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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended February 28, 2003

OR

For the transition period from                      to                     

COMMISSION FILE NUMBER 000-22793

PriceSmart, Inc.

(Exact name of registrant as specified in its charter)

4649 Morena Boulevard

San Diego, California 92117

(Address of principal executive offices)

(858) 581-4530

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x  No  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes  ¨  No  x

The registrant had 6,871,913 shares of its common stock, par value $.0001 per share, outstanding at March 31, 2003.

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PRICESMART, INC.

INDEX TO FORM 10-Q

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PART I—FINANCIAL INFORMATION

PriceSmart, Inc.’s (“PriceSmart” or the “Company”) unaudited condensed consolidated balance sheet as of February 28, 2003, the condensed consolidated balance sheet as of August 31, 2002, the unaudited condensed consolidated statements of operations for the three and six months ended February 28, 2003 and 2002, the unaudited condensed consolidated statements of cash flows for the six months ended February 28, 2003 and 2002, and the unaudited condensed consolidated statements of stockholders’ equity for the six months ended February 28, 2003 are included elsewhere herein. Also included within are notes to the unaudited condensed consolidated financial statements.

This quarterly report contains forward-looking statements concerning the Company’s anticipated future revenues and earnings, adequacy of future cash flow and related matters. These forward-looking statements include, but are not limited to, statements containing the words “expect,” “believe,” “will,” “may,” “should,” “project,” “estimate,” “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 involves risks, including the imposition of governmental controls and general political, economic and business conditions; any failure by the Company to manage its growth could adversely affect its business; the Company faces significant competition; the Company may encounter difficulties in the shipment of goods to its warehouses; the success of the Company’s business requires effective assistance from local business people with whom the Company has established strategic relationships; the Company is exposed to weather and other risks associated with international operations; declines in the economies of the countries in which the Company operates its warehouse stores would harm its business; substantial control of the Company’s voting stock by a few of the Company’s stockholders may make it difficult to complete some corporate transactions without their support and may prevent 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; the Company faces the risk of exposure to product liability claims, a product recall and adverse publicity; and a determination that the Company’s goodwill and intangible assets have been impaired as a result of a test under Statement of Financial Accounting Standards (“SFAS”) No. 142 could adversely affect the Company’s future results of operations and financial position; as well as the other risks described in the Company’s Securities and Exchange Commission (“SEC”) reports, including the Company’s Form 10-K filed pursuant to the Securities Exchange Act on November 29, 2002.

The following discussion and analysis compares the results of operations for the three and six months ended February 28, 2003 (fiscal 2003) and February 28, 2002 (fiscal 2002), and should be read in conjunction with the condensed consolidated financial statements and the accompanying notes included elsewhere herein.

PriceSmart’s business consists primarily of international membership shopping stores similar to, but smaller in size than, warehouse clubs in the United States. The number of warehouses in operation as of February 28, 2002 and 2003, the Company’s ownership percentages and basis of presentation for financial reporting purposes by each country or territory are as follows:

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The Company’s business strategy is to operate stores in Latin America, the Caribbean, and Asia that sell high quality merchandise at low prices to our customers, fair wages and benefits to our employees and a fair return to our stockholders.

Same-store sales, which are for stores open at least 12 full months, decreased 0.5% and 0.7% for the 13 and 26 weeks ended March 2, 2003, respectively, compared to the same periods last year. Sales and gross profit margins have been negatively impacted in the current year due in part to declining economic conditions, devaluation of foreign currencies and increased competition over the prior year period in several of the markets in which the Company operates. In the event that these factors continue, sales and gross profit margins may continue to be adversely affected.

During the first six months of fiscal 2003, the Company opened one new U.S.-style membership shopping warehouse in Alabang, Philippines, and as part of a 50/50 joint venture with Grupo Gigante, S.A. de C.V. (“Gigante”), the Company also opened two new U.S.-style membership shopping warehouses in Mexico. During the first six months of fiscal 2002, the Company opened two new U.S.-style membership shopping warehouses (one in Trinidad and one in the Philippines). The average life of the 27 and 24 warehouses in operation at the end of February 28, 2003 and 2002 was 31 and 22 months, respectively.

Subsequent to February 28, 2003, the Company opened two additional warehouses, one in Jamaica and one in Mexico (as part of a 50/50 joint venture). Additionally, there were twelve licensed warehouse stores in operation at the end of the second quarter of fiscal 2003, compared to ten licensed warehouse stores at the end of the second quarter of fiscal 2002.

COMPARISON OF THE THREE MONTHS ENDED FEBRUARY 28, 2003 AND 2002

Net warehouse sales increased 8.6% to $183.2 million in the second quarter of fiscal 2003, from $168.6 million in the second quarter of fiscal 2002. The increase is attributable to three new warehouses in Asia since the end of the second quarter of fiscal 2002, offset slightly by a decrease in sales in our Latin America and Caribbean regions due to a slower than anticipated holiday sales.

The Company’s warehouse gross profit margins (defined as net warehouse sales less associated cost of goods sold) in the second quarter of fiscal 2003 decreased to 13.7% from 14.4% in the second quarter of fiscal 2002. The decrease in gross profit margins of 70 basis points resulted primarily from lower non-food sales, aggressive pricing and markdowns over the prior year period.

Export sales represent U.S. merchandise exported to the Company’s licensee warehouses operating in Saipan, direct sales to third parties and sales to PriceSmart Mexico, an unconsolidated affiliate (see “Note 12-Related Party Transactions” in the Notes to Condensed Consolidated Financial Statements included within). Export sales in the second quarter of fiscal 2003 were $1.1 million compared to $285,000 in the second quarter of fiscal 2002. The increase is primarily due to greater sales to third parties, including sales of $305,000 to PriceSmart Mexico.

The Company’s export sales gross profit margins for the second quarter of fiscal 2003 were 4.6% compared to 1.8% in the second quarter of fiscal 2002. The increase in gross profit margins was due to higher margins on third party sales (excluding Mexico). The gross profit margins from sales to the Company’s Saipan licensee and sales to PriceSmart Mexico are approximately 2.5% and 0.4%, respectively.

Membership fees, which are recognized into income ratably over the one-year life of the membership, increased 2.4% to $2.24 million, or 1.2% of net warehouse sales, in the second quarter of fiscal 2003 compared to $2.18 million, or 1.3% of net warehouse sales, in the second quarter of fiscal 2002. The increase in amounts was due to additional stores and the 10 basis point decrease is attributable primarily to the Caribbean and Asia region’s lower average membership fees in both markets and a reduction in total active members in several Caribbean markets.

Other income consists of rental income, advertising revenues, construction revenue, vendor promotions and rebates, and fees earned from licensees. Other income, excluding licensee fees, decreased to $2.2 million, or 1.2% of net warehouse sales, in the second quarter of fiscal 2003 from $2.3 million, or 1.4% of net warehouse sales, in the second quarter of fiscal 2002. The decrease in amounts in the current year was primarily related to lower third party construction revenues and lower rental and ad revenues. Licensee fees increased to $312,000 in the second quarter of fiscal 2003 from $295,000 in the second quarter of fiscal 2002, due to two additional licensee warehouses opened.

Warehouse operating expenses increased to $19.8 million, or 10.8% of net warehouse sales, in the second quarter of fiscal 2003 from $18.0 million, or 10.7% of net warehouse sales, in the second quarter of fiscal 2002. The increase in warehouse operating expenses is attributable to the three new warehouses opened in Asia since the second quarter of fiscal 2002 and an increase in property insurance, utility costs and an increased percentage of credit card usage, offset by a reduction in payroll related costs.

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General and administrative expenses were $4.8 million, or 2.6% of net warehouse sales, in the second quarter of fiscal 2003 compared to $4.2 million, or 2.5% of net warehouse sales, in the second quarter of fiscal 2002. General and administrative expenses have increased by approximately $550,000 over the prior year second quarter primarily due to an increase in both internal and external tax and audit related activities and higher legal related costs.

Settlement and related expenses of $1.7 million in fiscal 2002 reflect a settlement agreement entered into with a former Philippine licensee of the Company on February 15, 2002.

Pre-opening expenses, which represent expenses incurred before a warehouse store is in operation, decreased to $288,000 in the second quarter of fiscal 2003 from $742,000 in the second quarter of fiscal 2002. The Company had no warehouse openings in the second quarter of fiscal 2003, with one opening subsequent to quarter end, compared to one opening in the second quarter of fiscal 2002, with one opening subsequent to the quarter end. In addition to the opening of the Jamaica store subsequent to February 28, 2003, the Company anticipates opening one additional store in Nicaragua in the fourth quarter of fiscal 2003.

Interest income reflects earnings on cash and cash equivalents, restricted cash deposits securing long term debt and marketable securities. Interest income was $739,000 in the second quarter of fiscal 2003 compared to $798,000 in the second quarter of fiscal 2002. The decrease in interest income primarily relates to lower daily cash balances and lower interest rates throughout the second quarter of fiscal 2003 in comparison to the prior year period.

Interest expense reflects borrowings by the Company’s majority or wholly owned foreign subsidiaries to finance the capital requirements of new warehouse store operations. Interest expense increased to $2.5 million in the second quarter of fiscal 2003 from $2.3 million in the second quarter of fiscal 2002. The increase is attributable to an increase in the amount of debt held by the Company and its subsidiaries between the periods presented offset by a reduction in lending rates between the periods and a reduction in short term borrowings.

Equity of unconsolidated affiliate represents the Company’s 50% share of losses from its Mexico joint venture. The joint venture is accounted for under the equity method of accounting, in which the Company reflects its proportionate share of income or loss. Two warehouses were opened in Mexico in November 2002 with a third opening in late March 2003. Losses from the Mexico joint venture for the second quarter of fiscal 2003 were $1.3 million, of which the Company’s share was $648,000. The Mexico joint venture was not in operation in last year’s second quarter.

Minority interest relates to the allocation of the joint venture income or loss to the minority stockholders’ respective interests.

The Company recorded an income tax provision of $793,000 (32.9% effective rate) and $854,000 (32.5% effective rate) for the three months ended February 28, 2003 and 2002, respectively. The increase in the effective tax provision rate between the periods presented is primarily a result of increased U.S. income tax expense, partially offset by a lower statutory tax rate in certain foreign countries in which the Company operates. Management expects the effective tax rate to vary period to period due to varying tax rates in its foreign operations and valuation allowances required on deferred tax assets.

Preferred dividends of $400,000 and $191,000 for the three months ended February 28, 2003 and 2002, respectively, reflect the payment of dividends on 20,000 shares of Series A Preferred Stock issued on January 22, 2002, which accrue 8% annual dividends that are cumulative and paid quarterly in cash.

COMPARISON OF THE SIX MONTHS ENDED FEBRUARY 28, 2003 AND 2002

Net warehouse sales increased 10.9% to $345.2 million in the first half of fiscal 2003, from $311.4 million in the first half of fiscal 2002. The increase is primarily attributable to three new warehouses in Asia since the end of the second quarter of fiscal 2002, offset slightly by a decrease in sales in our Latin America and Caribbean regions due to a slower than anticipated holiday season.

The Company’s warehouse gross profit margins (defined as net warehouse sales less associated cost of goods sold) in the first half of fiscal 2003 decreased to 14.1% from 14.5% in the first half of fiscal 2002. The decrease in gross profit margins of 40 basis points resulted primarily from lower non-food sales, aggressive pricing and markdowns over the prior year period, primarily occurring in the second quarter due to slower than anticipated holiday sales.

Export sales represent U.S. merchandise exported to the Company’s licensee warehouse operating in Saipan, direct sales to third parties and sales to PriceSmart Mexico, an unconsolidated affiliate (see “Note 12-Related Party Transactions” in the Notes to Condensed Consolidated Financial Statements included within). Export sales in the first half of fiscal 2003 were $3.7 million compared to $714,000 in the first half of fiscal 2002. The increase is primarily due to greater sales to third parties, including sales of $1.3 million to PriceSmart Mexico.

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The Company’s export sales gross margin for the first half of fiscal 2003 were 5.0% compared to 2.8% in the first half of fiscal 2002. The increase in gross profit margins was due to higher margins on third party sales (excluding Mexico). The gross profit margins from sales to the Company’s Saipan licensee and sales to PriceSmart Mexico are approximately 2.5% and 1.1%, respectively.

Membership fees, which are recognized into income ratably over the one-year life of the membership, increased 2.0% to $4.4 million, or 1.3% of net warehouse sales, in the first half of fiscal 2003 compared to $4.3 million, or 1.4% of net warehouse sales, in the first half of fiscal 2002. The increase in amounts was due to additional stores and the 10 basis point decrease is attributable primarily to the Caribbean and Asia regions as a result of lower average membership fees in both markets and a reduction in total active members in several Caribbean markets.

Other income consists of rental income, advertising revenues, construction revenue, vendor promotions and rebates, and fees earned from licensees. Other income, excluding licensee fees, increased to $4.5 million, or 1.3% of net warehouse sales, in the first half of fiscal 2003 from $4.3 million, or 1.4% of net warehouse sales, in the first half of fiscal 2002. The increase was primarily a result of increased vendor promotions and advertising revenue in the three new warehouse openings in Asia between the periods presented, offset by lower third party construction revenues. Licensee fees increased to $625,000 in the first half of fiscal 2003 from $557,000 in the first half of fiscal 2002, due to two additional licensee warehouse opened.

Warehouse operating expenses increased to $38.5 million, or 11.2% of net warehouse sales, in the first half of fiscal 2003 from $34.9 million, or 11.2% of net warehouse sales, in the first half of fiscal 2002. The increase in warehouse operating expenses is attributable to the three new warehouses opened in Asia since the second quarter of fiscal 2002 and an increase in property insurance, utility costs and an increased percentage of credit card usage, offset by a reduction in payroll related costs.

General and administrative expenses were $9.2 million, or 2.7% of net warehouse sales, in the first half of fiscal 2003 compared to $8.6 million, or 2.8% of net warehouse sales, in the first half of fiscal 2002. General and administrative expenses have increased by approximately $560,000 over the prior year period primarily due to an increase in both internal and external tax and audit related activities and higher legal related costs.

Settlement and related expenses of $1.7 million in fiscal 2002 reflect a settlement agreement entered into with a former Philippine licensee of the Company on February 15, 2002.

Pre-opening expenses, which represent expenses incurred before a warehouse store is in operation, decreased to $864,000 in the first half of fiscal 2003 from $1.6 million in the first half of fiscal 2002. The Company had one warehouse opening in the first half of fiscal 2003, with one opening subsequent to the period end (not including the two stores opened in Mexico as part of a 50/50 joint venture during the first half of fiscal 2003), compared to two in the first half of fiscal 2002, with two opening subsequent to the period end. In addition to the opening of the Jamaica store subsequent to February 28, 2003, the Company anticipates opening one additional store in Nicaragua in the fourth quarter of fiscal 2003.

Interest income reflects earnings on cash and cash equivalents, restricted cash deposits securing long term debt and marketable securities. Interest income was $1.4 million in the first half of fiscal 2003 compared to $1.6 million in the first half of fiscal 2002. The decrease in interest income primarily relates to lower daily cash balances and lower interest rates throughout the first half of fiscal 2003 in comparison to the prior year period.

Interest expense reflects borrowings by the Company’s majority or wholly owned foreign subsidiaries to finance the capital requirements of new warehouse store operations. Interest expense increased to $5.0 million in the first half of fiscal 2003 from $4.6 million in the first half of fiscal 2002. The increase is attributable to an increase in the amount of debt held by the Company and its subsidiaries between the periods presented offset by a reduction in lending rates between the periods and a reduction in short term borrowings.

Equity of unconsolidated affiliate represents the Company’s 50% share of losses from its Mexico joint venture. The joint venture is accounted for under the equity method of accounting, in which the Company reflects its proportionate share of income or loss. Two warehouses were opened in Mexico in November 2002 with a third opening in late March 2003. Losses from the Mexico joint venture for the first half of fiscal 2003 were $2.8 million, of which the Company’s share was $1.4 million. The Mexico joint venture was not in operation last year.

Minority interest relates to the allocation of the joint venture income or loss to the minority stockholders’ respective interests.

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The Company recorded an income tax provision of $1.6 million (33.7% effective rate) and $1.1 million (27.5% effective rate) for the six months ended February 28, 2003 and 2002, respectively. The increase in tax provision between the periods presented is primarily a result of increased U.S. income tax expense, partially offset by a lower statutory tax rate in certain foreign countries in which the Company operates. Management expects the effective tax rate to vary period to period due to varying tax rates in its foreign operations and valuation allowances required on deferred tax assets.

Preferred dividends of $800,000 and $191,000 for the six months ended February 28, 2003 and 2002, respectively, reflect the payment of dividends on 20,000 shares of Series A Preferred Stock issued on January 22, 2002, which accrue 8% annual dividends that are cumulative and paid quarterly in cash.

LIQUIDITY AND CAPITAL RESOURCES

Financial Position and Cash Flow

The Company’s primary capital requirements are the financing of land, construction, equipment costs, pre-opening expense and working capital requirements associated with new warehouse stores.

The Company had working capital as of February 28, 2003 of $10.2 million, compared to $14.8 million as of February 28, 2002. The decrease in working capital of $4.6 million was primarily due to a decrease in cash of $11.2 million, accounts receivable of $4.8 million, reduced short-term borrowings of $3.5 million and other accrued expenses of $1.3 million, and additional capital investment of $9.0 million in the Company’s Mexico joint venture. These decreases were offset by an increase in cash flows as of February 28, 2003, inventories of $1.0 million, prepaid assets of $3.8 million, deferred tax assets of $3.9 million and long-term debt of $1.8 million.

Net cash flows provided by (used in) operating activities were $10.6 million and $(623,000) in the first half of fiscal 2003 and 2002, respectively. The increase of $11.2 million resulted primarily from net income before the equity interest of unconsolidated affiliate of $1.7 million, depreciation and amortization of $1.2 million and a net increase in accounts receivable, prepaids, other current assets, accrued salaries, deferred membership and other accruals of $10.7 million.

Net cash used in investing activities was $21.8 million and $16.1 million in the first half of fiscal 2003 and 2002, respectively. The increase in investing activities of $5.7 million resulted from a $9.0 million capital investment in the Mexico joint venture in the current year and a repayment of notes receivable of $3.8 million in the prior year, offset by reduced spending in property and equipment of $7.0 million over the prior year.

Net cash provided by financing activities was $5.2 million and $28.6 million in the first half of fiscal 2003 and 2002, respectively. The decrease of approximately $23.4 million resulted from proceeds from the issuance of preferred stock of $19.9 million and $2.2 million in stock options in the prior year, and the use of $5.3 million in restricted cash and dividends paid on preferred stock of $800,000 in the current year. These decreases were offset by an increase in net bank borrowings of $2.2 million and the sale of treasury stock of $2.6 million to PSC, S.A. in connection with the new Nicaragua joint venture in the current year.

For fiscal 2003, the Company currently intends to spend an aggregate amount of $32 million in capital expenditures, including $9.0 million in capital contributions already made to the Company’s unconsolidated Mexico joint venture, for new warehouses.

For the first six months of fiscal 2003, the Company has spent approximately $12.8 million in capital expenditures (excluding Mexico) related to the construction of new warehouse openings. The Company, through its majority owned subsidiaries, currently anticipates opening a total of three new warehouses in fiscal 2003, compared to the previously announced four new warehouse openings. To date the Company has opened two new warehouses (one in the Philippines in November 2002 and one in Jamaica in March 2003), and currently has two additional warehouses under construction in Nicaragua and the Philippines. The Nicaragua location is anticipated to open by late August 2003, and the Philippines location is now anticipated to open in the first quarter of fiscal 2004. Actual capital expenditures for new warehouse locations may vary from estimated amounts depending on the number of new warehouses actually opened, business conditions and other risks and uncertainties to which the Company and its businesses are subject.

The Company, primarily through its foreign subsidiaries (excluding Mexico), intends to increase bank borrowings by approximately $15 million during fiscal 2003, including $10 million in loans secured by restricted cash deposits for foreign exchange hedging purposes, depending on the number of stores opened, and to use these proceeds, as well as excess cash generated from existing operations, to finance these expenditures.

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During the first half of fiscal 2003, the Company and Gigante each contributed $9.0 million in capital for a total capital investment of $40 million in the 50/50 Mexico joint venture, which is accounted for under the equity method of accounting. The Company currently does not anticipate making any additional capital contributions to the Mexico joint venture for the remainder of fiscal 2003 but will have receivables due from Mexico in the ordinary course of business, of which approximately $500,000 was due to the Company as of February 28, 2003. Since inception, the joint venture has opened a total of three warehouses in Mexico (two in November 2002 and one in March 2003) and has spent approximately $26.6 million in capital expenditures. Any decision to add additional warehouses will be based upon the three warehouses currently in operation achieving specific sales and expense benchmarks. As of February 28, 2003, the Mexico joint venture had approximately $1.8 million of cash on hand.

The Company believes that borrowings under its current and future credit facilities, together with its other sources of liquidity, will be sufficient to meet its working capital and capital expenditure requirements for the foreseeable future. However, if such sources of liquidity are insufficient to satisfy the Company’s liquidity requirements, the Company may need to sell equity or debt securities, obtain additional credit facilities or reduce the number of anticipated warehouse openings. Furthermore, the Company has and will continue to consider sources of capital, including reducing restricted cash and the sale of equity or debt securities, to strengthen its financial position and liquidity. There can be no assurance that such financing alternatives will be available under favorable terms, if at all.

Financing Activities

On January 22, 2002, the Company issued 20,000 shares of Series A Preferred Stock (“Preferred Stock”) and warrants to purchase 200,000 shares of common stock for an aggregate of $20 million, with net proceeds of $19.9 million. The Preferred Stock is convertible, at the option of the holder at any time, or automatically on January 17, 2012, into shares of the Company’s common stock at the conversion price of $37.50, subject to customary anti-dilution adjustments. The Preferred Stock accrues a cumulative preferred dividend at an annual rate of 8%, payable quarterly in cash. The shares are redeemable on or after January 17, 2007, in whole or in part, at the option of the Company, at a redemption price equal to the liquidation preference, or $1,000 per share plus accumulated and unpaid dividends to the redemption date. The warrants, which expired on January 17, 2003, were exercisable at $37.50 per share of common stock. At February 28, 2003, none of the shares of Preferred Stock had been converted and none of the warrants had been exercised.

On September 26, 2002, in connection with the new joint venture in Nicaragua, the Company sold 79,313 shares of the Company’s common stock to PSC, S.A. in a private placement for an aggregate purchase price and proceeds to the Company of approximately $2.6 million to be used for capital expenditures and working capital requirements related to future warehouse expansion.

Short-Term Borrowings and Debt

As of February 28, 2003, the Company, through its majority or wholly owned subsidiaries, had $20.0 million outstanding in short-term borrowings through 10 separate facilities, which are secured by certain assets of its subsidiaries and are guaranteed by the Company up to its respective ownership percentage. Each of the facilities expires throughout the year and is typically renewed. As of February 28, 2003, approximately $7.3 million was available on the facilities.

The Company’s long-term debt is collateralized by certain land, building, fixtures and equipment of each respective subsidiary and guaranteed by the Company up to its respective ownership percentages, except for approximately $31.0 million as of February 28, 2003, which is secured by collateral deposits for the same amount and which deposits are included in restricted cash on the condensed consolidated balance sheet.

Under the terms of each of its debt agreements, the Company must comply with certain covenants, which include, among others, current, debt service, interest coverage and leverage ratios. The Company is in compliance with all of these covenants, except for the current ratio for a $5.0 million note and the interest coverage ratio for a $6.0 million note. The Company obtained the necessary waivers for these notes through May 31, 2003 and August 31, 2003, respectively.

Pursuant to the terms of a bank credit agreement, the Company can issue up to $7.0 million of standby letters of credit. Fees are paid up front and charges are paid as incurred. As of February 28, 2003, approximately $3.9 million was outstanding under the letters of credit.

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Contractual Obligations

As of February 28, 2003, the Company’s commitments to make future payments under long-term contractual obligations were as follows (amounts in thousands):

Significant Accounting Policies

The preparation of the Company’s financial statements requires that management make estimates and judgments that affect the financial position and results of operations. Management continues to review its accounting policies and evaluate its estimates, including those related to merchandise inventory and impairment of long-lived assets. The Company bases its estimates on historical experience and on other assumptions that management believes to be reasonable under the present circumstances.

Merchandise Inventories:  Merchandise inventories, which include merchandise for resale, are valued at the lower of cost (average cost) or market. The Company provides for estimated inventory losses between physical inventory counts on the basis of a percentage of sales. The provision is adjusted periodically to reflect the trend of actual physical inventory count results, which occur primarily in the second and fourth fiscal quarters.

Impairment of Long-lived Assets:  The Company periodically evaluates its long-lived assets for indicators of impairment. Management’s judgments are based on market and operational conditions at the time of the evaluation. Future events could cause management to conclude that impairment factors exist, requiring an adjustment of these assets to their then-current fair market value.

Stock-Based Compensation:  As of February 28, 2003, the Company had four stock-based employee compensation plans. Prior to September 1, 2002, the Company accounted for those plans under the recognition and measurement provisions of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Effective September 1, 2002, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123 (“SFAS 123”), “Accounting for Stock-Based Compensation,” prospectively to all employee awards granted, modified or settled after September 1, 2002. Awards under the Company’s plans vest over five years. The cost related to stock-based employee compensation included in the determination of net income for the three and six months ended February 28, 2003 and 2002 is less than that which would have been recognized if the fair value based method had been applied to all awards since the original effective date of SFAS 123. In the second quarter of fiscal 2003 and for the first half of fiscal 2003, the Company recognized stock compensation costs of $39,000 and $64,000, respectively, versus stock compensation costs of $53,000 and $106,000 in the second quarter and first half, respectively, of fiscal 2002 (see “Note 5 – Stock-Based Compensation” in the Notes to Condensed Consolidated Financial Statements included within).

Basis of Presentation:  The consolidated financial statements include the assets, liabilities and results of operations of the Company’s majority and wholly owned subsidiaries that are more than 50% owned and controlled. All significant intercompany balances and transactions have been eliminated in consolidation. The Company’s 50% owned Mexico joint venture is accounted for under the equity method of accounting.

Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 143 (“SFAS 143”), “Accounting for Asset Retirement Obligations,” which became effective for the Company beginning in fiscal 2003. SFAS 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The adoption of SFAS 143 has not had a material impact on the Company’s consolidated financial statements.

In August 2001, the FASB issued SFAS No. 144 (“SFAS 144”), “Accounting for the Impairment or Disposal of Long-Lived Assets,” which became effective for the Company beginning in fiscal 2003. Prior period financial statements will not be restated as a result of the adoption of SFAS 144. SFAS 144 establishes a number of rules for the recognition, measurement and reporting of long-lived assets which are impaired and either held for sale or continuing use within the business. In addition, SFAS 144 broadly expands the definition of a discontinued operation to individual reporting units or asset groupings for which

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identifiable cash flows exist. The adoption of SFAS 144 has not had a material impact on the Company’s consolidated financial statements.

In April 2002, the FASB issued SFAS No. 145 (“SFAS 145”), “Rescission of FASB Statements Nos. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” In addition to rescinding three FASB statements, SFAS 145 amends SFAS No. 13, “Accounting for Leases,” to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. This statement also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. The adoption of SFAS 145 has not had a material impact on the Company’s consolidated financial statements.

In July 2002, the FASB issued SFAS No. 146 (“SFAS 146”), “Accounting for Costs Associated with Exit or Disposal Activities,” which addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3 (“Issue 94-3”), “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” The principal difference between SFAS 146 and Issue 94-3 relates to SFAS 146’s requirements for recognition of a liability for a cost associated with an exit or disposal activity. SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recorded as a liability when incurred. Under Issue 94-3, a liability for an exit cost as generally defined in Issue 94-3 was recognized at the date of an entity’s commitment to an exit plan. The provisions of this statement are effective for exit or disposal activities that are initiated after December 31, 2002 with early application encouraged. The adoption of SFAS 146 has not had a material impact on the Company’s consolidated financial statements.

The Company, through its majority or wholly owned subsidiaries, conducts foreign operations primarily in Latin America, the Caribbean and Asia, and as such is subject to both economic and political instabilities that cause volatility in foreign currency exchange rates or weak economic conditions. As of February 28, 2003, the Company had a total of 27 warehouses operating in ten foreign countries and two U.S. territories (excluding two warehouses owned in Mexico through its 50/50 joint venture). 19 of the 27 warehouses operate under foreign currencies other than the U.S. dollar. For the six months ended February 28, 2003 and 2002, approximately 74% and 75%, respectively, of the Company’s net warehouse sales were in foreign currencies. The Company may open stores in new foreign countries in the future, which may increase the percentage of net warehouse sales denominated in foreign currencies. In March 2003, the Company opened one warehouse in Mexico through its 50/50 joint venture, and its first warehouse in Jamaica. The two new warehouses operate under currencies other than the U.S. dollar.

Furthermore, the Company believes that because its present operations and expansion plans involve numerous countries and currencies, the effect from any one-currency devaluation may not significantly impact the overall financial or operating results of the Company. However, there can be no assurance that the Company will not experience a materially adverse effect on the Company’s business, financial condition, operating results, cash flow or liquidity as a result of the economic and political risks of conducting an international merchandising business.

Translation adjustments from the Company’s non-U.S. denominated majority or wholly owned subsidiaries, resulting from the translation of the assets and liabilities of the subsidiaries into U.S. dollars, were $5.2 million and $5.3 million as of February 28, 2003 and August 31, 2002, respectively.

Foreign currencies in most of the countries where the Company operates have historically devalued against the U.S. dollar and are expected to continue to devalue. The Company manages foreign currency risks at times by hedging currencies through non-deliverable forward exchange contracts (“NDF”) that are generally for durations of six months or less and that do not provide for physical exchange of currency at maturity (only the resulting gain or loss). The premium associated with each NDF is amortized on a straight-line basis over the term of the NDF, and mark-to-market amounts and realized gains or losses are recognized on the settlement date in cost of goods sold. The related receivables or liabilities with counterparties to the NDFs are recorded in the consolidated balance sheet. As of February 28, 2003, the Company had no outstanding NDFs and no mark-to-market unrealized amounts as of February 28, 2003. Additionally, no realized losses were incurred for the six months ended February 28, 2003, as none were entered into during the period. Although the Company has not purchased any NDFs subsequent to February 28, 2003, it may purchase NDFs in the future to mitigate foreign exchange losses. However, due to the volatility and lack of derivative financial instruments in the countries in which the Company operates, significant risk from unexpected devaluation of local currencies exists. Foreign exchange transaction losses realized, which are included as a part of the costs of goods sold in the consolidated statement of operations, were $835,000 and $593,000 for the six months ended February 28, 2003 and 2002, respectively (including the cost of any NDFs entered into).

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The following is a listing of each country or territory where the Company currently operates or anticipates operating in and their respective currencies, as of February 28, 2003: