**Form 10-Q**

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**(Mark One)**

 
| **ý**                                                | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934**  |
|-----------------------------------------------------------|----------------------------------------------------------------------------------------------------------|
|                                                      |
| **For the quarterly period ended November 26, 2005** |
|                                                      |
| **OR**                                                    |
| ** **                                                |
| **o**                                                     | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934** |

 

**Commission FileNumber       1-6807**

 

**FAMILY DOLLAR STORES, INC.**

(Exact name of registrant asspecified in its charter)

 
| **Delaware**                                                         | ** ** | **56-0942963**                        |
|----------------------------------------------------------------------|------------|---------------------------------------|
| (State  or other jurisdiction of                                     |       | (I.R.S.  EmployerIdentification  No.) |
| incorporation  or organization)                                      |       |
|                                                                 |       |                                  |
|                                                                 |       |                                  |
| **P. O. Box  1017, 10401 Monroe Road****Charlotte, North  Carolina** |       | **28201-1017**(Zip Code)              |
| (Address  of principal executive offices)                            |       |                                  |

 

Registrant’s telephone number, including areacode:  **(704)847-6961**

 

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

 

Indicateby check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act).   Yes ý   No o

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).  Yes o   No ý

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date.

 
| **Class**                      | ** ** | **Outstanding at December 30, 2005** |
|--------------------------------|------------|-------------------------------------------|
| Common  Stock, $0.10 par value |       | 155,275,213 shares                   |

 

 

 

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**FAMILYDOLLAR STORES, INC., AND SUBSIDIARIES**

** **

**INDEX**

 
| Part I - Financial Information                                                                                                 |   |
|-------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                |   |
| Item 1 - Consolidated  Condensed Financial Statements:                                                                              |   |
|                                                                                                                                |   |
|  Consolidated Condensed Balance Sheets – November 26,  2005 and August 27, 2005                            |   |
|                                                                                                                                |   |
|  Consolidated Condensed Statements of Income  – Quarter  Ended November 26, 2005 and November 27, 2004     |   |
|                                                                                                                                |   |
|  Consolidated Condensed Statements of Cash  Flows – Quarter  Ended November 26, 2005 and November 27, 2004 |   |
|                                                                                                                                |   |
|  Notes to Consolidated Condensed Financial  Statements                                                                         |   |
|                                                                                                                                |   |
| Item 2 - Management’s  Discussion and Analysis of Financial Condition and Results of Operations                           |   |
|                                                                                                                                |   |
| Item 3 - Quantitative and  Qualitative Disclosures About Market Risk                                                                |   |
|                                                                                                                                |   |
| Item 4 - Controls and Procedures                                                                                                    |   |
|                                                                                                                                |   |
| Part II - Other Information and  Signatures                                                                                    |   |
|                                                                                                                                |   |
| Item 1 - Legal Proceedings                                                                                                          |   |
|                                                                                                                                |   |
| Item 2 - Unregistered Sales  of Equity Securities and Use of Proceeds                                                               |   |
|                                                                                                                                |   |
| Item 6 - Exhibits                                                                                                                   |   |
|                                                                                                                                |   |
| Signatures                                                                                                                          |   |

 

 

2

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**PART I – FINANCIAL INFORMATION**

 

**Item 1.   Consolidated CondensedFinancial Statements**

 

**FAMILY DOLLAR STORES, INC., AND SUBSIDIARIES**

**CONSOLIDATED CONDENSED BALANCE SHEETS**

**(Unaudited)**

** **
| **(in thousands, except per share  and share amounts)**                                                                                                                                                                                                                      | ** ** | **November 26, 2005** | ** ** | **August 27, 2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|--------------------------|------------|
| **Assets**                                                                                                                                                                                                                                                                   |       |                       |       |                     |       |
| Current assets:                                                                                                                                                                                                                                                              |       |                       |       |                     |       |
| Cash and cash equivalents (Note 2)                                                                                                                                                                                                                                           |       | $                          | 112,468    |                     | $          | 105,175 |   |
| Investment securities (Note 2)                                                                                                                                                                                                                                               |       | 33,875                     |       | 33,530                   |       |
| Merchandise inventories                                                                                                                                                                                                                                                      |       | 1,110,785                  |       | 1,090,791                |       |
| Deferred income taxes                                                                                                                                                                                                                                                        |       | 106,942                    |       | 100,493                  |       |
| Prepayments and other current assets                                                                                                                                                                                                                                         |       | 36,243                     |       | 24,779                   |       |
| Total current assets                                                                                                                                                                                                                                                         |       | 1,400,313                  |       | 1,354,768                |       |
|                                                                                                                                                                                                                                                                         |       |                       |       |                     |       |
| Property and equipment, net                                                                                                                                                                                                                                                  |       | 1,041,742                  |       | 1,027,475                |       |
| Other assets                                                                                                                                                                                                                                                                 |       | 26,623                     |       | 27,258                   |       |
|                                                                                                                                                                                                                                                                         |       | $                          | 2,468,678  |                     | $          | 2,409,501 | ** ** |
| **Liabilities and Shareholders’ Equity**                                                                                                                                                                                                                                |       |                       |       |                     |       |
| Current liabilities:                                                                                                                                                                                                                                                         |       |                       |       |                     |       |
| Accounts payable                                                                                                                                                                                                                                                             |       | $                          | 488,032    |                     | $          | 574,831 |   |
| Accrued liabilities                                                                                                                                                                                                                                                          |       | 343,608                    |       | 315,508                  |       |
| Income taxes payable                                                                                                                                                                                                                                                         |       | 38,175                     |       | 4,272                    |       |
| Total current liabilities                                                                                                                                                                                                                                                    |       | 869,815                    |       | 894,611                  |       |
|                                                                                                                                                                                                                                                                         |       |                       |       |                     |       |
| Long-term debt (Note 4)                                                                                                                                                                                                                                                      |       | 250,000                    |       | —                   |       |
| Deferred income taxes                                                                                                                                                                                                                                                        |       | 84,278                     |       | 86,824                   |       |
| Commitments and contingencies (Note 8)                                                                                                                                                                                                                                       |       |                       |       |                     |       |
|                                                                                                                                                                                                                                                                         |       |                       |       |                     |       |
| Shareholders’ equity: (Notes 5 and 6)                                                                                                                                                                                                                                   |       |                       |       |                     |       |
| Preferred stock, $1 par; authorized and  unissued 500,000 shares                                                                                                                                                                                                             |       |                       |       |                     |       |
| Common stock, $.10 par; authorized  600,000,000 shares; issued 178,874,638 shares at November 26, 2005, and  188,871,738 shares at August 27, 2005, and outstanding 155,265,413  shares at November 26, 2005, and 165,262,513 shares at August 27,  2005 |       | 17,887                     |       | 18,887                   |       |
| Capital in excess of par                                                                                                                                                                                                                                                     |       | 127,180                    |       | 133,743                  |       |
| Retained earnings                                                                                                                                                                                                                                                            |       | 1,498,943                  |       | 1,654,861                |       |
|                                                                                                                                                                                                                                                                         |       | 1,644,010                  |       | 1,807,491                |       |
| Less: common stock held in treasury, at  cost (23,609,225 shares at November 26, 2005, and at August 27,  2005) (Note 5)                                                                                                                                           |       | 379,425                    |       | 379,425                  |       |
| Total shareholders’ equity                                                                                                                                                                                                                                              |       | 1,264,585                  |       | 1,428,066                |       |
|                                                                                                                                                                                                                                                                         |       | $                          | 2,468,678  |                     | $          | 2,409,501 |   |

 

## **Seenotes to the consolidated condensed financial statements.**

## ** **

3

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**FAMILYDOLLAR STORES, INC. AND SUBSIDIARIES**

**CONSOLIDATED CONDENSED STATEMENTS OF INCOME**

**(Unaudited)**

 
| ** **                                           | ** ** | **Quarter Ended**          | ** ** |
|------------------------------------------------------|------------|----------------------------|------------|
| **(in thousands, except per share  amounts)**        | ** ** | **November 26, 2005** | ** ** | **November 27, 2004** | ** ** |
| Net sales                                            |       | $                          | 1,511,457  |   | $ | 1,380,245 |   |
|                                                 |       |                       |       |   |   |
| Cost and expenses:                                   |       |                       |       |   |   |
| Cost of sales                                        |       | 1,003,254                  |       | 919,893 |   |
| Selling, general and administrative  expenses        |       | 425,291                    |       | 375,711 |   |
| Cost of sales and operating expenses                 |       | 1,428,545                  |       | 1,295,604 |   |
|                                                 |       |                       |       |   |   |
| Operating profit                                     |       | 82,912                     |       | 84,641 |   |
|                                                 |       |                       |       |   |   |
| Interest income                                      |       | 851                        |       | 524 |   |
|                                                 |       |                       |       |   |   |
| Interest expense (Note 4)                            |       | 2,193                      |       | — |   |
|                                                 |       |                       |       |   |   |
| Income before provision for taxes on income          |       | 81,570                     |       | 85,165 |   |
|                                                 |       |                       |       |   |   |
| Provision for taxes on income                        |       | 30,181                     |       | 30,736 |   |
|                                                 |       |                       |       |   |   |
| Net income                                           |       | $                          | 51,389     |   | $ | 54,429 |   |
|                                                 |       |                       |       |   |   |
| Net income per common share – basic (Note  7)   |       | $                          | 0.32       |   | $ | 0.32 |   |
| Average shares – basic (Note 7)                 |       | 159,330                    |       | 167,619 |   |
| Net income per common share – diluted (Note  7) |       | $                          | 0.32       |   | $ | 0.32 |   |
| Average shares – diluted (Note 7)               |       | 160,472                    |       | 168,008 |   |
|                                                 |       |                       |       |   |   |
| Dividends per common share                           |       | $                          | 0.095      |   | $ | 0.085 |   |

 

See notes to the consolidated condensed financialstatements.

 

4

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**FAMILYDOLLAR STORES, INC. AND SUBSIDIARIES**

**CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| ** **                                                                         | ** ** | **Quarter Ended**          | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------|------------|
| **(in thousands)**                                                                 | ** ** | **November 26, 2005** | ** ** | **November 27, 2004** | ** ** |
| **Cash  flows from operating activities:**                                         |       |                       |       |   |   |
| Net income                                                                         |       | $                          | 51,389     |   | $ | 54,429 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                       |       |   |   |
| Depreciation and amortization                                                      |       | 32,227                     |       | 26,354 |   |
| Deferred income taxes                                                              |       | (8,995                     | )          | (2,292 | ) |
| Stock-based compensation expense                                                   |       | 1,470                      |       | — |   |
| Tax benefit from stock option exercises                                            |       | 4                          |       | 972 |   |
| Excess tax benefits from stock-based  compensation                                 |       | (4                         | )          | — |   |
| Loss on disposition of property and  equipment                                     |       | 2,233                      |       | 497 |   |
| Changes in operating assets and  liabilities:                                      |       |                       |       |   |   |
| Merchandise inventories                                                            |       | (19,994                    | )          | (52,630 | ) |
| Income tax refund receivable                                                       |       | —                     |       | 1,304 |   |
| Prepayments and other current assets                                               |       | (11,464                    | )          | (8,227 | ) |
| Other assets                                                                       |       | 1,595                      |       | 1,057 |   |
| Accounts payable and accrued liabilities                                           |       | (46,261                    | )          | (18,875 | ) |
| Income taxes payable                                                               |       | 33,903                     |       | 29,139 |   |
|                                                                               |       | 36,103                     |       | 31,728 |   |
|                                                                               |       |                       |       |   |   |
| **Cash  flows from investing activities:**                                         |       |                       |       |   |   |
| Purchases of investment securities                                                 |       | (9,800                     | )          | (22,835 | ) |
| Sales of investment securities                                                     |       | 9,455                      |       | 60,600 |   |
| Capital expenditures                                                               |       | (48,804                    | )          | (42,981 | ) |
| Proceeds from dispositions of property and  equipment                              |       | 77                         |       | 153 |   |
|                                                                               |       | (49,072                    | )          | (5,063 | ) |
|                                                                               |       |                       |       |   |   |
| **Cash  flows from financing activities:**                                         |       |                       |       |   |   |
| Issuance of long-term debt                                                         |       | 250,000                    |       | — |   |
| Payment of debt issuance costs                                                     |       | (960                       | )          | — |   |
| Repurchases of common stock                                                        |       | (201,648                   | )          | — |   |
| Changes in cash overdrafts                                                         |       | (11,488                    | )          | (2,193 | ) |
| Exercise of employee stock options                                                 |       | 54                         |       | 5,436 |   |
| Excess tax benefits from stock-based  compensation                                 |       | 4                          |       | — |   |
| Payment of dividends                                                               |       | (15,700                    | )          | (14,248 | ) |
|                                                                               |       | 20,262                     |       | (11,005 | ) |
|                                                                               |       |                       |       |   |   |
| **Net  change in cash and cash equivalents**                                       |       | 7,293                      |       | 15,660 |   |
| **Cash and  cash equivalents at beginning of period**                              |       | 105,175                    |       | 87,023 |   |
| **Cash and  cash equivalents at end of period**                                    |       | $                          | 112,468    |   | $ | 102,683 |   |

## ** **

## **Seenotes to the consolidated condensed financial statements.**

 

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## ** **

## **FAMILY DOLLARSTORES, INC., AND SUBSIDIARIES**

## **NOTES TO CONSOLIDATEDCONDENSED FINANCIAL STATEMENTS**

## ** **

1.               In the opinion ofthe Company, the accompanying unaudited consolidated condensed financialstatements contain all adjustments (consisting of only normal recurringaccruals) necessary to present fairly the financial position as of November 26,2005, and the results of operations and cash flows for the quarters ended November 26,2005, and November 27, 2004.  Forfurther information, refer to the consolidated financial statements andfootnotes included in the Company’s Annual Report on Form 10-K for theyear ended August 27, 2005.

 

**Theresults of operations for the current quarter ended November 26, 2005, arenot necessarily indicative of the results to be expected for the full year.**

** **

Certain reclassifications of the amounts for thequarter ended November 27, 2004, have been made to conform to thepresentation for the quarter ended November 26, 2005.  This includes interest income, whichwas previously included in selling, general and administrative expenses.

 

**TheCompany manages its business on the basis of one reportable segment.**

** **

2.               The Companyconsiders all highly liquid investments with an original maturity of threemonths or less to be “cash equivalents.” The carrying amount of the Company’s cash equivalents approximates fairvalue due to the short maturities of these investments and consists primarilyof money market funds and other overnight investments.  The Company maintains cash deposits withmajor banks, which from time to time may exceed federally insured limits.  The Company periodically assesses thefinancial condition of the institutions and believes that the risk of any lossis minimal.

 

The items classified asinvestment securities are principally auction rate securities and variable ratedemand notes.  The Company classifies allinvestment securities as available-for-sale. Securities accounted for as available-for-sale are required to bereported at fair value with unrealized gains and losses, net of taxes, excludedfrom net income and shown separately as a component of accumulated othercomprehensive income within shareholders’ equity.  The securities that the Company hasclassified as available-for-sale generally trade at par and as a resulttypically do not have any realized or unrealized gains or losses.

 

3.               The preparation ofthe Company’s Consolidated Condensed Financial Statements, in conformity withaccounting principles generally accepted in the United States of America,requires management to make estimates and assumptions.  These estimates and assumptions affect thereported amounts of assets and liabilities, the disclosure of contingent assetsand liabilities at the date of the financial statements, and the reportedamounts of revenues and expenses during the reporting period.  Actual results could differ from theseestimates.

 

4.               The Company had nocurrent or long-term debt as of the fiscal year ended August 27,2005.  Current and long-term debtconsisted of the following at November 26, 2005:

 
| ** **             | ** ** | **Quarter Ended**          | ** ** |
|------------------------|------------|----------------------------|------------|
| **(in thousands)**     | ** ** | **November 26, 2005** | ** ** |
| 5.24% Notes            |       | $                          | 81,000     |   |
| 5.41% Notes            |       | 169,000                    |       |
|                   |       | 250,000                    |       |
| Less:  current portion |       | —                     |       |
| Long-term  portion     |       | $                          | 250,000    |   |

 

On September 27,2005, the Company obtained $250 million through a private placement ofunsecured Senior Notes (the “Notes”) to a group of institutional accreditedinvestors.  The Notes were issued in twotranches at par and rank *pari passu* inright of payment with the Company’s other unsecured senior indebtedness.  The first tranche has an aggregate principalamount of $169

 

6

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million, is payable in asingle installment on September 27, 2015, and bears interest at a rate of5.41% per annum from the date of issuance. The second tranche has an aggregate principal amount of $81 million,matures on September 27, 2015, with amortization commencing in the sixthyear, and bears interest at a rate of 5.24% per annum from the date ofissuance.  The second tranche has arequired principal payment of $16.2 million on September 27, 2011, and oneach September 27 thereafter to and including September 27,2015.  Interest on the Notes is payablesemi-annually in arrears on the 27th day of March and September ofeach year commencing on March 27, 2006. The sale of the Notes was effected in transactions not requiringregistration under the Securities Act of 1933, as amended.  The Notes contain certain restrictivecovenants, which include a consolidated debt to consolidatedcapitalization ratio, a fixed charges coverage ratio, and a priority debt toconsolidated net worth ratio.  At the endof the first quarter of fiscal 2006, the Company was in compliance with allsuch covenants.  The proceeds of theNotes are being used to repurchase the Company’s outstanding common stock, asdiscussed in Note 5 below.

 

In addition to the Notes,the Company has unsecured revolving credit facilities with banks for short-termborrowings of up to $200 million.  On May 25,2006, $100 million of the facilities will expire, and the remaining $100million will expire on May 31, 2010. The Company expects that the facilities expiring on May 25, 2006,will be extended.  Any borrowings underthese facilities are at a variable interest rate based on short-term marketinterest rates.  The Company had noborrowings against these facilities during the first quarter of fiscal 2006 orduring fiscal 2005.

 

5.               During fiscal 2005, the Company purchased inthe open market 3.3 million shares of its common stock at a cost of $92.0million.  On October 4, 2005, theCompany executed an overnight share repurchase transaction with a bank for theacquisition of 10 million shares, or approximately 6%, of the Company’soutstanding common stock for an initial purchase price of $19.97 pershare.  The transaction was financed withthe proceeds of the Notes, as discussed in Note 4 above.  Pursuant to the agreement with the bank, thebank will purchase ten million shares in the open market over a period endingno later than March 6, 2006.  At theend of the purchase period, the Company will either receive from or pay to thebank a price adjustment based on the volume weighted average purchase price ofthe shares acquired compared to the initial purchase price.  Such price adjustment can be either in cashor common stock at the discretion of the Company.  The Company has limited its potentialfinancial exposure in the event of an increase in its share price above a capduring the purchase period with respect to five million of the repurchasedshares.

 

The shares repurchased wereimmediately canceled and returned to the status of authorized but unissuedshares.  The total cost of the initialpurchase was approximately $201.2 million, including a $1.3 million cap premiumand $0.2 million in commissions and other fees. In accordance with Accounting Principles Board (APB) Opinion 6, “Statusof Accounting Research Bulletins,” the Company reduced common stock, capital inexcess of par, and retained earnings by approximately $1.0 million, $8.1million, and $192.1 million, respectively. In addition, the Company reduced retainedearnings by approximately $0.4 million in connection with a liability recordedfor a fee payable to the bank associated with scheduled dividend payments.  The forward contract associated with the overnight share repurchase transactionis being accounted for in accordance with EITF 00-19, “Accounting forDerivative Financial Instruments Indexed to, and Potentially Settled in, aCompany’s Own Stock,” as an equity instrument. Any amounts paid or received in cash or stock in connection with theprice adjustment will be recorded as an adjustment to Shareholders’Equity.  As of November 26, 2005,the bank had purchased approximately 5.3 million shares.  The diluted net income per share calculationfor the first quarter of fiscal 2006 includes the potential shares of commonstock that may be issued to settle the overnight share repurchase transaction.

 

There were no other purchasesof common stock by the Company during the first quarter of fiscal 2006.  Shares are purchased pursuant to sharerepurchase authorizations approved by the Board of Directors.  As of November 26, 2005, the Company hadoutstanding authorizations to purchase a total of approximately 6.9 millionshares, consisting of approximately 3.0 million shares (based on current shareprice) remaining under the authorization for $300 million of stock repurchasesapproved by the Board of Directors on August 19, 2005, and approximately 3.9million shares remaining pursuant to authorizations approved by the Board ofDirectors prior to August 19, 2005. Shares purchased prior to the end of fiscal 2005 under the sharerepurchase authorizations are held in treasury or have been reissued under theFamily Dollar 2000 Outside Directors Plan. Shares purchased with the proceeds of the Notes are canceled andreturned to the status of authorized but unissued shares.

 

7

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6.               The Company’s 1989Non-Qualified Stock Option Plan provides for the granting of options to keyemployees to purchase shares of common stock at prices not less than fair marketvalue on the date of the grant.  Optionsexpire five years from the date of grant and are exercisable to the extent of40% after the second anniversary of the grant and an additional 30% at each ofthe following two anniversary dates on a cumulative basis.  The maximum number of shares that maybe issued under the 1989 Non-Qualified Stock Option Plan is 20.1 millionshares, and there are 3.6 million remaining shares available for granting.

 

Effective August 28,2005, the Company adopted the provisions of Financial Accounting StandardsBoard (FASB) Statement of Financial Accounting Standards No. 123 (revised2004) “Share-Based Payment” (“SFAS 123R”) for its stock-based compensationplans.  Prior to the first quarter offiscal 2006, the Company accounted for stock-based compensation using theintrinsic value method prescribed in APB Opinion No. 25, “Accounting forStock Issued to Employees” (“APB 25”), and related Interpretations, aspermitted by the original provisions of SFAS 123, “Share-Based Payment.”  Under APB 25, the Company recorded nocompensation expense since the exercise price of the options equaled the fairmarket value of the underlying common stock on the date of grant.  The Company instead utilized the disclosure-onlyprovisions of SFAS No. 148, “Accounting for Stock-BasedCompensation-Transition and Disclosure.” Under SFAS 123R, all stock-based compensation cost is measured at thegrant date, based on the fair value of the award, and is recognized as anexpense in the income statement over the requisite service period.

 

The Company adopted SFAS123R using the modified prospective transition method.  Under the modified prospective transitionmethod, the Company is required to record equity-based compensation expense forall awards granted after the date of adoption and for the unvested portion ofpreviously granted awards outstanding as of the date of adoption.  Compensation cost related to the unvestedportion of previously granted awards was based on the grant-date fair value estimatedin accordance with the original provisions of SFAS 123.  Compensation cost for all share-basedpayments granted after the adoption date was based on the grant-date fair valueestimated in accordance with the provisions of SFAS 123R.  Results for prior periods have not beenrestated and do not reflect the recognition of stock-based compensation.  The Company used the Black-Scholesoption-pricing model to estimate the grant-date fair value of each optiongranted before and after the adoption of SFAS 123R.  The fair value of each option granted duringthe first quarter of fiscal 2006 was estimated using the following weightedaverage assumptions:

 

| ** **                        | ** ** | **Quarter Ended**          | ** ** |
|-----------------------------------|------------|----------------------------|------------|
| ** **                        | ** ** | **November 26, 2005** | ** ** |
| Expected  dividend yield          |       | 1.60                       | %          |
| Expected  stock price volatility  |       | 30.00                      | %          |
| Risk-free  interest rate          |       | 4.11                       | %          |
| Expected  life of options (years) |       | 4.57                       |       |

 

These assumptions areevaluated and revised, as necessary, to reflect market conditions andexperience.  During the firstquarter of fiscal 2006, these assumptions were adjusted to reflect a change inthe population of employees eligible to receive stock options.  This change increased the expected life ofthe stock options since the new population is expected to exercise their stockoptions closer to their respective expiration dates.  The weighted average grant-date fair value ofstock options granted during the first quarter of fiscal 2006 was $5.85.  The total intrinsic value of stockoptions exercised during the first quarter of fiscal 2006 was immaterial.  Total unrecognized compensation cost relatedto nonvested stock-based compensation totaled $12.6 million as of the end ofthe first quarter of fiscal 2006.  Theunrecognized compensation cost will be recognized over a weighted-averageperiod of 1.5 ears.

 

The following tablesummarizes the transactions under the stock option plan during the firstquarter of fiscal 2006:

 

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| **(in thousands, except per share  amounts)** | ** ** | **Options  Outstanding** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted Average  Remaining  Contractual Life  in Years** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|-----------------------------------------------|------------|--------------------------|------------|---------------------------------------|------------|-------------------------------------------------------------|------------|--------------------------------|------------|
| Balance at August 27, 2005               |       | 6,062                    |       | $                                     | 30.44      |                                                        |       |                           |       |   |
| Granted                                       |       | 742                      |       | 19.80                                 |       |                                                        |       |                           |       |
| Exercised                                     |       | (3                       | )          | 18.74                                 |       |                                                        |       |                           |       |
| Cancelled                                     |       | (146                     | )          | 26.35                                 |       |                                                        |       |                           |       |
| Balance at November 26, 2005             |       | 6,655                    |       | $                                     | 29.35      |                                                        | 2.91       |                           | $          | 2,684 |   |
| Exercisable at November 26, 2005         |       | 4,007                    |       | $                                     | 31.81      |                                                        | 2.26       |                           | $          | 80 |   |

 

Under SFAS 123R,compensation cost is recognized net of estimated forfeitures and is recognizedover the awards’ service period on a straight-line basis.  The compensation expense recorded during thefirst quarter of fiscal 2006 is classified within selling, general, andadministrative expenses on the Consolidated Condensed Statements ofIncome.  Prior to the adoption of SFAS123R, the Company reported all tax benefits resulting from the exercise ofstock options as operating cash flows in the Consolidated Condensed Statementsof Cash Flows.  SFAS 123R requires cashflows resulting from the tax deductions in excess of the compensation costrecognized for those options (excess tax benefits) to be classified asfinancing cash flows.  Excess taxbenefits recognized during the first quarter of fiscal 2006 wereimmaterial.  The Company has elected to adoptthe alternative transition method, as permitted by FASB Staff Position No. FAS123R-3 “Transition Election Related to Accounting for Tax Effects ofShare-Based Payment Awards,” for calculating the tax effects of stock-basedcompensation pursuant to SFAS 123R for those employee awards that wereoutstanding upon adoption of SFAS 123R. The alternative transition method allows the use of simplified methodsto calculate the beginning capital in excess of par pool related to the taxeffects of employee stock-based compensation and to determine the subsequentimpact of the tax effects of employee stock-based compensation awards on thecapital in excess of par pool and the Consolidated Condensed Statements of CashFlows.  The following table illustratesthe impact of stock-based compensation on reported amounts:

 
| ** **                                    | ** ** | **Quarter Ended**          | ** ** |
|-----------------------------------------------|------------|----------------------------|------------|
| ** **                                    | ** ** | **November 26, 2005** | ** ** |
| **(in thousands, except per share  amounts)** | ** ** | **As Reported**            | ** ** | **Impact of Equity-  Based Compensation** | ** ** |
| Income before provision for taxes on income   |       | $                          | 81,570     |   | $ | (1,470 | ) |
| Net income                                    |       | $                          | 51,389     |   | $ | (926 | ) |
|                                          |       |                       |       |   |   |
| Net income per common share -  Basic          |       | $                          | .32        |   | $ | (.01 | ) |
| Net income per common share -  Diluted        |       | $                          | .32        |   | $ | (.01 | ) |

 

The following tableillustrates the effect on net income and net income per share if the Companyhad adopted the fair value recognition provisions of SFAS 123 for the threemonths ended November 27, 2004:

 
| ** **                                    | ** ** | **Quarter Ended**          | ** ** |
|-----------------------------------------------|------------|----------------------------|------------|
| **(in thousands, except per share  amounts)** | ** ** | **November 27, 2004** | ** ** |
| Net income — as reported                 |       | $                          | 54,429     |   |
| Pro forma stock-based compensation cost       |       | (2,180                     | )          |
| Net income — pro forma                   |       | $                          | 52,249     |   |
|                                          |       |                       |       |
| Net income per share — as reported       |       |                       |       |
| basic                                         |       | $                          | .32        |   |
| diluted                                       |       | $                          | .32        |   |
| Net income per share — pro forma         |       |                       |       |
| basic                                         |       | $                          | .31        |   |
| diluted                                       |       | $                          | .31        |   |

 

9

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On March 29, 2005,the Securities and Exchange Commission (“SEC”) staff issued Staff AccountingBulletin (“SAB”) No. 107 to express the views of the staff regarding theinteraction between SFAS 123R and certain SEC rules and regulations and toprovide the staff’s views regarding the valuation of share-based paymentarrangements for public companies.  Theadditional guidance of SAB 107 was taken into consideration with theimplementation of SFAS 123R.

 

7.               Basic net income per common share is computedby dividing net income by the weighted average number of shares outstandingduring each period.  Diluted net incomeper common share gives effect to all securities representing potential commonshares that were dilutive and outstanding during the period.  The exercise prices for certain of theoutstanding stock options that the Company has awarded exceed the averagemarket price of the Company’s common stock. Such stock options are antidilutive (options for 5.8 million and 2.1million for the quarter ended November 26, 2005, and November 27,2004, respectively) and were not included in the computation of diluted netincome per share.  In the calculation ofdiluted net income per common share, the denominator includes the number ofadditional common shares that would have been outstanding if the Company’soutstanding stock options had been exercised. In addition, during the first quarter of fiscal 2006, the denominatorincludes the number of additional common shares that may be issued to settlethe Company’s forward contract related to the overnight share repurchasetransaction.

 

**Thefollowing table sets forth the computation of basic and diluted net income percommon share:**

 
| ** **                                        | ** ** | **Quarter Ended**          | ** ** |
|---------------------------------------------------|------------|----------------------------|------------|
| **(in thousands, except per share  amounts)**     | ** ** | **November 26, 2005** | ** ** | **November 27, 2004** | ** ** |
| **Basic  Net Income Per Share:**                  |       |                       |       |   |   |
| Net Income                                        |       | $                          | 51,389     |   | $ | 54,429 |   |
| Weighted  Average Number of Shares Outstanding    |       | 159,330                    |       | 167,619 |   |
| Net Income  Per Common Share - Basic              |       | $                          | 0.32       |   | $ | 0.32 |   |
|                                              |       |                       |       |   |   |
| **Diluted  Net Income Per Share:**                |       |                       |       |   |   |
| Net Income                                        |       | $                          | 51,389     |   | $ | 54,429 |   |
| Weighted  Average Number of Shares Outstanding    |       | 159,330                    |       | 167,619 |   |
| Effect of  Dilutive Securities - Stock Options    |       | —                     |       | 389 |   |
| Effect of  Dilutive Securities - Forward Contract |       | 1,142                      |       | — |   |
| Average  Shares -  Diluted                        |       | 160,472                    |       | 168,008 |   |
| Net Income  Per Common Share - Basic              |       | $                          | 0.32       |   | $ | 0.32 |   |

** **

**8.**               On January 30, 2001, Janice Morgan and Barbara Richardson, twoindividuals who have held the position of Store Manager for subsidiaries of theCompany, filed a Complaint against the Company in the United States DistrictCourt for the Northern District of Alabama. Thereafter, pursuant to the Court’s ruling, notice of the pendency ofthe lawsuit was sent to approximately 13,000 current and former Store Managersholding the position on or after July 1, 1999.  Approximately 2,550 of those receiving suchnotice filed consent forms and joined the lawsuit as plaintiffs, includingapproximately 2,300 former Store Managers and approximately 250 then currentemployees.  After rulings by the Court onmotions to dismiss certain plaintiffs filed by the Company and motions toreconsider filed by plaintiffs, 1,424 plaintiffs remained in the case at thecommencement of trial.

** **

**Thecase has proceeded as a collective action under the Fair Labor Standards Act (“FLSA”).  The Complaint alleges that the Companyviolated the FLSA by classifying the named plaintiffs and other similarlysituated current and former Store Managers as “exempt” employees who are notentitled to overtime compensation. Plaintiffs seek to recover unpaid overtime compensation in an amountcurrently estimated to be up to approximately $50 million, liquidated damagesequal to the overtime award, if any, plus an award of attorneys’ fees, costsand expenses, and such other relief as the Court may deem proper.**

** **

**10**

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** **

**Ajury trial in this case commenced on June 13, 2005, in Tuscaloosa,Alabama, and ended on June 28, 2005, with the judge declaring a mistrialafter the jury was unable to reach a unanimous decision in the matter.  The case is scheduled to be retriedcommencing on February 21, 2006.**

** **

**Ingeneral, the Company continues to believe that the Store Managers are “exempt”employees under the FLSA and have been properly compensated and that theCompany has meritorious defenses that should enable it ultimately to prevail.  However, the outcome of any litigation isinherently uncertain.  Resolution of thismatter could have a material adverse effect on the Company’s financialposition, liquidity or results of operation.**

** **

**TheCompany is involved in numerous other legal proceedings and claims incidentalto its business, including litigation related to alleged failures to complywith various state and federal employment laws. While the ultimate outcome cannot be determined, the Company currentlybelieves that these proceedings and claims, both individually and in theaggregate, should not have a material adverse effect on the Company’s financialposition, liquidity or results of operations. However, the outcome of any litigation is inherently uncertain and, ifdecided adversely to the Company, the Company may be subject to liability thatcould have a material adverse effect on the Company’s financial position,liquidity or results of operations.**

** **

**11**

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** **

**Item 2.   Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

** **

**This discussion summarizes thesignificant factors affecting the consolidated results of operations andfinancial condition of the Company for the first quarter of fiscal 2006, whichis the thirteen-week period ended November 26, 2005, and the first quarterof fiscal 2005, which is the thirteen-week period ended November 27,2004.  This discussion should be read inconjunction with, and is qualified by, the financial statements included in thisquarterly report and the financial statements for the fiscal year ended August 27,2005 (“fiscal 2005”) and Management’s Discussion and Analysis of FinancialCondition and Results of Operations (“MD&A”) contained in the Company’sAnnual Report on Form 10-K for fiscal 2005.**

** **

**This discussion containsforward-looking statements subject to the Cautionary Note RegardingForward-Looking Statements set forth following this MD&A.**

** **

**Results of Operations**

** **

**First Quarter Results andFiscal 2006 Outlook**

** **

During fiscal 2005, the Company began theimplementation of four key initiatives designed to increase sales andprofitability: the installation of refrigerated coolers in selected stores; theintroduction of a “Treasure Hunt” merchandise program; the continuation of anaggressive store opening program; and the Urban Initiative.  During the fiscal year ending August 26,2006, (“fiscal 2006”), the Company will continue these initiatives as discussedbelow.

 

•                              Coolers – The installation of refrigerated coolers for the sale ofperishable food began in the second quarter of fiscal 2005.  The customer traffic generated by coolers hasincreased sales of food and other merchandise throughout the store.  At the end of fiscal 2005, refrigeratedcoolers were installed in approximately 1,000 stores.  The Company plans to install refrigeratedcoolers in approximately 2,500 additional stores by the end of fiscal2006.  In addition, the Company istesting new point-of-sale software in a limited number of stores to facilitatethe acceptance of food stamps in stores with refrigerated coolers.  At the end of the first quarter of fiscal2006, approximately 1,400 stores had refrigerated coolers for the sale ofperishable food.

•                              “Treasure Hunt” merchandise program – During fiscal 2005, the Companybegan supplementing its basic assortment of merchandise with additionalopportunistically purchased goods designed to create more excitement in storesthroughout the year, with particular emphasis on holidays, spring andback-to-school seasons, and to balance gross margin pressure from increasedsales of lower margin consumables. During fiscal 2006, the Company is taking a more process-orientedapproach to this initiative by focusing on three key components: identifyingand selecting exciting values for customers; informing the customers of thecompelling values through circulars and in-store handouts; and effectively displayingthe items in stores to attract customer attention.

•                              New Stores – During fiscal 2005, the Company opened 500 stores and closed68 stores, with a substantial percentage of the new store openings occurring inthe last months of the fiscal year.  Inorder to build processes that will support a more balanced distribution ofstore openings throughout the year, the Company plans to open approximately 400stores and close approximately 65 stores in fiscal 2006.  During the first quarter of fiscal 2006, theCompany, as planned, opened 73 stores and closed 19 stores.

•                              Urban Initiative – The Urban Initiative is designed to improve the operatingperformance of high sales volume stores in large metropolitan markets throughinvestments in people, process changes and technology, including organizationalchanges to support a more mobile and flexible workforce.  During fiscal 2005, the Urban Initiative wasimplemented in approximately 1,200 stores. While the Urban Initiative stores experienced solid comparable storesales growth and continued to be profitable during fiscal 2005, the Company’sprofitability goals were not achieved. For fiscal 2006, the Company will continue its investments in thecurrent Urban Initiative markets (approximately 1,300 stores) but does notexpect to expand the initiative into new markets until processes have beenrefined to generate improved results. During the first quarter of fiscal 2006, the Company saw an improvementin profitability in most Urban Initiative markets, resulting from positivetrends in comparable store sales and inventory shrinkage.

 

12

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During the first quarter of fiscal 2006, HurricanesKatrina, Rita and Wilma struck the U.S. Gulf Coast and Florida, impactingnumerous stores in the afflicted areas. Since the Company’s stores are widely dispersed, lost sales due toclosed stores resulting from damage or power outages were generally limited andwere substantially offset by increased sales in other stores.  The most significant storm-related losseswere related to the loss of merchandise inventories, furniture and fixtures andleasehold improvements at individual stores in the paths of the storms.  The Company expects the majority of thelosses incurred will be covered by insurance. The net impact of these storms has not had and is not expected to have amaterial impact in the aggregate on the Company’s financial position, liquidityor results of operations.

 

Based on operating results for the first quarter offiscal 2006, as discussed below, and the Company’s plans for the remainder of theyear, the Company currently expects diluted net income per common share to bebetween $1.30 and $1.39 for fiscal 2006, compared to $1.30 in fiscal 2005.  The diluted net income per common shareguidance for fiscal 2006 includes the impact of the expensing of stock optionsas required by Statement of Financial Accounting Standards (“SFAS”) No. 123R,“Share-Based Payment,” and other new compensation programs, the interestexpense related to the Company’s debt placement, and the accretive benefit ofthe Company’s share repurchase program. See Note 6 to the Consolidated Condensed Financial Statements includedin this Report and the Selling, General and Administrative Expenses section inthis MD&A for more information on SFAS 123R and its impact.  See the Liquidity and Capital Resources section inthis MD&A for more information on the Company’s share repurchase programand related debt placement.  The Companycurrently expects diluted net income per common share to be between $0.45 and$0.50 for the second quarter of fiscal 2006.

 

# **Net Sales**

# ** **

Net sales in the first quarter of fiscal 2006 were$1.5 billion, an increase of approximately 9.5% ($131.2 million), as comparedwith an increase of 10.9% ($135.6 million) in the first quarter of fiscal2005.  The increase was attributable, inpart, to increased sales in comparable stores (stores open more than 13 months)of 3.0% ($40.2 million), with the balance of the increases primarily relatingto sales from new stores opened as part of the Company’s store growthprogram.  The comparable store salescalculation for the first quarter of fiscal 2006 excludes a limited number ofstores that were closed for an extended period of time as a result of thehurricanes as discussed above.  The UrbanInitiative, the installation of refrigerated coolers and the “Treasure Hunt”merchandise program all had positive impacts on sales in the first quarter offiscal 2006.  Sales of lower-margin basicconsumables continued to be stronger than sales of higher-margin discretionarygoods during the first quarter of fiscal 2006, reflecting the difficult economicenvironment, including higher energy prices, faced by the Company’s low andlower-middle income customer base.  However,certain categories of discretionary goods, such as toys and electronics, performedwell.  Home products also performed well,which may be attributable to hurricane recovery demand.

 

The 3.0% increase in comparable store sales duringthe first quarter of fiscal 2006 includes an increase of approximately 4.2% inthe sales of hardline merchandise and a decrease of approximately 1.6% in thesales of softline merchandise.  In thefirst quarter of fiscal 2006, the customer count, as measured by the number ofregister transactions in comparable stores, decreased approximately 2.1%, andthe average transaction increased approximately 5.1% to $9.36.  Recent research from an independent marketresearch group suggests that low-income customers have reduced their totalshopping frequency, combining trips and errands in response to higher gasolineprices.  The Company’s declining customercount trends and increasing transaction size during the first quarter of fiscal2006 are consistent with this research. Increased sales of hardline merchandise have been the primarycontributor to the overall sales increases. Hardline merchandise, as a percentage of net sales, increased toapproximately 79.9% in the first quarter of fiscal 2006 compared toapproximately 79.0% in the first quarter of fiscal 2005.  Softline merchandise, as a percentage of netsales, decreased to approximately 20.1% in the first quarter of fiscal 2006compared to approximately 21.0% in the first quarter of fiscal 2005.  The Company distributed one advertisingcircular in the first quarter of both fiscal 2006 and fiscal 2005.  The circulars are designed to stimulatetraffic and inform customers about the Company’s “Treasure Hunt” merchandise,seasonal values and competitive prices on core consumables.  During fiscal 2006, the Company currentlyexpects to distribute four advertising circulars.

 

**Hardlinemerchandise includes household chemical and paper products, candy, snacks andother food, health and beauty aids, electronics, housewares and giftware, petfood and supplies, toys, stationery and school**

** **

**13**

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** **

**supplies, seasonal goods, hardware and automotivesupplies.  Softline merchandise includesmen’s, women’s, boys’, girls’ and infants’ clothing, shoes, and domestic itemssuch as blankets, sheets and towels.**

** **

**Theaverage number of stores in operation during the first quarter of fiscal 2006 was7.7% more than stores in operation during the first quarter of fiscal2005.  The Company had 5,952 stores inoperation at the end of the first quarter of fiscal 2006, compared with 5,555stores in operation at the end of the first quarter of fiscal 2005,representing an increase of approximately 7.1%.**

** **

Sales in comparable stores for the five-weekperiod ending December 31, 2005 increased approximately 2.3% abovecomparable sales for the similar period in the prior fiscal year.  TheCompany currently expects comparable store sales to increase 2% to 3% duringthe second quarter of fiscal 2006 and 2% to 4% during fiscal 2006 as a resultof the ongoing rollout of refrigerated coolers, the impact from “Treasure Hunt”merchandise sales and the operational improvements resulting from the UrbanInitiative program.

 

**Cost of Sales**

 

Cost of sales increased approximately 9.1% in thefirst quarter of fiscal 2006 compared with the first quarter of fiscal2005.  This increase primarily reflectedthe additional sales volume between years. Cost of sales, as a percentage of net sales, was 66.4% in the firstquarter of fiscal 2006 and 66.6% in the first quarter of fiscal 2005.  The decrease in cost of sales, as apercentage of net sales, during the first quarter of fiscal 2006 was dueprimarily to the favorable impact of lower inventory shrinkage and improvedinitial mark-ups.  The initiativesthe Company has implemented to address inventory shrinkage are having apositive impact, but the Company expects to continue to focus its efforts inthis area.  These improvements were offset by higherfreight costs resulting from higher fuel costs and slightly higher markdownexpense.  The opening of the Company’seighth distribution center in Marianna, Florida, in the second quarter offiscal 2005 and its continued ramp-up have positively impacted freight costs bylowering the average distance to the stores from the distribution centers.  Increases in productivity and efficiency,such as increased back hauls and optimization and consolidation of inboundrouting have also offset some of the cost increases.  However, these savings did not fully offsetthe impact of higher year-over-year fuel costs. The Company expects that the opening of the ninth distribution center inRome, New York, during the third quarter of fiscal 2006 will continue to lowerthe average distance to the stores from the distribution centers and willpositively impact freight costs.  Thehigher markdowns in the first quarter of fiscal 2006 were the result of a moreaggressive program to keep inventories at appropriate levels to better managemarkdown exposure.

 

During fiscal 2006, the Company expects that cost ofsales, as a percentage of net sales, will be flat or increase slightly ascompared to fiscal 2005 due to the continuing effect of the shift in themerchandise mix to more lower-margin basic consumables and highertransportation expense resulting from higher fuel costs.  Lower markdowns and lower inventory shrinkageare expected to partially offset these increases.

 

**Selling,General and Administrative Expenses**

** **

Selling, general and administrative (“SG&A”)expenses increased 13.2% in the first quarter of fiscal 2006, compared with thefirst quarter of fiscal 2005.  Theincreases in these expenses were due primarily to additional costs arising fromthe continued growth in the number of stores in operation.  SG&A expenses, as a percentage of netsales, were 28.1% in the first quarter of fiscal 2006, compared with 27.2% inthe first quarter of fiscal 2005.  Theincrease in the percentage for the first quarter of fiscal 2006 was dueprimarily to increased occupancy costs (approximately 0.4% of net sales),increased insurance costs (approximately 0.3% of net sales) and increasedcompensation expense related to the expensing of stock options as required bySFAS 123R and other compensation programs (approximately 0.2% of netsales).  The increase in occupancy costswas due primarily to higher utility costs and higher depreciation charges,especially as it relates to urban markets. The increase in insurance costs was primarily a result of a limitednumber of large claims in the health care and workers’ compensation areas aswell as some hurricane related costs.

 

During fiscal 2006, the Company expects SG&Aexpense, as a percentage of net sales, to increase as compared to fiscal 2005due to higher occupancy costs, the expanded rollout of the cooler program andthe

 

14

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continued investments in the existing UrbanInitiative markets.  In addition, therequired expensing of stock options and other compensation plan changes,including a proposed performance share incentive plan as discussed in theCompany’s 2006 Annual Meeting Proxy Statement, is expected to increase SG&Aexpenses, as a percentage of net sales.

 

**InterestExpense**

** **

On September 27, 2005, the Company obtained$250 million in aggregate proceeds through a private placement of unsecuredSenior Notes (the “Notes”) to a group of institutional accreditedinvestors.  During the first quarter offiscal 2006, the Company incurred $2.2 million in interest expense related tothe Notes.  See Note 4 to theConsolidated Condensed Financial Statements included in this Report forinformation on the Company’s current and long-term debt.  The Company did not incur any interestexpense during fiscal 2005.

 

**Provision forTaxes on Income**

** **

The effective tax rate was37.0% for the first quarter of fiscal 2006, compared with 36.1% for the firstquarter of fiscal 2005.  A retroactivereinstatement of certain federal jobs tax credits for employees hired after December 31,2003, favorably impacted the effective tax rate in the first quarters of fiscal2005.  For the remainder of fiscal 2006, the Company’splan is for the effective tax rate to remain at 37.0% due to the effect ofchanges in state income taxes.

 

**Liquidity and Capital Resources**

** **

At the end of the first quarter of fiscal 2006, theCompany had working capital of $530.5 million. Changes in working capital during the first quarters of fiscal 2006 andfiscal 2005 were primarily the result of earnings, changes in merchandiseinventories and capital expenditures.  TheCompany’s inventories at the end of the first quarter of fiscal 2006 were 7.6%higher than at the end of the first quarter of fiscal 2005.  Inventory on a per store basis at the end ofthe first quarter of fiscal 2006 was flat compared with inventory on a perstore basis at the end of the first quarter of fiscal 2005.

 

**Capitalexpenditures for the first quarter of fiscal 2006 were approximately $48.8million and are currently expected to be approximately $210 to $225 million forfiscal 2006.  The majority of the plannedcapital expenditures for fiscal 2006 relate to the Company’s new storeopenings; existing store expansions, relocations and renovations; constructionof distribution centers; expenditures related to store-focused technologyinfrastructure; and the continued implementation of a refrigerated coolerprogram for perishable goods in selected stores.  The new store expansion and new distributioncenters also require additional investment in merchandise inventories.**

** **

**Inthe first quarter of fiscal 2006, the Company opened 73 stores, closed 19stores and expanded, relocated, or renovated 14 stores.  The Company plans to open approximately 400stores and close approximately 65 stores during fiscal 2006.  The Company also plans to relocate, expand,or renovate approximately 75 stores during fiscal 2006.  The Company occupies most of its stores underoperating leases.  Store opening,closing, expansion, relocation, and renovation plans, as well as overallcapital expenditure plans, are continuously reviewed and are subject to change.**

 

During fiscal2005 the Company purchased in the open market 3.3 million shares of its commonstock at a cost of $92.0 million.  OnSeptember 27, 2005, the Company obtained $250 million in aggregate proceedsthrough a private placement of unsecured Senior Notes (the “Notes”) to a groupof institutional accredited investors. On October 4, 2005, the Company executed an overnight share repurchasetransaction with a bank for the acquisition of 10 million shares, orapproximately 6%, of the Company’s outstanding common stock.  The transaction was financed with theproceeds of the Notes.  See Note 4 andNote 5 to the Consolidated Condensed Financial Statements included in thisReport for more information, including any remaining commitments related to theovernight share repurchase transaction. The shares repurchased were immediately canceled and returned to thestatus of authorized but unissued shares. There were no other purchases of common stock by the Company during thefirst quarter of fiscal 2006.  As ofNovember 26, 2005, the Company had outstanding authorizations to purchase atotal of approximately 6.9 million shares, consisting of approximately 3.0million shares (based on current share price) remaining under the authorizationfor $300 million of stock repurchases approved by the Board of Directors onAugust 19, 2005, and approximately 3.9 million shares remaining pursuant toauthorizations approved by the Board of Directors prior to August 19, 2005.

 

 

15

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TheCompany has unsecured revolving credit facilities with banks for short-termborrowings of up to $200 million.  On May25, 2006, $100 million of the facilities will expire, and the remaining $100million will expire on May 31, 2010.  TheCompany expects that the facilities expiring on May 25, 2006, will beextended.  The Company had no outstandingborrowings against these facilities during the first quarter of fiscal 2006 orduring fiscal 2005.  Cash flow fromcurrent operations and available revolving credit facilities, as discussedabove, are expected to be sufficient to meet planned liquidity and operationalcapital resource needs, including store expansion and other capital spendingprograms, scheduled interest payments, and any further repurchase of theCompany’s common stock.

 

The following table shows the Company’s obligationsand commitments as of the end of the first quarter of 2006 to make futurepayments under contractual obligations:

 
| ** **                                  | ** ** | **Payments Due During One Year Fiscal Period Ending** | ** ** |
|---------------------------------------------|------------|-------------------------------------------------------|------------|
| **(in thousands)  Contractual Obligations** | ** ** | **Total**                                             | ** ** | **November  2006** | ** ** | **November  2007** | ** ** | **November  2008** | ** ** | **November  2009** | ** ** | **November  2010** | ** ** | **Thereafter** | ** ** |
| Long-term debt                              |       | $                                                     | 250,000    |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 250,000 |   |
| Interest                                    |       | $                                                     | 123,151    |   | 13,387 |   | 13,387 |   | 13,387 |   | 13,387 |   | 13,387 |   | 56,216 |   |
| Merchandise letters of credit               |       | $                                                     | 89,356     |   | 89,356 |   | — |   | — |   | — |   | — |   | — |   |
| Operating leases                            |       | $                                                     | 1,144,480  |   | 259,676 |   | 226,914 |   | 190,836 |   | 150,770 |   | 108,080 |   | 208,204 |   |
| Construction obligations                    |       | $                                                     | 33,933     |   | 33,933 |   | — |   | — |   | — |   | — |   | — |   |
| Total                                       |       | $                                                     | 1,640,920  |   | $ | 396,352 |   | $ | 240,301 |   | $ | 204,223 |   | $ | 164,157 |   | $ | 121,467 |   | $ | 514,420 |   |

 

Most of the Company’s operating leasesprovide the Company with an option to extend the term of the lease atdesignated rates.

 

The following tableshows the Company’s other commercial commitments as of the end of the firstquarter of fiscal 2006:

** **

| **Other Commercial Commitments (in thousands)** | ** ** | **Total Amounts  Committed** | ** ** |
|-------------------------------------------------|------------|------------------------------|------------|
| Standby letters of credit                       |       | $                            | 105,505    |   |
| Surety bonds                                    |       | 6,508                        |       |
| Total Commercial Commitments                    |       | $                            | 112,013    |   |

### ** **

**At the end of the first quarterof fiscal 2006, approximately $14.2 million of the merchandise letters ofcredit were included in accounts payable on the Company’s ConsolidatedCondensed Balance Sheet.  A substantialportion of the outstanding amount of standby letters of credit and surety bonds(which are primarily renewed on an annual basis) are used as surety for futurepremium and deductible payments to the Company’s workers’ compensation andgeneral liability insurance carrier.  TheCompany accrues for these future payment liabilities as described in the “CriticalAccounting Policies” section of this discussion.**

 

**Critical Accounting Policies**

 

**Management believes the followingaccounting principles are critical because they involve significant judgments,assumptions, and estimates used in the preparation of the Company’sconsolidated condensed financial statements.**

** **

**16**

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** **

***Merchandise Inventories:***

** **

Inventories are valued using the retail method,based on retail prices less markon percentages, which approximates the lower offirst-in, first-out (FIFO) cost or market. The Company records adjustments to inventory through cost of goods soldwhen retail price reductions, or markdowns, are taken against on-handinventory.  In addition, management makesestimates and judgments regarding, among other things, initial markups,markdowns, future demand for specific product categories and market conditions,all of which can significantly impact inventory valuation.  If actual demand or market conditions aredifferent than those projected by management, additional markdowns may benecessary.  This risk is generally higherfor seasonal merchandise than for non-seasonal goods.  The Company also provides for estimatedinventory losses for damaged, lost or stolen inventory for the period from thephysical inventory to the financial statement date.  These estimates are based on historicalexperience and other factors.

 

***Propertyand Equipment:***

** **

Property and equipment is stated at cost.  Depreciation for financial reporting purposesis calculated using the straight-line method over the estimated useful lives ofthe related assets.  For leaseholdimprovements, this depreciation is over the shorter of the term of the relatedlease (generally five years) or the asset’s useful economic life.  The valuation and classification of theseassets and the assignment of useful depreciable lives involves significantjudgments and the use of estimates.  TheCompany generally assigns no salvage value to property and equipment.  Property and equipment is reviewed forimpairment whenever events or changes in circumstances indicate that thecarrying amount of an asset may not be recoverable.  Historically, impairment losses on fixedassets have not been material to the Company’s financial position and resultsof operations.

 

*Insurance Liabilities:*

 

The Company is primarily self-insured for healthcare, property loss, workers’ compensation and general liability costs.  These costs are significant primarily due tothe large number of the Company’s retail locations and employees.  Because the nature of these claims is suchthat there can be a significant lag from the incurrence of the claim (which iswhen the expense is accrued) until payment is made, the percentage increase inthe accrual can be much more pronounced than the percentage increase in theexpense.  The Company’s self-insuranceliabilities are based on the total estimated costs of claims filed andestimates of claims incurred but not reported, less amounts paid against suchclaims, and are not discounted. Management reviews current and historical claims data in developing itsestimates.  The Company also usesinformation provided by outside actuaries with respect to workers’ compensationand general liability claims.  If theunderlying facts and circumstances of the claims change or the historical trendis not indicative of future trends, then the Company may be required to recordadditional expense or a reduction to expense which could be material to thereported financial condition and results of operations.

 

*Lease Accounting:*

 

The Company leases substantially all of its storeproperties and accounts for store leases in accordance with SFAS 13, “Accountingfor Leases.”  For purposes of recognizingincentives, premiums and minimum rental expenses on a straight-line basis overterms of the leases, the Company uses the date of initial possession to beginamortization, which is generally when the Company enters the space and beginsto make improvements in preparation of intended use.  For tenant improvement allowances and rentholidays, the Company records a deferred rent liability at the inception of thelease term and amortizes the deferred rent over the terms of the leases asreductions to rent expense on the Consolidated Statements of Income.

 

*Stock-based Compensation Expense*

 

The Company adopted SFAS 123R during the firstquarter of fiscal 2006.  SFAS 123Rrequires the measurement and recognition of compensation expense for allstock-based awards made to employees based on

 

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estimated fair values.  The determination of the fair value ofstock-based awards on the date of grant using an option-pricing model isaffected by the Company’s stock price as well as assumptions regarding a numberof complex and subjective variables. These variables include, but are not limited to, the expected stockprice volatility over the term of the awards, and actual and projected employeestock option exercise behaviors.  Iffactors change and the Company employs different assumptions in the applicationof SFAS 123R in future periods, the compensation expense recorded under SFAS123R may differ significantly from the amount recorded in the current period.

 

**CautionaryStatement Regarding Forward-Looking Statements**

 

Certain statements contained in this Report, or inother public filings, press releases, or other written or oral communications madeby the Company or its representatives, which are not historical facts areforward-looking statements made pursuant to the safe harbor provisions of thePrivate Securities Litigation Reform Act of 1995.  These forward-looking statements address theCompany’s plans, activities or events which the Company expects will or mayoccur in the future and may include express or implied projections of revenueor expenditures, statements of plans and objectives for future operations,growth or initiatives, statements of future economic performance, or statementsregarding the outcome or impact of pending or threatened litigation.  These forward-looking statements may beidentified by the use of the words “plan,” “estimate,” “expect,” “anticipate,” “probably,”“should,” “project,” “intend,” “continue,” and other similar terms andexpressions.  Various risks,uncertainties and other factors may cause the Company’s actual results todiffer materially from those expressed or implied in any forward-lookingstatements.  Factors, uncertainties andrisks that may result in actual results differing from such forward-lookinginformation include, but are not limited to those listed below, as well as otherfactors discussed throughout this Report, including, without limitation, thefactors described under “Critical Accounting Policies.”

 

*Success of merchandising and marketing programs*

 

The Company undertakes new programs and refinesexisting programs to increase net sales and its customer base.  The Company may be adversely impacted ifmerchandise and marketing programs fail to attract customers into its stores orif the merchandising programs implemented by the Company are not attractive toits customers.

 

*Unusual weather or natural disasters that may impact sales and oroperations*

 

Extreme changes in weather patterns or other naturaldisasters influence customer trends and purchases.  Likewise, weather patterns and naturaldisasters may negatively impact sales and/or operation of the Company.

 

*Competitive factors*

 

The Company is in a highly competitive sector of thediscount retail merchandise sector with numerous competitors, some of whom mayhave greater resources than the Company. The Company competes for customers, merchandise, real estate locationsand employees.  This competitiveenvironment subjects the Company to various risks, including the ability tocontinue its store and sales growth and provide attractive merchandise to itscustomers at competitive prices that allow the Company to maintain itsprofitability.

 

*Pricing pressures, including inflation and energy prices*

 

Increases in the cost of goods and services,including changes resulting from inflationary pressures, may reduce the Company’sprofitability and/or sales.  The Company’sability to pass on incremental pricing changes may be limited due tooperational and/or competitive factors. Increases in prices, including changes in energy prices, may impact theCompany’s customer base by limiting the amount of discretionary spending of itscustomers and may impact the Company through increased costs of goods and/orincreased operating expenses.

 

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*Changes in consumer demand and product mix; and changes in overalleconomic conditions*

 

A general slowdown in the U.S. economy may adverselyaffect the spending of the Company’s customers, which may result in lower netsales than expected on a quarterly or annual basis.  In addition, changes in the types of productsmade available for sale and the selection of the products by customers affectsales, product mix and margins.  Futureeconomic conditions affecting disposable consumer income, such as employmentlevels, business conditions, fuel and energy costs, interest rates, and taxrates, could also adversely affect the Company’s business by reducing spendingor causing customers to shift their spending to other products.

 

*The impact of acts of war or terrorism and transportation anddistribution delays or interruptions*

 

Significant acts of terrorism, existing U.S.military efforts, as well as the involvement of the U.S. in other militaryengagements, could have an adverse impact on the Company by, among otherthings, disrupting its distribution or information systems, causing dramaticincreases in fuel prices which increase the cost of doing business, or impedingthe flow of imports or domestic products to the Company.  Delays or interruptions in the transportationand distribution of products could have an adverse impact on the Company.

 

*Merchandise supply and pricing and the interruption of and dependenceon imports*

 

The Company has generally been able to obtainsufficient quantities of attractive merchandise at prices that allow theCompany to profitably sell such merchandise. Any disruption in that supply and/or the pricing of such merchandisecould negatively impact the Company’s operations and results.  A significant amount of the goods sold by theCompany are imported, and changes to the flow of these goods for any reasoncould have an adverse impact on the Company.

 

*Delays associated with building and opening of distribution facilitiesand stores and costs of operating distribution facilities and stores*

 

The Company maintains a network of distributionfacilities in its geographic territory, and constructs new facilities tosupport its growth.  In addition, theCompany expands its network of stores through opening new stores and remodelingexisting stores each year.  Delays inopening distribution facilities or stores could adversely affect the Company’sfuture operations by slowing growth, which may in turn reduce revenuegrowth.  Adverse changes in the cost tooperate distribution facilities and stores, such as changes in labor, utility,and other operating costs, could have an adverse impact on the Company.  Adverse changes in inventory shrinkage at thestore-level or in distribution facilities could have a negative impact on theCompany.

 

*Operational difficulties*

 

The Company’s stores are decentralized and aremanaged through a network of geographically dispersed managementpersonnel.  Inability of the Company toeffectively and efficiently operate its stores, including the ability tocontrol losses resulting from inventory shrinkage, may negatively impact theCompany’s sales and/or margin.  Inaddition, the Company relies upon its distribution and logistics network toprovide goods to stores in a timely and cost-effective manner; any disruption,unanticipated expense or operational failure related to this process couldnegatively impact store operations. Finally, the Company’s operations are facilitated by the use of varioustechnologies, the disruption or failure of which could negatively impact theCompany’s operations.

 

*Higher costs, potential problems and achievement of targeted resultsassociated with the implementation of new programs, systems and technology,including supply chain systems, store technology, cooler installations andUrban Initiative program*

 

The Company is undertaking a variety of operatinginitiatives as well as infrastructure initiatives.  The failure to properly execute any of theseinitiatives could have an adverse impact on the future operating results of theCompany.

 

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*Changes in state or federal legislation or regulations, including theeffects of legislation and regulations on wage levels and entitlement programs;changes in currency exchange rates, trade restrictions, tariffs, quotas andfreight rates*

 

Unanticipated changes in federal or state wagerequirements or other changes in workplace regulation could adversely impactthe Company’s ability to achieve its financial targets.  Because a substantial amount of the Company’simported merchandise comes from China, a change in the Chinese currency policycould negatively impact the Company’s merchandise costs.  Changes in trade restrictions, new tariffsand quotas, and higher shipping costs for goods could also adversely impact theability of the Company to achieve anticipated operating results.

 

*Success of new store opening program*

 

The Company’s growth is dependent on both increasesin sales in existing stores and the ability to open new stores.  Unavailability of store locations that theCompany deems attractive, delays in the acquisition or opening of new stores,difficulties in staffing and operating new store locations and lack of customeracceptance of stores in expanded market areas all may negatively impact theCompany’s new store growth, the costs associated with new stores and/or theprofitability of new stores.

 

*The Company’s ability to attract and retain employees, and changes inhealth care and other insurance costs*

 

The growth of the Company could be adverselyimpacted by its inability to attract and retain employees at the storeoperations level, in distribution facilities, and at the corporate level,including the Company’s senior management team. Adverse changes in health care costs could also adversely impact theCompany’s ability to achieve its operational and financial goals and to offerattractive benefit programs to its employees.

 

*Adverse impacts associated with legal proceedings and claims*

 

The Company is a party to a variety of legalproceedings and claims, including those described elsewhere in this Report.  Operating results for the Company could beadversely impacted if such legal proceedings and claims result in the Company’sobligation to make either material damage or settlement payments or changes tothe operation of the business.

 

All of the forward-looking statements made by theCompany in this Report and other documents or statements are qualified by theseand other factors, risks and uncertainties. Readers are cautioned not to place undue reliance on theseforward-looking statements, which speak only as of the date of thisReport.  The Company does not undertaketo publicly update or revise its forward-looking statements even if experienceor future changes make it clear that projected results expressed or implied insuch statements will not be realized.

 

# **Item3. Quantitative and Qualitative Disclosures About Market Risk**

# ** **

The Company is subject to market risk from exposureto changes in interest rates based on its financing, investing and cashmanagement activities.  The Companymaintains unsecured revolving credit facilities at variable interest rates tomeet the short-term needs of its expansion program and seasonal inventoryincreases.  The Company had nooutstanding borrowings against these facilities during the first quarter offiscal 2006.  The Company’s long-termdebt associated with the Notes bears interest at fixed rates.

 

**Item 4.    Controls andProcedures**

 

Basedon an evaluation by management of the Company (with the participation of theCompany’s Chief Executive Officer and Chief Financial Officer), as of the endof the period covered by this report, the Company’s Chief Executive Officer andChief Financial Officer concluded that the Company’s disclosure controls andprocedures (as defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934, as amended

 

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(the “Exchange Act”))were effective to provide reasonable assurance that information required to bedisclosed by the Company in reports that the Company files or submits under theExchange Act is recorded, processed, summarized and reported within the timeperiods specified in Securities and Exchange Commission (“SEC”) rules andforms and that such information is accumulated and communicated to the Company’smanagement, including the Chief Executive Officer and Chief Financial Officer,to allow timely decisions regarding required disclosures.

 

The Company is continuously seeking toimprove the efficiency and effectiveness of its operations and of its internalcontrols.  This results in refinements toprocesses throughout the Company. However, there has been no change in the Company’s internal control overfinancial reporting during the most recent fiscal quarter that has materiallyaffected, or is reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

 

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**PART II - OTHER INFORMATION**

 

**Item 1. LegalProceedings**

** **

**The information in Note 8 to the Consolidated Condensed Financial Statementscontained in Part I, Item 1 of the Form 10-Q is incorporated hereinby this reference.**

** **

**Item 2. UnregisteredSales of Equity Securities and Use of Proceeds**

** **

The following table sets forth information withrespect to purchases of shares of the Company’s common stock made during thequarter ended November 26, 2005, by or on behalf of the Company or any “affiliatedpurchaser” as defined by Rule 10b-18(a)(3) of the Securities ExchangeAct of 1934:

 
| ** **          | ** ** | **Total Number  of Shares  Purchased** | ** ** | **Average  Price Paid  Per Share** | ** ** | **Total Number of  Shares Purchased  as Part of Publicly  Announced Plans  or Programs** | ** ** | **Maximum Number  of Shares that May  Yet Be Purchased  Under the Plans or  Programs****(1)** | ** ** |
|---------------------|------------|----------------------------------------|------------|------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|
| September           |       |                                   |       |                               |       |                                                                                          |       |                                                                                          |       |
| (8/28/05-10/1/05)   |       | —                                 |       | —                             |       | —                                                                                        |       | 18,981,338                                                                                    |       |
| October             |       |                                   |       |                               |       |                                                                                          |       |                                                                                          |       |
| (10/2/05-10/29/05)  |       | 10,000,000                             |       | $                                  | 19.97      |                                                                                          | 10,000,000 |                                                                                          | 7,830,201  |   |
| November            |       |                                   |       |                               |       |                                                                                          |       |                                                                                          |       |
| (10/30/05-11/26/05) |       | —                                 |       | —                             |       | —                                                                                        |       | 6,864,593                                                                                     |       |
|                     |            |                                        |            |                                    |            |                                                                                               |            |                                                                                               |            |  |

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(1)  Includes amountsconverted to shares using the Company’s closing stock price as of the end ofeach fiscal month.

 

**On October 4, 2005, the Companyexecuted an overnight share repurchase transaction with a bank for theacquisition of 10 million shares, or approximately 6%, of the Company’soutstanding common stock for an initial purchase price of $19.97 per share.  The transaction was financed with theproceeds of the Company’s Notes.  SeeNote 4 and Note 5 to the Consolidated Financial Statements included in thisReport for more information.  There wereno other purchases of common stock by the Company during the first quarter offiscal 2006.  Shares are purchasedpursuant to share repurchase authorizations approved by the Board ofDirectors.  As of November 26, 2005, theCompany had outstanding authorizations to purchase a total of approximately 6.9million shares, consisting of approximately 3.0 million shares (based oncurrent share price) remaining under the authorization for $300 million ofstock repurchases approved by the Board of Directors on August 19, 2005, andapproximately 3.9 million shares remaining pursuant to authorizations approvedby the Board of Directors prior to August 19, 2005.  Shares purchased prior to the end of fiscal2005 under the share repurchase authorizations are held in treasury or havebeen reissued under the Family Dollar 2000 Outside Directors Plan.  Shares that are purchased with the proceedsof the Notes are canceled and returned to the status of authorized but unissuedshares.  There is no expiration dategoverning the period during which the Company can make share repurchasespursuant to the above referenced authorizations.  There are no other repurchase programs underwhich the Company is authorized to repurchase outstanding shares.**

** **

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** **

**Item 6.Exhibits**

** **
| **(a)**    | ** ** | **Exhibits  incorporated by reference:**                                                                                                                                                                                          |
|------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                                                                                                        |
| **10.1**   | ** ** | **Employment  Agreement dated November 22, 2005 between the Company and Robert A. George (filed  as Exhibit 10 to the Company’s Report on Form 8-K filed November 25, 2005)**                                                |
| ** ** | ** ** | ** **                                                                                                                                                                                                                        |
| **(b)**    | ** ** | **Exhibits  filed herewith:**                                                                                                                                                                                                     |
| ** ** | ** ** | ** **                                                                                                                                                                                                                        |
| **31.1**   | ** ** | **Certification  of Principal Executive Officer Pursuant to Rules 13a-14(a) and  15d-14(a) under the Securities Exchange Act of 1934, as adopted pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002** |
| ** ** | ** ** | ** **                                                                                                                                                                                                                        |
| **31.2**   | ** ** | **Certification  of Principal Financial Officer Pursuant to Rules 13a-14(a) and  15d-14(a) under the Securities Exchange Act of 1934, as adopted pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002** |
| ** ** | ** ** | ** **                                                                                                                                                                                                                        |
| **32.1**   | ** ** | **Certification  of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350 as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002**                                                              |
| ** ** | ** ** | ** **                                                                                                                                                                                                                        |
| **32.2**   | ** ** | **Certification  of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350 as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002**                                                              |
|            |            |                                                                                                                                                                                                                                   |  |  |

** **

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SIGNATURES

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 

 
|                       | FAMILY DOLLAR STORES, INC.            |                 |
|----------------------------|---------------------------------------|----------------------|
|                       | (Registrant)                          |
|                       |                                  |
|                       |                                  |
| Date: January 5, 2006 |                                  | /s/ R. James Kelly   |   |
|                       | R. JAMES KELLY                        |
|                       | Vice Chairman-Chief Financial Officer |
|                       |                                  |
|                       |                                  |
| Date: January 5, 2006 |                                  | /s/ C. Martin Sowers |   |
|                       | C. MARTIN SOWERS                      |
|                       | Senior Vice President-Finance         |
|                            |                                       |                      |  |  |  |

 

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