** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-Q**
| x                                                   | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|-----------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|
| **For the quarterly period ended October 29, 2006** |
| **OR**                                              |
| o                                                   | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**CommissionFile Number 0-20269**

**DUCKWALL-ALCO STORES, INC.**

(Exact name of registrantas specified in its charter)

| **Kansas**                                                      | ** ** | **48-0201080**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |       | (I.R.S. Employer  Identification No.) |
|                                                            |       |                                  |
| **401  Cottage Street, Abilene, Kansas**                        | ** ** | **67410-2832**                        |
| (Address of  principal executive offices)                       |       | (Zip Code)                            |

 

**(785) 263-3350**

(Registrant’s telephonenumber including area code)

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.  Yes x** No o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” inRule 12b-2 of the Exchange Act. (Check One):

Large accelerated filer o          Acceleratedfiler x         Non-acceleratedfiler o

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the ExchangeAct).     Yes o No x

**APPLICABLEONLY TO CORPORATE ISSUERS:**

3,793,528shares of common stock, $.0001 par value (the issuer’s only class of commonstock), were outstanding as of October 29, 2006.

 

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**PART I —FINANCIAL INFORMATION**

**ITEM 1.  FINANCIAL STATEMENTS**

**Duckwall-ALCOStores, Inc.**

**AndSubsidiaries**

**ConsolidatedBalance Sheets**

(Dollars inThousands)

**Assets**
| ** **                         | ** ** | **October 29,** | ** ** | **January 29,** | ** ** |
|------------------------------------|------------|----------------------|------------|----------------------|------------|
| ** **                         | ** ** | **2006**             | ** ** | **2006**             | ** ** |
| ** **                         | ** ** | **(Unaudited)**      | ** ** | ** **           | ** ** |
| Current assets:                    |       |                 |       |                 |       |
| Cash and cash  equivalents         |       | $                    | 4,847      |                 | $          | 472 |   |
| Receivables                        |       | 3,745                |       | 2,874                |       |
| Refundable  income tax             |       | 2,973                |       | —               |       |
| Inventories                        |       | 164,621              |       | 135,077              |       |
| Prepaid expenses                   |       | 2,880                |       | 2,621                |       |
| Property held  for sale            |       | —               |       | 585                  |       |
| Total current  assets              |       | 179,066              |       | 141,629              |       |
| Property and equipment             |       | 89,261               |       | 92,615               |       |
| Less accumulated  depreciation     |       | 66,432               |       | 63,591               |       |
| Net property and  equipment        |       | 22,829               |       | 29,024               |       |
| Property under capital  leases     |       | 25,086               |       | 23,228               |       |
| Less accumulated  amortization     |       | 17,604               |       | 16,367               |       |
| Net property under  capital leases |       | 7,482                |       | 6,861                |       |
| Other non-current  assets          |       | 53                   |       | 55                   |       |
| Deferred income taxes              |       | 2,413                |       | 1,353                |       |
| Total assets                       |       | $                    | 211,843    |                 | $          | 178,922 |   |

 

See accompanyingnotes to unaudited consolidated financial statements.

2

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**Duckwall-ALCOStores, Inc.**

**AndSubsidiaries**

**ConsolidatedBalance Sheets**

(Dollars in Thousands)

 

 

**Liabilitiesand Stockholders’ Equity**

 

 
| ** **                                                                                                                                | ** ** | **October 29,** | ** ** | **January 29,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|----------------------|------------|
| ** **                                                                                                                                | ** ** | **2006**             | ** ** | **2006**             | ** ** |
| ** **                                                                                                                                | ** ** | **(Unaudited)**      | ** ** | ** **           | ** ** |
| Current liabilities:                                                                                                                      |       |                 |       |                 |       |
| Current  maturities of capital lease obligations                                                                                          |       | $                    | 2,192      |                 | $          | 1,879 |   |
| Accounts payable                                                                                                                          |       | 43,493               |       | 28,300               |       |
| Income taxes  payable                                                                                                                     |       | —               |       | 1,163                |       |
| Accrued salaries  and commissions                                                                                                         |       | 3,990                |       | 6,001                |       |
| Accrued taxes  other than income                                                                                                          |       | 5,084                |       | 4,743                |       |
| Self-insurance  claim reserves                                                                                                            |       | 4,413                |       | 3,915                |       |
| Stock purchase  payable                                                                                                                   |       | —               |       | 1,910                |       |
| Other current  liabilities                                                                                                                |       | 3,036                |       | 2,998                |       |
| Deferred income  taxes                                                                                                                    |       | 283                  |       | 86                   |       |
| Total current  liabilities                                                                                                                |       | 62,491               |       | 50,995               |       |
| Notes payable under  revolving loan                                                                                                       |       | 32,664               |       | 17,062               |       |
| Capital lease  obligations - less current maturities                                                                                      |       | 7,363                |       | 7,299                |       |
| Other noncurrent  liabilities                                                                                                             |       | 5,254                |       | 1,419                |       |
| Total  liabilities                                                                                                                        |       | 107,772              |       | 76,775               |       |
| Stockholders’ equity:                                                                                                                |       |                 |       |                 |       |
| Common stock,  $.0001 par value, authorized 20,000,000 shares; issued and outstanding 3,793,528  shares and 3,786,953 shares respectively |       | 1                    |       | 1                    |       |
| Additional  paid-in capital                                                                                                               |       | 37,024               |       | 36,411               |       |
| Retained  earnings                                                                                                                        |       | 67,046               |       | 65,735               |       |
| Total  stockholders’ equity                                                                                                          |       | 104,071              |       | 102,147              |       |
| Total liabilities and  stockholders’ equity                                                                                          |       | $                    | 211,843    |                 | $          | 178,922 |   |

 

See accompanyingnotes to unaudited consolidated financial statements.

3

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**Duckwall-ALCO Stores, Inc.**

**And Subsidiaries**

**Consolidated Statements of Operations**

(Dollarsin Thousands Except Per Share Amounts)

(Unaudited)
| ** **                                                         | ** ** | **For  the Thirteen Week** | **For  the Thirty-Nine Week** | ** **           |
|--------------------------------------------------------------------|------------|----------------------------|-------------------------------|----------------------|
| ** **                                                         | ** ** | **Period  Ended**          | ** **                    | **Period  Ended**    | ** ** |
| ** **                                                         | ** ** | **October 29,**       | ** **                    | **October 30,** | ** ** | **October 29,** | ** ** | **October 30,** | ** ** |
| ** **                                                         | ** ** | **2006**                   | ** **                    | **2005**             | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net sales                                                          |       | $                          | 110,109                       |                 | $ | 100,740 |   | $ | 339,124 |   | $ | 306,609 |   |
| Cost of sales                                                      |       | 75,815                     |                          | 68,184               |   | 236,214 |   | 210,947 |   |
| Gross margin                                                       |       | 34,294                     |                          | 32,556               |   | 102,910 |   | 95,662 |   |
| Selling, general and  administrative                               |       | 32,953                     |                          | 31,077               |   | 94,059 |   | 91,312 |   |
| Depreciation and  amortization                                     |       | 1,647                      |                          | 1,427                |   | 4,919 |   | 4,363 |   |
| Total operating  expenses                                          |       | 34,600                     |                          | 32,504               |   | 98,978 |   | 95,675 |   |
| Operating income (loss)  from continuing operations                |       | (306                       | )                             | 52                   |   | 3,932 |   | (13 | ) |
| Interest expense                                                   |       | 809                        |                          | 354                  |   | 2,010 |   | 809 |   |
| Earnings (loss) from  continuing operations before income taxes    |       | (1,115                     | )                             | (302                 | ) | 1,922 |   | (822 | ) |
| Income tax expense  (benefit)                                      |       | (564                       | )                             | (412                 | ) | 684 |   | (186 | ) |
| Earnings (loss) from  continuing operations                        |       | (551                       | )                             | 110                  |   | 1,238 |   | (636 | ) |
| Earnings (loss) from  discontinued operations, net of income taxes |       | (97                        | )                             | (297                 | ) | 72 |   | (2,575 | ) |
| Net earnings (loss)                                                |       | ($648                      | )                             | ($187                | ) | $ | 1,310 |   | ($3,211 | ) |
| Earnings (loss) per  share                                         |       |                       |                          |                 |   |   |   |   |   |
| Basic                                                              |       |                       |                          |                 |   |   |   |   |   |
| Continuing  operations                                             |       | ($0.15                     | )                             | $                    | 0.03 |   | $ | 0.33 |   | ($0.15 | ) |
| Discontinued  operations                                           |       | ($0.03                     | )                             | ($0.08               | ) | $ | 0.02 |   | ($0.62 | ) |
| Net earnings  (loss)                                               |       | ($0.18                     | )                             | ($0.05               | ) | $ | 0.35 |   | ($0.77 | ) |
| Diluted                                                            |       |                       |                          |                 |   |   |   |   |   |
| Continuing  operations                                             |       | ($0.15                     | )                             | $                    | 0.03 |   | $ | 0.32 |   | ($0.15 | ) |
| Discontinued  operations                                           |       | ($0.03                     | )                             | ($0.08               | ) | $ | 0.02 |   | ($0.62 | ) |
| Net earnings (loss)                                                |       | ($0.18                     | )                             | ($0.05               | ) | $ | 0.34 |   | ($0.77 | ) |
|                                                                    |            |                            |                               |                      |  |  |  |  |  |  |  |  |  |

 

See accompanying notes to unaudited consolidated financial statements.

4

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**Duckwall-ALCOStores, Inc.**

**AndSubsidiaries**

**ConsolidatedStatements of Cash Flows**

Dollars in Thousands

(Unaudited)
| ** **                                                                           | ** ** | **For Thirty-Nine Week** | ** ** |
|--------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                           | ** ** | **Period Ended**              | ** ** |
| ** **                                                                           | ** ** | **October 29,**               | ** ** | **October 30,** | ** ** |
| ** **                                                                           | ** ** | **2006**                           | ** ** | **2005** | ** ** |
| Cash flows from  operating activities:                                               |       |                               |       |   |   |
| Net earnings                                                                         |       | $                                  | 1,310      |   | ($3,211 | ) |
| Tax benefit of  stock options exercised                                              |       | 14                                 |       | — |   |
| Adjustments to  reconcile net earnings to net cash provided by operating activities: |       |                               |       |   |   |
| Increase in  receivables                                                             |       | (1,010                             | )          | (634 | ) |
| Increase in  prepaid expenses                                                        |       | (259                               | )          | (949 | ) |
| Increase in  inventories                                                             |       | (29,544                            | )          | (9,115 | ) |
| Depreciation and  amortization                                                       |       | 4,919                              |       | 4,373 |   |
| (Gain) loss on  sale of assets                                                       |       | (335                               | )          | 617 |   |
| Stock  compensation expense                                                          |       | 541                                |       | — |   |
| Increase in  accounts payable                                                        |       | 15,193                             |       | 12,493 |   |
| Decrease in  income taxes payable                                                    |       | (4,136                             | )          | (2,466 | ) |
| Decrease in  accrued salaries and commissions                                        |       | (2,011                             | )          | (362 | ) |
| Increase in  accrued taxes other                                                     |       | 342                                |       | 1,116 |   |
| Change in  deferred income taxes                                                     |       | (863                               | )          | (49 | ) |
| Increase in  other assets and liabilities                                            |       | 647                                |       | 1,548 |   |
| Net cash (used  in) provided by operating activities                                 |       | (15,192                            | )          | 3,361 |   |
| Cash flows from  investing activities:                                               |       |                               |       |   |   |
| Proceeds from  the sale of assets                                                    |       | 12,925                             |       | — |   |
| Capital  expenditures                                                                |       | (5,625                             | )          | (12,216 | ) |
| Net cash  provided by (used in) investing activities                                 |       | 7,300                              |       | (12,216 | ) |
| Cash flows from financing  activities:                                               |       |                               |       |   |   |
| Net borrowings  under revolving loan credit agreement                                |       | 15,602                             |       | 23,281 |   |
| Refinancing  costs on revolving loan                                                 |       | —                             |       | (61 | ) |
| Proceeds from  exercise of outstanding stock options                                 |       | 125                                |       | 382 |   |
| Excess tax  benefit on stock options exercises                                       |       | 35                                 |       | — |   |
| Repurchase of  stock                                                                 |       | (2,012                             | )          | (12,638 | ) |
| Principal  payments under capital lease obligations                                  |       | (1,483                             | )          | (643 | ) |
| Net cash  provided by financing activities                                           |       | 12,267                             |       | 10,321 |   |
| Net increase in  cash and cash equivalents                                           |       | 4,375                              |       | 1,466 |   |
| Cash and cash equivalents  at beginning of period                                    |       | 472                                |       | 352 |   |
| Cash and cash  equivalents at end of period                                          |       | $                                  | 4,847      |   | $ | 1,818 |   |
| Cash paid during the  period for:                                                    |       |                               |       |   |   |
| Interest                                                                             |       | $                                  | 1,829      |   | $ | 645 |   |
| Income taxes                                                                         |       | $                                  | 3,548      |   | $ | 568 |   |
| Supplemental disclosure  of non-cash activity:                                       |       |                               |       |   |   |
| Tax benefit  related to stock options exercised                                      |       | —                             |       | $ | 48 |   |
| Assets acquired  under capital lease                                                 |       | $                                  | 1,859      |   |   |   |
| Deferred gain on  sale/leaseback                                                     |       | $                                  | 3,833      |   |   |   |

 

See accompanyingnotes to unaudited consolidated financial statements.

5

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**Duckwall-ALCOStores, Inc.**

**AndSubsidiaries**

**Notes toUnaudited Consolidated Financial Statements**

(Dollars in Thousands Except Per Share Amounts)

(1)           Basis of Presentation

Theaccompanying unaudited consolidated financial statements are for interimperiods and, consequently, do not include all disclosures required by generallyaccepted accounting principles for annual financial statements.  It is suggested that the accompanyingunaudited consolidated financial statements be read in conjunction with theconsolidated financial statements included in the Company’s fiscal 2006 AnnualReport.  In the opinion of management ofDuckwall-ALCO Stores, Inc., the accompanying unaudited consolidated financialstatements reflect all adjustments (consisting of normal recurring accruals)necessary to present fairly the financial position of the Company and theresults of its operations and cash flows for the interim periods.  Because the Company’s business is moderatelyseasonal, the results from interim periods are not necessarily indicative ofthe results to be expected for the entire year.

(2)           Reclassification

The Companyreclassified certain accounts receivable on its Consolidated Balance Sheets,which were previously presented as cash and cash equivalents.  The amounts reclassified on the ConsolidatedBalance Sheet totaled $1,094, $848, and $605 in 2006, 2005 and 2004,respectively.  The related change in netcash provided by operating activities was ($246), ($243), and ($124) in 2006,2005 and 2004, respectively.

(3)           Principles of Consolidation

Theconsolidated financial statements include the accounts of Duckwall-ALCO Stores,Inc. and its wholly owned subsidiaries. All significant intercompany transactions and balances have beeneliminated in consolidation.

(4)           Stock-based Compensation

Effective January 30, 2006, the Companyadopted Statement of Financial Accounting Standards No. 123(R) “Share-BasedPayment” (“SFAS 123(R)”) and began recognizing compensation expense for itsshare-based payments based on the fair value of the awards. Share-basedpayments consist of stock option grants. SFAS 123(R) requires share-basedcompensation expense recognized since January 30, 2006 to be based on thefollowing: a) grant date fair value estimated in accordance with the originalprovisions of SFAS 123 for unvested options granted prior 

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tothe adoption date and b) grant date fair value estimated in accordance with theprovisions of SFAS 123(R) for all share-based payments granted subsequent tothe adoption date.

For the thirty-nine weeks ended October30, 2006, the SFAS 123(R)’s fair value method resulted in share-based expense(a component of selling and general and administrative expenses) in the amountof $541 related to the Company’s stock plans that the Company would not haverecognized if it had continued to account for share-based compensation underAPB 25 (defined hereafter). This share-based compensation lowered pre-taxearnings by $541, lowered net income by $317, and lowered basic and dilutedearnings per share by $0.08. SFAS 123(R) also requires the benefits of taxdeductions in excess of recognized compensation cost to be reported as afinancing activity, rather than as an operating activity in the statement ofcash flow as required prior to SFAS 123(R). The change resulted in $35 beingshown as a cash flow from financing activities rather than operatingactivities.  The impact of SFAS 123(R) onfuture results will depend on, among other things, levels of share-basedpayments granted in the future, actual forfeiture rates and the timing ofoption exercises.

Prior to January 30, 2006, the Companyaccounted for share-based payments using the intrinsic-value-based recognitionmethod prescribed by Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees,” (“APB 25”). As options were granted at anexercise price equal to the market value of the underlying common stock on thedate of grant, no stock-based employee compensation cost was reflected in netincome prior to adopting SFAS 123(R). As the Company adopted SFAS 123(R) underthe modified-prospective-transition method, results from prior periods have notbeen restated.

Thefollowing table illustrates the effect on net income and earnings per share asif the Company applied the fair value recognition provisions of Statement 123to options granted under the Company’s stock plans in all periods presentedprior to the adoption of FAS 123(R).  The periods represented include the third quarter of Fiscal 2006 and thethirty-nine week period of Fiscal 2006. For purposes of this pro forma disclosure, the value of the options isestimated using a modified Black-Scholes option pricing model for all optiongrants:
| ** **                                                    | ** ** | **For The Thirteen Week** | ** ** | **For The Thirty-Nine Week** | ** ** |
|---------------------------------------------------------------|------------|------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                    | ** ** | **Period Ended**                    | ** ** | **Period Ended**                       | ** ** |
| ** **                                                    | ** ** | **October 30,**                     | ** ** | **October 30,**                        | ** ** |
| ** **                                                    | ** ** | **2005**                                 | ** ** | **2005**                                    | ** ** |
| Net loss as  reported                                         |       | (187                                     | )          | (3,211                                      | )          |
| Pro forma  stock-based employee compensation cost, net of tax |       | (58                                      | )          | (137                                        | )          |
| Pro forma net  loss                                           |       | (245                                     | )          | (3,348                                      | )          |
| Loss per share  as reported:                                  |       |                                     |       |                                        |       |
| Basic                                                         |       | (0.05                                    | )          | (0.77                                       | )          |
| Diluted                                                       |       | (0.05                                    | )          | (0.77                                       | )          |
| Loss per share,  pro forma:                                   |       |                                     |       |                                        |       |
| Basic                                                         |       | (0.06                                    | )          | (0.81                                       | )          |
| Diluted                                                       |       | (0.06                                    | )          | (0.81                                       | )          |

 

Under SFAS 123(R), forfeitures areestimated at the time of valuation and reduce expense ratably over the vestingperiod. This estimate is adjusted periodically based on the extent to whichactual forfeitures differ, or are expected to differ, from the previousestimate. Under SFAS 123 and APB 25, the Company elected to account forforfeitures as they occurred.

Under the Company’s 2003 Incentive StockOption Plan, options may be granted to officers and key employees, not toexceed 500,000 shares.  According to theterms of the plan, the per share exercise price of options 

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grantedshall not be less than the fair market value of the stock on the date of grantand such options will expire no later than five years from the date of grant.The options vest in equal amounts over a four year requisite service periodbeginning from the grant date. In the case of a stockholder owning more than10% of the outstanding voting stock of the Company, the exercise price of anincentive stock option may not be less than 110% of the fair market value ofthe stock on the date of grant and such options will expire no later than fiveyears from the date of grant.  Also, theaggregate fair market value of the stock with respect to which incentive stockoptions are exercisable on a tax deferred basis for the first time by anindividual in any calendar year may not exceed $100,000. In the event that theforegoing results in a portion of an option exceeding the $100,000 limitation,such portion of the option in excess of the limitation shall be treated as anonqualified stock option.  At October29, 2006, the Company had 143,000 shares authorized for future optiongrants.  The Company issues these grantsfrom the unissued shares authorized.

Under the Company’s Non-Qualified StockOption Plan for Non-Management Directors, options may be granted to Directorsof the Company who are not otherwise officers or employees of the Company, notto exceed 120,000 shares.  According tothe terms of the plan, the per share exercise price of options granted shallnot be less than the fair market value of the stock on the date of grant andsuch options will expire five years from the date of grant.  The options vest in equal amounts over a fouryear requisite service period beginning from the grant date.  All options under the plan shall benon-qualified stock options.  There areno shares remaining to be issued under this plan.  The Company issued these grants from theunissued shares authorized, which the Company intends to register these duringthe fourth quarter 2007.

The Company previously issued optionsunder the 1993 Incentive Stock Option Plan. This plan was structured in the same fashion as the 2003 Incentive StockOption Plan described above, however it did not specify the 10% ownershiprules.  There are no shares remaining tobe issued under this plan.  As of October29, 2006, 12,726 options were outstanding under this plan.

The fair value of each option grant isseparately estimated for each grant. The fair value of each option is amortizedinto compensation expense on a straight-line basis from the grant date for theaward over the requisite service period as discussed above.  The Company has estimated the fair value ofall stock option awards as of the date of the grant by applying a modifiedBlack-Scholes pricing valuation model. The application of this valuation model involves assumptions that arejudgmental and highly sensitive in the determination of compensation expense.The weighted average for key assumptions used in determining the fair value ofoptions granted in the thirty-nine weeks ended October 29, 2006 and October 30,2005 and a summary of the methodology applied to develop each assumption are asfollows:
| ** **                                | ** ** | **October 29,** | ** ** | **October 30,** | ** ** |
|-------------------------------------------|------------|----------------------|------------|----------------------|------------|
| ** **                                | ** ** | **2006**             | ** ** | **2005**             | ** ** |
| Expected price  volatility                |       | 37.4                 | %          | 38.4                 | %          |
| Risk-free  interest rate                  |       | 5.0                  | %          | 4.0                  | %          |
| Weighted average  expected lives in years |       | 3.8                  |       | 5.0                  |       |
| Forfeiture rate                           |       | 5.6                  | %          | 0.0                  | %          |
| Dividend yield                            |       | 0.0                  | %          | 0.0                  | %          |

 

EXPECTED PRICEVOLATILITY — This is a measure of the amount by which a price has fluctuated oris expected to fluctuate. The Company uses actual historical changes in themarket value of its stock to calculate expected price volatility becausemanagement believes that this is the best indicator of future volatility. TheCompany calculates monthly market value changes from the date of grant over apast period to determine volatility. An increase in the expected volatilitywill increase compensation expense.

RISK-FREE INTEREST RATE— This is the U.S. Treasury rate for the date of the grant over the expectedterm.  An increase in the risk-freeinterest rate will increase compensation expense.

EXPECTED LIVES — This isthe period of time over which the options granted are expected to remainoutstanding and is based on management’s expectations in relation to theholders of the 

8

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options. Options grantedhave a maximum term of five years. An increase in the expected life willincrease compensation expense.

FORFEITURE RATE — Thisis the estimated percentage of options granted that are expected to beforfeited or cancelled before becoming fully vested. This estimate is based onmanagement’s expectations in relation to the holders of the options. Anincrease in the forfeiture rate will decrease compensation expense.

DIVIDEND YIELD --- TheCompany has not made any dividend payments nor does it have plans to paydividends in the foreseeable future. An increase in the dividend yield willdecrease compensation expense.

Asummary of stock option activity since the Company’s most recent fiscalyear-end is as follows:
| ** **                            | ** ** | **Number  of  Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighed  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|---------------------------------------|------------|------------------------|------------|----------------------------------------|------------|----------------------------------------------------|------------|---------------------------------|------------|
| Outstanding  January 29, 2006         |       | 133,238                |       | $                                      | 17.37      |                                               |       |                            |       |   |
| Granted                               |       | 377,000                |       | 30.01                                  |       |                                               |       |                            |       |
| Exercised                             |       | (9,912                 | )          | 12.50                                  |       |                                               |       |                            |       |
| Forfeited/Expired                     |       | (10,600                | )          | 29.74                                  |       |                                               |       |                            |       |
| Outstanding  October 29, 2006         |       | 489,726                |       | $                                      | 26.93      |                                               | 4.2        |                            | $          | 5,631 |   |
| Expected to vest  at October 29, 2006 |       | 479,508                |       | $                                      | 26.91      |                                               | 4.2        |                            | $          | 5,614 |   |
| Exercisable at October  29, 2006      |       | 40,226                 |       | $                                      | 16.53      |                                               | 2.5        |                            | $          | 881 |   |

 

The aggregate intrinsic values in thetable above represents the total difference between the Company’s closing stockprice on October 29, 2006 and the option exercise price, multiplied by thenumber of in-the-money options as of October 29, 2006. As of October 29, 2006,total unrecognized compensation expense related to non-vested stock options is$3.7 million with a weighted average expense recognition period of 3.6 years.

A summary of the status of the Company’snonvested shares as of October 29, 2006 is presented below:
| ** **                     | ** ** | **Number of   Shares** | ** ** | **Weighted Average  Grant Date  Fair Value   (per share)** | ** ** |
|--------------------------------|------------|----------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| Nonvested at  January 29, 2006 |       | 118,920                          |       | $                                                                                   | 7.20       |   |
| Granted                        |       | 377,000                          |       | $                                                                                   | 10.52      |   |
| Vested                         |       | (36,332                          | )          | $                                                                                   | 6.84       |   |
| Forfeited                      |       | (10,088                          | )          | $                                                                                   | 9.99       |   |
| Nonvested at October  29, 2006 |       | 449,500                          |       | $                                                                                   | 9.95       |   |

 

Other informationrelative to option activity during the thirty-nine weeks ended October 29, 2006and October 30, 2005 is as follows (in 000’s, except per share data):
| ** **                                                                   | ** ** | **October 29,** | ** ** | **October 30,** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------|------------|----------------------|------------|
| ** **                                                                   | ** ** | **2006**             | ** ** | **2005**             | ** ** |
| Weighted average  grant date fair value of stock options granted (per share) |       | $                    | 10.52      |                 | $          | 7.36 |   |
| Total fair value  of stock options vested                                    |       | $                    | 249        |                 | $          | 54 |   |
| Total intrinsic value  of stock options exercised                            |       | $                    | 163        |                 | $          | 395 |   |

 

9

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(5)           Earnings Per Share

Basic net earnings per share is computed by dividingnet earnings by the weighted average number of shares outstanding.  Diluted net earnings per share reflects thepotential dilution that could occur if contracts to issue securities (such as stockoptions) were exercised.

The average number of shares used in computingearnings per share was as follows:
| **Thirteen Weeks Ended**    | ** ** | **Basic** | ** ** | **Diluted** | ** ** |
|---------------------------------------|------------|-----------|------------|-------------|------------|
| October 29, 2006                      |       | 3,793,252 |       | 3,793,252   |       |
| October 30, 2005                      |       | 3,969,754 |       | 3,969,754   |       |
|                                  |       |      |       |        |       |
| **Thirty-Nine Weeks Ended** | ** ** | **Basic** | ** ** | **Diluted** | ** ** |
| October 29, 2006                      |       | 3,791,579 |       | 3,831,533   |       |
| October 30, 2005                      |       | 4,158,068 |       | 4,158,068   |       |

 

(6)           SubsequentEvents

The sale-leaseback of one location was completed on November2, 2006.  The cash proceeds from thetransaction amounted to $950.

ITEM 2.  MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Dollars in Thousands Except Per Share Amounts)

***OVERVIEW***

*Operations*.  The Company is a regional discount retaileroperating 253 stores in 21 states in the central United States, with twobusiness divisions, consisting of:

·                  The ALCOdivision which, as of October 29, 2006, operated 186 ALCO Stores which offer awide variety of general merchandise and a limited variety of food products andaccounted for 94% of the Company’s sales for the third quarter of fiscal 2007.

·                  The Duckwalldivision which, as of October 29, 2006, operated 67 Duckwall Stores which offera more limited general merchandise selection, but serve the needs of acommunity that is not large enough to support a full-line retail discountstore, and accounted for 6% of the Company’s sales for the third quarter offiscal 2007.

Thethirteen weeks ended October 29, 2006 and October 30, 2005 are referred toherein as the third quarter of fiscal 2007 and 2006, respectively.  For purposes of this management’s discussionand analysis of financial condition and results of operations, the financialnumbers are presented in thousands.

*Strategy.*  The Company’s overall business strategyinvolves identifying and opening stores in towns that will provide the Companywith the highest return on investment. The Company competes for retail sales with other entities, such as mailorder companies, specialty retailers, mass merchandisers, dollar stores,manufacturer’s outlets, and the internet.

TheCompany is routinely evaluating the appropriate mix of merchandise to improvesales and gross margin performance. The Company uses centralized purchasing,merchandising, pricing and warehousing to obtain volume discounts, improveefficiencies and achieve consistency among stores and the best overallresults.  The Company utilizesinformation obtained from its point-of-sale system and regular input from itsstore associates to determine its merchandise offerings.

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TheCompany went live on a new POS system in 152 stores during the second and thirdquarters of fiscal 2007, and will rollout this system to the remaining Alcostores in the fourth quarter of fiscal 2007.

*Recent Events*.

Key Items in Third Quarter Fiscal 2007

The Companymeasures itself against a number of financial metrics to assess itsperformance.  Some of the importantfinancial items during the third quarter of fiscal 2007 were:

·                  Net salesincreased 9.3% to $110,109.  Same storesales increased 5.9% compared to the prior year third quarter.

·                  Gross marginpercentage decreased to 31.2% of sales, when compared to 32.3% in the prioryear third quarter.

·                  Loss per sharewas ($0.18) in the third quarter of fiscal 2007 compared to ($.05) per share inthe prior year third quarter.

·                  The Company’searnings before interest, taxes, depreciation and amortization (“EBITDA”) fromcontinuing operations for the third quarter 2007 were $1,608.

·                  The Company’sreturn on average equity (“ROE”) for the third quarter 2007 was 1.4%.

Samestore sales growth is a measure which may indicate whether existing stores aremaintaining their market share.  Otherfactors, such as the overall economy, may also affect same store sales.  The Company defines same stores as thosestores that were open as of the first day of the prior fiscal year and remainopen at the end of the reporting period. The same store sales for all Company stores increased 5.9% compared tothe third quarter last year, the ALCO stores same store sales increased 6.0%,and the Duckwall same stores sales increased 4.5% during the third quarter offiscal 2007.  In the third quarter endedOctober 29, 2006, the Company closed one ALCO store.

Gross marginpercentage is a key measure of the Company’s ability to maximize profit on thepurchase and subsequent sale of merchandise, while minimizing promotional andclearance markdowns, shrinkage, damage, and returns.  Gross margin percentage is defined as salesless cost of sales, expressed as a percentage of sales.  Gross margin percent decreased to 31.2% ofsales in the third quarter of fiscal 2007, compared to 32.3% in the thirdquarter of fiscal 2006.

Earnings per share(“EPS”) growth are an indicator of the returns generated for the Company’sstockholders.  EPS from continuingoperations was reduced to ($0.15) per diluted share for the third quarter offiscal 2007, compared to $0.03 per diluted share for the third quarter of theprior fiscal year.

 The Company’s EBITDA and ROE are discussedunder *SG&A Detail; Certain Financial Measures*below.

**NewAccounting Standard**

In June 2006, theFinancial Accounting Standards Board, or FASB, issued Interpretation No. 48, “*Accounting for Uncertainty in Income Taxes*, or FIN 48, aninterpretation of FASB No. 109, *Accounting for Income Taxes*.”  FIN 48 clarifies the accounting foruncertainty in income taxes recognized in an enterprise’s financial statementsin accordance with FASB Statement No. 109, Accounting for Income Taxes andprescribes a recognition threshold and measurement attribute for the financialstatement recognition and measurement of a tax position taken or expected to betaken in a tax return.  FIN 48 alsoprovides guidance on derecognition, classification, interest and penalties,accounting in interim periods, disclosure, and transition.  FIN 48 is effective for fiscal yearsbeginning after December 15, 2006.  TheCompany is in the process of determining the impact of the adoption of thisInterpretation on our consolidated financial statements.

InMarch 2006, the Emerging Issues Task Force (“EITF”) reached a consensus on EITFIssue No. 06-3, “How Taxes Collected from Customers and Remitted toGovernmental Authorities Should Be Presented in the Income Statement (That Is,Gross Versus Net Presentation)”, which allows companies to adopt a policy ofpresenting 

11

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taxes in theincome statement on either a gross or net basis. Taxes within the scope of thisEITF would include taxes that are imposed on a revenue transaction between aseller and a customer, for example, sales taxes, use taxes, value-added taxes,and some types of excise taxes. EITF 06-3 is effective for interim and annualreporting periods beginning after December 15, 2006. EITF 06-3 will not impactthe method for recording and reporting these sales taxes in the Company’s consolidatedfinancial statements as the Company’s policy is to exclude all such taxes fromrevenue.

InSeptember 2006, the SEC staff issued SAB Topic 1N, “Financial Statements —Considering the Effects of Prior Year Misstatements When Quantifying Misstatementsin Current year Financial Statements” (SAB 108), which addresses how to quantify the effect of an error on thefinancial statements.  SAB 108 iseffective for our fiscal year ending January 28, 2007.  We are currently reviewing the applicabilityof SAB 108 to our operations and its potential impact on our consolidatedfinancial statements.

***CAUTIONARYSTATEMENT CONCERNING FORWARD-LOOKING STATEMENTS AND FACTORS THAT MAY AFFECTFUTURE RESULTS OF OPERATIONS, FINANCIAL CONDITION OR BUSINESS***

Certain statementscontained in this Quarterly Report on Form 10-Q that are not statements ofhistorical fact may constitute “forward-looking statements” within the meaningof Section 21E of the Exchange Act. These statements are subject to risks anduncertainties, as described below. Examples of forward-looking statementsinclude, but are not limited to: (i) projections of revenues, income or loss,earnings or loss per share, capital expenditures, store openings, storeclosings, payment or non-payment of dividends, capital structure and otherfinancial items, (ii) statements of plans and objectives of the Company’smanagement or Board of Directors, including plans or objectives relating toinventory, store development, marketing, competition, business strategy, storeenvironment, merchandising, purchasing, pricing, distribution, transportation,store locations and information systems, (iii) statements of future economicperformance, and (iv) statements of assumptions underlying the statementsdescribed in (i), (ii) and (iii). Forward-looking statements can often beidentified by the use of forward-looking terminology, such as “believes,” “expects,”“may,” “will,” “should,” “could,” “intends,” “plans,” “estimates”, “projects”or “anticipates,” variations thereof or similar expressions.

Forward-lookingstatements are not guarantees of future performance or results.  They involve risks, uncertainties andassumptions.  The Company’s futureresults of operations, financial condition and business operations may differmaterially from the forward-looking statements or the historical informationstated in this Quarterly Report on Form 10-Q. Stockholders and investors are cautioned not to put undue reliance onany forward-looking statement.

There are a number offactors and uncertainties that could cause actual results of operations,financial condition or business contemplated by the forward-looking statementsto differ materially from those discussed in the forward-looking statementsmade herein or elsewhere orally or in writing, by, or on behalf of, theCompany, including those factors described below. Other factors not identifiedherein could also have such an effect. Factors that could cause actual resultsto differ materially from those discussed in the forward-looking statements andfrom historical information include, but are not limited to, those factorsdescribed below.

# ***CRITICAL ACCOUNTING POLICIES***

*Inventory*:  As discussed in Note 1 (d) to theConsolidated Financial Statements, inventories are stated at the lower of costor net realizable value with cost determined using the last-in, first-out(LIFO) method.  The retail inventorymethod (“RIM”) used by the Company is an averaging method that has been widelyused in the retail industry.  This methodcalculates a cost to retail ratio that is applied to the retail value ofinventory to calculate cost inventory and the resulting gross margin.  Use of the RIM method does not eliminate theuse of management judgments and estimates, including markdowns and shrinkage,which significantly impact the ending inventory valuation at cost and theresulting gross margins.  The Companycontinually evaluates product categories to determine if markdown action isappropriate, or if a markdown reserve should be established.  The Company recognizes that the use of theRIM will result in valuing inventories at lower of cost or market if markdownsare currently taken as a reduction of the retail value of inventories.  Management believes that the RIM provides an inventoryvaluation which reasonably approximates cost and results in carrying inventoryat the lower of cost or market.

*Insurance*:  The Company considers determination ofoverall insurance costs a critical accounting policy. As described below, theCompany is essentially self insured for its workers compensation, medicalinsurance and general liability insurance. Due to the fact that it takes more than one year to determine the actualcosts under these 

12

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plans, these costs areestimated based on the Company’s historical loss experience and estimates fromthe insurance carriers and consultants.

WorkersCompensation and General Liability.  The Company is essentially self insured forworkers compensation and general liability claims due to large deductibles onits policies.  The Company records estimatesfor expense accruals.

Medical.  The Company is also essentially self insuredfor medical insurance and covers all claims in a plan year related to anindividual until they exceed $125.

*IncomeTaxes:*  The Company’stax provision and establishment of reserves for potential tax liabilitiesinvolves the use of estimates and professional judgment.  The Company has identified exposures forwhich they have established a reserve, such as differences in interpretation oftax laws at the federal, state, and local units of government.

***RESULTS OF OPERATIONS***

**ThirteenWeeks Ended October 29, 2006 Compared to Thirteen Weeks Ended October 30, 2005.**

***Net Sales***

Netsales for the third quarter of fiscal 2007 increased $9,369, or 9.3%, to$110,109 compared to $100,740 for the third quarter of fiscal 2006.  Same store sales increased 5.9% when comparedwith the prior quarter.  The sales werefavorably impacted by customer acceptance of the current merchandise strategythat focuses on soft-lines, a 1.4% increase in customer count and 7.1% increasein average sale generated.  Fuel salesalso contributed to same store sales increases.

***Gross Margin***

Grossmargin for the third quarter of fiscal 2007 increased $1,738, or 5.3%, to$34,294 compared to $32,556 in the third quarter of fiscal 2006.  Gross margin as a percentage of sales was31.2% for the third quarter of fiscal 2007, which decreased when compared to32.3% for the third quarter of fiscal 2006.  The decrease in gross margin as a percentage of sales was due to higherother markdowns, higher freight costs which accounted for 44 basis points ofthe erosion and lower margin on increased sales at the fuel centers whichaccounted for 82 basis points of the erosion. The Company believes the erosion of margin due to increase freight costswill continue through the end of the year. The margin was further impacted by the markdowns associated with theclearance of patio and garden products that had not sold.  This clearance, which reduced margin by 50basis points, while normal to running a retail business, has resulted in theCompany changing its method of managing these categories in an effort to avoidthis same problem in the future.

***SG&A***

Selling,general and administrative expense increased $1,876 or 6.0%, to $32,953 in thethird quarter of fiscal 2007 compared to $31,077 in the third quarter of fiscal2006.  As a percentage of net sales,selling, general and administrative expenses in the third quarter of fiscal2007 were 30.0%, compared to 30.9% in the third quarter of fiscal 2006.  The increase in selling, general andadministrative expenses was due in part to an increase in store level wages,increase in expenses related to stock options, professional fees and softwaremaintenance associated with rollout of IT initiative, increase in insurance andutilities, store level professional fees, offset by increased vendorparticipation in CO-OP advertising.

***Depreciation and Amortization***

Depreciationand amortization expense increased $220, or 15.4%, to $1,647 in the thirdquarter of fiscal 2007 compared to $1,427 in the third quarter of fiscal2006.  The increase is primarily due tonew stores opened in the fourth quarter of fiscal 2006 and the first quarter offiscal 2007 and items related to IT initiative.

** **

13

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***Interest Expense***

Interestexpense increased $455, or 128.5%, to $809 in the third quarter of fiscal 2007compared to $354 in the third quarter of fiscal 2006.  The increase in interest expense was due tohigher levels of borrowing and an increase in the interest rate for fiscal2007.

***Income Taxes***

TheCompany’s effective tax rate on earnings from continuing operations in thethird quarter of fiscal 2007 was 41.42%, compared to 35.4% in the third quarterof fiscal 2006.  The effective tax rateis higher due to the expiration of work opportunity employment tax credits andpermanent tax differences relating to stock compensation expense.

***Earnings (Loss) from Discontinued Operations***

Lossfrom discontinued operations, net of income tax, was $97 in the third quarterof fiscal 2007, compared to a loss from discontinued operations of $297 in thethird quarter of fiscal 2006.  Storesclosed where the Company has exited the market are reflected in discontinuedoperations in all periods presented.

**Thirty-NineWeeks Ended October 29, 2006 Compared to Thirty-Nine Weeks Ended October 30,2005.**

***Net Sales***

Netsales for the thirty-nine week period of fiscal 2007 increased $32,515, or10.6%, to $339,124 compared to $306,609 for the thirty-nine period of fiscal2006.  Same store sales increased 6.6%when compared with the prior year.  Thesales were favorably impacted by customer acceptance of its current merchandisestrategy that focuses on soft-lines, a 3.3% increase in customer count and a7.0% increase in average sale generated. Fuel sales also contributed to same store sales increases.

***Gross Margin***

Grossmargin for the thirty-nine week period of fiscal 2007 increased $7,248, or7.6%, to $102,910 compared to $95,662 in the thirty-nine week period of fiscal2006.  Gross margin as a percentage ofsales was 30.4% for the thirty-nine week period of fiscal 2007 compared to31.20% for the thirty-nine week period of fiscal 2006.  The decrease in the gross margin aspercentage of sales was due to higher promotional and other markdowns in thenormal course of business, higher freight costs resulting from higher fuelprices (a 23.2% increase compared to the thirty-nine week period of fiscal2006), and lower margin achieved on the increased sales at the fuel centers.

***SG&A***

Selling,general and administrative expense increased $2,747, or 3.0%, to $94,059 in thethirty-nine week period of fiscal 2007 compared to $91,312 in the thirty-nineweek period of fiscal 2006.  As apercentage of net sales, selling, general and administrative expenses in thethirty-nine week period of fiscal 2007 were 27.8%, compared to 29.8% in thethirty-nine week period of fiscal 2006. The decrease in selling, general and administrative expenses as apercentage of net sales was due in part to one time costs of approximately $734associated with the Company’s restructuring and workforce reduction in fiscal2006 that was not repeated in fiscal 2007 and an increase in vendorparticipation in CO-OP advertising, offset by increased payroll, increase inexpenses related to stock options, increase in credit card fees, increase inadvertising, professional services and software maintenance fees associatedwith rollout of IT initiative, increase in utilities, travel and new storerents.

 

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*** ***

***Depreciation and Amortization***

Depreciationand amortization expense increased $556, or 12.7%, to $4,919 in the thirty-nineweek period of fiscal 2007 compared to $4,363 in the thirty-nine week period offiscal 2006.  The increase is primarilydue to new stores opened in the fourth quarter of fiscal 2006 and the firstquarter of fiscal 2007.

***Interest Expense***

Interestexpense increased $1,201, or 148.30%, to $2,009 in the thirty-nine week periodof fiscal 2007 compared to $809 in the thirty-nine week period of fiscal2006.  The increase in interest expensewas due to higher levels of borrowing and increase in the interest rate for thethirty-nine week period of fiscal 2007.

***Income Taxes***

TheCompany’s effective tax rate on earnings from continuing operations for thethirty-nine week period of fiscal 2007 was 41.4%, compared to 35.3% in thethirty-nine week period of fiscal 2006. The effective tax rate is higher due to the expiration of workopportunity employment tax credits and permanent tax differences relating tostock compensation expense.

***Earnings (Loss) from Discontinued Operations***

Earningsfrom discontinued operations, net of income tax, was $72 in the thirty-nineweek period of fiscal 2007, compared to a loss from discontinued operations of$2,575 in the thirty-nine week period of fiscal 2006.  The increase in earnings from discontinuedoperations relates to the Company’s closing of 20 unprofitable stores in thethirty-nine week period of fiscal 2006 compared with one store closing in thethirty-nine week period of fiscal 2007. Additionally, the Company sold a property held for sale in relation tothe closings in fiscal 2006 in the thirty-nine week period of fiscal 2007resulting in a gain of $351. Stores closed where the Company has exited themarket are reflected in discontinued operations in all periods presented.

***SG&ADetail; Certain Financial Measures***

TheCompany believes the following detailed information is useful in analyzing itsbusiness results.  All informationpresented is from continuing operations.
| ** **                                      | ** ** | **For the Thirteen Week  Period Ended** | ** ** | **For the Thirty-Nine Week  Period Ended** | ** ** |
|-------------------------------------------------|------------|-------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| **SG&A Expenses Breakout**        | ** ** | ** **                                                  | ** ** | **October 29,  2006**                                     | ** ** | **October 30,  2005** | ** ** | **October 29,  2006** | ** ** | **October 30,  2005** | ** ** |
| ** **                                      | ** ** | ** **                                                  | ** ** | ** **                                                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| General Office                                  |       | 2,224                                                       |       | 3,268                                                          |       | 7,361 |   | 11,605 |   |
|                                            |       |                                                        |       |                                                           |       |   |   |   |   |
| Distribution  Center                            |       | 2,411                                                       |       | 2,080                                                          |       | 6,369 |   | 6,041 |   |
|                                            |       |                                                        |       |                                                           |       |   |   |   |   |
| SPD Truck Lines                                 |       | —                                                      |       | 297                                                            |       | — |   | 810 |   |
|                                            |       |                                                        |       |                                                           |       |   |   |   |   |
| 401K/Profit  Sharing                            |       | 124                                                         |       | —                                                         |       | 358 |   | — |   |
|                                            |       |                                                        |       |                                                           |       |   |   |   |   |
| Comparable  Stores SG&A                     |       | 25,887                                                      |       | 24,505                                                         |       | 74,323 |   | 71,208 |   |
|                                            |       |                                                        |       |                                                           |       |   |   |   |   |
| Non Comp Stores  SG&A #                     |       | 2,039                                                       |       | 927                                                            |       | 5,108 |   | 1,647 |   |
|                                            |       |                                                        |       |                                                           |       |   |   |   |   |
| Stock Option Expense                            |       | 268                                                         |       | —                                                         |       | 541 |   | — |   |
| Final SG&A  as reported on 3rd Qtr 10Q |       | 32,953                                                      |       | 31,077                                                         |       | 94,059 |   | 91,312 |   |
|                                            |       |                                                        |       |                                                           |       |   |   |   |   |
| Return on  Average Equity****                   |       | 1.40                                                        | %          | -0.29                                                          | %          | 1.94 | % | -2.82 | % |
| (ROE)                                           |       |                                                        |       |                                                           |       |   |   |   |   |
|                                            |       |                                                        |       |                                                           |       |   |   |   |   |
| Net Sales                                       |       | $                                                           | 110,109    |                                                           | $          | 100,740 |   | $ | 339,124 |   | $ | 306,609 |   |
|                                                 |            |                                                             |            |                                                                |            |  |  |  |  |  |  |  |  |  |  |

 

15

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|                                                               |   |   |   |   |   |   |   |   |   |
|--------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
| SG&A as % of  Sales                                            |   | 29.93  | %      | 30.85  | %      | 27.74  | %      | 29.78  | %      |
|                                                               |   |   |   |   |   |   |   |   |   |
| SG&A per  average selling square foot                          |   | $      | 7.89   |   | $      | 7.89   |   | $      | 22.77  |   | $ | 23.32 |   |
|                                                               |   |   |   |   |   |   |   |   |   |
| SG&A per  average selling square foot                          |   | $      | 7.89   |   | $      | 7.89   |   | $      | 22.77  |   | $ | 23.32 |   |
|                                                               |   |   |   |   |   |   |   |   |   |
| EBITDA**                                                           |   | $      | 1,608  |   | $      | 1,479  |   | $      | 9,389  |   | $ | 4,350 |   |
|                                                               |   |   |   |   |   |   |   |   |   |
| EBITDA per  average selling square foot***                         |   | $      | .39    |   | $      | 0.38   |   | $      | 2.27   |   | $ | 1.11 |   |
|                                                               |   |   |   |   |   |   |   |   |   |
| Sales per  average selling square feet*                            |   |   |   |   |   |   |   |   |   |
| ALCO                                                               |   | $      | 27.35  |   | $      | 26.59  |   | $      | 84.17  |   | $ | 80.22 |   |
| Duckwall                                                           |   | $      | 19.56  |   | $      | 19.05  |   | $      | 60.68  |   | $ | 59.73 |   |
| Total                                                              |   | $      | 26.37  |   | $      | 25.58  |   | $      | 82.10  |   | $ | 78.31 |   |
|                                                               |   |   |   |   |   |   |   |   |   |
| Average Selling  Square Feet*                                      |   | 4,176  |   | 3,939  |   | 4,131  |   | 3,915  |   |
| Average Square  Feet% Change                                       |   | 6.5    | %      | 2.1    | %      | 5.5    | %      | 2.1    | %      |
|                                                               |   |   |   |   |   |   |   |   |   |
| Total Stores  Operating beginning of Period                        |   | 254    |   | 245    |   | 251    |   | 266    |   |
| Total Stores  Operating end of Period                              |   | 253    |   | 249    |   | 253    |   | 249    |   |
|                                                               |   |   |   |   |   |   |   |   |   |
| Supplemental  Data:                                                |   |   |   |   |   |   |   |   |   |
| Same Store Sales  Change                                           |   | 5.9    | %      | 4.3    | %      | 6.6    | %      | 2.5    | %      |
| Total customer  count change                                       |   | 1.4    | %      | 2.0    | %      | 3.3    | %      | 1.8    | %      |
| Average sale per  ticket change                                    |   | 7.1    | %      | 4.9    | %      | 7.0    | %      | 3.5    | %      |
|                                                               |   |   |   |   |   |   |   |   |   |
| Average  annualized New Store Sale performance on prototype Stores |   | $      | 2,227  |   |   |   |   |   |   |   |
| Incremental  expenses related to IT initiative                     |   | $      | 274    |   |   |   | $      | 694    |   |   |   |
|                                                               |   |   |   |   |   |   |   |   |   |

----

*                         Averageselling square feet is (beginning square feet plus ending square feet) dividedby 2. 

**                  EBITDA isearnings from continuing operations before interest, taxes, depreciation andamortization, and stock option expense.

***           EBITDA per sellingsquare foot is a non-GAAP financial measure and is calculated as EBITDA dividedby selling square feet.

****    Return on average equity (ROE)is calculated as Net Earnings divided by average stockholders’ equity. AverageStockholders’ Equity is calculated as (beginning of period stockholders’ equityplus end of  period stockholders’ equity)divided by 2.

#                         Non CompStores are those stores opened in Fiscal 2006 & Fiscal 2007.

 

 

*Fiscal2007 Compared to Fiscal 2006*

GeneralOffice expenses for fiscal 2007 decreased $4,244 or 36.6%.  The decrease was due in part to one timecosts of approximately $734 associated with the Company’s restructuring andworkforce reduction in fiscal 2006 not repeated in fiscal 2007 and the relatedpayroll savings in fiscal 2007 relating to these reductions, and a $4,778increase in vendor participation in CO-OP advertising programs, offset byincreased utility costs.

SPDTruck Line is no longer in operation as the Company has contracted with adedicated service provider.

Comparablestore SG&A expenses increased $3,115 or 4.4%.  Advertising, insurance, wages, rent, utilitiesand credit card fees accounted for the majority of this increase.

 

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NonComparable Stores SG&A expenses increased $3,461 or 210.1%.  The Company has opened 15 stores since thefirst quarter of fiscal 2006.

***Reconciliationand Explanation of Non-GAAP Financial Measures***

Thefollowing table shows the reconciliation of EBITDA per selling square foot toearnings (loss) from continuing operations, the most directly comparablefinancial measure calculated and presented in accordance with GAAP:

 
| ** **                                       | ** ** | **For the Thirteen Week  Period Ended** | ** ** | **For the Thirty-nine Week  Period Ended** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                       | ** ** | **October 29,  2006**                                  | ** ** | **October 30,  2005**                                     | ** ** | **October 29,  2006** | ** ** | **October 30,  2005** | ** ** |
|                                             |       |                                                        |       |                                                           |       |   |   |   |   |
| Earnings from  continuing operations             |       | (551                                                        | )          | 110                                                            |       | 1,238 |   | (636 | ) |
| Plus interest                                    |       | 809                                                         |       | 354                                                            |       | 2,010 |   | 809 |   |
|                                             |       |                                                        |       |                                                           |       |   |   |   |   |
| Plus taxes                                       |       | (564                                                        | )          | (412                                                           | )          | 684 |   | (186 | ) |
| Plus  depreciation and amortization              |       | 1,647                                                       |       | 1,427                                                          |       | 4,919 |   | 4,363 |   |
| Plus stock  option expense                       |       | 268                                                         |       | —                                                         |       | 541 |   | — |   |
| =EBITDA                                          |       | 1,609                                                       |       | 1,479                                                          |       | 9,392 |   | 4,350 |   |
|                                             |       |                                                        |       |                                                           |       |   |   |   |   |
| Earnings from  continuing operations per sq foot |       | $                                                           | (0.13      | )                                                              | $          | 0.03 |   | $ | 0.30 |   | $ | (0.16 | ) |
| Plus interest  per sq foot                       |       | $                                                           | 0.19       |                                                           | $          | 0.09 |   | $ | 0.49 |   | $ | 0.21 |   |
| Plus taxes per  sq foot                          |       | $                                                           | (0.14      | )                                                              | $          | (0.10 | ) | $ | 0.17 |   | $ | (0.05 | ) |
| Plus  depreciation and amortization per sq foot  |       | $                                                           | 0.39       |                                                           | $          | 0.36 |   | $ | 1.19 |   | $ | 1.11 |   |
| Plus stock option  expense per sq foot           |       | $                                                           | 0.06       |                                                           | $          | 0.00 |   | $ | 0.13 |   | $ | 0.00 |   |
| =EBITDA per  selling sq foot                     |       | $                                                           | 0.37       |                                                           | $          | 0.38 |   | $ | 2.28 |   | $ | 1.11 |   |

 

***LIQUIDITY AND CAPITAL RESOURCES***

TheCompany’s primary sources of funds are cash flows from operations, borrowingsunder its revolving loan credit facility, and vendor trade credit financing(increases in accounts payable).

AtOctober 29, 2006 working capital (defined as current assets less currentliabilities) was $116,575 compared to $90,634 at the end of fiscal 2006.  The increase in working capital wasattributable to increases in inventory, accounts receivable, accounts payable,income tax receivable and cash and cash equivalents; and decreases stockpurchase payments and accrued salaries and commissions.

TheCompany has a loan agreement with its lenders that provides a revolving loancredit facility of up to $70,000 of long-term financing.  The amount advanced (through a note orletters of credit) to the Company under the credit facility bears interest at(i) the prime rate plus a margin, as defined, which varies based on the amountoutstanding (Base Loan) or (ii) based on the Euro dollar rate plus a margin, asdefined, (Index Loan).  Based upon itsprojected financial requirements, the Company uses a combination of short termEuro dollar contracts and borrowing at prime. The amount advanced is generally limited to 70% of eligible inventory,as defined in the loan agreement. Advances are secured by a security interest in the Company’sinventory.  The loan agreement containsvarious restrictions that are applicable if the Company fails to maintainexcess availability of at a least $27,500, including limitations on additionalindebtedness, acquisitions of assets and payment of dividends.  The loan agreement expires on April 15,2010.  As of October 29, 2006, theCompany has borrowed $32,664 under this facility.  The lender had 

 

17

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also issuedletters of credit aggregating $4,083 at such date on behalf of theCompany.  Availability under thisfacility as of October 29, 2006 was $33,253.

Cash(used in) provided by operating activities in the thirty-nine week period offiscal 2007 and 2006 was ($15,192) and $3,361 respectively.  The decrease in the amount of cash providedby operating activities in the thirty-nine week period of fiscal 2007 comparedto the thirty-nine week period of fiscal 2006 was primarily due to a increasein inventory relating to the stores opened since fiscal 2006, a decrease inaccrued salaries and wages, and a decrease in income taxes payable; offset byan increase in accounts payable from renegotiated vendor terms.

Totalanticipated cash payments for acquisition of property and equipment in fiscal2007, principally for improvements, store buildings and store and warehousefixtures and equipment are approximately $9,000.  Cash provided by (used in) investingactivities (including acquisitions and remodeling) in the thirty-nine weekperiod of fiscal 2007 and 2006 totaled $7,300 and ($12,216), respectively,which were used primarily for the acquisition of property and equipment, offsetin fiscal 2007 by the proceeds from the sale of assets.  During the thirty-nine week period endedOctober 29, 2006, the Company completed sales/leaseback transactions on 11 ALCOretail locations for $11,229.  Theremaining amount is due to the sale of a previously closed location.

TheCompany provided by cash from financing activities in the thirty-nine weekperiod of fiscal 2007 and 2006 of $12,267 and $10,321 respectively.  Net borrowings on the revolving loangenerated $15,602 during the thirty-nine week ended October 29, 2006, comparedto $23,281 during the thirty-nine week period of the prior fiscal year.  Cash used to purchase and retire 3,337 and399,362 shares of Common Stock was $2,012 and $12,638 for the thirty-nine weekperiod of fiscal 2007 and 2006, respectively. The Board of Directors of the Company has authorized the Company torepurchase up to 2,014,461 shares of Common Stock, of which 1,817,798 shareshad been purchased as of October 29, 2006. The Company continues to evaluate the timing and pricing of future sharerepurchases.

***BUSINESS OPERATIONS AND SEGMENT INFORMATION***

TheCompany’s business activities include operation of ALCO discount stores intowns with populations which are typically less than 5,000 not served by otherregional or national full-line discount chains and Duckwall variety stores thatoffer a more limited selection of merchandise which are primarily located incommunities of less than 2,500 residents.

Forfinancial reporting purposes, the Company has established two operatingsegments: “ALCO Discount Stores”, and “All Other”, which includes the Duckwallvariety stores and other business activities, such as general office, warehouseand distribution activities.
| ** **                     | ** ** | **For The Thirteen Week  Period Ended** | ** ** | **For The Thirty-Nine  Week Period Ended** | ** ** |
|--------------------------------|------------|-------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                     | ** ** | **October 29,**                                        | ** ** | **October 30,**                                           | ** ** | **October 29,** | ** ** | **October 30,** | ** ** |
| ** **                     | ** ** | **2006**                                                    | ** ** | **2005**                                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Segment  Information           |       |                                                        |       |                                                           |       |   |   |   |   |
|                           |       |                                                        |       |                                                           |       |   |   |   |   |
| Net Sales:                     |       |                                                        |       |                                                           |       |   |   |   |   |
| ALCO Discount Stores           |       | $                                                           | 102,979    |                                                           | $          | 93,748 |   | $ | 317,001 |   | $ | 284,847 |   |
| All Other                      |       |                                                        |       |                                                           |       |   |   |   |   |
| External                       |       | 7,130                                                       |       | 6,992                                                          |       | 22,123 |   | 21,762 |   |
| Intercompany                   |       | 71,908                                                      |       | 71,837                                                         |       | 195,480 |   | 185,619 |   |
|                           |       | $                                                           | 182,017    |                                                           | $          | 172,577 |   | $ | 534,604 |   | $ | 492,228 |   |
|                           |       |                                                        |       |                                                           |       |   |   |   |   |
| Depreciation and  Amortization |       |                                                        |       |                                                           |       |   |   |   |   |
| ALCO Discount Stores           |       | $                                                           | 808        |                                                           | $          | 921 |   | $ | 2,493 |   | $ | 2,750 |   |
| All Other                      |       | 839                                                         |       | 506                                                            |       | 2,426 |   | 1,613 |   |
|                           |       | $                                                           | 1,647      |                                                           | $          | 1,427 |   | $ | 4,919 |   | $ | 4,363 |   |

 

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| Income (expense)  from Operations: |   |   |    |   |   |    |   |    |    |
|------------------------------------|--------|--------|---------|--------|--------|---------|--------|---------|---------|
| ALCO Discount Stores               |   | $      | 5,400   |   | $      | 6,282   |   | $       | 20,397  |   | $ | 20,839 |   |
| All Other                          |   | (5,648 | )       | (6,146 | )      | (16,238 | )      | (20,598 | )       |
|                               |   | $      | (248    | )      | $      | 136     |   | $       | 4,159   |   | $ | 241 |   |
|                               |   |   |    |   |   |    |   |    |    |
| Capital  Expenditures:             |   |   |    |   |   |    |   |    |    |
| ALCO Discount Stores               |   | $      | 649     |   | $      | 3,309   |   | $       | 3,392   |   | $ | 6,027 |   |
| All Other                          |   | 1,076  |    | 5,204  |   | 2,233   |   | 6,189   |    |
|                               |   | $      | 1,725   |   | $      | 8,513   |   | $       | 5,625   |   | $ | 12,216 |   |
|                               |   |   |    |   |   |    |   |    |    |
| Identifiable  Assets:              |   |   |    |   |   |    |   |    |    |
| ALCO Discount Stores               |   | $      | 148,122 |   | $      | 139,366 |   | $       | 148,122 |   | $ | 139,366 |   |
| All Other                          |   | 59,365 |    | 45,297 |   | 59,365  |   | 45,297  |    |
|                               |   | $      | 207,487 |   | $      | 184,663 |   | $       | 207,487 |   | $ | 184,663 |   |

 

Income fromoperations as reflected in the above segment information has been determineddifferently than income from operations in the accompanying consolidatedstatements of operations as follows:

*IntercompanySales*

Intercompany sales represent transfers of merchandisefrom the warehouse to ALCO discount stores and Duckwall variety stores.

*IntercompanyExpense Allocations*

General and administrative expenses incurred at thegeneral office have not been allocated to the ALCO Discount Stores for purposesof determining income from operations for the segment information.

Warehousing and distribution costs, including freightapplicable to merchandise purchases, have been allocated to the ALCO DiscountStores segment based on the Company’s customary method of allocation for suchcosts.

*Inventories*

LIFO reserves are allocated to the ALCO and other forthe segment reporting based on ALCO and Duckwall proportionate inventorylevels.

*Leases*

All leases are accounted for as operating leases forpurposes of determining income from operations for purposes of determining thesegment information for the ALCO Discount Stores whereas capital leases areaccounted for as such in the consolidated statements of operations.

Identifiable assets as reflected in the above segment informationinclude cash and cash equivalents, receivables, inventory, property andequipment, and property under capital leases.

##### Areconciliation of the segment information to the amounts reported in theconsolidated financial statements is presented below: 

| ** **                                                                | ** ** | **For The Thirteen Week  Period Ended** | ** ** | **For The Thirty-Nine  Week Period Ended** | ** ** |
|---------------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                                | ** ** | **October 29,**                                        | ** ** | **October 30,**                                           | ** ** | **October 29,** | ** ** | **October 30,** | ** ** |
| ** **                                                                | ** ** | **2006**                                                    | ** ** | **2005**                                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                                      |       |                                                        |       |                                                           |       |   |   |   |   |
| Net sales per  above segment information                                  |       | $                                                           | 182,017    |                                                           | $          | 172,577 |   | $ | 534,604 |   | $ | 492,228 |   |
| Intercompany  elimination                                                 |       | 71,908                                                      |       | 71,837                                                         |       | 195,480 |   | 185,619 |   |
|                                                                      |       |                                                        |       |                                                           |       |   |   |   |   |
| Net sales per  consolidated statements of operations                      |       | $                                                           | 110,109    |                                                           | $          | 100,740 |   | $ | 339,124 |   | $ | 306,609 |   |
|                                                                      |       |                                                        |       |                                                           |       |   |   |   |   |
| Income (loss)  from operations per above segment information              |       | $                                                           | (248       | )                                                              | $          | 136 |   | $ | 4,159 |   | $ | 241 |   |
| Leases                                                                    |       | 58                                                          |       | 84                                                             |       | 227 |   | 254 |   |
|                                                                      |       |                                                        |       |                                                           |       |   |   |   |   |
| Income (loss) from  operations per consolidated  statements of operations |       | $                                                           | (306       | )                                                              | $          | 52 |   | $ | 3,932 |   | $ | (13 | ) |

 

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##### ***ITEM 3.  *QUANTITATIVEAND QUALITATIVE DISCLOSURE ABOUT MARKET RISK**

***INSTRUMENTSENTERED INTO OTHER THAN FOR TRADING — INTEREST RATE RISK***

TheCompany is exposed to various types of market risk in the normal course of itsbusiness, including the impact of interest rate changes.  The Company may enter into interest rateswaps to manage its exposure to interest rate changes, and we may employ otherrisk management strategies, including the use of foreign currency forwardcontracts.  The Company does notcurrently hold any derivative instruments and would enter into such instrumentssolely for cash flow hedging purposes and not for trading purposes.

Asdescribed under “Management’s Discussion and Analysis of Financial Conditionand Results of Operations-Liquidity and Capital Resources,” the Companyhas a variable interest rate debt facility that is subject to interest raterisk.  The Company uses this facility tomeet the short-term needs of its capital improvements and inventory purchasesand other operating activities.  Theseobligations expose the Company to variability in interest payments due tochanges in interest rates.  If interestrates increase, interest expense increases. Conversely, if interest rates decrease, interest expense also decreases.Based on the Company’s current borrowings under its revolving credit facility,if interest rates were to increase 1% on an annual basis interest expense wouldincrease $327.

The Company hasand continues to analyze its debt structure in relation to interest raterisk.  The Company believes that with themix of debt instruments it is using — revolving line of credit, capital leasesand operating leases — that its current structure adequately addresses theserisk issues.  This process of evaluationis continuous and the Company will adjust its debt structure as is appropriateto the market situation.

**ITEM 4.   CONTROLS ANDPROCEDURES**

**(a)   Evaluationof Disclosure Controls and Procedures**

Under thesupervision and with the participation of management, including the ChiefExecutive Officer and Chief Financial Officer, the Company evaluated the designand operation of its disclosure controls and procedures (as defined in Rules13a-15(e) and 15d-15(e) of the Securities and Exchange Act of 1934, or the“Exchange Act”) for the quarter ended October 29, 2006.

Based upon thatevaluation, the Chief Executive Officer and Chief Financial Officer haveconcluded that the Company’s disclosure controls and procedures were noteffective as of October 29, 2006 because of the material weaknesses discussedbelow.

To address thematerial weaknesses described below, the Company performed additional analysisand other post-closing procedures to ensure that the consolidated financialstatements were prepared in accordance with generally accepted accountingprinciples.  Accordingly, management,including the Chief Executive Officer and Chief Financial Officer, believe theconsolidated financial statements included in this report present, in allmaterial respects, the Company’s financial condition, results of operations andcash flows for the quarter ended October 29, 2006.

 

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**(b)   Management’sReport on Internal Control Over Financial Reporting**

Managementof the Company is responsible for establishing and maintaining adequate controlover financial reporting as defined in Rules 13a-15(f) under the Securities andExchange Act of 1934, as amended. The Company’s internal control system is aprocess designed to provide reasonable assurance to the Company’s management,Board of Directors and shareholders regarding the reliability of financialreporting and the preparation of financial statements for external reportingpurposes in accordance with U.S. generally accepted accounting principles.  Because of its inherent limitations, internalcontrol over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

Amaterial weakness represents a significant deficiency (as defined in the PublicCompany Accounting Oversight Board’s Auditing Standard No. 2), or a combinationof significant deficiencies, that results in more than a remote likelihood thata material misstatement of the annual or interim financial statements will notbe prevented or detected on a timely basis.

Managementassessed the effectiveness of the Company’s internal control over financialreporting as of October 29, 2006 based on the criteria established in *Internal Control- Integrated Framework*issued**by the Committee of Sponsoring Organizations of theTreadway Commission (“COSO”).  As aresult of this assessment, management concluded that the Company’s internalcontrol over financial reporting was not effective as of October 29, 2006.

 Management’s assessment identified thefollowing material weaknesses in the Company’s internal control over financialreporting as of October 29, 2006:

**1.**               The Company has not established controls to require a review of certaininformation prepared for inclusion in the Company’s financial statements.  Specifically:

·                 TheCompany’s information system generates a report of all changes in or additionsto its accounts payable vendor master file. The Company does not have a control that requires a review of thisreport by personnel independent of the accounts payable function to assure thatall changes were properly authorized.

·                 TheCompany makes manual journal entries as part of its reconciliation and closingprocess.  The Company does not have acontrol that requires a review of these journal entries and supporting analysisby someone other than the preparer prior to being recorded in the generalledger.

·                 TheCompany does not have a control that requires a sufficiently detailed review ofthe Company’s financial statements prior to their issuance.

·                  TheCompany records vendor support based on management estimates. The Company hasnot established controls to validate this estimate through comparison to actualpurchasing activity upon which the vendor support is based.

As a result of thisdeficiency, adjustments were made to cash, inventory and accruedliabilities.  Furthermore, there is amore than a remote likelihood that a material misstatement of our annual orinterim financial statements would not have been prevented or detected.

**2.**               The Company has insufficient controls to ensure that warehouse inventoryand cost of sales are properly reported in the interim financialstatements.  Specifically, warehouseinventory is only reconciled to the general ledger annually.  This deficiency resulted in more than aremote likelihood that a material misstatement of our interim financialstatements would not have been prevented or detected.

 

21

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** **

**(c)   Changes in InternalControl over Financial Reporting**

TheCompany is currently implementing procedures to establish and maintain controlswhich will result in all necessary reviews being performed. To date, theCompany has moved the responsibility for updating the vendor master file to adepartment independent of accounts payable. The procedures for secondary review of journal entries and supportinganalysis have been modified to assure adequate review.  The Company is currently implementingprocedures to ensure that detailed reconciliations are being prepared.  The Company initiated the development andimplementation of controls over the development of the financial statements inthe fourth quarter of fiscal 2006.  TheCompany has designed and implemented procedures to reconcile the warehouseinventory to the general ledger on a quarterly basis.  The Company will continue to review theseprocesses and reevaluate and test these controls to determine that theseweaknesses have been remediated.

Therewere no changes in the Company’s internal control over financial reporting thatoccurred during the quarter ended October 29, 2006 that materially affected, orare reasonably likely to material affect, the Company’s internal control overfinancial reporting.

##### **PART II - OTHER INFORMATION**

**ITEM 1.   LEGALPROCEEDINGS**

The Company is a party toroutine litigation from time to time in the ordinary course of business.

**ITEM 1A.   RISK FACTORS**

The Company encourages investors to carefully consider the risksdescribed below and other information contained in this document whenconsidering an investment decision with respect to he Company’s securities.Additional risks and uncertainties not presently known to management, or thatmanagement currently deems immaterial, may also impair the Company’s businessoperations. Any of the events discussed in the risk factors below may occur. Ifone or more of these events do occur, business, results of operations orfinancial condition could be materially adversely affected. In that instance, thetrading price of the Company’s securities could decline, and investors mightlose part or all of their investment.

**EconomicConditions**

Similar to other retail businesses, the Company’s operations may beaffected adversely by general economic conditions and events which result inreduced consumer spending in the markets served by its stores. Also, smallercommunities where the Company’s stores are located may be dependent upon a fewlarge employers or may be significantly affected by economic conditions in theindustry upon which the community relies for its economic viability, such asthe agricultural industry. This may make the Company’s stores more vulnerableto a downturn in a particular segment of the economy than the Company’scompetitors, which operate in markets which are larger metropolitan areas wherethe local economy is more diverse.

**Competition**

The Company operates in the discount retail business, which is highlycompetitive. Although the Company prefers markets that don’t have directcompetition from national or regional full-line discount stores, competitionstill exists. Even in non-competitive markets, the Company’s customers shop atretail discount stores and other retailers located in regional trade centers.The Company also competes for retail sales with other entities, such as mailorder companies, specialty retailers, mass merchandisers, dollar stores,manufacturer’s outlets, and the internet. This competitive environment subjectsthe Company to the risk of reduced profitability because the Company may beforced to lower its prices, resulting in lower margins, in order to maintainits competitive position.

 

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** **

**StoreExpansion**

The growth in the Company’s sales and operating net income depends to asubstantial degree on its expansion program. This expansion strategy isdependent upon the Company’s ability the open and operate new storeseffectively, efficiently, and on a profitable basis. The Company prefers tolocate its ALCO stores in smaller retail markets where no competing full-linediscount retail store is located within the primary trade area. The Company’sability to timely open new stores and to expand into additional market areasdepends in part on the following factors: availability of store locations, theability to hire and train new store personnel, the ability to react to consumerneeds and trends on a timely basis, and the availability of sufficient capitalfor expansion.

**InformationTechnology**

The Company’s ability to implement and train employees on the new POSsoftware, its ability to utilize technology upgrades, and to meet thetimetables for rolling out the new technology to the stores could have amaterial impact on the Company’s results of operations.

**GovernmentRegulation**

The Company is subject to numerous federal, state and local governmentlaws and regulations, including those relating to the development, constructionand operation of the Company’s stores. The Company is also subject to lawsgoverning its relationship with employees, including minimum wage requirements,laws and regulations relating to overtime, working and safety conditions, andcitizenship requirements. Material increases in the cost of compliance with anyapplicable law or regulation and similar matters could materially and adverselyaffect the Company.

**QuarterlyFluctuations**

Quarterly results of operations have historically fluctuated as aresult of retail consumers purchasing patterns, with the highest quarter interms of sales and profitability being the fourth quarter. Quarterly results ofoperations will likely continue to fluctuate significantly as a result of suchpatterns and may fluctuate due to the timing of new store openings.

**Dependenceon Officers**

The development of the Company’s business is largely dependent on theefforts of its current management team headed by Bruce C. Dale and seven otherexecutive officers. The loss of the services of one or more of these officerscould have a material adverse effect on the Company.

**InterestRate Risk**

The Company is subject to market risk from exposure to changes ininterest rates based on its financing requirements. Changes in interest ratescould have a negative impact on the Company’s profitability.

 

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** **

**ITEM 2.   UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

The Board of Directors of the Company has authorizedthe Company to repurchase up to 2,014,461 shares of Common Stock, of which1,817,798 shares had been purchased as of October 29, 2006.  The following are details of repurchasesunder this program for the period covered by this report: 
| ** **                             | ** ** | ** **                      | ** ** | ** **                   | ** ** | ** **                      | ** ** | **Maximum Number**                  | ** ** |
|----------------------------------------|------------|---------------------------------|------------|------------------------------|------------|---------------------------------|------------|------------------------------------------|------------|
| ** **                             | ** ** | ** **                      | ** ** | ** **                   | ** ** | **Total Number of**   | ** ** | **(or Approximate **           | ** ** |
| ** **                             | ** ** | ** **                      | ** ** | ** **                   | ** ** | **shares (or Units)** | ** ** | **Dollar Value) **                  | ** ** |
| ** **                             | ** ** | ** **                      | ** ** | ** **                   | ** ** | **Purchased as Part** | ** ** | **of Shares (or**              | ** ** |
| ** **                             | ** ** | **Total Number Of**   | ** ** | **Average Price**       | ** ** | **of Publicly **      | ** ** | **Units) that May Yet**   | ** ** |
| ** **                             | ** ** | **Shares (or Units)** | ** ** | **Paid per Share** | ** ** | **Announced**                   | ** ** | **Be Purchased Under**         | ** ** |
| **Period**                             | ** ** | **Purchased**                   | ** ** | **(or Unit)**                | ** ** | **Plans or Programs** | ** ** | **the Plans or Programs** | ** ** |
|                                   |       |                            |       |                         |       |                            |       |                                     |       |
| February 1 –  February 28, 2006   |       | 0                               |       | 0                            |       | 0                               |       | 200,000                                  |       |
| March 1 – March  31, 2006         |       | 0                               |       | 0                            |       | 0                               |       | 200,000                                  |       |
| April 1 – April  30, 2006         |       | 0                               |       | 0                            |       | 0                               |       | 200,000                                  |       |
| May 1 – May 31,  2006             |       | 0                               |       | 0                            |       | 0                               |       | 200,000                                  |       |
| June 1 – June  30, 2006           |       | 0                               |       | 0                            |       | 0                               |       | 200,000                                  |       |
| July 1 – July  30, 2006           |       | 3,337                           |       | $                            | 30.46      |                            | 3,337      |                                     | 196,663    |   |
| August 1 –  August 31, 2006       |       | 0                               |       | 0                            |       | 0                               |       | 196,663                                  |       |
| September 1 –  September 30, 2006 |       | 0                               |       | 0                            |       | 0                               |       | 196,663                                  |       |
| October 1 – October 31,  2006     |       | 0                               |       | 0                            |       | 0                               |       | 196,663                                  |       |
|                                        |            |                                 |            |                              |            |                                 |            |                                          |            |  |

 

**ITEM 3.   DEFAULTSUPON SENIOR SECURITIES**

Not applicable.

**ITEM 4.   SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

None

**ITEM 5.   OTHERINFORMATION**

None.

**ITEM 6.   EXHIBITS**

See the ExhibitIndex immediately following the signature page hereto.

** **

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**SIGNATURES**

Pursuant to the requirements of the SecuritiesExchange Act of 1934 the registrant has duly caused this report to be signed onits behalf by the undersigned thereunto duly authorized.
|                         | ** **   | **DUCKWALL-ALCO STORES, INC.**                                                                                                                   |
|-------------------------|--------------|--------------------------------------------------------------------------------------------------------------------------------------------------|
| *** ***            | *** *** | ***                     (Registrant)*** |
| Date, December  8, 2006 | * *     | */s/ Michael S. Marcus*                                                                                                                          |
|                    |         | Michael S. Marcus                                                                                                                                |
|                    |         | Vice President — Finance, Chief Financial Officer                                                                                           |
|                    |         | Signing on behalf of  the registrant and as principal financial officer                                                                          |

** **

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**EXHIBIT INDEX**

2                                          StockPurchase Agreement dated April 19, 2005 with K&A Asset Management, LLC onbehalf of Kenneth A. Macke Revocable Trust (filed as Exhibit 10.20 to theCompany’s Annual Report on 10-K for the fiscal year ended January 30, 2005 andincorporated herein by reference)

3.1                                 Articlesof Incorporation of Duckwall-ALCO Stores, Inc., amended as of June 13, 1994 andrestated solely for filing with the Securities and Exchange Commission (filedas Exhibit 3.1 to Company’s Quarterly Report on Form 10-Q for the fiscalquarter ended August 1, 2004 and incorporated herein by reference).

3.2                                 Bylawsof Duckwall-ALCO Stores, Inc. (filed as Exhibit 3.2 to Company’s QuarterlyReport on Form 10-Q for the fiscal quarter ended August 1, 2004 andincorporated herein by reference).

4.1                                 Specimenof Duckwall-ALCO Stores, Inc. Common Stock Certificate. (filed as Exhibit 4.1to Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended August1, 2004 and incorporated herein by reference).

4.2                 Reference is made to the Amended and Restated Articles ofIncorporation described under 3.1 above and Bylaws described under 3.2 above.

4.3                                 Loan and Security Agreement, dated as ofApril 15, 2002, between the Company and Fleet Retail Finance Inc. (filed asExhibit 10.16 to the Company’s Annual Report on Form 10-K for the fiscal yearended February 2, 2003 and hereby incorporated by reference).

4.4                                 Loan and Security Agreement, dated as ofApril 15, 2002, between the Company and Fleet Retail Finance, Inc. (filed asExhibit 10.16 to the Company’s Annual Report on Form 10-K for the fiscal yearended February 2, 2003 and hereby incorporated by reference).

4.5                                 Joinder Agreement and First Amendment toLoan and Security Agreement dated September 9, 2002 among the Company, FleetRetail Finance Inc., and DA Good Buys, Inc. (filed as Exhibit 10.17 to theCompany’s Annual Report on Form 10-K for the fiscal year ended February 2, 2003and hereby incorporated by reference).

31.1                           Certification of Chief Executive Officerof Duckwall-ALCO Stores, Inc. dated December 8, 2006, pursuant to Rule 13a-4(a)under the Securities Exchange Act of 1934, as adopted pursuant to Section 302of the Sarbanes-Oxley Act of 2002.

31.2                           Certification of Chief Financial Officerof Duckwall-ALCO Stores, Inc. dated December 8, 2006, pursuant to Rule 13a-4(a)under the Securities Exchange Act of 1934, as adopted pursuant to Section 302of the Sarbanes-Oxley Act of 2002.

32.1                           Certification of Chief Executive Officerof Duckwall-ALCO Stores, Inc, dated December 8, 2006, pursuant to 18 U.S.C.Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of2002, which is furnished with this Quarterly Report on Form 10-Q for thequarter ended October 29, 2006 and is not treated as filed in reliance upon § 601(b)(32)of Regulations S-K.

32.2                           Certification of Chief Financial Officerof Duckwall-ALCO Stores, Inc., dated December 8, 2006, pursuant to 18 U.S.C.Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of2002, which is furnished with this Quarterly Report on Form 10-Q for thequarter ended October 29, 2006 and is not treated as filed in reliance upon§ 601(b)(32) of Regulations S-K.

** **

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