REX

Business Context and Reporting Period

Company: REX Stores Corporation (REX American Resources Corp)

Filing Type: Form 10-Q (Quarterly Report)

Reporting Period: Quarter and six months ended July 31, 2002

Business Overview: A specialty retailer in the consumer electronics and appliance industry operating 255 stores in 37 states under the trade name "REX". The company also holds significant interests in synthetic fuel limited partnerships.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Net sales decreased 7.4% in the quarter and 9.1% in the six-month period compared to the prior year. This was driven by a 5.6% decline in comparable store sales and a net reduction of nine stores.
• Profitability Increase: Despite lower sales, Net Income increased 39.3% for the quarter and 37.3% for the six-month period. This growth was primarily fueled by non-operating income from synthetic fuel partnerships ($4.6 million in the quarter; $9.3 million in the six months).
• Margin Expansion: Gross profit margins improved to 31.5% (quarter) and 30.3% (six months) due to strong air conditioner sales and favorable vendor pricing.
• Interest Expense Reduction: Interest expense dropped significantly (44% for the quarter) due to the early extinguishment of approximately $7.0 million in mortgage debt and restructuring remaining debt to lower floating rates.
• Cash Flow: Operating cash flow turned negative, using $28.0 million in the first six months of 2002 compared to $10.0 million in the prior year, primarily due to a $37.8 million increase in inventory.

Outlook, Risks, and Unusual Items

• Synthetic Fuel Contingency: Approximately $2.5 million of payments from the sale of a synthetic fuel partnership interest is held in escrow pending an IRS audit. While the company believes it will prevail, the timing of the audit is undetermined.
• New Acquisition Risk: On September 5, 2002, the company purchased a synthetic fuel plant in Wyoming. If the plant cannot be relocated on acceptable terms, the company faces an estimated $2 million cost to remove it. There is no assurance the facility will reach commercial operation.
• Store Count: The company closed seven stores in the first half of fiscal 2002 and opened none, reducing the total count to 255.
• Accounting Changes: The company noted the issuance of SFAS 145, which may require reclassification of debt extinguishment gains/losses from extraordinary items to continuing operations in future periods.
• Auditor Change: The company dismissed Arthur Andersen LLP and engaged Deloitte & Touche LLP as its independent auditor.

Investor Verification Checklist

• IRS Audit Outcome: Verify the status of the IRS audit regarding the synthetic fuel partnership and the potential release of the $2.5 million escrowed funds.
• Wyoming Plant Viability: Monitor progress on relocating the Gillette, Wyoming plant and the likelihood of avoiding the $2 million removal cost.
• Inventory Levels: Assess the $37.8 million increase in inventory and its impact on future working capital and cash flow.
• Comparable Store Sales: Track the trend of comparable store sales, which declined 5.6% in the quarter, to gauge core retail performance excluding partnership income.
• Debt Structure: Review the terms of the restructured mortgage debt to confirm the sustainability of the reduced interest expense.