| REX STORES CORP Item 1A Risk Factors We encourage you to carefully consider the risks described below and other information contained in this document when considering an investment decision in REX common stock |
| Additional risks and uncertainties not presently known to management, or that management currently deems immaterial, may also impair our business operations |
| Any of the events discussed in the risk factors below may occur |
| If one or more of these events do occur, our results of operations, financial condition or cash flows could be materially adversely affected |
| In this instance, the trading price of REX stock could decline, and investors might lose all or part of their investment |
| We face significant competition from other retailers many of whom have greater financial resources |
| This could result in a decline of our sales and profitability |
| We face significant competition from a diverse group of retailers |
| Our competitors include national and regional large format merchandisers and superstores such as Best Buy Co, Inc, Lowes Corporation, Home Depot, Inc |
| and Circuit City Stores, Inc, other specialty electronics retailers including RadioShack Corporation, department and discount stores such as Sears, Roebuck and Co |
| and Wal-Mart Stores, Inc, furniture stores, warehouse clubs, home improvement retailers and Internet and store-based retailers who sell consumer electronics and home appliance products online |
| We also compete with small chains and specialty single-store operators in some markets, as well as Sears’ dealer-operated units |
| Some of our competitors have greater financial resources than us, which may increase their ability to purchase inventory at a lower cost, better withstand economic downturns or engage in aggressive price competition |
| We expect competition within the consumer electronics/appliance retailing industry to increase |
| National merchandisers are expanding their geographic markets and entering markets traditionally served by us |
| In the event that competitors enter markets we serve, we may experience pricing pressures, reduced gross margins and declines in same store sales |
| We may be unable to open new stores and any newly opened stores may not be profitable |
| While we did not open any new stores in fiscal 2005 or 2004, we may open new stores from time to time in the future |
| Several factors could affect our ability to open new stores or could adversely impact new store sales and profitability |
| These factors include: • identifying new geographic markets in which we can successfully compete; • identifying and acquiring or leasing suitable new store sites at an acceptable cost; • obtaining governmental and other third-party consents, permits and licenses needed to operate new stores; • securing favorable economic terms for newspaper, television and radio advertising; • hiring, promoting and training qualified personnel, including new store managers; • integrating new stores into our existing operations; • adapting our existing information systems and distribution infrastructure to a growing number of stores; and • having adequate financial resources available to us |
| 11 _________________________________________________________________ To execute a store expansion program, we may need to expend significant effort and additional managerial and financial resources to ensure the continuing adequacy of our financial controls, operating procedures, information systems, product purchasing and distribution systems and employee training programs |
| A decline in economic conditions could lead to reduced consumer demand for the products we sell |
| Demand for consumer electronics and home appliance products is dependent upon various economic factors outside of our control |
| These factors include: • general economic conditions; • consumer confidence; • consumer spending patterns and preferences; and • new housing starts |
| A slowdown in the national or regional economies or an uncertain economic outlook could adversely affect discretionary consumer spending habits and negatively impact our sales and operating results |
| If new products are not introduced or consumers do not accept new products, our sales may decline |
| We rely upon the periodic introduction of new products to help stimulate consumer demand |
| The lack of new products could reduce consumer interest and lower our sales |
| In addition, many products which incorporate the newest technologies, such as high definition television, are subject to technological and pricing limitations and may not achieve widespread or rapid consumer acceptance in the markets we serve |
| If these new products do not meet with widespread or rapid market acceptance, our results of operations may be impaired |
| Furthermore, the introduction or expected introduction of new products may depress sales of existing products and technologies |
| Government mandates for such areas as high definition TV tuners can increase production costs and lead to higher retail prices that could reduce product acceptance |
| Other mandates include the Department of Energy compliance mandates for major appliances that will be in effect in 2007 |
| This could also lead to higher retail prices and a slowdown in overall product demand |
| If we do not adequately anticipate and respond to changing consumer demand and preferences, our results of operations may be impaired |
| Our success depends, in part, on our ability to anticipate and respond in a timely manner to changing consumer demand and preferences regarding consumer electronics and home appliances |
| Our failure to adequately anticipate and respond to these changes could have a material adverse effect on our business, results of operation and financial condition either from lost sales or lower margins due to the need to mark down excess inventory |
| When available, we may purchase large quantities of merchandise on an opportunistic or when-available basis at favorable prices |
| Our inability to find suitable opportunistic product buying opportunities could negatively impact our sales and gross margins |
| As manufacturers move to more market-driven, supply chain management strategies, the opportunities for opportunistic purchases may decline |
| Products purchased on an opportunistic basis generally are held in inventory longer than our other products |
| This can result in increased inventory levels and lower inventory turnover, which increase our working capital requirements and inventory carrying costs |
| Increased inventory levels and lower turnover rates also increase the risk of inventory mark-downs |
| The introduction of digitally-based display products such as plasma, LCD and other micro display products has shortened product life cycles and introduced a higher degree of risk for opportunistic buying |
| Given the rate of change of technology and price levels, opportunity costs for purchasing in large quantities can be offset by the obsolescence risk of holding merchandise that may have to be deeply discounted to consumers |
| Income and tax credits from our investments in facilities producing synthetic fuel have contributed significantly to our operating and net income in past years but will not continue after December 31, 2007 |
| In fiscal 1998, we invested in two limited partnerships, Colona Synfuel Limited Partnership, LLLP (Colona) and Somerset Synfuel, LP (Somerset), which own facilities producing synthetic fuel |
| In fiscal 2002, we purchased a plant located in Gillette, Wyoming (Gillette) designed and constructed for the production of synthetic fuel |
| The entities earn federal income tax credits under Section 29/45K of the Internal Revenue Code based on the quantity and content of synthetic fuel production and sales |
| We sold our interest in the Colona partnership in three separate sale transactions and expect to receive cash payments from the sales on a quarterly basis through 2007, subject to production levels |
| We reported income from the sales of approximately dlra22dtta8 million and dlra18dtta1 million in fiscal 2005 and 2004, respectively, which accounted for approximately 63prca and 84prca of our income from continuing operations before income taxes in those years |
| We also sold our interest in the limited liability company that owned the Gillette facility and received dlra2dtta75 million at the time of the sale in March 2004 along with a secured contingent payment note that could provide additional investment income to us |
| The facility resumed commercial operations in the second quarter of 2005 and we received an additional dlra3dtta5 million |
| We are also eligible to receive dlra1dtta50 per ton of “qualified production” fuel produced by the facility and sold through 2007 |
| The loss of this income would significantly reduce our net income |
| Effective October 1, 2005, we sold our entire ownership interest in the Somerset partnership |
| We received dlra1dtta2 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 80prca of the Section 29/45K tax credits attributable to the ownership interest sold, subject to production levels |
| The current Section 29/45K tax credit program expires on December 31, 2007 |
| If not renewed by Congress, we will not receive income related to Section 29/45K tax credits for the production and sale of synthetic fuel after that date |
| 13 _________________________________________________________________ The Permanent Subcommittee on Investigations of the US Senate’s Committee on Government Affairs initiated an investigation on the subject of Section 29/45K tax credits in October 2003 |
| We cannot determine the outcome of this matter or its impact on the Section 29/45K tax credit program |
| We face synthetic fuel risks as future IRS audits may result in the disallowance of previously recognized tax credits |
| We have been allocated in total approximately dlra47dtta7 million in Section 29/45K credits |
| Should the tax credits be denied on any future audit and we fail to prevail through the Internal Revenue Service (IRS) or the legal process, there could be a significant tax liability owed for previously taken tax credits with a significant adverse impact on earnings and cash flows |
| The production and sale of synthetic fuel qualifies for Section 29/45K tax credits if certain requirements are satisfied, including a requirement that the synthetic fuel differs significantly in chemical composition from the coal used to produce the synthetic fuel and that the fuel was produced from a facility placed in service before July 1, 1998 |
| We face synthetic fuel risks associated with crude oil prices as our income could decrease significantly |
| Recent increases in the price of oil could limit the amount of Section 29/45K tax credits or eliminate them altogether for one or more years following fiscal 2005 |
| Section 29/45K 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 dlra53dtta20 per barrel and the Phase Out Price was dlra66dtta78 per barrel |
| The Threshold Price and the Phase Out Price are adjusted annually as a result of inflation |
| We cannot determine the Annual Average Price for 2006 or beyond |
| Therefore, we cannot determine whether the price of oil will have a material effect on our synthetic fuel business after fiscal 2005 |
| However, if during fiscals 2006 and 2007, oil prices remain at historically high levels or increase, our synthetic fuel business may be adversely affected for those years and, depending on the magnitude of the 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 and related income tax benefits |
| Based upon the price of oil to date, we estimate the tax credits, for calendar 2006, would be subject to approximately a 35prca phase out as of January 31, 2006 |
| Proposed federal legislation would establish both the 2006 Annual Average Price and 2006 Phase Out Price based on the previous calendar year |
| If the proposed legislation becomes law, we do not anticipate that we will reach the minimum phase-out levels in 2006 |
| Because synthetic fuel is not economical to produce absent the associated tax credits, and 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 |
| We may not be able to generate sufficient taxable income to realize our deferred tax assets |
| We have approximately dlra39dtta3 million of deferred tax assets recorded on our consolidated financial statements |
| Should future results of operations or other factors cause us to determine that it is unlikely that we will generate sufficient taxable income to fully utilize our deferred tax assets, we would then be required to establish a valuation allowance against such deferred tax assets by increasing our income tax expense in the amount of tax benefit we do not expect to realize |
| This would reduce our net income and could have a material adverse effect on our results of operations |
| 14 _________________________________________________________________ We may realize capital losses related to our sales of synthetic fuel ownership interests |
| We have, for income tax purposes, recognized capital gain in the year of sale for certain sales of our ownership interests in synthetic fuel entities |
| Should we, in subsequent years, realize a capital loss as a result of lower synthetic fuel production, for income tax purposes, we may be required to carry the loss back to prior years |
| This could result in the write down of previously used Section 29/45K tax credits |
| This would reduce our net income and could have a material adverse effect on our results of operations |
| The loss of the services of our Chief Executive Officer or our other key employees could jeopardize our ability to maintain our competitive position |
| We believe that our success depends on the continued service of our key executive management personnel |
| Loss of the services of Stuart Rose, our Chairman and Chief Executive Officer, or other key employees could jeopardize our ability to maintain our competitive position in the industry |
| We have entered into an employment agreement with Mr |
| Rose, which runs through January 31, 2008 |
| We have also entered into an employment agreement with David Bearden, our President and Chief Operating Officer, which runs through January 31, 2008 |
| We do not have employment agreements with any other members of our executive management team |
| Fluctuations in our comparable store sales may cause the price of our common stock to fluctuate substantially |
| “Comparable store sales” is a term we use to compare the year over year sales performance of our stores |
| We consider a store to be comparable after it has been open six full fiscal quarters |
| A number of factors have historically affected and will continue to affect our comparable store sales, including the following: • competition; • national and regional economic conditions; • consumer trends; • new product introductions; • weather conditions which can impact store traffic as well as sales of seasonal products such as air conditioners; • changes in our product mix and availability of products from key vendors; • duration of the holiday selling season; • timing of promotional events; and • attracting and retaining qualified sales personnel |
| Comparable store sales are often followed closely by the investment community and significant fluctuations in these results could cause the price of our common stock to fluctuate substantially |
| Our quarterly operating results are subject to seasonality |
| Our net retail sales and net income historically have been highest in our fourth fiscal quarter, which includes the Christmas selling season |
| The fourth quarter accounted for approximately 33prca and 32prca of our net sales and revenue, 52prca and 72prca of our income from operations, and 23prca and 61prca 15 _________________________________________________________________ of our net income in fiscal 2005 and 2004, respectively |
| Our annual financial results would be adversely impacted if our sales were to fall substantially below what we normally expect during this period |
| We depend on our suppliers for products and our business could be adversely affected if we do not maintain relationships with our key vendors |
| Our success depends to a significant degree upon our suppliers of consumer electronics and home appliance products |
| We do not have any long-term supply agreements or exclusive arrangements with vendors |
| We typically order merchandise by issuing individual purchase orders to vendors |
| We rely significantly on a few suppliers |
| Our 11 largest suppliers accounted for approximately 81prca of our purchases during fiscal 2005, with three suppliers representing approximately 40prca of our inventory purchases in fiscal 2005 |
| The loss of any of these key vendors, our failure to establish and maintain relationships with our vendors, or any prolonged disruptions in product supply, could have a material adverse impact on our business |
| We may incur higher costs or decreased sales and gross margins because we purchase imported products |
| A significant portion of our inventory is manufactured outside the United States |
| Changes in trade regulations, currency fluctuations or other factors may increase the cost of items manufactured outside the United States or create shortages of those items |
| Significant reductions in the cost of such items in US dollars may cause a significant reduction in retail price levels of those products, which could adversely affect our sales and gross margins |
| We face risks associated with our proposed ethanol investments and our lack of experience in this industry |
| We may realize lower than expected results from our proposed ethanol investments |
| At January 31, 2006, we have obtained letters of credit totaling dlra12dtta5 million to secure our commitments to invest in two entities that will construct and subsequently operate ethanol producing facilities |
| On March 17, 2006, we entered into an agreement to purchase a note in the principal amount of dlra14 million issued by a limited liability company organized to construct and operate an ethanol producing facility |
| We have obtained a letter of credit, subsequent to January 31, 2006, to secure our commitment in this facility |
| We have not previously been involved in this industry and we may encounter factors that could reduce the value of investments in the ethanol entities |
| Furthermore, each of these entities is a recently organized development stage company with virtually no operating history |
| We face risks associated with our proposed ethanol investments and the construction of the ethanol plants as profitability from the investments could be adversely affected if the plants are not completed within budget |
| The financial success of the entities is largely dependent upon the timely completion of the construction of ethanol plants within budget |
| Significant delays or cost overruns could significantly reduce profitability from the ethanol producing facilities |
| We face risks associated with our proposed ethanol investments as raw material prices will fluctuate and could increase significantly in the future, which will increase operating costs and adversely affect operating results |
| Raw materials such as corn and sorghum experience fluctuations in price related to weather, disease, changes in government incentives, demand and other factors |
| A significant reduction in the supply of raw materials, or increases in the demand of raw materials, could result in higher raw material prices |
| There is little correlation between the raw material prices and the price of ethanol, which generally tends to track with 16 _________________________________________________________________ gasoline prices |
| Increases in raw material prices will generally produce lower profit margins because the price obtained for ethanol may not increase |
| We face risks associated with our proposed ethanol investments as operating expenses will fluctuate and could increase significantly in the future, which will increase operating costs and adversely affect operating results |
| Operating expenses such as utilities and transportation charges can be volatile and are affected by such items as gasoline and natural gas costs, and the ability of the entities to locate and obtain suitable rail or alternative transportation means |
| We face risks associated with our proposed ethanol investments from government regulations and the potential reduction in the selling price of ethanol |
| The fuel ethanol industry is highly dependent upon tax policies and environmental regulations that favor the use of ethanol in motor fuel blends in North America |
| The repeal or substantial modification of federal or state tax programs encouraging the use of ethanol could have a detrimental effect on the industry |
| Fuel ethanol prices could fluctuate, which could result in returns from our ethanol investments being less than expected |
| Fuel ethanol prices are largely a function of government incentives and the wholesale price of gasoline |
| US fuel ethanol prices generally parallel the movement of oil prices, which are extremely difficult to forecast |
| A significant fall in fuel ethanol prices could have a significant adverse effect on the industry |
| Our proposed ethanol investments are illiquid |
| Our contemplated ethanol investments will not be readily marketable and their value is subject to adverse social and economic changes, rising operating costs, and other associated business and financial difficulties |
| In addition, these investments will not be registered under federal securities laws, and will be subject to certain restrictions on transfer intended to preserve exemptions from registration requirement under those securities laws |
| There can be no assurance that, if it becomes necessary to sell or transfer ownership, a buyer could be found or a suitable purchase price could be obtained |
| There is no public trading market for these investments, and it is not anticipated that any such public market will develop in the future |
| With no public trading market, it may be extremely difficult or impossible for us to resell our investments should we desire to do so |