Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    x YES    o NO

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    o YES    x NO

The registrant had 3,989,876 common shares, par value $0.001, outstanding at May 5, 2005.

COST-U-LESS, INC.

INDEX TO FORM 10-Q

2

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)

COST-U-LESS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)

(Unaudited)

The accompanying Notes to the Condensed Consolidated Financial Statements are an integral part of these statements.

3

COST-U-LESS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)

(Unaudited)

The accompanying Notes to the Condensed Consolidated Financial Statements are an integral part of these statements.

4

COST-U-LESS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(in thousands, except share data)

(Unaudited)

The accompanying Notes to the Condensed Consolidated Financial Statements are an integral part of these statements.

5

COST-U-LESS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

(Unaudited)

The accompanying Notes to the Condensed Consolidated Financial Statements are an integral part of these statements.

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COST-U-LESS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.   Nature of Business and Summary of Significant Accounting Policies

   Nature of Business

        Cost-U-Less, Inc. (the “Company”) operates mid-sized warehouse club-style stores in various United States Territories (“U.S. Territories”), foreign island countries in the Pacific and the Caribbean, the Hawaiian Islands and Sonora, California. At March 27, 2005, the Company operated eleven retail stores as follows: two stores in each of Hawaii and Guam, and one store in each of St. Thomas, St. Croix, American Samoa, Fiji, Curacao, St. Maarten and Sonora, California. The Company is in the process of building a new St. Croix store on a parcel of land located closer to the main trade area in the center of the island than its existing store.

   Basis of Presentation

        The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial reporting and pursuant to the rules and regulations of the SEC. In the opinion of management, the financial information includes all adjustments that the Company considers necessary for a fair presentation of the financial position at such dates and the operations and cash flows for the periods then ended. The condensed consolidated balance sheet at December 26, 2004 has been derived from the audited financial statements at that date. Certain information and footnote disclosures normally included in the financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to SEC rules and regulations on quarterly reporting. Operating results for the 13 weeks ended March 27, 2005, are not necessarily indicative of results that may be expected for the entire year. All quarterly periods reported consist of 13 weeks. For further information, refer to the financial statements and footnotes included in the Company’s annual report on Form 10-K filed with the SEC on March 23, 2005.

   Fiscal Year

        The Company reports on a 52/53-week fiscal year, consisting of four thirteen-week periods and ending on the Sunday nearest to the end of December. Fiscal 2005, ending on January 1, 2006, is a 53-week fiscal year. Fiscal 2004, which ended on December 26, 2004, was a 52-week year.

   Principles of Consolidation

        The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries in the U.S. Virgin Islands, Netherlands Antilles, Guam, American Samoa, Nevada, Fiji and New Zealand. All significant inter-company accounts and transactions have been eliminated in consolidation.

   Foreign Currency Translations and Comprehensive Income

        The U.S. dollar is the functional currency for all locations, except for Fiji and Netherlands Antilles, where the local currency is the functional currency. Assets and liabilities denominated in foreign currencies are translated at the applicable exchange rate on the balance sheet date. Net sales, costs and expenses are translated at the average rates of exchange prevailing during the period. Adjustments resulting from this process are reported, net of taxes, as Accumulated Other Comprehensive Income (Loss), a component of Shareholders’ Equity. Realized and unrealized gains on foreign currency transactions are included in Other Income (Expense). The cumulative translation adjustment resulting from a net investment in a country is recognized as income or expense in the period the Company has substantially liquidated operations in that country.

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COST-U-LESS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(Unaudited)

   Use of Estimates

        The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Estimates are used for, but not limited to: allowance for doubtful accounts; depreciable lives of assets; reserves for inventory; and deferred tax valuation allowances. Future events and their effects cannot be determined with certainty. Accordingly, the accounting estimates require the exercise of judgment. The accounting estimates used in the preparation of the consolidated financial statements may change as new events occur, as more experience is acquired, as additional information is obtained and as the Company’s operating environment changes. Actual results could differ from those estimates.

   Stock-Based Compensation

        The Company has elected to apply the disclosure-only provisions of Financial Accounting Standards Board Statement No. 123, Accounting for Stock-Based Compensation. Accordingly, the Company accounts for stock-based compensation using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations under APB No. 25, whereby compensation cost for stock options is measured as the excess, if any, of the fair value of the Company’s common stock at the date of grant over the stock option exercise price. The Company usually grants stock options at exercise prices equal to fair market value on the date of grant; as a result, no compensation cost has been recognized.

        Had stock option compensation expense for the Company’s stock option plans been recognized based on the estimated fair value on the grant date under the fair value methodology allowed by FAS 123, as amended by FAS 148, the Company’s net income and earnings per share amounts would have been as follows:

Reclassifications

        Certain reclassifications of prior years’ balances have been made for consistent presentation with the current year.

8

COST-U-LESS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(Unaudited)

New Accounting Pronouncements

        In December 2004, the Financial Accounting Standards Board issued Statement 123 (revised 2004), “Share-Based Payment” (Statement 123(R)).  Statement 123(R) requires that the compensation cost relating to share-based payment transactions be recognized in financial statements.  The cost will be measured based on the fair value of the instruments issued.  Statement 123(R) covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights and employee share purchase plans.  Statement 123(R) replaces Statement 123, “Accounting for Stock-Based Compensation” and supersedes Opinion 25, “Accounting for Stock Issued to Employees.”  As originally issued in 1995, Statement 123 established as preferable the fair-value-based method of accounting for share-based payment transactions with employees.  However, that Statement permitted entities the option of continuing to apply the guidance in Opinion 25, as long as the footnotes to the financial statements disclosed what net income would have been had the preferable fair-value-based method been used.  The Company will be required to apply Statement 123(R) as of the beginning of its fiscal year that begins after June 15, 2005. The Company plans on using the modified-prospective method effective with its first quarter of fiscal 2006.  The Company believes that the adoption of this new accounting standard will not have a material impact on the Company’s results of operations or financial position, as the Company has a limited amount of options available for issuance in the future.

2.   Earnings Per Share

        Basic earnings per share is computed using the weighted average number of common shares outstanding during the period and excludes any dilutive effects of stock options and warrants. Diluted earnings per share are computed using the weighted average number of common shares and potentially dilutive shares outstanding during the period. Potentially dilutive shares are excluded from the computation if their effect is anti-dilutive.

        The following table sets forth the computation of basic and diluted earnings per common share:

        The diluted share calculation for the 13 weeks ended March 28, 2004, excludes 132,916 stock options outstanding. These options are excluded due to their anti-dilutive effect.

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COST-U-LESS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(Unaudited)

3.   Line of Credit

        On April 9, 2003, the Company entered into a line of credit with Wells Fargo Business Credit that has a three year term, expiring on April 9, 2006. The line of credit consists of a $6.0 million committed, secured revolving credit line with a sublimit for letters of credit and bankers acceptances in the amount up to $0.7 million. At March 27, 2005, there were no borrowings outstanding on the line of credit. At March 27, 2005, there was $12,000 utilized for standby letters of credit and $0.1 million set aside for other reserves.

        Borrowings are limited to the lesser of $6.0 million or the amount calculated under the borrowing base. The borrowing base is equal to the lesser of (a) $6.0 million or (b) the sum of 70% of eligible inventory in the United States of America, plus 60% of eligible inventory in the U.S. Virgin Islands and Guam, less specified reserves. The line of credit, as amended, provided for the following: (i) an immediate reduction in the interest rate on the line of credit of one half of one percent (0.50%), (ii) a further reduction in the interest rate of one half of one percent (0.50%) if the Company met certain net income levels from December 29, 2003, through June 27, 2004, and (iii) the adoption of new measurement values for fiscal 2004. As the Company met the certain net income levels from December 29, 2003, through June 27, 2004, specified in the March 2, 2004, amendment, its interest rate was reduced from August 1, 2004, forward to the financial institution’s prime rate plus 0.5%. Borrowings under the amended line of credit were charged interest at the financial institution’s prime rate plus (i) 1.5% in January and February, (ii) 1.0% in March through July, and (iii) 0.5% in August 2004 through March 2005. At March 27, 2005, the rate charged by the financial institution was 6.25%.

        A fee of 0.25% is charged on the unused portion of the line of credit. The line of credit contains various covenants, including a requirement that the Company maintain minimum pre-tax income and tangible net worth and limitations on acquisitions, additional debt, changes in control and capital expenditures. As of March 27, 2005, the Company believes that it was in compliance with all such covenants.

4.   Commitments and Contingencies

   Legal Proceedings

        The Company is involved from time to time in claims, proceedings and litigation arising from its business and property ownership. The Company does not believe that any such claim, proceeding or litigation, either alone or in the aggregate, will have a material adverse effect on the Company’s business, financial condition or results of operation.

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

Certain Factors That May Affect Future Results of Operations

        This discussion and analysis should be read in conjunction with our unaudited condensed consolidated financial statements and the related notes thereto appearing in Item 1 of this report. In addition to historical information, this quarterly report on Form 10-Q contains, and may incorporate by reference, statements which may constitute forward-looking statements which involve known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements. Forward-looking statements may be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “estimate,” “anticipate,” “continue,” or similar terms, variations of such terms or the negative of those terms, but the absence of such terms does not mean that a statement is not forward-looking. Forward looking statements reflect the expectations of our management at the time that they are made and do not represent an opinion about what may happen in the future. More information about factors that could affect our financial results is included in the “Risk Factors that May Affect Future Results” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections of our annual report on Form 10-K for the fiscal year ended December 26, 2004, which was filed on March 23, 2005, with the Securities Exchange Commission.

        The following management’s discussion and analysis of financial condition and results of operations should be read in conjunction with management’s discussion and analysis of financial condition and results of operations included in our annual report on Form 10-K for the fiscal year ended December 26, 2004.

        As used in this quarterly report on Form 10-Q, unless the context otherwise requires, the terms “we,” “us,” “our,” “the Company,” and “Cost-U-Less” refer to Cost-U-Less, Inc., a Washington corporation, and its subsidiaries.

Overview

        We operate mid-sized warehouse club-style stores in various United States Territories, foreign island countries in the Pacific and the Caribbean, the Hawaiian Islands and Sonora, California. Our primary strategy is to operate in island markets, offering predominantly U.S. branded goods. We currently operate eleven retail stores as follows: two stores in each of Hawaii and Guam, and one store in each of St. Thomas, St. Croix, American Samoa, Fiji, Curacao, St. Maarten and Sonora, California.

        Our stores are patterned after the warehouse club concept, although the stores (i) are smaller (averaging approximately 31,000 square feet vs. large format warehouse clubs of approximately 115,000 square feet), (ii) generally target niche markets, mainly U.S. Territories, U.S. island states and foreign island countries, where demographics do not support large format warehouse clubs, (iii) carry a wide assortment of local and ethnic food items, and (iv) do not charge a membership fee. Although we do not have large seasonal fluctuations in sales, the fourth quarter is typically the highest sales quarter due to additional holiday sales.

        We are currently in the process of building a new St. Croix store on a parcel of land located closer to the main trade area in the center of the island than our existing store. This new building will expand the size of our St. Croix store by about 45% to approximately 38,000 square feet. We expect this new store to open on May 26, 2005. We are currently operating in our existing location under a short-term lease with our current landlord until such time as we can move into our new location.

Our management focus relative to our core island store operations includes reviewing our merchandising strategies, both those that apply to all stores and those specific to each store, in light of the different conditions in each market. We also continue to explore ways to maximize long-term value for our shareholders, including focusing on efforts to increase earnings, responding to competition, and improving same store sales and gross margins. We are currently evaluating methods of implementing future growth, including expansion opportunities in selected markets and relocation opportunities for stores in existing markets with leases expiring in the next few years, such as our St. Croix store. Additionally, we believe that although there are a number of new island markets that have the attributes necessary to support a growth strategy for our business, licensing restrictions and political resistance to foreign retailers, among other things, make it difficult for us to enter some of these markets. While we believe these actions can improve profitability, there can be no assurance that these actions will be successful.

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Results of Operations

        During the fiscal first quarter ended March 27, 2005, we continued to experience improvements in comparable-store sales. Additionally, our store expenses as a percentage of sales were in line with the first quarter of fiscal 2004 and our corporate expenses, both in dollars and as a percentage of sales, were lower than the first quarter of fiscal 2004. These factors resulted in higher operating income in the first quarter of fiscal 2005 as compared to the same period in the prior year. Additionally, during the fiscal first quarter ended March 27, 2005, we benefited from non-recurring insurance reimbursement recorded in other income and a reduction in interest expense as compared to the same period in 2004, which combined with the improved operating income, resulted in higher net income and EPS.

Comparison of the 13 Weeks Ended March 27, 2005 to the 13 Weeks Ended March 28, 2004:

        Net Sales: Net sales of $53.2 million for the first quarter of fiscal 2005 increased 6.3% compared to net sales of $50.1 million for the first quarter of fiscal 2004. The increase in net sales in the first quarter of fiscal 2005 was due to comparable-store sales increases offset by a decline in business-to-business sales as compared to the same period in the prior year. We expect the level of business-to-business activity for fiscal 2005 to be lower than fiscal 2004, as we de-emphasize these lower margin sales.

        Comparable-store sales (stores open for a full 13 months) increased 7.1% for the first quarter of fiscal 2005 compared to the first quarter of fiscal 2004. Ten of our eleven stores experienced increased sales in the first quarter of fiscal 2005 as compared to the same period in the prior year primarily due to improvements in our assortment of food and general merchandise, operating improvements including better in-stock inventory levels and improved economic conditions in some of our markets.

        Gross Profit: Gross profit of $9.6 million, or 18.0% of sales, for the first quarter of fiscal 2005 increased in dollars as compared to gross profit of $9.1 million, or 18.1% of sales, in the first quarter of fiscal 2004, primarily due to our increased sales.

        Store expenses: Store expenses of $6.7 million for the first quarter of fiscal 2005 increased $0.4 million compared to expenses of $6.3 million for the first quarter of fiscal 2004. Approximately 50% of the dollar increase in store expenses was attributable to higher volume-related expenses such as payroll and related costs such as health care, and bankcard fees. The remainder of the dollar increase was primarily attributable to a 7% increase in energy (utility) expense, a 7% increase in commercial insurance expense and a 4% increase in rent expense as compared to the same period in the prior year, partially offset by a reduction in bad debt expense.

        As a percentage of sales, store expenses remained flat at 12.6% of sales for the first quarters of both fiscal 2005 and fiscal 2004. Payroll and related costs, although higher due to volume, remained comparable as a percent of store sales at 5.2% of sales for the first quarters of both fiscal 2005 and fiscal 2004.

        General and administrative expenses: General and administrative expenses remained flat at $1.7 million for the first quarters of both fiscal 2005 and fiscal 2004. As a percent of sales, general and administrative expenses for the first quarter of fiscal 2005 decreased to 3.2% as compared to 3.5% for the first quarter of fiscal 2004, primarily due to the leveraging of corporate expenses over increased store sales.

        Store opening expenses: Store opening expenses were $31,000 in the first quarter of fiscal 2005 compared to $40,000 in the first quarter of fiscal 2004. Store opening expenses in both periods primarily relate to costs associated with the evaluation of potential new store locations. We expect store opening expenses in fiscal 2005 to be higher than those incurred in fiscal 2004 as we relocate our St. Croix store in the second quarter of fiscal 2005 and as we continue to evaluate alternative methods of implementing future expansion, including exploring expansion opportunities in selected markets and relocation opportunities for existing stores with leases expiring in the next few years.

        Interest expense, net: Interest expense, net decreased to $51,000 in the first quarter of fiscal 2005 as compared to $126,000 in the first quarter of fiscal 2004 as we capitalized approximately $64,000 of interest related to the construction of our new store in St. Croix during the first quarter of fiscal 2005 and as borrowings on our line of credit decreased compared to the prior year.

        Other income: Other income increased to $116,000 in the first quarter of fiscal 2005 as compared to $27,000 in the first quarter of fiscal 2004 primarily due to the receipt of a $0.1 million non-recurring insurance reimbursement. All other amounts included in other income are attributable to gains on foreign currency transactions and translation of intercompany balances for transactions that exceed the permanent investments in those countries.

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        Income tax provision: The tax provision for the first quarters of fiscal 2005 and fiscal 2004, represent taxes associated with income generated in the U.S. and U.S. Territories. Our effective tax rate is higher than the expected federal statutory rate because no tax benefits were provided on foreign losses, as we have no assurance that we will be able to generate an adequate amount of taxable income in the future to utilize such benefits.

        Net income: Net income was $734,000, or $0.18 per fully diluted share, for the first quarter of fiscal 2005 compared to net income for the first quarter of fiscal 2004 of $537,000, or $0.14 per fully diluted share. Weighted average diluted common shares outstanding were 4,085,090 for first quarter of 2005 as compared to 3,859,987 in the same period in the prior year.

Liquidity and Capital Resources

        We currently finance our operations with proceeds from various credit facilities and internally generated funds. Although we are currently financing the land and construction of our new St. Croix store with existing working capital, it is our intent to eventually finance the relocation of our St. Croix store, and any future relocations and new stores, either through an operating lease, a sale-leaseback arrangement or by obtaining long-term funding from a financial institution. We intend to continue leasing as many of our store locations as feasible. In those instances where a lease is not available on acceptable terms, we expect to finance our stores utilizing long-term funding from a financial institution (as we currently do for our St. Thomas and St. Maarten buildings).

        We generated $0.2 million and $0.3 million of net cash from operations during the first quarter of fiscal 2005 and fiscal 2004, respectively. The slight decrease in cash provided by operations in the first quarter of fiscal 2005, as compared to the same period in the prior year, was primarily due to the receipt in the first quarter of fiscal 2004 of insurance proceeds related to inventory damaged by the supertyphoon on December 8, 2002, partially offset by an increase in net income of $0.2 million in the first quarter of fiscal 2005 as compared to the same period in the prior year, and the effect of working capital fluctuations.

         Net cash used in investing activities was $2.0 million for the first quarter of fiscal 2005 compared to $0.4 million of cash generated in the first quarter of fiscal 2004. The cash used in investing activities in the first quarter of fiscal 2005 was primarily due to costs associated with the construction of the new building in St. Croix where we plan to relocate our St. Croix store on May 26, 2005. We expect to incur an additional $1.5 to $2.5 million for the cost of site development, the new building and equipment. The $0.7 million of proceeds received from our insurance settlement in the first quarter of fiscal 2004 relates to insurance reimbursements received on fixed assets lost in the supertyphoon in Guam that we replaced in 2003. We currently have no plans to open stores in new markets during fiscal 2005, but we are in the process of exploring expansion opportunities in selected markets and additional relocation opportunities for stores in existing markets.

        We utilized $0.2 million of cash for financing activities in the first quarter of fiscal 2005, as compared to $0.6 million provided by financing activities in the first quarter of fiscal 2004. The decrease was primarily due to an increase of $0.3 million of cash received related to stock option exercises in the first quarter of fiscal 2005 as compared to the same period in the prior year. Additionally, in the first quarter of fiscal 2004, we reduced our borrowings under our line of credit by $0.9 million, which was offset by $0.8 million received on a sale-leaseback arrangement on equipment in Guam.

        We have a line of credit with Wells Fargo Business Credit that has a three year term, expiring on April 9, 2006. At March 27, 2005, there were no borrowings outstanding on the line of credit. At March 27, 2005, there was $12,000 utilized for standby letters of credit and $0.1 million set aside for other reserves.

        The line of credit consists of a $6.0 million committed, secured revolving credit line with a sublimit for letters of credit and bankers acceptances in the amount up to $0.7 million. Borrowings under the line of credit are limited to the lesser of $6.0 million or the amount calculated under the borrowing base. The borrowing base is equal to the lesser of (a) $6.0 million or (b) the sum of 70% of eligible inventory in the United States of America, plus 60% of eligible inventory in the U.S. Virgin Islands and Guam, less specified reserves. The interest rate on borrowings under the line of credit is equal to Wells Fargo’s prime rate plus 0.5%, which was 6.25% at March 27, 2005. A fee of 0.25% is charged on the unused portion of the line of credit and we are required to pay Wells Fargo not less than $0.1 million of interest each calendar year. The line of credit contains various covenants, including a requirement that we maintain minimum pre-tax income and tangible net worth, as well as limitations on acquisitions, additional debt, changes in control and capital expenditures.

        A significant portion of our cash flow is generated by our operations. If our operating results deteriorate as a result of a decrease in customer demand, declining economic conditions in the markets in which we have stores, or pricing pressures from our customers or our competitors, our ability to generate positive cash flow from operations may be jeopardized. We believe that amounts available under our various credit facilities, existing cash available for working capital purposes, and cash flow from operations will most likely be sufficient to fund our operations through the next twelve months. However, if such sources of

13

liquidity are unavailable or insufficient to satisfy our liquidity requirements, we may need to issue equity or debt securities, obtain additional credit facilities or consider alternative financing arrangements. There can be no assurance that we will be able to obtain additional financing when needed, or that any available financing will be on terms acceptable to us.

Contractual Obligations

        As of March 27, 2005, our commitments to make future payments under long-term contractual obligations were as follows (in thousands):

Critical Accounting Policies

        We have chosen accounting policies that we believe are appropriate to report accurately and fairly our operating results and financial position, and we apply those accounting policies in a consistent manner. The significant accounting policies are summarized in Note 1 to the consolidated financial statements included in our annual report on Form 10-K for the year ended December 26, 2004.

        The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. We base our estimates on historical experience and other factors believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates.

        We believe that the following accounting policies are the most critical in the preparation of our financial statements because they involve the most difficult, subjective or complex judgments about the effect of matters that are inherently uncertain.

Inventories

        Inventories are carried at the lower of average cost or market. We provide for estimated inventory losses 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.

Long Lived Assets

        When facts and circumstances indicate that the carrying values of long-lived assets, including intangibles, may be impaired, an evaluation of the recoverability is performed by comparing the carrying value of the assets to projected future cash flows. Upon indication that the carrying value of such assets may not be recoverable, we recognize an impairment loss by a charge against current operations.

Foreign Currency Translation

        The U.S. dollar is the functional currency for all our locations, except for Fiji and Netherlands Antilles, where the local currency is the functional currency. Assets and liabilities denominated in foreign currencies are translated at the applicable exchange rate on the balance sheet date. Net sales costs and expenses are translated at the average rates of exchange prevailing during the period. Adjustments resulting from this process are reported, net of taxes, as Accumulated Other Comprehensive Income (Loss), a component of Shareholders’ Equity. Realized and unrealized gains on foreign currency transactions are included in Other Income (Expense). The cumulative translation adjustment resulting from a net investment in a country is recognized as income or expense in the period we substantially liquidated operations in that country.

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Income Taxes

        Income tax expense includes U.S. and foreign income taxes. We account for income taxes under the liability method. Under the liability method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax basis realized, and valuation allowances are established when necessary. Our effective tax rate is currently higher than the expected federal statutory rate because valuation allowances have been established against the tax benefits of foreign losses, as we have no assurance that we will be able to generate an adequate amount of taxable income in the future to utilize such benefits. We are developing and implementing certain tax planning strategies, which may affect our ability to recognize some of the deferred tax assets that are currently allowed for and may ultimately change our estimate of the valuation allowance.

Accounting Pronouncements

        In December 2004, the Financial Accounting Standards Board issued Statement 123 (revised 2004), “Share-Based Payment” (Statement 123(R)). Statement 123(R) requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. The cost will be measured based on the fair value of the instruments issued. Statement 123(R) covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights and employee share purchase plans. Statement 123(R) replaces Statement 123, “Accounting for Stock-Based Compensation” and supersedes Opinion 25, “Accounting for Stock Issued to Employees.” As originally issued in 1995, Statement 123 established as preferable the fair-value-based method of accounting for share-based payment transactions with employees.  However, that Statement permitted entities the option of continuing to apply the guidance in Opinion 25, as long as the footnotes to the financial statements disclosed what net income would have been had the preferable fair-value-based method been used. We will be required to apply Statement 123(R) as of the beginning of our fiscal year that begins after June 15, 2005. We plan on using the modified-prospective method effective with our first quarter of fiscal 2006.  We believe that the adoption of this new accounting standard will not have a material impact on our results of operations or financial position, as we have a limited amount of options available for issuance in the future.

Risk Factors That May Affect Future Results

        You should carefully consider the following factors that may affect future results and other information included in this quarterly report. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that are currently deemed immaterial also may impair our business operations or could cause actual results to differ from historical results or those anticipated. If any of the following risks actually occur, our business, financial condition and operating results could be materially adversely affected.

        Because we have a small store base, adverse store performance or increased expenses will have a more significant adverse impact on our operating and financial results than if we had a larger store base. We opened our first store in 1989 and opened a total of 21 stores through December 2004 and presently operate eleven stores. Our closure of the ten other stores prior to March 2001 adversely affected our operating results. Should any existing store experience a significant decline in profitability or any new store be unprofitable, the negative effect on our business would be more significant than would be the case if we had a larger store base, and could have a material adverse effect on our business, financial condition and operating results. In addition, if our general and administrative expenses increase, the negative effect on our business and results of operations would be more significant than if we had a larger store base. Although we intend to carefully plan for the implementation of additional stores, there can be no assurance that such plans can be executed as envisioned or that the implementation of those plans will not have a material adverse effect on our business, financial condition and operating results. In addition, our ability to acquire products at a lower cost than competitors or obtain volume-based pricing can be adversely affected because of our small store base.

        Our ability to operate profitably in existing markets and to expand into new markets may be adversely affected by competing warehouse clubs or discount retailers. The warehouse club and discount retail businesses are highly competitive. If we fail to successfully respond to competitive pressures in this industry, or to effectively implement our strategies to respond to these pressures, our operating results may be negatively affected. Many of our competitors have substantially greater resources, buying power and name recognition than we have. The cost of doing business in island markets is typically higher than on the U.S. mainland because of ocean freight and duty costs and higher facility costs. In addition, our gross margin and operating income are generally lower for stores in markets where traditional warehouse clubs and discount retailers also operate stores, due to increased price competition and reduced market share. We may be required to implement price reductions and other actions in

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order to remain competitive in our markets. Furthermore, our ability to expand into and operate profitably in new markets may be adversely affected by the existence or entry of competing warehouse clubs or discount retailers. These factors could result in reduced sales and margins or loss of market share, any of which could negatively affect our results of operations.

        We are exposed to weather and other risks associated with island operations, which could affect our business and results of our operations. Our operations are primarily located on islands subject to volatile weather conditions and natural disasters, such as tsunamis, floods, typhoons and earthquakes, which could result in delays in construction or result in significant damage to, or destruction of, our stores. On December 8, 2002, our two stores on the island of Guam suffered damage from Supertyphoon Pongsona, resulting in the immediate closure of both stores. Our Tamuning store lost its generator in the storm and our Dededo store had to be closed for reconstruction. Additionally, we have four stores in the Caribbean, which has experienced increased activity from several hurricanes and tropical storms in the past few years.

        While we maintain property, casualty and business interruption insurance coverage in amounts we consider adequate for these types of events, insurance payments generally do not fully reimburse us for all of the damages and lost profits caused by adverse weather events. If we were to experience a catastrophic loss, we may exceed our policy limit and we may have difficulty obtaining similar insurance coverage in the future. If our insurance coverage is not adequate to cover the losses and business interruption caused by severe weather events or natural disasters, we may be required to pay substantial amounts and our financial condition and liquidity would suffer.

        In addition to weather, island operations involve uncertainties arising from such as:

        Our net sales from island operations represented approximately 92.9% of our total net sales for fiscal 2004. We expect that our island and international operations together will continue to account for nearly all of our total net sales. The distance, as well as the time-zone differences, involved with island locations impose significant challenges to our ability to manage our operations. Logistical challenges are presented by operating individual store units in remote locations, whether in terms of information flow or transportation of goods. Our inability to effectively manage our island and international operations could have a significant adverse effect on our business, results of operations and financial condition.

        There can be no assurance that we will be able to devote the resources necessary to meet the challenges posed by island operations, or that losses from business interruption will be adequately compensated by insurance; any failure to do so would have a material adverse effect on our business, financial condition and operating results.

        If we are unable to execute our growth strategy, our business could suffer. The success of our future growth strategy will depend to a significant degree on our ability to do the following:

        We have not opened stores in foreign island markets at a rapid pace. Currently, we have no plans to open stores in new markets during 2005, but we are in the process of exploring expansion opportunities in selected markets and relocation opportunities for stores in existing markets, such as our St. Croix store.

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        New markets may present operational, competitive, regulatory and merchandising challenges that are different from those we currently encounter. We do not have operating experience in many of the markets in which we may consider opening new stores. In fact, in June 2000, we closed the two stores that we had opened in New Zealand in 1999, as they had performed below expectations, due in part to competitive and merchandising challenges that are different from our other stores. Additionally, in February 2001, we closed one of our two Fiji stores, due primarily to the impact that political turmoil and the resulting economic downturn in Fiji were having on the tourist industry. There can be no assurance that we will be able to adapt our operations to support our future expansion plans or that our new stores will be profitable. Any failure on our part to manage our growth could have a material adverse effect on our business, financial condition and operating results.

        Additionally, we rely significantly on the skill and expertise of our on-site store managers. We will be required to hire, train and retain skilled managers and personnel to support any growth, and may experience difficulties locating store managers and employees who possess the training and experience necessary to operate our new stores, including our management information and communications systems, particularly in island markets where language, education and cultural factors may impose additional challenges. We have encountered, and may continue to encounter, substantial delays, increased expenses or loss of potential sites due to the complexities, cultural differences, and local political issues associated with the regulatory and permitting processes in the island markets in which we may locate our stores. There can be no assurance that we will be able to open new stores, or that we will be able to continue to attract, develop and retain the personnel necessary to pursue our growth strategy. Failure to do so could have a material adverse effect on our business, financial condition and operating results.

        We believe that there are certain attributes of appropriate markets into which we may expand our operations through the opening of new stores, including:

        We also will need to continually evaluate the adequacy of our existing systems and procedures, including store management, financial and inventory control and distribution systems. As we grow, we will need to continually analyze the sufficiency of our distribution depots and inventory distribution methods and may require additional facilities in order to support our planned growth. There can be no assurance that we will anticipate all the changing demands that our expanding operations will impose on such systems. Failure to adequately update our internal systems or procedures as required could have a material adverse effect on our business, financial condition and operating results.

        A decline in the general economic condition in the United States or in island markets in which we operate could have a significant impact on our financial performance. The success of our operations depends to a significant extent on a number of factors relating to discretionary consumer spending, including employment rates, business conditions, interest rates, inflation, population and gross domestic product levels in each of our island markets, taxation, consumer spending patterns and customer preferences. We cannot fully foresee the changes in business and economic conditions that may result from domestic or foreign factors. There can be no assurance that consumer spending in our markets will not be adversely affected by these factors, thereby affecting our growth, net sales and profitability. A downturn in tourism or a decline in the national or regional economies of the United States and the U.S. Territories or any foreign countries in which we currently or will operate, could have a material adverse effect on our business, financial condition and operating results.

        A prolonged decrease in tourism and air travel could have an indirect but significant impact on our financial performance, operations and liquidity. Because our operations are primarily located in U.S. Territories and foreign island countries throughout the Pacific and Caribbean, the success of our operations depends to a significant extent on tourism and the travel industry. Prolonged adverse occurrences affecting tourism or air travel, particularly to non-U.S. destinations, including political instability, armed hostilities, terrorism, or other activity that involves or affects air travel or the tourism industry generally, could have an indirect but adverse and significant impact on our financial performance, operations liquidity or capital resources.

        If we cannot maintain our current or similar insurance coverage, our business and results of operations could suffer. We utilize a combination of insurance policies and self-insurance mechanisms to provide for the potential liabilities for property insurance, general liability, director and officers’ liability, workers’ compensation and employee health care insurance. The costs related to obtaining our current insurance coverage have been increasing. If the costs of maintaining this insurance coverage continue to increase significantly, we would experience an associated increase in our store and administrative expenses that may negatively impact our operating results. In addition, if we are unable to maintain our current or similar insurance coverage, or if

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an event were to occur that was not covered by our current insurance policy coverage levels (including acts of terrorism, war and actions such as government nationalizations), our business and results of operations could suffer.

        If our store employees decided to become unionized, we may experience increased operating costs or other operation problems. None of our employees are currently covered by a collective bargaining agreement. However, presently there is an attempt to unionize our hourly employees in our St. Maarten store. Unionization of any of our stores could result in higher employee compensation and restrictive working condition demands that could increase our operating costs and have a material adverse effect on our business, financial condition and operating results.

        We are subject to various governmental regulations and licensing requirements, which may have an adverse effect on our business. Governmental regulations and licensing requirements in foreign countries where we plan to expand our operations might prevent or delay entry into the market or prevent or delay the introduction, or require modification, of certain of our operations. Additionally, our ability to compete may be adversely affected by foreign governmental regulations and licensing requirements that encourage or mandate the employment of citizens of, or purchase of supplies from vendors, in a particular jurisdiction. We may also be subject to taxation in these foreign jurisdictions, and the final determination of our tax liabilities may involve the interpretation of the statutes and requirements of the various domestic and foreign taxing authorities. We may also be subject to currency repatriation restrictions. There can be no assurance that any of these risks will not have a material adverse effect on our business, financial condition and operating results.

        If we are unable to overcome challenges resulting from the isolation of store operations from our corporate management and our increased dependence on local managers, we may experience decreased productivity or other operational problems. Our headquarters and administrative offices are located in Washington state; however, ten of our eleven stores and a majority of our employees are located on islands. Although we invest resources to hire and train our on-site managers, the inability of our executives to be physically present at our current and planned store sites on a regular basis may result in the following:

        We may need to invest significant resources to update and expand our communications systems and information networks and to devote a substantial amount of time, effort and expense to national and international travel in order to overcome these challenges; failure to do so could have a material adverse effect on our business, financial condition and operating results.

        We may encounter disruption in the transportation of our products, which would significantly harm our business. Our island locales require the transportation of products over great distances on water, which results in the following:

        Moreover, only a limited number of transportation companies service our regions, none of which has entered into a long-term contract with us. The inability or failure of one or more key transportation companies to provide transportation services to us, changes in the regulations that govern shipping tariffs or any other disruption in our ability to transport our merchandise could have a material adverse effect on our business, financial condition and operating results.

        We face a number of uncertainties associated with expansion outside of the United States or its territories. Our failure to adequately address these uncertainties could cause our business to suffer. Three of our stores are located outside the United States or its territories. Our future expansion plans may involve entry into additional foreign countries, which may involve additional or heightened barriers and challenges that are different from those we currently encounter, including risks associated with being further removed from the political and economic systems in the United States and anti-American sentiment as a result of political or military action. We do not currently engage in currency hedging activities. The failure to adequately address the additional challenges involved with international operations could have a material adverse effect on our business, financial condition and operating results.

        The loss of key personnel could harm our business and results of operations. Our success depends in large part on the abilities and continued service of our executive officers and other key employees. We do not carry key-man life insurance on any

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of our personnel. There can be no assurance that we will be able to retain the services of such executive officers and other key employees, the loss of any of whom could have a material adverse effect on our business, financial condition and operating results.

         A disruption of our information systems could cause our business and results of operations to suffer. Our business is highly dependent on communications and information systems, primarily systems provided by third-party vendors. We may experience systems failures or interruptions, which could have a material adverse effect on our business, financial condition and operating results. Any failure or interruption of our systems or systems provided by third-party vendors could cause delays or other problems in our operations, which could have a material adverse effect on our business, financial condition and operating results.

        Certain provisions in our charter documents and otherwise may discourage third parties from attempting to acquire control of our Company, which may have an adverse effect on the price of our stock. Our board of directors has the authority, without obtaining shareholder approval, to issue up to 2,000,000 shares of preferred stock and to fix the rights, preferences, privileges and restrictions of such shares without any further vote or action by our shareholders. Our articles of incorporation and bylaws also provide for a classified board and special advance notice provisions for proposed business at annual meetings. In addition, Washington law contains certain provisions that may have the effect of delaying, deferring or preventing a hostile takeover of our company. Further, we have a shareholder rights plan that is designed to cause substantial dilution to a person or group that attempts to acquire our company without approval of our board of directors, and thereby make a hostile takeover attempt prohibitively expensive for a potential acquirer. These provisions, among others, may have the effect of making it more difficult for a third party to acquire, or discouraging a third party from attempting to acquire, control of our company, even if shareholders may consider such a change in control to be in their best interests, which may cause the price of our common stock to suffer.

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