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

**Form10-Q**

**(Mark One)**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934

** **

**For the quarterly periodended November 25, 2006**

** **

**OR**

** **

**o**                                 TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

**CommissionFile Number 1-6807**

**FAMILYDOLLAR STORES, INC.**(Exact name of registrant as specified in its charter)

 

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

 

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

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes o   No x

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer.  See definition of“accelerated filer and large accelerated filer” in Rule 12b-2 of the ExchangeAct.  (Check one):

Large AcceleratedFiler x   Accelerated Filer o   Non-Accelerated Filer o

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).Yes o   No x

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date.

| **Class**                      | ** ** | **Outstanding  at March 3, 2007** |
|--------------------------------|------------|-----------------------------------|
| Common Stock,  $0.10 par value |       | 150,807,820  shares               |

 

 

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**FAMILY DOLLARSTORES, INC. AND SUBSIDIARIES**

**INDEX**
|                                                                                                          | ** ** | ** ** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|------------|------------|
| Part  I - Financial Information                                                                          |       |       |       |
| Item 1 - Consolidated Condensed Financial  Statements (unaudited):                                       |       |       |       |
| Consolidated Condensed Balance Sheets - November  25, 2006 and August 26, 2006                           |       |       |       |
| Consolidated Condensed Statements of Income -  Quarter Ended November 25, 2006 and November 26, 2005     |       |       |       |
| Consolidated Condensed Statements of Cash Flows -  Quarter Ended November 25, 2006 and November 26, 2005 |       |       |       |
| 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 1A  - Risk Factors                                                                                  |       |       |       |
| Item 2 - Unregistered Sales of Equity Securities  and Use of Proceeds                                    |       |       |       |
| Item 5 -  Other  Information                                                                             |       |       |       |
| Item 6 -  Exhibits                                                                                       |       |       |       |
| Signatures                                                                                               |       |       |       |

 

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**PART I —FINANCIAL INFORMATION**

**Item 1.   Consolidated Condensed Financial Statements**

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

**CONSOLIDATED CONDENSED BALANCESHEETS**

**(Unaudited)**
| **(in thousands, except per share and share amounts)**                                                                                                                                                                | ** ** | **November 25,  2006** | ** ** | **August 26,  2006** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|---------------------------|------------|
| **Assets**                                                                                                                                                                                                                                               |       |                        |       |                      |       |
| Current assets:                                                                                                                                                                                                                                          |       |                        |       |                      |       |
| Cash and cash  equivalents (Note 2)                                                                                                                                                                                                                      |       | $                           | 115,270    |                      | $          | 79,727 |   |
| Investment  securities (Note 2)                                                                                                                                                                                                                          |       | 121,165                     |       | 136,505                   |       |
| Merchandise  inventories                                                                                                                                                                                                                                 |       | 1,090,266                   |       | 1,037,859                 |       |
| Deferred income  taxes                                                                                                                                                                                                                                   |       | 138,352                     |       | 133,468                   |       |
| Income tax  refund receivable                                                                                                                                                                                                                            |       | —                      |       | 2,397                     |       |
| Prepayments and  other current assets                                                                                                                                                                                                                    |       | 36,520                      |       | 28,892                    |       |
| Total current  assets                                                                                                                                                                                                                                    |       | 1,501,573                   |       | 1,418,848                 |       |
|                                                                                                                                                                                                                                                     |       |                        |       |                      |       |
| Property and equipment,  net                                                                                                                                                                                                                             |       | 1,062,215                   |       | 1,077,608                 |       |
| Other assets                                                                                                                                                                                                                                             |       | 25,667                      |       | 26,573                    |       |
| ** **                                                                                                                                                                                                                                               |       | $                           | 2,589,455  |                      | $          | 2,523,029 |   |
| ** **                                                                                                                                                                                                                                               |       |                        | ** ** | ** **                |       |
| **Liabilities and Shareholders’  Equity**                                                                                                                                                                                                           |       |                        |       |                      |       |
| Current liabilities:                                                                                                                                                                                                                                     |       |                        |       |                      |       |
| Accounts payable                                                                                                                                                                                                                                         |       | $                           | 541,704    |                      | $          | 556,531 |   |
| Accrued  liabilities                                                                                                                                                                                                                                     |       | 432,146                     |       | 429,580                   |       |
| Income taxes  payable                                                                                                                                                                                                                                    |       | 32,573                      |       | —                    |       |
| Total current  liabilities                                                                                                                                                                                                                               |       | 1,006,423                   |       | 986,111                   |       |
|                                                                                                                                                                                                                                                     |       |                        |       |                      |       |
| Long-term debt (Note 4)                                                                                                                                                                                                                                  |       | 250,000                     |       | 250,000                   |       |
| Deferred income taxes                                                                                                                                                                                                                                    |       | 76,592                      |       | 78,525                    |       |
| Commitments and  contingencies                                                                                                                                                                                                                           |       |                        |       |                      |       |
|                                                                                                                                                                                                                                                     |       |                        |       |                      |       |
| 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 178,901,327 shares at  November 25, 2006, and 178,559,411 shares at August 26, 2006, and outstanding  150,552,400 shares at November 25, 2006, and 150,210,484 shares at August 26,  2006 |       | 17,890                      |       | 17,856                    |       |
| Capital in  excess of par                                                                                                                                                                                                                                |       | 150,536                     |       | 140,829                   |       |
| Retained  earnings                                                                                                                                                                                                                                       |       | 1,584,672                   |       | 1,546,366                 |       |
|                                                                                                                                                                                                                                                     |       | 1,753,098                   |       | 1,705,051                 |       |
| Less: common  stock held in treasury, at cost (28,348,927 shares both at November 25, 2006,  and August 26, 2006)                                                                                                                                        |       | 496,658                     |       | 496,658                   |       |
| Total  shareholders’ equity                                                                                                                                                                                                                         |       | 1,256,440                   |       | 1,208,393                 |       |
|                                                                                                                                                                                                                                                     |       | $                           | 2,589,455  |                      | $          | 2,523,029 |   |

 

## Seenotes to the consolidated condensed financial statements.

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

**CONSOLIDATED CONDENSED STATEMENTSOF INCOME**

**(Unaudited)**

** **
| ** **                                                            | ** ** | **Quarter Ended**      | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------------|------------|
| **(in thousands, except per share amounts)** | ** ** | **November 25,  2006** | ** ** | **November 26,  2005** | ** ** |
| Net sales                                                             |       | $                           | 1,600,264  |   | $ | 1,511,457 |   |
|                                                                  |       |                        |       |   |   |
| Cost and  expenses:                                                   |       |                        |       |   |   |
| Cost of sales                                                         |       | 1,047,382                   |       | 1,003,254 |   |
| Selling, general and administrative                                   |       | 461,755                     |       | 425,291 |   |
| Cost of sales  and operating expenses                                 |       | 1,509,137                   |       | 1,428,545 |   |
|                                                                  |       |                        |       |   |   |
| Operating profit                                                      |       | 91,127                      |       | 82,912 |   |
|                                                                  |       |                        |       |   |   |
| Interest income                                                       |       | 1,447                       |       | 851 |   |
|                                                                  |       |                        |       |   |   |
| Interest expense                                                      |       | 5,506                       |       | 2,193 |   |
|                                                                  |       |                        |       |   |   |
| Income before  income taxes                                           |       | 87,068                      |       | 81,570 |   |
|                                                                  |       |                        |       |   |   |
| Income taxes                                                          |       | 32,944                      |       | 30,181 |   |
|                                                                  |       |                        |       |   |   |
| Net income                                                            |       | $                           | 54,124     |   | $ | 51,389 |   |
|                                                                  |       |                        |       |   |   |
| Net income per  common share — basic (Note 7)                    |       | $                           | 0.36       |   | $ | 0.32 |   |
| Average shares — basic (Note 7)                                  |       | 150,461                     |       | 159,330 |   |
|                                                                  |       |                        |       |   |   |
| Net income per  common share — diluted (Note 7)                  |       | $                           | 0.36       |   | $ | 0.32 |   |
| Average shares — diluted (Note 7)                                |       | 150,961                     |       | 160,472 |   |
|                                                                  |       |                        |       |   |   |
| Dividends declared per  common share                                  |       | $                           | 0.105      |   | $ | 0.095 |   |

 

See notes to the consolidated condensed financialstatements.

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

**CONSOLIDATED CONDENSED STATEMENTSOF CASH FLOWS**

**(Unaudited)**

## ** **

| ** **                                                                         | ** ** | **Quarter Ended**            | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| **(in thousands)**                                                            | ** ** | **November 25,   2006** | ** ** | **November 26,   2005** | ** ** |
| **Cash  flows from operating activities:**                                         |       |                              |       |   |   |
| Net income                                                                         |       | $                                 | 54,124     |   | $ | 51,389 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                              |       |   |   |
| Depreciation and amortization                                                      |       | 35,473                            |       | 32,227 |   |
| Deferred income taxes                                                              |       | (6,817                            | )          | (8,995 | ) |
| Stock-based compensation expense, including tax  benefits                          |       | 2,000                             |       | 1,470 |   |
| Loss on disposition of property and equipment                                      |       | 465                               |       | 2,233 |   |
| Changes in operating assets and liabilities:                                       |       |                              |       |   |   |
| Merchandise inventories                                                            |       | (52,407                           | )          | (19,994 | ) |
| Income tax refund receivable                                                       |       | 2,397                             |       | — |   |
| Prepayments and other current assets                                               |       | (7,628                            | )          | (11,464 | ) |
| Other assets                                                                       |       | 906                               |       | 1,595 |   |
| Accounts payable and accrued liabilities                                           |       | (13,472                           | )          | (46,261 | ) |
| Income taxes payable                                                               |       | 32,573                            |       | 33,903 |   |
|                                                                               |       | 47,614                            |       | 36,103 |   |
|                                                                               |       |                              |       |   |   |
| **Cash  flows from investing activities:**                                         |       |                              |       |   |   |
| Purchases of investment securities                                                 |       | (81,745                           | )          | (9,800 | ) |
| Sales of investment securities                                                     |       | 97,085                            |       | 9,455 |   |
| Capital expenditures                                                               |       | (20,654                           | )          | (48,804 | ) |
| Proceeds from dispositions of property and equipment                               |       | 109                               |       | 77 |   |
|                                                                               |       | (5,205                            | )          | (49,072 | ) |
|                                                                               |       |                              |       |   |   |
| **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                                                         |       | 1,179                             |       | (11,488 | ) |
| Proceeds from employee stock options                                               |       | 7,344                             |       | 54 |   |
| Excess tax benefits from stock-based compensation                                  |       | 397                               |       | 4 |   |
| Payment of dividends                                                               |       | (15,786                           | )          | (15,700 | ) |
|                                                                               |       | (6,866                            | )          | 20,262 |   |
|                                                                               |       |                              |       |   |   |
| **Net  change in cash and cash equivalents**                                       |       | 35,543                            |       | 7,293 |   |
| **Cash  and cash equivalents at beginning of period**                              |       | 79,727                            |       | 105,175 |   |
| **Cash and cash equivalents at  end of period**                                    |       | $                                 | 115,270    |   | $ | 112,468 |   |

 

## Seenotes to the consolidated condensed financial statements.

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

## **NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS**

1.               In the opinion of the Company, the accompanyingunaudited consolidated condensed financial statements contain all adjustments(consisting of only normal recurring accruals unless otherwise stated)necessary to present fairly the Company’s financial position as of November 25,2006; the results of operations for the first quarter ended November 25, 2006 (“firstquarter of fiscal 2007”), and November 26, 2005 (“first quarter of fiscal 2006”);and the cash flows for the first quarter of fiscal 2007 and first quarter offiscal 2006.  For further information,refer to the consolidated financial statements and footnotes included in theCompany’s Annual Report on Form 10-K for the fiscal year ended August 26, 2006(“fiscal 2006”).

**Theresults of operations for the first quarter of fiscal 2007 are not necessarilyindicative of the results to be expected for the full year.**

**Certainreclassifications of the amounts for the first quarter of fiscal 2006 have beenmade to conform to the presentation for the first quarter of fiscal 2007.**

2.               The Company considers all highly liquidinvestments with an original maturity of three months or less to be “cashequivalents.”  The carrying amount of theCompany’s cash equivalents approximates fair value due to the short maturitiesof these investments and consists primarily of money-market funds and otherovernight investments.  The Companymaintains cash deposits with major banks, which from time to time may exceedfederally insured limits.  The Companyperiodically assesses the financial condition of the institutions and believesthat the risk of any loss is 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 of the Company’s ConsolidatedCondensed Financial Statements, in conformity with accounting principlesgenerally accepted in the United States of America, requires management to makeestimates and assumptions.  Theseestimates and assumptions affect the reported amounts of assets andliabilities, the disclosure of contingent assets and liabilities at the date ofthe financial statements, and the reported amounts of revenues and expensesduring the reporting period.  Actualresults could differ from these estimates.

4.               On December 19, 2006, the Company enteredinto separate agreements in connection with its unsecured Senior Notes (the “Notes”)and its unsecured revolving credit facility. The agreements extended the delivery date for the fiscal 2006 auditedfinancial statements, the unaudited financial statements for the first quarterof fiscal 2007 and the corresponding compliance certificates to March 31, 2007,and waived any Defaults or Events of Default that would have occurred due tothe failure of the Company to deliver such information in connection with theNotes and credit facility.  As discussedin Note 5 below, the Company formed a Special Committee of the Board ofDirectors to investigate the Company’s stock option granting practices.  As a result, the Company was unable to fileits Annual Report on Form 10-K for fiscal 2006 and Form 10-Q for the firstquarter of fiscal 2007 by the required deadlines.  As of the date of the filing of this Report,the Company has delivered the appropriate financial statements and compliancecertificates and is in compliance with all covenants under both the Notes andcredit facility.  As of the end of the firstquarter of fiscal 2007, the Company had outstanding long-term debt of $250.0million related to the Notes.  TheCompany had no borrowings against its credit facility during the first quarterof fiscal 2007.

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5.               The Company accounts for its stock-basedcompensation plans in accordance with Statement of Financial AccountingStandards (“SFAS”) No. 123 (revised 2004) “Share-Based Payment” (“SFAS 123R”).  Under SFAS 123R, all stock-based compensationcost is measured at the grant date, based on the estimated fair value of theaward, and is recognized as an expense in the income statement over therequisite service period.  The Companycurrently recognizes stock-based compensation in connection with its stockoption and performance share right awards.

During the firstquarter of fiscal 2007 and the first quarter of fiscal 2006, the Companyrecognized stock-based compensation expense (related to stock options andperformance share rights) of $2.7 million and $1.5 million, respectively.  These amounts were included within selling,general, and administrative expenses on the Consolidated Condensed Statementsof Income.  Tax benefits recognized inconjunction with stock-based compensation during the first quarter of fiscal2007 and the first quarter of fiscal 2006 were not material.

*StockOptions*

The Company’s stockoption plans provide for grants of stock options to key employees at prices notless than the fair market value of the Company’s common stock on the grantdate.  The Company’s practice for anumber of years has been to make a single annual grant to all employeesparticipating in the stock option program and to generally make other grantsonly in connection with employment or promotions.  Options expire five years from the grant dateand are exercisable to the extent of 40% after the second anniversary of thegrant and an additional 30% at each of the following two anniversary dates on acumulative basis.  Compensation cost isrecognized on a straight-line basis, net of estimated forfeitures, over therequisite service period.  The Companyused the Black-Scholes option-pricing model to estimate the grant-date fairvalue of each option granted before and after the adoption of SFAS 123R on August 28, 2005.  The fair values of options granted during thefirst quarter of fiscal 2007 were estimated using the followingweighted-average assumptions:

|                                           | ** ** | **Quarter Ended**          | ** ** |
|-------------------------------------------|------------|---------------------------------|------------|
| ** **                                | ** ** | **November 25, 2006** | ** ** |
| Expected  dividend yield                  |       |                            |       | 1.78 | % |
| Expected stock  price volatility          |       |                            |       | 29.00 | % |
| Weighted average  risk-free interest rate |       |                            |       | 4.56 | % |
| Expected life of  options (years)         |       |                            |       | 4.49 |   |

 

The expecteddividend yield is based on the projected annual dividend payment per sharedivided by the stock price on the grant date. Expected stock price volatility is derived from an analysis of thehistorical and implied volatility of the Company’s publicly traded stock.  The risk-free interest rate is based on theU.S. Treasury rates on the grant date with maturity dates approximating theexpected life of the option on the grant date. The expected life of the options is based on an analysis of historicaland expected future exercise behavior, as well as certain demographiccharacteristics.  These assumptions areevaluated and revised for future grants, as necessary, to reflect marketconditions and experience.  There were nosignificant changes made to the methodology used to determine the assumptionsduring the first quarter of fiscal 2007. The weighted-average grant-date fair value of stock options grantedduring the first quarter of fiscal 2007 was $7.85.  The following table summarizes thetransactions under the stock option plans during the first quarter of fiscal2007.

| (in thousands, except per share amounts) | ** ** | **Options  Outstanding** | ** ** | **Weighted Average  Exercise Price** | ** ** |
|-------------------------------------------------------------------|------------|--------------------------|------------|------------------------------------------------|------------|
| Balance at  August 26, 2006                                       |       | 5,757                    |       | $                                              | 29.54      |   |
| Granted                                                           |       | 667                      |       | 29.28                                          |       |
| Exercised                                                         |       | (296                     | )          | 25.27                                          |       |
| Cancelled                                                         |       | (366                     | )          | 25.89                                          |       |
| Balance at November 25,  2006                                     |       | 5,762                    |       | $                                              | 29.96      |   |

 

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The total intrinsicvalue of stock options exercised during the first quarter of fiscal 2007 was$0.8 million.  As of November 25, 2006,there was approximately $12.0 million of unrecognized compensation cost relatedto outstanding stock options.  Theunrecognized compensation cost will be recognized over a weighted-averageperiod of 1.4 years.

*PerformanceShare Rights*

Performance sharerights give employees the right to receive shares of the Company’s common stockat a future date based on the Company’s performance relative to a peergroup.  Performance is measured based ontwo pre-tax metrics: Return on Equity and Income Growth.  The Compensation Committee of the Board ofDirectors establishes the peer group and performance metrics.  The performance share rights vest at the endof the performance period (generally three years), and the shares are issuedshortly thereafter.  The actual number ofshares issued can range from 0% to 200% of the employee’s target awarddepending on the Company’s performance relative to the peer group.  The following table summarizes thetransactions under the performance share rights program during the firstquarter of fiscal 2007.

| (in thousands, except per share amounts) | ** ** | **Performance  Share Rights  Outstanding** | ** ** | **Weighted  Average  Grant-Date  Fair Value** | ** ** |
|-------------------------------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------------------------|------------|
| Nonvested -  August 26, 2006                                      |       | 261                                             |       | $                                                  | 24.17      |   |
| Granted                                                           |       | 245                                             |       | 29.33                                              |       |
| Vested                                                            |       | (68                                             | )          | 24.16                                              |       |
| Cancellations                                                     |       | —                                          |       | —                                             |       |
| Performance  Adjustments                                          |       | (2                                              | )          | N/A                                                |       |
| Nonvested - November  25, 2006                                    |       | 436                                             |       | $                                                  | 27.08      |   |

 

Compensation costis recognized on a straight-line basis, net of estimated forfeitures, over therequisite service period and adjusted quarterly to reflect the ultimate numberof shares expected to be issued.  ThePerformance Adjustments number in the table above represents changes in thenumber of shares expected to be issued. As of November 25, 2006, there was approximately $10.0 million ofunrecognized compensation cost related to outstanding performance share rights,based on the Company’s most recent performance analysis.  The unrecognized compensation cost will berecognized over a weighted-average period of 2.2 years.

*SpecialCommittee Review of Historical Stock Option Granting Procedures*

On September 25,2006, the Company filed a Form 8-K with the Securities and Exchange Commission(“SEC”) in which the Company advised that it was named as a nominal defendantin a lawsuit filed in the Superior Court of North Carolina, Mecklenburg County,alleging that certain of the Company’s stock option grants were “backdated.”  In connection with the lawsuit, the Company’sBoard of Directors formed a Special Committee (the “Special Committee”),consisting solely of independent directors who were not named as defendants inthe lawsuit, to conduct an independent investigation of the Company’s stockoption practices, evaluate the lawsuit and take such actions with respect tothe lawsuit and related matters as the Special Committee deemedappropriate.  The Special Committee wasadvised in its review by independent legal counsel, Richards, Layton &Finger, P.A., and by independent accounting experts. The Special Committee’s five month review included 35 interviews of 21current or former officers, directors and employees of the Company, as well asthe review of documents and electronically-stored information amounting tohundreds of thousands of pages of documents and data.

On March 7, 2007, the Company filed a Form8-K announcing that, based on its review of the principal factual findings ofthe Special Committee, the Companydetermined it did not properly account for certain stock options granted duringthe period from fiscal 1995 to fiscal 2006. As a result, the Company recorded a cumulative charge during the fourthquarter of fiscal 2006 to correct the errors. See the Company’s fiscal 2006 Annual Report on Form 10-K for moreinformation.  The impact of theseaccounting adjustments on the first quarter of fiscal 2007 was not material.

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The Company iscurrently assessing if any negative tax consequences will impact the Company’semployees as a result of this matter. When this determination is reached, the Board of Directors may decide tocompensate the impacted employees in an amount sufficient to offset any negative tax consequences that they mayincur.  The Company does not expect suchadditional compensation expense to be material.

6.               Duringfiscal 2006, the Company purchased in the open market 15.4 million shares ofits common stock at a cost of $367.3 million.  The Company did not purchase any shares ofits common stock during the first quarter of fiscal 2007.  As of November 25, 2006,the Company had outstanding authorizations to purchase a total of approximately6.1 million shares.

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 2.3 million for thequarter ended November 25, 2006, and options for 5.8 million for the quarterended November 26, 2005) and were not included in the computation of dilutednet income per common share.  In thecalculation of diluted net income per common share, the denominator includesthe number of additional common shares that would have been outstanding if theCompany’s outstanding stock options and performance share rights had been exercised.

**The following table sets forth the computation of basic and diluted netincome per common share:**
| ** **                                                            | ** ** | **Quarter Ended**          | ** ** |
|-----------------------------------------------------------------------|------------|---------------------------------|------------|
| **(in thousands, except per share amounts)** | ** ** | **November 25, 2006** | ** ** | **November 26, 2005** | ** ** |
| **Basic  Net Income Per Share:**                                      |       |                            |       |   |   |
| Net income                                                            |       | $                               | 54,124     |   | $ | 51,389 |   |
| Weighted average  number of shares outstanding                        |       | 150,461                         |       | 159,330 |   |
| Net income per  common share — basic                             |       | $                               | 0.36       |   | $ | 0.32 |   |
|                                                                  |       |                            |       |   |   |
| **Diluted  Net Income Per Share:**                                    |       |                            |       |   |   |
| Net income                                                            |       | $                               | 54,124     |   | $ | 51,389 |   |
| Weighted average  number of shares outstanding                        |       | 150,461                         |       | 159,330 |   |
| Effect of  dilutive securities — stock options                   |       | 282                             |       | — |   |
| Effect of  dilutive securities — performance share rights        |       | 218                             |       | — |   |
| Effect of  dilutive securities — forward contract                |       | —                          |       | 1,142 |   |
| Average shares —  diluted                                        |       | 150,961                         |       | 160,472 |   |
| Net income per common  share — diluted                           |       | $                               | 0.36       |   | $ | 0.32 |   |

 

8.               On January 30,2001, Janice Morgan and Barbara Richardson, two individuals who have held theposition of Store Manager for subsidiaries of the Company, filed aComplaint against the Company in the United States District Court for theNorthern 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 such notice filed consent formsand joined the lawsuit as plaintiffs, including approximately 2,300 formerStore Managers and approximately 250 then current employees.  After rulings by the Court on motions to dismisscertain plaintiffs filed by the Company and motions to reconsider filed byplaintiffs, 1,424 plaintiffs remained in the case at the commencement of trial.

**The case has proceeded as a collective action under the Fair LaborStandards Act (“FLSA”).  The Complaintalleged that the Company violated the FLSA by classifying the named plaintiffsand other similarly situated current and former Store Managers as “exempt”employees who are not entitled to overtime compensation.**

**A jury trial in this case was held in June 2005, in Tuscaloosa, Alabama,and ended with the judge declaring a mistrial after the jury was unable toreach a unanimous decision in the matter. The case was subsequently retried to a jury in Tuscaloosa, Alabama,which found that the Company should have classified the Store Managerplaintiffs as hourly employees entitled to overtime pay rather than as salariedexempt managers and awarded**

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**damages.  Subsequently, the Courtruled the Company did not act in good faith in classifying the plaintiffs asexempt, and after making adjustments to the damages award based upon the filingof personal bankruptcy by certain plaintiffs, the Court entered a judgment forapproximately $33.3 million.  The Companyand the plaintiffs have filed post-trial motions, which have suspended the entryof a final judgment.  The Company posteda bond to stay execution on any judgment which may be finally entered.  In addition, the Court ruled that it willconsider the plaintiffs’ motion for an award of attorneys’ fees and expenses atthe conclusion of the Company’s appeal. The Company plans to appeal if the Court denies the pending post-trialmotions and enters a final judgment.**

**The Company recognized $45.0 million as a litigation charge in the secondquarter of fiscal 2006 with respect to this litigation.  During the appellate process, the Company willnot be required to pay the amount of the judgment.  Accordingly, this charge will not have anyimpact on cash flow while the Company pursues its appellate rights with respectto this judgment.**

**In general, 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 positions on appeal that should enable it ultimately toprevail.  However, the outcome of anylitigation is inherently uncertain.  Resolutionof this matter could have a material adverse effect on the Company’s financialposition, liquidity or results of operation.**

**On August 24, 2006, a shareholder derivative complaint was filed in theSuperior Court of North Carolina, Mecklenburg County, by Rebecca Mitchellagainst the Company as a nominal defendant and certain of its current andformer officers and directors as individual defendants.  The complaint asserted claims under state lawin connection with allegations that certain of the Company’s stock optiongrants were “backdated.”  This complaintwas subsequently consolidated with a second, nearly identical complaint filedby Jeffrey Alasina and transferred to the North Carolina Business Court.  On January 4, 2007, the plaintiffs filed aconsolidated amended complaint in the case, which is now captioned In reFamily Dollar Stores, Inc. Derivative Litigation, Master File No.06-CVS-16796 in the General Court of Justice, Superior Court Division,Mecklenburg County.  The consolidatedamended complaint names the Company as a nominal defendant and Howard R.Levine, R. James Kelly, R. David Alexander, Jr., George R. Mahoney, Jr., JohnJ. Scanlon, C. Martin Sowers, Charles S. Gibson, Jr., Gilbert A. LaFare, SamuelN. McPherson, Mark R. Bernstein, James G. Martin, and Sharon A. Decker asindividual defendants.  The consolidatedamended complaint contains claims for an accounting, breach of fiduciary duty,restitution/unjust enrichment, and recission in connection with the Company’salleged backdating.  The consolidatedamended complaint seeks unspecified damages, disgorgement, equitable relief,and costs, including attorneys’ fees.**

**On December 15, 2006, a shareholder derivative complaint was filed in theUnited States District Court for the Western District of North Carolina, CaseNo. 3:06CV510-W, by Dorothy M. Lee against the Company as a nominal defendantand certain of its current and former officers and directors, Howard R. Levine,Leon Levine, R. James Kelly, R. David Alexander, Jr., Charles S. Gibson, Jr.,C. Martin Sowers, George R. Mahoney, Jr., Mark R. Bernstein, Sharon AllredDecker, Edward C. Dolby, Glenn A. Eisenberg, James G. Martin, and Dale C. Pond,as individual defendants.  The complaintasserted claims under state and federal law in connection with allegations thatcertain of the Company’s stock option grants were “backdated.”  On December 20, 2006, a second, nearlyidentical complaint was filed by Stanford H. Arden in the United StatesDistrict Court for the Western District of North Carolina, Case No.3:06CV523-C.  The complaints each containclaims for violations of section 14(a) of the Exchange Act, an accounting,breach of fiduciary duty, abuse of control, gross mismanagement, constructivefraud, corporate waste, unjust enrichment, recission, and breach of fiduciaryduty for insider selling and misappropriation of information in connection withthe Company’s alleged backdating of stock option grants.  The complaints each seek unspecified moneydamages, an accounting, corporate governance and internal control reforms,imposition of a constructive trust over the defendants’ stock options, punitivedamages, and costs, including attorneys’ fees. On March 23, 2007, theCourt advised that these two federal actions were to be consolidated under thecaption In re Family Dollar Stores, Inc. Derivative Litigation,Case No. 3106CV510-W.**

**As previously disclosed, the Company has formed a Special Committee toinvestigate the Company’s stock option granting practices and to makedeterminations regarding appropriate remedial measures and what actions theCompany should take with respect to the pending shareholder derivative litigation.  See Note 5 for more information.**

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**The Company is involved in numerous other legal proceedings and claimsincidental to its business, including litigation related to alleged failures tocomply with various state and federal employment laws, some of which are or maybe pled as class or collective actions, and litigation related to allegedpersonal or property damage, as to which the Company carries insurance coverageand/or, pursuant to Statement of Financial Accounting Standards No. 5, “Accountingfor Contingencies,” has established reserves as set forth in the Company’sfinancial statements.  While the ultimateoutcome cannot be determined, the Company currently believes that theseproceedings and claims, both individually and in the aggregate, should not havea material adverse effect on the Company’s financial position, liquidity orresults of operations.  However, theoutcome of any litigation is inherently uncertain and, if decided adversely tothe Company, the Company may be subject to liability that could have a materialadverse effect on the Company’s financial position, liquidity or results ofoperations.**

9.               The Company manages itsbusiness on the basis of one reportable segment.  All of the Company’s operations are locatedin the United States.  The followinginformation regarding classes of similar products is presented in accordancewith SFAS No. 131, “Disclosures about Segments of an Enterprise and RelatedInformation.”

|                               | ** ** | **Quarter Ended**          | ** ** |
|-------------------------------|------------|---------------------------------|------------|
| **(in thousands)**       | ** ** | **November 25, 2006** | ** ** | **November 26, 2005** | ** ** |
| Classes of  similar products: |       |                            |       |   |   |
| Consumables                   |       | $                               | 964,944    |   | $ | 906,481 |   |
| Home products                 |       | 242,413                         |       | 233,319 |   |
| Apparel and accessories       |       | 222,901                         |       | 210,785 |   |
| Seasonal and electronics      |       | 170,006                         |       | 160,872 |   |
| Net sales                     |       | $                               | 1,600,264  |   | $ | 1,511,457 |   |

 

**The consumables category includeshousehold chemical and paper products, candy, snacks and other food, health andbeauty aids, hardware and automotive supplies, and pet food and supplies.  The home products category includes domesticitems such as blankets, sheets and towels as well as housewares andgiftware.  The apparel and accessoriescategory includes men’s, women’s, boys’, girls’ and infants’ clothing andshoes.  The seasonal and electronicscategory includes toys, stationery and school supplies, seasonal goods andelectronics, including pre-paid cellular phones and services.**

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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 thirteen-week periods ended November25, 2006, and November 26, 2005 (“first quarter of fiscal 2007” and “firstquarter of fiscal 2006”, respectively). This discussion should be read in conjunction with, and is qualified by,the financial statements included in this quarterly report, the financialstatements for the fiscal year ended August 26, 2006 (“fiscal 2006”), andManagement’s Discussion and Analysis of Financial Condition and Results ofOperations (“MD&A”) contained in the Company’s Annual Report on Form 10-K forfiscal 2006.  This discussion should alsobe read in conjunction with the “Cautionary Statement Regarding Forward LookingStatements” set forth following this MD&A, and the “Risk Factors” set forthin Part I, Item 1A of the Company’s Annual Report on Form 10-K for fiscal 2006.**

**Explanatory Note**

**The Company was named as a nominal defendant in certain litigation filedin September 2006, alleging that the Company “backdated” certain stock optiongrants.  In connection with that lawsuit,the Board of Directors appointed a Special Committee to conduct an independentinvestigation of the Company’s stock option practices, evaluate the lawsuit andtake such actions with respect to the lawsuit and related matters as theCommittee deemed appropriate.  Followingthe completion of the Special Committee’s investigation and the Company’sreceipt of their factual findings, the Company determined that it did notproperly account for certain stock options issued during fiscal 1995 to fiscal2006 and therefore incurred a cumulative charge in the fourth quarter of fiscal2006 of $10.5 million.  As the impact ofthe resulting accounting adjustments attributable to any prior reportingperiods was not material to any of such periods and as the cumulative impact ofthe adjustments was not material to the current year, the Company did notrestate previously issued financial statements. However, as a result of such investigation, the Company was unable tocomplete and timely file its fiscal 2006 Annual Report on Form 10-K and itsfiscal 2007 first quarter Quarterly Report on Form 10-Q.  See Note 5 to the Consolidated Condensed FinancialStatements included in this Report for more information regarding the findingsof the Special Committee.**

**Results of Operations**

**First Quarter Results and Fiscal 2007 Outlook**

Fiscal 2007 is a 53-week year, compared with a 52-week year in fiscal2006.  The second quarter of fiscal 2007will include 14 weeks compared with 13 weeks in the second quarter of fiscal2006.

During the first quarter of fiscal 2007, the Company’s net salesincreased 5.9% to $1.6 billion, net income increased 5.3% to $54.1 million anddiluted net income per common share increased 12.5% to $0.36 as compared to thefirst quarter of fiscal 2006.  Despite alower than planned increase in sales in comparable stores (stores open morethan 13 months), the Company was able to achieve its expected results due toimprovements in gross margin.  TheCompany continued to focus on inventory productivity during the first quarterof fiscal 2007.  Inventory on a per storebasis at the end of the first quarter of fiscal 2007 was approximately 7.8%lower than inventory on a per store basis at the end of the first quarter offiscal 2006, excluding merchandise in transit to the distribution centers.  The various components affecting the Company’sresults for the first quarter of fiscal 2007 are discussed in more detailbelow.

During the first quarter of fiscal 2007, the Company continued to focusits efforts on key initiatives designed to support sustainable and profitablegrowth, as discussed below.

·                              The Company installed refrigerated coolers inapproximately 460 stores during the first quarter of fiscal 2007.  The coolers are part of an enhanced foodstrategy designed to increase customer traffic. At the end of the first quarter of fiscal 2007, 4,260 stores had coolersfor the sale of refrigerated food.  TheCompany currently expects to have coolers in approximately 5,000 stores by theend of fiscal 2007.  In addition, theCompany plans to increase its food assortment in approximately 2,000 stores andinstall technology to facilitate the acceptance of food stamps in approximately1,000 stores by the end of fiscal 2007.

·                              The Urban Initiative markets experiencedimprovements in store manager retention, inventory levels and profitabilityduring the first quarter of fiscal 2007. The Company plans to continue to focus on driving

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betterreturns in these markets and plans to implement a new technological platform inapproximately 1,000 Urban Initiative stores by the end of fiscal 2007.  The new platform is designed to facilitatebetter customer service and make stores easier to manage.

·                              In support of the Treasure Hunt program, theCompany continued to: develop an event-driven strategy that creates excitementfor customers and employees; focus on improving inventory flow and turns,resulting in better presentation of new products; and enhance the apparelassortment.

·                              During fiscal 2007, the Company plans to openapproximately 300 stores and close approximately 45 stores.  The Company also plans to continue to refineits site selection process and increase its cross-functional focus on new storeperformance.  During the first quarter offiscal 2007, the Company opened 87 stores and closed 8 stores.

·                              During the first quarter of fiscal 2007, theCompany continued to enhance its research and development effort known as “ConceptRenewal.”  The Concept Renewal effortinvolves developing new ideas and initiatives designed to sustain profitablegrowth.  The Company currently has twoConcept Renewal stores being used to test new ideas, including store layoutsand design elements.  The Company plansto have approximately ten Concept Renewal test stores by the end of fiscal2007.  During the second quarter offiscal 2007, the Company plans to begin incorporating many of its new designand layout elements into most new stores.

·                              The Company initiated an effort known as “ProjectAccelerate” during the first quarter of fiscal 2007.  Project Accelerate is a strategic, multi-yearinitiative designed to optimize the Company’s merchandising and supply chainprocesses and will include improvements to price optimization, categorymanagement, space management, and assortment planning.

# *Net Sales*

Net sales in the first quarter of fiscal 2007 were $1.6 billion, anincrease of approximately 5.9% ($88.8 million), as compared with an increase of9.5% ($131.2 million) in the first quarter of fiscal 2006.  The increase was attributable, in part, toincreased sales in comparable stores (stores open more than 13 months) of 0.9%($13.1 million), with the balance of the increase primarily relating to salesfrom new stores opened as part of the Company’s store growth program.  The increase in sales in comparable storesresulted from an increase in the average customer transaction, which offset aslight decline in customer traffic, as measured by the number of registertransactions in comparable stores.  Salesduring the first quarter of fiscal 2007 were strongest in consumables, appareland accessories, and seasonal and electronics, including prepaid cellularphones and services.  Sales of homeproducts were weak.  Sales of prepaidservices are recorded on a net basis.  Asa result, only the markup on the sales of these products is recorded asrevenue.

The Company distributed one advertising circularduring the first quarter of both fiscal 2007 and fiscal 2006.  The circulars are designed to stimulatetraffic and inform customers about the Company’s Treasure Hunt merchandise,seasonal values and competitive prices on core consumables.

**The average number of stores in operation during the first quarter offiscal 2007 was 5.0% higher than the average number of stores in operationduring the first quarter of fiscal 2006. The Company had 6,252 stores in operation at the end of the firstquarter of fiscal 2007, compared with 5,952 stores in operation at the end ofthe first quarter of fiscal 2006, representing an increase of approximately 5.0%.**

*Cost of Sales*

Cost of sales increased approximately 4.4% in the first quarter offiscal 2007 compared with the first quarter of fiscal 2006.  This increase primarily reflected theadditional sales volume between years. Cost of sales, as a percentage of net sales, was 65.5% in the firstquarter of fiscal 2007 and 66.4% in the first quarter of fiscal 2006.  Theimprovement in cost of sales, as a percentage of net sales, was due to theleverage effect of an increase in sales of prepaid services, which are reportedon a net basis, as discussed above, lower markdown expense and lower inventoryshrinkage.  Freight expense, as apercentage of net sales, was substantially unchanged.  The further refinement of the inventoryreplenishment system has positively impacted inventory productivity byimproving in-stocks of basic merchandise, while reducing excess safety stock.

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***Selling, General andAdministrative Expenses***

Selling, general and administrative (“SG&A”) expenses increased8.6% in the first quarter of fiscal 2007, compared with the first quarter offiscal 2006.  The increases in theseexpenses were due primarily to additional costs arising from the continuedgrowth in the number of stores in operation. SG&A expenses, as a percentage of net sales, were 28.9% in the firstquarter of fiscal 2007 and 28.1% in the first quarter of fiscal 2006.  As a result of lower than planned comparablestore sales growth and the leverage effect of an increase in sales of prepaidservices, most costs in the first quarter of fiscal 2007 were deleveraged.  Increasedoccupancy costs (approximately 0.7% of net sales) and expenses associated withthe Company’s review of its stock option granting practices (approximately 0.3%of net sales) were partially offset by a decrease in insurance costs(approximately 0.3% of net sales).  Theincrease in occupancy costs, as a percentage of net sales, was due primarily tohigher rent, depreciation and utility expense. See Note 5 to the Consolidated Condensed Financial Statements includedin this Report for more information on the Company’s review of its stock optiongranting practices.  The decrease ininsurance costs, as a percentage of net sales, was due to a reduction in healthcare and workers compensation expenses. The Company believes that improvements in processes, lower inventorylevels and increased store manager retention rates contributed to the reductionin workers compensation costs.

***Interest Income***

**Interest income increased $0.6million in the first quarter of fiscal 2007 compared with the first quarter offiscal 2006.  The increase in interestincome was due to an increase in interest rates and investments.**

***Interest Expense***

Interest expense increased $3.3 million inthe first quarter of fiscal 2007 compared with the first quarter of fiscal2006.  The increase in interest expensewas due primarily to interest on taxes proposed by the Internal Revenue Serviceduring their examination of the Company’s consolidated federal income taxreturns for fiscal 2005, fiscal 2004 and fiscal 2003.

***Income Taxes***

**The effective tax rate was 37.8%for the first quarter of fiscal 2007 compared with 37.0% for the first quarterof fiscal 2006.  The increase in theeffective tax rate was primarily the result of the effect of changes in stateincome taxes.  In addition, theexpiration of certain federal jobs tax credits for employees hired afterDecember 31, 2005, negatively impacted the effective tax rate during the firstquarter of fiscal 2007.**

**Liquidity and CapitalResources**

At the end of the first quarter of fiscal 2007, the Company had workingcapital of $495.2 million, compared with $432.7 million as of August 26,2006.  Changes in working capital duringthe first quarters of fiscal 2007 and fiscal 2006 were primarily the result ofearnings, changes in merchandise inventories, capital expenditures, changes inincome taxes payable, and, in the first quarter of fiscal 2006, repurchases ofthe Company’s common stock.  The Company’sinventories at the end of the first quarter of fiscal 2007 were 1.8% lower thanat the end of the first quarter of fiscal 2006. Inventory on a per store basis at the end of the first quarter of fiscal2007 was approximately 7.8% lower than inventory on a per store basis at theend of the first quarter of fiscal 2006, excluding merchandise in transit tothe distribution centers.  The decreasein inventory on a per store basis is the result of the Company’s continuedrefinement of its replenishment system and renewed focus on inventoryproductivity, which includes improved planning and flow of fashion merchandiseand the use of more aggressive exit strategies.

**Capital expenditures for thefirst quarter of fiscal 2007 were approximately $20.7 million and are currentlyexpected to be approximately $155 million to $165 million for fiscal 2007.  The majority of the planned capitalexpenditures for fiscal 2007 relate to the Company’s new store openings;existing store expansions, relocations and renovations; and expendituresrelated to store-focused technology infrastructure.**

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**In the first quarter of fiscal 2007, the Company opened 87stores, closed 8 stores and expanded, relocated, or renovated 8 stores.  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 fiscal 2006, the Company purchased in the openmarket 15.4 million shares of its common stock at a cost of $367.3million.  The Company did not purchaseany shares of its common stock during the first quarter of fiscal 2007.  As of November 25, 2006, the Company hadoutstanding authorizations to purchase a total of approximately 6.1 millionshares.**

**The Company has an unsecured revolving credit facility witha syndicate of lenders for short-term borrowings of up to $350 million.  Outstanding standby letters of credit reducethe borrowing capacity of the credit facility. The credit facility expires on August 24, 2011.  The Company had no outstanding borrowingsagainst the credit facility during the first quarter of fiscal 2007.  Cash flow from current operations and theavailable credit facility, as discussed above, are expected to be sufficient tomeet planned liquidity and operational capital resource needs, including storeexpansion and other capital spending programs, scheduled interest payments, andany further repurchases of the Company’s common stock.**

**On December 19, 2006, the Company entered into separateagreements in connection with its unsecured Senior Notes (the “Notes”) and itsunsecured revolving credit facility.  Theagreements extended the delivery date for the fiscal 2006 audited financialstatements, the unaudited financial statements for the first quarter of fiscal2007 and the corresponding compliance certificates to March 31, 2007, andwaived any Defaults or Events of Default that would have occurred due to thefailure of the Company to deliver such information in connection with the Notesand credit facility.  As discussed inNote 5  to the Consolidated CondensedFinancial Statements, the Company formed a Special Committee of the Board ofDirectors to investigate the Company’s stock option granting practices.  As a result, the Company was unable to fileits Annual Report on Form 10-K for fiscal 2006 and Form 10-Q for the firstquarter of fiscal 2007 by the required deadlines.  As of the date of the filing of this Report,the Company has delivered the appropriate financial statements and compliancecertificates and is in compliance with all covenants under both the Notes andcredit facility.  As of the end of thefirst quarter of fiscal 2007, the Company had outstanding long-term debt of$250.0 million related to the Notes.  TheCompany had no borrowings against its credit facility during the first quarterof fiscal 2007.**

**The following table shows the Company’s obligations andcommitments as of the end of the first quarter of fiscal 2007 to make futurepayments under contractual obligations:**
| ** **                       | ** ** | **Payments Due During Period Ending** | ** ** |
|----------------------------------|------------|-----------------------------------------------------------|------------|
| **(in thousands)**          | ** ** | ** **                                                | ** ** | **November** | ** ** | **November** | ** ** | **November** | ** ** | **November** | ** ** | **November** | ** ** | ** ** | ** ** |
| **Contractual Obligations** | ** ** | **Total**                                                 | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **Thereafter** | ** ** |
| Long-term debt                   |       | $                                                         | 250,000    |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 16,200 |   | $ | 233,800 |   |
| Interest                         |       | 111,996                                                   |       | 13,387 |   | 13,387 |   | 13,387 |   | 13,387 |   | 13,246 |   | 45,202 |   |
| Merchandise letters of  credit   |       | 104,142                                                   |       | 104,142 |   | — |   | — |   | — |   | — |   | — |   |
| Operating leases                 |       | 1,241,308                                                 |       | 281,293 |   | 248,327 |   | 208,134 |   | 164,329 |   | 117,958 |   | 221,267 |   |
| Construction  obligations        |       | 3,834                                                     |       | 3,834 |   | — |   | — |   | — |   | — |   | — |   |
| Total                            |       | $                                                         | 1,711,280  |   | $ | 402,656 |   | $ | 261,714 |   | $ | 221,521 |   | $ | 177,716 |   | $ | 147,404 |   | $ | 500,269 |   |

 

At the end of thefirst quarter of fiscal 2007, approximately $21.2 million of the merchandiseletters of credit were included in accounts payable on the Company’sConsolidated Condensed Balance Sheet. Most of the Company’s operating leases provide the Company with anoption to extend the term of the lease at designated rates.

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Thefollowing table shows the Company’s other commercial commitments as of the endof the first quarter of fiscal 2007:

|                                                                     | ** ** | **Total Amounts** | ** ** |
|---------------------------------------------------------------------|------------|------------------------|------------|
| **Other Commercial Commitments (in thousands)** | ** ** | **Committed**          | ** ** |
| Standby letters  of credit                                          |       | $                      | 127,397    |   |
| Surety bonds                                                        |       | 44,935                 |       |
| Total Commercial  Commitments                                       |       | $                      | 172,332    |   |

 

**Asubstantial portion of the outstanding amount of standby letters of credit(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 “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” in the Company’s Annual Reporton Form 10-K for fiscal 2006.  Includedin the outstanding amount of surety bonds is a $41.6 million bond obtained bythe Company during the third quarter of fiscal 2006 in connection with anadverse litigation judgment, as discussed in Note 8 to the ConsolidatedCondensed Financial Statements included in this Report.**

**Recent AccountingPronouncements**

**In May 2005, the FASB issued SFASNo. 154, “Accounting Changes and Error Corrections” (“SFAS 154”).  SFAS 154 replaces Accounting Principles BoardOpinion No. 20, “Accounting Changes,” and SFAS No. 3, “Reporting AccountingChanges in Interim Financial Statements.” SFAS 154 changes the requirements for the accounting for and reportingof a change in accounting principle. SFAS 154 is effective for accounting changes and corrections of errorsmade in fiscal years beginning after December 15, 2005.  The Company does not expect SFAS 154 to havea material impact on its Consolidated Financial Statements.**

**In July 2006, the FASB issuedInterpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”).  FIN 48 provides guidance regarding therecognition and measurement of tax positions and the related reporting anddisclosure requirements and will be effective for the Company beginning withits first quarter of fiscal 2008.  TheCompany has not yet determined the impact, if any, that FIN 48 will have on itsConsolidated Financial Statements.**

**In September 2006, the FASBissued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”).  SFAS 157 defines fair value, establishes aframework for measuring fair value in generally accepted accounting principlesand expands disclosures about fair value measurements.  SFAS 157 is effective for the first annualperiod ending after November 15, 2007. The Company has not yet determined the impact, if any, that SFAS 157will have on its Consolidated Financial Statements.**

**In September 2006, the Securitiesand Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 108, “Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements” (“SAB 108”). SAB 108 provides guidance on the consideration of the effects of prioryear misstatements in quantifying current year misstatements for the purpose ofa materiality assessment.  SAB 108requires quantification of financial statement errors based on the effects ofthe error on each of the company’s financial statements and the relatedfinancial statement disclosures.  Thisapproach is referred to as the “dual approach” because it requires both thecarryover and reversing effects of prior year misstatements to bequantified.  SAB 108 is effective for thefirst annual period ending after November 15, 2006.  The Company is currently assessing the impactthat SAB 108 will have on its Consolidated Financial Statements.**

**Critical AccountingPolicies**

**There have been no changes to theCritical Accounting Policies outlined in the Company’s Annual Report on Form10-K for fiscal 2006.**

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**Cautionary Statement Regarding Forward-Looking Statements**

Certainstatements contained in this Report, or in other public filings, pressreleases, or other written or oral communications made by the Company or itsrepresentatives, which are not historical facts are forward-looking statementsmade pursuant to the safe harbor provisions of the Private SecuritiesLitigation Reform Act of 1995.  Theseforward-looking statements address the Company’s plans, activities or eventswhich the Company expects will or may occur in the future and may includeexpress or implied projections of revenue or expenditures; statements of plansand objectives for future operations, growth or initiatives; statements offuture economic performance; or statements regarding the outcome or impact ofpending or threatened litigation.  Theseforward-looking statements may be identified by the use of the words “plan,” “estimate,”“expect,” “anticipate,” “probably,” “should,” “project,” “intend,” “continue,”and other similar terms and expressions. Various risks, uncertainties and other factors may cause the Company’sactual results to differ materially from those expressed or implied in anyforward-looking statements.  Factors,uncertainties and risks that may result in actual results differing from suchforward-looking information include, but are not limited to those listed inPart I, Item 1A of the Company’s Annual Report on Form 10-K for fiscal 2006, aswell as other factors discussed throughout this Report, including, withoutlimitation, the factors described under “Critical Accounting Policies” in PartI, Item 2 above, or in other filings or statements made by the Company.  All of the forward-looking statements made bythe Company in this Report and other documents or statements are qualified bythese and other factors, risks and uncertainties.  Readers are cautioned not to place unduereliance on these forward-looking statements, which speak only as of the dateof this Report.  The Company does notintend to 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, except as may be required by law.

**Item 3. 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 an unsecured revolving credit facility at a variable rate of interestto meet the short-term needs of its expansion program and seasonal inventoryincreases.  The Company had nooutstanding borrowings against this facility during the first quarter of fiscal2007.  The Company’s long-term debtassociated with the Notes bears interest at fixed rates.

**Item 4. Controls and Procedures**

As discussed in Note 5 to the Consolidated CondensedFinancial Statements included in this Report, a Special Committee of the Boardof Directors has reviewed the Company’s historical stock option grantingpractices and, as a result of such review, the Company recorded a charge in thefourth quarter of fiscal 2006 for certain non-cash stock-based compensationexpense and related interest expense. Management has reviewed the Special Committee’s factual findingsregarding the Company’s stock option granting practices, including findingsregarding changes in the Company’s stock option granting process instituted infiscal 2005.  The Special Committee hasnot yet made its determinations concerning remediation or what actions theCompany should take with respect to the pending shareholder litigation.

Based on an evaluation bymanagement of the Company (with the participation of the Company’s ChiefExecutive Officer and Chief Financial Officer), including consideration of thematters set forth in the preceding paragraph, as of the end of the periodcovered by this report, the Company’s Chief Executive Officer and Chief FinancialOfficer concluded that the Company’s disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of1934, as amended, (the “Exchange Act”)) were effective to provide reasonableassurance that information required to be disclosed by the Company in reportsthat the Company files or submits under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in SEC rulesand forms and that such information is accumulated and communicated to theCompany’s management, including the Chief Executive Officer and Chief FinancialOfficer, to allow timely decisions regarding required disclosures.

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The Company is continuously seeking to improve the efficiency andeffectiveness of its operations and of its internal controls.  This results in refinements to processesthroughout the Company.  However, therehas been no change in the Company’s internal control over financial reporting(as defined in Exchange Act Rule 13a-15(f)) during the most recent fiscalquarter that has materially affected, or is reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

 

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**PART II -OTHER INFORMATION**

**Item 1. Legal Proceedings**

**Theinformation in Note 8 to the Consolidated Condensed Financial Statementscontained in Part I, Item 1 of the Form 10-Q is incorporated herein by thisreference.**

**Item 1A. Risk Factors**

**Therehave been no material changes in the Risk Factors outlined in the Company’sAnnual Report on Form 10-K for fiscal 2006.**

**Item 2. Unregistered Sales of Equity Securities andUse of Proceeds**

The following table sets forth information with respect to purchases ofshares of the Company’s common stock made during the quarter ended November 25,2006, by or on behalf of the Company or any “affiliated purchaser” as definedby Rule 10b-18(a)(3) of the Securities Exchange Act of 1934.
| **Period**                      | ** ** | **Total Number  of Shares  Purchased** | ** ** | **Average Price  Paid Per Share** | ** ** | **Total Number of  Shares Purchased as  Part of Publicly  Announced Plans or  Programs**(1) | ** ** | **Maximum Number  of Shares that May  Yet Be Purchased  Under the Plans or  Programs**(1) | ** ** |
|---------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------|------------|
| September (8/27/06 -  9/30/06)  |       | —                                           |       | —                                           |       | —                                                                                                                              |       | 6,071,254                                                                                                                              |       |
| October (10/1/06 -  10/28/06)   |       | —                                           |       | —                                           |       | —                                                                                                                              |       | 6,071,254                                                                                                                              |       |
| November (10/29/06 -  11/25/06) |       | —                                           |       | —                                           |       | —                                                                                                                              |       | 6,071,254                                                                                                                              |       |
| Total                           |       | —                                           |       | —                                           |       | —                                                                                                                              |       | 6,071,254                                                                                                                              |       |

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(1)             On April 13, 2005, the Company announced thatthe Board of Directors authorized the purchase of up to five million shares ofits outstanding common stock from time to time as market conditionswarrant.  As of November 25, 2006, theCompany had 1.1 million shares remaining under this authorization.  On August 18, 2006, the Company announcedthat the Board of Directors authorized the purchase of up to an additional fivemillion shares of its outstanding common stock from time to time as marketconditions warrant.  As of November 25,2006, the Company had not purchased any shares under this authorization.  There is no expiration date governing theperiod during which the Company can make share repurchases pursuant to theabove referenced authorizations.

**Item 5. OtherInformation**

**Pursuantto the provisions of the Company’s Bylaws and Delaware law, during the firstquarter of fiscal 2007, the Company received affirmations and undertakings fromcertain current or former officers and/or directors in connection with theCompany’s advancement of defense costs incurred in connection with derivativeshareholder actions filed against the Company, as a nominal defendant, andagainst such officers and directors.  SeeNote 5 to the Consolidated Condensed Financial Statements, “Special CommitteeReview of Historical Stock Option Granting Procedures,” for a discussion of theCompany’s stock option investigation and Note 8 to the Consolidated CondensedFinancial Statements for a discussion of such derivative litigation.**

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**Item 6.Exhibits**

| (a) | Exhibits  incorporated by reference: |
|-----|--------------------------------------|

 

| *      | 10.1   | Director’s Share Award Guidelines (filed as Exhibit  10.1 to the Company’s  Report on Form 8-K filed August 21, 2006).                                                                                                                                                |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                            |
|   | 10.2   | Letter Agreement dated December 8, 2006, between the  Company, Family  Dollar, Inc., Wachovia Bank, National Association as Administrative Agent and  the Lenders (filed as Exhibit 10 to the Company’s report on Form 8-K filed  December 14, 2006).                      |
|   |   |                                                                                                                                                                                                                                                                            |
|   | 10.3   | Consent dated December 19, 2006, between the  Company, Family Dollar, Inc.,  the Subsidiary Guarantors, Wachovia Bank, National Association as  Administrative Agent and the Lenders (filed as Exhibit 10.1 to the Company’s  Report on Form 8-K filed December 22, 2006). |
|   |   |                                                                                                                                                                                                                                                                            |
|   | 10.4   | Letter Agreement dated December 19, 2006, between  the Company, Family  Dollar, Inc. and various institutional accredited investors (filed as Exhibit  10.2 to  the Company’s Report on Form 8-K filed December 22, 2006).                                                 |
|   |   |                                                                                                                                                                                                                                                                            |
| *      | 10.5   | The Family Dollar Stores, Inc. 2006 Incentive Plan  Guidelines for Annual Cash  Bonus Awards (filed as Exhibit 10 to the Company’s Report on Form 8-K filed  October 6, 2006).                                                                                             |
|   |   |                                                                                                                                                                                                                                                                            |
| *      | 10.6   | Summary of compensation arrangements of the  Company’s named executive  officers (filed as Exhibit 10.50 to the Company’s report on Form 10-K filed  March 28, 2006).                                                                                                 |

 

| (b) | Exhibits filed  herewith: |
|-----|---------------------------|

 

| *      | 10.7   | Form of Affirmation and Undertaking Agreement in  Connection with Advancement of Expenses                                                                                                                |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                     |
|   | 23     | Consent of Independent Registered Public Accounting  Firm                                                                                                                                                |
|   |   |                                                                                                                                                                                                     |
|   | 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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* Exhibit represents a management contract or compensatory plan

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SIGNATURES

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
|                       | FAMILY DOLLAR STORES, INC.              |
|-----------------------|-----------------------------------------|
|                  | (Registrant)                            |
|                  |                                    |
|                  |                                    |
|                  |                                    |
| Date: March 28,  2007 | /s/ R. James Kelly                      |
|                  | R. JAMES KELLY                          |
|                  | President and Chief Operating Officer - |
|                  | Interim Chief Financial Officer         |
|                  |                                    |
|                  |                                    |
|                  |                                    |
| Date: March 28, 2007  | /s/ C. Martin Sowers                    |
|                  | C. MARTIN SOWERS                        |
|                  | Senior Vice President-Finance           |

 

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