** **

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549**

**FORM 10-Q**

x **QUARTERLY REPORT PURSUANTTO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

**For thequarterly period ended April 30, 2006**

**OR**

o**TRANSITION REPORT PURSUANT TO SECTION 13or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

**CommissionFile Number 0-20269**

**DUCKWALL-ALCOSTORES, INC.**(Exact name of registrant as 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 telephone number including area code)

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.   Yes x No o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 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 Exchange Act).    Yes o No x

APPLICABLE ONLY TOCORPORATE ISSUERS:

3,790,386shares of common stock, $.0001 par value (the issuer’s only class of commonstock), were outstanding as of April 30, 2006.

 

 

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**PART I— FINANCIAL INFORMATION**

**ITEM 1. FINANCIAL STATEMENTS**

**Duckwall-ALCOStores, Inc.**

**AndSubsidiaries**

**ConsolidatedBalance Sheets**

(Dollars inThousands)

**Assets**
| ** **                         | ** ** | **April 30,** | ** ** | **January 29,** | ** ** |
|------------------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                         | ** ** | **2006**           | ** ** | **2006**             | ** ** |
| ** **                         | ** ** | **(Unaudited)**    | ** ** | ** **           | ** ** |
| Current assets:                    |       |               |       |                 |       |
| Cash and cash  equivalents         |       | $                  | 4,658      |                 | $          | 1,565 |   |
| Receivables                        |       | 2,209              |       | 1,781                |       |
| Inventories                        |       | 143,136            |       | 135,077              |       |
| Prepaid expenses                   |       | 2,312              |       | 2,621                |       |
| Property held  for sale            |       | 350                |       | 585                  |       |
|                               |       |               |       |                 |       |
| Total current  assets              |       | 152,665            |       | 141,629              |       |
|                               |       |               |       |                 |       |
| Property and equipment             |       | 95,478             |       | 92,615               |       |
| Less accumulated  depreciation     |       | 64,817             |       | 63,591               |       |
|                               |       |               |       |                 |       |
| Net property and  equipment        |       | 30,661             |       | 29,024               |       |
|                               |       |               |       |                 |       |
| Property under capital  leases     |       | 23,228             |       | 23,228               |       |
| Less accumulated  amortization     |       | 16,746             |       | 16,367               |       |
|                               |       |               |       |                 |       |
| Net property  under capital leases |       | 6,482              |       | 6,861                |       |
|                               |       |               |       |                 |       |
| Other non-current  assets          |       | 29                 |       | 55                   |       |
| Deferred income taxes              |       | 1,363              |       | 1,353                |       |
|                               |       |               |       |                 |       |
| Total assets                       |       | $                  | 191,200    |                 | $          | 178,922 |   |

 

See accompanying notes tounaudited consolidated financial statements.

 

** **

2

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**Duckwall-ALCOStores, Inc.**

**AndSubsidiaries**

**ConsolidatedBalance Sheets**

(Dollars inThousands)

**Liabilitiesand Stockholders’ Equity**
| ** **                                                                                                                                | ** ** | **April 30,** | ** ** | **January 29,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                                                                                                                                | ** ** | **2006**           | ** ** | **2006**             | ** ** |
| ** **                                                                                                                                | ** ** | **(Unaudited)**    | ** ** | ** **           | ** ** |
| Current  liabilities:                                                                                                                     |       |               |       |                 |       |
| Current maturities of capital lease obligations                                                                                           |       | $                  | 1,878      |                 | $          | 1,879 |   |
| Accounts payable                                                                                                                          |       | 31,542             |       | 28,300               |       |
| Income taxes payable                                                                                                                      |       | 348                |       | 1,163                |       |
| Accrued salaries and commissions                                                                                                          |       | 4,057              |       | 6,001                |       |
| Accrued taxes other than income                                                                                                           |       | 5,153              |       | 4,743                |       |
| Self-insurance claim reserves                                                                                                             |       | 4,137              |       | 3,915                |       |
| Stock purchase payable                                                                                                                    |       | —             |       | 1,910                |       |
| Other current liabilities                                                                                                                 |       | 2,740              |       | 2,998                |       |
| Deferred income taxes                                                                                                                     |       | 37                 |       | 86                   |       |
|                                                                                                                                      |       |               |       |                 |       |
| Total current liabilities                                                                                                                 |       | 49,892             |       | 50,995               |       |
|                                                                                                                                      |       |               |       |                 |       |
| Notes payable  under revolving loan                                                                                                       |       | 30,300             |       | 17,062               |       |
| Capital lease  obligations - less current maturities                                                                                      |       | 6,835              |       | 7,299                |       |
| Other noncurrent  liabilities                                                                                                             |       | 1,387              |       | 1,419                |       |
|                                                                                                                                      |       |               |       |                 |       |
| Total liabilities                                                                                                                         |       | 88,414             |       | 76,775               |       |
|                                                                                                                                      |       |               |       |                 |       |
| Stockholders’  equity:                                                                                                               |       |               |       |                 |       |
| Common stock, $.0001 par value, authorized 20,000,000  shares; issued and outstanding 3,790,386 shares and 3,786,953 shares  respectively |       | 1                  |       | 1                    |       |
| Additional paid-in capital                                                                                                                |       | 36,509             |       | 36,411               |       |
| Retained earnings                                                                                                                         |       | 66,276             |       | 65,735               |       |
| Total stockholders’ equity                                                                                                           |       | 102,786            |       | 102,147              |       |
|                                                                                                                                      |       |               |       |                 |       |
| Total  liabilities and stockholders’ equity                                                                                          |       | $                  | 191,200    |                 | $          | 178,922 |   |

 

**See accompanying notes tounaudited consolidated financial statements.**

** **

 

 

3

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**Duckwall-ALCOStores, Inc.**

**AndSubsidiaries**

**ConsolidatedStatements of Operations**

(Dollars in ThousandsExcept Per Share Amounts)

(Unaudited)
| ** **                                                       | ** ** | **For the Thirteen Week** | ** ** |
|------------------------------------------------------------------|------------|---------------------------|------------|
| ** **                                                       | ** ** | **Periods Ended**         | ** ** |
| ** **                                                       | ** ** | **April 30,**        | ** ** | **May 1,** | ** ** |
| ** **                                                       | ** ** | **2006**                  | ** ** | **2005** | ** ** |
| Net sales                                                        |       | $                         | 109,071    |   | $ | 98,026 |   |
| Cost of sales                                                    |       | 76,496                    |       | 67,466 |   |
| Gross margin                                                     |       | 32,575                    |       | 30,560 |   |
|                                                             |       |                      |       |   |   |
| Selling, general and  administrative                             |       | 29,901                    |       | 30,592 |   |
| Depreciation and  amortization                                   |       | 1,606                     |       | 1,547 |   |
| Total operating  expenses                                        |       | 31,507                    |       | 32,139 |   |
|                                                             |       |                      |       |   |   |
| Operating income (loss)  from continuing operations              |       | 1,068                     |       | (1,579 | ) |
| Interest expense                                                 |       | 571                       |       | 210 |   |
| Earnings (loss) from  continuing operations before income taxes  |       | 497                       |       | (1,789 | ) |
| Income tax expense  (benefit)                                    |       | 188                       |       | (633 | ) |
| Earnings (loss) from  continuing operations                      |       | 309                       |       | (1,156 | ) |
| Earnings (loss) from  discontinued operations, net of income tax |       | 232                       |       | (1,574 | ) |
| Net earnings (loss)                                              |       | $                         | 541        |   | ($2,730 | ) |
|                                                             |       |                      |       |   |   |
| Earnings (loss) per  share                                       |       |                      |       |   |   |
| Basic                                                            |       |                      |       |   |   |
| Continuing  operations                                           |       | $                         | 0.08       |   | ($0.26 | ) |
| Discontinued  operations                                         |       | $                         | 0.06       |   | ($0.36 | ) |
| Net earnings (loss)                                              |       | $                         | 0.14       |   | ($0.62 | ) |
|                                                             |       |                      |       |   |   |
| Diluted                                                          |       |                      |       |   |   |
| Continuing  operations                                           |       | $                         | 0.08       |   | ($0.26 | ) |
| Discontinued  operations                                         |       | $                         | 0.06       |   | ($0.36 | ) |
| Net earnings (loss)                                              |       | $                         | 0.14       |   | ($0.62 | ) |
|                                                                  |            |                           |            |  |  |  |  |

 

See accompanying notes tounaudited consolidated financial statements.

4

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**Duckwall-ALCOStores, Inc.**

**AndSubsidiaries**

**ConsolidatedStatements of Cash Flows**

Dollars in Thousands

(Unaudited)
| ** **                                                                                             | ** ** | **For the Thirteen Week**    | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                                             | ** ** | **Periods Ended**            | ** ** |
| ** **                                                                                             | ** ** | **April 30, 2006** | ** ** | **May 1, 2005** | ** ** |
| Cash Flows From  Operating Activities:                                                                 |       |                         |       |   |   |
| Net earnings  (loss)                                                                                   |       | $                            | 541        |   | ($2,730 | ) |
| Tax benefit of  stock options exercised                                                                |       | 4                            |       | — |   |
| Adjustments to  reconcile net earnings (loss) to net cash provided by (used in) operating  activities: |       |                         |       |   |   |
| Increase in receivables                                                                                |       | (428                         | )          | (318 | ) |
| Decrease in prepaid expenses                                                                           |       | 309                          |       | 490 |   |
| Decrease (increase) in inventories                                                                     |       | (8,059                       | )          | 1,831 |   |
| Depreciation and amortization                                                                          |       | 1,605                        |       | 1,555 |   |
| (Gain) loss on disposal of assets                                                                      |       | (351                         | )          | 388 |   |
| Stock compensations expense                                                                            |       | 46                           |       | — |   |
| Amortization of debt financing costs                                                                   |       | 26                           |       | 18 |   |
| Increase in accounts payable                                                                           |       | 3,242                        |       | 6,620 |   |
| Decrease in income taxes payable                                                                       |       | (815                         | )          | (1,985 | ) |
| Increase (decrease) in accrued salary &  commissions                                          |       | (1,944                       | )          | 990 |   |
| Increase in accrued taxes other than income                                                            |       | 410                          |       | 992 |   |
| Change in deferred income taxes                                                                        |       | (59                          | )          | (26 | ) |
| Increase (decrease) in other liabilities                                                               |       | (1,978                       | )          | 783 |   |
| Net cash  provided by (used in) operating activities                                                   |       | (7,451                       | )          | 8,608 |   |
| Cash Flows From  Investing Activities:                                                                 |       |                         |       |   |   |
| Capital expenditures                                                                                   |       | (2,863                       | )          | (1,276 | ) |
| Proceeds from the sale of assets                                                                       |       | 586                          |       | — |   |
| Net cash used in  investing activities                                                                 |       | (2,277                       | )          | (1,276 | ) |
| Cash Flows From  Financing Activities:                                                                 |       |                         |       |   |   |
| Net borrowings under revolving loan credit agreement                                                   |       | 13,238                       |       | 2,058 |   |
| Principal payments on capital leases                                                                   |       | (465                         | )          | (214 | ) |
| Proceeds from exercise of stock options                                                                |       | 43                           |       | 106 |   |
| Excess tax benefit on stock options exercises                                                          |       | 5                            |       | — |   |
| Common stock repurchase                                                                                |       | —                       |       | (7,188 | ) |
| Net cash (used  in) provided by financing activities                                                   |       | 12,821                       |       | (5,238 | ) |
| Net increase in  cash                                                                                  |       | 3,093                        |       | 2,094 |   |
| Cash and cash  equivalents at beginning of period                                                      |       | 1,565                        |       | 1,200 |   |
| Cash at end of  period                                                                                 |       | $                            | 4,658      |   | $ | 3,294 |   |
| Cash paid during  the period for:                                                                      |       |                         |       |   |   |
| Interest                                                                                               |       | $                            | 421        |   | $ | 69 |   |
| Income taxes                                                                                           |       | $                            | 1,222      |   | $ | 556 |   |
|                                                                                                   |       |                         |       |   |   |
| Supplemental  disclosure of non-cash activity:                                                         |       |                         |       |   |   |
| Tax benefit  related to stock options exercised                                                        |       | —                       |       | $ | 3 |   |

 

See accompanying notes tounaudited 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 suggestedthat the accompanying unaudited consolidated financial statements be read inconjunction with the consolidated financial statements included in the Company’sfiscal 2006 Annual Report. In the opinion of management of Duckwall-ALCO Stores, Inc.,the accompanying unaudited consolidated financial statements reflect alladjustments (consisting of normal recurring accruals) necessary to presentfairly the financial position of the Company and the results of its operationsand cash flows for the interim periods.

(2)           Principles of Consolidation

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

(3)           Stock-based Compensation

Effective January 30, 2006, theCompany adopted 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 include stock option grants. SFAS 123(R) requires share-based compensationexpense recognized since January 30, 2006 to be based on the following: a)grant date fair value estimated in accordance with the original provisions ofSFAS 123 for unvested options granted prior to the adoption date and b) grantdate fair value estimated in accordance with the provisions of SFAS 123(R) forall share-based payments granted subsequent to the adoption date.

For the three months ended April 30,2006, the adoption of SFAS 123(R)’s fair value method resulted in share-basedexpense (a component of selling and general and administrative expenses) in theamount of $46 related to the Company’s stock plans that the Company would nothave recognized if it had continued to account for share-based compensationunder APB 25. This share-based compensation lowered pre-tax earnings by $46,lowered net income by $36, and lowered basic and diluted earnings per share by$0.01. SFAS 123(R) also requires the benefits of tax deductions in excessof recognized compensation cost to be reported as a financing activity, ratherthan as an operating activity in the statement of cash flow as required priorto SFAS 123(R). The change resulted in $5 being shown as a cash flow fromfinancing activities rather than operating activities. The impact of adoptingSFAS 123(R) on future results will depend on, among other things, levelsof share-based payments granted in the future, actual forfeiture rates and thetiming of option exercises.

Priorto January 30, 2006, the Company accounted for share-based payments usingthe intrinsic-value-based recognition method prescribed by AccountingPrinciples Board Opinion No. 25, “Accounting for Stock Issued toEmployees,” (“APB 25”). As options were granted at an exercise price equal tothe market value of the underlying common stock on the date of grant, nostock-based employee compensation cost was reflected in net income prior toadopting SFAS 123(R). As the Company adopted SFAS 123(R) under themodified-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 presented.For purposes of this pro forma disclosure, the value of the options isestimated using a modified Black-Scholes option pricing model for all optiongrants:

6

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| ** **                                                    | ** ** | **For The Thirteen Week** | ** ** |
|---------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                    | ** ** | **Period Ended**                    | ** ** |
| ** **                                                    | ** ** | **May 1,**                          | ** ** |
| ** **                                                    | ** ** | **2005**                                 | ** ** |
| Net earnings  (loss) as reported                              |       | ($2,730                                  | )          |
| Pro forma  stock-based employee compensation cost, net of tax |       | ($21                                     | )          |
| Pro forma net  earnings (loss)                                |       | ($2,751                                  | )          |
|                                                          |       |                                     |       |
| Earnings (loss)  per share as reported:                       |       |                                     |       |
| Basic                                                         |       | ($0.62                                   | )          |
| Diluted                                                       |       | ($0.62                                   | )          |
|                                                          |       |                                     |       |
| Earnings (loss)  per share, pro forma:                        |       |                                     |       |
| Basic                                                         |       | ($0.62                                   | )          |
| Diluted                                                       |       | ($0.62                                   | )          |

 

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. 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 no later than five years from the date of grant. Theoptions vest in equal amounts over a four year requisite service periodbeginning one calendar year from the grant. In the case of a stockholder owningmore than 10% of the outstanding voting stock of the Company, the exerciseprice of an incentive stock option may not be less than 110% of the fair marketvalue of the stock on the date of grant and such options will expire no laterthan five years from the date of grant. Also, the aggregate fair market valueof the stock with respect to which incentive stock options are exercisable on atax deferred basis for the first time by an individual in any calendar year maynot exceed $100,000. In the event that the foregoing results in a portion of anoption exceeding the $100,000 limitation, such portion of the option in excessof the limitation shall be treated as a nonqualified stock option.

The Company previously issued stock underthe 1993 Incentive Stock Option Plan. This plan was structured in the samefashion as the 2003 Incentive Stock Option Plan described above, however it didnot specify the 10% ownership rules. There are no shares remaining to be issuedunder this plan. As of April 30, 2006, 19,455 options were outstandingunder this plan.

Under the terms of the 2003 IncentiveStock Option Plan adopted by the Company effective May 22, 2003, a maximumof 500,000 shares are available for a grant as stock options or otherawards  At April 30, 2006, theCompany had shares authorized for future option grants of 370,000. The Companyissues these grants from the unissued shares authorized by the Company.

The fair value of each option grant isseparately estimated for each vesting date. The fair value of each option isamortized into compensation expense on a straight-line basis between the grantdate for the award over the requisite service period as discussed above. TheCompany has estimated the fair value of all stock option awards as of the dateof the grant by applying a modified Black-Scholes pricing valuation model. Theapplication of this valuation model involves assumptions that are judgmentaland highly sensitive in the determination of compensation expense. The weightedaverage for key assumptions used in determining the fair value of optionsgranted in the three months ended April 30, 2006 and May 1, 2005 anda summary of the methodology applied to develop each assumption are as follows:

 
| ** **                                | ** ** | **April 30,** | ** ** | **May 1,** | ** ** |
|-------------------------------------------|------------|--------------------|------------|-----------------|------------|
| ** **                                | ** ** | **2006**           | ** ** | **2005**        | ** ** |
| Expected price  volatility                |       | 37.9               | %          | 38.4            | %          |
| Risk-free  interest rate                  |       | 4.8                | %          | 4.0             | %          |
| Weighted average  expected lives in years |       | 5.0                |       | 5.0             |       |
| Forfeiture rate                           |       | 0.0                | %          | 0.0             | %          |
| Dividend yield                            |       | 0.0                | %          | 0.0             | %          |

 

7

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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 and two of its peers to calculate expected pricevolatility because management believes that this is the best indicator offuture volatility. The Company calculates monthly market value changes from thedate of grant over a past period to determine volatility. An increase in the expectedvolatility will increase compensation expense.

RISK-FREE INTEREST RATE— This is the U.S. Treasury rate for the date of the grant having a term offive years. An increase in the risk-free interest rate will increasecompensation expense.

EXPECTED LIVES — This isthe period of time over which the options granted are expected to remainoutstanding and is based on managements expectations in relation to the holdersof the options. Options granted have a maximum term of five years. An increasein the expected life will increase 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 onmanagements expectations in relation to the holders of the options. An increasein 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                                  |       | 20,000                 |       | 25.79                                  |       |                                               |       |                            |       |
| Exercised                                |       | (3,433                 | )          | 12.50                                  |       |                                               |       |                            |       |
| Cancelled                                |       | (350                   | )          | 12.50                                  |       |                                               |       |                            |       |
| Outstanding  April 30, 2006         |       | 149,455                |       | $                                      | 18.62      |                                               | 3.7        |                            | $          | 1,013 |   |
|                                     |       |                   |       |                                   |       |                                               |       |                            |       |
| Expected to vest  at April 30, 2006 |       | 149,455                |       | $                                      | 18.62      |                                               | 3.7        |                            | $          | 1,013 |   |
|                                     |       |                   |       |                                   |       |                                               |       |                            |       |
| Exercisable at  April 30, 2006      |       | 44,455                 |       | $                                      | 15.73      |                                               | 2.6        |                            | $          | 430 |   |

 

The aggregate intrinsic values in thetable above represents the total difference between the Company’s closing stockprice on April 30, 2006 and the option exercise price, multiplied by thenumber of in-the-money options as of April 30, 2006. As of April 30,2006, total unrecognized compensation expense related to non-vested stockoptions is $628 with a weighted average expense recognition period of 3.4years.

8

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A summary of the status of the Company’snonvested shares as of April 30, 2006 is presented below:
| ** **                          | ** ** | **Number of  Shares** | ** ** | **Weighted Average  Grant Date  Fair Value** | ** ** |
|-------------------------------------|------------|----------------------------|------------|-------------------------------------------------------------|------------|
| Nonvested at  January 29, 2006 |       | 118,920                    |       | $                                                           | 7.20       |   |
| Granted                             |       | 20,000                     |       | $                                                           | 10.56      |   |
| Vested                              |       | (33,832                    | )          | $                                                           | 6.76       |   |
| Forfeited                           |       | (88                        | )          | $                                                           | 5.23       |   |
| Nonvested at  April 30, 2006   |       | 105,000                    |       | $                                                           | 7.98       |   |

 

Otherinformation relative to option activity during the thirteen weeks ended April 30,2006 and May 1, 2005 is as follows:
| ** **                                                       | ** ** | **April 30,** | ** ** | **May 1,** | ** ** |
|------------------------------------------------------------------|------------|--------------------|------------|-----------------|------------|
| ** **                                                       | ** ** | **2006**           | ** ** | **2005**        | ** ** |
| Weighted average  grant date fair value of stock options granted |       | $                  | 10.56      |            | $          | 7.30 |   |
| Total fair value  of stock options vested                        |       | $                  | 229        |            | $          | 54 |   |
| Total intrinsic value  of stock options exercised                |       | $                  | 41         |            | $          | 90 |   |

 

(4)           Earnings Per Share

Basicnet earnings per share is computed by dividing net earnings by the weightedaverage number of shares outstanding. Diluted net earnings per share reflectsthe potential dilution that could occur if contracts to issue securities (suchas stock options) were exercised.

Theaverage number of shares used in computing earnings per share was as follows:
| **Thirteen Weeks Ended** | ** ** | ** ** | ** ** | **Basic** | ** ** | **Diluted** | ** ** |
|------------------------------------|------------|------------|------------|-----------|------------|-------------|------------|
|                               |       |       |       |      |       |
| April 30,  2006               |       | 3,788,184  |       | 3,810,329 |       |
| May 1, 2005                   |       | 4,437,969  |       | 4,437,969 |       |

 

(5)           SubsequentEvents

TheCompany entered into a definitive agreement to sell and leaseback 11 ALCOretail locations to Realty Income Corporation for approximately $11.2 million. Theterm of each lease is 15 years with three, five-year options to extend the termof such leases. The aggregate annual base rent amount is an amount equal to thepurchase price multiplied by a capitalization rate of approximately 8.85%. Thesale-leaseback for nine of the locations was completed on May 25, 2006. Thesale-leaseback for one location is expected to be completed on or about June 16,2006. The final location is currently still under construction and will be soldupon completion.

Thecash proceeds from the transaction will be used to repay a significant portionof the Company’s long-term debt. The estimated annual base rent for the tencompleted locations is $907.

On May 23,2006, the Company’s stockholders approved the Company’s Non-Qualified StockOption Plan for Non-Management Directors, which had been adopted by the Boardof Directors subject to stockholder approval. The total number of shares ofstock available for grants under this plan is 120,000. The shares under thisplan may consist, in whole or in part, of authorized but unissued stock ortreasury stock, not reserved for any other purposes. All eligible directors mayreceive no more than 20,000 options annually. Specific grants will be based onthe Company’s performance, creation of shareholder value, and the performanceof each director. Grants vest equally over a four year period from the date ofthe grant and expire five years from grant date. Pursuant to this plan, on May 23,2006, the Company’s compensation committee approved the granting of 20,000stock options to each of the Company’s directors at a purchase price equal to$29.21, the closing price that day.

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**ITEM2.****     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 retailer operating 254 stores in 21 statesin the central United States, with two business divisions, consisting of:

·                  TheALCO division which, as of April 30, 2006, operated 186 ALCO Stores whichoffer a wide variety of general merchandise and a limited variety of foodproducts and accounted for 93% of the Company’s sales for the first quarter offiscal 2007.

·                  TheDuckwall division which, as of April 30, 2006, operated 68 Duckwall Storeswhich offer a more limited general merchandise selection, but serve the needsof a community that is not large enough to support a full-line retail discountstore, and accounted for 7% of the Company’s sales for the first quarter offiscal 2007.

Thethirteen weeks ended April 30, 2006 and May 1, 2005 are referred toherein as the first quarter of fiscal 2007 and 2006, respectively. For purposesof this management’s discussion and analysis of financial condition and resultsof operations, the financial numbers are presented in thousands.

*Strategy.*The Company’s overallbusiness strategy involves identifying and opening stores in towns that willprovide the Company with the highest return on investment. Although the Companyprefers markets that don’t have direct competition, its strategy does notpreclude it from entering competitive markets.  Even in non-competitive markets, competitionstill exists, as the Company’s customers still shop at retail discount storesand other retailers located in regional trade centers. The Company alsocompetes for retail sales with other entities, such as mail order 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 overall results.The Company utilizes information obtained from its point-of-sale system andregular input from its store associates to determine its merchandise offerings.

TheCompany has evaluated the costs and benefits of upgrading its currentpoint-of-sale “POS”, merchandising, human resources/payroll and financialsystems. The Company’s project team has selected the hardware and software andentered into agreements with respective vendors. The Company went live on thehuman resources/payroll and financial systems during the third quarter offiscal 2006. The Company will pilot the new POS system in one store during thesecond quarter of fiscal 2007, with the rollout of this system to all storeslater in the year. Financial Planning, Performance Analysis and MerchandiseAllocation systems went live in the first quarter of fiscal 2007. A requiredfeature of this new point-of-sale system is perpetual inventory, which theCompany does not currently have in its stores. Perpetual inventory allowstracking of on-hand quantities at the item level, and enables automatedreplenishment. These features will allow the Company to better manage inventorylevels and store in stock positions. The new system will also enable otherimprovements in the stores which are not available today due to technologylimitations. Once those limitations are removed, the Company expects tore-engineer the stores to take full advantage of the new technology.

TheCompany, when appropriate, implements new merchandising and marketinginitiatives in an effort to increase customer traffic and same-store sales. Overthe last year, the Company has implemented a plan to improve merchandise mix,with greater emphasis on soft-lines. This strategy will enhance the Company’sofferings in fashion merchandise and accessories. The Company’s marketingstrategy has been enhanced to highlight more of these products. As the Companyevaluates changes, it refines its merchandise mix and advertising strategies. Tofurther create a more customer friendly shopping experience, the Companycontinues to refine its store prototype and make changes to its layout toaccommodate new merchandise strategies. As these changes are analyzed,successful initiatives are rolled out to all locations.

TheCompany is also proactive in looking for and implementing ways to improve thebottom line through expense reductions in selling, general and administrativeexpenses (“SG&A”). The Company finalized its restructuring plan on April 28,2005 and on May 3, 2005, the Company publicly announced the restructuring.The 

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restructuring isdesigned to help the Company more effectively compete in today’s competitiveretail environment. As a part of the restructuring, 46 corporate positions wereeliminated, which will result in an annualized savings of approximately $2,200.One-time costs associated with the restructuring were approximately $734.

*Recent Events.*The Companyentered into a definitive agreement to sell and leaseback 11 ALCO retaillocations to Realty Income Corporation for approximately $11.2 million. Theterm of each lease is 15 years with three, five-year options to extend the termof such leases. The aggregate annual base rent amount is an amount equal to thepurchase price multiplied by a capitalization rate of approximately 8.85%. Thesale-leaseback for nine of the locations was completed on May 25, 2006. Thesale-leaseback for one location is expected to be completed on or about June 16,2006. The final location is currently still under construction and will be soldupon completion.

Thecash proceeds from the transaction will be used to repay a significant portionof the Company’s long-term debt. The estimated annual base rent for the tencompleted locations is $907. This amount will be offset by the interest savingson the retired debt and the recognition of the deferred gain on the propertiessold. This transaction furthers the Company’s initiative to lease its store locations.

On May 23,2006, the Company’s stockholders approved the Company’s Non-Qualified StockOption Plan for Non-Management Directors, which had been adopted by the Boardof Directors subject to stockholder approval. The total number of shares ofstock available for grants under this plan is 120,000. The shares under thisplan may consist, in whole or in part, of authorized but unissued stock ortreasury stock, not reserved for any other purposes. All eligible directors mayreceive no more than 20,000 options annually. Specific grants will be based onthe Company’s performance, creation of shareholder value, and the performanceof each director. Grants vest equally over a four year period from the date ofthe grant and expire five years from grant date. Pursuant to this plan, on May 23,2006, the Company’s compensation committee approved the granting of 20,000stock options to each of the Company’s directors at a purchase price equal to$29.21, the closing price that day.

*Key Items in Fiscal 2007.*The Companymeasures itself against a number of financial metrics to assess its performance.Some of the important financial items during the first quarter of fiscal 2007were:

·                  Net salesincreased 11.3% to $109,071. Same store sales increased 6.6% compared to theprior year.

·                  Gross marginpercentage decreased to 29.9% of sales, compared to 31.2% in the prior yearfirst quarter.

·                  Earnings pershare were $0.14 in the first quarter of fiscal 2007 compared to a loss of($.62) per share in the prior year first quarter.

·                  The Company’searnings before interest, taxes, depreciation and amortization (“EBITDA”) fromcontinuing operations for the first quarter 2007 were $2,674.

·                  The Company’sreturn on average equity (“ROE”) for the first quarter 2007 was 0.53%.

·                  TheCompany opened three new ALCO stores during the first quarter of fiscal 2007.

Samestore sales growth is a measure which may indicate whether existing stores aremaintaining their market share. Other factors, such as the overall economy, mayalso affect same store sales. The Company defines same stores as those storesthat were open as of the first day of the prior fiscal year and remain open atthe end of the reporting period. The same store sales for all Company storesincreased 6.6% compared to the first quarter last year, the ALCO stores samestore sales increased 6.8%, and the Duckwall same stores sales increased 3.7%during the first quarter of fiscal 2007.

Grossmargin percentage is a key measure of the Company’s ability to maximize profiton the purchase and subsequent sale of merchandise, while minimizingpromotional and clearance markdowns, shrinkage, damage, and returns. Grossmargin percentage is defined as sales less cost of sales, expressed as apercentage of sales. Gross margin percent decreased to 29.9% of sales in thefirst quarter of fiscal 2007, compared to 31.2% in the first quarter of fiscal2006.

Earningsper share (“EPS”) growth are an indicator of the returns generated for theCompany’s stockholders. EPS from continuing operations improved to $0.08 perdiluted share for the first quarter of fiscal 2007, compared to a loss of($0.26) per diluted share for the first quarter of the prior fiscal year.

 

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TheCompany’s EBITDA and ROE are discussed under *SG&ADetail; Certain Financial Measures*below.

***CAUTIONARY STATEMENT CONCERNINGFORWARD-LOOKING STATEMENTS AND FACTORS THAT MAY AFFECT FUTURE RESULTS OFOPERATIONS, FINANCIAL CONDITION OR BUSINESS***

Certainstatements contained in this Quarterly Report on Form 10-Q that arenot statements of historical fact may constitute “forward-looking statements”within the meaning of Section 21E of the Exchange Act. These statementsare subject to risks and uncertainties, as described below. Examples offorward-looking statements include, but are not limited to: (i) projectionsof revenues, income or loss, earnings or loss per share, capital expenditures,store openings, store closings, payment or non-payment of dividends, capitalstructure and other financial items, (ii) statements of plans andobjectives of the Company’s management or Board of Directors, including plansor objectives relating to inventory, store development, marketing, competition,business strategy, store environment, merchandising, purchasing, pricing,distribution, transportation, store locations and information systems, (iii) statementsof future economic performance, and (iv) statements of assumptionsunderlying the statements described in (i), (ii) and (iii).Forward-looking statements can often be identified by the use offorward-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 involverisks, uncertainties and assumptions. The Company’s future results ofoperations, financial condition and business operations may differ materiallyfrom the forward-looking statements or the historical information stated inthis Quarterly Report on Form 10-Q. Stockholders and investors arecautioned not to put undue reliance on any forward-looking statement.

Thereare a number of factors and uncertainties that could cause actual results ofoperations, financial condition or business contemplated by the forward-lookingstatements to differ materially from those discussed in the forward-lookingstatements made herein or elsewhere orally or in writing, by, or on behalf of,the Company, including those factors described below. Other factors notidentified herein could also have such an effect. Factors that could causeactual results to differ materially from those discussed in the forward-lookingstatements and from historical information include, but are not limited to,those factors described 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 inventory method (“RIM”) used by the Company is anaveraging method that has been widely used 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 ofthe RIM method does not eliminate the use of management judgments andestimates, including markdowns and shrinkage, which significantly impact theending inventory valuation at cost and the resulting gross margins. The Companycontinually evaluates product categories to determine if markdown action isappropriate, or if a markdown reserve should be established. The Companyrecognizes that the use of the RIM will result in valuing inventories at lowerof cost or market if markdowns are currently taken as a reduction of the retailvalue of inventories. As of April 30, 2006 and May 1, 2005, theCompany had recorded markdowns that had not been taken and which served toreduce inventories to lower of cost or market by approximately $677 and $901,respectively. Management believes that the RIM provides an inventory valuationwhich reasonably approximates cost and results in carrying inventory at thelower 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 morethan one year to determine the actual costs under these 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 isessentially self insured for workers compensation and general liability claimsdue to large deductibles on its policies. The Company records estimates forexpense accruals.

Medical.The Company is also essentially self insured for medical insurance and coversall claims in a plan year related to an individual until they exceed $125. TheCompany has responded to increases in the cost of medical coverage  by taking steps that were effective August 1,2005 to increase the premiums 

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paidby its associates and by implementing other changes that are designed tocontrol future medical insurance costs.

*IncomeTaxes:*  The Company’stax provision and establishment of reserves for potential tax liabilitiesinvolves the use of estimates and professional judgment. The Company hasidentified exposures for which they have established a reserve, such asdifferences in interpretation of tax laws at the federal, state, and localunits of government.

***RESULTS OF OPERATIONS***

**ThirteenWeeks Ended April 30, 2006 Compared to Thirteen Weeks Ended May 1,2005.**

***Net Sales***

Netsales for the first quarter of fiscal 2007 increased $11,045, or 11.3%, to$109,071 compared to $98,026 for the first quarter of fiscal 2006. Same storesales increased 6.6% when compared with the prior year. The sales werefavorably impacted by customer acceptance of its current merchandise strategythat focuses on soft-lines, a 4.8% increase in customer count and a 6.4%increase in average sale generated.

***Gross Margin***

Grossmargin for the first quarter of fiscal 2007 increased $2,015, or 6.6%, to$32,575 compared to $30,560 in the first quarter of fiscal 2006. Gross marginas a percentage of sales was 29.9% for the first quarter of fiscal 2007compared to 31.2% for the first quarter of fiscal 2006. The decrease in thegross margin percentage was due to higher promotional markdowns, highertransportation costs resulting from higher fuel prices (a 20% increase comparedto the first quarter of fiscal 2006), and a markdown reserve adjustment made infiscal 2006 that was not repeated in fiscal 2007.

***SG&A***

Selling,general and administrative expense decreased $691, or 2.3%, to $29,901 in thefirst quarter of fiscal 2007 compared to $30,592 in the first quarter of fiscal2006. As a percentage of net sales, selling, general and administrativeexpenses in the first quarter of fiscal 2007 were 27.4%, compared to 31.2% inthe first quarter of fiscal 2006. The decrease in selling, general andadministrative expenses 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 utility costs.

***Depreciation and Amortization***

Depreciationand amortization expense increased $59, or 3.8%, to $1,606 in the first quarterof fiscal 2007 compared to $1,547 in the first quarter of fiscal 2006. Theincrease is primarily due to new stores opened in the fourth quarter of fiscal2006 and the first quarter of fiscal 2007.

***Interest Expense***

Interestexpense increased $361, or 171.9%, to $571 in the first quarter of fiscal 2007compared to $210 in the first quarter of fiscal 2006. The increase in interestexpense was due primarily to higher levels of borrowing for the thirteen weekperiod of fiscal 2007.

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***Income Taxes***

TheCompany’s effective tax rate on earnings from continuing operations for thefirst quarter of fiscal 2007 was 37.8%, compared to 35.4% in the first quarterof fiscal 2006. The effective tax rate is higher due to the expiration ofcertain employment tax credits and the Company’s increased profitability.

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

Earningsfrom discontinued operations, net of income tax, was $232 in the first quarterof fiscal 2007, compared to a loss from discontinued operations of $1,574 inthe first quarter of fiscal 2006. The increase in earnings from discontinuedoperations relates to the Company’s closing of 20 unprofitable stores in thefirst quarter of fiscal 2006 compared with no store closings in the firstquarter of fiscal 2007. Additionally, the Company sold property held for salein relation to the closings in fiscal 2006 in the first quarter 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 information presented is from continuing operations.
| ** **                                  | ** ** | **For the Thirteen Week  Periods Ended** | ** ** |
|---------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                  | ** ** | **April 30, 2006**                                 | ** ** | **May 1, 2005** | ** ** |
| **SG&A  Expenses Breakout**             | ** ** | ** **                                                   | ** ** | ** ** | ** ** |
| General Office                              |       | $                                                            | 2,430      |   | $ | 5,084 |   |
| Distribution  Center                        |       | 2,262                                                        |       | 2,010 |   |
| SPD Truck Lines                             |       | —                                                       |       | 240 |   |
| 401K/Profit  Sharing                        |       | 116                                                          |       | — |   |
| Comparable  Stores SG&A                 |       | 23,722                                                       |       | 23,144 |   |
| Non Comp Stores  SG&A #                 |       | 1,371                                                        |       | 114 |   |
| Final SG&A  as reported on 1st Qtr 10Q  |       | $                                                            | 29,901     |   | $ | 30,592 |   |
|                                        |       |                                                         |       |   |   |
| Return on  Average Equity (ROE)****         |       | 0.53                                                         | %          | (2.49 | %) |
|                                        |       |                                                         |       |   |   |
| Net Sales                                   |       | $                                                            | 109,071    |   | $ | 98,026 |   |
| SG&A as% of  Sales                      |       | 27.41                                                        | %          | 31.21 | % |
|                                        |       |                                                         |       |   |   |
| SG&A per  average selling square foot   |       | $                                                            | 7.30       |   | $ | 7.78 |   |
|                                        |       |                                                         |       |   |   |
| EBITDA**                                    |       | $                                                            | 2,674      |   | $ | (32 | ) |
| EBITDA per  average selling square foot***  |       | $                                                            | 0.65       |   | $ | (0.01 | ) |
|                                        |       |                                                         |       |   |   |
| Sales per  average selling square feet*     |       |                                                         |       |   |   |
| ALCO                                        |       | $                                                            | 27.32      |   | $ | 25.54 |   |
| Duckwall                                    |       | $                                                            | 19.60      |   | $ | 19.19 |   |
| Total                                       |       | $                                                            | 26.62      |   | $ | 24.94 |   |
|                                        |       |                                                         |       |   |   |
| Average Selling  Square Feet*               |       | 4,098                                                        |       | 3,930 |   |
| Average Square  Feet% Change                |       | 4.3                                                          | %          | 3.32 | % |
|                                        |       |                                                         |       |   |   |
| Total Stores  Operating beginning of Period |       | 251                                                          |       | 266 |   |
| Total Stores Operating  end of Period       |       | 254                                                          |       | 259 |   |

 

* Average selling squarefeet is (beginning square feet plus ending square feet) divided by 2.

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** EBITDA is earnings from continuing operations before interest, taxes,depreciation and amortization.

*** EBITDA per selling square foot is a non-GAAP financial measure andis calculated as EBITDA divided by selling square feet.

**** Return on average equity (ROE) is calculated as Net Earningsdivided by average stockholders’ equity.

      Average Stockholders’ Equityis calculated as (beginning of period stockholders’ equity plus end of periodstockholders’ equity) divided by 2

#  Non Comp Stores are those stores opened inFiscal 2006 & Fiscal 2007.

 

***Fiscal2007 Compared to Fiscal 2006***

GeneralOffice expenses for fiscal 2007 decreased $2,654 or 52.2%. The decrease was duein part to one time costs of approximately $734 associated with the Company’srestructuring and workforce reduction in fiscal 2006 not repeated in fiscal2007 and the related payroll savings in fiscal 2007 relating to thesereductions, and a $1,605 increase in vendor participation in CO-OP advertisingprograms, offset by increased utility costs.

Distributioncenter expenses increased $252 or 12.5%. The increase is related to payrollincreased on the increase in the volume of inventory processed.

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

Comparablestore SG&A expenses increased $578 or 2.5%. Advertising, utility and creditcard fees accounted for the majority of this increase.

NonComparable Stores SG&A expenses increased $1,257. The Company has opened 11stores since the first 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  Periods Ended** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                           | ** ** | **April 30,**                                           | ** ** | **May 1,** | ** ** |
| ** **                                           | ** ** | **2006**                                                     | ** ** | **2005** | ** ** |
| Earnings from  continuing operations                 |       | $                                                            | 309        |   | $ | (1,156 | ) |
| Plus interest                                        |       | 571                                                          |       | 210 |   |
| Plus taxes                                           |       | 188                                                          |       | (633 | ) |
| Plus  depreciation and amortization                  |       | 1,606                                                        |       | 1,547 |   |
| =EBITDA                                              |       | $                                                            | 2,674      |   | $ | (32 | ) |
|                                                 |       |                                                         |       |   |   |
| Earnings from  continuing operations per square foot |       | $                                                            | 0.08       |   | $ | (0.29 | ) |
| Plus interest  per square foot                       |       | $                                                            | 0.14       |   | $ | 0.05 |   |
| Plus taxes per  square foot                          |       | $                                                            | 0.05       |   | $ | (0.16 | ) |
| Plus  depreciation and amortization per square foot  |       | $                                                            | 0.39       |   | $ | 0.39 |   |
| =EBITDA per selling  square foot                     |       | $                                                            | 0.65       |   | $ | (0.01 | ) |

 

***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).

 

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At April 30,2006 working capital (defined as current assets less current liabilities) was$102,775 compared to $90,634 at the end of fiscal 2006. The increase in workingcapital was attributable to increases in inventory and cash and cashequivalents, and accounts payable; and decreases in income taxes payables, andaccrued 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 (througha note or letters of credit) to the Company under the credit facility bearsinterest at (i) the prime rate plus a margin, as defined, which variesbased on the amount outstanding (Base Loan) or (ii) based on the Eurodollar rate plus a margin, as defined, (Index Loan). Based upon its projectedfinancial requirements, the Company uses a combination of short term Eurodollar contracts and borrowing at prime. The amount advanced is generallylimited to 70% of eligible inventory, as defined in the loan agreement. Advancesare secured by a security interest in the Company’s inventory. The loanagreement contains various restrictions that are applicable if the Companyfails to maintain excess availability of at a least $27,500, includinglimitations on additional indebtedness, acquisitions of assets and payment ofdividends. The loan agreement expires on April 15, 2010. As of April 30,2006, the Company has borrowed $30,300 under this facility. The lender had alsoissued letters of credit aggregating $3,897 at such date on behalf of theCompany. Availability under this facility as of April 30, 2006 was$35,803.

Cashprovided by (used in) operating activities in the thirteen week period offiscal 2007 and 2006 was ($7,446) and $8,608 respectively. The decrease in theamount of cash provided by operating activities in the thirteen week period offiscal 2007 compared to the thirteen week period of fiscal 2006 was primarilydue to a increase in inventory relating to the stores opened since fiscal 2006,a decrease in accrued salaries and wages, and a decrease in other liabilities;offset by an 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 $22,000. Cash used in investingactivities (including acquisitions and remodeling) in the thirteen week periodof fiscal 2007 and 2006 totaled $2,277 and $1,276, respectively, which wereused primarily for the acquisition of property and equipment, offset in fiscal2007 by the proceeds from the sale of assets.

TheCompany generated (used) from financing activities in the thirteen week periodof fiscal 2007 and 2006 of $12,816 and ($5,238) respectively. Borrowings on therevolving loan generated $13,238 during the thirteen week ended April 30,2006, compared to $2,058 during the thirteen week period of the prior fiscalyear. Cash was used to purchase and retire 399,362 shares of Common Stockduring the thirteen week period of fiscal 2006 for $7,188. The Board ofDirectors of the Company has authorized the Company to repurchase up to2,014,461 shares of Common Stock, of which 1,814,461 shares had been purchasedas of April 30, 2006. The Company continues to evaluate the timing andpricing of future share repurchases.

***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.

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**SegmentInformation**
| ** **                         | ** ** | **For The Thirteen Week** | ** ** |
|------------------------------------|------------|---------------------------|------------|
| ** **                         | ** ** | **Periods Ended**         | ** ** |
| ** **                         | ** ** | **June 1,**          | ** ** | **May 1,** | ** ** |
| ** **                         | ** ** | **2006**                  | ** ** | **2005** | ** ** |
| Net Sales:                         |       |                      |       |   |   |
| ALCO Discount  Stores              |       | $                         | 102,056    |   | $ | 91,006 |   |
| All Other                          |       |                      |       |   |   |
| External                           |       | 7,015                     |       | 7,020 |   |
| Intercompany                       |       | 65,957                    |       | 61,747 |   |
|                               |       | $                         | 175,028    |   | $ | 159,773 |   |
|                               |       |                      |       |   |   |
| Depreciation and  Amortization     |       |                      |       |   |   |
| ALCO Discount  Stores              |       | $                         | 922        |   | $ | 942 |   |
| All Other                          |       | 684                       |       | 605 |   |
|                               |       | $                         | 1,606      |   | $ | 1,547 |   |
|                               |       |                      |       |   |   |
| Income (expense)  from Operations: |       |                      |       |   |   |
| ALCO Discount  Stores              |       | $                         | 6,303      |   | $ | 6,442 |   |
| All Other                          |       | (5,150                    | )          | (7,936 | ) |
|                               |       | $                         | 1,153      |   | ($1,494 | ) |
|                               |       |                      |       |   |   |
| Capital  Expenditures:             |       |                      |       |   |   |
| ALCO Discount  Stores              |       | $                         | 949        |   | $ | 1,068 |   |
| All Other                          |       | 1,914                     |       | 208 |   |
|                               |       | $                         | 2,863      |   | $ | 1,276 |   |
|                               |       |                      |       |   |   |
| Identifiable  Assets:              |       |                      |       |   |   |
| ALCO Discount  Stores              |       | $                         | 141,595    |   | $ | 127,082 |   |
| All Other                          |       | 49,604                    |       | 37,498 |   |
|                               |       | $                         | 191,199    |   | $ | 164,580 |   |

 

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

*              Intercompany Sales*

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

*Intercompany Expense 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.

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*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** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                               | ** ** | **Periods  Ended**         | ** ** |
| ** **                                                               | ** ** | **April 30,**         | ** ** | **May 1,** | ** ** |
| ** **                                                               | ** ** | **2006**                   | ** ** | **2005** | ** ** |
| Net sales per  above segment information                                 |       | $                          | 175,028    |   | $ | 159,773 |   |
| Intercompany  elimination                                                |       | 65,957                     |       | 61,747 |   |
| Net sales per consolidated statements of operations                      |       | $                          | 109,071    |   | $ | 98,026 |   |
| Income (loss)  from operations per above segment information             |       | $                          | 1,153      |   | ($1,494 | ) |
| Leases                                                                   |       | 85                         |       | 85 |   |
| Income (loss)  from operations per consolidated statements of operations |       | $                          | 1,068      |   | ($1,579 | ) |

 

##### **ITEM3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK**

***INSTRUMENTS ENTERED 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 enterinto interest rate swaps to manage its exposure to interest rate changes, andwe may employ other risk management strategies, including the use of foreigncurrency forward contracts. The Company does not currently hold any derivativeinstruments and would enter into such instruments solely for cash flow hedgingpurposes 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 to meet the short-term needs of itscapital improvements and inventory purchases and other operating activities. Theseobligations expose the Company to variability in interest payments due tochanges in interest rates. If interest rates increase, interest expenseincreases. Conversely, if interest rates decrease, interest expense alsodecreases. Based on the Company’s current borrowings under its revolving creditfacility, if interest rates were to increase 1% on an annual basis interestexpense would increase $300.

**ITEM 4. CONTROLS AND PROCEDURES**

**(a) Evaluation of Disclosure Controls and Procedures**

Underthe supervision 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 

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(asdefined in Rules 13a-15(e) and 15d-15(e) of theSecurities and Exchange Act of 1934, or the “Exchange Act”) for the quarterended April 30, 2006.

Basedupon that evaluation, the Chief Executive Officer and Chief Financial Officerhave concluded that the Company’s disclosure controls and procedures were noteffective as of April 30, 2006 because of the material weaknessesdiscussed below.

Toaddress the material weaknesses described below, the Company performedadditional analysis and other post-closing procedures to ensure that theconsolidated financial statements were prepared in accordance with generallyaccepted accounting principles. Accordingly, management, including the ChiefExecutive Officer and Chief Financial Officer, believe the consolidatedfinancial statements included in this report present, in all material respects,the Company’s financial condition, results of operations and cash flows for thequarter ended April 30, 2006.

**(b)  Management’s Report on Internal Control Over FinancialReporting**

Management of the Companyis responsible for establishing and maintaining adequate control over financialreporting as defined in Rules 13a-15(f) under the Securitiesand Exchange Act of 1934, as amended. The Company’s internal control system isa process 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. Becauseof its inherent limitations, internal control over financial reporting may notprevent 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.

A material weaknessrepresents a significant deficiency (as defined in the Public CompanyAccounting Oversight Board’s Auditing Standard No. 2), or a combination ofsignificant deficiencies, that results in more than a remote likelihood that amaterial misstatement of the annual or interim financial statements will not beprevented or detected on a timely basis.

Management assessed theeffectiveness of the Company’s internal control over financial reporting as of April 30,2006 based on the criteria established in *Internal Control-Integrated Framework*issued**by theCommittee of Sponsoring Organizations of the Treadway Commission (“COSO”). As aresult of this assessment, management concluded that the Company’s internalcontrol over financial reporting was not effective as of April 30, 2006.

 Management’s assessment identified thefollowing material weaknesses in the Company’s internal control over financialreporting as of April 30, 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 controlthat requires a review of this report by personnel independent of the accountspayable function to assure that all changes were properly authorized.

·                 TheCompany makes manual journal entries as part of its reconciliation and closingprocess. The Company does not have a control that requires a review of thesejournal entries and supporting analysis by someone other than the preparerprior to being recorded in the general ledger.

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

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As a result of thisdeficiency, adjustments were made to cash, inventory and accrued liabilities. Furthermore,there is a more than a remote likelihood that a material misstatement of ourannual or interim financial statements would not have been prevented ordetected.

**2.**               The Company has insufficient controls to ensure that warehouse inventoryand cost of sales are properly reported in the interim financial statements. Specifically,warehouse inventory is only reconciled to the general ledger annually. Thisdeficiency resulted in more than a remote likelihood that a materialmisstatement of our interim financial statements would not have been preventedor detected.

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

The Company is currentlyimplementing procedures to establish and maintain controls which will result inthe necessary reviews being performed. These procedures include secondaryreview of journal entries and supporting analysis and independent review ofchanges or additions to the accounts payable vendor master file. The Companyinitiated the development and implementation of controls over the developmentof the financial statements in the fourth quarter of fiscal 2006. The Companyhas designed and implemented procedures to reconcile the warehouse inventory tothe general ledger on a quarterly basis. The Company will continue to reviewthese processes and reevaluate these controls to determine that theseweaknesses have been remediated.

There were no changes inthe Company’s internal control over financial reporting that occurred duringthe quarter ended April 30, 2006 that materially affected, or arereasonably likely to materially affect, the Company’s internal control overfinancial reporting.

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

**ITEM 1. LEGAL PROCEEDINGS**

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,the trading price of the Company’s securities could decline, and investorsmight lose 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. 

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Even in non-competitive markets, the Company’s customers shop at retaildiscount stores and other retailers located in regional trade centers. TheCompany also competes for retail sales with other entities, such as mail ordercompanies, specialty retailers, mass merchandisers, dollar stores, manufacturer’soutlets, and the internet. This competitive environments subjects the Companyto the risk of reduced profitability because the Company may be forced to lowerits prices, resulting in lower margins, in order to maintain its competitiveposition.

**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.

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

The Board ofDirectors of the Company has authorized the Company to repurchase up to2,014,461 shares of Common Stock, of which 1,814,461 shares had been purchasedas of April 30, 2006. The following are details of repurchases under thisprogram for the period covered by this report:

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| ** **                                     | ** ** | ** **                  | ** ** | ** **                   | ** ** | ** **                  | ** ** | **Maximum**                   | ** ** |
|------------------------------------------------|------------|-----------------------------|------------|------------------------------|------------|-----------------------------|------------|-------------------------------|------------|
| ** **                                     | ** ** | ** **                  | ** ** | ** **                   | ** ** | **Total Number**       | ** ** | **Number (or**           | ** ** |
| ** **                                     | ** ** | ** **                  | ** ** | ** **                   | ** ** | **of shares (or** | ** ** | **Approximate**               | ** ** |
| ** **                                     | ** ** | ** **                  | ** ** | ** **                   | ** ** | **Units)**                  | ** ** | **Dollar Value)**        | ** ** |
| ** **                                     | ** ** | ** **                  | ** ** | ** **                   | ** ** | **Purchased as**       | ** ** | **of Shares (or**   | ** ** |
| ** **                                     | ** ** | ** **                  | ** ** | ** **                   | ** ** | **Part of**            | ** ** | **Units (that May** | ** ** |
| ** **                                     | ** ** | **Total Number**       | ** ** | ** **                   | ** ** | **Publicly**                | ** ** | **Yet Be**               | ** ** |
| ** **                                     | ** ** | **Of Shares) or** | ** ** | **Average Price**       | ** ** | **Announced**               | ** ** | **Purchased**                 | ** ** |
| ** **                                     | ** ** | **Units)**                  | ** ** | **Paid per Share** | ** ** | **Plans or**           | ** ** | **Under the Plans** | ** ** |
| **Period**                                     | ** ** | **Purchased**               | ** ** | **(or Unit)**           | ** ** | **Programs**                | ** ** | **or Programs**          | ** ** |
| February 1 —  February 28, 2006 |       | 0                           |       | 0                            |       | 0                           |       | 0                             |       |
| March 1 —  March 31, 2006       |       | 0                           |       | 0                            |       | 0                           |       | 0                             |       |
| April 1 — April 30, 2006        |       | 0                           |       | 0                            |       | 0                           |       | 0                             |       |

 

**ITEM 3. DEFAULTSUPON SENIOR SECURITIES**

Not applicable.

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

(a)           Theannual meeting of stockholders of the Company was held on May 23, 2006.

(b)           Atthe annual meeting, the following persons where elected to the Board ofDirectors:

Warren H. Gfeller waselected for a term expiring in 2007 with 3,601,720 common share votes for hiselection and 1,349 votes withheld.

Dennis A. Mullin waselected for a term expiring in 2007 with 3,239,723 common share votes for hiselection and 363,346 votes withheld.

Lolan C. Mackey waselected for a term expiring in 2007 with 3,547,724 common share votes for hiselection and 55,345 votes withheld.

Jeffrey J. Macke waselected for a term expiring in 2007 with 3,601,718 common share votes for hiselection and 1,351 votes withheld.

Robert L. Ring waselected for a term expiring in 2007 with 3,601,720 common share votes for hiselection and 1,349 votes withheld.

Dennis E. Logue waselected for a term expiring in 2007 with 3,550,511 common share votes for hiselection and 52,558 votes withheld.

(c)           At the annual meeting thestockholders (i) approved the Duckwall-ALCO Stores, Inc.Non-Qualified Stock Option Plan for Non-Management Directors with 2,107,316common share votes for and 87,026 votes withheld and (ii) ratified and approved the selection of KPMGLLP****with 3,587,228 commonshare votes for and 710 votes withheld.

**ITEM 5. OTHERINFORMATION**

None.

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**ITEM 6. EXHIBITS**

See the Exhibit Indeximmediately following the signature page hereto.

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934 the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
|                           | ** **   | **DUCKWALL-ALCO STORES, INC.**                                          |
|---------------------------|--------------|-------------------------------------------------------------------------|
|                      | *** *** | ***    (Registrant)***                              |
|                      | *** *** | *** ***                                                            |
| Date,  June 13, 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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**EXHIBITINDEX**

2                                          StockPurchase Agreement dated April 19, 2005 with K&A Asset Management, LLCon behalf of Kenneth A. Macke Revocable Trust (filed as Exhibit 10.20 tothe Company’s Annual Report on 10-K for the fiscal year ended January 30,2005 and incorporated herein by reference)

3.1                                 Articlesof Incorporation of Duckwall-ALCO Stores, Inc., amended as of June 13,1994 and restated solely for filing with the Securities and Exchange Commission(filed as Exhibit 3.1 to Company’s Quarterly Report on Form 10-Qfor the fiscal quarter ended August 1, 2004 and incorporated herein byreference).

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

4.2                                 Referenceis made to the Amended and Restated Articles of Incorporation described under3.1 above and Bylaws described under 3.2 above.

4.3                                 Loanand Security Agreement, dated as of April 15, 2002, between the Companyand Fleet Retail Finance Inc. (filed as Exhibit 10.16 to the Company’sAnnual Report on Form 10-K for the fiscal year ended February 2,2003 and hereby incorporated by reference).

4.4                                 Loanand Security Agreement, dated as of April 15, 2002, between the Companyand Fleet Retail Finance, Inc. (filed as Exhibit 10.16 to the Company’sAnnual Report on Form 10-K for the fiscal year ended February 2,2003 and hereby incorporated by reference).

4.5                                 JoinderAgreement and First Amendment to Loan and Security Agreement dated September 9,2002 among the Company, Fleet Retail Finance Inc., and DA Good Buys, Inc.(filed as Exhibit 10.17 to the Company’s Annual Report on Form 10-Kfor the fiscal year ended February 2, 2003 and hereby incorporated byreference).

31.1                           Certificationof Chief Executive Officer of Duckwall-ALCO Stores, Inc. dated June 13,2006, pursuant to Rule 13a-4(a) under the Securities ExchangeAct of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Actof 2002.

31.2                           Certificationof Chief Financial Officer of Duckwall-ALCO Stores, Inc. dated June 13,2006, pursuant to Rule 13a-4(a) under the Securities ExchangeAct of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Actof 2002.

32.1                           Certificationof Chief Executive Officer of Duckwall-ALCO Stores, Inc, dated June 13,2006, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906of the Sarbanes-Oxley Act of 2002, which is furnished with this QuarterlyReport on Form 10-Q for the quarter ended April 30, 2006 and isnot treated as filed in reliance upon § 601(b)(32) of Regulations S-K.

32.2                           Certificationof Chief Financial Officer of Duckwall-ALCO Stores, Inc., dated June 13,2006, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906of the Sarbanes-Oxley Act of 2002, which is furnished with this QuarterlyReport on Form 10-Q for the quarter ended April 30, 2006 and isnot treated as filed in reliance upon § 601(b)(32) of Regulations S-K.

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