**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C. 20549**

**FORM 10-Q**

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

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

**OR**

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

**CommissionFile Number 0-20269**

**DUCKWALL-ALCO STORES, INC.**

(Exact name of registrantas specified in its charter)

 

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

 

**(785) 263-3350**

(Registrant’stelephone number including area code)

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.    Yesx 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:

3,792,515shares of common stock, $.0001 par value (the issuer’s only class of commonstock), were outstanding as of July 30, 2006.

 

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**PART I –FINANCIAL INFORMATION**

**ITEM 1.  FINANCIAL STATEMENTS**

**Duckwall-ALCOStores, Inc.**

**AndSubsidiaries**

**ConsolidatedBalance Sheets**

(Dollars in Thousands)

 

**Assets**

 
| ** **                         | ** ** | **July 30,** | ** ** | **January 29,** | ** ** |
|------------------------------------|------------|-------------------|------------|----------------------|------------|
| ** **                         | ** ** | **2006**          | ** ** | **2006**             | ** ** |
| ** **                         | ** ** | **(Unaudited)**   | ** ** | ** **           | ** ** |
| Current assets:                    |       |              |       |                 |       |
| Cash and cash  equivalents         |       | $                 | 1,686      |                 | $          | 472 |   |
| Receivables                        |       | 4,062             |       | 2,874                |       |
| Inventories                        |       | 139,821           |       | 135,077              |       |
| Prepaid expenses                   |       | 2,712             |       | 2,621                |       |
| Property held  for sale            |       | —            |       | 585                  |       |
|                               |       |              |       |                 |       |
| Total current  assets              |       | 148,281           |       | 141,629              |       |
|                               |       |              |       |                 |       |
| Property and equipment             |       | 88,780            |       | 92,615               |       |
| Less accumulated  depreciation     |       | 65,222            |       | 63,591               |       |
|                               |       |              |       |                 |       |
| Net property and  equipment        |       | 23,558            |       | 29,024               |       |
|                               |       |              |       |                 |       |
| Property under capital  leases     |       | 24,255            |       | 23,228               |       |
| Less accumulated  amortization     |       | 17,177            |       | 16,367               |       |
|                               |       |              |       |                 |       |
| Net property  under capital leases |       | 7,078             |       | 6,861                |       |
|                               |       |              |       |                 |       |
| Other non-current  assets          |       | 62                |       | 55                   |       |
| Deferred income taxes              |       | 1,415             |       | 1,353                |       |
|                               |       |              |       |                 |       |
| Total assets                       |       | $                 | 180,394    |                 | $          | 178,922 |   |

 

See accompanying notes to unaudited consolidated financial statements.

2

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**Duckwall-ALCOStores, Inc.**

**AndSubsidiaries**

 

**Liabilitiesand Stockholders’ Equity**

(Dollars in Thousands)

 
| ** **                                                                                                                                | ** ** | **July 30,** | ** ** | **January 29,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|----------------------|------------|
| ** **                                                                                                                                | ** ** | **2006**          | ** ** | **2006**             | ** ** |
| ** **                                                                                                                                | ** ** | **(Unaudited)**   | ** ** | ** **           | ** ** |
| Current  liabilities:                                                                                                                     |       |              |       |                 |       |
| Current maturities of capital lease obligations                                                                                           |       | $                 | 2,089      |                 | $          | 1,879 |   |
| Accounts payable                                                                                                                          |       | 26,701            |       | 28,300               |       |
| Income taxes payable                                                                                                                      |       | 432               |       | 1,163                |       |
| Accrued salaries and commissions                                                                                                          |       | 4,956             |       | 6,001                |       |
| Accrued taxes other than income                                                                                                           |       | 4,664             |       | 4,743                |       |
| Self-insurance claim reserves                                                                                                             |       | 4,181             |       | 3,915                |       |
| Stock purchase payable                                                                                                                    |       | —            |       | 1,910                |       |
| Other current liabilities                                                                                                                 |       | 2,454             |       | 2,998                |       |
| Deferred income taxes                                                                                                                     |       | 64                |       | 86                   |       |
|                                                                                                                                      |       |              |       |                 |       |
| Total current liabilities                                                                                                                 |       | 45,541            |       | 50,995               |       |
|                                                                                                                                      |       |              |       |                 |       |
| Notes payable  under revolving loan                                                                                                       |       | 18,136            |       | 17,062               |       |
| Capital lease  obligations - less current maturities                                                                                      |       | 7,140             |       | 7,299                |       |
| Other noncurrent  liabilities                                                                                                             |       | 5,148             |       | 1,419                |       |
|                                                                                                                                      |       |              |       |                 |       |
| Total liabilities                                                                                                                         |       | 75,965            |       | 76,775               |       |
|                                                                                                                                      |       |              |       |                 |       |
| Stockholders’  equity:                                                                                                               |       |              |       |                 |       |
| Common stock, $.0001 par value, authorized 20,000,000  shares; issued and outstanding 3,792,515 shares and 3,786,953 shares  respectively |       | 1                 |       | 1                    |       |
| Additional paid-in capital                                                                                                                |       | 36,735            |       | 36,411               |       |
| Retained earnings                                                                                                                         |       | 67,693            |       | 65,735               |       |
| Total stockholders’ equity                                                                                                           |       | 104,429           |       | 102,147              |       |
|                                                                                                                                      |       |              |       |                 |       |
| Total  liabilities and stockholders’ equity                                                                                          |       | $                 | 180,394    |                 | $          | 178,922 |   |

 

See accompanying notes tounaudited consolidated financial statements.

3

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**Duckwall-ALCO Stores, Inc.**

**And Subsidiaries**

**Consolidated Statements of Operations**

(Dollarsin Thousands Except Per Share Amounts)

(Unaudited)

 
| ** **                                                         | ** ** | **For the Thirteen Week** | ** ** | **For the Twenty-Six  Week** | ** ** |
|--------------------------------------------------------------------|------------|------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                         | ** ** | **Period Ended**                    | ** ** | **Period Ended**                  | ** ** |
| ** **                                                         | ** ** | **July 30,**                        | ** ** | **July 31,**                      | ** ** | **July 30,** | ** ** | **July 31,** | ** ** |
| ** **                                                         | ** ** | **2006**                                 | ** ** | **2005**                               | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                               |       |                                     |       |                                   |       |   |   |   |   |
| Net sales                                                          |       | $                                        | 120,748    |                                   | $          | 108,535 |   | $ | 229,735 |   | $ | 206,458 |   |
| Cost of sales                                                      |       | 84,527                                   |       | 75,909                                 |       | 160,983 |   | 143,197 |   |
| Gross margin                                                       |       | 36,221                                   |       | 32,626                                 |       | 68,752 |   | 63,261 |   |
|                                                               |       |                                     |       |                                   |       |   |   |   |   |
| Selling, general and  administrative                               |       | 31,448                                   |       | 29,831                                 |       | 61,303 |   | 60,422 |   |
| Depreciation and  amortization                                     |       | 1,667                                    |       | 1,448                                  |       | 3,273 |   | 2,942 |   |
| Total operating  expenses                                          |       | 33,115                                   |       | 31,279                                 |       | 64,576 |   | 63,364 |   |
|                                                               |       |                                     |       |                                   |       |   |   |   |   |
| Operating income (loss)  from continuing operations                |       | 3,106                                    |       | 1,347                                  |       | 4,176 |   | (103 | ) |
| Interest expense                                                   |       | 631                                      |       | 245                                    |       | 1,201 |   | 455 |   |
| Earnings (loss) from  continuing operations before income taxes    |       | 2,475                                    |       | 1,102                                  |       | 2,975 |   | (558 | ) |
| Income tax expense  (benefit)                                      |       | 1,034                                    |       | 390                                    |       | 1,224 |   | (197 | ) |
| Earnings (loss) from  continuing operations                        |       | 1,441                                    |       | 712                                    |       | 1,751 |   | (361 | ) |
| Earnings (loss) from  discontinued operations, net of income taxes |       | (24                                      | )          | (1,006                                 | )          | 207 |   | (2,663 | ) |
| Net earnings (loss)                                                |       | $                                        | 1,417      |                                   | $          | (294 | ) | $ | 1,958 |   | $ | (3,024 | ) |
|                                                               |       |                                     |       |                                   |       |   |   |   |   |
| Earnings (loss) per  share                                         |       |                                     |       |                                   |       |   |   |   |   |
| Basic                                                              |       |                                     |       |                                   |       |   |   |   |   |
| Continuing  operations                                             |       | $                                        | 0.38       |                                   | $          | 0.18 |   | $ | 0.46 |   | $ | (0.08 | ) |
| Discontinued  operations                                           |       | $                                        | (0.01      | )                                      | $          | (0.25 | ) | $ | 0.06 |   | $ | (0.63 | ) |
| Net earnings  (loss)                                               |       | $                                        | 0.37       |                                   | $          | (0.07 | ) | $ | 0.52 |   | $ | (0.71 | ) |
|                                                               |       |                                     |       |                                   |       |   |   |   |   |
| Diluted                                                            |       |                                     |       |                                   |       |   |   |   |   |
| Continuing  operations                                             |       | $                                        | 0.38       |                                   | $          | 0.17 |   | $ | 0.46 |   | $ | (0.08 | ) |
| Discontinued  operations                                           |       | $                                        | (0.01      | )                                      | $          | (0.24 | ) | $ | 0.05 |   | $ | (0.63 | ) |
| Net earnings  (loss)                                               |       | $                                        | 0.37       |                                   | $          | (0.07 | ) | $ | 0.51 |   | $ | (0.71 | ) |

 

See accompanying notes to unaudited consolidated financial statements.

4

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**Duckwall-ALCOStores, Inc.**

**AndSubsidiaries**

**ConsolidatedStatements of Cash Flows**

Dollars in Thousands

(Unaudited)

 
| ** **                                                                           | ** ** | **For Twenty-Six Week** | ** ** |
|--------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                           | ** ** | **Period Ended**             | ** ** |
| ** **                                                                           | ** ** | **July 30,**                 | ** ** | **July 31,** | ** ** |
| ** **                                                                           | ** ** | **2006**                          | ** ** | **2005** | ** ** |
| Cash flows from  operating activities:                                               |       |                              |       |   |   |
| Net earnings                                                                         |       | $                                 | 1,958      |   | $ | (3,024 | ) |
| Tax benefit of stock options exercised                                               |       | 14                                |       | — |   |
| Adjustments to reconcile net earnings to net cash provided  by operating activities: |       |                              |       |   |   |
| (Increase) decrease in receivables                                                   |       | (1,328                            | )          | 180 |   |
| Increase in prepaid expenses                                                         |       | (91                               | )          | (85 | ) |
| (Increase) decrease in inventories                                                   |       | (4,744                            | )          | 10,768 |   |
| Depreciation and amortization                                                        |       | 3,273                             |       | 3,076 |   |
| (Gain) loss on sale of assets                                                        |       | (354                              | )          | 617 |   |
| Stock compensation expense                                                           |       | 273                               |       | — |   |
| (Decrease) increase in accounts payable                                              |       | (1,599                            | )          | 2,803 |   |
| Decrease in income taxes payable                                                     |       | (731                              | )          | (2,188 | ) |
| (Decrease) increase in accrued salaries and  commissions                             |       | (1,045                            | )          | 591 |   |
| (Decrease) increase in accrued taxes other                                           |       | (79                               | )          | 558 |   |
| Change in deferred income taxes                                                      |       | (84                               | )          | 2 |   |
| (Decrease) increase in other assets and liabilities                                  |       | (389                              | )          | 72 |   |
|                                                                                 |       |                              |       |   |   |
| Net cash (used in) provided by operating activities                                  |       | (4,926                            | )          | 13,370 |   |
|                                                                                 |       |                              |       |   |   |
| Cash flows from  investing activities:                                               |       |                              |       |   |   |
| Proceeds from the sale of assets                                                     |       | 11,815                            |       | — |   |
| Capital expenditures                                                                 |       | (3,900                            | )          | (3,703 | ) |
|                                                                                 |       |                              |       |   |   |
| Net cash provided by (used in) investing activities                                  |       | 7,915                             |       | (3,703 | ) |
|                                                                                 |       |                              |       |   |   |
| Cash flows from  financing activities:                                               |       |                              |       |   |   |
| Net borrowings under revolving loan credit agreement                                 |       | 1,074                             |       | 472 |   |
| Refinancing costs on revolving loan                                                  |       | —                            |       | (61 | ) |
| Proceeds from exercise of outstanding stock options                                  |       | 111                               |       | 280 |   |
| Excess tax benefit on stock options exercises                                        |       | 28                                |       | — |   |
| Repurchase of stock                                                                  |       | (2,012                            | )          | (8,985 | ) |
| Principal payments under capital lease obligations                                   |       | (976                              | )          | (428 | ) |
|                                                                                 |       |                              |       |   |   |
| Net cash used in financing activities                                                |       | (1,775                            | )          | (8,722 | ) |
|                                                                                 |       |                              |       |   |   |
| Net increase in cash and cash equivalents                                            |       | 1,214                             |       | 945 |   |
|                                                                                 |       |                              |       |   |   |
| Cash and cash  equivalents at beginning of period                                    |       | 472                               |       | 352 |   |
|                                                                                 |       |                              |       |   |   |
| Cash and cash  equivalents at end of period                                          |       | $                                 | 1,686      |   | $ | 1,297 |   |
|                                                                                 |       |                              |       |   |   |
| Cash paid during  the period for:                                                    |       |                              |       |   |   |
| Interest                                                                             |       | $                                 | 1,097      |   | $ | 371 |   |
| Income taxes                                                                         |       | $                                 | 2,147      |   | $ | 567 |   |
|                                                                                 |       |                              |       |   |   |
| Supplemental  disclosure of non-cash activity:                                       |       |                              |       |   |   |
| Tax benefit related to stock options exercised                                       |       | —                            |       | $ | 27 |   |
| Assets acquired under capital lease                                                  |       | $                                 | 1,027      |   | — |   |
| Deferred gain on  sale/leaseback                                                     |       | $                                 | 3,833      |   | — |   |

 

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)           Basisof Presentation

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

(2)           Reclassification

The Companyreclassified to accounts receivable credit cards receivable on its ConsolidatedBalance Sheets, which were previously presented as cash and cashequivalents.  The amounts reclassified onthe Consolidated Balance Sheet totaled $1,094, $848, and $605 in 2006, 2005 and2004, respectively.  The related changein net cash provided by operating activities was ($246), ($243), and ($124) in2006, 2005 and 2004, respectively.

(3)           Principlesof Consolidation

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

(4)           Stock-basedCompensation

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

For the twenty-six weeks ended July 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 $273 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 (defined hereafter). This share-based compensation lowered pre-taxearnings by $273, lowered net income by $161, and lowered basic and dilutedearnings per share by $0.04. SFAS 123(R) also

6

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requiresthe benefits of tax deductions in excess of recognized compensation cost to bereported as a financing activity, rather than as an operating activity in thestatement of cash flow as required prior to SFAS 123(R). The change resulted in$28 being shown as a cash flow from financing activities rather than operatingactivities.  The impact of adopting SFAS123(R) on future results will depend on, among other things, levels ofshare-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 using theintrinsic-value-based recognition method prescribed by Accounting PrinciplesBoard Opinion No. 25, “Accounting for Stock Issued to Employees,” (“APB 25”).As options were granted at an exercise price equal to the market value of the underlyingcommon stock on the date of grant, no stock-based employee compensation costwas reflected in net income prior to adopting SFAS 123(R). As the Companyadopted SFAS 123(R) under the modified-prospective-transition method, resultsfrom prior periods have not been restated.

The followingtable illustrates the effect on net income and earnings per share as if theCompany applied the fair value recognition provisions of Statement 123 tooptions granted under the Company’s stock plans in all periods presented.   The periods represented include the secondquarter of Fiscal 2006 and the twenty-six week period of Fiscal 2006.  For purposes of this pro forma disclosure,the value of the options is estimated using a modified Black-Scholes option pricingmodel for all option grants:
| ** **                                                    | ** ** | **For The Thirteen Week** | ** ** | **For The Twenty-Six  Week** | ** ** |
|---------------------------------------------------------------|------------|------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                    | ** ** | **Period Ended**                    | ** ** | **Period Ended**                  | ** ** |
| ** **                                                    | ** ** | **July 31,**                        | ** ** | **July 31,**                      | ** ** |
| ** **                                                    | ** ** | **2005**                                 | ** ** | **2005**                               | ** ** |
| Net loss as  reported                                         |       | (294                                     | )          | (3,024                                 | )          |
| Pro forma  stock-based employee compensation cost, net of tax |       | (58                                      | )          | (79                                    | )          |
| Pro forma net  loss                                           |       | (352                                     | )          | (3,103                                 | )          |
|                                                          |       |                                     |       |                                   |       |
| Loss per share  as reported:                                  |       |                                     |       |                                   |       |
| Basic                                                         |       | (0.07                                    | )          | (0.71                                  | )          |
| Diluted                                                       |       | (0.07                                    | )          | (0.71                                  | )          |
|                                                          |       |                                     |       |                                   |       |
| Loss per share,  pro forma:                                   |       |                                     |       |                                   |       |
| Basic                                                         |       | (0.09                                    | )          | (0.73                                  | )          |
| Diluted                                                       |       | (0.09                                    | )          | (0.73                                  | )          |

 

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 to the terms of the plan, the pershare exercise price of options granted shall not be less than 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. The options vest in equal amounts overa four year requisite service period beginning one calendar year from the grant.In the case of a stockholder owning more than 10% of the outstanding votingstock of the Company, the exercise price of an incentive stock option may notbe less than 110% of the fair market value of the stock on the date of grantand such options will expire no later than five years from the date ofgrant.  Also, the aggregate fair marketvalue of the stock with respect to which incentive stock options areexercisable on a tax deferred basis for the first time by an individual in anycalendar year may not exceed $100,000. In the event that the

7

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foregoingresults in a portion of an option exceeding the $100,000 limitation, suchportion of the option in excess of the limitation shall be treated as anonqualified stock option.

Under the Company’s Non-Qualified StockOption Plan for Non-Management Directors, options may be granted to Directorsof the Company who are not otherwise officers or employees of the Company.  According to the terms of the plan, the pershare exercise price of options granted shall not be less than the fair marketvalue of the stock on the date of grant and such options will expire five yearsfrom the date of grant.  The options vestin equal amounts over a four year requisite service period beginning onecalendar year from the grant date.  Alloptions under the plan shall be non-qualified stock options.

The Company previously issued stock underthe 1993 Incentive Stock Option Plan. This plan was structured in the same fashion as the 2003 Incentive StockOption Plan described above, however it did not specify the 10% ownershiprules.  There are no shares remaining tobe issued under this plan.  As of July30, 2006, 13,989 options were outstanding under this plan.

Under the terms of the 2003 IncentiveStock Option Plan adopted by the Company effective May 22, 2003, a maximum of500,000 shares are available for a grant as stock options or other awards  At July 30, 2006, the Company had sharesauthorized for future option grants of 133,000. The Company issues these grants from the unissued shares authorized, orany treasury shares held by the Company.

Under the terms of the Non-QualifiedStock Option Plan for Non-Management Directors adopted by the Company on May23, 2006, a maximum of 120,000 shares are available for a grant as stockoptions.  There are no shares remainingto be issued under this plan.  TheCompany issues these grants from the unissued shares authorized, or anytreasury shares held 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.  The Company has estimated the fair value ofall stock option awards as of the date of the grant by applying a modifiedBlack-Scholes pricing valuation model. The application of this valuation model involves assumptions that arejudgmental and highly sensitive in the determination of compensation expense.The weighted average for key assumptions used in determining the fair value ofoptions granted in the twenty-six weeks ended July 30, 2006 and July 31, 2005and a summary of the methodology applied to develop each assumption are asfollows:
| ** **                                | ** ** | **July 30,** | ** ** | **July 31,** | ** ** |
|-------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                | ** ** | **2006**          | ** ** | **2005**          | ** ** |
| Expected price  volatility                |       | 37.4              | %          | 38.4              | %          |
| Risk-free  interest rate                  |       | 5.0               | %          | 4.0               | %          |
| Weighted average  expected lives in years |       | 3.8               |       | 5.0               |       |
| Forfeiture rate                           |       | 3.2               | %          | 0.0               | %          |
| Dividend yield                            |       | 0.0               | %          | 0.0               | %          |

 

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

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

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

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

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

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

Asummary of stock option activity since the Company’s most recent fiscalyear-end is as follows:
| ** **                         | ** ** | **Number  of  Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighed  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|------------------------------------|------------|------------------------|------------|----------------------------------------|------------|----------------------------------------------------|------------|---------------------------------|------------|
| Outstanding  January 29, 2006      |       | 133,238                |       | $                                      | 17.37      |                                               |       |                            |       |   |
| Granted                            |       | 377,000                |       | 30.01                                  |       |                                               |       |                            |       |
| Exercised                          |       | (8,899                 | )          | 12.50                                  |       |                                               |       |                            |       |
| Cancelled                          |       | (2,350                 | )          | 28.05                                  |       |                                               |       |                            |       |
| Outstanding July  30, 2006         |       | 498,989                |       | $                                      | 26.96      |                                               | 4.5        |                            | $          | 3,834 |   |
|                               |       |                   |       |                                   |       |                                               |       |                            |       |
| Expected to vest  at July 30, 2006 |       | 488,771                |       | $                                      | 26.88      |                                               | 4.5        |                            | $          | 3,795 |   |
|                               |       |                   |       |                                   |       |                                               |       |                            |       |
| Exercisable at July 30,  2006      |       | 41,489                 |       | $                                      | 16.41      |                                               | 2.7        |                            | $          | 756 |   |

 

The aggregate intrinsic values in thetable above represents the total difference between the Company’s closing stockprice on July 30, 2006 and the option exercise price, multiplied by the numberof in-the-money options as of July 30, 2006. As of July 30, 2006, totalunrecognized compensation expense related to non-vested stock options is $4.0million with a weighted average expense recognition period of 4.6 years.

A summary of the status of the Company’snonvested shares as of July 30, 2006 is presented below:
| ** **                     | ** ** | **Number of  Shares** | ** ** | **Weighted Average  Grant Date  Fair Value (per  share)** | ** ** |
|--------------------------------|------------|----------------------------|------------|-------------------------------------------------------------------------------|------------|
| Nonvested at  January 29, 2006 |       | 118,920                    |       | $                                                                             | 7.20       |   |
| Granted                        |       | 377,000                    |       | $                                                                             | 10.52      |   |
| Vested                         |       | (36,332                    | )          | $                                                                             | 6.84       |   |
| Forfeited                      |       | (2,088                     | )          | $                                                                             | 9.99       |   |
| Nonvested at July 30,  2006    |       | 457,500                    |       | $                                                                             | 9.95       |   |

 

Otherinformation relative to option activity during the twenty-six weeks ended July30, 2006 and July 31, 2005 is as follows:

 
| ** **                                                                   | ** ** | **July 30,** | ** ** | **July 31,** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                                                   | ** ** | **2006**          | ** ** | **2005**          | ** ** |
| Weighted average  grant date fair value of stock options granted (per share) |       | $                 | 10.52      |              | $          | 7.36 |   |
| Total fair value  of stock options vested                                    |       | $                 | 249        |              | $          | 54 |   |
| Total intrinsic value  of stock options exercised                            |       | $                 | 139        |              | $          | 234 |   |

 

9

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(4)           EarningsPer Share

Basic net earnings pershare is computed by dividing net earnings by the weighted average number ofshares outstanding.  Diluted net earningsper share reflects the potential dilution that could occur if contracts toissue securities (such as stock options) were exercised.

 

The average number ofshares used in computing earnings per share was as follows:

 
| **Thirteen Weeks Ended** | ** ** | **Basic** | ** ** | **Diluted** | ** ** |
|------------------------------------|------------|-----------|------------|-------------|------------|
|                               |       |      |       |        |       |
| July 30, 2006                      |       | 3,793,392 |       | 3,828,546   |       |
| July 31, 2005                      |       | 4,066,479 |       | 4,101,105   |       |

 
| **Twenty-Six Weeks Ended** | ** ** | **Basic** | ** ** | **Diluted** | ** ** |
|--------------------------------------|------------|-----------|------------|-------------|------------|
|                                 |       |      |       |        |       |
| July 30, 2006                        |       | 3,790,788 |       | 3,820,778   |       |
| July 31, 2005                        |       | 4,252,224 |       | 4,252,224   |       |

 

(5)           Sale and Leaseback Agreement

The Company has completed the sale/leaseback of 11 ALCO retaillocations during the second quarter of Fiscal 2007 for approximately $11.2million.  The term of each lease is 15years with three, five-year options to extend the term of such leases.  The aggregate annual base rent amount is anamount equal to the purchase price multiplied by a capitalization rate ofapproximately 8.85%.  An additionallocation is currently under construction and will be sold upon completion.

The Company deferred the resulting gain of $3.8 million onthese transactions.  This deferred gainwill be amortized over the 15 year life of the leases as a reduction of rentexpense.

The cash proceeds fromthe transaction were used to repay a significant portion of the Company’slong-term debt.

**ITEM2.  MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

(Dollars in Thousands Except Per Share Amounts)

***OVERVIEW***

*Operations*.  The Company is a regional discount retaileroperating 254 stores in 21 states in the central United States, with twobusiness divisions, consisting of:

·      TheALCO division which, as of July 30, 2006, operated 187 ALCO Stores which offera wide variety of general merchandise and a limited variety of food productsand accounted for 94% of the Company’s sales for the second quarter of fiscal2007.

·      TheDuckwall division which, as of July 30, 2006, operated 67 Duckwall Stores whichoffer a more limited general merchandise selection, but serve the needs of acommunity that is not large enough to support a full-line retail discountstore, and accounted for 6% of the Company’s sales for the second quarter offiscal 2007.

Thethirteen weeks ended July 30, 2006 and July 31, 2005 are referred to herein asthe second quarter of fiscal 2007 and 2006, respectively.  For purposes of this management’s discussion andanalysis of financial condition and results of operations, the financialnumbers are presented in thousands.

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*Strategy.*  The Company’s overall business strategyinvolves identifying and opening stores in towns that will provide the Companywith the highest return on investment. Although the Company prefers markets that don’t have direct competition,its strategy does not preclude 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 also competes for retail saleswith 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.  TheCompany uses centralized purchasing, merchandising, pricing and warehousing toobtain volume discounts, improve efficiencies and achieve consistency amongstores and the best overall results.  TheCompany utilizes information obtained from its point-of-sale system and regularinput 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 hasselected the hardware and software and entered into agreements with respectivevendors.  The Company went live on thehuman resources/payroll and financial systems during the third quarter offiscal 2006.  The Company piloted the newPOS system in five stores during the second quarter of fiscal 2007, with therollout of this system to all stores later in the year.  Financial Planning, Performance Analysis andMerchandise Allocation systems went live in the first quarter of fiscal 2007. Arequired feature of this new point-of-sale system is perpetual inventory, whichthe Company does not currently have in its stores.  Perpetual inventory allows tracking ofon-hand quantities at the item level, and enables automated replenishment.  These features will allow the Company tobetter manage inventory levels 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 areremoved, the Company expects to re-engineer the stores to take full advantageof the new technology.

TheCompany, when appropriate, implements new merchandising and marketinginitiatives in an effort to increase customer traffic and same-storesales.  Over the last year, the Companyhas implemented a plan to improve merchandise mix, with greater emphasis onsoft-lines.  This strategy will enhancethe Company’s offerings in fashion merchandise and accessories.  The Company’s marketing strategy has beenenhanced to highlight more of these products. As the Company evaluates changes, it refines its merchandise mix andadvertising strategies.  To furthercreate a more customer friendly shopping experience, the Company continues torefine its store prototype and make changes to its layout to accommodate newmerchandise strategies.  As these changesare 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 Companyfinalized its restructuring plan on April 28, 2005 and on May 3, 2005, theCompany publicly announced the restructuring. The restructuring is designed to help the Company more effectivelycompete in today’s competitive retail environment.  As a part of the restructuring, 46 corporatepositions were eliminated, which will result in an annualized savings ofapproximately $2,200.  One-time costsassociated with the restructuring were approximately $734.

*Recent Events*.

On August 1, 2006, the Company entered into a new employmentagreement with Bruce C. Dale, President and CEO.  The employment agreement is effective August1, 2006 and has a term ending on March 31, 2012.  The employment agreement may be terminated byMr. Dale upon 30 days prior written notice to the Company and by the Company atanytime, with certain conditions.  Theagreement also restricts Mr. Dale in competing with the Company or solicitingemployees from the Company during the terms of the agreement and for two yearsafter the term ends.  Under the terms ofthe agreement the Company will pay Mr. Dale a base salary of $365,000 and he iseligible, under preset terms, to receive a performance bonus equal to 75% ofhis base pay

11

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Key Items in Second Quarter Fiscal 2007

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

·      Netsales increased 11.3% to $120,748.  Samestore sales increased 7.4% compared to the prior year second quarter.

·      Grossmargin percentage of 30.0% of sales, remained flat when compared to 30.0% inthe prior year second quarter.

·      Earningsper share were $0.37 in the second quarter of fiscal 2007 compared to a loss of($.07) per share in the prior year second quarter.

·      TheCompany’s earnings before interest, taxes, depreciation and amortization (“EBITDA”)from continuing operations for the second quarter 2007 were $4,999.

·      TheCompany’s return on average equity (“ROE”) for the second quarter 2007 was1.4%.

Samestore sales growth is a measure which may indicate whether existing stores aremaintaining their market share.  Otherfactors, such as the overall economy, may also affect same store sales.  The Company defines same stores as thosestores that were open as of the first day of the prior fiscal year and remainopen at the end of the reporting period. The same store sales for all Company stores increased 7.4% compared tothe second quarter last year, the ALCO stores same store sales increased 7.8%,and the Duckwall same stores sales increased 2.4% during the second quarter offiscal 2007.  In the second quarter endedJuly 30, 2006, in one market, the Company closed a Duckwall store and opened anALCO store.

Gross marginpercentage is a key measure of the Company’s ability to maximize profit on thepurchase and subsequent sale of merchandise, while minimizing promotional andclearance markdowns, shrinkage, damage, and returns.  Gross margin percentage is defined as salesless cost of sales, expressed as a percentage of sales.  Gross margin percent remained flat at 30.0%of sales in the second quarter of fiscal 2007, compared to 30.0% in the secondquarter of fiscal 2006.

Earnings per share(“EPS”) growth are an indicator of the returns generated for the Company’sstockholders.  EPS from continuingoperations improved to $0.37 per diluted share for the second quarter of fiscal2007, compared to $0.17 per diluted share for the second quarter of the priorfiscal year.

The Company’sEBITDA and ROE are discussed under *SG&A Detail; CertainFinancial Measures*below.

**NewAccounting Standard**

In June 2006, theFinancial Accounting Standards Board, or FASB, issued Interpretation No. 48, “*Accounting for Uncertainty in Income Taxes*, or FIN 48, aninterpretation of FASB No. 109, *Accounting for IncomeTaxes*.”  FIN 48 clarifies theaccounting for uncertainty in income taxes recognized in an enterprise’sfinancial statements in accordance with FASB Statement No. 109, Accounting forIncome Taxes and prescribes a recognition threshold and measurement attributefor the financial statement recognition and measurement of a tax position takenor expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interestand penalties, accounting in interim periods, disclosure, and transition.  FIN 48 is effective for fiscal yearsbeginning after December 15, 2006.  TheCompany is in the process of determining the impact of the adoption of thisInterpretation on our consolidated financial statements.

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

Certain statements contained in this Quarterly Reporton Form 10-Q that are not statements of historical fact may constitute “forward-lookingstatements” within the meaning of Section 21E of the Exchange Act. Thesestatements are subject to risks and uncertainties, as described below. Examplesof forward-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 and objectives ofthe Company’s management or Board of Directors, including plans or objectivesrelating to inventory, store development, marketing, competition, businessstrategy, store environment, merchandising, purchasing, pricing, distribution,transportation, store locations and information

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systems,(iii) statements of future economic performance, and (iv) statements ofassumptions underlying 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 involve risks, uncertainties andassumptions.  The Company’s futureresults of operations, financial condition and business operations may differmaterially from the forward-looking statements or the historical informationstated in this Quarterly Report on Form 10-Q. Stockholders and investors are cautioned not to put undue reliance onany forward-looking statement.

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

# *CRITICAL ACCOUNTING POLICIES*

*Inventory*:  As discussed in Note 1 (d) to theConsolidated Financial Statements, inventories are stated at the lower of costor net realizable value with cost determined using the last-in, first-out(LIFO) method.  The retail inventorymethod (“RIM”) used by the Company is an averaging method that has been widelyused in the retail industry.  This methodcalculates a cost to retail ratio that is applied to the retail value ofinventory to calculate cost inventory and the resulting gross margin.  Use of the RIM method does not eliminate theuse of management judgments and estimates, including markdowns and shrinkage,which significantly impact the ending inventory valuation at cost and theresulting gross margins.  The Company continuallyevaluates product categories to determine if markdown action is appropriate, orif a markdown reserve should be established. The Company recognizes that the use of the RIM will result in valuinginventories at lower of cost or market if markdowns are currently taken as areduction of the retail value of inventories. As of July 30, 2006 and July 31, 2005, the Company had recordedmarkdowns that had not been taken and which served to reduce inventories to lowerof cost or market by approximately $187 and $200, respectively. Managementbelieves that the RIM provides an inventory valuation which reasonablyapproximates cost and results in carrying inventory at the lower of cost ormarket.

*Insurance*:  The Company considers determination ofoverall insurance costs a critical accounting policy. As described below, theCompany is essentially self insured for its workers compensation, medicalinsurance and general liability insurance. Due to the fact that it takes more than one year to determine the actualcosts under these plans, these costs are estimated based on the Company’shistorical loss experience and estimates from the insurance carriers andconsultants.

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

Medical.  The Company is also essentially self insuredfor medical insurance and covers all claims in a plan year related to anindividual until they exceed $125.  TheCompany has responded to increases in the cost of medical coverage  by taking steps that were effective August 1,2005 to increase the premiums paid by its associates and by implementing otherchanges that are designed to control 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 has identified exposures forwhich they have established a reserve, such as differences in interpretation oftax laws at the federal, state, and local units of government.

13

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***RESULTS OF OPERATIONS***

**ThirteenWeeks Ended July 30, 2006 Compared to Thirteen Weeks Ended July 31, 2005.**

***Net Sales***

Netsales for the second quarter of fiscal 2007 increased $12,213, or 11.3%, to$120,748 compared to $108,535 for the second quarter of fiscal 2006.  Same store sales increased 7.4% when comparedwith the prior year.  The sales werefavorably impacted by customer acceptance of its current merchandise strategythat focuses on soft-lines, a 5.1% increase in customer count and a 6.3%increase in average sale generated.

***Gross Margin***

Grossmargin for the second quarter of fiscal 2007 increased $3,595, or 11.0%, to$36,221 compared to $32,626 in the second quarter of fiscal 2006.  Gross margin as a percentage of sales was30.0% for the second quarter of fiscal 2007, which remained flat when comparedto 30.0% for the second quarter of fiscal 2006. Lower markdowns were offset by increased freight costs.

***SG&A***

Selling,general and administrative expense increased $1,617 or 5.4%, to $31,448 in thesecond quarter of fiscal 2007 compared to $29,831 in the second quarter offiscal 2006.  As a percentage of net sales,selling, general and administrative expenses in the second quarter of fiscal2007 were 26.0%, compared to 27.5% in the second quarter of fiscal 2006.  The increase in selling, general andadministrative expenses was due in part to an increase in store level wages,increase in expenses related to stock options, incremental costs associatedwith rollout of IT initiative, increase in insurance and utilities, offset byincreased vendor participation in CO-OP advertising.

***Depreciation and Amortization***

Depreciationand amortization expense increased $219, or 15.1%, to $1,667 in the secondquarter of fiscal 2007 compared to $1,448 in the second quarter of fiscal2006.  The increase is primarily due tonew stores opened in the fourth quarter of fiscal 2006 and the first quarter offiscal 2007.

***Interest Expense***

Interestexpense increased $386, or 157.6%, to $631 in the second quarter of fiscal 2007compared to $245 in the second quarter of fiscal 2006.  The increase in interest expense was due tohigher levels of borrowing and an increase in the interest rate for fiscal2007.

***Income Taxes***

TheCompany’s effective tax rate on earnings from continuing operations in thesecond quarter of fiscal 2007 was 41.8%, compared to 35.4% in the secondquarter of fiscal 2006.  The effectivetax rate is higher due to the expiration of certain employment tax credits,stock option expense and the Company’s increased profitability.

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

Lossfrom discontinued operations, net of income tax, was $24 in the second quarterof fiscal 2007, compared to a loss from discontinued operations of $1,006 inthe second quarter of fiscal 2006.  Thedecrease in loss from discontinued operations relates to the Company’s closingof 20 unprofitable stores in the second quarter of fiscal 2006 compared with nostore closings in the second quarter of fiscal 2007.  Stores closed where the Company has exitedthe market are reflected in discontinued operations in all periods presented.

**Twenty-SixWeeks Ended July 30, 2006 Compared to Twenty-Six Weeks Ended July 31, 2005.**

***Net Sales***

Netsales for the twenty-six week period of fiscal 2007 increased $23,277, or11.3%, to $229,735 compared to $206,458 for the twenty-six period of fiscal2006.  Same store sales increased 7.0% whencompared with the prior

14

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year.  The sales were favorably impacted by customeracceptance of its current merchandise strategy that focuses on soft-lines, a4.9% increase in customer count and a 6.2% increase in average sale generated.

***Gross Margin***

Grossmargin for the twenty-six week period of fiscal 2007 increased $5,491, or 8.7%,to $68,752 compared to $63,261 in the twenty-six week period of fiscal2006.  Gross margin as a percentage ofsales was 29.9% for the twenty-six week period of fiscal 2007 compared to 30.6%for the twenty-six week period of fiscal 2006. The decrease in the gross margin as percentage of sales was due tohigher promotional markdowns, higher freight costs resulting from higher fuelprices (a 24.2% increase compared to the twenty-six week period of fiscal2006), and lower margin on increased sales at the fuel centers.

***SG&A***

Selling,general and administrative expense increased $881, or 1.5%, to $61,303 in thetwenty-six week period of fiscal 2007 compared to $60,442 in the twenty-sixweek period of fiscal 2006.  As apercentage of net sales, selling, general and administrative expenses in thetwenty-six week period of fiscal 2007 were 26.7%, compared to 29.3% in thetwenty-six week period of fiscal 2006. The decrease in selling, general and administrative expenses as apercentage of net sales was due in part to one time costs of approximately $734associated with the Company’s restructuring and workforce reduction in fiscal2006 that was not repeated in fiscal 2007 and an increase in vendorparticipation in CO-OP advertising, offset by increased payroll, increase inexpenses related to stock options, increase in credit card fees, incrementalcosts associated with rollout of IT initiative, increase in utilities and newstore rents.

***Depreciation and Amortization***

Depreciationand amortization expense increased $331, or 11.3%, to $3,273 in the twenty-sixweek period of fiscal 2007 compared to $2,942 in the twenty-six week period offiscal 2006.  The increase is primarilydue to new stores opened in the fourth quarter of fiscal 2006 and the firstquarter of fiscal 2007.

***Interest Expense***

Interestexpense increased $746, or 164.0%, to $1,201 in the twenty-six week period offiscal 2007 compared to $455 in the twenty-six week period of fiscal 2006.  The increase in interest expense was due tohigher levels of borrowing and increase in the interest rate for the twenty-sixweek period of fiscal 2007.

***Income Taxes***

TheCompany’s effective tax rate on earnings from continuing operations for thetwenty-six week period of fiscal 2007 was 41.1%, compared to 35.3% in thetwenty-six week period of fiscal 2006. The effective tax rate is higher due to the expiration of certainemployment tax credits.

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

Earningsfrom discontinued operations, net of income tax, was $207 in the twenty-sixweek period of fiscal 2007, compared to a loss from discontinued operations of$2,663 in the twenty-six week period of fiscal 2006.  The increase in earnings from discontinuedoperations relates to the Company’s closing of 20 unprofitable stores in thetwenty-six week period of fiscal 2006 compared with no store closings in thetwenty-six week period of fiscal 2007. Additionally, the Company sold a property held for sale in relation tothe closings in fiscal 2006 in the twenty-six week period of fiscal 2007resulting in a gain of $351. Stores closed where the Company has exited themarket are reflected in discontinued operations in all periods presented.

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

TheCompany believes the following detailed information is useful in analyzing itsbusiness results.  All informationpresented is from continuing operations.
| ** **                                                         | ** ** | **For the Thirteen Week** | ** ** | **For the Twenty-Six Week** | ** ** |
|--------------------------------------------------------------------|------------|------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                         | ** ** | **Period Ended**                    | ** ** | **Period Ended**                      | ** ** |
| ** **                                                         | ** ** | **July 30, 2006**              | ** ** | **July 31, 2005**                | ** ** | **July 30, 2006** | ** ** | **July 31, 2005** | ** ** |
| **SG&A  Expenses Breakout**                                    | ** ** | ** **                               | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| General Office                                                     |       | 2,753                                    |       | 3,253                                      |       | 5,137 |   | 8,337 |   |
| Distribution  Center                                               |       | 1,695                                    |       | 1,951                                      |       | 3,958 |   | 3,961 |   |
| SPD Truck Lines                                                    |       | —                                   |       | 275                                        |       | — |   | 516 |   |
| 401K/Profit  Sharing                                               |       | 118                                      |       | —                                     |       | 234 |   | — |   |
| Comparable  Stores SG&A                                        |       | 24,998                                   |       | 23,852                                     |       | 48,633 |   | 46,887 |   |
| Non Comp Stores  SG&A #                                        |       | 1,658                                    |       | 500                                        |       | 3,068 |   | 721 |   |
| Stock Option  Expense                                              |       | 226                                      |       | —                                     |       | 273 |   | — |   |
| Final SG&A  as reported                                        |       | 31,448                                   |       | 29,831                                     |       | 61,303 |   | 60,422 |   |
|                                                               |       |                                     |       |                                       |       |   |   |   |   |
| Return on Average  Equity**** (ROE)                                |       | 1.37                                     | %          | -0.28                                      | %          | 1.90 | % | -2.78 | % |
|                                                               |       |                                     |       |                                       |       |   |   |   |   |
| Net Sales                                                          |       | $                                        | 120,748    |                                       | $          | 108,535 |   | $ | 229,735 |   | 206,458 |   |
| SG&A as % of  Sales                                            |       | 26.04                                    | %          | 27.49                                      | %          | 26.68 | % | 29.27 | % |
|                                                               |       |                                     |       |                                       |       |   |   |   |   |
| SG&A per  average selling square foot                          |       | $                                        | 7.61       |                                       | $          | 7.67 |   | $ | 14.95 |   | $ | 15.53 |   |
|                                                               |       |                                     |       |                                       |       |   |   |   |   |
| EBITDA**                                                           |       | $                                        | 4,999      |                                       | $          | 2,795 |   | $ | 7,722 |   | $ | 2,839 |   |
| EBITDA per  average selling square foot***                         |       | $                                        | 1.21       |                                       | $          | 0.72 |   | $ | 1.88 |   | $ | 0.73 |   |
|                                                               |       |                                     |       |                                       |       |   |   |   |   |
| Sales per  average selling square feet*                            |       |                                     |       |                                       |       |   |   |   |   |
| ALCO                                                               |       | $                                        | 30.02      |                                       | $          | 28.61 |   | $ | 57.48 |   | $ | 54.38 |   |
| Duckwall                                                           |       | $                                        | 21.15      |                                       | $          | 20.95 |   | $ | 41.12 |   | $ | 40.54 |   |
| Total                                                              |       | $                                        | 29.22      |                                       | $          | 27.90 |   | $ | 56.03 |   | $ | 53.08 |   |
|                                                               |       |                                     |       |                                       |       |   |   |   |   |
| Average Selling  Square Feet*                                      |       | 4,132                                    |       | 3,890                                      |       | 4,100 |   | 3,890 |   |
| Average Square  Feet % Change                                      |       | 6.1                                      | %          | 1.4                                        | %          | 5.4 | % | 1.5 | % |
|                                                               |       |                                     |       |                                       |       |   |   |   |   |
| Total Stores  Operating beginning of Period                        |       | 254                                      |       | 245                                        |       | 251 |   | 266 |   |
| Total Stores  Operating end of Period                              |       | 254                                      |       | 247                                        |       | 254 |   | 247 |   |
|                                                               |       |                                     |       |                                       |       |   |   |   |   |
| Supplemental  Data:                                                |       |                                     |       |                                       |       |   |   |   |   |
| Same Store Sales  Change                                           |       | 7.4                                      | %          | 3.5                                        | %          | 7.0 | % | 1.7 | % |
| Total customer  count change                                       |       | 5.1                                      | %          | 8.2                                        | %          | 4.9 | % | 1.5 | % |
| Average sale per  ticket change                                    |       | 6.3                                      | %          | 0.8                                        | %          | 6.2 | % | 3.0 | % |
|                                                               |       |                                     |       |                                       |       |   |   |   |   |
| Average  annualized New Store Sale performance on prototype Stores |       | $                                        | 2,284      |                                       | —     |   | — |   | — |   |
| Incremental expenses  related to IT initiative                     |       | $                                        | 248        |                                       | —     |   | $ | 420 |   | — |   |

 

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

**           EBITDA is earnings from continuing operationsbefore interest, taxes, depreciation, amortization and stock option expense.

***         EBITDA per selling square foot is a non-GAAPfinancial measure and is calculated as EBITDA divided by selling square feet.

****       Return on average equity (ROE) is calculatedas Net Earnings divided by average stockholders’ equity. Average Stockholders’Equity is calculated as (beginning of period stockholders’ equity plus end ofperiod stockholders’ equity) divided by 2

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

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*Fiscal2007 Compared to Fiscal 2006*

GeneralOffice expenses for fiscal 2007 decreased $3,200 or 38.4%.  The decrease was due in part to one timecosts of approximately $734 associated with the Company’s restructuring andworkforce reduction in fiscal 2006 not repeated in fiscal 2007 and the relatedpayroll savings in fiscal 2007 relating to these reductions, and a $3,255increase in vendor participation in CO-OP advertising programs, offset byincreased utility costs.

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

Comparablestore SG&A expenses increased $1,746 or 3.7%.  Advertising, insurance, utility and creditcard fees accounted for the majority of this increase.

NonComparable Stores SG&A expenses increased $2,347 or 325.5%.  The Company has opened 15 stores since thefirst quarter of fiscal 2006.

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

The following table showsthe reconciliation of EBITDA per selling square foot to earnings (loss) fromcontinuing operations, the most directly comparable financial measurecalculated and presented in accordance with GAAP:

 
| ** **                                           | ** ** | **For the Thirteen Week** | ** ** | **For the Twenty-Six Week** | ** ** |
|------------------------------------------------------|------------|------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                           | ** ** | **Period Ended**                    | ** ** | **Period Ended**                      | ** ** |
| ** **                                           | ** ** | **July 30, 2006**              | ** ** | **July 31, 2005**                | ** ** | **July 30, 2006** | ** ** | **July 31, 2005** | ** ** |
|                                                 |       |                                     |       |                                       |       |   |   |   |   |
| Earnings from  continuing operations                 |       | 1,441                                    |       | 712                                        |       | 1,751 |   | (361 | ) |
| Plus interest                                        |       | 631                                      |       | 245                                        |       | 1,201 |   | 455 |   |
| Plus taxes                                           |       | 1,034                                    |       | 390                                        |       | 1,224 |   | (197 | ) |
| Plus depreciation and  amortization                  |       | 1,667                                    |       | 1,448                                      |       | 3,273 |   | 2,942 |   |
| Plus stock option  expense                           |       | 226                                      |       | —                                     |       | 273 |   | — |   |
|  =EBITDA                                        |       | 4,999                                    |       | 2,795                                      |       | 7,722 |   | 2,839 |   |
|                                                 |       |                                     |       |                                       |       |   |   |   |   |
| Earnings from  continuing operations per square foot |       | $                                        | 0.35       |                                       | $          | 0.18 |   | $ | 0.43 |   | $ | (0.09 | ) |
| Plus interest per  square foot                       |       | $                                        | 0.15       |                                       | $          | 0.06 |   | $ | 0.29 |   | $ | 0.12 |   |
| Plus taxes per square  foot                          |       | $                                        | 0.25       |                                       | $          | 0.10 |   | $ | 0.30 |   | $ | (0.05 | ) |
| Plus depreciation and  amortization per square foot  |       | $                                        | 0.40       |                                       | $          | 0.37 |   | $ | 0.80 |   | $ | 0.76 |   |
| Plus stock option  expense per square foot           |       | $                                        | 0.05       |                                       | $          | — |   | $ | 0.07 |   | $ | — |   |
|  =EBITDA per selling square  foot               |       | $                                        | 1.20       |                                       | $          | 0.71 |   | $ | 1.89 |   | $ | 0.74 |   |

 

***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).

AtJuly 30, 2006 working capital (defined as current assets less currentliabilities) was $102,740 compared to $90,634 at the end of fiscal 2006.  The increase in working capital wasattributable to increases in inventory, accounts receivable and cash and cashequivalents; and decreases in accounts payable, stock purchase payments, incometaxes payables, and accrued salaries and commissions.   

TheCompany has a loan agreement with its lenders that provides a revolving loancredit facility of up to $70,000 of long-term financing.  The amount advanced (through a note orletters of credit) to the Company under the credit facility bears interest at(i) the prime rate plus a margin, as defined, which varies based on the amount

17

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outstanding (BaseLoan) or (ii) based on the Euro dollar rate plus a margin, as defined, (IndexLoan).  Based upon its projectedfinancial requirements, the Company uses a combination of short term Eurodollar contracts and borrowing at prime. The amount advanced is generally limited to 70% of eligible inventory,as defined in the loan agreement. Advances are secured by a security interest in the Company’sinventory.  The loan agreement containsvarious restrictions that are applicable if the Company fails to maintainexcess availability of at a least $27,500, including limitations on additionalindebtedness, acquisitions of assets and payment of dividends.  The loan agreement expires on April 15,2010.  As of July 30, 2006, the Companyhas borrowed $18,136 under this facility. The lender had also issued letters of credit aggregating $4,357 at suchdate on behalf of the Company. Availability under this facility as of July 30, 2006 was $47,507.

Cash(used in) provided by operating activities in the twenty-six week period offiscal 2007 and 2006 was ($4, 926) and $13,370 respectively.  The decrease in the amount of cash providedby operating activities in the twenty-six week period of fiscal 2007 comparedto the twenty-six week period of fiscal 2006 was primarily due to a increase ininventory relating to the stores opened since fiscal 2006, a decrease inaccrued salaries and wages, and a decrease in other liabilities; offset by anincrease 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 $12,000.  Cash provided by (used in) investingactivities (including acquisitions and remodeling) in the twenty-six weekperiod of fiscal 2007 and 2006 totaled $7,915 and ($3,703), respectively, whichwere used primarily for the acquisition of property and equipment, offset infiscal 2007 by the proceeds from the sale of assets.  During the twenty-six week period ended July30, 2006, the Company completed sales/leaseback transactions on 11 ALCO retaillocations for $11,229.  The remainingamount is due to the sale of a previously closed location.

TheCompany  used cash from financingactivities in the twenty-six week period of fiscal 2007 and 2006 of ($1,775)and ($8,722) respectively.  Borrowings onthe revolving loan generated $1,074 during the twenty-six week ended July 30,2006, compared to $472 during the twenty-six week period of the prior fiscalyear.  Cash used to purchase and retire 78,337and 399,362 shares of Common Stock was $2,012 and $8,985 for the twenty-sixweek period of fiscal 2007 and 2006, respectively.  The Board of Directors of the Company hasauthorized the Company to repurchase up to 2,014,461 shares of Common Stock, ofwhich 1,817,798 shares had been purchased as of July 30, 2006.  The Company continues to evaluate the timingand pricing 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. 

18

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Segment Information

 
|                                   | ** ** | **For The Thirteen Week** | ** ** | **For The Twenty-Six** | ** ** |
|-----------------------------------|------------|------------------------------------------|------------|----------------------------------|------------|
| ** **                        | ** ** | **Period Ended**                    | ** ** | **Week Period Ended**  | ** ** |
| ** **                        | ** ** | **July 30,**                        | ** ** | **July 31,**                | ** ** | **July 30,** | ** ** | **July 31,** | ** ** |
| ** **                        | ** ** | **2006**                                 | ** ** | **2005**                         | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net Sales:                        |       |                                     |       |                             |       |   |   |   |   |
| ALCO Discount Stores              |       | $                                        | 113,036    |                             | $          | 100,847 |   | $ | 214,744 |   | $ | 191,689 |   |
| All Other                         |       |                                     |       |                             |       |   |   |   |   |
| External                          |       | 7,712                                    |       | 7,688                            |       | 14,991 |   | 14,769 |   |
| Intercompany                      |       | 57,615                                   |       | 52,035                           |       | 123,572 |   | 113,782 |   |
|                              |       | $                                        | 178,363    |                             | $          | 160,570 |   | $ | 353,307 |   | $ | 320,240 |   |
|                              |       |                                     |       |                             |       |   |   |   |   |
| Depreciation and Amortization     |       |                                     |       |                             |       |   |   |   |   |
| ALCO Discount Stores              |       | $                                        | 764        |                             | $          | 892 |   | $ | 1,686 |   | $ | 1,835 |   |
| All Other                         |       | 903                                      |       | 556                              |       | 1,587 |   | 1,107 |   |
|                              |       | $                                        | 1,667      |                             | $          | 1,448 |   | $ | 3,273 |   | $ | 2,942 |   |
|                              |       |                                     |       |                             |       |   |   |   |   |
| Income (expense) from Operations: |       |                                     |       |                             |       |   |   |   |   |
| ALCO Discount Stores              |       | $                                        | 8,537      |                             | $          | 7,988 |   | $ | 14,840 |   | $ | 14,430 |   |
| All Other                         |       | (5,347                                   | )          | (6,557                           | )          | (10,495 | ) | (14,364 | ) |
|                              |       | 3,190                                    |       | 1,431                            |       | 4,345 |   | 66 |   |
|                              |       |                                     |       |                             |       |   |   |   |   |
| Capital Expenditures:             |       |                                     |       |                             |       |   |   |   |   |
| ALCO Discount Stores              |       | $                                        | 390        |                             | $          | 1,650 |   | $ | 2,743 |   | $ | 2,718 |   |
| All Other                         |       | 647                                      |       | 777                              |       | 1,157 |   | 985 |   |
|                              |       | $                                        | 1,037      |                             | $          | 2,427 |   | $ | 3,900 |   | $ | 3,703 |   |
|                              |       |                                     |       |                             |       |   |   |   |   |
| Identifiable Assets:              |       |                                     |       |                             |       |   |   |   |   |
| ALCO Discount Stores              |       | $                                        | 131,419    |                             | $          | 120,379 |   | $ | 131,419 |   | $ | 120,379 |   |
| All Other                         |       | 48,975                                   |       | 34,756                           |       | 48,975 |   | 34,756 |   |
|                              |       | $                                        | 180,394    |                             | $          | 155,135 |   | $ | 180,394 |   | $ | 155,135 |   |

 

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

*IntercompanySales*

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

*IntercompanyExpense Allocations*

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

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

*Inventories*

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

*Leases*

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

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

19

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

| ** **                                                               | ** ** | **For The Thirteen Week** | ** ** | **For The Twenty-Six** | ** ** |
|--------------------------------------------------------------------------|------------|------------------------------------------|------------|----------------------------------|------------|
| ** **                                                               | ** ** | **Period Ended**                    | ** ** | **Week Period Ended**  | ** ** |
| ** **                                                               | ** ** | **July 30,**                        | ** ** | **July 31,**                | ** ** | **July 30,** | ** ** | **July 31,** | ** ** |
| ** **                                                               | ** ** | **2006**                                 | ** ** | **2005**                         | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                                     |       |                                     |       |                             |       |   |   |   |   |
| Net sales per  above segment information                                 |       | $                                        | 178,363    |                             | $          | 160,570 |   | $ | 353,307 |   | $ | 320,240 |   |
| Intercompany  elimination                                                |       | 57,615                                   |       | 52,035                           |       | 123,572 |   | 113,782 |   |
|                                                                     |       |                                     |       |                             |       |   |   |   |   |
| Net sales per consolidated statements of operations                      |       | $                                        | 120,748    |                             | $          | 108,535 |   | $ | 229,735 |   | $ | 206,458 |   |
|                                                                     |       |                                     |       |                             |       |   |   |   |   |
| Income (loss)  from operations per above segment information             |       | $                                        | 3,190      |                             | $          | 1,431 |   | $ | 4,345 |   | $ | 66 |   |
| Leases                                                                   |       | 84                                       |       | 84                               |       | 169 |   | 169 |   |
|                                                                     |       |                                     |       |                             |       |   |   |   |   |
| Income (loss)  from operations per consolidated statements of operations |       | $                                        | 3,106      |                             | $          | 1,347 |   | $ | 4,176 |   | $ | (103 | ) |

 

##### **ITEM3.  QUANTITATIVE AND QUALITATIVEDISCLOSURE ABOUT MARKET RISK**

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

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

Asdescribed under “Management’s Discussion and Analysis of Financial Conditionand Results of Operations-Liquidity and Capital Resources,” the Companyhas a variable interest rate debt facility that is subject to interest raterisk.  The Company uses this facility tomeet the short-term needs of its capital improvements and inventory purchasesand other operating activities.  Theseobligations expose the Company to variability in interest payments due tochanges in interest rates.  If interestrates increase, interest expense increases. Conversely, if interest rates decrease, interest expense also decreases.Based on the Company’s current borrowings under its revolving credit facility,if interest rates were to increase 1% on an annual basis interest expense wouldincrease $300. 

TheCompany has and continues to analyze its debt structure in relation to interestrate risk.  The Company believes thatwith the mix of debt instruments it is using — revolving line of credit,capital leases and operating leases — that its current structure adequatelyaddresses these risk issues.  Thisprocess of evaluation is continuous and the Company will adjust its debtstructure as is appropriate to the market situation. 

**ITEM 4.  CONTROLSAND PROCEDURES**

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

Under thesupervision and with the participation of management, including the ChiefExecutive Officer and Chief Financial Officer, the Company evaluated the designand operation of its disclosure controls and procedures (as defined in Rules13a-15(e) and 15d-15(e) of the Securities and Exchange Act of 1934, or the “ExchangeAct”) for the quarter ended July 30, 2006.

20

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Based upon thatevaluation, the Chief Executive Officer and Chief Financial Officer have concludedthat the Company’s disclosure controls and procedures were not effective as ofJuly 30, 2006 because of the material weaknesses discussed below.

To address thematerial weaknesses described below, the Company performed additional analysisand other post-closing procedures to ensure that the consolidated financialstatements were prepared in accordance with generally accepted accountingprinciples.  Accordingly, management,including the Chief Executive Officer and Chief Financial Officer, believe theconsolidated financial statements included in this report present, in allmaterial respects, the Company’s financial condition, results of operations andcash flows for the quarter ended July 30, 2006.

**(b)  Management’s Report on Internal Control OverFinancial Reporting**

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

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

Managementassessed the effectiveness of the Company’s internal control over financialreporting as of July 30, 2006 based on the criteria established in *Internal Control- Integrated Framework*issued**by the Committee of Sponsoring Organizations of theTreadway Commission (“COSO”).  As aresult of this assessment, management concluded that the Company’s internalcontrol over financial reporting was not effective as of July 30, 2006. 

Management’sassessment identified the following material weaknesses in the Company’sinternal control over financial reporting as of July 30, 2006:

**1.**     TheCompany has not established controls to require a review of certain informationprepared for inclusion in the Company’s financial statements.  Specifically:

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

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

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

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

21

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

**(c)  Changes in Internal Control over FinancialReporting**

Inresponse to the material weaknesses initially reported as of January 29, 2006 theCompany is currently implementing procedures to establish and maintain controlswhich will result in all necessary reviews being performed. To date, theCompany has moved the responsibility for updating the vendor master file to adepartment independent of accounts payable. The procedures for secondary review of journal entries and supportinganalysis have been modified to assure adequate review.  The Company initiated the development andimplementation of controls over the development of the financial statements inthe fourth quarter of fiscal 2006.  TheCompany has designed and implemented procedures to reconcile the warehouseinventory to the general ledger on a quarterly basis.  The Company will continue to review theseprocesses and reevaluate and test these controls to determine that these weaknesseshave been remediated.

Therewere no changes in the Company’s internal control over financial reporting thatoccurred during the quarter ended July 30, 2006 that materially affected, orare reasonably likely to material affect, the Company’s internal control overfinancial reporting.

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

**Item1.  Legal Proceedings**

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

**Item1A.  Risk Factors**

The Companyencourages investors to carefully consider the risks described below and otherinformation contained in this document when considering an investment decisionwith respect to he Company’s securities. Additional risks and uncertainties notpresently known to management, or that management currently deems immaterial,may also impair the Company’s business operations. Any of the events discussedin the risk factors below may occur. If one or more of these events do occur,business, results of operations or financial condition could be materiallyadversely affected. In that instance, the trading price of the Company’ssecurities could decline, and investors might lose part or all of theirinvestment. 

**EconomicConditions**

Similar to otherretail businesses, the Company’s operations may be affected adversely bygeneral economic conditions and events which result in reduced consumerspending in the markets served by its stores. Also, smaller communities wherethe Company’s stores are located may be dependent upon a few large employers ormay be significantly affected by economic conditions in the industry upon whichthe community relies for its economic viability, such as the agriculturalindustry. This may make the Company’s stores more vulnerable to a downturn in aparticular segment of the economy than the Company’s competitors, which operatein markets which are larger metropolitan areas where the local economy is morediverse. 

**Competition**

The Companyoperates in the discount retail business, which is highly competitive. Althoughthe Company prefers markets that don’t have direct competition from national orregional full-line discount stores, competition still exists. Even innon-competitive markets, the Company’s customers 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. This

22

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competitiveenvironment subjects the Company to the risk of reduced profitability becausethe Company may be forced to lower its prices, resulting in lower margins, inorder to maintain its competitive position. 

**StoreExpansion**

The growth in theCompany’s sales and operating net income depends to a substantial degree on itsexpansion program. This expansion strategy is dependent upon the Company’sability the open and operate new stores effectively, efficiently, and on aprofitable basis. The Company prefers to locate its ALCO stores in smallerretail markets where no competing full-line discount retail store is locatedwithin the primary trade area. The Company’s ability to timely open new storesand to expand into additional market areas depends in part on the followingfactors: availability of store locations, the ability to hire and train newstore personnel, the ability to react to consumer needs and trends on a timelybasis, and the availability of sufficient capital for expansion. 

**InformationTechnology**

The Company’sability to implement and train employees on the new POS software, its abilityto utilize technology upgrades, and to meet the timetables for rolling out thenew technology to the stores could have a material impact on the Company’sresults of operations. 

**GovernmentRegulation**

The Company issubject to numerous federal, state and local government laws and regulations,including those relating to the development, construction and operation of theCompany’s stores. The Company is also subject to laws governing itsrelationship with employees, including minimum wage requirements, laws andregulations 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 resultsof operations have historically fluctuated as a result of retail consumers purchasingpatterns, with the highest quarter in terms of sales and profitability beingthe fourth quarter. Quarterly results of operations will likely continue tofluctuate significantly as a result of such patterns and may fluctuate due tothe timing of new store openings. 

**Dependenceon Officers**

The development ofthe Company’s business is largely dependent on the efforts of its currentmanagement team headed by Bruce C. Dale and seven other executive officers. Theloss of the services of one or more of these officers could have a materialadverse effect on the Company. 

**InterestRate Risk**

The Company issubject to market risk from exposure to changes in interest rates based on itsfinancing requirements. Changes in interest rates could have a negative impacton the Company’s profitability. 

**Item 2.  Unregistered Sales ofEquity 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 1,817,798 shares had been purchasedas of July 30, 2006.  The following aredetails of repurchases under this program for the period covered by thisreport: 

23

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| ** **                           | ** ** | ** **                      | ** ** | ** **                             | ** ** | ** **                          | ** ** | **Maximum Number**                  | ** ** |
|--------------------------------------|------------|---------------------------------|------------|----------------------------------------|------------|-------------------------------------|------------|------------------------------------------|------------|
| ** **                           | ** ** | ** **                      | ** ** | ** **                             | ** ** | **Total Number of**       | ** ** | **(or Approximate Dollar**     | ** ** |
| ** **                           | ** ** | ** **                      | ** ** | ** **                             | ** ** | **shares (or Units)**     | ** ** | **Value) of Shares (or**  | ** ** |
| ** **                           | ** ** | **Total Number Of**   | ** ** | ** **                             | ** ** | **Purchased as Part**     | ** ** | **Units) that May Yet**   | ** ** |
| ** **                           | ** ** | **Shares (or Units)** | ** ** | **Average Price Paid**       | ** ** | **of Publicly Announced** | ** ** | **Be Purchased Under**         | ** ** |
| **Period**                           | ** ** | **Purchased**                   | ** ** | **per Share (or Unit)** | ** ** | **Plans or Programs**     | ** ** | **the Plans 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                                        |       |
| May 1 – May 30,  2006           |       | 0                               |       | 0                                      |       | 0                                   |       | 0                                        |       |
| June 1 – June  30, 2006         |       | 0                               |       | 0                                      |       | 0                                   |       | 0                                        |       |
| July 1 – July 30, 2006          |       | 3,337                           |       | $                                      | 30.46      |                                | 3,337      |                                     | 196,663    |   |
|                                      |            |                                 |            |                                        |            |                                     |            |                                          |            |  |

 

**ITEM3.  DEFAULTS UPON SENIOR SECURITIES**

Not applicable.

**ITEM4.  SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

(a)           The annual meetingof stockholders of the Company was held on May 23, 2006. At the annual meeting,the following persons where elected to the Board of Directors:

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.

(b)           At the annual meeting thestockholders (i) approved the Duckwall-ALCO Stores, Inc. Non-Qualified StockOption Plan for Non-Management Directors with 2,107,316 common share votes forand 87,026 votes withheld and (ii) ratifiedand approved the selection of KPMG LLP****with3,587,228 common share votes for and 710 votes withheld.

**ITEM5.  OTHER INFORMATION**

None.

24

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**ITEM6.  EXHIBITS**

See the ExhibitIndex immediately following the signature page hereto.

**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, September  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                                     |         |         |
|                           |                                                        |              |              |  |  |  |

 

25

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**EXHIBITINDEX**

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

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

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

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

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

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

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

31.1                           Certificationof Chief Executive Officer of Duckwall-ALCO Stores, Inc. dated September 13,2006, pursuant to Rule 13a-4(a) under the Securities Exchange Act of 1934, asadopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2                           Certificationof Chief Financial Officer of Duckwall-ALCO Stores, Inc. dated September 13,2006, pursuant to Rule 13a-4(a) under the Securities Exchange Act of 1934, asadopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1                           Certificationof Chief Executive Officer of Duckwall-ALCO Stores, Inc, dated September 13,2006, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 ofthe Sarbanes-Oxley Act of 2002, which is furnished with this Quarterly Reporton Form 10-Q for the quarter ended July 30, 2006 and is not treated as filed inreliance upon § 601(b)(32) of Regulations S-K.

32.2                           Certificationof Chief Financial Officer of Duckwall-ALCO Stores, Inc., dated September 13,2006, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 ofthe Sarbanes-Oxley Act of 2002, which is furnished with this Quarterly Reporton Form 10-Q for the quarter ended July 30, 2006 and is not treated as filed inreliance upon § 601(b)(32) of Regulations S-K.

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