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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended February 28, 2005

OR

¨    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

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 24,553,844 shares of its common stock, par value $.0001 per share, outstanding at March 31, 2005.

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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 February 28, 2005, the consolidated balance sheet as of August 31, 2004, the unaudited consolidated statements of operations for the three and six month periods ended February 28, 2005 and February 29, 2004, the unaudited consolidated statements of cash flows for the six month periods ended February 28, 2005 and February 29, 2004, and the unaudited consolidated statements of stockholders’ equity for the six month period ended February 28, 2005 are included elsewhere herein. Also included within 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,” and “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 – Factors That May Affect Future Performance.”

The following discussion and analysis compares the results of operations for the three and six month periods ended February 28, 2005 (fiscal 2005) and February 29, 2004 (fiscal 2004), and should be read in conjunction with the consolidated financial statements and the accompanying notes included within.

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 February 28, 2005 and February 29, 2004, 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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During fiscal 2004, the Company opened a new U.S.-style membership shopping warehouse club in the Philippines and closed its warehouse club in Guam. No consolidated warehouse clubs were opened or closed during the first six months of fiscal 2005. As a result, there were 26 consolidated warehouse clubs in operation, operating in twelve countries and one U.S. territory as of February 28, 2005, compared to 25 consolidated warehouse clubs in operation, operating in twelve countries and one U.S. territory at the end of the second quarter of fiscal 2004. During the first quarter of fiscal 2005 the Company announced that it had entered into an agreement to acquire land in San Jose, Costa Rica for a planned fourth location in that market, which the Company plans to open in the second half of calendar year 2005. The average life of the 26 warehouse clubs in operation as of February 28, 2005 was 50 months. The average life of the 25 warehouse clubs in operation as of February 29, 2004 was 44 months.

On February 11, 2005, it was announced that the Company and Grupo Gigante S.A. had decided to close the warehouse club operations of PSMT Mexico, S.A. de C.V. This closure was completed February 28, 2005. PSMT Mexico, S.A. de C.V. is a 50/50 joint venture of PriceSmart and Grupo Gigante S.A. de C.V. and operated three membership warehouse clubs in Mexico. The joint venture will continue to have real estate assets and is evaluating various business strategies associated with those assets, including leasing, selling or further commercial development of the sites.

In addition to the warehouse clubs operated directly by the Company or through joint ventures, there was one warehouse club in operation in Saipan, Micronesia licensed to and operated by local business people, through which the Company earns a licensee fee. During the second quarter of fiscal 2005, the Company terminated the license agreement with its China licensee, under which the China licensee operated 11 warehouse clubs. The Company has not recorded any licensing revenue under the license agreement in fiscal 2005.

COMPARISON OF THE THREE MONTHS ENDED FEBRUARY 28, 2005 AND FEBRUARY 29, 2004

Net warehouse sales increased 10.5% to $178.5 million in the second quarter of fiscal 2005 from $161.5 million in the second quarter of fiscal 2004. Warehouse sales grew in all of the regions in which the Company operates as a result of improved merchandise quantity and selection as compared to last year’s second quarter. The sales increase over the prior year was primarily reflected in an increase in the average sale per transaction. The Company considers this a positive outcome resulting from the Company’s efforts to offer higher quality brand name merchandise to its members. The Company experienced 19% sales growth from the prior year in its Caribbean market, which was helped by strengthening currency and an improved economic environment in the Dominican Republic, 7% growth in Central America and 14% growth in the Philippine market as a result of having four clubs in operation compared to three in the second quarter of fiscal 2004.

Comparable warehouse sales for warehouse clubs that were open at least 12 full months grew 10.1% for the thirteen week period ending March 6, 2005 compared to the same period a year earlier. The Company reports comparable warehouse sales on a “same week” basis with 13 weeks in each quarter beginning on a Monday and ending on a Sunday. The periods are established at the beginning of the fiscal year to provide as close a match as possible to the calendar month that is used for financial reporting purposes. This approach equalizes the number of weekend days and week days in each period for improved sales comparison as the Company experiences higher warehouse sales on the weekends. Further, each of the warehouse clubs that were used had been open for at least 12 months from the beginning of the measurement period and were in operation for the full period under review.

The Company’s warehouse gross profit margins (defined as net warehouse sales less associated cost of goods sold divided by net warehouse sales) decreased to 13.7% in the second quarter of fiscal 2005 from 14.0% in the second quarter of fiscal 2004. This reduction includes a $1.0 million charge to cost of goods sold taken by the Company related to additional import duties on merchandise for fiscal years 2001, 2002 and 2003, which negatively impacted margins in the period by 58 basis points. Currency movements in both the current and prior periods had only small positive effects on warehouse gross profit margins of 10 and 20 basis points, respectively. For a further definition of the expenses included in cost of goods sold, please refer to Note 2 – Summary of Significant Accounting Policies.

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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 (see “Note 9-Related Party Transactions” in the Notes to Consolidated Financial Statements included within). Export sales in the second quarter of fiscal 2005 were $138,000 compared to $304,000 in the second quarter of fiscal 2004. The change between periods reflects a continued reduction in the direct export sales business the Company does with non-affiliated third parties or unconsolidated affiliates.

Membership fees, which are recognized into income ratably over the one-year life of the membership and reported as membership income, increased to $2.5 million in the second quarter of fiscal 2005 compared to $2.2 million in the second quarter of fiscal 2004. The Company has been putting an increased emphasis on membership. Membership renewal rates average approximately 83% for the Company’s warehouse clubs and total accounts have increased 3.0% during the second quarter of fiscal 2005. The average membership fee is approximately $24.00.

Other income consists of commission revenue, rental income, advertising revenue, construction revenue, vendor promotions, and fees earned from licensees. Other income, excluding license fees, increased to $1.6 million in the second quarter of fiscal 2005 compared to $1.3 million in the second quarter of fiscal 2004. The increase is due to a $400,000 refund of an accumulated marketing fund related to the Company’s co-branded credit card. Other income excluding license fees decreased primarily due to a decrease in construction management revenues. The Company recorded no license fees in the second quarter of fiscal 2005 compared to $386,000 in the second quarter of fiscal 2004 as a result of the previously announced termination of the technology and trademark licensing agreements with the Company’s China licensee.

Warehouse club operating expenses increased to $21.2 million in the second quarter of fiscal 2005 from $20.4 million in the second quarter of fiscal 2004, but decreased as a percent of net warehouse sales to 11.9% from 12.6%. Warehouse operating expense increases resulted from various factors including one additional warehouse club in operation and higher payroll and utility costs. As a percent of net warehouse sales, the Company experienced reductions most notably in depreciation expense and other operating costs that are not variable with sales, such as rent expense.

General and administrative expenses were $6.3 million, or 3.5% of net warehouse sales, in the second quarter of fiscal 2005 compared to $5.9 million, or 3.6% of net warehouse sales, in the second quarter of fiscal 2004. The Company incurred $1.1 million in costs with outside consultants in the analysis and documentation of processes related to compliance with Section 404 of the Sarbanes-Oxley Act. The Company has determined that, as a result of the announcement made by the SEC on March 2, 2005, it will have an additional year to comply with Section 404. However, the Company has decided to proceed with and complete the documentation and remediation phases of the project and begin testing as a core part of its overall internal controls effort. This effort will require additional incremental costs in the third quarter, although at a significantly reduced level from that experienced in the second quarter. The current quarter also includes a $700,000 charge related to the tentative settlement of the consolidated securities litigation announced on March 3, 2005 and includes that portion of the tentative settlement not covered by insurance as well as related legal fees. The Company also incurred $200,000 in litigation costs related to disputes with the minority stockholders of its Guatemala and Philippines subsidiaries in the second quarter of fiscal 2005. The expenses in the second quarter of fiscal 2004 included approximately $780,000 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 and for severance related to the restructuring of its headquarters operations, including the closure of substantially all of its Miami-based buying operations and consolidating those activities with the buying team in San Diego.

Pre-opening expenses were $2,000 in the second quarter of fiscal 2005, which represent expenses incurred before a warehouse club is in operation, in the current period. The Company expects to incur additional pre-opening costs associated with the planned fourth location in San Jose, Costa Rica. In the second quarter of fiscal 2004 the Company incurred $156,000 of pre-opening expenses related to the Aseana site in the Philippines, which subsequently opened in June 2004.

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The Company incurred $211,000 in operating costs to maintain four closed warehouse club locations while it seeks tenants or alternative uses for those facilities. Closure costs in the second quarter of fiscal year 2004 were $1.5 million, $1.2 million of which was associated with the closure of the Guam warehouse on December 24, 2003.

Operating income for the second quarter of fiscal 2005 was $803,000 compared to a loss of $1.5 million in the second quarter of fiscal 2004.

Interest income primarily reflects earnings on cash and cash equivalent balances and restricted cash deposits securing long-term debt. Interest income was $696,000 in the second quarter of fiscal 2005 compared to $632,000 in the second quarter of fiscal 2004. The increase in interest income is due to the combination of higher cash and cash equivalent balances and higher interest rates.

Interest expense primarily reflects borrowings by the Company’s majority or wholly-owned foreign subsidiaries to finance the capital requirements of the initial construction of the warehouse clubs, local currency loans secured by U.S. dollar deposits and on-going working capital requirements. Interest expense decreased to $2.2 million in the second quarter of fiscal 2005 from $2.7 million in the second quarter of fiscal 2004. The decrease is a result of a reduced level of debt held by the Company, partially offset by higher interest rates.

The Company recorded an income tax provision of $316,000 for the second quarter of fiscal year 2005, compared to $241,000 for the same period in the prior year. The current period provision represents the net effect of income tax expense in certain subsidiaries that are generating taxable income and income tax credits for those subsidiaries generating losses. Income tax audits recognized are only when the recoverability of those credits are deemed to be more likely than not. Due to the current interplay of income and losses within the different group companies, the Company does not believe that the resulting effective tax rate is an adequate measurement tool at this time.

Equity of unconsolidated affiliate represents the Company’s 50% share of losses from its Mexico joint venture. On February 11, 2005, the Company, along with its joint venture shareholders Grupo Gigante S.A. de C.V., announced that it was closing the warehouse operations of PSMT Mexico, S.A. de C.V. effective February 28, 2005. At that time the Company indicated that it believed that the closure would not result in a significant loss for PriceSmart, Inc. While this is still the Company’s view with respect to the total carrying value of that investment, PSMT Mexico did incur larger than estimated operating losses in the month of February associated with the liquidation of merchandise, the refund of membership fees, the severance of employees and the settlement of contractual obligations. 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 $2.0 million, as compared to $377,000 in the prior year period.

Minority interest relates to the allocation of joint venture income or loss to the minority stockholders. In the second quarter of fiscal 2004, the Company’s joint venture subsidiaries collectively recorded an operating loss, resulting in a $497,000 allocation of that loss to the minority stockholders’ interests. In the second quarter of 2005, the Company’s joint venture subsidiaries collectively recorded net income, resulting in an allocation of $114,000 of income to the minority stockholders’ interests in those joint ventures. It should be noted that in fiscal 2005 the Philippines joint venture is no longer included in the minority interest allocation as the minority stockholders’ interests in that joint venture have been reduced to zero as a result of the prior accumulated losses.

No preferred stock dividends accrued in the second quarter of fiscal 2005 as all classes of preferred stock and their accrued dividends were converted to common stock during the first quarter of fiscal 2005. Accrued dividends on preferred stock in the second quarter of fiscal year 2004 were $840,000.

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COMPARISON OF THE SIX MONTHS ENDED FEBRUARY 28, 2005 AND FEBRUARY 29, 2004

Net warehouse sales grew 8.6% to $331.5 million in the first half of fiscal 2005 from $305.2 million in the first half of fiscal 2004. Improved merchandise quantity and selection in the Company’s warehouse clubs was the primary contributor to the growth in sales.

Comparable warehouse sales for warehouse clubs that were open at least 12 full months grew 8.6% for the twenty-six week period ending March 6, 2005 compared to the same period a year earlier. The Company reports comparable warehouse sales on a “same week” basis with 13 weeks in each quarter beginning on a Monday and ending on a Sunday. The periods are established at the beginning of the fiscal year to provide as close a match as possible to the calendar month which is used for financial reporting purposes. This approach equalizes the number of weekend days and week days in each period for improved sales comparison as the Company experiences higher warehouse sales on the weekends. Further, the warehouse clubs that are used have been open for at least 12 months from the beginning of the measurement period and were in operation for the full period under review.

The Company’s warehouse gross profit margins (defined as net warehouse sales less associated cost of goods sold divided by net warehouse sales) in the first half of fiscal 2005 increased to 14.5% from 13.3% in the first half of fiscal 2004. The improvement in gross profit margins of 1.2% resulted from improvements in merchandising and operating efforts of the Company, as well as beneficial currency movements in certain countries (primarily the Dominican Republic). These factors were partially offset by a $1.0 million charge to cost of goods sold related to additional import duties on merchandise for fiscal years 2001, 2002, and 2003. In the prior year, warehouse gross profit margins were impacted negatively by reduced margins in Guam as merchandise was marked down in advance of the December closing, as well as reduced margins (primarily in the first quarter of fiscal year 2004) in order to dispose of slower moving inventory. For a further definition of the expenses included in cost of goods sold, please refer to Note 2 – Summary of Significant Accounting Policies.

Export sales were $371,000 in the first half of fiscal 2005 compared to $809,000 in the first half of fiscal 2004. The decrease reflects a reduction in the direct export sales business the Company does with non-affiliated third parties and unconsolidated affiliates.

Membership fees, which are recognized into income ratably over the one-year life of the membership and reported as membership income, were $4.9 million in the first half of fiscal 2005 compared to $4.3 million during the same period of fiscal 2004 primarily reflecting higher average membership fees.

Other income consists of commission revenue, rental income, advertising revenues, construction revenue, vendor promotions, and fees earned from licensees. Other income, excluding license fees, increased to $2.7 million in the first half of fiscal 2005 compared to $2.5 million in the first half of fiscal 2004. The increase is due to a $400,000 refund of an accumulated marketing fund related to the Company’s co-branded credit card in the current period. Other income, excluding license fees, decreased primarily due to a decrease in construction management revenues. The Company recorded no license fees in the first half of fiscal 2005 compared to $727,000 in the first half of fiscal 2004 as a result of the previously announced termination of the technology and trademark licensing agreements with the Company’s China licensee.

Warehouse operating expenses increased to $40.9 million in the first half of fiscal 2005 from $40.6 million in the same period in fiscal 2004. As a percent of net warehouse sales, however, warehouse operating expenses decreased to 12.4% of net warehouse sales in fiscal 2005 from 13.3% of net warehouse sales in fiscal 2004. Improvements as a percent of net warehouse sales were attributable to improvements in labor productivity and the effect of higher sales on generally fixed costs such as building rent and depreciation.

General and administrative expenses were $11.4 million, or 3.4% of net warehouse sales, in the first half of fiscal 2005 compared to $11.0 million, or 3.6% of net warehouse sales, in the first half of fiscal 2004. In the first

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half of fiscal 2005, the Company has incurred approximately $1.2 million for outside consultants in the analysis and documentation of processes related to compliance with the Sarbanes-Oxley Act and $700,000 in settlement costs related to securities litigation. The Company also recorded $200,000 in litigation costs related to the Guatemala and Philippines disputes in the first half of fiscal 2005. By comparison, the first half of fiscal year 2004 included severance costs of approximately $700,000 relating to the departure of certain members of senior management and the closure of substantially all of the Company’s Miami-based buying operations and the consolidation of those activities with the buying team in San Diego, and approximately $450,000 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.

Pre-opening expenses, which represent expenses incurred before a warehouse club is in operation, were $2,000 in the first six months of fiscal 2005. The Company expects to incur more pre-opening costs associated with the planned fourth location in San Jose, Costa Rica. In the first half of fiscal 2004, the Company incurred $166,000 of pre-opening expenses related to the Aseana site in the Philippines, which subsequently opened in June 2004.

Closure costs for the first half of fiscal 2005 were $578,000 for the operating costs to maintain the four closed warehouse club locations while the Company seeks tenants or alternative uses for those facilities. In the first half of fiscal year 2004, closure costs were $1.7 million, $1.2 million of which was associated with the closure of the Guam location in December 2003.

Operating income for the first half of fiscal year 2005 was $2.6 million compared to an operating loss of $5.3 million in the same period last year.

Interest income reflects earnings on cash and cash equivalents and restricted cash deposits securing long term debt. Interest income was $1.3 million for both the first half of fiscal 2005 and the first half of fiscal 2004.

Interest expense reflects the borrowings of the Company’s majority and wholly-owned subsidiaries used to finance the capital requirements of the initial construction of the warehouse clubs, local currency loans secured by U.S. deposits and on-going working capital requirements. Interest expense in the first half of fiscal 2005 was $5.1 million, compared to $5.6 million in the first half of fiscal 2004. The decrease is a result of a reduced level of debt held by the Company, partially offset by higher interest rates.

The Company recorded income tax provisions of $1.0 million and $189,000 for the six-month periods ended February 28, 2005 and February 29, 2004, respectively. The current period provision represents the net effect of income tax expense in certain subsidiaries that are generating taxable income and income tax credits for those subsidiaries generating losses. Income tax audits are recognized only when the recoverability of the credits are deemed to be more likely than not. Due to the current interplay of income and losses within the different group companies, the Company does not believe that the resulting effective tax rate is an adequate measurement tool at this time.

Equity of unconsolidated affiliate represents the Company’s 50% share of losses from its Mexico joint venture. On February 11, 2005, the Company, along with its joint venture partner Grupo Gigante S.A. de C.V, announced that it was closing the warehouse operations of PSMT Mexico, S.A. de C.V. effective February 28, 2005. At that time the Company indicated that it believed that the closure would not result in a significant loss for PriceSmart, Inc. While this is still the Company’s position with respect to the total carrying value of that investment, PSMT Mexico did incur large operating losses in the month of February associated with the liquidation of merchandise, the refund of membership fees, the severance of employees and the settlement of contractual obligations. 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 first half of fiscal year 2005 was $2.4 million, as compared to $781,000 in the prior year period.

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Minority interest relates to the allocation of the joint venture income or loss to the minority stockholders. In the first six months of fiscal 2004, those joint ventures collectively recorded an operating loss resulting in a $1.0 million allocation of that loss to the minority shareholders’ interests. In the first six months of fiscal 2005, the Company’s joint ventures collectively recorded net income, resulting in an allocation of $166,000 to the minority stockholders’ interests in those joint ventures. It should be noted that in fiscal 2005 the Philippines joint venture is no longer included in the minority interest allocation as the minority stockholders’ interest in that joint venture have been reduced to zero as a result of the prior accumulated losses.

Preferred dividends decreased to $648,000 in the first half of fiscal 2005, compared to $1.7 million the same period in the prior year, due to the conversion of all classes of preferred stock to common stock in the first quarter of fiscal 2005.

LIQUIDITY AND CAPITAL RESOURCES

Financial Position and Cash Flow

The Company’s primary capital requirements are for the operating working capital needs of the Company, particularly those associated with the acquisition of an adequate level of U.S. and locally sourced merchandise for the Company’s warehouse clubs.

The Company significantly improved its working capital position (defined as current assets less current liabilities) in the second quarter of fiscal 2005, and as of February 28, 2005, had a working capital surplus of $38.3 million, compared to working capital deficits of $4.3 million as of November 30, 2004 and $15.5 million as of August 31, 2004. The $42.6 million improvement since November 2004 was largely a result of the sale of 6,827,542 shares of the Company’s common stock for aggregate proceeds of $47.8 million pursuant to the exercise of subscription rights during the $7 exercise period of the Company’s previously announced rights offering. The $7 subscription period ended on January 24, 2005. The $8 subscription period extends until December 21, 2005. The Company used a portion of the additional capital to reduce short-term borrowings by $11.7 million, including the $3.0 million repayment of a short-term loan from a related party associated with the initial acquisition of land in San Jose, Costa Rica. For the first six months of the fiscal year, the Company’s working capital position improved by $53.8 million, attributable to the $47.8 million in common stock sales and also the conversion of approximately $20 million in short-term related party borrowings to common stock as part of the Financial Program (see “Note 6- Financial Program” in the Notes to Consolidated Financial Statements included herein).

Net cash flows provided by operating activities were $7.1 million and $8.8 million in the first six months of fiscal 2005 and 2004, respectively. During the first half of fiscal 2005, the Company increased merchandise inventories by $7.3 million. During the same period in fiscal 2004, the merchandise inventories decreased $12.8 million.

Net cash used in investing activities was $5.9 million and $2.5 million in the first six months of fiscal 2005 and 2004, respectively. The increase in the use of cash of approximately $3.4 million resulted primarily from the acquisition of land and the initial building costs associated with the planned new warehouse club location in San Jose, Costa Rica.

Financing activities contributed $23.7 million in the first half of fiscal 2005 compared to approximately $149,000 in the first six months of fiscal 2004. A number of transactions related to the previously announced Financial Program during the first half of fiscal year 2005 accounted for the increase in the periods presented. The Company received $47.8 million from the sale of 6,827,542 shares of the Company’s common stock pursuant to the exercise of subscription rights during the $7 exercise period of the Company’s previously announced rights offering. The $7 subscription period ended on January 24, 2005. The $8 subscription period extends until December 21, 2005. In the first six months of fiscal 2005, the Company reduced long-term debt by

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$47.9 million; $26.4 million was through conversion to common stock and $21.5 million was through either net principal repayments or the complete retirement of the debt. In addition, short-term debt was reduced by $8.2 million during the period.

Financing Activities

The Company concluded significant phases of its previously announced Financial Program during the first half of the fiscal year (See “Note 6-Financial Program” in the Notes to Consolidated Financial Statements included herein).

In the first fiscal quarter of 2005, the Company converted $22 million of its Series B Cumulative Convertible Redeemable Preferred Stock into shares of common stock, valued for such purposes at $10 per share. The Company also converted a $25 million bridge loan plus accrued interest, the $5 million real estate advance for the subsequently cancelled sale of the Santiago, Dominican Republic land and building plus accrued interest and $14.9 million of purchase order financing plus accrued interest from, each extended to the Company by The Price Group, LLC, to common stock, valued for such purposes at $8 per share. The Price Group, LLC is affiliated with Robert E. Price, Interim Chief Executive Officer, Chairman of the Board of Directors and a significant stockholder of the Company and Sol Price, a significant stockholder of the Company and father of Robert E. Price. Directors Robert E. Price, Murray L. Galinson, Jack McGrory and former director James F. Cahill are co-managers of The Price Group, LLC and collectively own a significant interest in that entity. In addition, as part of a separate transaction, the Company converted $20 million of its Series A Cumulative Convertible Redeemable Preferred Stock plus accrued dividends to common stock valued for such purpose at $10 per share.

In addition, the Company purchased a $10.2 million long-term note of its Philippine subsidiary from the International Finance Corporation (“IFC”) and paid-off the outstanding balance of a $3.8 million long-term note to the Overseas Private Investment Corporation (“OPIC”). The Company simultaneously obtained the release of $6.8 million in restricted cash being held as partial collateral for those loans as part of the Financial Program.

In the second quarter of fiscal 2005, the Company received $47.8 million as a result of the sale of 6,827,542 shares of the Company’s common stock pursuant to the exercise of subscription rights during the $7 exercise period of the Company’s previously announced rights offering. The $7 subscription period ended on January 24, 2005. The $8 subscription period extends until December 21, 2005. The rights offering is part of the Financial Program.

On November 5, 2004, the Company entered into a short-term loan agreement for $3.0 million for a period of 90 days at a rate of 5% with The Price Group, LLC. This short-term loan was repaid on January 10, 2005.

Short-Term Borrowings and Long-Term Debt

As of February 28, 2005, the Company, together with its majority or wholly-owned subsidiaries, had $5.2 million outstanding in short-term borrowings, which are secured by certain assets of the Company and its subsidiaries and are guaranteed by the Company up to its respective ownership percentage. Each of the facilities expires during the year and is typically renewed. As of February 28, 2005, the Company had approximately $11.0 million available on these facilities.

Additionally, the Company has a bank credit agreement for up to $7.0 million, which can be used as a line of credit or to issue letters of credit. As of February 28, 2005, letters of credit and lines of credit totaling $4.6 million were outstanding under this facility, leaving availability under this facility of $2.4 million.

As of February 28, 2005, the Company, together with its majority or wholly-owned subsidiaries, had $75.8 million outstanding in long-term borrowings. The Company’s long-term debt is collateralized by certain land, building, fixtures, equipment and shares of each subsidiary to which the debt relates and guaranteed by the

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Company up to its respective ownership percentage, except for approximately $24.9 million as of February 28, 2005, which is secured by collateral deposits included in restricted cash on the balance sheet and letters of credit. Certain obligations under leasing arrangements are collateralized by the underlying asset being leased.

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 February 28, 2005, the Company was in compliance with all of these covenants, except for the following: (i) debt service ratio for a $11.3 million note (with an outstanding balance of $1.9 million at February 28, 2005), which the Company repaid in full on March 23, 2005; (ii) interest cost/EBIT (earnings before interest and taxes) ratio for a $6.0 million note (with an outstanding balance of $3.8 million at February 28, 2005), for which the Company has requested and received a written waiver of its noncompliance through the quarter ending May 31, 2005; and (iii) debt to equity ratio for a $7.0 million note (with an outstanding balance of $3.7 million at February 28, 2005), for which the Company has requested and received a written waiver of its noncompliance through the quarter ending August 31, 2005. Additionally, the Company has debt agreements, with an aggregate principal amount outstanding as of February 28, 2005 of $26.5 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. As of February 28, 2005, 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. The Company believes that, primarily as a result of the Financial Program, it has sufficient financial resources to pay-down the two above obligations that were not repaid which had maintenance covenant noncompliance as of February 28, 2005, even though the Company has obtained waivers for each of them. Accordingly, the two obligations for which the Company has received waivers are reflected in the accompanying balance sheet under the original contractual maturities and $340,000 of the obligation the Company repaid on March 23, 2005, which was not already classified as current, was reclassified as current.

Contractual Obligations

As of February 28, 2005, the Company’s commitments to make future payments under long-term contractual obligations were as follows (amounts in thousands):

Critical Accounting 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 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.

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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. In addition, the Company may be required to take markdowns below the carrying cost of certain inventory to expedite the sale of such merchandise.

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.

Allowance for Bad Debt:    Credit is extended to a portion of the Company’s members as part of the Company’s wholesale business and to third-party wholesalers for direct sales. The Company maintains an allowance for doubtful accounts based on assessments as to the collectibility of specific customer accounts, the aging of accounts receivable, and general economic conditions. Additionally, the Company formerly utilized the importation and exportation businesses of one of the minority interest shareholders in the Company’s Philippines subsidiary for the movement of merchandise inventories both to and from the Asian regions. As of February 28, 2005, the Company had a total of approximately $645,000 in net receivables due from the minority interest shareholder’s importation and exportation businesses, which is included in accounts receivable on the consolidated financial statements. If the credit worthiness of a specific customer or the minority interest shareholder deteriorates, the Company’s estimates could change and it could have a material impact on the Company’s reported results.

Stock-Based Compensation:    As of February 28, 2005, 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.

Deferred Taxes:    A valuation allowance is recorded to reduce deferred tax assets to the amount that is more likely than not to be realized. As of February 28, 2005, the Company evaluated its deferred tax assets and liabilities and determined that, in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes,” a valuation allowance is necessary for certain foreign deferred tax asset balances, primarily because of the existence of significant negative objective evidence, such as the fact that certain countries are in a cumulative loss position for the past three years.

The Company has a federal and state tax net operating loss carry-forward at August 31, 2004 of approximately $40.5 million and $6.7 million, respectively. In calculating the tax provision, and assessing the likelihood that the Company will be able to utilize the deferred tax assets, the Company considered and weighed all of the evidence, both positive and negative, and both objective and subjective. The Company factored in the inherent risk of forecasting revenue and expenses over an extended period of time and considered the potential risks associated with its business. Because of the Company’s history of U.S. income and based on projections of future taxable income in the U.S., the Company was able to determine that there was sufficient positive evidence to support the conclusion that it was more likely than not that the Company would be able to realize the U.S. deferred tax assets by generating taxable income during the carry-forward period. However, if the Company does not achieve its projections of future taxable income in the U.S., the Company could be required to take a charge

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to earnings related to the recoverability of these deferred tax assets. Due to their shorter recovery period, the Company has maintained valuation allowances on U.S. foreign tax credits and capital loss carryforwards.

As a result of significant losses in many of the Company’s foreign subsidiaries at February 28, 2005, the Company has concluded that full valuation allowances are necessary in all but two of its subsidiaries. The Company has factored in the inherent risk of forecasting revenue and expenses over an extended period of time and also considered the potential risks associated with its business. There was insufficient positive evidence to overcome the existence of the negative objective evidence of cumulative losses. As a result, management concluded that it was more likely than not that the deferred tax assets would not be realized in these subsidiaries.

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

During December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement No. 123R, “Share-Based Payment” (“SFAS 123R”), which requires companies to measure and recognize compensation expense for all stock-based payments at fair value. Stock-based payments include stock option grants. The Company grants options to purchase common stock to some of its employees and directors under various plans at prices equal to the market value of the stock on the dates the options were granted. SFAS 123R is effective for all interim or annual periods beginning after June 15, 2005. Early adoption is encouraged and retroactive application of the provisions of FAS 123R to the beginning of the fiscal year that includes the effective date is permitted, but not required. The Company has not yet adopted this pronouncement and is currently evaluating the expected impact that the adoption of SFAS 123R will have on its consolidated financial position, results of operations and cash flows.

In December 2004, the FASB issued Staff Position No. SFAS 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004” (“SFAS 109-2”). The American Jobs Creation Act of 2004 introduces a special one-time dividends-received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer, provided certain criteria are met. SFAS 109-2 provides accounting and disclosure guidance for the repatriation provision, and was effective immediately upon issuance. The Company has not yet adopted this pronouncement and is currently evaluating the expected impact that the adoption of SFAS 109-2 will have on its consolidated financial position, results of operations and cash flows.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs- An Amendment of ARB No. 43, Chapter 4” (“SFAS 151”). SFAS 151 clarifies that abnormal amounts of idle facility expense, freight, handling costs and spoilage should be expensed as incurred and not included in overhead. Further, SFAS 151 requires that allocation of fixed and production facilities overheads to conversion costs should be based on normal capacity of the production facilities. The provisions in this statement are effective for inventory costs incurred during fiscal periods beginning after June 15, 2005. The Company has not yet adopted this pronouncement and is currently evaluating the expected impact that the adoption of SFAS 151 will have on its consolidated financial position, results of operations and cash flows.

In November 2004, the FASB issued SFAS No. 153, “Exchanges of Non-monetary Assets- An Amendment of APB No. 29” (“SFAS 153”). The provisions of this statement are effective for non-monetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. This statement eliminates the exception to fair value for exchanges of similar productive assets and replaces it with a general exception for exchange transactions that do not have commercial substance- that is, transactions that are not expected to result in significant changes in the cash flows of the reporting entity. The Company has not yet adopted this pronouncement and is currently evaluating the expected impact that the adoption of SFAS 153 will have on its consolidated financial position, results of operations and cash flows.

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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 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, 2005, the Company had a total of 26 consolidated warehouse clubs operating in 12 foreign countries and one U.S. territory (excluding the three closed warehouse clubs owned in Mexico through its 50/50 joint venture). Nineteen of the 26 warehouse clubs operate under currencies other than the U.S. dollar. For the six months ended February 28, 2005 and February 29, 2004, approximately 79% and 77%, 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 81% during fiscal 2003 and approximately 13% during fiscal 2004. There can be no assurance that the Company will not experience any other material adverse effects on the Company’s business, financial condition, operating results, cash flow or liquidity from currency devaluations in other countries as a result of the economic and political risks of conducting an international merchandising business.

Foreign exchange transaction gains/(losses), which are included as a part of the costs of goods sold in the consolidated statement of operations, were approximately $1.2 million and $(190,000) for the six month periods ended February 28, 2005 and February 29, 2004, respectively. Translation adjustment gains/(losses) from the Company’s share of 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 into U. S. dollars were $1.9 million and $(4.3) million for the six months and year ended February 28, 2005 and August 31, 2004, respectively. Foreign exchange gains/(losses) were positively impacted by $755,000 relating to the Dominican Republic during the first six months of fiscal 2005. The Dominican Republic experienced a favorable currency revaluation of approximately 40% between the quarter ended February 29, 2004 and the quarter ended February 28, 2005.

The following is a listing of each country or territory where the Company currently operates and their respective currencies, as of February 28, 2005:

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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 pre-tax loss (excluding any minority interest impact) by approximately $530,000 on an annualized basis.