Earnings Call Transcript - PSMT Q3 2022

Operator, Operator

Good afternoon, everyone, and welcome to PriceSmart, Incorporated's Earnings Release Conference Call for the Third Quarter of Fiscal Year 2022, which ended on May 31, 2022. After remarks from our company's representatives, Ms. Sherry Bahrambeygui, Chief Executive Officer, and Michael McCleary, Chief Financial Officer, you will be given an opportunity to ask questions as time permits. As a reminder, this conference call is limited to 1 hour and is being recorded today, Tuesday, July 12, 2022. A digital replay will be available following the conclusion of today's conference call through July 19, 2022, by dialing 1 (877) 344-7529 for domestic callers or 1 (412) 317-0088 for international callers and by entering the replay access code 6291871. For opening remarks, I would like to turn the conference over to PriceSmart's Chief Financial Officer, Mr. Michael McCleary. Please proceed, sir.

Michael McCleary, CFO

Thank you, operator, and welcome to the PriceSmart earnings call for the third quarter of fiscal year 2022 that ended on May 31, 2022. We will be discussing the information that we provided in our earnings press release in our 10-Q, which were both released yesterday afternoon, July 11, 2022. You can find these documents on our Investor Relations website at investors.pricesmart.com, or you can also sign up for e-mail alerts. As a reminder, all statements made on this conference call other than statements of historical fact are forward-looking statements concerning the company's anticipated plans, revenues and related matters. Forward-looking statements include, but are not limited to, statements containing the words expect, believe, plan, will, may, should, estimate and some other expressions. All forward-looking statements are based on current expectations and assumptions as of today, July 12, 2022. These statements are subject to risks and uncertainties that could cause actual results to differ materially, including the risks detailed in the company's most recent annual report on Form 10-K and other filings with the SEC, which are accessible on the SEC's website at www.sec.gov. These risks may be updated from time to time. The company undertakes no obligation to update forward-looking statements made during this call. Now I will turn the call over to Sherry Bahrambeygui, PriceSmart's Chief Executive Officer.

Sherry Bahrambeygui, CEO

Thank you, Michael. Good day, everyone, and welcome to our third quarter fiscal '22 earnings call. Sales momentum continued during the third quarter, and we almost reached our $1 billion mark again, finishing at about $999 million, similar to last quarter. Our company is achieving significant sales and progressing positively. Net merchandise sales grew by 16.5% despite a negative 2.3% currency impact, and comparable net merchandise sales increased by 12.8% after considering a negative 2.2% impact. Membership accounts rose to 1.75 million, setting a new record with a strong renewal rate of 88.9%. Although margins are a key focus today, our total gross margin dollars increased by 4% compared to the same prior year period. However, merchandise gross profit as a percentage of net merchandise sales decreased to 14.2%, down 170 basis points from last year. As mentioned in our earnings release, like many retailers, we have faced challenges due to global supply chain disruptions and sudden shifts in consumer demand. Our hardlines and non-food categories are primarily composed of imported items that are affected by discretionary spending. Consequently, we made strategic inventory investments months ago to remain stocked and capture higher sales. Since then, the environment has changed extensively, marked by global supply chain disruptions, including COVID-related port closures in Asia, container shortages, and rising freight and fuel costs, along with inflation impacting consumer demand. This has led to excess inventory, mainly in hardlines. In response, we are actively working to sell through this excess inventory and rebalance our inventory mix, which has resulted in higher-than-normal markdowns in Q3. Our goal is to efficiently handle this situation to prepare for the holiday season and ideally sell through most of this by the end of Q4. We view this as a temporary issue; we have gained valuable insights and expect to return to a healthy historical margin structure soon. In Q3, our gross margin percentage was primarily impacted in two significant ways. The first was a 100 basis point reduction in margin percentage due to markdowns on excess inventory. For inventory sold in Q3 and that remaining at the end of May, unforeseen factors could affect the timeline, but we are aiming to sell this by the end of Q4. The second factor, responsible for 35 basis points, was the increased costs associated with fuel, freight, and handling, which we did not pass on to our members in Q3. We do not expect this to recur in the next quarter, as this past quarter included an unusually high proportion of these costs. Significant swings in spot rates for non-contracted freight from Asia, as well as substantial increases in U.S. transportation and third-party storage costs resulting from excess inventory, contributed to these issues. Other margin compression factors included a reduction in our COVID accrual, resulting in a lower need to accrue compared to last year, and steps taken to increase compensation for U.S. distribution center employees due to competitive market conditions. We anticipate our inventory levels will remain slightly above historical levels due to ongoing supply chain complexities, but we are committed to reducing our inventory days toward historical levels in the coming quarters. We expect margin percentage compression to continue in the range of 25 to 50 basis points into Q4 based on excess inventory. We believe this situation is temporary, and we acted promptly once we recognized the challenges. We are proactively working to sell excess inventory and revert to our standard inventory balance and typical margin structures. To clarify our expectations for future margin compression, we are sharing our best assessment for Q4. Turning to the results of our third quarter, our membership base grew to a record 1.75 million accounts, representing a 6.6% increase compared to last year. Our 12-month membership renewal rate was 88.9%, and membership income reached a record $15.4 million, up 7.8% over the same period last year. Looking ahead to Q4, our total net merchandise sales for the month ending June 30, '22, was $321.4 million, which marked a 15.5% increase compared to last year. Comparable merchandise sales for the four-week period ending June 26, '22, grew by over 11.8%. Currency fluctuations continued to negatively affect both net merchandise and comparable net merchandise sales by 2.5% and 2.8%, respectively, in June. Trinidad faced significant club closures and restrictions on non-essential merchandise sales last year. The increase in Trinidad sales this June compared to June 2021 positively impacted net merchandise and comparable merchandise sales by 2.3% and 3%, respectively. We are pleased with the ongoing strong sales growth, which we believe sets a solid foundation for the last quarter of this fiscal year. Now, regarding our growth drivers, as we've mentioned in previous calls, we focus on expanding our geographic footprint through real estate, enhancing membership value, and driving incremental sales through our online platform and technology investments. We marked our 50th club milestone with the opening of our Portmore Club in April, our second club in Jamaica. The support we received during the opening was impressive, highlighting our strong presence and reputation in that market. Initially, we expected new sign-ups to be lower, yet they were 25% higher than anticipated in the first month, and our net merchandise sales exceeded forecasts by over 12%. This club was important for alleviating the pressure on our Kingston location, which had been experiencing long lines and access difficulties. Our goal was to improve the experience for our members, and while some sales have shifted, Portmore is performing exceptionally well on its own. We are excited about these early results and optimistic about future opportunities. Our real estate team is actively adding to our club locations. We guided two new clubs into the construction pipeline and announced plans to open a smaller format warehouse club in San Miguel, El Salvador, in spring 2023, our third club in that country. We are finding ways to drive more sales potential with lower capital investment in smaller formats. We are also constructing a smaller format warehouse club in the affluent El Poblado area of Medellin, Colombia, which will be our second club in Medellin and tenth in Colombia by summer 2023. Once these two clubs open, we will operate 52 warehouse clubs, and we are exploring additional opportunities. Our real estate strategy also emphasizes the importance of distribution centers to enhance efficiency and reduce risk, allowing us to serve multiple clubs more effectively. We are currently reviewing potential sites for local distribution centers in Central America, the Caribbean, and Colombia, as well as a regional distribution center in the Northern Triangle countries. This will create alternative routes for imports from Asia, supporting job creation in key markets. We're also working on a sustainable packaging plant in Trinidad set to begin operations around the end of August. This project addresses several key company objectives, such as near-sourcing products, vertical integration, and enhancing our B2B business. The packaging will be compostable or recyclable, supporting our environmental goals. Additionally, this initiative aims to generate more U.S. dollars to support our Trinidad operations by selling these items to other markets. Regarding membership benefits, during the first nine months of fiscal 2022, our private label sales accounted for 24.2% of total merchandise sales, up from 21.7% in fiscal year '21. Private label offerings differentiate us from competitors, providing our members with quality merchandise at competitive prices. Unfortunately, my computer just shut down. Michael, would you like to take over your section, and then we can return to the remaining topics?

Michael McCleary, CFO

Okay. I'll do that. So thanks, Sherry. Good morning or afternoon to everyone, and thanks for joining us today to talk about our third quarter results. Total revenues and net merchandise sales came in at $1.03 billion and $999 million for the quarter, respectively, increasing of 15.1% and 16.5% over the comparable prior year period, respectively. We ended this quarter with 50 warehouse clubs compared to 47 warehouse clubs at the end of the third quarter of fiscal 2021. Our comparable net merchandise sales growth for our fiscal third quarter was 12.8% for the 13 weeks ended May 29, 2022. Foreign currency fluctuations had a negative impact on net merchandise sales and comparable net merchandise sales growth of 2.3% and 2.2% or approximately $19.1 million and $18.6 million, respectively. By segment, in Central America, where we had 27 clubs at quarter end, net merchandise sales increased 12.7% with a 9.7% increase in comparable net merchandise sales. Foreign currency fluctuations had a negative impact on both net merchandise and comparable net merchandise sales growth in Central America of approximately 2.8% during the quarter. All of our markets in Central America had positive comparable net merchandise sales growth, except for Guatemala, which had a small negative comp due to sales transfers from other clubs following the opening of our new Aranda Club. In the Caribbean region, where we had 14 clubs at the quarter end, all of our markets had positive comparable net merchandise sales growth with total net merchandise sales increasing 21.4% and comparable net merchandise sales increasing 17.4%. Trinidad and Tobago net merchandise sales increased 22.8% for the quarter and contributed 1.9% of the total net merchandise sales growth of 16.5%. The significant improvement versus the prior period was due to COVID-19 closures last year combined with our decisions to increase imported inventory levels in the current period to meet current demand, which has helped to increase sales as our ability to source additional U.S. dollars has improved. In Colombia, where we had 9 clubs open at quarter end, net merchandise sales increased 25% and comparable net merchandise sales increased 18.1%. These significant growth levels were achieved despite the impact that the devaluation of the Colombian peso had on merchandise and comparable net merchandise sales growth in Colombia of approximately 7% and 6.8%, respectively, during the quarter. In terms of merchandise, we saw our food category grow approximately 10% compared to the same quarter in the prior year. Our cleaning, beverages, and oils and condiments departments led the way with 11%, 33%, and 23% growth, respectively. Our fresh category grew 14% compared to the same quarter in the prior year, led by our poultry, seafood, and meat departments with 18%, 15%, and 11% growth, respectively. Our non-foods category where we took significant markdowns in several areas, such as sporting goods, garden and patio, and TVs grew 18% compared to the same quarter in the prior year. Improved conditions in Trinidad and Tobago also boosted sales growth for our non-foods categories as these categories have generally performed quite well in this market. Finally, our other business category rebounded with 16% growth primarily from our food service and bakery departments and growth in our optical services and sales. Turning to margins. Total gross margins on the merchandise sales were 14.2% for the quarter versus 15.9% for the same period last year. As Sherry described, this decrease was from a variety of factors, including pricing actions taken to reduce inventory levels of seasonal and high cube merchandise, primarily in our non-foods categories, increased freight and handling costs, and a reduction of the premium we applied to our sales prices to offset our COVID-related operating costs. Total revenue margins decreased 220 basis points to 15.6% of total revenues when compared to the same period last year. This revenue margin decrease is primarily attributable to the 170 basis point decline in gross margins and a decrease of 40 basis points due to the sale of Aeropost during the first quarter. SG&A expenses decreased during the quarter by 130 basis points as a percentage of total revenue, primarily due to the sale of Aeropost, which lowered warehouse club and other operating expenses and general and administrative expenses by 50 basis points each for a total of 100 basis points. Operating income for the quarter decreased 6.3% from the same period last year to $36.1 million. Other expense of $2.4 million was primarily driven by $2 million in transaction costs associated with converting Trinidad dollars into available tradable currencies. Our effective tax rate for the third quarter of fiscal 2022 came in higher than last year at 33.7% versus 30.9% a year ago with our year-to-date rate coming in at 32.8%. This increase in the quarter was primarily related to comparatively unfavorable changes in uncertain tax positions and valuation allowances on our foreign tax credits. On a go-forward basis, we continue to estimate an annualized effective tax rate of 33% to 34%. Net income for the third quarter of fiscal 2022 was $19.3 million or $0.62 per diluted share compared to $22.5 million or $0.73 per diluted share in the comparable prior year period. Moving on to the balance sheet. We ended the quarter with cash, cash equivalents, and restricted cash totaling $222.7 million. From a cash flow perspective, for the 9 months ended May 31, 2022, cash provided by operating activities decreased $15.7 million compared to the prior year, which was primarily a result of non-working capital changes on the balance sheet of $22.3 million. These changes were primarily due to prepaid expenses and income taxes, which increased due to higher sales volume and VAT paid, which increased due to higher inventory. Another contributor to the change in cash flows from operations was our inventory position which increased to $461 million as of May 31, 2022, versus $336.6 million as of May 31, 2021. As Sherry mentioned, this was due to a combination of factors, including purchasing patterns, supply chain disruptions, inflation, and the addition of 3 new clubs. We've taken various actions in Q3, and we're taking further actions in Q4 to continue reducing our inventory days on hand. Net cash used in investing activities decreased by $32.6 million for the 9 months ended May 31, 2022, compared to the prior year, primarily due to the decrease in balances of certificates of deposit compared to the same period a year ago due to a significant improvement or a decrease in our balance of Trinidad dollars on hand versus the prior year. With respect to Trinidad, our balance of Trinidad dollar-denominated cash, cash equivalents, and short and long-term investments measured in U.S. dollars improved this year, decreasing $24.1 million from our fiscal year 2021 ending balance of $52.9 million to approximately $28.8 million. The $100.3 million change from cash used in to cash provided by financing activities for the 9 months ended May 31, 2022, is primarily the result of obtaining additional Trinidad-related financing in the current year along with lower net repayments of short-term debt compared to the same 9-month period a year ago when we were repaying short-term facilities accessed at the early stages of the COVID-19 pandemic. In closing, although our results for the quarter were hampered by significant markdowns in freight and handling costs, we believe that the fundamentals of our business remain strong with continued sales growth and solid membership acquisitions and renewal rates. The entire PriceSmart team continues to put in maximum effort to serve our members despite the significant challenges we face while staying true to our legacy and working to build the future. We believe our value proposition, the investments we are making in our team and technology and how we conduct our business resonates with our members and within our communities. So that wraps up my section. Sherry, are you ready to finish up yours or should we move on to Q&A? Sherry, are you there?

Sherry Bahrambeygui, CEO

Thank you for stepping in, Michael. I think we're now ready to go. Regarding membership benefits, we left off discussing private label. We are continuing with our well-being services and seeing positive results, especially with optical and audiology. Currently, we have 47 optical centers and expect to have 49 open by year-end. This service offers four free eye exams with every membership, and we've conducted over 88,000 eye exams in the first nine months of the fiscal year, including nearly 1,000 exams and eyeglasses for local school children. We are excited about providing this service not only for our members but also to support our local communities. In Costa Rica, all eight of our warehouse clubs will have pharmacy centers, and we expect to add pharmacies in all seven of our clubs in Panama by the end of fiscal year 2023. We are also assessing the possibility of opening pharmacies in other countries, which may vary based on regulatory conditions. Our third growth driver involves leveraging pricesmart.com to drive additional sales and improve efficiencies through digital capabilities. Currently, total e-commerce sales represent 3.6% of total merchandise sales. Compared to the same period last year, online sessions increased by 10%, leading to a 7% rise in online orders, while the average online order value rose by 14%. We are seeing encouraging trends regarding how our members engage with their online experience at pricesmart.com. Our digital capabilities have also positively impacted new member enrollment. To provide context, about one-third of our operating income comes from membership fees, with the remaining two-thirds from profits on our sales and services. By enhancing membership value, we can potentially justify fee increases or ensure more reliable fee collections, which would significantly boost our operating income. We can now sign up members online, with 14% of new memberships purchased online last quarter and online renewals making up 4% of total renewals. As of May 31, 2022, roughly 46.6% of our members have created an online profile with pricesmart.com. In under two years, we have increased this from 0 to nearly half of our membership base having an online digital credential. Furthermore, 12.5% of our total membership has made purchases on pricesmart.com, and the average online purchase value in Q3 was 31.5% higher than in-club purchases. Our omnichannel members, who shop both online and in-store, placed about three more orders than those shopping only in-store, with their orders growing by 14% and average spending increasing by 25% compared to the previous fiscal third quarter. We acknowledge that these omnichannel members typically tend to spend more, but we still observe growth even when comparing this group against itself. Additionally, 8% of our total membership, which equates to 1.75 million accounts, is enrolled in our auto-renewal option, with many having credit cards on file. The increase in online auto-renewals with credit cards stabilizes a portion of our operating income, allowing for more predictable revenue forecasting since this income can be counted on for at least a year. The likelihood of this income repeating for the following year improves with members set up for auto-renewal. This stability is especially beneficial in an environment with many unpredictable factors affecting our sales. Our aim is to continue enhancing this aspect for better revenue projection and to minimize any leakage from membership fee renewals. Concerning our commitment to ESG and sustainability, we remain dedicated despite challenges related to inflation and the global economy. We strive to foster a healthy environment for our employees, members, vendors, and the communities around us. This includes initiatives like the recycling center we opened in San Pedro Sula, Honduras, which shows promise, and we plan to establish two more centers in Honduras by the fiscal year's end. These centers allow community members to bring their recyclables and sometimes receive payment for them. Lastly, we continue investing in our relationships with the U.S. administration and the governments of the markets we serve. We participated in the summit of the Americas last month, providing an opportunity to moderate a panel with three presidents from our markets, as we work to strengthen our relationships and ensure good communication and access. This way, we can maintain a better understanding of our markets and demonstrate the value we bring to those countries and communities. I want to express my gratitude to our team, particularly in buying and finance, for swiftly addressing our inventory challenges, as well as logistics and operations for managing inventory effectively to return to normal inventory flow by the end of the fourth quarter. Thank you all for your patience with the technical issues, and I hope you have a great day.

Operator, Operator

And the first question will come from Rodrigo Echagaray with Scotiabank.

Rodrigo Echagaray, Analyst

A couple of questions from my side. I want to clarify, if I understood correctly, you said the non-food categories grew in the teens in the quarter. Did I misunderstand?

Michael McCleary, CFO

Yes, I said 18%, yes. We grew 18%. Sorry, I was on the wrong. I got some technical difficulties of my own. Sorry, yes, it went up 18%.

Rodrigo Echagaray, Analyst

So I guess what I'm curious to understand is the markdowns in the context of same-store sales in the double digits, also within non-food categories. And I guess when I look at what happened in Q1 or the first half of the year at some of the retailers in the U.S. that face some similar challenges on excess inventory, there was a much sharper slowdown on the top line, which does not appear to be there, at least, not in Q3 for you guys. So is that — how should we read that? Is that an expectation that Q4 is going to be extremely challenging?

Sherry Bahrambeygui, CEO

Rodrigo, are you referring to — with regard to generating top line sales?

Rodrigo Echagaray, Analyst

Right. So I'm trying to understand the markdowns in the context of a healthy top line and within that strong sales on the non-food categories, which — it sounds like that's where you had the excess — or you have the excess inventory?

Sherry Bahrambeygui, CEO

Right. Right. So you're perhaps trying to distinguish between the healthy sales growth and sales growth that may be just the result of markdowns below cost, is that —

Rodrigo Echagaray, Analyst

I guess is that the best way to understand the dynamics in Q3 and the markdowns?

Sherry Bahrambeygui, CEO

Well, I mean, certainly, one could look and say, sales were impacted by the fact that merchandise was marked down significantly, but there are a number of different factors. One is our top line sales have been consistently growing. And just to give you some context, approximately 17% of our sales in Q3 were for non-food. Of that, about two-thirds of it was in hardlines and approximately one-third within softlines. And it was only with respect to a portion of the hardlines that we had this excess inventory. And I think, Michael, have you quantified that as of the end of May, the amount of excess inventory, what we deem to be excess in the hardline? Is that —

Michael McCleary, CFO

Yes, we’re yes, we’ve increased our days on hand targets because of all the supply chain complexities. But when you carve that out, we’re estimating that we’re probably about $20 million to $30 million higher than we would like to be in general as of the end of Q3 for - between hardlines and softlines. But I think to your question about markdowns and does that signal a slowdown, I mean we did — Sherry did share the June comps, right, 11.8%. So you do have an indicator of the direction of sales — that sales are headed, at least for the first month of the quarter. And I think Sherry has also emphasized that we’ve really been trying to clear out this problem and that doesn’t necessarily mean that there’s going to be a slowdown. We’re just trying to work through some of the backlog we have of overlapping programs and most importantly, just cleaning things up, so that when the red and green starts hitting at the beginning of the fiscal year that we have space for it, and we’re out of this stuff that’s kind of accumulated. So I don’t think we’re directly linking markdowns to a slowdown in growth at this point. I mean, obviously, at some point, the higher ticket items, housing inflation impact, but — and we’re especially focused on those. The current quarter, we’re working on a furniture program, which has some higher ticket items, and we have to keep an eye on those, but we’re not directly projecting a slowdown at this point.

Sherry Bahrambeygui, CEO

Now to fill that in a bit, Rodrigo, if your question is with regard to the excess inventory, I’ll reiterate what Michael is saying is we don’t see the excess inventories being a cause for a slowdown. There are other factors our business is facing. I mean — and we can’t really predict other than FX as providing major headwinds, Colombia’s FX, Costa Rica’s FX. Whether or not that results in a slowdown remains to be seen, I mean we have been operating with significant FX headwinds more so than historically, I think, for a couple of years now and we’ve managed to continue to grow sales. So clearly, we have to continue doing what we do best, and we know we’re in tough markets with currencies that fluctuate and at least more recently, over the past few years, don’t fluctuate in our favor very often, but we’re still delivering sales growth and healthy comps and that is through all the multitude of decisions we make along the way in order to achieve those sales. So I can’t answer — I couldn’t answer to you whether or not there will be a slowdown because, again, there are so many factors that are beyond our control. All I can tell you is that we’re very conscious of them, and we’re trying to make the right business decision every day to be able to keep the members happy, keep the memberships renewing, grow the membership base and generate those sales.

Rodrigo Echagaray, Analyst

Got it. And so I guess maybe a better way to ask that same question is, would it be fair to say that the expectations were much higher for certain hardlines in terms of top line for Q3, and that's where the excess inventory came from just on the expectations front rather than weakness on the top line in terms of consumers already adopting?

Sherry Bahrambeygui, CEO

To the extent, we’re not clear about it. There’s no doubt, I mean, when we were making these — remember, these hardlines usually have long lead times. And the decisions regarding consumer preferences and what we anticipate the market will demand are made nine months — six months, nine months, 12 months in advance of the time that the consumer will actually be in a position to transact. So in an environment where things are shifting pretty significantly back and forth, we did take a point of view. And we took a point of view that we are going to make a strategic investment in more inventory with the expectation that we would be able to capture higher sales and be able to sell these items. After that is really when a number of these other factors came together and sort of created a perfect storm, even though some of it was ongoing, but we saw the Asia club — Asia port closures increasing more extensively. What would happen is we’d have merchandise there, ready to go, it was seasonal. No one was there to put it on the ship to us. But then we’d have the next season coming up on the heels of the prior season’s merchandise. And by the time the first season got to the clubs, it was almost — it almost ran out of time in the schedule, so we have 2 rotational seasons backed up. That’s the kind of challenge that we didn’t — we couldn’t predict. It was caused again by the supply chain disruption, the unexpected closures, the unavailability of containers, but that’s what we were faced with at a time when we basically took a point of view that we want to have the in-stocks, and we want to push for the sales. Now as it turns out, looking back, had we known all these other things would happen as well, we probably wouldn’t have taken that same point of view.

Rodrigo Echagaray, Analyst

No, that makes sense. Yes, for sure. I think I get it. It may makes sense.

Sherry Bahrambeygui, CEO

Yes, I think it’s important to recognize, again, we’re not happy about it, but it’s a point in time. It’s a point in time where these different variables came together and resulted in the current situation with excess inventory and we are, as a result, addressing it directly and as quickly as we can to get back on track. And we don’t see it as a development that should continue on an ongoing basis or something that we have an issue with in terms of our ordinary course of business and how we do business and make decisions.

Rodrigo Echagaray, Analyst

That makes sense. And just another question to clarify. If I understood correctly, the expectation is that, roughly speaking, the impact on gross — consolidated gross margins in Q4 is upwards to 50 bps just on the excess inventory issue, if I understood correctly.

Sherry Bahrambeygui, CEO

We’re estimating within a range of 25 to 50 basis points to account for the rest of the merchandise that has not yet been sold and the compression on that merchandise has not already been accounted for in your Q3 numbers — in our Q3 numbers, which you see. And that the residual that would be about 25 to 50 basis points, which again we’ve got to have more sales information in terms of trends, but we think we should be out by the end of Q4.

Rodrigo Echagaray, Analyst

Given the short-term challenges we are facing and the normalization of excess margin, what do you see as a reasonable expectation for gross margins moving forward? I'm not asking for specific guidance, but I'm trying to gauge where you feel comfortable with gross margins considering these two issues that are affecting visibility.

Sherry Bahrambeygui, CEO

This is an area that comes up over and over again. And I personally have wondered how someone in your position can rely solely on a gross margin percentage because knowing what we know about how our business operates and how it’s evolved, I think we talked about this before, historically, almost all of our sales were the result of purchasing merchandise, marking it up, getting it to the clubs and selling it. As a business, we’ve intentionally evolved and have developed new capabilities and have expanded ways that we think we can either create greater value or create efficiencies. And as a result, we’ve got more than just purchasing items and then getting them to the club. And the examples are the produce distribution center — I mean, I’m sorry, our farm program, direct farm program. We’ve invested our own people in identifying and teaching farmers food safety and helping identify what they need to be able to provide a reliable source of produce to a company like ours; we’ve invested in a produce distribution center. We’ve invested in teaching them food safety and handling. That is more like getting involved in actually creating or a business that then supplies us. And as a result, the margin structure on that program is different. It’s higher. But we only will do something like that if we feel, ultimately, the product that comes from that is going to be as good, if not better quality, and a better price for the member. And in that circumstance, there’s — and will still remain very competitive and maintain our typical comp umbrella. So in that circumstance, you’re going to see a higher margin percentage that’s applied to that specific function.

Rodrigo Echagaray, Analyst

Yes, that makes sense. Efficiencies that were not there before should be accounted for, but tough to put a number around that. But I guess I do have a good perspective with these comments in that not necessarily going back to a 16% range, necessarily makes sense just because that used to be the gross margin, especially after these investments have been made.

Sherry Bahrambeygui, CEO

But in some cases, the gross margin may be higher in certain ways of our business. So for example, private label. As we’re expanding private label, what we’re really doing is we’re getting more involved in product development ourselves. That requires more expertise. It’s more investment on our part; it’s more involvement further up in the supply chain. Once again, that would, in some cases, merit a different margin structure. But the bottom line is we have to always tie it back to, are we giving the greatest value we can to the member? Do we have a healthy comp umbrella? Have we squeezed out the inefficiencies? And all eyes are on that effort, but we recognize that when we have to participate so much more than just identifying the merchandise and then getting it to the club, that the shareholders must have a return on the investment that it requires from us to be able to create that opportunity and make it available.

Operator, Operator

That is all the time we have for today's call. I would now like to turn the call back over to management for any closing remarks.

Sherry Bahrambeygui, CEO

We do not have — can you hear me? Okay. We want to thank our shareholders and our employees for continuing to stand strong with us as we navigate some choppy waters. But again, this was a limited time, limited scope situation in our view. And our focus remains on the medium-term and long-term growth of the company and continuing to invest in that and make sure that we are doing our best for the future. So thank you for being with us today.

Operator, Operator

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.