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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended May 31, 2004

OR

For the transition period from              to             

COMMISSION FILE NUMBER 0-22793

PriceSmart, Inc.

(Exact name of registrant as specified in its charter)

9740 Scranton Road

San Diego, California 92121

(Address of principal executive offices)

(858) 404-8800

(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 7,362,005 shares of its common stock, par value $.0001 per share, outstanding at June 30, 2004.

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PRICESMART, INC.

INDEX TO FORM 10-Q

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PART I—FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

The Company’s unaudited consolidated balance sheet as of May 31, 2004, the consolidated balance sheet as of August 31, 2003, the unaudited consolidated statements of operations for the three and nine month periods ended May 31, 2004 and 2003, the unaudited consolidated statements of cash flows for the nine month periods ended May 31, 2004 and 2003, and the unaudited consolidated statements of stockholders’ equity for the nine month period ended May 31, 2004 are included elsewhere herein. Also included herein are notes to the unaudited consolidated financial statements.

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

This Form 10-Q contains forward-looking statements concerning PriceSmart’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 or phrases such as “believe,” “will,” “expect,” “anticipate,” “estimate,” “intend,” “plan,” “would” and like expressions, and the negative thereof. Forward-looking statements are not guarantees of performance. These statements are subject to risks and uncertainties that could cause actual results to differ materially from the statements, including foreign exchange risks, political or economic instability of host countries, and competition as well as those risks described in the Company’s SEC reports, including the risk factors referenced in this Form 10-Q. See “Part II – Item 5 – Other Information – Factors That May Affect Future Performance.”

The following discussion and analysis compares the results of operations for the three and nine-month periods ended May 31, 2004 (fiscal 2004) and May 31, 2003 (fiscal 2003), and should be read in conjunction with the consolidated financial statements and the accompanying notes included herein.

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

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 number of warehouse clubs in operation as of May 31, 2004 and 2003, the Company’s ownership percentages and basis of presentation for financial reporting purposes by each country or territory are as follows:

During the first nine months of fiscal 2004, the Company closed its warehouse club in Guam. During the first nine months of fiscal 2003, the Company opened two new U.S.-style membership shopping warehouse clubs (one in Alabang, Metro Manila,

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Philippines and one in Jamaica), and as part of a 50/50 joint venture with Grupo Gigante, S.A. de C.V. (“Gigante”), the Company also opened three new U.S.-style membership shopping warehouse clubs in Mexico. During the fourth quarter of fiscal 2003, the Company closed three warehouse clubs, one each in Guatemala, Dominican Republic and Philippines, and subsequent to the end of the third quarter of fiscal 2004, the Company opened another warehouse club in Aseana, Metro Manila, Philippines.

At the end of the first nine months of fiscal year 2004, the total number of consolidated warehouse clubs in operation was 25 in 12 countries and one U.S. territory, in comparison to 28 consolidated warehouse clubs in operation in 11 countries and two U.S. territories at the end of the first nine months of fiscal year 2003. The average life of the 25 and 28 consolidated warehouse clubs in operation as of May 31, 2004 and 2003 was 45 and 33 months, respectively.

In addition to the warehouse clubs operated directly by the Company and the three operated through a joint venture in Mexico, as of May 31, 2004, there were 12 warehouse clubs in operation (11 in China and one in Saipan, Micronesia), licensed to and operated by local business people, through which the Company primarily earns a licensee fee on a per warehouse club basis, at the end of the third quarter of fiscal 2004 and 2003.

COMPARISON OF THE THREE MONTHS ENDED MAY 31, 2004 AND 2003

Net warehouse sales decreased 11.6% to $142.2 million in the third quarter of fiscal 2004, from $160.8 million in the third quarter of fiscal 2003. Excluding $15.2 million in wholesale telephone card sales in the Philippines (which began in September 2002 and were discontinued in May 2003), net warehouse sales decreased $3.4 million or 2.3% from the year earlier period sales of $145.6 million. Management believes net warehouse sales excluding wholesale telephone card sales provides a better measure of ongoing operations and a more meaningful comparison of past and present operating results than total warehouse sales, because wholesale phone card sales were only for a limited time, were discontinued in May 2003 and fell outside of the Company’s core business of operating international membership warehouse clubs. The decrease of $3.4 million in net warehouse sales, excluding wholesale telephone card sales, is largely attributable to a net of three fewer warehouse clubs in the third quarter of fiscal 2004 compared to the third quarter of fiscal 2003. In the third quarter of fiscal 2004, the Company experienced warehouse sales growth in nearly all of its Caribbean markets, specifically Trinidad, Barbados, Aruba and Jamaica, as compared to the third quarter of fiscal 2003. Warehouse club sales in Central America produced a small growth overall. Sales growth in Costa Rica offset declines in some other Central America markets, notably Honduras and El Salvador. The Asia market segment experienced a large sales decline from the same quarter of fiscal year 2003 due primarily to two fewer warehouse clubs in operation on a comparable basis. There were no significant issues related to merchandise quality or quantity at the warehouse clubs in the quarter, although the Company continues to experience some negative sales impact due to the restrictions that were in effect in some countries during the quarter related to the importation of beef products and poultry.

Comparable warehouse sales for warehouse clubs that were open at least 12 full months declined 0.1% in the four weeks ended March 28, 2004, increased 2.2% in the four weeks ended April 25, 2004 and increased 3.8% in the five weeks ended May 30, 2004 (excluding prior year wholesale telephone card sales).

The Company continues to increase the portion of its merchandise mix comprised of U.S. sourced merchandise. U.S. sourced merchandise accounted for 44% of the sales in the current quarter, compared to 40% in the prior year, with U.S. hard-line and soft-line merchandise sales growing 19.0% from the prior year. The Company also continues to expand its bulk program, both in terms of the locations in which it is offered as well as the number of products available in that format.

The Company’s warehouse gross profit margins (defined as net warehouse sales less associated cost of goods sold) in the third quarter of fiscal 2004 increased to 13.8% from 10.9% in the third quarter of fiscal 2003. Third quarter fiscal year 2003 margins were impacted by a $2.0 million charge for the write-down of slow moving inventory and $1.0 million from the Dominican Republic’s 57% currency devaluation.

Export sales represent U.S. merchandise exported to the Company’s licensee warehouse operating in Saipan and direct sales to third parties through the Company’s distribution centers, which include sales to PriceSmart Mexico, an unconsolidated affiliate. Export sales in the third quarter of fiscal 2004 were $169,000 compared to $2.3 million in the third quarter of fiscal 2003. The change between periods is primarily due to decreased direct sales to third parties from the Company’s distribution centers, and reduced sales to Mexico and Saipan.

Membership income, which is recognized into income ratably over the one-year life of the membership, increased to $2.2 million, in the third quarter of fiscal 2004 compared to $2.0 million in the third quarter of fiscal 2003. Total membership accounts were 458,000 as of May 31, 2004, a reduction of 6,700 from the year earlier period as a result of three fewer warehouses and a reduction in Panama and the Philippines, where heavily discounted memberships sold in fiscal 2003 were not renewed at the higher current fee for 2004. These discounted memberships did not generate a significant level of warehouse sales, and their non-renewal is not expected to have a proportional effect on warehouse sales. The Company continues its efforts to increase membership through marketing and improving the value and quality of the merchandise available to members. The average cash collected for membership fees from renewals and new members, for all markets, increased 30% from the year earlier period to $23.04.

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Other revenue consists of commission revenue, rental income, advertising revenues, construction revenue, merchandise demonstration income, and fees earned from licensees. Other income decreased to $1.4 million in the third quarter of fiscal 2004 from $1.5 million in the third quarter of fiscal 2003. The decrease in amounts in the current year was primarily related to a discontinuation of certain promotional programs and a reduction in merchandise demonstration activity. Licensee fees increased to $315,000 in the third quarter of fiscal 2004 from $310,000 in the third quarter of fiscal 2003.

Warehouse club operating expenses decreased to $20.0 million, or 14.1% of net warehouse sales, in the third quarter of fiscal 2004 from $21.0 million, or 13.0% of net warehouse sales, in the third quarter of fiscal 2003. The increase in operating expenses as a percentage of net warehouse sales is attributable to lower net warehouse sales and an increase in utilities, repairs and maintenance, increased wage rates in certain warehouse club locations, and the increasing cost with respect to credit card usage and fees. The Company continues to explore arrangements to reduce the costs it incurs to process credit card transactions for its members.

General and administrative expenses were $5.5 million, or 3.9% of net warehouse sales, in the third quarter of fiscal 2004 compared to $7.2 million, or 4.5% of net warehouse sales, in the third quarter of fiscal 2003. The current quarter expenses include approximately $360,000 in costs for outside professional services attributable to legal proceedings arising from the Company’s restatement of financial results for fiscal year 2002 and the first three quarters of fiscal year 2003. The Company expects to incur additional costs for these services in the upcoming fiscal quarters. Third quarter of fiscal year 2003 included severance costs of $1.1 million, related to several former executives whom left the Company in the third quarter and $833,000 in option repricing expense for vested options.

Asset impairment and closure costs in the third quarter of fiscal year 2004 total $3.7 million. Included in this amount is a non-cash asset impairment charge of $3.3 million to write-down the carrying value of the building related to the closed warehouse club in the Philippines. This charge results from revised cash flow estimates regarding the marketability of the land and building for this location. The original estimate regarding the market price of leasing these assets was derived from negotiations that discontinued during the second quarter of fiscal 2004. At that time, the Company believed the price being offered was a reasonable estimate of market value. However, during the third quarter an offer (which is still under review) was received at a significantly lower price, therefore, the Company has revised its estimates downward.

Pre-opening expenses, which represent expenses incurred before a warehouse club is in operation, decreased to $322,000 in the third quarter of fiscal 2004 from $649,000 in the third quarter of fiscal 2003. In the current quarter, pre-opening expenses were associated with the Aseana site in the Philippines, which opened subsequent to third quarter in early June 2004. The Company had one warehouse club opening during the third quarter of fiscal 2003, in Jamaica.

Interest income primarily reflects earnings on cash and cash equivalents and restricted cash deposits securing long-term debt. Interest income was $581,000 in the third quarter of fiscal 2004, compared to $791,000 in the third quarter of fiscal 2003. The decrease in interest income is due to the amounts of interest-bearing instruments held by the Company throughout the periods presented and the interest rate earned on those instruments.

Interest expense primarily reflects borrowings by the Company’s majority or wholly owned foreign subsidiaries to finance the capital requirements of warehouse club operations and for local currency loans secured by U.S. dollar deposits to lessen foreign exchange risks. Interest expense decreased to $2.6 million in the third quarter of fiscal 2004 from $3.0 million in the third quarter of fiscal 2003. The decrease is attributable to a decrease in the amount of debt held by the Company and its subsidiaries between the periods presented and associated interest expense incurred on the amounts borrowed within the periods presented.

Income from related party was $500,000 in the third quarter of fiscal 2004. In April 2004, the Company received $500,000 from its then landlord, Price Legacy Corporation, as an incentive to terminate early the lease of its corporate headquarters. Sol Price is a principal stockholder of Price Legacy Corporation and directors James F. Cahill, Murray L. Galinson and Jack McGrory are on its board of directors. The Company moved to its new corporate headquarters, located in San Diego, on March 26, 2004.

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, through which the Company reflects its proportionate share of income or loss of the unconsolidated joint venture’s results from operations. The Company’s proportionate share of the loss in PriceSmart Mexico for the current quarter was $565,000, as compared to $905,000 in the prior year period.

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

The Company recorded an income tax provision of $991,000 for the third quarter of fiscal year 2004, compared to a benefit of $2.2 million for the same period in the prior year. The current period provision consists primarily of taxes due from profit making entities and a provision against the recoverability of foreign tax credits. Due to the current interplay of income and losses between PriceSmart, Inc. and its consolidated subsidiaries, the Company does not believe that the resulting effective tax rate is an adequate measurement tool at this time.

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Preferred dividends increased from $400,000 to $840,000 in the third quarter of fiscal 2004 compared to the same period in the prior year, due to additional preferred shares issued in fiscal 2003. These shares accrue dividends at 8% per annum. During the first quarter of fiscal 2004, the Company’s Board of Directors determined that the Company should not declare or pay any dividends on the preferred stock to ensure that the Company does not violate any loan covenants under loan agreements to which the Company is a party that restrict the Company’s ability to pay dividends unless it satisfies specified balance sheet criteria and/or other financial ratios.

COMPARISON OF THE NINE MONTHS ENDED MAY 31, 2004 AND 2003

Net warehouse sales declined 9.9% to $447.4 million for the nine months ended May 31, 2004 from $496.3 million for the nine months ended May 31, 2003. Excluding $23.9 million in wholesale telephone card sales in the Philippines (which began in September 2002 and were discontinued in May 2003), net warehouse sales decreased $25.0 million or 5.3%. Management believes net warehouse sales excluding wholesale telephone card sales provides a better measure of ongoing operations and a more meaningful comparison of past and present operating results than total warehouse sales, because phone card sales were only for a limited time, were discontinued in May 2003 and fell outside of the Company’s core business of operating international membership warehouse clubs. The Company began fiscal 2004 with 26 warehouse clubs and, with the closure of the Guam warehouse club in December, ended the first nine months of its fiscal year with 25 warehouse clubs. The Company began fiscal year 2003 with 26 warehouse clubs and, with the opening of a warehouse club in the Philippines and Jamaica, ended the first nine months of its fiscal year with 28 warehouse clubs. Contributing to the sales reduction in U.S. dollars was currency devaluation, most notably in the Dominican Republic, Jamaica and Costa Rica. December has historically produced the highest sales of the nine month period due to holiday sales. Comparable warehouse sales for warehouse clubs that were open at least 12 full months declined 4.7% for the thirty-nine weeks ended May 30, 2004 (excluding prior year wholesale telephone card sales). In fiscal 2004, December sales declined 9.4% on a comparable warehouse club basis (for warehouse clubs open at least 12 months) primarily due to limited levels of merchandise in stock in many locations, impacting the first nine month period.

The Company’s warehouse gross profit margins (defined as net warehouse sales less associated cost of goods sold) for the nine months ended May 31, 2004 decreased to 13.5% from 13.6% for the nine months ended May 31, 2003.

Export sales were $1.0 million compared to $6.0 million for the nine months ended May 31, 2004 and 2003, respectively. The reduction is attributable to decreased direct sales to third parties from the Company’s distribution centers, and reduced sales to Mexico and Saipan. In addition, fiscal 2003 included sales of $1.8 million to PriceSmart Mexico as that entity opened three warehouse clubs in the period, and only $521,000 in fiscal 2004.

Membership income, which is recognized ratably over the one-year life of the membership, was $6.5 million for the nine months ended May 31, 2004 and $6.3 million for the nine months ended May 31, 2003. The average number of membership accounts during the nine month period declined 1.6% from the average of the same period last year on fewer warehouse clubs. The average cash collected for membership fees from renewals and new members, for all markets, during the period has increased 31% from the prior year’s average, due to the discontinuance of sales of discounted memberships in the Philippines and Panama.

Other revenue consists of commission revenue, rental income, advertising revenues, construction revenue, vendor income, and fees earned from licensees. Other income declined to $4.7 million in fiscal 2004 from $5.6 million in fiscal 2003, primarily as a result of a discontinuation of certain promotional programs and a reduction in merchandise demonstration activity. License fees increased to $1.0 million from $935,000 due to a net increase in warehouse clubs in China.

Warehouse operating expenses increased to $60.9 million, or 13.6% of net warehouse sales, for the nine months ended May 31, 2004 from $59.9 million, or 12.1% of net warehouse sales, for the nine months ended May 31, 2003. The increase in operating expenses is primarily attributable to higher costs for utilities, repair and maintenance, and costs associated with an increased use of credit cards. Further, the Company increased wage rates in many locations.

General and administrative expenses were $16.5 million, or 3.7% of net warehouse sales, for the nine months ended May 31, 2004 compared to $16.4 million, or 3.3% of net warehouse sales for the nine months ended May 31, 2003. In the first nine months of fiscal 2004, the Company has incurred severance costs of approximately $760,000 relating to the departure of certain members of senior management and the closure of substantially all of its Miami-based buying operations and consolidating those activities with the buying team in San Diego and approximately $815,000 of expense was incurred for outside professional services attributable to legal proceedings arising from the Company’s restatement of financial results for fiscal year 2002 and the first three quarters of fiscal year 2003. In addition, the Company continues to experience increased insurance costs associated with workers compensation and director and officer liability as compared to fiscal 2003.

Asset impairment and closure costs for the nine months ended May 31, 2004 was $5.4 million. Included in this amount is a non-cash asset impairment charge of $3.3 million to write-down the carrying value of the building related to the closed warehouse club in the Philippines. This charge results from revised cash flow estimates regarding the marketability of the land and building for this location. The original estimate regarding the market price of leasing these assets was derived from negotiations that discontinued during the second quarter of fiscal 2004. At that time, the Company believed the price being offered was a reasonable estimate of market value. However, during the third quarter an offer (which is still under review) was received at a significantly lower price, therefore, the Company has revised its estimates downward. The Company also recorded costs of $1.4 million related to the closure of the Guam location in December 2003.

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Pre-opening expenses, which represent expenses incurred before a warehouse club is in operation, decreased to $488,000 for the nine months ended May 31, 2004 from $1.5 million for the nine months ended May 31, 2003. The Company incurred pre-opening costs in the prior year period for Alabang, Metro Manila, Philippines which opened in November 2002, as well as costs for the Jamaica location which began operation in March 2003. In the current nine-month period, the Company incurred pre-opening costs for one new location in the Philippines, which opened in early June 2004.

Interest income reflects earnings on cash and cash equivalents and restricted cash deposits securing long-term debt. Interest income was $1.8 million for the nine months ended May 31, 2004, compared to $2.2 million for the nine months ended May 31, 2003.

Interest expense primarily reflects borrowings by the Company’s majority or wholly owned foreign subsidiaries to finance the capital requirements of warehouse club operations and for local currency loans secured by U.S. dollar deposits to lessen foreign exchange risks. Interest expense for the nine months ended May 31, 2004 and 2003 was $8.0 million.

Income from related party was $500,000 for the nine months ended May 31, 2004. In April 2004, the Company received $500,000 from its then landlord, Price Legacy Corporation, as an incentive to terminate early the lease of its corporate headquarters. Sol Price is a principal stockholder of Price Legacy Corporation and directors James F. Cahill, Murray L. Galinson and Jack McGrory are on its board of directors. The Company moved to its new corporate headquarters, located in San Diego, on March 26, 2004.

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, through which the Company reflects its proportionate share of income or loss. For the first nine months of fiscal 2004, the Company’s share of the joint venture’s loss was $1.3 million compared to $2.3 million in the first nine months of fiscal 2003.

The Company recorded an income tax provision of $1.2 million and a benefit of $786,000 for the nine-month periods ended May 31, 2004 and May 31, 2003, respectively. The current period provision consists primarily of taxes due from profit making entities and a provision against the recoverability of foreign tax credits. Due to the current interplay of income and losses between PriceSmart, Inc. and its consolidated subsidiaries, the Company does not believe that the resulting effective tax rate is an adequate measurement tool at this time.

Preferred dividends increased from $1.2 million to $2.5 million in the first nine months of fiscal 2004, compared to the same period in the prior year, primarily due to additional preferred shares issued in fiscal 2003. These shares accrue dividends at 8% per annum. During the first quarter of fiscal 2004, the Company’s Board of Directors determined that the Company should not declare or pay any dividends on the preferred stock for the first nine months of fiscal 2004 to ensure that the Company does not violate any loan covenants under loan agreements to which the Company is a party that restrict the Company’s ability to pay dividends unless it satisfies specified balance sheet criteria and/or other financial ratios.

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 expenses and working capital requirements associated with its warehouse clubs.

The Company had a working capital deficit as of May 31, 2004 of $30.1 million, compared to a working capital deficit of $12.0 million as of August 31, 2003. The decrease in net working capital of $18.1 million was primarily due to decreases in cash of $8.2 million, receivables of $2.4 million and inventories of $14.6 million, which were only partially offset by a net decrease in accounts payable and accrued expenses of $2.0 million and short-term debt of $6.0 million.

Net cash flows provided by operating activities were $3.7 million and $11.6 million in the first nine months of fiscal 2004 and 2003, respectively. The decrease of $7.9 million is primarily due to a decline in results from operating activities.

Net cash provided by (used in) investing activities was $1.6 million and $(27.3) million in the first nine months of fiscal 2004 and 2003, respectively. The net decrease in the use of cash of approximately $28.9 million resulted primarily from $9.0 million for capital investment in the Mexico joint venture occurring in the first nine months of 2003, and a decrease period over period in additions to property and equipment for new warehouse clubs constructed or under construction of $16.9 million.

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Net cash (used in) provided by financing activities was $(10.1) million and $12.5 million in the first nine months of fiscal 2004 and 2003, respectively. The net change of approximately $22.6 million resulted primarily from the Company’s net repayment of $18.8 million of bank borrowings during the first nine months of 2004 compared to $17.9 million of net borrowings from banks in the first nine months of 2003, a reduction of $3.7 million in restricted cash in the first nine months of 2004 and restricted cash increase of $10.2 million in the first nine months of 2003, $2.6 million more in proceeds from issuance of common stock in the first nine months of 2004 compared to the first nine months of 2003, $3.3 million in contributions from minority shareholders in the first nine months of 2003 and payment of $1.2 million in preferred dividends in first nine months of 2003. The Company has accrued dividends, but has not paid dividends since July 2003.

The Company believes that it has sufficient financial resources to meet its working capital and capital expenditure requirements by borrowing under its current and future credit facilities, the inventory financing agreement with The Price Group, LLC as described below, as well as through its ability to sell specified real property to the Sol and Helen Price Trust, as per the agreement entered into as of December 2003 and described in the sub-section below entitled “Short-Term Borrowings and Long-Term Debt”. However, if such sources of liquidity are unavailable or insufficient to satisfy the Company’s liquidity requirements, the Company may need to sell equity or debt securities, obtain additional credit facilities or consider alternative financing arrangements. Furthermore, the Company has and will continue to consider other 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. In addition, some of the Company’s vendors extend trade credit to the Company and allow payment for products upon delivery or on terms of 30 days or more. If these vendors extend less credit to the Company or require prepayment for products, the Company’s cash requirements and financing needs may increase further.

Financing and Investing Activities

On September 5, 2003, the Company determined it would not declare a dividend on the 8% Series A Cumulative Convertible Redeemable Preferred Stock (the “Series A Preferred Stock”) for the fourth quarter of 2003. Also, no dividends can be declared or paid on the 8% Series B Cumulative Redeemable Preferred Stock (the “Series B Preferred Stock”) until full cumulative dividends have been declared and paid on the Series A Preferred Stock. Instead, dividends on the Series A Preferred Stock and the Series B Preferred Stock will accrue in accordance with the terms of the Certificate of Designation for the Series A Preferred Stock and the Series B Preferred Stock.

On October 22, 2003, an entity affiliated with Robert E. Price, Interim President and Chief Executive Officer, Chairman of the Board of Directors and a significant shareholder of PriceSmart, Inc., and an entity affiliated with Sol Price, a significant stockholder of PriceSmart, Inc., purchased an aggregate of 500,000 shares of PriceSmart’s Common Stock, for an aggregate purchase price of $5.0 million.

In February 2004, the Company entered into an agreement with The Price Group, LLC which provides the Company with up to $10.0 million of purchase order financing. Directors Robert E. Price, James F. Cahill, Murray L. Galinson and Jack McGrory are managers of The Price Group, LLC and collectively own more than 80% of that entity. This agreement allows The Price Group, LLC to place a lien on merchandise inventories in the United States as security for such financing. Interest accrues at a rate of 12% per year. As of May 31, 2004, approximately $6.7 million was owed under this agreement. It is anticipated that in July 2004 this agreement will be modified to provide: (i) for an additional $5.0 million (for a total of $15.0 million) of purchase order financing; and (ii) for additional security for such additional financing, consisting of a pledge of either the Company’s shares of PriceSmart Real Estate Panama, S.A., or the Company’s shares of PSMT Mexico, S.A. de C.V.

In May 2004, the Company entered into an agreement with The Price Group, LLC to sell the real estate and improvements owned by the Company in Santiago, Dominican Republic. The purchase price will be the fair market value of the property and improvements as determined by an independent appraiser. Under terms of the agreement The Price Group made an initial payment of $5.0 million during the third quarter of fiscal 2004, with the balance to be paid upon closing, and if the closing does not occur for any reason, the initial payment shall be returned to The Price Group (plus accrued interest at the rate of 8% per annum). The agreement is subject to several contingencies, including the right of each party to terminate the agreement after receipt of the final appraisal report, and the approval by the Company’s Board of Directors of the final terms of the agreement.

Short-Term Borrowings and Long-Term Debt

As of May 31, 2004, the Company, through its majority or wholly owned subsidiaries, had $14.1 million outstanding in short-term borrowings through 13 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 during the year and typically each is renewed. As of May 31, 2004, the Company had approximately $16.0 million available on these facilities.

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The Company’s long-term debt is collateralized by certain land, building, fixtures and equipment and shares of each respective subsidiary and guaranteed by the Company up to its respective ownership percentages, except for approximately $28.4 million as of May 31, 2004, which is secured by collateral deposits for the same amount and which deposits are included in restricted cash on the balance sheet. Certain obligations under leasing arrangements are collateralized by the underlying asset being leased. Certain short-term borrowings, $2.0 million as of May 31, 2004, have been excluded from current liabilities because the Company refinanced it in June 2004 and that amount is included in long-term debt, net of current portion.

Under the terms of debt agreements to which the Company and/or one or more of its wholly owned or majority owned subsidiaries are parties, the Company must comply with specified financial maintenance covenants, which include among others, current ratio, debt service, interest coverage and leverage ratios. As of May 31, 2004, the Company was in compliance with all of these covenants, except for the following: (i) current ratio and cash flow to debt service and projected debt service ratio for a $5.0 million note (current outstanding amount $4.1 million), for which the Company has requested and received a written waiver of its noncompliance; (ii) debt service ratio for a $11.3 million note (current outstanding amount $3.2 million), for which the Company has requested and received a written waiver of its noncompliance; (iii) interest cost/EBIT (earnings before interest and taxes) ratio for a $6.0 million note (current outstanding amount $4.2 million), for which the Company has requested and received a written waiver of its noncompliance; (iv) debt service ratio, cash coverage ratio, and interest coverage ratio for a $3.5 million note (current outstanding amount $1.3 million), for which the Company has reached an agreement to amend the financial covenants and is in the process of finalizing an amendment to the loan agreement; and (v) debt to equity ratio for a $7.0 million note (current outstanding amount $5.3 million), for which the Company has requested, but not yet received, a written waiver.

Additionally, the Company has debt agreements, with an aggregate principal amount outstanding as of May 31, 2004 of $27.9 million that, among other things, allow the lender to accelerate the indebtedness upon a default by the Company under other indebtedness and prohibit the Company from incurring additional indebtedness unless the Company is in compliance with specified financial ratios set forth in those debt agreements. As of May 31, 2004, the Company did not satisfy these ratios. As a result, the Company is prohibited from incurring additional indebtedness and would need to obtain a waiver from the lender as a condition to incurring additional indebtedness. If the Company is unsuccessful in obtaining the necessary waivers or fails to comply with these financial covenants in future periods, the lenders may elect to accelerate the indebtedness described above and foreclose on the collateral pledged to secure the indebtedness. In such a case, the Company would need additional financing in order to service or extinguish the indebtedness. Accordingly, to address these potential needs for additional capital, the Company has entered into an agreement with the Sol and Helen Price Trust, a trust affiliated with Sol Price, a significant stockholder of the Company, giving the Company the right to sell all or a portion of specified real property to the Trust at any time on or prior to August 31, 2004 at a price equal to the Company’s net book value for the respective properties and other commercially reasonable terms. The specified real property covers both the land and building at nine warehouse club locations. As of May 31, 2004, the net book value of this real property is approximately $53.4 million, with approximately $31.9 million of encumbrances (including $5.0 million received as an advance payment for one of these properties). Under the terms of the agreement, the Company would have the option, but not the obligation, to lease back one or more warehouse club buildings at an annual lease rate equal to 9% of the selling price for the building and other commercially reasonable terms.

The Company has a credit agreement for $7.5 million which can be used for short-term borrowings or standby letters of credit. As of May 31, 2004, short-term borrowings include $1.1 million and there are $4.5 million of outstanding letters of credit related to this agreement.

Contractual Obligations

As of May 31, 2004, the Company’s commitments to make future payments under long-term contractual obligations were as follows (amounts in thousands):

Critical Accounting Policies

Use of Estimates: 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, impairment of long-lived assets and the fair value of lease obligations for closed warehouse clubs. The Company bases its estimates on historical experience and on other assumptions that management believes to be reasonable under the present circumstances.

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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 and obsolescence 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. Future circumstances may result in the Company’s actual future closing costs or the amount recognized upon the sale of the property differing substantially from the estimates.

Stock-Based Compensation: As of May 31, 2004, the Company had four stock-based employee compensation plans. Beginning September 1, 2002, the Company adopted the fair value based method of recording stock options contained in Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation,” which is considered the preferable accounting method for stock-based employee compensation. Beginning September 1, 2002, all future employee stock option grants will be expensed over the stock option vesting period based on the fair value at the date the options are granted. Historically, and through August 31, 2002, the Company had applied Accounting Principles Board Opinion No. 25 and related interpretations in accounting for its stock option plans.

Basis of Presentation: The consolidated financial statements include the assets, liabilities and results of operations of the Company’s majority and wholly owned subsidiaries. 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 January, 2003, the FASB issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities”, an interpretation of ARB No. 51. FIN 46 was revised in December, 2003 and clarifies the application of ARB 51 to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. The application of FIN 46 may require that an entity be subject to consolidation even though the investor does not have a controlling financial interest that, under ARB 51, was usually deemed to exist through ownership of a majority voting interest. FIN 46, as revised, is generally effective for all entities subject to the interpretation no later than the end of the first reporting period that ends after March 15, 2004. The adoption of this interpretation did not have an impact on the Company’s consolidated results of operations, financial position or cash flows.

Emerging Issues Task Force Issue No. 02-16 (“EITF 02-16”), “Accounting by a Customer (Including a Reseller) for Certain Consideration Received by a Vendor,” addresses how a reseller should account for cash consideration received from a vendor. Under this provision, effective for arrangements entered into or modified after December 31, 2002, cash consideration received from a vendor is generally presumed to be a reduction of the prices of the vendor’s products and, therefore, should be characterized as a reduction of these costs. The adoption of the provisions of EITF 02-16 did not result in any changes in the Company’s reported net income, but certain consideration which had been classified as other income in prior years is now reflected as a reduction of cost of sales. As permitted by the transition provisions of EITF 02-16, other income and cost of sales in prior periods have been reclassified to conform to the current period presentation. This resulted in a decrease in other income and an offsetting decrease in net warehouse cost of goods sold of $292,000 and $1.5 million for the nine-month periods ended May 31, 2004 and 2003, respectively.

Emerging Issues Task Force Issue No. 03-10 (“EITF 03-10”), “Application of Issue No. 02-16 by Resellers to Sales Incentives Offered to Consumers by Manufacturers”, provides guidance for the reporting of vendor consideration received by a reseller as it relates to manufacturers’ incentives (such as rebates or coupons) tendered by consumers. Vendor consideration may be included in revenues only if defined criteria are met, otherwise, such consideration would be recorded as a decrease in cost of goods sold. The provisions of EITF 03-10 became effective for transactions entered into by consumers in fiscal periods beginning after November 25, 2003 and, therefore apply to transactions starting with the Company’s fiscal second quarter of 2004. The adoption of EITF 03-10 did not affect the Company’s consolidated gross profit or net loss, as there was not a material impact on the consolidated financial statements.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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 can cause volatility in foreign currency exchange rates and weak economic conditions. As of May 31, 2004, the Company had a total of 25 consolidated warehouse clubs operating in 12 foreign countries and one U.S. territory (excluding the three warehouse clubs owned in Mexico through its 50/50 joint venture). Eighteen of the 25 warehouse clubs operate under foreign currencies other than the U.S. dollar. For the nine months ended May 31, 2004 and 2003, approximately 79% and 74%, respectively, of the Company’s net warehouse sales were in foreign currencies. The Company may enter into additional foreign countries in the future or open additional locations in existing countries, which may involve similar economic and political risks as well as challenges that are different from those currently encountered by the Company. 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. For example, the Dominican Republic experienced a currency devaluation of approximately 73% between the quarter ended May 31, 2003 and the quarter ended May 31, 2004. There can be no assurance that the Company will not experience any other materially adverse effect on its business, financial condition, operating results, cash flow or liquidity from foreign currency devaluations, as a result of the economic and political risks of conducting an international merchandising business.

Foreign exchange transaction losses, which are included as a part of the costs of goods sold in the consolidated statement of operations, were approximately $555,000 and $1.7 million for the nine-month periods ended May 31, 2004 and 2003, respectively. Translation adjustments from the Company’s non-U.S. denominated majority or wholly owned subsidiaries and investment in affiliate, resulting from the translation of the assets and liabilities of the subsidiaries and affiliate into U.S. dollars, were $3.8 million for the nine-month period ended May 31, 2004.

The following is a listing of each country or territory where the Company currently operates and their respective currencies, as of May 31, 2004:

The Company is exposed to changes in interest rates on various debt facilities. A hypothetical 100 basis point adverse change in interest rates along the entire interest rate yield curve could adversely affect the Company’s pretax net loss (excluding any minority interest impact) by approximately $546,000 on an annualized basis.

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ITEM 4. CONTROLS AND PROCEDURES

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in its reports pursuant to the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules, and that such information is accumulated and communicated to the Company’s management, including its Interim Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As required by SEC Rule 13a-15(b), the Company carried out an evaluation, under the supervision and with the participation of its management, including the Interim Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the quarter covered by this report. Based on the foregoing, its Interim Chief Executive Officer and Chief Financial Officer determined that disclosure controls and procedures were effective at a reasonable assurance level.

During the first half of fiscal year 2004, the Company implemented remedial measures to address material weaknesses in internal controls previously identified by the Company and subsequently by Ernst & Young LLP in connection with its audit of fiscal year 2003. Management believes these measures have materially improved its internal controls over financial reporting. Actions taken included the replacement of management, including senior management, with responsibility for functions where control issues were noted, the appointment of a new Chief Financial Officer and two new controllers to oversee the accounting activities, and generally heightened scrutiny by the Company’s management and finance and accounting departments related to revenue recognition issues and financial reporting in all of the Company’s geographic segments. The Company believes the measures it has taken and additional measures it continues to implement are reasonably likely to have a material, positive impact on its internal controls over financial reporting in future periods.

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PART II—OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

From time to time, the Company and its subsidiaries are subject to legal proceedings and claims in the ordinary course of business, including those identified below. The Company evaluates such matters on a case by case basis, and vigorously contests any such legal proceedings or claims which the Company believes are without merit.

On November 10, 2003, the Company announced it would be restating its financial statements for the fiscal year ending August 31, 2002 and for the nine months ending May 31, 2003. Subsequent to the announcement, seven separate class action complaints have been filed against the Company and certain of its current and former directors and officers in the United States District Court for the Southern District of California for alleged violations of federal securities laws (“Federal Class Action Complaints”). The complaints purport to be class actions on behalf of purchasers of the Company’s common stock (with one complaint also filed on behalf of purchasers of the Series A preferred stock in a January 2002 private placement) between December 20, 2001 and November 7, 2003 with respect to all but one of the Federal Class Action Complaints and between November 1, 2001 and November 7, 2003 with respect to the complaint that also addresses the Series A preferred stock, and seek damages, rescission (in the case of the Series A preferred stock) and attorney’s fees. Plaintiffs have filed motions to consolidate all seven of the Federal Class Action Complaints and to appoint a lead plaintiff, which are currently pending before the Court.

On December 5, 2003, a shareholder derivative complaint was filed against the Company as a nominal defendant and certain of the Company’s current and former officers and directors, in the Superior Court of the State of California, County of San Diego. Based on the Company’s restatement and the filing of the Federal Class Action Complaints, the derivative complaint purportedly alleges claims for breach of fiduciary duty, abuse of control, gross mismanagement, wasted corporate assets, unjust enrichment and violations of the California Corporations Code. On April 5, 2004, defendants filed a demurrer to the derivative complaint, as well as a motion to stay the derivative action pending resolution of the Federal Class Action Complaints and a motion requiring plaintiff to post a