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PSMT > SEC Filings for PSMT > Form 10-Q on 9-Jan-2014All Recent SEC Filings

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Form 10-Q for PRICESMART INC


9-Jan-2014

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

This quarterly report on Form 10-Q contains forward-looking statements concerning PriceSmart, Inc.'s ("PriceSmart or the Company") anticipated future revenues and earnings, adequacy of future cash flow, projected warehouse club openings, the Company's performance relative to competitors and related matters. These forward-looking statements include, but are not limited to, statements containing the words "expect," "believe," "will," "may," "should," "project," "estimate," "anticipated," "scheduled," and like expressions, and the negative thereof. These statements are subject to risks and uncertainties that could cause actual results to differ materially, including the following risks: the Company's financial performance is dependent on international operations, which exposes the Company to various risks; any failure by the Company to manage its widely dispersed operations could adversely affect its business; the Company faces significant competition; future sales growth depends, in part, on the Company's ability to successfully open new warehouse clubs; the Company might not identify in a timely manner or effectively respond to changes in consumer trends and changes in consumer preferences for merchandise and shopping modalities, which could adversely affect its relationship with members, demand for its products and market share; the Company faces difficulties in the shipment of, and risks inherent in the importation of, merchandise to its warehouse clubs; the Company is exposed to weather and other natural disaster risks; general economic conditions could adversely impact the Company's business in various respects; the Company is subject to changes in relationships and agreements with third parties with which the Company does business and/or from which the Company acquires merchandise; the Company relies extensively on computer systems to process transactions, summarize results and manage its business, and failure to adequately maintain the Company's systems and disruptions in its systems could harm its business and adversely affect its results of operations; the Company could be subject to additional tax liabilities; a few of the Company's stockholders own approximately 28.3% of the Company's voting stock, which may make it difficult to complete some corporate transactions without their support and may impede a change in control; the loss of key personnel could harm the Company's business; the Company is subject to volatility in foreign currency exchange rates; the Company faces the risk of exposure to product liability claims, a product recall and adverse publicity; potential future impairments of long lived assets could adversely affect the Company's future results of operations and financial position; write-offs of goodwill and other intangible assets could adversely affect the Company's future results of operations and financial position; the Company faces increased public company compliance risks and compliance risks related to the Company's international operations; the Company faces increased compliance risks associated with compliance with Section 404 of the Sarbanes-Oxley Act of 2002; if remediation costs or hazardous substance contamination levels at certain properties for which the Company maintains financial responsibility exceed management's current expectations, the Company's financial condition and results of operations could be adversely impacted. The risks described above as well as the other risks detailed in the Company's U.S. Securities and Exchange Commission ("SEC") reports, including under the heading "Part II - Item 1A - Risk Factors" in the Company's Annual Report on Form 10-K filed for the fiscal year ended August 31, 2013 filed on October 30, 2013 pursuant to the Securities Exchange Act of 1934, could materially and adversely affect our business, financial condition and results of operations. These risks are not the only risks that the Company faces. The Company also could be affected by additional factors that apply to all companies operating globally and in the U.S., as well as other risks that are not presently known to the Company or that the Company currently considers to be immaterial.

The following discussion and analysis compares the results of operations for the three-month period ended November 30, 2013 and 2012 and should be read in conjunction with the consolidated financial statements and the accompanying notes included therein.

PriceSmart's business consists primarily of international membership shopping warehouse clubs similar to, but smaller in size than, warehouse clubs in the United States. The Company's ownership in all operating subsidiaries as of November 30, 2013 is 100%, and they are presented on a consolidated basis as wholly owned subsidiaries. The number of warehouse clubs in operation as of November 30, 2013 and 2012 for each country or territory are as follows:


                           Number of             Number of        Anticipated warehouse
                        Warehouse Clubs       Warehouse Clubs         club openings
                      in Operation as of    in Operation as of              in
Country/Territory      November 30, 2013     November 30, 2012       Fiscal year 2014
Colombia                               3                     2                        -
Panama                                 4                     4                        -
Costa Rica                             6                     5                        -
Dominican Republic                     3                     3                        -
Guatemala                              3                     3                        -
El Salvador                            2                     2                        -
Honduras                               2                     2                        1
Trinidad                               4                     4                        -
Aruba                                  1                     1                        -
Barbados                               1                     1                        -
U.S. Virgin Islands                    1                     1                        -
Jamaica                                1                     1                        -
Nicaragua                              1                     1                        -
Totals                                32                    30                        1

During fiscal 2013, the Company opened its second and third clubs in Colombia. These clubs are in south and north Cali and opened in October 2012 and May 2013, respectively. Additionally, in February 2013, the Company acquired property located in La Union, Cartago, Costa Rica, upon which it opened its sixth membership warehouse club in Costa Rica on October 18, 2013. Finally, in February 2013, the Company acquired land in Tegucigalpa, Honduras upon which it anticipates opening its third warehouse club in Honduras in the spring of 2014.

The Company's warehouse clubs are located in Latin America and the Caribbean, and its corporate, U.S. buying operations and distribution centers are primarily located in the United States. The Company's reportable segments are based on management's organization of these locations into operating segments by general geographic location. The Company's operating segments are the United States, Latin America and the Caribbean.

General Economic Factors

The economies in the major PriceSmart markets continue to experience moderate year-over-year growth. Specific events in some of the smaller countries in which the Company has warehouse clubs, such as increases in value-added taxes, reduced economic activity, political unrest and other factors are contributing to a more challenging retail environment in those markets, adversely impacting sales growth.

The Company does not currently face direct competition from U.S. branded membership warehouse club operators. However, it does face competition from various retail formats such as hypermarkets, supermarkets, cash and carry, home improvement centers, electronic retailers and specialty stores, including those within Central America that are owned and operated by a large U.S. - based retailer. The Company has competed effectively in these markets in the past and expects to continue to do so in the future due to the unique nature of the membership warehouse club format. The Company has noted that certain retailers are making investments in upgrading their stores and adding new locations within the Company's markets resulting in increased competition. For example, Cost-U-Less, a cash and carry, low price operator with which the Company also competes in St. Thomas, opened a location in Barbados. Further, it is possible that U.S. warehouse club operators may decide to enter the Company's markets and compete more directly with PriceSmart in a similar warehouse club format.

Many PriceSmart markets are susceptible to foreign currency exchange rate volatility. Currency exchange rate changes either increase or decrease the cost to the Company's subsidiaries of imported products purchased in U.S. dollars and priced in local currency. For the three months ended November 30, 2013, approximately 53% of the Company's net warehouse sales were comprised of products purchased in U.S. dollars and imported into the markets where PriceSmart warehouse clubs are located, but approximately 79% of the Company's net warehouse sales were in foreign currencies.


Currency exchange rate fluctuations affect affect the Company's consolidated sales as local-currency-denominated sales are translated to U.S. dollars. Also, as a result of local currency fluctuations, the Company revalues all U.S. dollar-denominated monetary assets and liabilities within the Company's markets that do not use the U.S. dollar as their functional currency. These monetary assets and liabilities include, but are not limited to, excess cash permanently reinvested offshore, U.S. dollar-denominated long-term debt used to finance land acquisition and the construction of warehouse clubs, and U.S. dollar-denominated accounts payable related to the purchase of merchandise.

The Company seeks to manage its foreign exchange risk by (1) adjusting selling prices from time to time; (2) obtaining local currency loans from banks within certain markets where it is economical to do so and where management believes the risk of devaluation and the level of U.S. dollar denominated liabilities warrants this action; (3) reducing the time between the acquisition of product in U.S. dollars and the settlement of that purchase in local currency; and (4) by entering into cross-currency interest rate swaps and forward currency derivatives. The Company has local-currency-denominated long-term loans in Honduras and Guatemala; has cross-currency interest rate swaps and forward currency derivatives in Colombia and has forward currency derivatives in Costa Rica. Turbulence in the currency markets can have a significant impact on the value of the foreign currencies within the countries in which the Company operates. For example, in the first quarter of fiscal year 2012, concerns related to European sovereign debt contributed to a 9.3% devaluation of the Colombian peso against the U.S. dollar, resulting in the Company's Colombian subsidiary's recording approximately $1.5 million in currency losses upon the translation of U.S. dollar-denominated liabilities. Future volatility and uncertainties regarding the currencies in the Company's countries could have a material impact on the Company's operations in future periods. However, there is no way to accurately forecast how currencies may trade in the future and, as a result, the Company cannot accurately project the impact of the change in rates on the Company's future demand for imported products, reported sales, or financial results.

Business Strategy

The Company's business strategy is to offer for sale to businesses and families a limited number of stock keeping units (SKU's) covering a wide range of products at the lowest possible prices. The Company charges an annual membership fee to its customers. These fees combined with warehouse and distribution operating efficiencies and volume purchasing enable PriceSmart to operate its business on lower merchandise margins than conventional retail stores. The combination of annual membership fees, operating efficiencies and low margins enable PriceSmart to offer its members high quality merchandise at very competitive prices which, in turn, enhances the value of the PriceSmart membership.

Current and Future Management Actions

Generally, the Company's operating efficiencies, earnings and cash flow from operations improve as sales increase. Higher sales provide greater purchasing power and often result in lower product prices from the Company's suppliers. Further, increased sales permit the Company to leverage its selling, general and administrative expenses. Sales growth in our existing locations (comparable warehouse club sales) creates the highest degree of expense leverage. Therefore, the Company prioritizes initiatives that it expects will have the greatest impact on increasing sales, particularly within our existing locations. Looking forward to the next several quarters, the following items are likely to have an impact on the Company's business and the results of operations.

The Company seeks to increase sales by growing sales with existing members in its warehouse clubs, by attracting new members at both existing and new clubs and by adding new PriceSmart warehouse clubs. The Company's continued focus on initiatives to increase comparable warehouse club sales within existing warehouse clubs locations allowed the Company to increase comparable warehouse club sales for the 13-week period ended December 1, 2013 7.9% compared to the same 13-week period the prior year. In addition, the Company increased the number of member accounts 12.1% over the prior year. During fiscal 2013, the Company opened its second and third clubs in Colombia. These clubs are in south and north Cali and opened in October 2012 and May 2013, respectively. Additionally, in February 2013, the Company acquired property located in La Union, Cartago, Costa Rica, upon which it opened its sixth membership warehouse club in Costa Rica on October 18, 2013. Finally, in February 2013, the Company acquired land in Tegucigalpa, Honduras upon which it anticipates opening its third warehouse club in Honduras in the spring of 2014. The Company continues to explore other potential sites for future warehouse clubs in its markets.

Effective June 1, 2012, the Company raised the annual membership fee by approximately $5.00 in most markets. The annual fee for a Diamond membership in these markets is now approximately $35.00 (entitling members to two cards). A membership fee helps PriceSmart offer high quality merchandise at low prices, providing value to its members. In October 2012, the Company launched the Platinum membership account in Costa Rica. Platinum members pay an annual membership fee of approximately $75.00 for a primary membership card for which they receive an annual 2% rebate of their purchases on most items, up to a maximum annual rebate of $500.00. The Company is currently evaluating the Platinum membership program to determine if Platinum membership should be offered in other of the Company's markets.


Logistics and distribution operations are an important part of what allows PriceSmart to deliver high quality merchandise at low prices to our members. The Company continues to explore areas to improve efficiency, lower costs and ensure a good flow of merchandise to our warehouse clubs. The Company is adding regional distribution centers in some of its markets (currently Costa Rica and Panama) to improve merchandise flow and lower operating costs, the benefit of which can be passed on to our members in the form of lower merchandise prices.

Purchasing land and constructing warehouse clubs is the Company's single largest capital investment. Securing land for warehouse club locations is challenging within the Company's markets, especially in Colombia, because suitable sites at economically feasible prices are difficult to find. Although the Company has entered into real estate leases in the past and will likely do so in the future, the Company's preference is to own rather than lease real estate. Real estate ownership provides a number of advantages as compared to leasing, including lower operating expenses, flexibility to expand or otherwise enhance PriceSmart buildings, long-term control over the use of the property and the residual value that the real estate may have in future years. In order to secure warehouse club locations, the Company occasionally has to purchase more land than is actually needed for the warehouse club facility. To the extent that the Company acquires property in excess of what is needed for a particular warehouse club, the Company generally plans to either sell or develop the excess property. Excess land at Alajuela and Brisas is being held for development by joint ventures formed by the Company and the sellers of the property, which commenced in fiscal year 2011. A similar development strategy is being employed for the Company's excess land at the San Fernando, Trinidad and Arroyo Hondo, Dominican Republic locations where the properties are fully owned by the Company. The profitable sale or development of real estate is highly dependent on real estate market conditions.

Financial highlights for the first quarter of fiscal year 2014 included:

Net warehouse club sales increased 12.6% over the comparable prior year period. The Company ended the quarter with 32 warehouse clubs compared to 30 warehouse clubs at the end of the first quarter of fiscal 2012. Comparable warehouse club sales (that is, sales in the warehouse clubs that have been open for greater than 13 1/2 calendar months) for the 13 weeks ended December 1, 2013 grew 7.9%.

Membership income for the first quarter of fiscal year 2014 increased 20.8% to $9.3 million.

Warehouse sales gross profits (net warehouse club sales less associated cost of goods sold) in the quarter increased 8.6% over the prior year period and warehouse sales gross profits as a percent of net warehouse sales were 14.5%, a reduction of 54 basis points from the same period last year.

Selling, general and administrative expenses (not including pre-opening expenses and loss on the disposal of assets) decreased 21 basis points as a percentage of sales compared to the first quarter of last year.

Operating income for the first quarter of fiscal year 2014 was $32.4 million, an increase of $2.6 million over the first quarter of fiscal year 2013.

The Company had a $311,000 net gain from currency exchange transactions in the current quarter compared to a $1,000 net loss from currency exchange transactions in the same period last year.

Net income for the first quarter of fiscal year 2014 was $21.4 million, or $0.71 per diluted share, compared to $20.0 million, or $0.66 per diluted share, in the comparable prior year period.


Reclassifications to consolidated statement of income recorded during fiscal year 2014 for fiscal year 2013 - The Company recorded asset disposal activity during fiscal year 2013 under other income (expense), net. This activity consisted mainly of normally scheduled asset replacement and upgrades involved in operating activities. The Company has determined that these costs represent operating expenses. Therefore, the Company has accordingly recorded such asset disposal activity as operating expenses under loss/ (gain) on disposal of assets starting in fiscal year 2014. The Company has made reclassifications to the consolidated statement of income for fiscal year 2013 to conform to the presentation in fiscal year 2014. These reclassifications did not impact net income. The following tables summarize the impact of this reclassification (in thousands):

                                                        Three Months Ended
                                                                                                             Total Fiscal Year
                          November 30, 2012      February 28, 2013      May 31, 2013     August 31, 2013           2013
Other income (expense),
net - as previously
reported                $            (58 )      $           (312 )     $     (1,034 )   $         (439 )     $      (1,843 )
Loss/(gain) on disposal
of assets, other income
(expense), net
reclassified to
Loss/(gain) on disposal
of assets, total
operating expenses                    57                      49                249                534                 889
Other income (expense),
net - as currently
reported                $             (1 )      $           (263 )     $       (785 )   $           95       $        (954 )

COMPARISON OF THE THREE MONTHS ENDED NOVEMBER 30, 2013 AND 2012

The Company's fiscal first quarter ended on November 30, 2013.  Unless otherwise
noted, all tables present U.S. dollar amounts in thousands. Certain percentages
presented are calculated using actual results prior to rounding.

Net Warehouse Club Sales

                                 Three Months Ended November 30,
                                        2013                     2012
                                 Amount           % Change      Amount
Net Warehouse club sales $     589,694               12.6 %   $ 523,599

Comparison of Three Months Ended November 30, 2013 and 2012

The Company recorded positive sales growth in all countries. Colombia and Costa Rica, in particular, experienced strong sales growth with the addition of one new warehouse club in each country compared to the first quarter of fiscal year 2013 along with sales growth in Panama and Trinidad. Total net warehouse sales growth of 12.6% during the three months ended November 30, 2013 resulted from an 11.7% growth in transactions and a 0.8% growth in average ticket. All merchandise categories experienced growth during the quarter.


Comparable Sales

The Company reports comparable warehouse club sales on a "same week" basis with 13 weeks in each quarter beginning on a Monday and ending on a Sunday. The periods are established at the beginning of the fiscal year to provide as close a match as possible to the calendar month and quarter that is used for financial reporting purposes. This approach equalizes the number of weekend days and weekdays in each period for improved sales comparison, as the Company experiences higher warehouse club sales on the weekends. Further, each of the warehouse clubs used in the calculations was open for at least 13 1/2 calendar months before its results for the current period were compared with its results for the prior period. For example, the sales related to the warehouse club opened in Cali, Colombia ("Canas Gordas") on October 19, 2012 will not be used in the calculation of comparable warehouse club sales until January 2014. Sales related to the warehouse club opened in Cali, Colombia ("Menga") on May 3, 2013 will not be used in the calculation of comparable warehouse club sales until July 2014. In addition, sales related to the warehouse club opened in La Union, Cartago, Costa Rica ("Tres Rios") on October 18, 2013 will not be used in the calculation of comparable warehouse sales until January 2015.

Comparable warehouse club sales increased 7.9% for the 13-week period ended December 1, 2013, compared to the same 13-week period last year. The Company opened a new warehouse club in La Cartago, Costa Rica in October. While this new warehouse club is expected to attract new members from an area of greater San Jose who were not being served by the Company, it also will result in some existing members, particularly those that shopped at our Zapote warehouse club, choosing to shop at the new location. This transfer of sales from a warehouse club that is included in the calculation of comparable warehouse club sales to a warehouse club that is not included in the calculation has an adverse impact on comparable warehouse club sales. The Company has not made a specific determination of the impact given various factors, such as whether previously existing members are now shopping more often given the greater convenience of this new club, which would make it difficult to provide an accurate assessment.

Net Warehouse Club Sales by Segments

The following tables indicate the net warehouse club sales and the percentage
growth in net warehouse club sales during the three months ended November 30,
2013 and 2012 in the segments in which the Company operates.

                                                  Three Months Ended November 30,
                                              2013                                              2012
                                                    Increase from
                    Amount       % of net sales       prior year        Change        Amount       % of net sales
Latin America    $  400,366             67.9 %     $       49,760         14.2 %   $  350,606             67.0 %
Caribbean           189,328             32.1 %             16,335          9.4 %      172,993             33.0 %
Net warehouse
club sales       $  589,694            100.0 %     $       66,095         12.6 %   $  523,599            100.0 %

Comparison of Three Months Ended November 30, 2013 and 2012

For the three months ended November 30, 2013 and 2012, the higher net warehouse club sales growth in Latin America compared to the Caribbean reflects improved economic conditions in those more diversified and larger markets, plus the sales associated with the additional warehouse club sales in Cali, Colombia and La Union, Costa Rica in the current periods compared to the prior period. We expect Latin America sales growth to continue to out pace Caribbean sales growth as the next warehouse club the Company expects to open is located in Honduras.


Export Sales
                                               Three Months Ended November 30,
                                     2013                                                    2012
                                                Increase from
                 Amount      % of net sales       prior year        Change        Amount        % of net sales
Export sales   $  5,721             1.0 %      $        2,648         86.2 %   $     3,073             0.6 %

The increase in export sales was due to direct sales to a single institutional customer (retailer) in the Philippines for which the Company achieves a gross profit margin of approximately 5%, which is below the Company's warehouse club gross profit margin.

Membership Income
                                                    Three Months Ended November 30,
                                                       2013                               2012
                                                      Increase from
                                      Amount           prior year       % Change         Amount
Membership income                 $      9,268       $       1,595         20.8 %   $         7,673
Membership income % to net
warehouse club sales                       1.6 %                                                1.5 %
Number of total accounts             1,120,033             120,755         12.1 %           999,278
. . .
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