction, which is a positive thing in Panama. For some of us that have been travelling those markets for the last 10 years, we have seen how many new constructions are coming along. There is a lot of traffic I believe in Panama from Venezuela that are visiting there. We actually keep seeing good signups in some of our locations in Panama and when we look into some of those signups in memberships, we have found that a lot of them are from Venezuela, that are definitely moving to Panama. In addition, I would say that the expansion of the canal has been bringing a lot of positive things. Now, is that going to continue? We are really still pretty optimistic that retiring community is also growing in Panama, so there are lot of good things happening in Panama which, and obviously competition keeps getting better also. We see more stores opening from Rey, from 99, from the different competitors over there. So it's been a good market for a lot of us, for all companies and hopefully we'll continue on that trend.

In terms of Costa Rica, we probably have some of the same concerns they are sharing. There is a lot of pressure on that economy, but in the meantime, we are still seeing solid growth. Tourist remains still quite positive for that country and hopefully we will be able to continue growing in those two market which, as you said, they are pretty important markets now. We are -- a few years ago we had about 10% of valuation in Costa Rica, their colon went from 500 to 550, then there was a little bit of a recovery and colon got a little stronger and it's been holding, hanging in there for quite some. It's hard predict obviously and we are kind of ready for anything that can happen in those, in any markets, that's kind of overview for those two markets.

Analyst:

Great. Thank you so much for your time and best of luck with Q3.

Jose Luis Laparte:

Thank you very much.

Operator:

We have no further questions at this time. I would like to turn the conference over to Mr. Heffner for any closing remarks.

John M. Heffner:

Well, thank you Tony and thank you all for participating with us today. I will sign off now, have a good day and a nice weekend.

Operator:

Thank you. This does conclude today's conference. We do thank you for your participation. You may now disconnect.