U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934. (Mark One) /X/ Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 [NO FEE REQUIRED] for the fiscal year ended August 31, 1998. / / Transitional report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 [NO FEE REQUIRED] for the transition period from ___________ to ____________. COMMISSION FILE NUMBER: 0-22793 PRICESMART, INC. (Exact name of small business issuer in its charter) DELAWARE 33-0628530 (State of other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 4649 MORENA BLVD., SAN DIEGO, CA 92117 (Address of principal executive offices, Zip Code) Registrant's telephone number, including area code: (619) 581-4530 Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, $.0001 PAR VALUE (Title of Class) Indicate by check mark whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes /X/ No / / Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. /X/ The aggregate market value of the voting stock held by non-affiliates of the Registrant as of November 16, 1998 was $31,287,666, based on the last reported sale of $15.125 per share on November 16, 1998. As of November 16, 1998, 5,315,794 shares of Common Stock were outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Company's Annual Report for fiscal year ending August 31, 1998, are incorporated by reference into Part II of this Form 10-K. Portions of the Company's Proxy Statement for the Annual Meeting of Stockholders to be held on January 12, 1999 are incorporated by reference into Part III of this Form 10-K.
TABLE OF CONTENTS <TABLE> <CAPTION> PAGE ---- <S> <C> Part I Item 1. Business 3 Item 2. Properties 8 Item 3. Legal Proceedings 10 Item 4. Submission of Matters to a Vote of Security Holders 10 Part II Item 5. Market for Common Stock and Related Stockholder Matters 11 THE INFORMATION REQUIRED BY ITEM 5 IS INCORPORATED HEREIN BY REFERENCE FROM PRICESMART'S ANNUAL REPORT FOR THE FISCAL YEAR ENDED AUGUST 31, 1998 Item 6. Selected Financial Data 11 THE INFORMATION REQUIRED BY ITEM 6 IS INCORPORATED HEREIN BY REFERENCE FROM PRICESMART'S ANNUAL REPORT FOR THE FISCAL YEAR ENDED AUGUST 31, 1998 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 THE INFORMATION REQUIRED BY ITEM 7 IS INCORPORATED HEREIN BY REFERENCE FROM PRICESMART'S ANNUAL REPORT FOR THE FISCAL YEAR ENDED AUGUST 31, 1998 Item 7A. Quantitative and Qualitative Disclosures About Market Risk 11 Item 8. Financial Statements 11 THE INFORMATION REQUIRED BY ITEM 8 IS INCORPORATED HEREIN BY REFERENCE FROM PRICESMART'S ANNUAL REPORT FOR THE FISCAL YEAR ENDED AUGUST 31, 1998 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 11 THE INFORMATION REQUIRED BY ITEM 9 IS INCORPORATED HEREIN BY REFERENCE FROM PRICESMART'S ANNUAL REPORT FOR THE FISCAL YEAR ENDED AUGUST 31, 1998 Part III Item 10. Directors and Executive Officers of the Registrant 12 THE INFORMATION REQUIRED BY ITEM 10 IS INCORPORATED HEREIN BY REFERENCE FROM PRICESMART'S PROXY STATEMENT FOR THE ANNUAL MEETING OF STOCKHOLDERS TO BE HELD ON JANUARY 12, 1999 Item 11. Executive Compensation 12 THE INFORMATION REQUIRED BY ITEM 11 IS INCORPORATED HEREIN BY REFERENCE FROM PRICESMART'S PROXY STATEMENT FOR THE ANNUAL MEETING OF STOCKHOLDERS TO BE HELD ON JANUARY 12, 1999 Item 12. Security Ownership of Certain Beneficial Owners and Management 12 THE INFORMATION REQUIRED BY ITEM 12 IS INCORPORATED HEREIN BY REFERENCE FROM PRICESMART'S PROXY STATEMENT FOR THE ANNUAL MEETING OF STOCKHOLDERS TO BE HELD ON JANUARY 12, 1999 Item 13. Certain Relationships and Related Transactions 12 THE INFORMATION REQUIRED BY ITEM 13 IS INCORPORATED HEREIN BY REFERENCE FROM PRICESMART'S PROXY STATEMENT FOR THE ANNUAL MEETING OF STOCKHOLDERS TO BE HELD ON JANUARY 12, 1999 Part IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 13 </TABLE> 2
PART I ITEM 1. BUSINESS PriceSmart, Inc. ("PriceSmart" or the "Company") was formed in August 1994 as a subsidiary of Price Enterprises, Inc. ("Price Enterprises" or "PEI") in connection with the spin off of PEI from Costco Companies, Inc. ("Costco"), formerly Price/Costco, Inc. PEI began to operate as a separate company from Costco effective August 29, 1994 and became a separate publicly-traded company on December 21, 1994. PriceSmart initially operated under the name Price Quest, Inc. and was subsequently operated under the name PQI, Inc. The Company changed its name to PriceSmart, Inc. effective June 30, 1997 in anticipation of the spin-off of the Company from PEI. In June 1997, the PEI Board of Directors approved, in principle, a plan to separate PEI's core real estate business from the merchandising businesses it operated through a number of subsidiaries. These merchandising businesses included international merchandising businesses and domestic merchandising businesses consisting of an auto referral program (the "Auto Referral Program") and a travel program (the "Travel Program"). To effect such separation, PEI first transferred to the Company, through a series of preliminary transactions, the merchandising businesses, certain properties formerly held for sale by PEI, $58.4 million of cash, and certain notes receivable. PEI then distributed on August 29, 1997 to PEI's existing stockholders all of the Company's outstanding Common Stock through a special dividend (the "Distribution"). The Company's international merchandising businesses focus on emerging consumer markets in Latin America and Asia. The Company licenses, and in Panama owns through a joint venture, membership stores using the trade name "PriceSmart" in most markets and "PriceCostco" in Panama and the Northern Mariana Islands. The Company's Auto Referral Program and Travel Program offer discounts on new cars and on travel services to Costco members pursuant to an agreement with Costco under which the Company is the exclusive provider of such programs to Costco's members. BUSINESS STRATEGY The Company's strategy is to focus on development of the international merchandising business and to invest in, acquire or create new merchandising businesses that leverage existing capabilities and provide appropriate returns for its stockholders. Specifically, key elements of the Company's business strategy include: PROVIDE LOWER PRICES IN THE MARKET PLACE. The Company's principal business philosophy is bringing lower prices to the consumer. Future development of the Company's business will be directed to markets in which the Company can compete effectively by lowering the costs of goods and services to consumers. INCREASE MARKET SHARE IN DEVELOPING MARKETS. The Company believes that it is well positioned to profit from the growth in developing markets due to its capital resources and experience with membership stores in Latin America and Asia. The Company has, and intends to continue, to satisfy the growing demand for consumer goods in such markets by entering into additional joint venture relationships with local business people and opening additional membership stores through such joint ventures, principally in Latin America. The Company intends to continue to expand its business in Asia, primarily focusing on China. AUTO REFERRAL PROGRAM STRATEGY. The Company's strategy for its Auto Referral Program is to provide a hassle-free, high value Auto Program to Costco members and to develop and provide the dealership network with affinity products and services to create additional value to our customers. In August 1998, the Company entered into an agreement to sell the Auto Referral Program, effective November 1, 1999. The Company will continue to own and operate the Program through the expiration of the agreement with Costco on October 31, 1999. TRAVEL PROGRAM STRATEGY. The Company's strategy for its Travel Program is to provide low prices on travel services for consumers who are customers of other companies with which the Company has established affinity relationships. The Company plans to maintain and enhance its relationships with the travel service providers in order to offer the best possible prices on travel services to its customers. The Company will continue to operate in an efficient manner by referring its customers directly to travel service providers whenever possible. The Company currently provides direct customer service for its cruise program because the Company has concluded that such an approach offers its cruise customers the best combination of service and value. 3
INTERNATIONAL MERCHANDISING BUSINESSES The Company owns and manages international merchandising businesses which own and license membership stores using the trade name "PriceSmart" and, in certain markets, "PriceCostco". The Company currently has a license agreement for the operation of one store in the Northern Mariana Islands and the Company owns a 51% interest in a Panama joint venture that has opened two stores in Panama. The Company also has a licensing arrangement with an entrepreneur in the Peoples Republic of China currently operating two membership stores. In July 1998, the Company entered into an agreement with a Guatemalan headquartered company to form a new joint venture that plans to open two PriceSmart membership shopping warehouses in Guatemala. PriceSmart owns 66% of this venture. In September 1998, the Company entered into an agreement with PSC, S.A., a Panamanian company whose stockholders are Latin American businessmen, to open a total of nine PriceSmart membership shopping warehouses in Costa Rica, the Dominican Republic, El Salvador, Honduras, and Nicaragua. PriceSmart owns 60% of this venture. The international stores sell basic consumer goods with an emphasis on quality, low prices and efficient operations. By offering low prices on brand name and private label merchandise, the stores seek to generate sales volumes high enough to enable the stores to operate profitably at relatively low gross margins. The typical stores are no-frills warehouse-type buildings that range in size from 40,000 to 65,000 square feet. Stores are generally located in urban areas to take advantage of dense populations and relatively higher levels of disposable income. Product selection includes perishable foods and basic consumer products. The target customers are consumers and small businesses. The shopping format includes an annual membership fee that varies by market from $25 to $35. Typically, the Company enters into licensing and technology transfer agreements with either a joint venture company (whose stockholders are local business people) as licensees or with local business people as licensees and provides licensees with the Company's know-how package, which includes training and management support, as well as access to the Company's computer software systems. The license also includes the right to use the "PriceSmart" mark and certain other trademarks. The Company and its licensees also enter into product sourcing agreements. The Company believes that the local business people have been interested in obtaining such licenses for a variety of reasons, including the track record of the Company's management team, the opportunity to purchase U.S.-sourced products, the benefits of the Company's modern distribution techniques and the opportunity to obtain exclusive rights to use the Company's trademarks in the region. AUTO REFERRAL PROGRAM The Company's Auto Referral Program offers its approximately 1600 participating dealers an efficient method for marketing their cars. In return, these car dealers agree to sell cars to qualifying consumers at preferred prices. The Company generates revenues from its Auto Referral Program primarily from advertising fees charged to participating dealers. The Company generated revenues of $7.5 million from operations of the Auto Referral Program during fiscal year 1998. Pursuant to an agreement with Costco, the Company has the exclusive right to provide auto referral program services to Costco members. In August 1998, the Company entered into an agreement to sell the Auto Referral Program, effective November 1, 1999. The Company will continue to own and operate the Program through the expiration of the agreement with Costco on October 31, 1999. TRAVEL PROGRAM The Company's Travel Program offers discounted prices on airline tickets, cruises, travel packages, car rentals and hotels to Costco members. The Company's operating strategy is based on generating large sales volume rather than high margins on individual sales. The Company has been successful in obtaining discounts not available to most travel agencies because of the large volume of reservations made through the Company's Travel Program. The Company's strategy allows it to satisfy its customers' demands for low-price travel products, while the Company benefits from the higher commissions and additional incentives available to high-volume travel agencies. The Company has limited the scope of its Travel Program to products on which it can offer discounts to its customers. The Company's Travel Program generates revenues from commissions as a function of sales and co-op promotions from certain suppliers, including car rental companies and hotels. In addition, the Company has entered into agreements with certain travel service providers for the payment of override commissions above the standard commissions the Company receives. Under such agreements, additional commissions are generally awarded if the volume of sales exceeds certain agreed upon thresholds. The Company generated commission revenues of $5.8 million from the Travel Program during fiscal 1998. 4
The Company believes that its Travel Program is well positioned to take advantage of anticipated future growth in the travel industry. The Company has established relationships with travel providers, wholesalers and travel agencies. Pursuant to an agreement with Costco, the Company has the exclusive right to provide car rental, cruise, hotel room discount programs and prepackaged travel arrangements to Costco members. This agreement expires October 31, 1999. As a result of the expected termination of the Costco agreement, the Company is making efforts to re-position the business. The major challenge for the Travel Program will be to find new sales opportunities to replace the Costco business when the Costco agreement expires in October 1999. RELATIONSHIP WITH COSTCO PEI, Costco and certain of their respective subsidiaries, including the Company, entered into an Agreement Concerning Transfer of Certain Assets (the "Asset Transfer Agreement") in connection with the settlement of litigation arising from the spin-off of PEI from Costco and the prior merger between The Price Company and Costco Wholesale Corporation. A final settlement of IN RE PRICE/COSTCO SHAREHOLDER LITIGATION, Case No. C-94-1874C, was reached in November 1996 and approved by the United States District Court for the Western District of Washington in April 1997, as a result of which the Asset Transfer Agreement became effective. Pursuant to the Asset Transfer Agreement, Costco assigned its 49% interests in PEI's Price Global Trading, L.L.C. ("Price Global") and Price Quest, L.L.C. ("Price Quest") subsidiaries to other subsidiaries of PEI, making such entities wholly owned indirect subsidiaries of PEI. PEI and Costco also agreed in the Asset Transfer Agreement to eliminate all noncompete and operating agreements and to terminate all trademark and license agreements between the parties, subject to certain exceptions. Under the Asset Transfer Agreement, Costco has agreed to refrain from conducting membership store businesses in the Northern Mariana Islands and Guam through the earlier of October 31, 1999 or termination of the Company's license with Joeten Enterprises, Inc. and has agreed to refrain from conducting membership store businesses in Panama through the earlier of October 31, 1999 or termination of the Company's license with PriceCostco Panama, S.A. Pursuant to a License Agreement with Costco, which was modified by the Asset Transfer Agreement, the Company has an exclusive (including against Costco), royalty-free license in the Northern Mariana Islands and Guam to use "Price Club" and "PriceCostco" marks in connection with the development, operation, advertising and promotion of the Company's business activities in such areas, subject to certain restrictions on the use of the marks and quality control and confidentiality provisions. The Company currently owns rights to the name "PriceCostco" in Panama, and the Company has agreed, subject to the outcome of trademark applications in Panama, to transfer to Costco its rights to the name "PriceCostco." If the Company transfers such rights to Costco, Costco will license back to the Company the right to use the name "PriceCostco" in Panama upon the same terms as the Northern Mariana Islands and Guam licenses. The Asset Transfer Agreement, however, requires the Company to use diligent and reasonable efforts to negotiate with its licensee in the Northern Mariana Islands and Guam and Price Global's joint venture partner in Panama to terminate such licensees' rights to use the "Price Club" and "PriceCostco" names and marks at the earliest possible date before December 12, 2009 for the Northern Mariana Islands and Guam and December 21, 2015 for Panama. The Company's rights to use such names and marks in Panama are further subject to the outcome of trademark application proceedings in Panama, which could result in earlier termination of the Company's rights. The Asset Transfer Agreement also gives the Company the exclusive right to operate its Auto Referral Program and Travel Program in certain Costco warehouses, through advertisements published in "The Costco Connection" and through promotional materials linked to and from Costco's Internet home page. The Company currently operates its Auto Referral and Travel Programs in approximately 200 Costco warehouses. The Asset Transfer Agreement provides for the expansion of the Auto Referral Program and the Travel Program into as many as ten additional Costco warehouses (to the extent they exist) in each of the 3 fiscal years ended August 31, 1999. Costco has the right to select the warehouses for expansion, subject to the Company's reasonable consent. The agreement requires Costco to provide sufficient space to display a brochure rack and to use its best efforts to provide sufficient space to display an automobile. Costco also is required to maintain and stock the brochure rack and to provide security for the rack and for any displayed automobiles. The Company's rights under the Asset Transfer Agreement to conduct the Auto Referral and Travel Programs in Costco warehouses, through "The Costco Connection" and through Costco's Internet home page will extend until October 31, 1999 unless earlier terminated by the Company upon 60 days prior written notice to Costco. The Asset Transfer Agreement requires the Company to pay Costco, for the Auto Referral Program, 20% of the gross revenues derived from the Costco Auto Program Internet site linked to and from Costco's Internet home page and 55% of the gross revenues derived from all other advertising or promotion via Costco warehouses, "The Costco Connection" or other media which utilize the "Costco" name or mark. Likewise, the Asset Transfer Agreement requires the Company to pay Costco, for car rentals, hotel bookings and other travel services other than vacation packages and cruises, 15% of the received commissions derived from any advertising or promotion via Costco warehouses, "The Costco Connection," the Costco Travel Program Internet site linked to and from Costco's Internet home page or other media which use the "Costco" name or mark. For vacation packages and cruises, the Company is required to pay Costco 1% of the net sales derived from any such advertising or promotion. The Company is required to use "Costco Auto Program" and "Costco Travel Program" marks in connection with the sales and promotional activities described above. 5
The Asset Transfer Agreement does not limit the Company's ability to own or operate any automobile related or travel service related businesses as long as such businesses do not use the names or marks "PriceCostco," "PriceClub" or "Costco" and do not operate, through October 31, 1999, from locations owned or operated by Sam's Warehouse Club, BJ's Wholesale Club or Wal-Mart or any of their affiliates. Costco has the right under the Asset Transfer Agreement to sell automobiles (but not by referral to a third party) and vacation packages (but not cruises) and airline tickets directly to its members. Costco also may investigate and experiment with other concepts in auto and travel businesses. Costco has agreed in the Asset Transfer Agreement that PEI and its downstream affiliates may use the name "Price" in a "PriceSmart" mark, but PEI and its downstream affiliates may not use a "PriceSmart" mark in connection with a club business or other membership activity named "PriceSmart" in the United States, Canada or Mexico; provided that the limitations on the Company's rights to use the "PriceSmart" name in the United States, Canada and Mexico terminate 24 months after Costco and its downstream affiliates discontinue their use of the names "PriceCostco" and "Price Club." SERVICES PROGRAM-RELATIONSHIP WITH RALPHS In August 1997, PEI and Ralphs entered into a Memorandum of Agreement ("Memorandum"), which PEI has assigned to the Company. Pursuant to the Memorandum, the Company and Ralphs had developed, and the Company operated on a test basis, three PriceSmart Service Centers in Ralphs stores located in San Diego, California. The Service Centers offered Ralphs customers the following services: same-day and next day photo processing, copying, faxing, key making, binding, Federal Express shipping, TicketMaster, Western Union money orders and money transfers, and Internet access to the Company's Travel Program and Auto Referral Program. The Company operated the Service Centers throughout the test period, which expired on May, 13, 1998. The relationship was terminated at that time. CITY NOTES AND OTHER NOTES RECEIVABLE The Company owns certain notes receivable from various municipalities and agencies (the "City Notes") and certain other notes receivable. As of August 31, 1998, the carrying value of the City Notes was approximately $22.0 million. The City Notes carry interest rates which range from 8% to 10%. Repayment of each City Note is generally based on the relevant municipality's allocation of sales tax revenues generated by retail businesses located on a particular property associated with such City Note. For accounting purposes, the carrying value of $22.0 million of such notes represents management's estimate of discounted cash flow from the City Notes. Management's analysis of the discounted cash flow from the City Notes assumes no payment at maturity, because, under the terms of the City Notes, the unpaid balance of the note is forgiven at its maturity date. If actions taken by Costco, such as closure or relocation of a particular Costco warehouse, would entitle the governmental agency to withhold payment, the Company would be entitled to cause Costco to purchase such City Note at an amount equal to 72% of the June 5, 1994 book balance, less any subsequent principal repayments, plus all accrued and unpaid interest from June 5, 1994. The Company also holds another note receivable with a carrying value of approximately $3.8 million as of August 31, 1998. COMPETITION Each of the Company's businesses faces competition unique to its line of business. The Company's international merchandising businesses compete with exporters, wholesalers and trading companies in various international markets. Specifically, the Company's international merchandising businesses compete with local store operations and, in certain markets, Makro, Carrefour, Wal-Mart, and Costco. The Company's Auto Referral Program competes with affinity programs offered by several companies such as Wal-Mart; Internet vehicle buying services such as Auto By Tel; and automobile brokerage firms. The Company's Travel Program competes with a variety of other providers of travel and travel-related products and services, including telemarketing travel companies, traditional travel agencies and various on-line services available on the Internet. Many of the Company's current and potential competitors have longer operating histories, greater name recognition and significantly greater financial and marketing resources than the Company. Such competitors could undertake more aggressive and costly marketing campaigns than the Company, which may adversely affect the Company's marketing strategies, which, in turn, could have a material adverse effect on the Company's business, results of operations or financial condition. There can be no assurance that the Company can compete successfully against current or future competitors nor can there be any assurance that competitive pressures faced by the Company will not result in loss of market share or otherwise will not materially adversely affect its business, results of operations and financial condition. INTELLECTUAL PROPERTY RIGHTS It is the Company's policy to obtain appropriate proprietary rights protection for trademarks and significant new technologies acquired or developed by the Company. In addition, the Company relies on copyright and trade secret laws to protect its proprietary rights. The Company attempts to protect its trade secrets and other proprietary information through agreements with employees, consultants and 6
suppliers, and other similar measures. There can be no assurance, however, that the Company will be successful in protecting its proprietary rights. While management believes that the Company's trademarks, copyrights and other proprietary know-how have significant value, changing technology and the competitive marketplace make the Company's future success dependent principally upon its employees' technical competence and creative skills for continuing innovation. There can be no assurance that third parties will not assert claims against the Company with respect to existing and future trademarks, trade names and sales techniques. In the event of litigation to determine the validity of any third party's claims, such litigation could result in significant expense to the Company and divert the efforts of the Company's management, whether or not such litigation is determined in favor of the Company. The Company has filed applications to register the mark "PriceSmart" in the U.S. Patent and Trademark Office, and in certain foreign countries; however, because of objections by one or more parties, there can be no assurance that the Company will obtain such registrations or that the Company has proprietary rights to the mark. In addition, as noted above, the Company has limited rights to use the "PriceCostco" name in connection with its international merchandising businesses and certain Costco marks with its Auto Referral and Travel Programs. The Asset Transfer Agreement requires the Company to attempt to phase out the use of the "PriceCostco" name and related marks in the Northern Mariana Islands, Guam and Panama. See "--International Merchandising Businesses." EMPLOYEES The Company employs approximately 147 employees, 52 of which are assigned to the Company's international merchandising business, 45 to the Auto Referral and Travel Programs, and 50 in corporate administrative activities. The Company believes that its future prospects will depend, in part, on its ability to continue to attract and retain skilled management personnel. The individuals employed in the cruise division of the Company's Travel Program are members of a union. The Company currently has a collective bargaining agreement with such union with a one year term, renewable year to year. The Company has never experienced any business interruption as a result of labor disputes. The Company believes that its relations with its employees are good. SEASONALITY The Company's businesses are subject to traditional retail sales trends associated with the calendar year-end holiday season. FACTORS WHICH MAY AFFECT FUTURE PERFORMANCE RISKS INHERENT IN INTERNATIONAL OPERATIONS. The Company increasingly will be subject to risks inherent in conducting international business as the Company expands its international merchandising businesses, in particular its PriceSmart membership store concept. Such risks include the imposition of governmental controls, the need to comply with a wide variety of foreign and U.S. export laws, political and economic instability, trade restrictions, ability to source local merchandise, changes in tariffs and taxes, longer payment cycles typically associated with international sales, and greater difficulty and costs of administering business overseas. Success of the international business is subject to additional factors, including the availability of suitable sites, the negotiation of acceptable lease or purchase terms for such sites, permitting and regulatory compliance, the ability to meet construction schedules, the ability to hire and train qualified management and store personnel, the financial and other capabilities of the Company's licensees and business partners, and general economic and business conditions. There can be no assurance that any of these factors will not have a material adverse effect on the Company's business, financial condition or results of operations. See "BUSINESS - International Merchandising Businesses." INTERNATIONAL OPERATIONS; DEPENDENCY ON FOREIGN LICENSEES AND BUSINESS PARTNERS AND ASSOCIATED RISKS. Several of the risks associated with the international merchandising business will be within the control (in whole or in part) of the Company's licensees and business partners or may be affected by the acts or omissions of such licensees and business partners. Certain of the Company's licensees and business partners have had limited experience operating membership stores that sell consumer goods. There can be no assurance that the Company's PriceSmart membership store concept will be implemented effectively or that they will be successful in their respective markets. In the event one or more licensees or business partners are displeased with their relationship with the Company, such licensees or business partners could seek to terminate their relationships with the Company or make claims against the Company alleging that the Company acted, or failed to act, in a manner that damaged such licensees or business partners. In addition, the Company has experienced contractual problems with its licensee in China, which, if not resolved to the Company's satisfaction, could result in termination of the Company's relationship with such licensee. There can be no assurance that a dissatisfied licensee or business partner would not file litigation, that the Company would 7
prevail if any such litigation were filed or that such litigation would not have a material adverse effect of the Company's business, financial condition and results of operation. See "BUSINESS - International Merchandising Businesses." TRAVEL PROGRAM DEPENDENT ON TRAVEL PROVIDERS. The Company's Travel Program is dependent upon certain travel providers, wholesalers and high volume travel agencies for access to reduced-price travel products. Such access enables the Company to price its travel services more competitively. The Company's agreements with travel providers, wholesalers and high volume travel agencies generally can be cancelled or modified upon relatively short notice. The loss of a contract, changes in the Company's pricing agreements or commission schedules or more restricted access to reduced-price travel products would have a material adverse effect on the Company's Travel Program. See "BUSINESS - - Travel Program." RELIANCE ON COSTCO FOR TRAVEL PROGRAM. The Company currently operates its Travel Program at Costco warehouses, and the Company offers the program to Costco members. The Company's rights to conduct the Travel Program at Costco warehouses are set forth in an Agreement Concerning Transfer of Certain Assets (the "Asset Transfer Agreement") with Costco. Pursuant to the Asset Transfer Agreement, the Company's rights to operate such programs at Costco warehouses terminate automatically on October 31, 1999 unless earlier terminated by the Company pursuant to an early termination provision. There can be no assurance that the Company and Costco will agree to extend the Company's rights to conduct the Travel Program beyond October 31, 1999 or that the Company will be able to develop sufficient alternatives to Costco for operating its Travel Program. See "BUSINESS - Relationship with Costco." COMPETITION. Each of the Company's Merchandising Businesses faces competition unique to its line of business. The Company's international merchandising businesses compete with exporters, wholesalers, other membership/warehouse merchandisers, local retailers and trading companies in various international markets. The Company's Travel Program competes with a variety of other providers of travel and travel-related products and services, including telemarketing travel companies, traditional travel agencies and various on-line services available on the Internet. Many of the Company's current and potential competitors have longer operating histories, greater name recognition and significantly greater financial and marketing resources than the Company. Such competitors could undertake more aggressive and costly marketing campaigns than the Company, which may adversely affect the Company's marketing strategies, which, in turn, could have a material adverse effect on the Company's business, results of operations or financial condition. There can be no assurance that the Company can compete successfully against current or future competitors nor can there be any assurance that competitive pressures faced by the Company will not result in loss of market share or otherwise will not materially adversely affect its business, results of operations and financial condition. See "BUSINESS - Competition." NOTES RECEIVABLE. The Company holds the City Notes. Repayment of each City Note by the relevant municipality is generally made based on that municipality's allocation of sales tax revenues generated by retail businesses located on a particular property associated with such City Note. For accounting purposes, the carrying value of $22 million of such notes represents management's estimate of discounted cash flow from the City Notes. Management's analysis of the discounted cash flows from the City Notes assumes no payment at maturity, because, under the terms of most of the City Notes, the unpaid balance of the note is forgiven at its maturity date. Consequently, there can be no assurance that the full stated principal amount of the City Notes will be repaid. CONTROL OF PRICESMART BY CERTAIN STOCKHOLDERS. Robert E. Price, who is Chairman of the Board of PriceSmart, and Sol Price, a significant stockholder of PriceSmart and father of Robert E. Price, beneficially owned as of November 16, 1998 an aggregate of 2,437,027 shares, or approximately 46%, of the outstanding PriceSmart Common Stock. As a result, these stockholders will effectively control the outcome of all matters submitted to the Company's stockholders for approval, including the election of directors. In addition, such ownership could discourage acquisition of Company Common Stock by potential investors, and could have an anti-takeover effect, possibly depressing the trading price of Company Common Stock. DEPENDENCE ON KEY PERSONNEL The Company is dependent on the efforts of its executive management team. While the Company believes that it could find replacements for these key personnel, the loss of their services could have a temporary adverse effect on the operations of the Company. ITEM 2. PROPERTIES PROPERTIES HELD FOR SALE. In connection with the Distribution, PEI transferred to the Company certain properties historically held for sale by PEI (the "Properties"). The Company anticipates selling the remaining properties within the next twelve months. Proceeds from sales of such properties will be used to fund the Company's businesses and the Company's general working capital requirements. 8
The table set forth below describes the portfolio of Properties held by the Company as of August 31, 1998. Amounts shown for annual minimum rents are based on executed leases as of August 31, 1998. Due to the nature of real estate investments, actual rental income may differ from amounts shown in this table. <TABLE> <CAPTION> LEASES IN EFFECT AS OF AUGUST 31, 1998 Gross Net Book Annual Leasable Value Minimum Land Area (sq. ft.) Percent 8/31/98 Rent Acreage (In 000's) Leased (In 000's) (In 000's) ----------- ----------------- ------------------ ------------ -------------- <S> <C> <C> <C> <C> <C> PROPERTIES WITH BUILDINGS Mesa/Broadway, AZ 2.7 24.2 100% $ 1,228 $ 201 Riverside/Third St., CA 4.9 17.9 100% 673 151 Milwaukee, WI (leased) 8.8 115.0 100% -- -- ----------- ----------------- ------------------ ------------ -------------- Subtotal 16.4 157.1 100% 1,901 352 UNIMPROVED LAND Sterling, VA 2.5 -- -- 1,189 -- Carlsbad, CA 1.8 -- -- 926 -- East Mesa/Superstition Springs, AZ 3.5 -- -- 195 -- Fountain Valley, CA 2.5 -- -- 475 -- Denver/Westminister, CO 2.8 -- -- 310 -- Denver/Aurora, CO 1.0 -- -- 115 -- ----------- ----------------- ------------------ ------------ -------------- Subtotal 14.1 -- -- 3,210 -- Provision for Asset Impairments -- -- -- (225) -- ----------- ----------------- ------------------ ------------ -------------- Total 30.5 157.1 100% $ 4,886 $ 352 ---- ----- ---- -------- ----- ---- ----- ---- -------- ----- </TABLE> SUBSEQUENT AND PENDING REAL ESTATE TRANSACTIONS. Subsequent to year-end, the Company sold the Riverside/Third Street property for $.9 million of net proceeds. The Company is currently under contract to sell six (6) properties, which sales are expected to generate $3.6 million of net proceeds. The Company anticipates no significant gains or losses from these sales. The Company expects such transactions to be completed within the next twelve (12) months; however, given the nature of such sales activities, there can be no assurance that these potential sales will be completed by their expected dates or that such proceeds will be fully realized. ENVIRONMENTAL MATTERS. The Company has agreed to indemnify PEI for all of PEI's liabilities (including obligations to indemnify Costco with respect to environmental liabilities) arising out of PEI's prior ownership of the Properties and the real properties transferred by Costco to PEI that have been sold prior to the Distribution. The Company's ownership of real properties and its agreement to indemnify PEI could subject it to certain environmental liabilities. As discussed below, certain Properties are located in areas of current or former industrial activity, where environmental contamination may have occurred. Under various Federal, State and local environmental laws, ordinances and regulations, a current or previous owner or operator of real estate may be required to investigate and remediate releases or threatened releases of hazardous or toxic substances or petroleum products located at such property, and may be held liable to a governmental entity or to third parties for property damage and for investigation and remediation costs incurred by such parties in connection with the contamination. Under certain of these laws, liability may be imposed without regard to whether the owner knew of or caused the presence of the contaminants. These costs may be substantial, and the presence of such substances, or the failure to remediate properly the contamination on such property, may adversely affect the owner's ability to sell or lease such property or to borrow money using such property as collateral. Certain Federal and State laws require the removal or encapsulation of asbestos-containing material in poor condition in the event of remodeling or renovation. Other Federal, State and local laws have been enacted to protect sensitive environmental resources, including threatened and endangered species and wetlands. Such laws may restrict the development and diminish the value of property which is inhabited by an endangered or threatened species, is designated as critical habitat for an endangered or threatened species or is characterized as wetlands. In 1994, Costco engaged environmental consultants to conduct Phase I assessments (involving investigation without soil sampling or groundwater analysis) at each of the properties that Costco transferred to PEI in 1994, including the Properties. The Company is unaware of any environmental liability or noncompliance with applicable environmental laws or regulations arising out of the 9
Properties or the real properties transferred by Costco to PEI and sold prior to the Distribution that the Company believes would have a material adverse effect on its business, assets or results of operations. Nevertheless, there can be no assurance that the Company's knowledge is complete with regard to, or that the Phase I assessments have identified, all material environmental liabilities. The Company is aware of certain environmental issues, which the Company does not expect to have a material adverse effect on the Company's business assets or results of operation, relating to three properties transferred from Costco to PEI that were sold prior to the Distribution. The Company has agreed to indemnify PEI for environmental liabilities arising out of such properties. The Company has reserved approximately $15,000 and $30,000 with respect to potential environmental liabilities arising from PEI's prior ownership of the Phoenix (Fry's) property and Silver City property, respectively, discussed below. The Company has not taken a reserve with respect to the Meadowlands property. Set forth below are summaries of certain environmental matters relating to the properties already sold. Phoenix (Fry's). The Phoenix (Fry's) site is a 37.1 acre site located in Phoenix, Arizona. The Phoenix (Fry's) site is located within the West Van Buren Study Area (the "WVBSA"). Volatile organic compounds ("VOCs") and petroleum hydrocarbons are present in groundwater in the WVBSA. To date, PEI (as successor to Costco) has not been identified as a potentially responsible party ("PRP") for the WVBSA. On March 8, 1995, PEI sold the Phoenix (Fry's) site, and retained responsibility for certain environmental matters. Investigations conducted in connection with the sale of the property revealed some hydrocarbon contamination in an area previously occupied by a fuel pump island. Seven underground fuel storage tanks were removed in 1989. The Arizona Department of Environmental Quality is requiring some additional testing prior to granting closure of the site. PEI's prior ownership of the Phoenix (Fry's) site creates the potential of liability for remediation costs associated with groundwater beneath the site. Costco previously agreed to indemnify and hold PEI harmless in respect of one-half of all environmental liabilities relating to the Phoenix (Fry's) site. Costco has continued to pay its share of the ongoing investigation costs associated with this site. PEI and the Company lack sufficient information about the activity of WVBSA PRPs to form an estimate of the equitable share of total liability, if any, that could be allocated to PEI for its previous ownership of this site. Although designated by Arizona law as a "study area," the WVBSA is not a federal CERCLA site and is not listed on the National Properties List ("NPL"). Immediately to the east of the WVBSA, however, is the East Washington Study Area (the "EWSA"), which is listed on the NPL. VOCs are also present in groundwater in the EWSA. If the contamination plumes from the WVBSA and the EWSA merge, the possibility exists that the two study areas will be merged into one Federal CERCLA site. Meadowlands. The Meadowlands site is an unimproved, 12.9 acre site located in Meadowlands, New Jersey. A prior owner used this site as a debris disposal area. Elevated levels of heavy metals (including a small area contaminated with polychlorinated biphenyl) and petroleum hydrocarbons are present in soil at the Meadowlands site. PEI, however, has not been notified by any governmental authority, and is not otherwise aware, of any material noncompliance, liability or claim relating to hazardous or toxic substances or petroleum products in connection with the Meadowlands site. PEI sold the Meadowlands site on August 11, 1995. Nevertheless, PEI's previous ownership of the Meadowlands site creates the potential of liability for remediation costs associated with groundwater beneath the site. Silver City. The Silver City site contains or has contained petroleum hydrocarbons in the soil and groundwater. On March 20, 1996, PEI sold the Silver City site and retained responsibility for certain environmental matters. PEI is continuing to remediate the soil and groundwater at this property under supervision of local authorities. CORPORATE HEADQUARTERS. The Company maintains its headquarters at 4649 Morena Blvd., San Diego, California 92117. The Company leases 42,000 square feet of office space from PEI at a rate $25,700 per month pursuant to a triple net lease. The initial term of the lease is two years, commencing September 1, 1997, with five renewal options of two years each. The Company believes that its existing facilities are adequate to meet its current needs and that suitable additional or alternative space will be available on commercially reasonable terms as needed. ITEM 3. LEGAL PROCEEDINGS The Company is not a party to any legal proceedings other than various claims and lawsuits arising in the ordinary course of its business which, in the opinion of the Company's management, are not individually or in the aggregate material to its business. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Company did not submit any matters to a vote of security holders during the fourth quarter of fiscal 1998. The Company's Annual Meeting of Stockholders is scheduled for 10:00 a.m. on January 12, 1999, at the San Diego Hilton Beach and Tennis Resort in San Diego, California. Matters to be voted on will be included in the Company's proxy statement to be filed with the Securities and Exchange Commission and distributed to stockholders prior to the meeting. 10
PART II ITEM 5. MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS The information required by Item 5 is incorporated herein by reference to page 36 of PriceSmart's Annual Report for the fiscal year ended August 31, 1998. ITEM 6. SELECTED FINANCIAL DATA The information required by Item 6 is incorporated herein by reference to page 14 of PriceSmart's Annual Report for the fiscal year ended August 31, 1998. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information required by Item 7 is incorporated herein by reference to pages 15 to 19 of PriceSmart's Annual Report for the fiscal year ended August 31, 1998. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Not Applicable. ITEM 8. FINANCIAL STATEMENTS The information required by Item 8 is incorporated herein by reference to pages 20 to 35 of PriceSmart's Annual Report for the fiscal year ended August 31, 1998. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE The information required by Item 9 is incorporated herein by reference to page 36 of PriceSmart's Annual Report for the fiscal year ended August 31, 1998. 11
PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by Item 10 is incorporated herein by reference from PriceSmart's Proxy Statement for the Annual Meeting of Stockholders to be held on January 12, 1999. ITEM 11. EXECUTIVE COMPENSATION The information required by Item 11 is incorporated herein by reference from PriceSmart's Proxy Statement for the Annual Meeting of Stockholders to be held on January 12, 1999. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by Item 12 is incorporated herein by reference from PriceSmart's Proxy Statement for the Annual Meeting of Stockholders to be held on January 12, 1999. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by Item 13 is incorporated herein by reference from PriceSmart's Proxy Statement for the Annual Meeting of Stockholders to be held on January 12, 1999. 12
PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The following financial statements are incorporated by reference into Part II, Item 8 of this Form 10-K from the annual report Report of Independent Auditors Consolidated Balance Sheets as of August 31, 1998 and 1997 Consolidated Statements of Operations for each of the three years ended August 31, 1998, 1997 and 1996 Consolidated Statements of Stockholders' Equity for each of the three years ended August 31, 1998, 1997 and 1996 Consolidated Statements of Cash Flows for each of the three years August 31, 1998, 1997 and 1996 Notes to Consolidated Financial Statements (b) Reports on Form 8-K: No reports on Form 8-K were filed during the fourth quarter of fiscal 1998. (c) See Exhibit Index and Exhibits attached to this report (d) Financial Statement Schedules See "Schedule II: Valuation and Qualifying Accounts" attached to this report 13
SCHEDULE II PRICESMART, INC. VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS) <TABLE> <CAPTION> BALANCE OF ADDITIONS BEGINNING OF CHARGED TO COSTS BALANCE AT PERIOD AND EXPENSES DEDUCTIONS END OF PERIOD ------------ ---------------- ---------- ------------- <S> <C> <C> <C> <C> PROVISIONS FOR ASSET IMPAIRMENTS Year ended August 31, 1996 $ -- $ 8,042 $ -- $ 8,042 Year ended August 31, 1997 8,042 2,000 (5,247)(1) 4,795 Year ended August 31, 1998 4,795 -- (4,570)(2) 225 ALLOWANCE FOR DOUBTFUL ACCOUNTS Year ended August 31, 1997 $ -- $ 1,000 $ -- $ 1,000 Year ended August 31, 1998 1,000 116 (702)(3) 414 </TABLE> (1) Deductions from asset impairments related to the sale of seven properties and the recovery of prior year write-down of land. (2) Deductions from asset impairments related to the sale of six properties. (3) Deductions from allowance for doubtful accounts primarily related to the recovery of prior year write down on accounts receivable. 14
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: November 24, 1998 PRICESMART, INC. By: /s/ GILBERT A. PARTIDA ---------------------- Title PRESIDENT AND CHIEF EXECUTIVE OFFICER Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated. SIGNATURE TITLE DATE - --------- ----- ---- /s/ ROBERT E. PRICE Chairman of the Board November 24, 1998 - ----------------------- Robert E. Price /s/ GILBERT A. PARTIDA President and Chief November 24, 1998 - ----------------------- Executive Officer Gilbert A. Partida (Principal Executive Officer) /s/ KAREN J. RATCLIFF Executive Vice President, November 24, 1998 - ----------------------- Chief Financial Officer Karen J. Ratcliff (Principal Financial and Accounting Officer) /s/ RAFAEL E. BARCENAS Director November 24, 1998 - ----------------------- Rafael E. Barcenas /s/ KATHERINE L. HENSLEY Director November 24, 1998 - ----------------------- Katherine L. Hensley /s/ LEON C. JANKS Director November 24, 1998 - ----------------------- Leon C. Janks /s/ LAWRENCE B. KRAUSE Director November 24, 1998 - ----------------------- Lawrence B. Krause 15
PRICESMART, INC. EXHIBIT INDEX AND EXHIBITS <TABLE> <CAPTION> EXHIBIT NUMBER DESCRIPTION - ------- ----------- <S> <C> 2.1(1) Distribution Agreement dated as of August 26, 1997 between the Company and Price Enterprises, Inc. 3.1(2) Amended and Restated Certificate of Incorporation of PriceSmart, Inc. 3.2(2) Amended and Restated Bylaws of PriceSmart, Inc. 10.1(2) 1997 Stock Option Plan of PriceSmart, Inc. 10.2(3) Agreement Concerning Transfer of Certain Assets dated as of November 1996 by and among Price Enterprises, Inc., Costco Companies, Inc. and certain of their respective subsidiaries 10.3(4) Employment Agreement dated September 20, 1994 between Price Enterprises, Inc. and Robert M. Gans 10.4(1) Employee Benefits and Other Employment Matters Allocation Agreement dated as of August 26, 1997 between the Company and Price Enterprises, Inc. 10.5(1) Tax Sharing Agreement dated as of August 26, 1997 between the Company and Price Enterprises, Inc. 10.6(1) Asset Management and Disposition Agreement dated as of August 26, 1997 between the Company and Price Enterprises, Inc. 10.7(5) Third Amendment to Employment Agreement dated April 28, 1997 between Price Enterprises, Inc. and Robert M. Gans 10.8(6) Form of Indemnity Agreement 10.9(1) Transitional Services Agreement dated as of August 26, 1997 between the Company and Price Enterprises, Inc. 10.10(2) Assignment and Assumption of Employment Agreement dated August 29, 1997 between the Company and Price Enterprises, Inc. 10.11(2) Fourth Amendment to Employment Agreement dated as of September 2, 1997 between the Company and Robert M. Gans 10.12(2) Employment Agreement dated as of September 29, 1997 between the Company and Karen C. Ratcliff 10.14(9) Employment Agreement dated March 31, 1998 between the Company and Thomas D. Martin 10.15(9) Employment Agreement dated August 19, 1998 between the Company and Kurt A. May 10.16(9) Members' Agreement dated September 14, 1998 between the Company and PSMT Caribe, Inc. 10.17(9) Auto Referral Purchase Agreement dated August 18, 1998 between the Company and Affinity Development Group Incorporated 13.1(9) Portions of the Company's Annual Report to Stockholders for the year ended August 31, 1998 21.1(7) Subsidiaries of PriceSmart, Inc. 23.1(9) Consent of Ernst & Young LLP, Independent Auditors 27.1(9) Financial Data Schedule 99(8) Employment Agreement dated December 15, 1997 between the Company and Gilbert A. Partida </TABLE> (1) Incorporated by reference to the Current Report on Form 8-K filed September 12, 1997 by Price Enterprises, Inc. (2) Incorporated by reference to the Annual Report on Form 10-K for the year ended August 31, 1997 filed with the Commission on November 26, 1997. (3) Incorporated by reference to Exhibit 10.2 to the Company's Registration Statement on Form 10 filed July 3, 1997. (4) Incorporated by reference to Exhibit 10.14 to Amendment No. 1 to the Registration Statement on Form S-4 of Price Enterprises, Inc. filed with the Commission on November 3, 1994. (5) Incorporated by reference to Exhibit 10.4 to the Quarterly Report on Form 10-Q of Price Enterprises, Inc. for the quarter ended June 8, 1997 filed with the Commission on July 17, 1997. (6) Incorporated by reference to Exhibit 10.8 to Amendment No. 1 to the Company's Registration Statement on Form 10 filed with the Commission on August 1, 1997. (7) Incorporated by reference to Exhibit 21.1 to Amendment No. 2 to the Company's Registration Statement on Form 10 filed with the Commission on August 13, 1997. (8) Incorporated by reference to Exhibit 99 to the Quarterly Report on Form 10-Q of PriceSmart, Inc. for the quarter ended February 28, 1998 filed with the Commission on April 14, 1998. (9) Filed herewith. 16