NOTE 7 – DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

The Company is exposed to interest rate risk relating to its ongoing business operations. To manage interest rate exposure, the Company enters into hedge transactions (interest rate swaps) using derivative financial instruments. The objective of entering into interest rate swaps is to eliminate the variability of cash flows in the LIBOR interest payments associated with variable-rate loans over the life of the loans. As changes in interest rates impact the future cash flow of interest payments, the hedges provide a synthetic offset to interest rate movements.

In addition, the Company is exposed to foreign currency and interest rate cash flow exposure related to non-functional currency long-term debt of three of its wholly owned subsidiaries. To manage this foreign currency and interest rate cash flow exposure, the Company’s subsidiaries entered into cross-currency interest rate swaps that convert their U.S. dollar denominated floating interest payments to functional currency fixed interest payments during the life of the hedging instrument. As changes in foreign exchange and interest rates impact the future cash flow of interest payments, the hedges are intended to offset changes in cash flows attributable to interest rate and foreign exchange movements.

These derivative instruments (cash flow hedging instruments) are designated and qualify as cash flow hedges, with the effective portion of the gain or loss on the derivative reported as a component of other comprehensive income (loss) and reclassified into earnings in the same period or periods during which the hedged transaction is determined to be ineffective. There were no such amounts recorded for ineffectiveness for the periods reported herein related to the interest rate or cross-currency interest rate swaps of long-term debt.

The Company is exposed to foreign-currency exchange-rate fluctuations in the normal course of business, including foreign-currency exchange-rate fluctuations on U.S. dollar denominated liabilities within its international subsidiaries whose functional currency is other than the U.S. dollar. The Company manages these fluctuations, in part, through the use of non-deliverable forward foreign-exchange contracts that are intended to offset changes in cash flow attributable to currency exchange movements. These contracts are intended primarily to economically address exposure to U.S. dollar merchandise inventory expenditures made by the Company’s international subsidiaries whose functional currency is other than the U.S. dollar. Currently, these contracts do not qualify for derivative hedge accounting. The Company seeks to mitigate foreign-currency exchange-rate risk with the use of these contracts and does not intend to engage in speculative transactions. These contracts do not contain any credit-risk-related contingent features.

Cash Flow Hedges

As of November 30, 2017, all of the Company’s interest rate swap and cross-currency interest rate swap derivative financial instruments are designated and qualify as cash flow hedges. The Company formally documents the hedging relationships for its derivative instruments that qualify for hedge accounting.

The following table summarizes agreements for which the Company has recorded cash flow hedge accounting for the three months ended November 30, 2017:

Subsidiary

Date
Entered
into

Derivative
Financial
Counter-
party

Derivative
Financial
Instruments

Initial
US$
Notional
Amount

Bank
US$
loan
Held
with

Floating Leg
(swap
counter-party)

Fixed Rate
for PSMT
Subsidiary

Settlement
Dates

Effective
Period of swap

PriceSmart, Inc (1)

7-Nov-16

MUFG Union Bank, N.A. ("Union Bank")

Interest rate swap

35,700,000

Union Bank

Variable rate 1-month Libor plus 1.7%

3.65

1st day of each month beginning on April 1, 2017

March 1, 2017 -
March 1, 2027

Costa Rica

28-Aug-15

Citibank, N.A. ("Citi")

Cross currency interest rate swap

7,500,000

Citibank, N.A.

Variable rate 3-month Libor plus 2.50%

7.65

28th day of August, November, February, and May beginning on November 30, 2015

August 28, 2015 -
August 28, 2020

Honduras

24-Mar-15

Citibank, N.A. ("Citi")

Cross currency interest rate swap

8,500,000

Citibank, N.A.

Variable rate 3-month Libor plus 3.25%

10.75

24th day of March, June, September, and December beginning on June 24, 2015

March 24,2015 -
March 20, 2020

El Salvador

16-Dec-14

Bank of Nova Scotia ("Scotiabank")

Interest rate swap

4,000,000

Bank of Nova Scotia

Variable rate 30-day Libor plus 3.5%

4.78

29th day of each month beginning on December 29, 2014

December 1, 2014 -
August 29, 2019

Colombia

10-Dec-14

Citibank, N.A. ("Citi")

Cross currency interest rate swap

15,000,000

Citibank, N.A.

Variable rate 3-month Libor plus 2.8%

8.25

4th day of March, June, Sept, Dec. beginning on March 4, 2015

December 4, 2014 -
December 3, 2019

Panama

9-Dec-14

Bank of Nova Scotia ("Scotiabank")

Interest rate swap

10,000,000

Bank of Nova Scotia

Variable rate 30-day Libor plus 3.5%

5.16

28th day of each month beginning December 29, 2014

November 28, 2014 -
November 29, 2019

Honduras

23-Oct-14

Citibank, N.A. ("Citi")

Cross currency interest rate swap

5,000,000

Citibank, N.A.

Variable rate 3-month Libor plus 3.5%

11.6

22nd day of January, April, July, and October beginning on January 22, 2015

Settled on
October 22, 2017

Panama

1-Aug-14

Bank of Nova Scotia ("Scotiabank")

Interest rate swap

5,000,000

Bank of Nova Scotia

Variable rate 30-day Libor plus 3.5%

4.89

21st day of each month beginning on September 22, 2014

August 21, 2014 -
August 21, 2019

Panama

22-May-14

Bank of Nova Scotia ("Scotiabank")

Interest rate swap

3,970,000

Bank of Nova Scotia

Variable rate 30-day Libor plus 3.5%

4.98

4th day of each month beginning on June 4, 2014

May 5, 2014 -
April 4, 2019

⁽¹⁾

The initial notional amount and fixed rate were modified effective January 2017.

For the three months ended November 30, 2017 and 2016, the Company included the gain or loss on the hedged items (that is, variable-rate borrowings) in the same line item—interest expense—as the offsetting gain or loss on the related interest rate swaps as follows (in thousands):



Income Statement Classification	Interest expense on borrowings(1)		Cost of swaps (2)		Total
Interest expense for the three months ended November 30, 2017	$	849	$	322	$	1,171
Interest expense for the three months ended November 30, 2016	$	750	$	423	$	1,173

⁽¹⁾

This amount is representative of the interest expense recognized on the underlying hedged transactions.

⁽²⁾

This amount is representative of the interest expense recognized on the cross-currency interest rate swaps designated as cash flow hedging instruments.

The total notional balance of the Company’s pay-fixed/receive-variable interest rate swaps and cross-currency interest rate swaps was as follows (in thousands):



	Notional Amount as of
	November 30,		August 31,
Floating Rate Payer (Swap Counterparty)	2017		2017
Union Bank	$	35,700	$	35,700
Citibank N.A.		25,063		26,088
Scotiabank		12,924		13,724
Total	$	73,687	$	75,512

Derivatives listed on the table below were designated as cash flow hedging instruments. The table summarizes the effect of the fair value of interest rate swap and cross-currency interest rate swap derivative instruments that qualify for derivative hedge accounting and its associated tax effect on accumulated other comprehensive (income)/loss (in thousands):



		November 30, 2017						August 31, 2017
Derivatives designated as cash flow hedging instruments	Balance Sheet Location	Fair Value		Net Tax Effect		Net OCI		Fair Value		Net Tax Effect		Net OCI
Cross-currency interest rate swaps	Other non-current assets	$	2,514		(938)		1,576	$	2,547	$	(950)	$	1,597
Interest rate swaps	Other non-current assets		764		(272)		492		—		—		—
Interest rate swaps	Other long-term liabilities		(4)		(3)		(7)		(231)		80		(151)
Cross-currency interest rate swaps	Other long-term liabilities		(342)		114		(228)		(451)		135		(316)
Net fair value of derivatives designated as hedging instruments		$	2,932	$	(1,099)	$	1,833	$	1,865	$	(735)	$	1,130

Fair Value Instruments

The Company has entered into non-deliverable forward foreign-exchange contracts. These contracts are treated for accounting purposes as fair value contracts and do not qualify for derivative hedge accounting. The use of non-deliverable forward foreign-exchange contracts is intended to offset changes in cash flow attributable to currency exchange movements. These contracts are intended primarily to economically hedge exposure to U.S. dollar merchandise inventory expenditures made by the Company’s international subsidiaries whose functional currency is other than the U.S. dollar. The following table summarizes the non-deliverable forward foreign exchange contracts that are open as of November 30, 2017:

Subsidiary

Dates
entered into

Financial
Derivative
(Counterparty)

Derivative
Financial
Instrument

Notional
Amount
(in thousands)

Settlement
Date

Effective Period
of Forward

Colombia

Oct-17

Citibank, N.A.

Forward foreign
exchange contracts (USD)

1,000

Dec-17

October 13, 2017 -
December 6, 2017

Colombia

Oct-17

Citibank, N.A.

Forward foreign
exchange contracts (USD)

1,000

Dec-17

October 17, 2017 -
December 13, 2017

Colombia

Oct-17

Citibank, N.A.

Forward foreign
exchange contracts (USD)

1,000

Dec-17

October 18, 2017 -
December 20, 2017

Colombia

Oct-17

Citibank, N.A.

Forward foreign
exchange contracts (USD)

1,000

Dec-17

October 19, 2017 -
December 27, 2017

For the three months ended November 30, 2017, the Company included in its consolidated statements of income the forward derivative gain or (loss) on the non-deliverable forward foreign-exchange contracts as follows (in thousands):

The following table summarizes the fair value of foreign currency forward contracts that do not qualify for derivative hedge accounting (in thousands):



	November 30, 2017			August 31, 2017
Non-deliverable forward foreign exchange contracts	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
Foreign currency forward contracts	Other current assets	$	71	Other current assets	$	—
Foreign currency forward contracts	Other accrued expenses		—	Other accrued expenses		—
Net fair value of non-deliverable forward foreign exchange contracts designated as hedging instruments that do not qualify for hedge accounting(1)		$	71		$	—

⁽¹⁾

The fair value of these financial assets and liabilities measured and recorded using Level 2 inputs, which are inputs other than quoted prices in active markets that are either directly or indirectly observable.

Three Months Ended

November 30,

November 30,

Income Statement Classification

Other income (expense), net