PriceSmart (PSMT)

 

ITEM 1.                      FINANCIAL STATEMENTS

PriceSmart, Inc.’s (“PriceSmart” or the “Company”) unaudited consolidated balance sheet as of May 31, 2010, the consolidated balance sheet as of August 31, 2009, the unaudited consolidated statements of income for the three and nine month periods ended May 31, 2010 and 2009, the unaudited consolidated statements of equity for the nine months ended May 31, 2010 and 2009, and the unaudited consolidated statements of cash flows for the nine months ended May 31, 2010 and 2009, are included elsewhere herein. Also included herein are the notes to the unaudited consolidated financial statements.

 

1

---

 

 

 

 

														Tax Benefit				Accum-
														From				ulated																Total
														Stock-				Other																PriceSmart
										Additional				based				Compre-				Accum-												Stock-				Non-
		Common Stock								Paid-in				Compen-				hensive				ulated				Treasury Stock								holders'				Controlling				Total
		Shares				Amount				Capital				sation				Loss				Deficit				Shares				Amount				Equity				Interest				Equity
Balance at August 31, 2008			30,196			$	3			$	373,192			$	4,563			$	(12,897	)		$	(77,510	)			580			$	(12,845	)		$	274,506			$	480			$	274,986
Purchase of treasury stock			—				—				—				—				—				—				68				(1,112	)			(1,112	)			—				(1,112	)
Issuance of restricted stock awards			104				—				—				—				—				—				—				—				—				—				—
Forfeiture of restricted stock awards			(18	)			—				—				—				—				—				—				—				—				—				—
Exercise of stock options			33				—				210				—				—				—				—				—				210				—				210
Stock-based compensation			—				—				2,480				(175	)			—				—				—				—				2,305				—				2,305
Common stock subject to put agreement			—				—				161				—				—				—				—				—				161				—				161
Purchase of treasury stock for PSC settlement			—				—				—				—				—				—				7				(161	)			(161	)			—				(161	)
Dividend payable to stockholders			—				—				—				—				—				(7,411	)			—				—				(7,411	)			—				(7,411	)
Dividend paid to stockholders			—				—				—				—				—				(7,392	)			—				—				(7,392	)			—				(7,392	)
Change in fair value of interest rate swaps			—				—				—				—				(621	)			—				—				—				(621	)			—				(621	)
Net income			—				—				—				—				—				32,069				—				—				32,069				211				32,280
Translation adjustment			—				—				—				—				(3,352	)			—				—				—				(3,352	)			9				(3,343	)
Comprehensive income																																			28,096				220				28,316
Balance at May 31, 2009			30,315			$	3			$	376,043			$	4,388			$	(16,870	)		$	(60,244	)			655			$	(14,118	)		$	289,202			$	700			$	289,902
Balance at August 31, 2009			30,337			$	3			$	377,210			$	4,547			$	(17,230	)		$	(49,998	)			656			$	(14,134	)		$	300,398			$	770			$	301,168
Purchase of treasury stock			—				—				—				—				—				—				69				(1,388	)			(1,388	)			—				(1,388	)
Issuance of restricted stock awards			111				—				—				—				—				—				—				—				—				—				—
Forfeiture of restricted stock awards			(5	)			—				—				—				—				—				—				—				—				—				—
Exercise of stock options			138				—				836				—				—				—				—				—				836				—				836
Stock-based compensation			—				—				2,829				(46	)			—				—				—				—				2,783				—				2,783
Dividend payable to stockholders			—				—				—				—				—				(7,429	)			—				—				(7,429	)			—				(7,429	)
Dividend paid to stockholders			—				—				—				—				—				(7,433	)			—				—				(7,433	)			—				(7,433	)
Stockholder contribution			—				—				396				—				—				—				—				—				396				—				396
Acquisition of 5% minority interest			—				—				(2,914	)			—				—				—				—				—				(2,914	)			(886	)			(3,800	)
Change in fair value of interest rate swaps, net of tax			—				—				—				—				13				—				—				—				13				—				13
Net income			—				—				—				—				—				36,098				—				—				36,098				132				36,230
Translation adjustment			—				—				—				—				265				—				—				—				265				(16	)			249
Comprehensive income											24																								36,400				(770	)			36,516
Balance at May 31, 2010			30,581			$	3			$	378,381			$	4,501			$	(16,952	)		$	(28,762	)			725			$	(15,522	)		$	321,649			$	—			$	321,649

See accompanying notes.

 

 

 

 

 

4

---

 

 

 

 

PRICESMART, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED—AMOUNTS IN THOUSANDS)

		Nine Months Ended
		May 31,
		2010				2009
Operating Activities:
Net income		$	36,230			$	32,280
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			11,191				9,700
Allowance for doubtful accounts			(4	)			2
Asset impairment and closure costs			—				74
Loss on sale of  property and equipment			254				13
Release from escrow account due to settlement of litigation			—				256
Deferred income taxes			2,329				(701	)
Discontinued operations			(40	)			27
Equity in losses of unconsolidated affiliates			11				20
Excess tax deficiency on stock-based compensation			46				175
Stock-based compensation			2,829				2,480
Change in operating assets and liabilities:
Change in receivables, prepaid expenses and other current assets, accrued salaries and benefits, deferred membership income and other accruals			3,267				(3,485	)
Merchandise inventories			(17,218	)			904
Accounts payable			12,086				(4,110	)
Net cash provided by continuing operating activities			50,981				37,635
Net cash provided by discontinued operating activities			142				57
Net cash provided by operating activities			51,123				37,692
Investing Activities:
Additions to property and equipment			(38,162	)			(38,451	)
Proceeds from disposal of property and equipment			85				91
Collection of note receivable from sale of closed warehouse club in the Dominican Republic			—				2,104
Purchase of 5% Trinidad noncontrolling interest			(3,800	)			—
Purchase of interest in Costa Rica joint ventures			—				(2,635	)
Capital contribution to Costa Rica joint ventures			—				(377	)
Purchase of interest in Panama joint venture			—				(4,616	)
Capital contribution to Panama joint venture			(433	)			—
Net cash used in continuing investing activities			(42,310	)			(43,884	)
Net cash used in discontinued investing activities			—				(9	)
Net cash used in investing activities			(42,310	)			(43,893	)
Financing Activities:
Proceeds from bank borrowings			35,460				28,982
Repayment of bank borrowings			(19,119	)			(19,898	)
Restricted cash			(6,000	)			—
Cash dividend payments			(7,433	)			(12,136	)
Stockholder contribution			396				—
Excess tax deficiency on stock-based compensation			(46	)			(175	)
Purchase of treasury stock for PSC settlement			—				(161	)
Proceeds from exercise of stock options			836				210
Purchase of treasury shares			(1,388	)			(1,112	)
Net cash provided by (used in) financing activities			2,706				(4,290	)
Effect of exchange rate changes on cash and cash equivalents			(621	)			1,405
Net increase (decrease) in cash and cash equivalents			10,898				(9,086	)
Cash and cash equivalents at beginning of period			44,193				48,121
Cash and cash equivalents at end of period		$	55,091			$	39,035

 

 

 

5

---

 

 

PRICESMART, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS—(Continued)

(UNAUDITED—AMOUNTS IN THOUSANDS)

		Nine Months Ended
		May 31,
		2010				2009
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest, net of amounts capitalized		$	1,836			$	1,905
Income taxes		$	13,661			$	10,138
Supplemental disclosure of non-cash financing activities:
Dividends declared but not paid		$	7,429			$	7,411

 

 

 

 

 

 

 

 

6

---

 

 

PRICESMART, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

May 31, 2010

NOTE 1 – COMPANY OVERVIEW AND BASIS OF PRESENTATION

PriceSmart, Inc.’s (“PriceSmart” or the “Company”) business consists primarily of international membership shopping warehouse clubs similar to, but smaller in size than, warehouse clubs in the United States. As of May 31, 2010, the Company had 27 consolidated warehouse clubs in operation in 11 countries and one U.S. territory (five in Costa Rica, four each in Panama and Trinidad, three in Guatemala, two each in Dominican Republic, El Salvador, and Honduras and one each in Aruba, Barbados, Jamaica, Nicaragua and the United States Virgin Islands), of which the Company owns 100% of the corresponding legal entities (see Note 2-Summary of Significant Accounting Policies).  In addition to the warehouse clubs operated directly by the Company, there is one facility in operation in Saipan, Micronesia licensed to and operated by local business people, from which the Company earns a royalty fee.  The Company primarily operates in three segments based on geographic area.

Basis of Presentation -> The interim consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q for interim financial reporting pursuant to the rules and regulations of the U.S. Securities and Exchange Commission ("SEC"). These interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the Company’s annual report filed on Form 10-K for the fiscal year ended August 31, 2009. The interim consolidated financial statements include the accounts of PriceSmart, Inc., a Delaware corporation, and its subsidiaries.  Intercompany transactions between the Company and its subsidiaries have been eliminated in consolidation.

In February 2010 the Financial Accounting Standards Board (“FASB”) issued revised guidance establishing general accounting standards and disclosure of subsequent events. The Company, in accordance with this guidance, evaluated subsequent events through the date and time these financial statements were issued. 

The Company has utilized net income as the starting point on the consolidated statements of cash flows for the periods presented, in order to reconcile net income to cash flows from operating activities as required by the indirect method.  Prior disclosures reconciled income from continuing operations to cash flows from operating activities.  This change had no effect on cash from operating activities.

 

Reclassifications - As a result of the application of a new accounting pronouncement for noncontrolling interests in consolidated entities, as discussed below in Recent Accounting Pronouncements, the Company:

·

Reclassified to noncontrolling interest, a component of total equity, $770,000 at August 31, 2009, which was previously reported as minority interest on the consolidated balance sheet.   A new subtotal, "Total PriceSmart stockholders’ equity", refers to the equity attributable to stockholders of PriceSmart; and

·	Reported as separate captions within the consolidated statements of income:  "Net income attributable to noncontrolling interest" and "Net income attributable to PriceSmart."

These reclassifications did not have a material impact on the Company’s previously reported results of operations, financial position or cash flows.

 

 

 

7

---

 

 

PRICESMART, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation -> The interim consolidated financial statements of the Company included herein include the assets, liabilities and results of operations of the Company’s majority and wholly owned subsidiaries as listed below. All significant intercompany accounts and transactions have been eliminated in consolidation. The interim consolidated financial statements have been prepared by the Company without audit, pursuant to the rules and regulations of the SEC, and reflect all adjustments (consisting of normal recurring adjustments) that are, in the opinion of management, necessary to fairly present the financial position, results of operations, and cash flows for the interim periods presented. Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles ("U.S. GAAP") have been condensed or omitted pursuant to such SEC rules and regulations. Management believes that the disclosures made are adequate to make the information presented not misleading. The results for interim periods are not necessarily indicative of the results for the full year.

The table below indicates the Company’s percentage ownership of and basis of presentation for each subsidiary as of May 31, 2010:  

	Subsidiary		Countries		Ownership		Basis of Presentation
	PriceSmart, Aruba		Aruba		100.0%		Consolidated
	PriceSmart, Barbados		Barbados		100.0%		Consolidated
	PriceSmart, Colombia		Colombia		100.0%		Consolidated(1)
	PSMT Caribe, Inc.:
	Costa Rica		Costa Rica		100.0%		Consolidated
	Dominican Republic		Dominican Republic		100.0%		Consolidated
	El Salvador		El Salvador		100.0%		Consolidated
	Honduras		Honduras		100.0%		Consolidated
	PriceSmart, Guam		Guam		100.0%		Consolidated(2)
	PriceSmart, Guatemala		Guatemala		100.0%		Consolidated
	PriceSmart, Jamaica		Jamaica		100.0%		Consolidated
	PriceSmart, Nicaragua		Nicaragua		100.0%		Consolidated
	PriceSmart, Panama		Panama		100.0%		Consolidated
	PriceSmart, Trinidad		Trinidad		100.0%		Consolidated(3)
	PriceSmart, U.S. Virgin Islands		U.S. Virgin Islands		100.0%		Consolidated
	GolfPark Plaza, S.A.		Panama		50.0%		Equity(4)
	Price Plaza Alajuela PPA, S.A.		Costa Rica		50.0%		Equity(4)
	Newco2		Costa Rica		50.0%		Equity(4)

 

(1)	For the nine month period ended May 31, 2010, this entity had no activity.
(2)	Entity is treated as discontinued operations in the consolidated financial statements.
(3)	The Company acquired the remaining 5% ownership in May 2010.  See Note 13 – Acquisition of Noncontrolling Interest.
(4)	Purchases of joint venture interests during the first quarter of fiscal year 2009 recorded as investment in unconsolidated affiliates on the consolidated balance sheets.

 

Use of Estimates> – The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.  

 

Variable Interest Entities –>  The Company reviews and determines at the start of each arrangement, or subsequently if a reconsideration event occurs, whether any of its investments in joint ventures are a Variable Interest Entity (“VIE”) and whether it must consolidate a VIE and/or disclose information about its involvement in a VIE. The Company has determined that the joint ventures for GolfPark Plaza, Price Plaza Alajuela and Newco2 are VIEs.  The Company has determined that it is not the primary beneficiary of the VIEs and, therefore, has accounted for these entities under the equity method.  

 

Cash and Cash Equivalents –> Cash and cash equivalents represent cash and short-term investments with maturities of three months or less when purchased.

 

 

 

 

8

---

 

 

PRICESMART, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Restricted Cash –> As of May 31, 2010, the Company had short-term restricted cash of approximately $1.2 million.  This consisted of the current portion of a certificate of deposit maintained by the Company’s Honduras subsidiary with the Banco Del Pais related to the loan agreement entered into by the subsidiary with Banco del Pais.  Long-term restricted cash consists of a $4.8 million long-term portion of the Banco Del Pais certificate of deposit and deposits made directly with federal regulatory agencies and within banking institutions in compliance with federal regulatory requirements in Costa Rica and Panama of approximately $865,000.

 

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, with physical inventories occurring 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.

 

Allowance for Doubtful Accounts –> The Company generally does not extend credit to its members, but may do so for specific wholesale, government, other large volume members and for subtenants. The Company maintains an allowance for doubtful accounts based on assessments as to the probability of collection of specific customer accounts, the aging of accounts receivable, and general economic conditions.

Property and Equipment – >Property and equipment are stated at historical cost. Depreciation is computed on the straight-line basis over the estimated useful lives of the assets. The useful life of fixtures and equipment ranges from three to 15 years and that of buildings from ten to 25 years. Leasehold improvements are amortized over the shorter of the life of the improvement or the expected term of the lease. In some locations, leasehold improvements are amortized over a period longer than the initial lease term as management believes it is reasonably assured that the renewal option in the underlying lease will be exercised as an economic penalty may be incurred if the option is not exercised. The sale or purchase of property and equipment is recognized upon legal transfer of property. For property and equipment sales, if any long term notes are carried by the Company as part of the sales terms, the sale is reflected at the net present value of current and future cash streams.

 

Acquisition of Business – >The Company’s business combinations, where the Company acquires control of one or more businesses, are accounted for under the acquisition method of accounting and include the results of operations of the acquired business from the date of acquisition.  Net assets of the acquired business are recorded at their fair value at the date of the acquisition.  Any excess of the purchase price over the fair value of tangible net assets acquired is included in goodwill in the accompanying consolidated balance sheets.

Changes in the Company’s ownership interest in subsidiaries, while the Company retains controlling financial interest in the subsidiary, are accounted for as an equity transaction. No gain or loss is recognized in consolidated net income or comprehensive income. The carrying amount of the noncontrolling interest is adjusted to reflect the change in the Company’s ownership interest in the subsidiary.  Any difference between the fair value of the consideration received or paid and the book value of the noncontrolling interest is recognized in equity attributable to the parent.

Lease Accounting – >Certain of the Company's operating leases where the Company is the lessee (see Revenue Recognition Policy for lessor accounting), provide for minimum annual payments that increase over the life of the lease. The aggregate minimum annual payments are expensed on the straight-line basis beginning when the Company takes possession of the property and extending over the term of the related lease including renewal options where the exercise of the option is reasonably assured as an economic penalty may be incurred if the option is not exercised in some locations. The amount by which straight-line rent exceeds actual lease payment requirements in the early years of the leases is accrued as deferred rent and reduced in later years when the actual cash payment requirements exceed the straight-line expense. The Company also accounts in its straight-line computation for the effect of any “rental holidays.” In addition to the minimum annual payments, in certain locations, the Company pays additional contingent rent based on a contractually stipulated percentage of sales.

 

Fair Value Measurements –> The Company measures the fair value for all financial and nonfinancial assets and liabilities that are recognized or disclosed at fair value in the consolidated financial statements on a recurring basis or on a nonrecurring basis during the reporting period.  The Company measures fair value for interest rate swaps on a recurring basis.  As of the balance sheet dates, there were no other financial assets for which the Company measures fair value.  As of the balance sheet dates, there were no nonfinancial assets and liabilities that are recognized or disclosed at fair value in the consolidated financial statements measured on a recurring basis, and there were certain nonfinancial assets and liabilities, such as goodwill and long-lived assets, that are recognized or disclosed at fair value in the consolidated financial statements measured on a non-recurring basis.  The Company measures at fair value nonfinancial assets and liabilities recognized or disclosed in the consolidated financial statements on a nonrecurring basis that require measurement at fair value after taking into account impairment charges (if any) that are deemed necessary.  Also included as nonfinancial assets and liabilities measured on a nonrecurring basis are those initially measured at fair value in a business combination or other new basis event, but not measured at fair value in subsequent periods.  

 

 

 

9

---

 

PRICESMART, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The Company has established a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions. The Company was not required to revalue any assets or liabilities utilizing Level 1 or Level 3 inputs at the balance sheet dates.  The Company's Level 2 assets and liabilities at the balance sheet dates primarily included cash flow hedges (interest rate swaps) and pricing of assets in connection with business acquisitions prior to fiscal year 2010.   The Company did not make any significant transfers in and out of Level 1 and Level 2 fair value tiers.

Valuation techniques utilized in the fair value measurement of assets and liabilities presented on the Company’s consolidated balance sheets were not changed from previous practice during the reporting period.  The Company discloses the valuation techniques and any change in method of such within the body of each footnote.

Goodwill> – Goodwill resulting from certain business combinations totaled $37.5 million at May 31, 2010 and August 31, 2009.  Foreign exchange translation gains and losses related to this balance sheet caption have largely offset themselves during the nine month period ended May 31, 2010. The Company reviews previously reported goodwill at the entity reporting level for impairment on an annual basis or more frequently if circumstances dictate.  No impairment of goodwill has been recorded to date.

Derivative Instruments and Hedging Activities – >Derivative instruments and hedging activities consist of interest rate swaps.  Interest rate swaps are accounted for as cash flow hedges. Under cash flow hedging, the effective portion of the fair value of the derivative, calculated as the net present value of the future cash flows, is deferred on the consolidated balance sheets in accumulated other comprehensive loss. If any portion of an interest rate swap were determined to be an ineffective hedge, the gains or losses from changes in market value would be recorded directly in the consolidated statements of income. Amounts recorded in accumulated other comprehensive loss are released to earnings in the same period that the hedged transaction impacts consolidated earnings. (See Note 12—Interest Rate Swaps.)

Components of Equity Attributable to PriceSmart and Noncontrolling Interests – >The Company reports its noncontrolling interests in consolidated subsidiaries as a component of equity separate from the Company’s equity. The other comprehensive loss due to foreign currency translation adjustments, related to the noncontrolling interests investment in consolidated subsidiaries and the translation of the financial statements of those consolidated subsidiaries, is reported within noncontrolling interests, separate from the amount attributable to the Company.

Revenue Recognition – >The Company recognizes merchandise sales revenue when title passes to the customer. Membership income represents annual membership fees paid by the Company’s warehouse club members, which are recognized ratably over the 12-month term of the membership. The historical membership fee refunds have been minimal and, accordingly, no reserve has been established for membership refunds for the periods presented.  The Company recognizes and presents revenue-producing transactions on a net of tax basis.  The Company recognizes gift certificates sales revenue when the certificates are redeemed. The outstanding gift certificates are reflected as "Other accrued expenses" in the consolidated balance sheets. These gift certificates generally have a one-year stated expiration date from the date of issuance.  The Company periodically reviews unredeemed outstanding gift certificates, and the gift certificates that have expired are recognized as “Revenues-Other Income” on the consolidated statements of income. Operating leases, where the Company is the lessor, with lease payments that have fixed and determinable rent increases are recognized as revenue on a straight-line basis over the lease term. The Company also accounts in its straight-line computation for the effect of any "rental holidays." Contingent rental revenue is recognized as the contingent rent becomes due per the individual lease agreements.

 

Cost of Goods Sold> – The Company includes the cost of merchandise, food service and bakery raw materials, and one hour photo supplies in cost of goods sold. The Company also includes the external and internal distribution and handling costs for supplying such merchandise, raw materials and supplies to the warehouse clubs. External costs include inbound freight, duties, drayage, fees, insurance, and non-recoverable value-added tax related to inventory shrink, spoilage and damage. Internal costs include payroll and related costs, utilities, consumable supplies, repair and maintenance, rent expense, and building and equipment depreciation at our distribution facilities.

 

 

 

 

10

---

 

 

PRICESMART, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Vendor consideration consists primarily of volume rebates, time limited product promotions and prompt payment discounts. Volume rebates are generally linked to pre-established purchase levels and are recorded as a reduction of cost of goods sold when the achievement of these levels is confirmed by the vendor in writing or upon receipt of funds, whichever is earlier. On a quarterly basis, the Company calculates the amount of rebates recorded in cost of goods sold that relates to inventory on hand and this amount is recorded as a reduction to inventory, if significant. Product promotions are generally linked to coupons that provide for reimbursement to the Company from vendor rebates for the product being promoted.  The Company records the reduction in cost of goods sold on a transactional basis for these programs.  Prompt payment discounts are taken in substantially all cases and, therefore, are applied directly to reduce the acquisition cost of the related inventory, with the resulting impact to cost of goods sold when the inventory is sold.

 

Selling, General and Administrative> – Selling, general and administrative costs are comprised primarily of expenses associated with warehouse operations. Warehouse operations include the operating costs of the Company's warehouse clubs, including all payroll and related costs, utilities, consumable supplies, repair and maintenance, rent expense, building and equipment depreciation, and bank and credit card processing fees. Also included in selling, general and administrative expenses are the payroll and related costs for the Company's U.S. and regional purchasing and management centers.

 

Pre-Opening Costs> – The Company expenses pre-opening costs (the costs of start-up activities, including organization costs and rent) as incurred.

Asset Impairment Costs –  >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 and can include management's best estimate of future business activity. These periodic evaluations could cause management to conclude that impairment factors exist, requiring an adjustment of these assets to their then-current fair market value. Future business conditions and/or activity could differ materially from the projections made by management causing the need for additional impairment charges.

Closure Costs – >The Company records the costs of closing warehouse clubs as follows:  severance costs that are determined to be an arrangement for one-time employee termination benefits are accrued at the date the plan of termination has received management authority and approval, the plan identifies the number of employees, job classification, functions, locations and expected completion dates, the plan establishes the terms of the severance, and management has deemed it unlikely that significant changes to the plan will be made.  In addition the plan must have been communicated to employees (referred to as the communication date).  Lease obligations are accrued at the cease use date by calculating the net present value of the minimum lease payments net of the fair market value of rental income that is expected to be received for these properties from third parties. Gain or loss on the sale of property, buildings and equipment is recognized based on the cash or net present value of future cash to be received as compensation upon consummation of the sale. All other costs are expensed as incurred. 

Contingencies and Litigation – > The Company accounts and reports for loss contingencies if (a) information available prior to issuance of the consolidated financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the consolidated financial statements and (b) the amount of loss can be reasonably estimated.  

Common Stock Put Agreement> – The Company recorded in fiscal year 2008 a liability for a common stock put agreement (see Note 14—PSC Settlement). The Company utilized the Black-Scholes method to determine the fair value of the put agreement, taking the fair market value of the common stock, time to expiration of the put agreement, volatility of the common stock and the risk-free interest rate over the term of the put agreement as part of the fair market valuation. The Company recorded in fiscal year 2008 an expense for the fair value of the put agreement granted as part of the legal settlement with the PSC Parties.  On September 9, 2008 (fiscal year 2009), the Company recorded the final settlement of the related liability.

 

Foreign Currency Translation >– The assets and liabilities of the Company’s foreign operations are primarily translated to U.S. dollars when the functional currency in our international subsidiaries is the local currency, which in many cases is not U.S. dollars. Assets and liabilities of these foreign subsidiaries are translated to U.S. dollars at the exchange rate on the balance sheet date, and revenue, costs and expenses are translated at average rates of exchange in effect during the period. The corresponding translation gains and losses are recorded as a component of accumulated other comprehensive income or loss.  These adjustments will affect net income upon the sale or liquidation of the underlying investment.

Monetary assets and liabilities in currencies other than the functional currency of the respective entity are revalued to the functional currency using the exchange rate on the balance sheet date. These foreign exchange transaction gains (losses), including repatriation of funds, which are included as a part of costs of goods sold in the consolidated statements of income, for the first nine months of fiscal years 2010 and 2009 were approximately $1.5 million and ($1.3) million, respectively.

 

 

 

11

---

 

 

PRICESMART, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Stock-Based Compensation> – Compensation related to stock options is accounted for by applying the valuation technique based on the Black-Scholes model. Compensation related to stock awards is based on the fair market value at the time of grant with the application of an estimated forfeiture rate, as opposed to only recognizing these forfeitures and the corresponding reduction in expense as they occur. Upon vesting, the Company records compensation expense for the previously estimated forfeiture on stock awards no longer under risk of forfeiture. The Company records as additional paid-in capital the tax savings resulting from tax deductions in excess of expense for stock-based compensation, based on the Tax Law Ordering method.  In addition, the Company reflects the tax saving resulting from tax deductions in excess of expense as a financing cash flow in its consolidated statement of cash flows, rather than as operating cash flows.

Income Taxes> – The Company is required to file federal and state income tax returns in the United States and various other tax returns in foreign jurisdictions. The preparation of these tax returns requires the Company to interpret the applicable tax laws and regulations in effect in such jurisdictions, which could affect the amount of tax paid by the Company. The Company, in consultation with its tax advisors, bases its tax returns on interpretations that are believed to be reasonable under the circumstances. The tax returns, however, are subject to routine reviews by the various federal, state and international taxing authorities in the jurisdictions in which the Company files its returns. As part of these reviews, a taxing authority may disagree with respect to the income tax positions taken by the Company (“uncertain tax positions”) and, therefore, require the Company to pay additional taxes. As required under applicable accounting rules, the Company accrues an amount for its estimate of additional income tax liability, including interest and penalties, which the Company could incur as a result of the ultimate or effective resolution of the uncertain tax positions. The Company reviews and updates the accrual for uncertain tax positions as more definitive information becomes available from taxing authorities, completion of tax audits, expiration of statute s of limitation, or upon occurrence of other events.

The Company accounts for uncertain income tax positions by accruing for the estimated additional amount of taxes for the uncertain tax positions when the uncertain tax position does not meet the more likely than not standard for sustaining the position.

As of May 31, 2010 and August 31, 2009, the Company had $13.7 million and $13.9 million, respectively, of aggregate accruals for uncertain tax positions (“gross unrecognized tax benefits”). Of these totals, $2.0 million represents the amount, as of these dates, of net unrecognized tax benefits that, if recognized, would favorably affect the Company’s effective income tax rate in any future period.

The Company records the aggregate accrual for uncertain tax positions as a component of current or long-term income taxes payable and the offsetting amounts as a component of the Company’s net deferred tax assets and liabilities. These liabilities are generally classified as long-term, even if the underlying statute of limitation will expire in the following twelve months. The Company classifies these liabilities as current if it expects to settle them in cash in the next twelve months. As of May 31, 2010 and August 31, 2009, the Company did not expect to make cash payments for these liabilities in the respective following 12 months.

The Company expects changes in the amount of unrecognized tax benefits in the next twelve months as the result of a lapse in various statutes of limitations. For the three and nine months ended May 31, 2010, the Company reduced the long-term income tax payable and recorded a net reduction in the income tax expense as the result of a lapse in the underlying statute of limitations totaling $253,000 and $193,000, respectively. The lapse of statutes of limitation in the twelve-month period ending May 31, 2011 would result in a reduction to long-term income taxes payable totaling $1.1 million.

The Company’s continuing practice is to recognize interest and/or penalties related to income tax matters in income tax expense. Any such items that are unpaid at the balance sheet date and not projected to be paid within the following 12 months are reflected in the long-term income tax payable caption on the consolidated balance sheets. As of May 31, 2010 and August 31, 2009, the Company had accrued $1.4 million for the payment of interest and penalties.

The Company has various audits and appeals pending in foreign jurisdictions. The Company does not anticipate that any adjustments from these audits and appeals would result in a significant change to the results of operations, financial conditions or liquidity.

 

 

 

 

12

---

 

 

PRICESMART, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Tax expense for the first nine months of fiscal year 2010 was $16.9 million on pre-tax income of $53.1 million, as compared to $11.7 million of tax expense on pre-tax income of $44.0 million for the first nine months of fiscal year 2009. The effective tax rate for the first nine months of fiscal year 2010 is 31.8% as compared to 26.6% for the first nine months of fiscal year 2009. The increase in the effective tax rate is primarily attributable to the following factors: (i) a significant increase in U.S. pre-tax income relative to non-U.S. pre-tax income, which is taxed at a statutory rate that is generally 4% to 9% higher than the foreign statutory tax rates; and (ii) the Company recorded a net reversal of approximately $193,000 of previously accrued income tax liability for uncertain tax positions due to a lapse in various statues of limitations in the first nine months of fiscal year 2010, as compared to  a reversal of approximately $2.2 million in the first nine months of fiscal year 2009.

The Company is subject to taxation in the U.S. and various states and foreign jurisdictions. The Company is generally no longer subject to income tax examinations by tax authorities in its major jurisdictions except for the fiscal years subject to audit as set forth in the table below:

Tax Jurisdiction		Fiscal Years Subject to Audit
U.S. federal		1995 through 1998, 2000 through 2001, and 2005 through 2009
California (U.S.)		2000 through 2001 and 2005 to the present
Florida (U.S.)		2000 through 2001 and 2005 to the present
Aruba		2002 to the present
Barbados		2001 to the present
Costa Rica		2007 to the present
Dominican Republic		2006 to the present
El Salvador		2007 to the present
Guatemala		2006 to the present
Honduras		2003 to the present
Jamaica		2004 to the present
Mexico		2006 to the present
Nicaragua		2006 to the present
Panama		2007 to the present
Trinidad		2004 to the present
U.S. Virgin Islands		2001 to the present

Recent Accounting Pronouncements> –

 

FASB ASC 855

In February 2010, the FASB amended its guidance removing the requirement for a Securities and Exchange Commission (“SEC”) filer to disclose a date through which subsequent events have been evaluated in both issued and revised financial statements.  This amendment is effective upon issuance date of February 24, 2010.  The Company adopted this amendment as of February 28, 2010.  The adoption of this amendment did not have a material effect on the Company’s financial position or results of operations.

FASB ASC 810

In January 2010, the FASB issued a clarification of scope with regard to accounting for noncontrolling interest in consolidation.  The Company adopted the original guidance as of the beginning of its annual reporting period beginning on September 1, 2009 (fiscal year 2010) and for all subsequent interim and annual periods.  The adoption of this amendment did not have a material effect on the Company’s financial position or results of operations.

FASB ASC 820

In January 2010, the FASB amended guidance and issued a clarification with regard to disclosure requirements about fair market value measurement.  A reporting entity is required to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers.  In addition, for measurements utilizing significant unobservable inputs, a reporting entity should present separately information about purchases, sales, issuances, and settlements. The Company adopted this guidance beginning with the interim reporting period ended February 28, 2010.  The adoption of this amendment did not have a material effect on the Company’s financial position or results of operations.

 

 

 

13

---

 

 

PRICESMART, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

FASB ASC 810

In December 2009, the FASB amended guidance and changes on how a reporting entity determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated.  The determination of whether a reporting entity is required to consolidate another entity is based on, among other things, the other entity’s purpose and design, and the reporting entity's ability to direct the activities that most significantly impact the other entity’s economic performance.  The guidance also requires a reporting entity to provide additional disclosures about its involvement with variable interest entities and any significant changes in risk exposure due to that involvement.  A reporting entity will be required to disclose how its involvement with a variable interest entity affects the reporting entity’s financial statements. The Company is required to adopt this guidance as of the beginning of its first annual reporting period that begins after November 15, 2009, which will be fiscal year 2011 for the Company.  Early adoption is not permitted.  The adoption of the standard is not expected to have a material impact on the Company's consolidated financial statements.

FASB ASC 105

In June 2009, the FASB established the FASB Accounting Standards Codification (“ASC” or the “Codification”).   The Codification supersedes all existing accounting standard documents and will become the single source of authoritative non-governmental U.S. GAAP. All other accounting literature not included within the Codification will be considered non-authoritative. The Company adopted the Codification effective September 1, 2009. The adoption of the Codification did not have a material effect on the Company’s financial position or results of operations.

 

FASB ASC 855

In May 2009, the FASB issued guidance that establishes general standards of accounting for, and disclosure of, events that occur after the balance sheet date but before financial statements are issued or are available to be issued.  The Company adopted this guidance as of August 31, 2009. The adoption of this guidance did not have a material effect on the Company’s financial position or results of operations.

 

FASB ASC 820

In April 2009, the FASB amended guidance on determining the fair value of assets and liabilities when the volume and level of activity for the asset or liability have significantly decreased and identifying transactions that are not orderly. In addition, the FASB set the effective date of guidance for FASB ASC 820 for the recognition and presentation of other than temporary impairments and interim disclosure about fair value of financial instruments. The Company adopted the guidance in the fourth quarter of fiscal year 2009.  The adoption of this guidance did not have a material impact on the Company’s consolidated financial condition and results of operations.

 

 

 

 

14

---

 

 

PRICESMART, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

FASB ASC 825

 In April 2009, the FASB amended guidance on interim disclosures related to the fair value of financial instruments, which the Company adopted on a prospective basis beginning September 1, 2009. This guidance extends the disclosure requirements to interim financial statements of publicly traded companies, and requires the inclusion of those disclosures in summarized financial information at interim reporting periods. The adoption of this guidance did not have a material effect on the Company’s financial position or results of operations.

FASB ASC 323

In October 2008, the FASB amended guidance on equity method investment accounting considerations.  The objective of this guidance is to clarify how to account for certain transactions involving equity method investments. These transactions are the initial investment, decrease in investment value and change in ownership or degree of influence.  The Company was required to adopt this amended guidance on a prospective basis beginning on September 1, 2009. Because this guidance relates specifically to transactions recorded by the Company as required by the guidance there was no impact on the Company’s consolidated financial statements as a result of the adoption of this guidance.

 

FASB ASC 260

In June 2008, the FASB issued guidance on determining whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share (“EPS”) under the two-class method.  The two-class method of computing EPS is an earnings allocation formula that determines EPS for each class of common stock and participating security according to dividends declared (or accumulated) and participation rights in undistributed earnings that would have been available to common stockholders.  The terms of the Company’s restricted stock awards provide a non-forfeitable right to receive dividend equivalent payments on unvested awards. As such, these awards are considered participating securities under the new guidance.  Effective September 1, 2009, the Company adopted this guidance and applied such guidance retrospectively to all periods presented (see Note 5 - Earnings Per Share).

 

FASB ASC 815

In March 2008, the FASB issued guidance requiring enhanced disclosures regarding derivative instruments and hedging activities.  This guidance requires enhanced disclosures about an entity’s derivative and hedging activities, including: (a) the manner in which an entity uses derivative instruments; (b) the manner in which derivative instruments and related hedged items are accounted for; and (c) the effect of derivative instruments and related hedged items on an entity’s financial position, financial performance, and cash flows. The Company adopted this guidance beginning December 1, 2008. The adoption of this guidance did not have a material effect on the Company’s financial position or results of operations.

 

FASB ASC 805

In December 2007, the FASB changed the requirements for an acquirer’s recognition and measurement of the assets acquired and liabilities assumed in a business combination, including the treatment of contingent consideration, pre-acquisition contingencies, transaction costs, in-process research and development and restructuring costs. In addition, changes in an acquired entity’s deferred tax assets and uncertain tax positions after the measurement period will impact income tax expense.  The Company adopted this guidance prospectively effective September 1, 2009. The Company has not entered into any business combinations subsequent to adoption.

 

FASB ASC 810

In December 2007, the FASB amended existing guidance requiring that noncontrolling interests be reported as a component of equity, that net income attributable to the parent and to the noncontrolling interest be separately identified in the income statement, that changes in a parent’s ownership interest while the parent retains its controlling interest be accounted for as equity transactions, and that any retained noncontrolling equity investment be initially measured at fair value upon the deconsolidation of a subsidiary.  The Company adopted these new requirements retrospectively to prior periods at the beginning of its first quarter of fiscal year 2010.    

 

 

 

15

---

 

 

PRICESMART, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

NOTE 3 – DISCONTINUED OPERATIONS

In accordance with FASB guidance on accounting for the impairment or disposal of long-lived assets the accompanying consolidated financial statements reflect the results of operations and financial position of the Company’s activities in the Philippines and Guam as discontinued operations.  As a result of the closure of the Guam operations in December 2003, the Company included the results of operations from Guam in the asset impairment and closure costs line of the consolidated statements of income through May 2005. Since the sale of the Philippine operations in August 2005, the results of the Philippine and Guam activities have been consolidated in the discontinued operations line of the consolidated statements of income. Management views these activities as one activity managed under a shared management structure. Cash flow activities related to the Guam discontinued operations’ leased property will terminate in August 2011, which is the end date of the lease term.

The assets and liabilities of the discontinued operations are presented in the consolidated balance sheets under the captions “Assets of discontinued operations” and “Liabilities of discontinued operations.” The underlying assets and liabilities of the discontinued operations for the periods presented are as follows (in thousands):

 

		May 31, 2010				August 31, 2009
Cash and cash equivalents		$	236			$	28
Accounts receivable, net			230				223
Prepaid expenses and other current assets			39				46
Other assets			475				603
Assets of discontinued operations		$	980			$	900
Other accrued expenses		$	117			$	299
Liabilities of discontinued operations		$	117			$	299

 

The Company’s former Guam operation has a deferred tax asset of $2.6 million, primarily generated from Net Operating Losses (“NOLs”). This deferred tax asset has a 100% valuation allowance, as the Company currently has no plans that would allow it to utilize these losses. Additionally, a significant portion of these losses are limited as to future use due to the Company’s Section 382 change of ownership in October 2004.

The following table sets forth the income (loss) from discontinued operations for each period presented (in thousands):

		Three Months Ended								Nine Months Ended
		May 31,								May 31,
		2010				2009				2010				2009
Net warehouse club sales		$	—			$	—			$	—			$	—