REX

Business Context and Reporting Period

Company: REX Stores Corporation (REX American Resources Corp)

Filing Type: Form 10-Q (Quarterly Report)

Reporting Period: Three months ended April 30, 2006 (First Quarter of Fiscal 2006)

Business Overview: REX is a specialty retailer in the consumer electronics and appliance industry. As of April 30, 2006, the company operated 211 stores in 36 states, primarily in small to medium-sized markets. The company also holds significant interests in synthetic fuel partnerships and has contingent commitments to invest in ethanol production facilities.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Net sales decreased 2.1% to $86.1 million, primarily due to a net reduction of 18 stores compared to the prior year. This was partially offset by a 0.5% increase in comparable store sales.
• Profitability Drop: Net income fell 75.6% to $1.5 million. The primary driver was a significant decrease in income from synthetic fuel investments, which dropped from $6.0 million in Q1 2005 to $2.1 million in Q1 2006.
• Operating Expenses: Selling, general, and administrative (SG&A) expenses increased 3.9% to $23.3 million. This increase was largely due to the adoption of SFAS 123(R), which resulted in $0.6 million of stock-based compensation expense.
• Cash Flow Reversal: Operating cash flow swung from a $6.2 million inflow in Q1 2005 to a $6.1 million outflow in Q1 2006. The outflow was driven by a $11.1 million increase in merchandise inventory (seasonal buildup of televisions and air conditioners) and a decrease in other current liabilities.
• Debt Reduction: Total debt decreased by approximately $9.0 million due to mortgage debt pay-offs since the prior year.

Outlook, Risks, and Management Commentary

• Synthetic Fuel Risk: Management notes that high oil prices have increased the likelihood that Section 29/45K tax credits will be phased out in 2006 and 2007. Subsequent to the quarter end, a major partner (Progress Energy) ceased production at synthetic fuel facilities. Consequently, the company no longer anticipates additional income from these interests unless operations resume.
• Product Mix: The appliance category drove comparable store sales up 3.2%, aided by hurricane recovery demand in the Gulf Coast. Televisions also grew 2.2% due to demand for LCD and plasma sets. Audio and video categories declined due to commoditization and lower price points.
• Ethanol Investments: The company has entered into multiple contingent agreements to invest in ethanol producing facilities (totaling potential commitments of $24.9 million as of June 2006). These are secured by letters of credit and are subject to the investees obtaining additional financing.
• Tax Rate: The effective tax rate for Q1 2006 was 37.7%, up from 15.1% in Q1 2005, due to the reduction in federal income tax credits from synthetic fuel production. The company expects the fiscal 2006 tax rate to range between 35% and 40%.
• Store Count: The company closed seven stores in Q1 2006 and opened none. It currently owns 25 properties where it acts as a landlord, with five owned properties currently vacant.

Investor Verification Checklist

• Synthetic Fuel Income Sustainability: Verify the status of the Section 29/45K tax credit phase-out and the operational status of partner facilities (Colona, Somerset, Gillette) given the cessation of production announced by Progress Energy.
• Ethanol Commitments: Review the status of the contingent agreements for ethanol investments ($5M, $7.5M, $14M, and $24.9M notes) and the associated letters of credit, noting that some were cancelled or modified subsequent to the quarter end.
• Inventory Levels: Assess the $11.1 million increase in inventory and the company's ability to sell through seasonal stockpiles of televisions and air conditioners without significant markdowns.
• Store Consolidation Impact: Monitor the impact of the net store reduction (18 fewer stores vs. prior year) on long-term revenue stability and SG&A efficiency.
• Stock-Based Compensation: Confirm the ongoing impact of SFAS 123(R) adoption on future earnings, noting $3.9 million of unrecognized compensation cost remaining.