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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED OCTOBER 31, 2006
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE TRANSITION PERIOD FROM _________ TO _________
COMMISSION FILE NUMBER 001-09097
--------------------------------
REX STORES CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
--------------------------------
DELAWARE 31-1095548
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
2875 NEEDMORE ROAD, DAYTON, OHIO 45414
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(937) 276-3931
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
--------------------------------
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 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.
Yes (X) No ( )
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act (Check one):
Large accelerated filer ( ) Accelerated filer (X) Non-accelerated filer ( )
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes ( ) No (X)
At the close of business on December 7, 2006 the registrant had 10,344,888
shares of Common Stock, par value $.01 per share, outstanding.
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REX STORES CORPORATION AND SUBSIDIARIES
INDEX
Page
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Condensed Balance Sheets ............................. 3
Consolidated Condensed Statements of Income ....................... 4
Consolidated Condensed Statements of Shareholders' Equity ......... 5
Consolidated Condensed Statements of Cash Flows ................... 6
Notes to Consolidated Condensed Financial Statements .............. 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ........................................ 20
Item 3. Quantitative and Qualitative Disclosures About Market Risk ....... 29
Item 4. Controls and Procedures .......................................... 29
PART II. OTHER INFORMATION
Item 1A. Risk Factors ..................................................... 30
Item 6. Exhibits ......................................................... 30
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
REX STORES CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
UNAUDITED
October 31 January 31 October 31
2006 2006 2005
---- ---- ----
(In Thousands)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 15,923 $ 21,363 $ 1,254
Accounts receivable, net 3,757 3,457 4,460
Synthetic fuel receivable 7,592 1,680 2,930
Merchandise inventory 116,065 97,371 135,220
Prepaid expenses and other 1,655 2,052 1,555
Future income tax benefits 9,588 9,361 10,929
-------- -------- --------
Total current assets 154,580 135,284 156,348
PROPERTY AND EQUIPMENT, NET 121,846 125,245 127,626
ASSETS HELD FOR SALE 1,497 1,497 1,669
OTHER ASSETS 7,193 760 823
GOODWILL 726 - -
FUTURE INCOME TAX BENEFITS 28,397 30,031 27,978
INVESTMENTS 5,000 - -
RESTRICTED INVESTMENTS 2,384 2,318 2,300
-------- -------- --------
Total assets $321,623 $295,135 $316,744
======== ======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt $ 2,354 $ 2,389 $ 2,958
Current portion of deferred income and deferred gain
on sale and leaseback 11,176 10,883 10,609
Accounts payable, trade 23,153 20,396 38,919
Accrued income taxes 1,587 541 418
Accrued payroll and related items 4,302 7,183 5,777
Other current liabilities 6,300 5,863 6,596
-------- -------- --------
Total current liabilities 48,872 47,255 65,277
-------- -------- --------
LONG-TERM LIABILITIES:
Long-term mortgage debt 21,454 21,462 27,774
Deferred income and deferred gain on sale
and leaseback 13,106 12,213 11,349
-------- -------- --------
Total long-term liabilities 34,560 33,675 39,123
-------- -------- --------
MINORITY INTEREST 12,119 - -
-------- -------- --------
SHAREHOLDERS' EQUITY:
Common stock 295 294 293
Paid-in capital 138,700 135,775 134,985
Retained earnings 248,699 240,898 234,332
Treasury stock (161,622) (162,762) (157,266)
-------- -------- --------
Total shareholders' equity 226,072 214,205 212,344
-------- -------- --------
Total liabilities and shareholders' equity $321,623 $295,135 $316,744
======== ========= ========
The accompanying notes are an integral part of these unaudited consolidated
condensed financial statements.
3
REX STORES CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
UNAUDITED
Three Months Ended Nine Months Ended
October 31 October 31
---------- ----------
2006 2005 2006 2005
---- ---- ---- ----
(In Thousands, Except Per Share Amounts)
NET SALES AND REVENUE $85,215 $91,759 $251,495 $259,553
Cost of sales 62,702 66,380 182,722 186,132
------- ------- -------- --------
Gross profit 22,513 25,379 68,773 73,421
Selling, general and administrative expenses 23,284 24,102 68,485 69,578
------- ------- -------- --------
OPERATING (LOSS) INCOME (771) 1,277 288 3,843
INVESTMENT INCOME 341 23 920 155
INTEREST EXPENSE (562) (664) (1,549) (1,946)
GAIN ON SALE OF REAL ESTATE 462 253 2,197 253
INCOME FROM SYNTHETIC FUEL INVESTMENTS 5,865 8,433 8,650 24,813
------- ------- -------- --------
Income from continuing operations before provision
for income taxes and discontinued operations 5,335 9,322 10,506 27,118
PROVISION FOR INCOME TAXES 1,713 2,251 3,627 4,992
------- ------- -------- --------
Income from continuing operations 3,622 7,071 6,879 22,126
Income (loss) from discontinued operations, net of tax 103 (189) (168) (548)
Gain on disposal of discontinued operations, net of tax 1,090 - 1,090 125
------- ------- -------- --------
NET INCOME $4,815 $6,882 $7,801 $21,703
======= ======= ======== ========
WEIGHTED AVERAGE SHARES
OUTSTANDING - BASIC 10,333 10,532 10,268 10,850
======= ======= ======== ========
Basic income per share from continuing operations $0.35 $0.67 $0.67 $2.04
Basic income (loss) per share from discontinued operations 0.01 (0.02) (0.02) (0.05)
Basic income per share on disposal of discontinued operations 0.11 - 0.11 0.01
------- ------- -------- --------
BASIC NET INCOME PER SHARE $0.47 $0.65 $0.76 $2.00
======= ======= ======== ========
WEIGHTED AVERAGE SHARES
OUTSTANDING - DILUTED 11,517 11,865 11,608 12,353
======= ======= ======== ========
Diluted income per share from continuing operations $0.31 $0.60 $0.59 $1.79
Diluted income (loss) per share from discontinued operations 0.01 (0.02) (0.01) (0.04)
Diluted income per share on disposal of discontinued operations 0.10 - 0.09 0.01
------- ------- -------- --------
DILUTED NET INCOME PER SHARE $0.42 $0.58 $0.67 $1.76
======= ======= ======== ========
The accompanying notes are an integral part of these unaudited consolidated
condensed financial statements.
4
REX STORES CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF SHAREHOLDERS' EQUITY
UNAUDITED
Common Shares
Issued Treasury Total
------ -------- Paid-in Retained Shareholders'
Shares Amount Shares Amount Capital Earnings Equity
------ ------ ------ ------ ------- -------- ------
(In Thousands)
Balance at January 31, 2006 29,390 $294 19,289 $(162,762) $135,775 $ 240,898 $214,205
Net income 7,801 7,801
Share-based compensation 1,297 1,297
Stock options exercised
and related tax effects 101 1 (135) 1,140 1,628 2,769
------ ---- ------ --------- -------- --------- --------
Balance at October 31, 2006 29,491 $295 19,154 $(161,622) $138,700 $248,699 $226,072
====== ==== ====== ========= ======== ======== ========
Common Shares
Issued Treasury Total
------ -------- Paid-in Retained Shareholders'
Shares Amount Shares Amount Capital Earnings Equity
------ ------ ------ ------ ------- -------- ------
(In Thousands)
Balance at January 31, 2005 29,038 $290 17,865 $(137,839) $133,474 $ 212,629 $208,554
Net income 21,703 21,703
Treasury stock acquired 1,697 (24,383) (24,383)
Stock options exercised
and related tax effects 289 3 (627) 4,956 1,511 6,470
------ ---- ------ --------- -------- --------- --------
Balance at October 31, 2005 29,327 $293 18,935 $(157,266) $134,985 $234,332 $212,344
====== ==== ====== ========= ======== ======== ========
The accompanying notes are an integral part of these unaudited consolidated
condensed financial statements.
5
REX STORES CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
UNAUDITED
Nine Months Ended
October 31
2006 2005
---- ----
(In Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 7,801 $ 21,703
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization 2,892 3,330
Stock based compensation expense 1,297 -
Impairment charges 85 -
Income from limited partnerships (8,650) (24,813)
Gain on disposal of fixed assets (3,778) (46)
Deferred income 531 (177)
Excess tax benefits from stock option exercises (24) -
Deferred income tax 1,407 -
Changes in assets and liabilities:
Accounts receivable (276) 1,000
Merchandise inventory (18,694) (11,032)
Prepaid expenses and other 397 (325)
Other long term assets (198) 18
Accounts payable, trade 2,180 6,077
Other current liabilities (412) (1,231)
-------- --------
NET CASH USED IN OPERATING ACTIVITIES (15,442) (5,496)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (438) (2,390)
Proceeds from sale of partnership interest 2,738 23,558
Purchase of equity investment in ethanol (5,000) -
Purchase of note receivable (5,595) -
Repayment of note receivable 5,595 -
Acquisition, net of cash acquired 1,665 -
Proceeds from sale of real estate and fixed assets 9,339 1,520
Restricted investments (66) (30)
-------- --------
NET CASH PROVIDED BY INVESTING ACTIVITIES 8,238 22,658
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term debt 3,092 -
Payments of long-term debt (3,135) (2,666)
Stock options exercised 1,783 4,598
Excess tax benefits from stock option exercises 24 -
Treasury stock acquired - (22,511)
-------- --------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 1,764 (20,579)
-------- --------
NET DECREASE IN CASH AND CASH EQUIVALENTS (5,440) (3,417)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 21,363 4,671
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 15,923 $ 1,254
======== ========
The accompanying notes are an integral part of these unaudited consolidated
condensed financial statements.
6
REX STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
OCTOBER 31, 2006
NOTE 1. CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
The consolidated condensed financial statements included in this report
have been prepared by the Company, without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission and include, in the
opinion of management, all adjustments necessary to state fairly the information
set forth therein. Any such adjustments were of a normal recurring nature.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been omitted pursuant to such rules and
regulations, although the Company believes that the disclosures are adequate to
make the information presented not misleading. It is suggested that these
unaudited consolidated condensed financial statements be read in conjunction
with the consolidated financial statements and the notes thereto included in the
Company's Annual Report on Form 10-K for the year ended January 31, 2006 (fiscal
2005). The results of operations for the interim periods are not necessarily
indicative of the results to be expected for the year.
Basis of Consolidation - The consolidated condensed financial
statements in this report include the operating results and financial position
of REX Stores Corporation and its wholly-owned subsidiaries and all variable
interest entities where the Company has been determined to be the primary
beneficiary. Levelland/Hockley County Ethanol, LLC ("Levelland/Hockley")
qualifies as a Variable Interest Entity ("VIE"), but not a Special Purpose
Entity under FASB Interpretation No. 46R ("FIN 46R"), "Consolidation of Variable
Interest Entities". The Company is the primary beneficiary of Levelland/Hockley,
and in accordance with FIN 46R, the Company consolidated Levelland/Hockley
effective with the third quarter of fiscal 2006. The Company includes the
results of operations of Levelland/Hockley in its Consolidated Condensed
Statement of Income on a delayed basis of one fiscal quarter.
NOTE 2. RECLASSIFICATIONS
The Company reclassified $0.3 million and $0.7 million of lease income
from selling, general and administrative expenses to net sales and revenue for
the quarter and nine months ended October 31, 2005, respectively, to conform to
current year presentation. The Company reclassified $1.3 million of outstanding
checks from accounts payable to cash at January 31, 2006 to conform to current
year presentation.
NOTE 3. ACCOUNTING POLICIES
The interim consolidated condensed financial statements have been
prepared in accordance with the accounting policies described in the notes to
the consolidated financial statements included in the Company's 2005 Annual
Report on Form 10-K. While management believes that the procedures followed in
the preparation of interim financial information are reasonable, the accuracy of
some estimated amounts is dependent upon facts that will exist or calculations
that will be accomplished at fiscal year end. Examples of such estimates include
management bonuses, income
7
from synthetic fuel limited partnership sales and the provision for income
taxes. Any adjustments pursuant to such estimates during the quarter were of a
normal recurring nature. Actual results could differ from those estimates.
The following table reflects the approximate percent of net sales and
revenue for each major product group for the periods presented.
Three Months Ended Nine Months Ended
October 31 October 31
---------- ----------
Product Category 2006 2005 2006 2005
------------------ ---- ---- ---- ----
Televisions............................................... 55.1% 56.6% 53.1% 53.7%
Appliances................................................ 27.3 24.2 28.0 24.6
Audio..................................................... 5.9 7.6 7.1 9.2
Video..................................................... 3.6 4.5 3.7 4.9
Other..................................................... 8.1 7.1 8.1 7.6
----- ----- ----- -----
100.0% 100.0% 100.0% 100.0%
===== ===== ===== =====
Vendors often fund, up front, certain advertising costs and exposure to
general changes in pricing to customers due to technological change. Allowances
are deferred as received from vendors and recognized into income as an offset to
the cost of merchandise sold when the related product is sold or expense
incurred. Advertising costs are expensed as incurred.
The Company recognizes income from synthetic fuel partnership sales as
the synthetic fuel is produced and sold. The Company estimates the impact of oil
prices and the likelihood of any phase out of Section 29/45K credits and the
resulting reduction of synthetic fuel income quarterly. See Note 10 for a
further discussion of synthetic fuel partnership sales.
Cost of sales includes the cost of merchandise (net of vendor
allowances), markdowns and inventory shrink, receiving, warehousing and freight
charges to deliver merchandise to retail stores, service repair bills as well as
cash discounts and rebates. The Company classifies purchasing costs as selling,
general and administrative expenses. As a result of this classification, the
Company's gross margins may not be comparable to those of other retailers that
include costs related to their distribution network in selling, general and
administrative expense.
The Company includes stores expenses (such as payroll and occupancy
costs), advertising, purchasing, depreciation, insurance and overhead costs in
selling, general and administrative expenses.
Interest expense was $1,549,000 for the nine months ended October 31,
2006 and no interest was capitalized. Interest expense of $1,946,000 for the
nine months ended October 31, 2005 is net of approximately $15,000 of interest
capitalized. Cash paid for interest for the nine months ended October 31, 2006
and 2005 was approximately $1,483,000 and $1,907,000, respectively.
The Company applies an effective tax rate to interim periods that is
consistent with the Company's estimated annual tax rate. The Company provides
for deferred tax liabilities and assets for the future tax consequences
attributable to differences between the financial statement carrying
8
amounts of existing assets and liabilities and their respective tax basis and
operating loss and tax credit carryforwards. The Company provides for a
valuation allowance if, based on the weight of available evidence, it is more
likely than not that some or all of the deferred tax assets will not be
realized.
The Company paid income taxes of approximately $0.1 million and $4.5
million for the nine months ended October 31, 2006 and 2005, respectively.
From time to time, in advance of making an investment in debt or equity
securities of investees, such as the contingent investments the Company has in
ethanol entities, the Company may enter into a commitment for such investment
which is contingent upon future events occurring, including but not limited to,
the investee raising additional financing and/or equity. These commitments may
be backed by letters of credit or other means as mutually agreed to by the
Company and the investee. Generally, because commitments are contingently
exercisable and represent the potential acquisition of a minority position in
the investee, the Company believes that it is not the primary beneficiary of the
investee under the guidance in FASB Interpretation Number 46R ("FIN 46R"). When,
and if the commitment is exercised and the Company makes its investment, the
Company is required to re-evaluate whether the Company is the primary
beneficiary under the guidance in FIN 46R.
The method of accounting applied to long-term investments, whether
consolidated, equity or cost, involves an evaluation of the significant terms of
each investment that explicitly grant or suggest evidence of control or
influence over the operations of the investee and also includes the
identification of any variable interests in which the Company is the primary
beneficiary. See Note 4 for a further discussion of the acquisition of
Levelland/Hockley. Investments in businesses that the Company does not control,
but has the ability to exercise significant influence over operating and
financial matters, are accounted for using the equity method. An equity
investment of $5 million in Big River Resources, LLC ("Big River") is accounted
for using the equity method. The investment in Big River represents an ownership
interest of 4.3%. Big River is an Iowa limited liability company and holding
company for several entities including Big River Resources West Burlington, LLC
which presently operates a 52 million gallon ethanol manufacturing facility.
Investments in which the Company does not have the ability to exercise
significant influence over operating and financial matters are accounted for
using the cost method. All intercompany transactions between the consolidated
subsidiaries are eliminated.
Investments in debt securities are considered "held to maturity",
"available for sale", or "trading securities" under Statement of Financial
Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt
and Equity Securities ("SFAS 115".) Under SFAS 115, held to maturity securities
are required to be carried at their cost; while available-for-sale securities
are required to be carried at their fair value, with unrealized gains and
losses, net of income taxes, that are considered temporary in nature recorded in
accumulated other comprehensive income (loss) in the accompanying consolidated
condensed balance sheets. The fair values of the Company's investments in debt
securities are determined based upon market quotations and various valuation
techniques, including discounted cash flow analysis. The Company periodically
evaluates its investments in debt securities for impairment due to declines in
market value considered to be other than temporary. Such impairment evaluations
include, in addition to persistent, declining market prices, general
9
economic and company-specific evaluations. If the Company determines that a
decline in market value is other than temporary, then a charge to earnings is
recorded in investment and other income (expense), net in the accompanying
consolidated income statements for all or a portion of the unrealized loss, and
a new cost basis in the investment is established. Restricted investments of
$2.4 million, which are principally marketable debt securities of a federal
government agency, are classified as held to maturity, and are stated as cost
plus accrued interest, which approximates market.
RECENTLY ISSUED ACCOUNTING STANDARDS
In July 2006, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 48 ("FIN 48") "Accounting for Uncertainty in Income
Taxes" which prescribes a recognition threshold and measurement process for
recording in the financial statements uncertain tax positions taken or expected
to be taken in a tax return. Additionally, FIN 48 provides guidance on the
derecognition, classification, accounting in interim periods and disclosure
requirements for uncertain tax positions. The provisions of FIN 48 will be
effective for the Company beginning February 1, 2007. The Company is in the
process of determining the effect, if any, the adoption of FIN 48 will have on
its financial statements.
In September 2006, the SEC issued Staff Accounting Bulletin No. 108
("SAB 108"), "Considering the Effects of Prior Year Misstatements when
Quantifying Misstatements in Current Year Financial Statements." SAB 108
provides interpretative guidance on the process of quantifying financial
statement misstatements and is effective for fiscal years ending after November
15, 2006. The Company applied the provisions of SAB 108 in the third quarter of
fiscal 2006 and there was no impact to the financial statements.
NOTE 4. BUSINESS COMBINATIONS
On September 30, 2006, the Company acquired 47 percent of the
outstanding membership units of Levelland/Hockley County Ethanol, LLC
("Levelland/Hockley"). The results of Levelland/Hockley's operations have not
been included in the consolidated financial statements subsequent to the
acquisition date as the Company records Levelland/Hockley' results of operations
on a delayed basis of one fiscal quarter. The aggregate purchase price was $11.5
million, all of which was cash.
10
The following table summarizes the estimated fair values of the assets
acquired and liabilities assumed at the date of acquisition. The allocation of
the purchase price to the assets and liabilities of the Levelland/Hockley
acquisition is based upon preliminary estimates and is therefore subject to
change.
(In thousands)
Cash $ 13,165
Accrued interest receivable 24
Property, plant and equipment 4,046
Intangible assets 1,015
Deposits 5,220
Goodwill 726
--------
Total assets acquired 24,196
Current liabilities (577)
Minority interest (12,119)
--------
Net purchase price $ 11,500
========
The intangible assets represent prepaid loan fees and have an estimated
useful life of 6 years. None of the goodwill is expected to be deductible for
income tax purposes. Levelland/Hockley is a development stage entity that plans
to commence construction of an ethanol production facility in Levelland, Texas,
which will have a design capacity of 40 million gallons of ethanol annually. The
purchase, along with the Company's $5 million convertible secured promissory
note commitment, enables the Company to secure a majority equity interest in
Levelland/Hockley.
The unaudited financial information in the table below summarizes the
combined results of operations of the Company and Levelland/Hockley, on a pro
forma basis, as though the companies had been combined as of the beginning of
each of the periods presented. The pro forma financial information is presented
for informational purposes only and is not indicative of the results of
operations that would have been achieved if the acquisitions had taken place at
the beginning of each of the periods presented. The pro forma financial
information for all periods presented includes adjustments to interest income
and expense and related income tax effects.
(In thousands, except per share data) Quarter Ended Quarter Ended
October 31, 2006 October 31, 2005
---------------- ----------------
Net sales and revenue $ 85,215 $ 91,759
Net income $ 4,536 $ 6,790
Basic net income per share $ 0.44 $ 0.65
Diluted net income per share $ 0.39 $ 0.57
(In thousands, except per share data) Nine Months Ended Nine Months Ended
October 31, 2006 October 31, 2005
----------------- ----------------
Net sales and revenue $ 251,495 $ 259,553
Net income $ 7,321 $ 21,387
Basic net income per share $ 0.71 $ 1.97
Diluted net income per share $ 0.63 $ 1.73
11
NOTE 5. OTHER ASSETS
The components of other assets at October 31, 2006 and 2005 are as
follows (amounts in thousands):
2006 2005
---- ----
Contract deposits $5,220 $ -
Prepaid loan fees 2,057 712
Other 221 111
--- ---
Total 7,498 823
Less current portion 305 -
------ ----
Long term $7,193 $823
====== ====
Contract deposits represent amounts paid in advance for the contract to
construct the facility in which Levelland/Hockley intends to produce ethanol.
This amount will be depreciated over the estimated useful lives of the plant and
equipment, which is expected to be ten to twenty years.
Prepaid loans fees represent amounts paid to obtain both mortgage debt
and borrowings under the Company's line of credit. Such amounts are amortized as
interest expense. Future amortization expense is as follows (amounts in
thousands):
YEAR ENDED
----------
Remainder of January 31, 2007 $148
January 31, 2008 $459
January 31, 2009 $456
January 31, 2010 $342
January 31, 2011 $190
Thereafter $462
NOTE 6. LONG TERM DEBT
The Company borrowed $3.1 million by obtaining two mortgage loans
during the third quarter of fiscal 2006. One of the mortgage loans had an
original principal balance of $1.6 million bearing interest at a variable rate
of prime minus 0.25 percent (presently 8.0%) and is payable over 5 years. The
other mortgage loan had an original principal balance of $1.5 million bearing
interest at a fixed rate of 8.0% and is payable over 15 years.
NOTE 7. STOCK OPTION PLANS
The Company has stock-based compensation plans under which stock
options have been granted to directors, officers and key employees at the market
price on the date of the grant.
In December 2004, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 123 (revised
2004), SHARE-BASED PAYMENT ("SFAS
12
123(R)"), which requires the recognition of the cost of employee services
received in exchange for an award of equity instruments in the financial
statements and measurement based on the grant-date fair value of the award. It
also requires the cost to be recognized over the period during which an employee
is required to provide service in exchange for the award (presumptively the
vesting period.) SFAS 123(R) replaces SFAS No. 123, ACCOUNTING FOR STOCK-BASED
COMPENSATION, and supersedes Accounting Principles Board Opinion No. 25,
ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES ("APB25"), and its related
interpretations. The Company adopted SFAS 123(R) on February 1, 2006. The
Company chose the Modified Prospective Application ("MPA") method for
implementing SFAS 123(R). Under the MPA method, new awards, if any, are valued
and accounted for prospectively upon adoption. Outstanding prior awards that are
unvested as of February 1, 2006 will be recognized as compensation cost over the
remaining requisite service period. Prior periods have not been restated.
On May 26, 2005, the Company's Board of Directors approved accelerating
the vesting of out-of-the-money, unvested stock options held by current
employees, including non-director executive officers. An option was considered
out-of-the-money if the stated option exercise price was greater than $13.82,
which was the closing price of the Company's common stock on May 26, 2005. As a
result, options to purchase approximately 118,000 shares, including options to
purchase approximately 60,000 shares held by executive officers, became
immediately exercisable. The decision to accelerate vesting of these options was
made to avoid recognizing compensation cost in the consolidated statement of
income upon the adoption of SFAS 123(R). As a result of the acceleration, stock
option expense was reduced by approximately $542,000 ($336,000 net of tax) in
the first nine months of fiscal 2006 under the MPA.
Prior to its adoption of SFAS 123(R), the Company accounted for
stock-based compensation in compliance with APB 25, under which no compensation
cost was recognized. The Company provided disclosures based on the fair value as
permitted by SFAS 123.
In the third quarter of fiscal 2006, the adoption of SFAS 123(R)
resulted in incremental stock-based compensation expense of approximately
$363,000 ($225,000 net of tax, or $0.02 per basic and diluted share.) In the
first nine months of fiscal 2006, the adoption of SFAS 123(R) resulted in
incremental stock-based compensation expense of approximately $1,297,000
($804,000 net of tax, or $0.08 per basic and $0.07 per diluted share.) Prior to
the adoption of SFAS 123(R), the Company reported all tax benefits resulting
from the exercise of non-qualified stock options as operating cash flows in its
consolidated statements of cash flows. In accordance with SFAS 123(R), the
Company revised its current year statement of cash flows presentation to report
the excess tax benefits from the exercise of non-qualified stock options as
financing cash flows. There were approximately $24,000 of excess tax benefits
from the exercise of non-qualified stock options for the nine months ended
October 31, 2006.
SFAS 123 requires the presentation of pro forma information for the
comparative period prior to the adoption as if all of the Company's employee
stock options had been accounted under the fair value method of the original
SFAS 123.
13
Had compensation cost for all options granted been determined based on
the fair value at grant date consistent with SFAS 123, the Company's net
earnings and earnings per share would have been as follows (in thousands, except
per share amounts):
Three Months Nine Months
Ended Ended
October 31, 2005 October 31, 2005
---------------- ----------------
Net income As Reported $6,882 $21,703
Compensation Cost, net of tax 625 2,965
Pro forma 6,257 18,738
Basic net income per share As Reported $ 0.65 $2.00
Compensation Cost, net of tax 0.06 0.27
Pro forma 0.59 1.73
Diluted net income per share As Reported $ 0.58 $1.76
Compensation Cost, net of tax 0.05 0.24
Pro forma 0.53 1.52
No options have been granted since fiscal 2004. The fair values of
options granted were estimated as of the date of grant using a Black-Scholes
option pricing model with the following weighted average assumptions used for
grants in fiscal years ended January 31, 2005 and 2004, respectively: risk-free
interest rate of 4.7% and 4.3%, expected volatility of 65.4% and 65.9% and a
weighted average stock option life of nine years for all years.
The total intrinsic value of options exercised during the nine months
ended October 31, 2006 and 2005 was approximately $2.3 million and $8.2 million,
respectively, resulting in tax deductions to realize benefits of approximately
$1.0 million and $1.8 million, respectively.
14
The following table summarizes options granted, exercised and canceled
or expired during the nine months ended October 31, 2006:
Weighted Average Aggregate
Weighted Average Remaining Intrinsic Value
Shares Exercise Price Contractual Term (in thousands)
Outstanding at January 31, 2006 4,673,721 $8.15
Exercised (235,642) $7.19
Forfeited (4,200) $12.69
--------- ------
Outstanding at October 31, 2006 4,433,879 $8.20 4.0 $38,079
========= ====== === =======
Exercisable at October 31, 2006 4,094,020 $7.83 3.8 $36,672
========= ====== === =======
At October 31, 2006, there was approximately $3.2 million (pre-tax) of
unrecognized compensation cost related to nonvested stock options, which is
expected to be recognized over a weighted average period of 2.3 years.
NOTE 8. SALE AND LEASEBACK TRANSACTION
On July 28, 2006, the Company completed a transaction for the sale and
leaseback of one of its stores under an initial three-year lease term. A pre-tax
financial statement gain of $1.7 million (net of expenses) resulted from this
sale. The Company has also deferred $0.6 million, which represents the present
value of the minimum lease payments and will amortize this deferred gain as a
reduction to lease expense over the lease term. The lease has been accounted for
as an operating lease.
15
NOTE 9. INCOME PER SHARE FROM CONTINUING OPERATIONS
The following table reconciles the basic and diluted net income per
share from continuing operations computation for each period presented (in
thousands, except per share amounts):
Three Months Ended Nine Months Ended
October 31, 2006 October 31, 2006
---------------- ----------------
Per Per
Income Shares Share Income Shares Share
------ ------ ----- ------ ------ -----
Basic income per share from continuing
operations $3,622 10,333 $0.35 $6,879 10,268 $0.67
===== =====
Effect of stock options 1,184 1,340
------ ------ ------ ------
Diluted income per share from continuing
operations $3,622 11,517 $0.31 $6,540 11,608 $0.59
====== ====== ===== ====== ====== =====
Three Months Ended Nine Months Ended
October 31, 2005 October 31, 2005
---------------- ----------------
Per Per
Income Shares Share Income Shares Share
------ ------ ----- ------ ------ -----
Basic income per share from continuing
operations $7,071 10,532 $0.67 $22,126 10,850 $2.04
===== =====
Effect of stock options 1,333 1,503
------ ------ ------- ------
Diluted income per share from continuing
operations $7,071 11,865 $0.60 $22,126 12,353 $1.79
====== ====== ===== ======= ====== =====
For the three months ended October 31, 2006 and 2005, a total of
620,820 shares and 303,502 shares, respectively, and for the nine months ended
October 31, 2006 and 2005, a total of 354,820 shares and 303,502 shares,
respectively, subject to outstanding options were not included in the common
equivalent shares outstanding calculation as the effect from these shares was
antidilutive.
NOTE 10. SYNTHETIC FUEL
Income from continuing operations for the third quarter and first nine
months of fiscal 2006 includes approximately $2.8 million and $4.2 million,
respectively, of pre-tax investment income from the sales of the Company's
entire partnership interest in Colona SynFuel Limited Partnership, L.L.L.P.,
(Colona). The Company was to receive payments from the three separate sales of
its interests in Colona, on a quarterly basis through 2007, ranging from 74.25%
to 82.5% of the federal income tax credits attributable to the interest sold
subject to certain annual limitations and production levels. The Company has
agreed to accept payments for calendar year 2006 production in 2007 after the
2006 "Annual Adjustment Amount" is published by the Internal Revenue Service.
During the first quarter of fiscal 2006, the Company recorded approximately
$504,000 of income which relates to a payment received for 2005 production. The
2005 production payments were based upon estimated income tax credits per ton of
coal produced. The $504,000 payment was made to the Company after the Internal
Revenue Service published the 2005 income tax credit per ton amount in April of
2006.
16
During the first quarter of fiscal 2005, the Company recorded approximately
$448,000 of income which relates to a payment received for 2004 production. The
2004 production payments were based upon estimated income tax credits per ton of
coal produced. The $448,000 payment was made to the Company after the Internal
Revenue Service published the 2004 income tax credit per ton amount in April of
2005. The Company recognized income of approximately $121,000 in the third
quarter of fiscal 2006 that related to production occurring in the quarter. The
Company recognized income of approximately $2,712,000 in the third quarter of
fiscal 2006 that related to previously unrecognized income as a result of
changes in the Company's estimates of the phase out of Section 29/45K credits as
a result of the price of oil.
Income from continuing operations for the third quarter and first nine
months of fiscal 2006 includes approximately $2.4 million and $3.3 million,
respectively, of pre-tax investment income from the sale of the Company's entire
partnership interest in Somerset Synfuel, L.P. (Somerset), which produces
synthetic fuel. Effective October 1, 2005, the Company sold its entire ownership
interest in Somerset, which owned two synthetic fuel facilities. The Company
received $1.2 million, net of commissions, at closing along with a secured
contingent payment note that could provide additional investment income. The
Company expects to receive quarterly payments through 2007 equal to 80% of the
Section 29/45K tax credits attributable to the ownership interest sold, subject
to production levels. During the first quarter of fiscal 2006, the Company
recorded approximately $58,000 of income which relates to 2005 production. The
2005 production payments were based upon estimated income tax credits per ton of
coal produced. The $58,000 was recognized after the Internal Revenue Service
published the 2005 income tax credit per ton amount in April of 2006. The
Company recognized income of approximately $1,147,000 in the third quarter of
fiscal 2006 that related to production occurring in the quarter. The Company
recognized income of approximately $1,249,000 in the third quarter of fiscal
2006 that related to previously unrecognized income as a result of changes in
the Company's estimates of the phase out of Section 29/45K credits as a result
of the price of oil.
Income from synthetic fuel investments for the third quarter and first
nine months of fiscal 2006 also includes approximately $0.6 million and $1.1
million, respectively of pre-tax investment income from the sale of the
Company's entire membership interest in the limited liability company that owned
a synthetic fuel facility in Gillette, Wyoming. The Company received $2.8
million at the time of sale on March 30, 2004 along with a secured contingent
payment note that could provide additional income. The facility resumed
commercial operations during the second quarter of fiscal 2005; as such, the
Company received $3.5 million as a one-time payment per the terms of the
purchase agreement. In addition, the Company is eligible to receive $1.50 per
ton of "qualified production" produced by the facility and sold through 2007.
Payments for qualified production occurring after January 31, 2006 through March
31, 2006 have been placed into escrow. Subject to certain conditions, the
Company may receive certain payments placed into escrow in calendar year 2007
after information necessary to calculate any phase out of Section 29/45K credits
is published by the Department of Treasury. The Company recognized income of
approximately $635,000 in the third quarter of fiscal 2006 that related to
previously unrecognized income as a result of changes in the Company's estimates
of the phase out of Section 29/45K credits as a result of the price of oil.
During the third quarter of fiscal 2006, the Company entered into an agreement
with the owners and operators of the synthetic fuel facility. Based on the terms
of the agreement, the Company may currently not be able to determine the
likelihood of collecting payments related to production
17
occurring after September 30, 2006. Thus, the Company cannot currently determine
the impact and timing of income recognition related to production occurring
after September 30, 2006.
As provided by the current Internal Revenue Code, the Code Section
29/45K tax credit program is expected to continue through December 31, 2007;
however, recent increases in the price of oil could limit the amount of those
credits or eliminate them altogether for 2006 and 2007. This possibility is due
to a provision of Section 29/45K that provides that if the average wellhead
price per barrel for unregulated domestic crude oil for the year (the "Annual
Average Price") exceeds a certain threshold value (the "Threshold Price"), the
Section 29/45K tax credits are subject to phase out. For calendar year 2005, the
Threshold Price was $53.20 per barrel and the Phase Out Price was $66.78 per
barrel. The Threshold Price and the Phase Out Price are adjusted annually as a
result of inflation and are published by the Internal Revenue Service in April
of the following year.
The Company cannot predict with absolute certainty the Annual Average
Price for 2006 or beyond. Therefore, it cannot predict whether the price of oil
will have a material effect on its synthetic fuel business after 2005. However,
if during 2006 or 2007 oil prices remain at historically high levels or
increase, such that the Annual Average Price exceeds the Threshold Price, the
Company's synthetic fuel business may be adversely affected for those years,
and, depending on the magnitude of such increases in oil prices, the adverse
effect for those years could be material and could have an impact on the
Company's synthetic fuel results of operations. Based upon the price of oil to
date and considering the NYMEX futures market, the Company estimates the tax
credits would be subject to approximately a 40% phase out as of October 31,
2006. Because synthetic fuel is not economical to produce absent the associated
tax credits and the fact that the Company has no control or decision involvement
with production levels, the Company cannot determine the impact of possible
production reduction or elimination on the Company's financial results.
Below is a table summarizing the income from the sales, net of certain
expenses, of the Company's interests in synthetic fuel entities (in thousands):
Three Months Ended Nine Months Ended
October 31, October 31,
----------- -----------
2006 2005 2006 2005
---- ---- ---- ----
February 1, 1999 Colona sale................................ $1,130 $2,149 $1,492 $ 6,670
July 31, 2000 Colona sale................................... 902 2,058 1,457 6,079
May 31, 2001 Colona sale.................................... 802 1,829 1,296 5,403
October 1, 2005 Somerset sale............................... 2,396 1,178 3,347 1,178
March 30, 2004 Gillette sale................................ 635 1,219 1,058 5,483
------ ------ ------ -------
$5,865 $8,433 $8,650 $24,813
====== ====== ====== =======
NOTE 11. DISCONTINUED OPERATIONS AND ASSETS HELD FOR SALE
During the first nine months of fiscal 2006 the Company closed eight
stores in which the Company vacated the market or will not have a further
continuing involvement with the related property. Those stores and certain other
stores closed in
18
previous periods or scheduled to be closed in the next twelve months were
classified as discontinued operations for all periods presented. Two of the
closed stores are classified as held for sale. The net assets of those stores at
October 31, 2006 were approximately $1.5 million. The Company expects to sell
the assets related to these stores within the next 12 months through normal real
estate channels.
Below is a table reflecting certain items of the income statement that
were reclassified as discontinued operations for the period indicated.
Three Months Ended Nine Months Ended
October 31, October 31,
---------- ----------
2006 2005 2006 2005
---- ---- ---- ----
(In Thousands)
Net sales and revenue.......................................... $1,298 $3,637 $4,233 $12,157
Cost of merchandise sold ...................................... 1,138 2,759 3,490 9,183
Income (loss) before income taxes ............................. 159 (291) (258) (843)
(Provision) benefit for income taxes........................... (56) 102 90 295
Net income (loss).............................................. $103 $(189) $(168) $(548)
NOTE 12. COMMITMENTS
On November 28, 2005, the Company entered into a contingent agreement
with Levelland/Hockley to purchase a convertible secured promissory note in the
principal amount of $5 million. The proceeds of the note will be used to
capitalize Levelland/Hockley which intends to construct and, subsequently,
operate an ethanol producing facility. The facility is expected to have a design
capacity of 40 million gallons annually. The purchase of the note is expected to
occur before December 31, 2006, subject to certain conditions.
On July 27, 2006, the Company entered into a contingent agreement with
Levelland/Hockley to make an equity investment ranging from $11.5 to $18.0
million. The Company has funded $11.5 million of this commitment. The Company
may, subject to certain conditions, invest up to an additional $6.5 million.
On March 17, 2006, the Company entered into a contingent agreement to
purchase a note in the principal amount of $14 million to be issued by
Millennium Ethanol, LLC ("Millennium") which has commenced construction of an
ethanol producing facility in Marion, South Dakota. The facility is expected to
have a design capacity of 100 million gallons annually. The Company expects to
fund the note in December 2006 as all conditions necessary for the Company to
fund the note have been satisfied. The Company has obtained a $14 million
irrevocable letter of credit to secure its purchase obligation. The note
purchase agreement provides the Company rights to purchase a minority equity
interest in Millennium in exchange for the note. At October 31, 2006, the $14
million letter of credit remained outstanding.
On May 26, 2006, the Company entered into a contingent agreement to
invest $24.9 million in One Earth Energy, LLC ("One Earth") which was organized
to construct and, subsequently, operate an ethanol producing facility in Gibson
City, Illinois. The facility is expected to have a design
19
capacity of 100 million gallons annually. The equity investment is expected to
occur before June 30, 2007, subject to One Earth obtaining additional financing
and certain other conditions.
On June 8, 2006, the Company entered into a contingent agreement to
invest $16 million in Patriot Renewable Fuels, LLC ("Patriot") which has
commenced construction of an ethanol producing facility in Annawon, Illinois.
The facility is expected to have a design capacity of 100 million gallons
annually. The equity investment is expected to occur before December 31, 2006,
subject to Patriot obtaining additional financing and certain other conditions.
See Note 13 for a discussion of subsequent events affecting this commitment.
On October 1, 2006, the Company entered into an agreement to invest $20
million in Big River Resources, LLC ("Big River".) The Company has funded $5
million of this investment in exchange for a 4.3% ownership interest. The
remaining $15 million investment is expected to occur in fiscal 2007, subject to
certain conditions. The Company's final ownership percentage will be determined
once Big River has obtained all funding.
NOTE 13. SUBSEQUENT EVENTS
In November 2006, the Company entered into 12 mortgage loan agreements
to borrow approximately $10.0 million. The loans are secured by real estate,
payable over 10 years and bear interest at a fixed rate of 7.31%.
On November 29, 2006, the Company received notice that all conditions
necessary for the Company to fund $16 million in Patriot have been satisfied.
The Company funded the equity investment on December 4, 2006.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
We are a specialty retailer in the consumer electronics/appliance
industry. As of October 31, 2006 we operated 207 stores in 36 states,
predominantly in small to medium-sized markets under the trade name "REX". Over
the past eight years, we have also been active in several synthetic fuel
investments and as of October 31, 2006, we had funded two ethanol producing
entities and had contingent agreements to fund three additional ethanol
producing entities.
FISCAL YEAR
All references in this report to a particular fiscal year are to REX's
fiscal year ended January 31. For example, "fiscal 2006" means the period
February 1, 2006 to January 31, 2007.
20
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the relative
percentages that certain income and expense items bear to net sales and revenue:
Three Months Nine Months
Ended Ended
October 31 October 31
---------- ----------
2006 2005 2006 2005
---- ---- ---- ----
Net sales and revenue.......................................... 100.0% 100.0% 100.0% 100.0%
Cost of merchandise sold....................................... 73.6 72.3 72.7 71.7
----- ----- ----- -----
Gross profit................................................... 26.4 27.7 27.3 28.3
Selling, general and administrative expenses................... 27.3 26.3 27.2 26.8
----- ----- ----- -----
Operating (loss) income........................................ (0.9) 1.4 0.1 1.5
Investment income.............................................. 0.4 - 0.4 -
Interest expense............................................... (0.6) (0.7) (0.6) (0.7)
Gain on sale of real estate.................................... 0.5 0.3 0.9 0.1
Income from synthetic fuel investments......................... 6.9 9.2 3.4 9.5
----- ----- ----- -----
Income from continuing operations before provision for
income taxes and discontinued operations.................
6.3 10.2 4.2 10.4
Provision for income taxes.................................... 1.9 2.5 1.5 1.9
----- ----- ----- -----
Income from continuing operations.............................. 4.4 7.7 2.7 8.5
Loss from discontinued operations, net of tax.................. - (0.2) - (0.2)
Gain on disposal of discontinued operations, net of tax 1.3 - 0.4 0.1
----- ----- ----- -----
Net income..................................................... 5.7% 7.5% 3.1% 8.4%
===== ===== ===== =====
COMPARISON OF THREE MONTHS AND NINE MONTHS ENDED OCTOBER 31, 2006 AND 2005
Net sales and revenue in the quarter ended October 31, 2006 were $85.2
million compared to $91.8 million in the prior year's third quarter,
representing a decrease of $6.6 million or 7.2%. Net sales and revenue do not
include sales from stores classified in discontinued operations.
This decrease was primarily caused by a decrease in comparable store
sales of 5.6% for the third quarter of fiscal 2006, which accounted for
approximately $3.4 million of the decrease. We consider a store to be comparable
after it has been open six full fiscal quarters. Comparable store sales do not
include sales of extended service contracts. In addition, the decrease was
caused by a net reduction of 19 stores (11 of which were classified as
discontinued operations) since the end of the third quarter of fiscal 2005. The
reduction in stores accounted for approximately $3.2 million of the decrease.
Our strongest product category for the third quarter of fiscal 2006 was
the appliance category which positively impacted comparable store sales by 1.7%.
This increase is primarily related to an increased promotional effort and an
increase in the breadth of products offered. The television
21
category negatively impacted comparable store sales by 3.8%. We continue to
experience growth in LCD and plasma sets, however, the growth was offset by
declines in other television sets. The audio category negatively impacted
comparable store sales by 1.7%. The video category negatively impacted
comparable store sales by 1.0%. Both the audio and video categories have been
impacted by lower price points of their respective products, as these products
are becoming more of a commodity item with very high levels of competition.
Net sales and revenue for the first nine months of fiscal 2006 were
$251.5 million compared to $259.6 million for the first nine months of fiscal
2005. This represents a decrease of $8.1 million or 3.1%. This decrease was
primarily caused by a net reduction of 19 stores (11 of which were classified as
discontinued operations) since the end of the third quarter of fiscal 2005. The
reduction in stores accounted for approximately $8.0 million of the decrease.
This decrease was also caused by a decrease in comparable store sales of 0.7%
for the first nine months of fiscal 2006.
The appliance category positively impacted comparable store sales for
the first nine months of fiscal 2006 by 3.7%. The appliance category increase is
primarily related to an increased promotional effort and an increase in the
breadth of products offered. The television, audio and video categories
negatively impacted comparable store sales for the first nine months of fiscal
2006 by 0.6%, 2.2% and 1.3%, respectively. We experienced growth in LCD and
plasma sets, however, the growth was offset by declines in other television
sets. Both the audio and video categories reflect a continuing trend of lower
price points of the respective products, as these products are becoming more of
a commodity item with very high levels of competition.
The following table reflects the approximate percent of net sales and
revenue for each major product group for the periods presented.
Three Months Ended Nine Months Ended
October 31 October 31
---------- ----------
Product Category 2006 2005 2006 2005
------------------ ---- ---- ---- ----
Televisions.................................... 55.1% 56.6% 53.1% 53.7%
Appliances..................................... 27.3 24.2 28.0 24.6
Audio.......................................... 5.9 7.6 7.1 9.2
Video.......................................... 3.6 4.5 3.7 4.9
Other.......................................... 8.1 7.1 8.1 7.6
----- ----- ----- -----
100.0% 100.0% 100.0% 100.0%
===== ===== ===== =====
As of October 31, 2006, we operated 207 stores compared to 226 stores
one year earlier. We did not open any stores and closed 11 stores during the
first nine months of fiscal 2006. Of the 11 stores closed, we have lease
agreements, as landlord, for four of the locations. We abandoned three of the
stores upon the expiration of our lease as lessee and sold four of the stores we
owned. We did not open any stores and closed eight stores during the first nine
months of fiscal 2005.
At October 31, 2006, we had lease agreements, as landlord/sub landlord,
for all or parts of 24 properties. We own 21 of these properties and are the
tenant/sub landlord for three of the properties. In eight of the owned
locations, we operate a store and lease a portion of the property to another
party.
22
We do not operate a store in 13 of the owned properties. We have two owned
properties that are vacant and classified as assets held for sale at October 31,
2006.
Gross profit of $22.5 million (26.4% of net sales and revenue) in the
third quarter of fiscal 2006 was approximately $2.9 million lower than the $25.4
million (27.7% of net sales and revenue) recorded in the third quarter of fiscal
2005. Gross profit for the first nine months of fiscal 2006 was $68.8 million
(27.3% of net sales and revenue) compared to $73.4 million (28.3% of net sales
and revenue) for the first nine months of fiscal 2005. Gross profit margin for
the third quarter and first nine months of fiscal 2006 was negatively impacted
by approximately $0.7 million and $1.9 million, respectively, as a result of
having 19 net fewer stores compared to the prior year. Gross profit margin for
the third quarter and first nine months of fiscal 2006 was negatively impacted
by a change in product mix, a competitive market environment, and a focused
effort to sell slow moving or aged inventory.
Selling, general and administrative expenses for the third quarter of
fiscal 2006 were $23.3 million (27.3% of net sales and revenue), a decrease of
$0.8 million or 3.3% from $24.1 million (26.3% of net sales and revenue) for the
third quarter of fiscal 2005. Selling, general and administrative expenses were
$68.5 million (27.2% of net sales and revenue) for the first nine months of
fiscal 2006 representing a decrease of $1.1 million or 1.6% from $69.6 million
(26.8% of net sales and revenue) for the first nine months of fiscal 2005. The
decrease in expenditures was primarily a result of lower advertising
expenditures. These decreases were partially offset by an increase in payroll
costs associated with higher commissions paid to sales personnel. In addition,
we recognized stock based compensation expense in the third quarter and first
nine months of fiscal 2006 of $0.4 million and $1.3 million, respectively as we
adopted SFAS 123(R) during the first quarter of fiscal 2006.
Operating loss in the third quarter of fiscal 2006 was $0.8 million
(0.9% of net sales and revenue), a decrease of $2.1 million (161.5%) from
operating income of $1.3 million (1.4% of net sales and revenue) for the third
quarter of fiscal 2005. Operating income in the first nine months of fiscal 2006
was $0.3 million (0.1% of net sales and revenue), a decrease of $3.5 million
(92.1%) from the $3.8 million (1.5% of net sales and revenue) for the first nine
months of fiscal 2005.
Investment income was $341,000 and $23,000 for the third quarter of
fiscal 2006 and 2005, respectively. Investment income for the first nine months
of fiscal 2006 was $920,000 compared to $155,000 for the first nine months of
fiscal 2005. A majority of the increase in investment income results from higher
levels of excess cash invested and higher interest rates during fiscal 2006 as
compared to fiscal 2005.
Interest expense was $0.6 million (0.6% of net sales and revenue) for
the third quarter of fiscal 2006 compared to $0.7 million (0.7% of net sales and
revenue) for the third quarter of fiscal 2005. Interest expense was $1.5 million
(0.6% of net sales and revenue) for the first nine months of fiscal 2006
compared to $1.9 million (0.7% of net sales and revenue) for the first nine
months of fiscal 2005. Interest expense for the current year has been lowered
primarily due to lower average borrowings on the line of credit.
23
We sold one property, classified in continuing operations, during the
third quarter of fiscal 2006 for a gain of $0.5 million. In addition, during the
nine months ended October 31, 2006, we executed a sale and leaseback agreement
for one owned property for a gain of approximately $1.7 million. During the
third quarter and nine months ended October 31, 2005, we sold one parcel of land
attached to an owned property for a gain of approximately $0.3 million.
Results for the third quarter and first nine months of fiscal 2006
include approximately $2.8 million and $4.2 million, respectively, from the
sales of our investment in Colona SynFuel Limited Partnership, L.L.L.P.
(Colona), which produces synthetic fuel. We sold our ownership interest in the
Colona limited partnership through a series of three sales. We were to receive
payments from the sales of our interests in Colona, on a quarterly basis through
2007, ranging from 74.25% to 82.5% of the federal income tax credits
attributable to the interest sold subject to certain annual limitations and
production levels. We have agreed to accept payments for calendar year 2006
production in 2007 after the 2006 "Annual Adjustment Amount" is published by the
Internal Revenue Service. During the first quarter of fiscal 2006, we recorded
approximately $504,000 of income which relates to a payment received for 2005
production. The 2005 production payments were based upon estimated income tax
credits per ton of coal produced. The $504,000 payment was made to us after the
Internal Revenue Service published the 2005 income tax credit per ton amount in
April of 2006. During the first quarter of fiscal 2005, we recorded
approximately $448,000 of income which relates to a payment received for 2004
production. The 2004 production payments were based upon estimated income tax
credits per ton of coal produced. The $448,000 payment was made to us after the
Internal Revenue Service published the 2004 income tax credit per ton amount in
April of 2005. We recognized income of approximately $121,000 in the third
quarter of fiscal 2006 that related to production occurring in the quarter. We
recognized income of approximately $2,712,000 in the third quarter of fiscal
2006 that related to previously unrecognized income as a result of changes in
our estimates of the phase out of Section 29/45K credits as a result of the
price of oil.
Results for the third quarter and first nine months of fiscal 2006
include approximately $2.4 million and $3.3 million, respectively, from the sale
of our investment in Somerset SynFuel L.P. (Somerset), which produces synthetic
fuel. Effective October 1, 2005, we sold our entire ownership interest in
Somerset, which owned two synthetic fuel facilities. We received $1.2 million,
net of commissions, at closing along with a secured contingent payment note that
could provide additional investment income. We expect to receive quarterly
payments through 2007 equal to 80% of the Section 29/45K tax credits
attributable to the ownership interest sold, subject to production levels.
During the first quarter of fiscal 2006, we recorded approximately $58,000 of
income which relates to 2005 production. The 2005 production payments were based
upon estimated income tax credits per ton of coal produced. The $58,000 was
recognized after the Internal Revenue Service published the 2005 income tax
credit per ton amount in April of 2006. We recognized income of approximately
$1,147,000 in the third quarter of fiscal 2006 that related to production
occurring in the quarter. We recognized income of approximately $1,249,000 in
the third quarter of fiscal 2006 that related to previously unrecognized income
as a result of changes in our estimates of the phase out of Section 29/45K
credits as a result of the price of oil.
Income from synthetic fuel investments for the third quarter and first
nine months of fiscal 2006 also includes approximately $0.6 million and $1.1
million, respectively of pre-tax investment income from the sale of our entire
membership interest in the limited liability company that owned a
24
synthetic fuel facility in Gillette, Wyoming. We received $2.8 million at the
time of sale on March 30, 2004 along with a secured contingent payment note that
could provide additional investment income to us. The facility resumed
commercial operations during the second quarter of fiscal 2005; as such, we
received $3.5 million as a one-time payment per the terms of the purchase
agreement. In addition, we are eligible to receive $1.50 per ton of "qualified
production" produced by the facility and sold through 2007. Payments for
qualified production occurring after January 31, 2006 through March 31, 2006
have been placed into escrow. Subject to certain conditions, we will receive any
payments placed into escrow in calendar year 2007 after information necessary to
calculate any phase out of Section 29/45K credits is published by the Department
of Treasury. We recognized income of approximately $635,000 in the third quarter
of fiscal 2006 that related to previously unrecognized income as a result of
changes in our estimates of the phase out of Section 29/45K credits as a result
of the price of oil. During the third quarter of fiscal 2006, we entered into an
agreement with the owners and operators of the synthetic fuel facility. Based on
the terms of the agreement, including the timing of the receipt of payments, we
may not be able to currently determine the likelihood of collecting payments
related to production occurring after September 30, 2006. Thus, we cannot
currently determine the impact and timing of the receipt of payments and income
recognition related to production occurring after September 30, 2006.
As provided by the current Internal Revenue Code, the Code Section
29/45K tax credit program is expected to continue through December 31, 2007;
however, recent increases in the price of oil could limit the amount of those
credits or eliminate them altogether for 2006 and 2007. This possibility is due
to a provision of Section 29/45K that provides that if the average wellhead
price per barrel for unregulated domestic crude oil for the year (the "Annual
Average Price") exceeds a certain threshold value (the "Threshold Price"), the
Section 29/45K tax credits are subject to phase out. For calendar year 2005, the
Threshold Price was $53.20 per barrel and the Phase Out Price was $66.78 per
barrel. The Threshold Price and the Phase Out Price are adjusted annually as a
result of inflation and are published by the Internal Revenue Service in April
of the following year.
We cannot predict with absolute certainty the Annual Average Price for
2006 or beyond. Therefore, we cannot predict whether the price of oil will have
a material effect on our synthetic fuel business after 2005. However, if during
2006 or 2007, oil prices remain at historically high levels or increase, such
that the Annual Average Price exceeds the Threshold Price, our synthetic fuel
business may be adversely affected for those years, and, depending on the
magnitude of such increases in oil prices, the adverse affect for those years
could be material and could have an impact on our synthetic fuel results of
operations. Based upon the price of oil to date and considering the NYMEX
futures market, we estimate the tax credits would be subject to approximately a
40% phase out as of October 31, 2006. Because synthetic fuel is not economical
to produce absent the associated tax credits and the fact that we have no
control or decision involvement with production levels, we cannot determine the
impact of possible production reduction or elimination on our financial results.
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Below is a table summarizing the income from the sales, net of certain
expenses, of our interests in synthetic fuel entities (in thousands):
Three Months Ended Nine Months Ended
October 31 October 31
---------- ----------
2006 2005 2006 2005
---- ---- ---- ----
February 1, 1999 Colona sale................................ $1,130 $2,149 $1,492 $ 6,670
July 31, 2000 Colona sale................................... 902 2,058 1,457 6,079
May 31, 2001 Colona sale.................................... 802 1,829 1,296 5,403
October 1, 2005 Somerset sale............................... 2,396 1,178 3,347 1,178
March 30, 2004 Gillette sale................................ 635 1,219 1,058 5,483
------ ------ ------ -------
$5,865 $8,433 $8,650 $24,813
====== ====== ====== =======
Our effective tax rate was 32.1% and 24.1% for the third quarter of
fiscal 2006 and 2005, respectively, after reflecting our share of federal income
tax credits earned during 2005 by the limited partnerships under Section 29/45K
of the Internal Revenue Code. Our effective tax rate was 34.5% and 18.4% for the
first nine months of fiscal 2006 and 2005, respectively, after reflecting our
share of federal income tax credits earned during 2005 by the limited
partnerships under Section 29/45K of the Internal Revenue Code. As we no longer
earn federal income tax credits from synthetic fuel production, we expect our
tax rate in fiscal 2006 to be in the range of 32% to 40%.
During the quarter and nine months ended October 31, 2006 we closed or
committed to close four and eight stores, respectively, that were classified as
discontinued operations. As a result of these closings and certain other store
closings from prior periods, we had income from discontinued operations, net of
tax, of $0.1 million for the third quarter of fiscal 2006, compared to a loss of
$0.2 million for the third quarter of fiscal 2005. We had a loss from
discontinued operations, net of tax benefit, of $0.2 million for the first nine
months of fiscal 2006 compared to $0.5 million for the first nine months of
fiscal 2005.
We sold six properties, classified in discontinued operations, during
the third quarter and first nine months of fiscal 2006 resulting in a gain, net
of tax expense, of $1.1 million.
As a result of the foregoing, net income for the third quarter of
fiscal 2006 was $4.8 million, a 30.4% decrease from $6.9 million for the third
quarter of fiscal 2005. Net income for the first nine months of fiscal 2006 was
$7.8 million, a 64.1% decrease from $21.7 million for the first nine months of
fiscal 2005.
26
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities was approximately $15.4 million
for the first nine months of fiscal 2006, compared to $5.5 million used in
operating activities for the first nine months of fiscal 2005.
For the first nine months of fiscal 2006, cash was provided by net
income of $7.8 million, adjusted for the impact of $8.7 million for gains on our
installment sales of the limited partnership interests, non-cash items of $2.4
million, which consisted of depreciation and amortization, stock based
compensation expense, impairment charges, deferred income, gain on disposal of
fixed assets, and the deferred income tax provision. In addition, accounts
payable provided cash of $2.2 million, primarily a result of the timing of
vendor payments. The primary use of cash was an increase in inventory of $18.7
million primarily due to seasonal fluctuations. The inventory decline from
October 31, 2005 primarily results from lower television and audio levels.
For the first nine months of fiscal 2005, cash was provided by net
income of $21.7 million, adjusted for the impact of $24.8 million for gains on
our installment sales of the limited partnership interests, non-cash items of
$3.8 million, which consisted of depreciation and amortization, accounts
receivable, deferred income, prepaid expenses and loss on disposal of fixed
assets. In addition, accounts payable provided cash of $6.1 million, primarily a
result of changes in inventory levels. The primary use of cash was an increase
in inventory of $11.0 million primarily due to seasonal fluctuations. The other
use of cash was a decrease in other current liabilities of $1.2 million.
At October 31, 2006, working capital was $105.7 million compared to
$88.0 million at January 31, 2006. This increase is primarily a result of
inventory level fluctuations and synthetic fuel receivables. The ratio of
current assets to current liabilities was 3.2 to 1 at October 31, 2006 and 2.9
to 1 at January 31, 2006.
Cash of $8.2 million was provided by investing activities for the first
nine months of fiscal 2006, compared to cash provided by investing activities of
$22.7 million for the first nine months of fiscal 2005. We paid $5.0 million for
an equity investment in Big River and received proceeds of $9.3 million from the
sale of real estate and fixed assets during the first nine months of fiscal
2006. The acquisition and resulting consolidation of Levelland/Hockley provided
cash of $1.7 million as Levelland Hockley's cash balance of $13.2 million
exceeded the purchase price of $11.5 million. Additionally, during the first
nine months of fiscal 2006, we received proceeds of $2.7 million from
installment sales of our ownership interests in synthetic fuel entities. We had
capital expenditures of approximately $0.4 million during the first nine months
of fiscal 2006, primarily related to improvements at selected stores.
During the first nine months of fiscal 2005, we received proceeds of
approximately $23.6 million from installment sales of our ownership interest in
the synthetic fuel entities. We had capital expenditures of approximately $2.4
million during the first nine months of fiscal 2005, primarily related to the
relocation of a store, the purchase of a store previously leased and
improvements to a distribution center. We received proceeds of approximately
$1.5 million from the sale of a store previously closed and reported as
discontinued operations and the sale of one parcel of land attached to an owned
property.
27
Cash provided by financing activities totaled approximately $1.8
million for the first nine months of fiscal 2006 compared to cash used in
financing activities of $20.6 million for the first nine months of fiscal 2005.
Cash was provided by stock option activity of $1.8 million. We also recorded a
tax benefit of approximately $1.0 million during the first nine months of fiscal
2006 from the exercise of non-qualified stock options as an increase in
additional paid-in capital. Cash of $3.1 million was used for scheduled payments
of mortgage debt and cash of $3.1 million was provided by new borrowings.
Cash used in financing activities totaled approximately $20.6 million
for the first nine months of fiscal 2005. Cash was provided by stock option
activity of $4.6 million. We also recorded a tax benefit of approximately $1.8
million during the first nine months of fiscal 2005 from the exercise of
non-qualified stock options as an increase in additional paid-in capital. Cash
of $2.7 million was used for scheduled payments of mortgage debt. Cash of
approximately $22.5 million was also used to acquire approximately 1.6 million
shares of our common stock.
On November 28, 2005, we entered into a contingent agreement with
Levelland/Hockley to purchase a convertible secured promissory note in the
principal amount of $5 million. The proceeds of the note will be used to
capitalize Levelland/Hockley which intends to construct and, subsequently,
operate an ethanol producing facility. The facility is expected to have a design
capacity of 40 million gallons annually. The purchase of the note is expected to
occur before December 31, 2006, subject to certain conditions.
On July 27, 2006, we entered into a contingent agreement with
Levelland/Hockley to make an equity investment ranging from $11.5 to $18.0
million. We have funded $11.5 million of this commitment. We may, subject to
certain conditions, fund up to an additional $6.5 million.
On March 17, 2006, we entered into a contingent agreement to purchase a
note in the principal amount of $14 million to be issued by Millennium Ethanol,
LLC ("Millennium") which has commenced construction of an ethanol producing
facility in Marion, South Dakota. The facility is expected to have a design
capacity of 100 million gallons annually. We expect to fund the note in December
2006 as all conditions necessary for us to fund the note have been satisfied. We
have obtained a $14 million irrevocable letter of credit to secure our purchase
obligation. The note purchase agreement provides us rights to purchase a
minority equity interest in Millennium in exchange for the note. At October 31,
2006, the $14 million letter of credit remained outstanding.
On May 26, 2006, we entered into a contingent agreement to invest $24.9
million in One Earth Energy, LLC ("One Earth") which was organized to construct
and, subsequently, operate an ethanol producing facility in Gibson City,
Illinois. The facility is expected to have a design capacity of 100 million
gallons annually. The equity investment is expected to occur before June 30,
2007, subject to One Earth obtaining additional financing and certain other
conditions.
On June 8, 2006, we entered into a contingent agreement to invest $16
million in Patriot Renewable Fuels, LLC ("Patriot") which has commenced
construction of an ethanol producing facility in Annawon, Illinois. The facility
is expected to have a design capacity of 100 million gallons annually. We funded
this equity investment on December 4, 2006.
28
On October 1, 2006, we entered into a contingent agreement to invest
$20 million in Big River Resources, LLC ("Big River".) We have funded $5 million
of this investment in exchange for a 4.3% ownership interest. The remaining $15
million investment is expected to occur in fiscal 2007, subject to certain
conditions. Our final ownership percentage will be determined once Big River has
obtained all funding.
We believe we have sufficient resources to fund these and other
potential ethanol investments. However, depending upon the timing of these
ethanol investments and future results of retail operations and synthetic fuel
investments, we may incur increased borrowings, and a corresponding increase in
interest expense, or seek other sources of financing.
In November 2006, we entered into 12 mortgage loan agreements to borrow
approximately $10.0 million. The loans are secured by real estate, payable over
10 years and bear interest at a fixed rate of 7.31%.
FORWARD-LOOKING STATEMENTS
This Form 10-Q contains or may contain forward-looking statements as
defined in the Private Securities Litigation Reform Act of 1995. The words
"believes", "estimates", "plans", "expects", "intends", "anticipates" and
similar expressions as they relate to the Company or its management are intended
to identify such forward-looking statements. Forward-looking statements are
inherently subject to risks and uncertainties. These risks and uncertainties
include among other things: the highly competitive nature of the consumer
electronics retailing industry, changes in the national or regional economies,
weather, the effects of terrorism or acts of war on consumer spending patterns,
the availability of certain products, technological changes, new regulatory
restrictions or tax law changes relating to the Company's synthetic fuel
investments, the fluctuating amount of quarterly payments received by the
Company with respect to sales of its partnership interests in synthetic fuel
investments, the uncertain amount of synthetic fuel production and resulting
income received from time to time from the Company's synthetic fuel investments,
and the potential for Section 29/45K tax credits to phase out based on the price
of crude oil adjusted for inflation. As it relates to ethanol investments, risks
and uncertainties include among other things: the uncertainty of constructing
plants on time and on budget and the volatility of corn, dried distiller grains,
ethanol, gasoline and natural gas prices. Other factors that could cause actual
results to differ materially from those in the forward-looking statements are
set forth in Item 1A of the Company's Annual Report on Form 10-K for the fiscal
year ended January 31, 2006 (File No. 001-09097).
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
No material changes since January 31, 2006.
ITEM 4. CONTROLS AND PROCEDURES
Our management evaluated, with the participation of our Chief Executive
Officer and Chief Financial Officer, the effectiveness of our disclosure
controls and procedures, as of the end of the period covered by this report.
Based on that evaluation, the Chief Executive Officer and Chief
29
Financial Officer concluded that our disclosure controls and procedures are
effective to ensure that information required to be disclosed by us in the
reports that we file or submit under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commission's rules and forms and designed to
ensure that information required to be disclosed in the reports that we file or
submit under the Act is accumulated and communicated to our management,
including our Chief Executive Officer and Chief Financial Officer, as
appropriate to allow timely decisions regarding required disclosure.
There were no changes in our internal control over financial reporting
that occurred during our last fiscal quarter that have materially affected, or
are reasonably likely to materially affect, our internal control over financial
reporting.
We acquired Levelland/Hockley County Ethanol, LLC on September 30,
2006. Levelland/Hockley is a development stage entity that plans to commence
construction of an ethanol production facility in Levelland, Texas. It is a
separate control environment. We have excluded this business from management's
evaluation of internal control over financial reporting, as permitted by the
SEC, for the quarter ended October 31, 2006.
PART II. OTHER INFORMATION
ITEM 1A. RISK FACTORS
During the quarter and nine months ended October 31, 2006, there have
been no material changes to the risk factors discussed in our Annual Report on
Form 10-K for the year ended January 31, 2006.
ITEM 6. EXHIBITS.
The following exhibits are filed with this report:
4(a) Fourth Amendment to Amended and Restated Loan Agreement
dated as of August 18, 2006 among the Borrowers, REX
Stores Corporation, the Lenders named therein, Bank of
America, N.A. (f/k/a Fleet Retail Group, Inc.) as agent
for the Lenders and KeyBank National Association as
syndication agent
31 Rule 13a-14(a)/15d-14(a) Certifications
32 Section 1350 Certifications
30
SIGNATURES
Pursuant to the requirements 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.
REX STORES CORPORATION
Registrant
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Stuart A. Rose Chairman of the Board December 8, 2006
------------------ (Chief Executive Officer)
(Stuart A. Rose)
/s/ Douglas L. Bruggeman Vice President, Finance and Treasurer December 8, 2006
------------------------ (Chief Financial Officer)
(Douglas L. Bruggeman)
31