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

Show all filings for PRICESMART INC

Form 10-Q for PRICESMART INC


10-Jul-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 or 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 28.1% 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, as amended, 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 Company assumes no obligation and expressly disclaims any duty to update any forward-looking statement to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events.

The following discussion and analysis compares the results of operations for the three and nine month periods ended May 31, 2014 and 2013 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 May 31, 2014 is 100%, and they are presented on a consolidated basis. The number of warehouse clubs in operation as of May 31, 2014 and 2013 for each country or territory are as follows:

                                                                      Anticipated
                           Number of              Number of            warehouse
                        Warehouse Clubs        Warehouse Clubs       club openings
                       in Operation as of     in Operation as of    within the next
Country/Territory         May 31, 2014           May 31, 2013          12 months
Colombia                               3                      3                 3
Panama                                 4                      4                 -
Costa Rica                             6                      5                 -
Dominican Republic                     3                      3                 -
Guatemala                              3                      3                 -
El Salvador                            2                      2                 -
Honduras                               3                      2                 -
Trinidad                               4                      4                 -
Aruba                                  1                      1                 -
Barbados                               1                      1                 -
U.S. Virgin Islands                    1                      1                 -
Jamaica                                1                      1                 -
Nicaragua                              1                      1                 -
Totals                                33                     31                 3

During May of fiscal year 2014, the Company opened its third warehouse club in Honduras in Tegucigalpa. 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. In January of fiscal year 2014, the Company acquired land in the southern area of Pereira, Colombia and in the city of Medellin, Colombia and leased land in the city of Bogota, Colombia. The Company is currently constructing new warehouse clubs at these three sites and plans to open them before the end of calendar year 2014. Together with the three warehouse clubs currently operating in Colombia (one in Barranquilla and two in Cali), these three new clubs will bring the number of PriceSmart warehouse clubs operating in Colombia to six. In October 2013, the Company opened its sixth membership warehouse club in Costa Rica in La Union, Cartago.

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

Economic conditions in the Company's markets are not homogenous. Where economic conditions are stable or favorable, the Company is experiencing generally positive retail strength (in Panama, Trinidad, Guatemala, the Dominican Republic and Aruba). On the other hand, the approximate 10% devaluation of the Costa Rican colon which occurred in February has negatively impacted the purchasing power of consumers in that country. This devaluation negatively impacts warehouse sales and membership income when translated to and reported in U.S. dollars in the near term and requires the Company to increase the price of imported merchandise to maintain target margins which may negatively impact the demand for those items. In addition, there have been recent announcements of large employers planning to reduce their workforce in Costa Rica, which will likely act as a headwind to economic growth. Costa Rica is PriceSmart's largest market with six warehouse clubs and therefore can have a material impact on the Company's financial performance. Other countries experiencing some level of slower economic and retail activity are Jamaica, Honduras and El Salvador.

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. However, new retail competitors may enter our markets (for example, Cost-U-Less, a cash and carry, low price operator with which the Company competes in St. Thomas, opened a location in Barbados a year ago) and existing retailers may expand (for example Wal-Mart's announcement that it intends to invest $1.1 billion in Mexico and Central America) which could adversely impact the Company's ability to compete within these markets. 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, although the Company has no current indication that such an event is imminent.

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 nine months ended May 31, 2014, approximately 52% 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 the Company's consolidated sales and membership income 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 acquisitions 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 prices on goods acquired in U.S. dollars on a periodic basis to maintain its target margins after taking into account changes in exchange rates; (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; (4) maintaining a balance between assets held in local currency and in U.S. dollars; and (5) 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 and has cross-currency interest rate swaps and forward currency derivatives in Colombia. 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. The Company reports the gains or losses associated with the revaluation of these monetary assets and liabilities on its Consolidated Statements of Income under the heading "Other income (expense), net." 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 resulted in a 2.9% increase in comparable warehouse club sales for the 13-week period ended June 1, 2014 compared to the same 13-week period the prior year. During the first quarter of fiscal 2014, the Company opened its sixth membership warehouse club in Costa Rica in La Union,


Cartago, and in the most recent quarter opened its third warehouse club in Honduras. In both cases, these new clubs negatively impacted reported comparable warehouse club sales in the period as warehouse sales transferred to these new clubs from existing clubs. With the addition of these new warehouse clubs, the Company grew warehouse sales by 7.6% for the quarter ended May 31, 2014 compared to the same quarter a year ago. In addition, the Company increased the number of member accounts 10.0% over the prior year.

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. Platinum members can apply this rebate to future purchases at the warehouse club at the end of the annual membership period. The Company is currently evaluating the Platinum membership program to determine if Platinum memberships 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 has added local and regional distribution centers in several of its markets to improve merchandise flow and in-stock conditions and reduce operating costs, the benefit of which can be passed on to our members in the form of lower merchandise prices. The Company is evaluating whether to add additional local and regional distribution centers in certain countries.

The Company has the capability to service members through on-line sales. Members have the ability to purchase merchandise that is not stocked in their local warehouse clubs through PriceSmart's e-commerce website. These purchases are shipped from the U.S. distribution warehouse for pick-up at the member's local warehouse club location. In addition, in certain markets, members who do not reside in a city where a PriceSmart warehouse club is located can purchase in-club merchandise on-line from warehouse clubs located within their country and have it delivered to their home or office via a third party delivery service. The Company has been expanding its offerings in these alternative shopping methods, and while the percentage of sales through these channels relative to the Company's overall sales is small, the Company believes it is an important and growing way to serve its membership.

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. In January of fiscal year 2014, the Company acquired land in the southern area of Pereira, Colombia and in the city of Medellin, Colombia and leased land in the city of Bogota, Colombia. The Company is currently constructing new warehouse clubs at these sites that are currently planned to open before the end of calendar year 2014. The Colombia land acquisitions and lease are in keeping with the Company's real estate philosophy. The Company has entered into real estate leases in the past and will likely do so in the future, but 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 recent land purchases in Colombia do not contain excess property beyond that which will be needed by the Company. The profitable sale or development of real estate is highly dependent on real estate market conditions.

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

Net warehouse club sales increased 7.6% over the comparable prior year period. The Company ended the quarter with 33 warehouse clubs compared to 31 warehouse clubs at the end of the third quarter of fiscal year 2013. 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 June 1, 2014 grew 2.9%.

Membership income for the third quarter of fiscal year 2014 increased 8.9% to $9.6 million.

Warehouse gross profits (net warehouse club sales less associated cost of goods sold) in the quarter increased 10.1% over the prior year period and warehouse gross profits as a percent of net warehouse club sales were 14.8%, an increase of 34


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) increased 13 basis points as a percentage of sales compared to the third quarter of last year.

Operating income for the third quarter of fiscal year 2014 was $31.2 million, an increase of $2.7 million over the third quarter of fiscal year 2013.

The Company had a $489,000 net gain from currency exchange transactions in the current quarter compared to a $785,000 net loss from currency exchange transactions in the same period last year.

Net income for the third quarter of fiscal year 2014 was $21.3 million, or $0.70 per diluted share, compared to $18.5 million, or $0.61 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                      47                249                536                 889
Other income (expense),
net - as currently
reported                $             (1 )      $           (265 )     $       (785 )   $           97       $        (954 )

COMPARISON OF THE THREE AND NINE MONTHS ENDED MAY 31, 2014 AND 2013

The Company's fiscal second quarter ended on May 31, 2014.  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 May 31,                    Nine Months Ended May 31,
                                      2014                   2013                 2014                  2013
                              Amount          % Change      Amount         Amount       % Change       Amount
Net warehouse club sales $    597,885            7.6 %    $ 555,815     $ 1,844,746        10.4 %   $ 1,671,269

Comparison of Three and Nine Months Ended May 31, 2014 and 2013

The Company recorded positive sales growth in nearly all countries, the exceptions being Jamaica, that has experienced a significant devaluation of its local currency over the past year (12%) and El Salvador where the Company has also experienced challenges in the economy of the country. The Company recorded double digit sales growth in Colombia, Panama and Aruba and experienced high single digit sales growth in Guatemala and Barbados. The other countries recorded sales growth between 2.5% and 7.2%. The Company opened one new warehouse club in Costa Rica and Honduras compared to the third quarter of fiscal year 2013. Sales growth in Colombia was positively impacted by the full quarter effect of the third warehouse club which opened in May of 2013. Total net warehouse club sales growth of 7.6% during the three months ended May 31, 2014 resulted from a 7.3% growth in transactions and a 0.2% growth in average ticket.

Sales for the nine months ended May 31, 2014 continued to reflect positive sales growth in all countries with the exception of Jamaica which has experienced a 12% devaluation of its currency over the past 12 months. The additional sales of one new warehouse club in each of Colombia and Costa Rica during the nine months ended May 31, 2014, compared to the nine-month period ended May 31, 2013, contributed a 4.3% increase in sales. The Company opened a new warehouse club in Honduras on May 1, 2014, which had not yet materially affected sales growth through May 31, 2014.


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 were not 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. 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 . . .

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