**UNITED
        STATES**
 **SECURITIES
        AND EXCHANGE COMMISSION**
 **Washington,
        D.C. 20549**
 
 **FORM
        10-K**
 
 **(X)
        ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
        ACT OF
        1934**
 
 For
        the
        fiscal year ended January 28, 2007
 
 or
 
 (
        ) **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
        ACT
        OF 1934**
 
 Commission
        File Number 0-20269
 
 
 
 **DUCKWALL-ALCO
        STORES, INC.**
 (Exact
        name of registrant as specified in its charter)
 
 Kansas
              48-0201080(State
                  or other jurisdiction of incorporation or organization)
              (I.R.S.
                  Employer Identification No.)401
                  Cottage Street
                Abilene,
                  Kansas
              67410-2832(Address
                  of principal executive offices)
              (Zip
                  Code)
 
 Registrant's
        telephone number including area code: (785)
        263-3350
 
 Securities
        registered pursuant to Section 12(b) of the Act:
 NONE
 
 Securities
        registered pursuant to Section 12(g) of the Act:
 Common
        Stock, par value $.0001 per share
 (Title
        of
        Class)
 
 Indicate
        by check mark if the registrant is a well-known seasoned issuer, as defined
        in
        Rule 405 of the Securities Act. Yes_____ No __ X _
 
 Indicate
        by check mark if the registrant is not required to file reports pursuant
        to
        Section 13 or Section 15(d) of the Exchange Act. Yes___ No _ X __
 
 Indicate
        by check mark whether the registrant (1) has filed all reports required to
        be
        filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
        the
        preceding 12 months (or for such shorter period that the registrant was required
        to file such reports), and (2) has been subject to such filing requirements
        for
        the past 90 days. Yes X No
        _____
 
 Indicate
        by check mark if disclosure of delinquent filers pursuant to Item 405 of
        Regulation S-K is not contained herein, and will not be contained, to the
        best
        of registrant's knowledge, in definitive proxy or information statements
        incorporated by reference in Part III of this Form 10-K or any amendment
        to this
        Form 10-K. [ ]
 
 Indicate
        by check mark whether the registrant is a large accelerated filer, an
        accelerated filer, or a non-accelerated filer.. See definition of “accelerated
        filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. Large
        accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
 
 Indicate
        by check mark whether the registrant is a shell company (as defined in Rule
        12b-2 of the Exchange Act). Yes ____ No _ _X __
 
 The
        aggregate market value of the 3,792,515 shares of Common Stock, par value
        $.0001
        per share, of the registrant held by non-affiliates of the registrant is
        $134,330,881 on August 1, 2006, based on a closing sale price of $35.42.
        As of
        April 23, 2007, there were 3,804,216 shares of Common Stock
        outstanding.
 
 Documents
        incorporated by reference: portions of the Registrant's Proxy Statement for
        the
        2007 Annual Meeting of Stockholders are incorporated by reference in Part
        III
        hereof.
  
  **DUCKWALL-ALCO
        FISCAL 2007 FORM 10-K**
  
 **TABLE
                  OF CONTENTS****PART
                  I**Item
                  1.
              
              Business.
              
              **3**Item
                  1A.
              
              Risk
                  Factors.
              
              **6**Item
                  1B.
              
              Unresolved
                  Staff Comments.
              
              **7**Item
                  2.
              
              Properties.
              
              **7**Item
                  3.
              
              Legal
                  Proceedings.
              
              **7**Item
                  4.
              
              Submission
                  of Matters to a Vote of Security Holders.
              
              **7**Item
                  4A.
              
              Executive
                  Officers.
              
              **7****PART
                  II**
              
              ****Item
                  5.
              
              Market
                  for Registrant's Common Equity, Related Stockholder Matters and
                  Issuer
                  Purchases of Equity Securities.
              
              **8**Item
                  6.
              
              Selected
                  Financial Data.
              
              **10**Item
                  7.
              
              Management's
                  Discussion and Analysis of Financial Condition and Results of Operations.
              
              **11**Item
                  7A.
              
              Quantitative
                  and Qualitative Disclosures About Market Risk.
              
              **18**Item
                  8.
              
              Financial
                  Statements and Supplementary Data.
              
              **19**Item
                  9.
              
              Changes
                  in and Disagreements With Accountants on Accounting and Financial
                  Disclosure.
              
              **35**Item
                  9A.
              
              Controls
                  and Procedures.
              
              **36**Item
                  9B.
              
              Other
                  Information.
              
              **38****PART
                  III**
              
              ****Item
                  10.
              
              Directors,
                  Executive Officers and Corporate Governance.
              
              **38**Item
                  11.
              
              Executive
                  Compensation.
              
              **39**Item
                  12.
              
              Security
                  Ownership of Certain Beneficial Owners and Management and Related
                  Stockholder Matters.
              
              **39**Item
                  13.
              
              Certain
                  Relationships and Related Transactions, and Director Independence.
              
              **39**Item
                  14.
              
              Principal
                  Accountant Fees and Services.
              
              **39****PART
                  IV**
              
              ****Item
                  15.
              
              Exhibits
                  and Financial Statement Schedules.
              
              **39**Signatures
              
              **41**
 
 
 2
  **PART
        I**
 
 **ITEM
        1.**   **BUSINESS**
 
 **History**
 
 Duckwall-ALCO
        Stores, Inc., (the “Company” or “Registrant”), was founded as a general
        merchandising operation in 1901 in Abilene, Kansas by A. L. Duckwall. From
        its
        founding until 1968, the Company conducted its retail operations as small
        variety or “dime” stores. In 1968, the Company followed an emerging trend to
        discount retailing when it opened its first ALCO discount store. The Company's
        overall business strategy involves identifying and opening stores in towns
        that
        will provide the Company with the highest return on investment. Although
        the
        Company prefers markets that don’t have direct competition from national or
        regional full-line discount stores, its strategy does not preclude it from
        entering competitive markets. This strategy includes opening ALCO discount
        stores. As of January 28, 2007, the Company operates 256 retail stores located
        in the central United States, consisting of 189 ALCO retail discount stores
        and
        67 Duckwall variety stores.
  The
        Company was incorporated on July 2, 1915 under the laws of Kansas. The Company's
        executive offices are located at 401 Cottage Street, Abilene, Kansas 67410-2832,
        and its telephone number is (785) 263-3350.
 
 **General**
 
 The
        Company is a regional retailer operating 256 stores in 21 states in the central
        United States. The Company's strategy is to target smaller markets not served
        by
        other regional or national full-line retail discount chains and to provide
        the
        most convenient access to retail shopping within each market. The Company's
        ALCO
        discount stores offer a full line of merchandise consisting of approximately
        35,000 items, including automotive, candy, crafts, domestics, electronics,
        fabrics, furniture, hardware, health and beauty aids, housewares, jewelry,
        ladies', men's and children's apparel and shoes, pre-recorded music and video,
        sporting goods, seasonal items, stationery and toys. The Company's smaller
        Duckwall variety stores offer a more limited selection of similar
        merchandise.
 
 Of
        the
        Company's 189 ALCO discount stores, 155 stores are located in communities
        that
        do not have another full-line discounter. The ALCO discount stores account
        for
        94% of the Company's net sales. The current ALCO store averages 20,300 square
        feet of selling space. However, the Company's store expansion program is
        primarily directed toward opening stores with a design prototype of
        approximately 21,500 square feet of selling space. Based on the Company’s
        experience, the design of the Class 20 Stores produces the greatest return
        on
        investment for newly opened stores.
 
 All
        of
        the Company's discount and variety stores are serviced by the Company's 352,000
        square foot distribution center in Abilene, Kansas.
 
 For
        2007
        and 2006, the percentage of sales by product category were as
        follows:
 Percentage
                  of Sales2007
              
              
              2006Merchandise
                  Category:Consumables
                  and commodities
              
              
              30
              %
              
              30
              %Electronics,
                  entertainment, sporting goods, toys and outdoor living
              
              
              25
              %
              
              25
              %Apparel
                  and accessories
              
              
              20
              %
              
              19
              %Home
                  furnishings and decor
              
              
              14
              %
              
              15
              %Other
              
              
              11
              %
              
              11
              %Total
              
              
              100
              %
              
              100
              %
 
 **Business
        Strategy**
 
 The
        Company intends to focus on executing a business strategy that includes the
        following key components:
 
 *Markets:* The
        Company intends to open ALCO stores primarily in towns with populations of
        typically less than 5,000 that are in trade areas with populations of less
        than
        16,000 where: (1) there is no direct competition from national or regional
        full-line discount retailers; (2) economic and demographic criteria indicate
        the
        market is able to commercially support a discount retailer; and (3) the opening
        of an ALCO store would significantly reduce the likelihood of the entry into
        such market by another full-line discount retailer. This key component of
        the
        Company's strategy has guided the Company in both its opening of new stores
        and
        in its closing of existing stores.
 
 *Market
        Selection:* The
        Company utilizes a detailed process to analyze under-served markets which
        includes examining factors such as distance from competition, trade area,
        demographics, retail sales levels, existence and stability of major employers,
        location of county government, disposable income, and distance from the
        Company’s distribution center. Markets that are determined to be sizable enough
        to support an ALCO and that have no direct competition from another full-line
        discount retailer are examined closely and eventually selected or passed
        over by
        the Company's experienced management team.
  *Store
        Expansion:* The
        Company's expansion program is designed primarily around the prototype Class
        20
        Store. This prototype details shelf space, merchandise presentation, store
        items
        to be offered, parking, storage requirements, as well as other store design
        considerations. The 21,500 square feet of selling space is large enough to
        permit a full line of the Company's merchandise, while minimizing capital
        expenditures, labor costs and general overhead costs. The Company will also
        consider opportunities in acceptable markets to open ALCO stores in available
        space in buildings already constructed.
 
 *Technology* :
        The
        Company went live on the human resources/payroll and financial systems during
        fiscal 2006. The Company went live on the Point-of-Sale (POS) system in the
        third quarter of fiscal 2007. Financial Planning, Performance Analysis, and
        Merchandise Allocation systems went live in the second quarter of fiscal
        2007.
        The Company is conducting a review of its logistics. This could result in
        the
        determination that the Company will need to consider a new integrated Warehouse
        Management System.
  3
 *Advertising
        and Promotion:* The
        Company utilizes full-color photography advertising circulars of eight to
        24
        pages distributed through newspaper insertion or, in the case of inadequate
        newspaper coverage, through direct mail. During fiscal 2007, these circulars
        were distributed 40 times in ALCO markets. In its Duckwall markets, the Company
        distributed a full-color, four page insert 11 times during fiscal 2007. The
        Company’s marketing program is designed to create awareness and recognition of
        its competitive pricing on a comprehensive merchandise selection for the
        whole
        family. During fiscal 2008, the Company will distribute approximately 42
        circulars in ALCO markets and will discontinue advertising in Duckwall
        markets.
 
 *Store
        Environment:* The
        Company's stores are open, clean, bright and offer a pleasant atmosphere
        with
        disciplined product presentation, attractive displays and efficient check-out
        procedures. The Company endeavors to staff its stores with courteous, highly
        motivated, knowledgeable store associates in order to provide a convenient,
        friendly and enjoyable shopping experience.
 
 **Store
        Development**
 
 The
        Company expects to open approximately 25 ALCO stores during fiscal year 2008.
        The Company's strategy regarding store development is to increase sales and
        profitability at existing stores by continually refining the merchandising
        mix
        and improving operating efficiencies, and through new store openings in the
        Company's targeted base of under-served markets in the central United States.
        The following table summarizes the Company's store development during the
        past
        three fiscal years:
 
 2007
              
              2006
              
              2005ALCO
              
              
              Duckwall
              
              
              ALCO
              
              
              Duckwall
              
              
              ALCO
              
              
              DuckwallStores
                  Opened
              
              
              7
              
              
              -
              
              
              7
              
              
              1
              
              
              8
              
              
              -Stores
                  Closed
              
              
              1
              
              
              1
              
              
              10
              
              
              13
              
              
              2
              
              
              6Net
                  New Stores
              
              
              6
              
              
              (1)
              
              
              (3)
              
              
              (12)
              
              
              6
              
              
              (6)
 
 As
        of
        January 28, 2007, the Company owned three ALCO and one Duckwall location,
        and
        leased 186 ALCO and 66 Duckwall locations. The Company's present intention
        is to
        lease all new stores; however, the company may own some of the ALCO locations.
        The estimated investment to open a new prototype ALCO store that is leased
        is
        approximately $800,000 for the equipment and inventory.
 
 **Store
        Environment and Merchandising**
 
 The
        Company manages its stores to attractively and conveniently display a full
        line
        of merchandise within the confines of the stores' available square footage.
        Corporate merchandising direction is provided to each store to ensure a
        consistent company-wide store presentation. To facilitate long-term
        merchandising planning, the Company divides its merchandise into three core
        categories driven by the Company's customer profile: primary, secondary,
        and
        convenience. The primary core receives management's primary focus, with a
        wide
        assortment of merchandise being placed in the most accessible locations within
        the stores and receiving significant promotional consideration. The secondary
        core consists of categories of merchandise for which the Company maintains
        a
        strong assortment that is easily and readily identifiable by its customers.
        The
        convenience core consists of categories of merchandise for which ALCO will
        maintain convenient (but limited) assortments, focusing on key items that
        are in
        keeping with customers' expectations for a discount store. Secondary and
        convenience cores include merchandise that the Company feels is important
        to
        carry, as the target customer expects to find them within a discount store
        and
        they ensure a high level of customer traffic. The Company continually evaluates
        and ranks all product lines, shifting product classifications when necessary
        to
        reflect the changing demand for products.
 
 **Purchasing**
 
 Procurement
        and merchandising of products is directed by a staff of two Vice President
        -
        Divisional Merchandise Managers and one Assistant Vice President Divisional
        Merchandise Manager who are each responsible for specific product categories.
        The Company employs twenty merchandise buyers and two assistant buyers who
        each
        report to a Divisional Merchandise Manager. Buyers are assisted by a management
        information system that provides them with current price and volume information
        by SKU, thus allowing them to react quickly with buying and pricing adjustments
        dictated by customer buying patterns.
 
 The
        Company purchases its merchandise from approximately 2,200 suppliers. The
        Company generally does not utilize long-term supply contracts. Only one supplier
        accounted for more than 5% of the Company's total purchases in fiscal 2007
        and
        competing brand name and private label products are available from other
        suppliers at competitive prices. The Company believes that its relationships
        with its suppliers are good and that the loss of any one or more of its
        suppliers would not have a material adverse effect on the Company.
  **Pricing**
 
 Merchandise
        pricing is done at the corporate level with the impact significantly different
        depending upon the level of competition in the market. This pricing strategy,
        with its promotional activities, is designed to bring consistent value to
        the
        customer. In fiscal 2008, promotions on various items will be offered
        approximately 42 times through advertising circulars.
 
 **Distribution
        and Transportation**
 
 The
        Company operates a 352,000 square foot distribution center in Abilene, Kansas,
        from which it services all stores. The distribution center is responsible
        for
        distributing approximately 80% of the Company's merchandise, with the balance
        being delivered directly to the Company's stores by its vendors. The
        distribution center maintains an integrated management information system,
        allowing the Company to utilize such cost cutting efficiencies as perpetual
        inventories, safety programs, and employee productivity software. As stated
        previously, the Company is considering an upgrade to the system.
 
 Effective
        January 1, 2006, the Company contracted with Werner Enterprises, Inc. to
        be its
        dedicated transportation provider. Werner will sublease the Subsidiary’s
        equipment which includes five tractors and 23 trailers until such equipment
        leases expire.
  4
 **Management
        Information Systems**
 
 The
        Company has committed significant resources to the purchase and application
        of
        available computer hardware and software to its discount retailing operations
        with the intent to lower costs, improve customer service and enhance general
        business planning. In general, the Company's merchandising systems are designed
        to integrate the key retailing functions of seasonal merchandise planning,
        purchase order management, merchandise distribution, sales information and
        inventory maintenance and replenishment. All of the Company's ALCO discount
        stores have POS computer terminals that record certain sales data in a format
        that can be transmitted nightly to the Company's data processing facility
        where
        it is used to produce daily and weekly management reports. During the last
        four
        fiscal years, the Company has devoted resources to development of systems
        that
        have improved information available to management and improved specific
        operational efficiencies.
 
 Approximately
        2,000 of the Company's merchandise suppliers currently participate in the
        Company's electronic data interchange (“EDI”) system, which makes it possible
        for the Company to place purchase orders electronically. A number of these
        suppliers are able to utilize additional EDI functions, including transmitting
        invoices and advance shipment notices to the Company and receiving sales
        history
        from the Company. Refer to the section above: Business Strategy: Technology,
        for
        additional discussion on the Company’s planned technology upgrades.
 
 **Store
        Locations**
 
 As
        of
        January 28, 2007, the Company operated 189 ALCO stores in 21 states located
        in
        smaller communities in the central United States. The ALCO stores average
        approximately 20,800 square feet of selling space, with an additional 5,000
        square feet utilized for merchandise processing, temporary storage and
        administration. The Company also operates 67 Duckwall stores in 10 states.
        The
        geographic distribution of the Company's stores is as follows:
  Duckwall
                    Stores
                
                ALCO
                    StoresArkansas
                1
                
                Arizona
                9
                
                Montana
                1Colorado
                5
                
                Arkansas
                5
                
                Nebraska
                16Iowa
                4
                
                Colorado
                12
                
                New
                    Mexico
                8Kansas
                27
                
                Idaho
                3
                
                North
                    Dakota
                7Nebraska
                7
                
                Illinois
                7
                
                Ohio
                5New
                    Mexico
                1
                
                Indiana
                13
                
                Oklahoma
                8North
                    Dakota
                2
                
                Iowa
                10
                
                South
                    Dakota
                9Oklahoma
                9
                
                Kansas
                26
                
                Texas
                26South
                    Dakota
                2
                
                Minnesota
                8
                
                Utah
                6Texas
                9
                
                Missouri
                6
                
                Wisconsin
                1Wyoming
                3
  **Competition**
 
 While
        the
        discount retail business in general is highly competitive, the Company's
        business strategy is to locate its ALCO discount stores in smaller markets
        where
        there is no direct competition with larger national or regional full-line
        discount chains, and where it is believed no such competition is likely to
        develop. Accordingly, the Company's primary method of competing is to offer
        its
        customers a conveniently located store with a wide range of merchandise at
        discount prices in a primary trade area population under 16,000 that does
        not
        have a large national or regional full-line discount store. The Company believes
        that trade area size is a significant deterrent to larger national and regional
        full-line discount chains. Duckwall variety stores are located in very small
        markets, and like the ALCO stores, emphasize the convenience of location
        to the
        primary customer base.
  In
        the
        discount retail business in general, price, merchandise selection, merchandise
        quality, advertising and customer service are all important aspects of
        competing. The Company encounters direct competition with national full-line
        discount stores in 26 of its ALCO markets, and another eight ALCO stores
        are in
        direct competition with regional full-line discount stores. The competing
        regional and national full-line discount retailers are generally larger than
        the
        Company and the stores of such competitors in the Company's markets are
        substantially larger, have a somewhat wider selection of merchandise and
        are
        very price competitive in some lines of merchandise. Where there are no national
        or regional full-line discount retail stores directly competing with the
        Company's ALCO stores, the Company's customers nevertheless shop at retail
        discount stores and other retailers located in regional trade centers, and
        to
        that extent the Company competes with such discount stores and retailers.
        The
        Company also competes for retail sales with mail order companies, specialty
        retailers, mass merchandisers, dollar stores, manufacturer’s outlets, and the
        internet. In the 123 markets in which the Company operates a Class 18 Store,
        only 12 markets have direct competition from a national or regional full-line
        discount retailer. The Company competes with dollar stores in 87 percent
        of its
        ALCO stores and approximately 40 percent of its Duckwall stores.
 
 **Employees**
  As
        of
        January 28, 2007, the Company employed approximately 4,800 people. Of these
        employees, approximately 490 were employed in the general office and
        distribution center in Abilene Kansas, 4,310 in the store locations. Additional
        employees are hired on a seasonal basis, most of whom are sales personnel.
        We
        offer a broad range of company-paid benefits to our employees, including
        a
        401(k) plan, medical and dental plans, short-term and long-term disability
        insurance, paid vacation and merchandise discounts. Eligibility for and the
        level of these benefits varies depending on the employees' full-time or
        part-time status and/or length of service. There is no collective bargaining
        agent for any of the Company's employees. The Company considers its relations
        with its employees to be excellent.
  5
 **ITEM
        1A. RISK FACTORS**
 
 The
        Company encourages investors to carefully consider the risks described below
        and
        other information contained in this document when considering an investment
        decision with respect to he Company’s securities. Additional risks and
        uncertainties not presently known to management, or that management currently
        deems immaterial, may also impair the Company’s business operations. Any of the
        events discussed in the risk factors below may occur. If one or more of these
        events do occur, business, results of operations or financial condition could
        be
        materially adversely affected. In that instance, the trading price of the
        Company’s securities could decline, and investors might lose part or all of
        their investment.
 
 **Economic
        Conditions**
 
 Similar
        to other retail businesses, the Company’s operations may be affected adversely
        by general economic conditions and events which result in reduced consumer
        spending in the markets served by its stores. Also, smaller communities where
        the Company’s stores are located may be dependent upon a few large employers or
        may be significantly affected by economic conditions in the industry upon
        which
        the community relies for its economic viability, such as the agricultural
        industry. This may make the Company’s stores more vulnerable to a downturn in a
        particular segment of the economy than the Company’s competitors, which operate
        in markets which are larger metropolitan areas where the local economy is
        more
        diverse.
 
 **Competition**
 
 The
        Company operates in the discount retail business, which is highly competitive.
        Although the Company prefers markets that don’t have direct competition from
        national or regional full-line discount stores, competition still exists.
        Even
        in non-competitive markets, the Company’s customers shop at retail discount
        stores and other retailers located in regional trade centers. The Company
        also
        competes for retail sales with other entities, such as mail order companies,
        specialty retailers, mass merchandisers, dollar stores, manufacturer’s outlets,
        and the internet. This competitive environment subjects the Company to the
        risk
        of reduced profitability because the Company may be forced to lower its prices,
        resulting in lower margins, in order to maintain its competitive
        position.
 
 **Store
        Expansion**
 
 The
        growth in the Company’s sales and operating net income depends to a substantial
        degree on its expansion program. This expansion strategy is dependent upon
        the
        Company’s ability the open and operate new stores effectively, efficiently, and
        on a profitable basis. The Company prefers to locate its ALCO stores in smaller
        retail markets where no competing full-line discount retail store is located
        within the primary trade area. The Company’s ability to timely open new stores
        and to expand into additional market areas depends in part on the following
        factors: availability of store locations, the ability to hire and train new
        store personnel, the ability to react to consumer needs and trends on a timely
        basis, and the availability of sufficient capital for expansion.
 
 **Information
        Technology**
 
 The
        Company completed its rollout of the new POS in its ALCO stores in the fourth
        quarter of fiscal 2007. The Company’s ability to train employees on the new POS
        software and to utilize technology upgrades could have a material impact
        on the
        Company’s results of operations.
  **Government
        Regulation**
 
 The
        Company is subject to numerous federal, state and local government laws and
        regulations, including those relating to the development, construction and
        operation of the Company’s stores. The Company is also subject to laws governing
        its relationship with employees, including minimum wage requirements, laws
        and
        regulations relating to overtime, working and safety conditions, and citizenship
        requirements. Material increases in the cost of compliance with any applicable
        law or regulation and similar matters could materially and adversely affect
        the
        Company.
 
 **Internal
        Control**
 
 The
        Company continues to refine and test its internal control processes. The
        Company
        created an Internal Audit Department in the fourth quarter of fiscal 2007.
        The
        inability of the Company to correct deficiencies could adversely affect the
        Company.
 
 **Quarterly
        Fluctuations**
 
 Quarterly
        results of operations have historically fluctuated as a result of retail
        consumers purchasing patterns, with the highest quarter in terms of sales
        and
        profitability being the fourth quarter. Quarterly results of operations will
        likely continue to fluctuate significantly as a result of such patterns and
        may
        fluctuate due to the timing of new store openings.
 
 **Stock
        Price**
 
 No
        assurance can be given that operating results will not vary from quarter
        to
        quarter, and any fluctuations in quarterly operating results may result in
        volatility in the Company’s stock price.
 
 **Dependence
        on Officers**
 
 The
        development of the Company’s business is largely dependent on the efforts of its
        current management team headed by Bruce C. Dale and eight other executive
        officers. The loss of the services of one or more of these officers could
        have a
        material adverse effect on the Company.
 
 **Interest
        Rate Risk**
 
 The
        Company is subject to market risk from exposure to changes in interest rates
        based on its financing requirements. Changes in interest rates could have
        a
        negative impact on the Company’s profitability.
 
 6
 **ITEM
        1B.**   **UNRESOLVED
        STAFF COMMENTS**
 
 None.
 
 **ITEM
        2.**   **PROPERTIES** .
 
 The
        Company owns facilities in Abilene, Kansas that consist of a general office
        (approximately 35,000 square feet), the Distribution Center (approximately
        352,000 square feet) and additional warehouse space adjacent to the general
        office.
 
 Three
        of
        the ALCO stores and one of the Duckwall stores operate in buildings owned
        by the
        Company. The remainder of the stores operate in properties leased by the
        Company. As of January 28, 2007, such ALCO leases account for approximately
        4,700,000 square feet of lease space, which expire as follows: approximately
        652,668 square feet (14.0%) expire between January 28, 2007 and February
        3,
        2008; approximately 689,542 square feet (14.8%) expire between February 3,
        2008
        and February 1, 2009; and approximately 578,648 square feet (12.4%) expire
        between February 1, 2009 and January 31, 2010. The remainder of the leases
        expire through 2021. All Duckwall store leases have terms remaining of fifty
        months or less. The majority of the leases that are about to expire have
        renewal
        options with lease terms that are the same as the existing lease.
 
 **ITEM
        3.**   **LEGAL
        PROCEEDINGS.**
 
 Other
        than routine litigation from time to time in the ordinary course of business,
        the Company is not a party to any material litigation.
 
 **ITEM
        4.**   **SUBMISSION
        OF MATTERS TO A VOTE OF SECURITY HOLDERS** .
 
 No
        matters were submitted to a vote of the stockholders of the Company during
        the
        fourth quarter of the fiscal year ended January 28, 2007.
  **ITEM 4A.    Executive
        Officers.**
  The
        following table sets forth the names, ages, positions and certain other
        information regarding the executive officers of the Company as of April 23,
        2007.
 
 **Name**
              **Age**
              **Position**Bruce
                  C. Dale
              59
              President
                  and Chief Executive OfficerJames
                  E. Schoenbeck
              63
              Senior
                  Vice PresidentJohn
                  R. Sturdivant
              62
              Senior
                  Vice PresidentTom
                  L. Canfield, Jr.
              53
              Senior
                  Vice PresidentAnthony
                  C. Corradi
              46
              Senior
                  Vice PresidentMichael
                  S Marcus
              52
              Vice
                  President - Finance and TreasurerMichael
                  J. Gawin
              55
              Vice
                  President - Divisional Merchandise Manager - SoftlinesRobert
                  E. Swartz, Jr.
              50
              Vice
                  President - Divisional Merchandise Manager - HardlinesVirginia
                  A. Meyer
              63
              Vice
                  President - Marketing
 
 Except
        as
        set forth below, all of the executive officers have been associated with
        the
        Company in their present position or other capacity for more than the past
        five
        years. There are no family relationships among the executive officers of
        the
        Company.
 
 *Bruce
        C. Dale* has
        served as President and Chief Executive Officer of the Company since March
        28,
        2005. From 2003 to 2004, Mr. Dale was President and CEO of Franks Nursery
        and
        Crafts, Inc. From 1993 to 2003, Mr. Dale was with Michaels Stores, Inc.,
        where
        he served for eight of those years as president of Aaron Brothers Art &
Framing. Mr. Dale has approximately 37 years of experience in the retail
        industry.
 
 *James
        E. Schoenbeck* has
        served as Senior Vice President of Real Estate and Travel since 2005. From
        1988
        to 2005, Mr. Schoenbeck served as Senior Vice President - Operations and
        Advertising. From 1975 to 1988, Mr. Schoenbeck served in various capacities
        with
        the Company. Mr. Schoenbeck has approximately 32 years of experience in the
        retail industry.
 
 *John
        R. Sturdivant* has
        served as Senior Vice President - Stores since February 13, 2006. For more
        than
        five years prior to that, he served as Regional Vice President of Jo-Ann
        Stores,
        Inc. Mr. Sturdivant has approximately 44 years experience in the retail
        industry.
 
 *Tom
        L. Canfield, Jr* .
        has
        served as Senior Vice President - Logistics and Administration since 2006.
        From
        1973 to 2006, Mr. Canfield served in various capacities with the Company.
        Mr.
        Canfield has approximately 34 years of experience in the retail
        industry.
 
 *Anthony
        C. Corradi* has
        served as Senior Vice President - Chief Technology Officer since 2007. Mr.
        Corradi served as Vice President - Chief Technology Officer since 2005. For
        five
        years prior to that, he was an independent consultant. Mr. Corradi has
        approximately 24 years experience in the retail technology
        industry.
 
 *Michael
        S. Marcus* has
        served as Vice President - Finance and Treasurer since 2006. From 2004 to
        2006,
        Mr. Marcus served in various capacities with the Company. From 1997 to 2003,
        Mr.
        Marcus served as Vice President and Chief Financial Officer of Weiner’s Stores,
        Inc. Mr. Marcus has approximately 18 years experience in the retail
        industry.
 
 *Michael
        J. Gawin* has
        served as Vice President - Divisional Merchandise Manager since 1997. For
        more
        than five years prior to that, he served as Divisional Merchandise Manager
        for
        Shopko Stores, Inc. Mr. Gawin has approximately 34 years experience in the
        retail industry.
 
 *Robert
        E. Swartz, Jr* .
        has
        served as Vice President - Divisional Merchandise Manger since 2000. From
        1978
        to 2000, Mr. Swartz served in various capacities with the Company. Mr. Swartz
        has approximately 29 years experience in the retail industry.
 
 7
 *Virginia
        A. Meyer* has
        served as Vice President - Marketing since 2007. From 2002 to 2007, Ms. Meyer
        served as Director of Marketing and Advertising. For more than five years
        prior
        to that, she served as Vice President - Marketing with Cato Corporation.
        Ms.
        Meyer has approximately 37 years experience in the retail industry.
  **PART
        II**
 
 **ITEM
        5.**   **MARKET
        FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS**  **AND
        ISSUER PURCHASES OF EQUITY SECURITIES.**
 
 The
        Common Stock of the Company is quoted on the NASDAQ National Market tier
        of The
        NASDAQ Stock Market under the symbol “DUCK”. The following table sets forth the
        range of high and low bid information for the Company's Common Stock for
        each
        quarter of fiscal 2007 and 2006.
 **Fiscal
                  2007**
              
              
              
              **High**
              
              **Low**First
                  quarter
              
              
              
              $26.70
              
              $22.34Second
                  quarter
              
              
              
              $34.93
              
              $25.40Third
                  quarter
              
              
              
              $38.54
              
              $33.65Fourth
                  quarter
              
              
              
              $42.06
              
              $33.77**Fiscal
                  2006**
              
              
              
              **High**
              
              **Low**First
                  quarter
              
              
              
              $19.79
              
              $16.79Second
                  quarter
              
              
              
              $23.90
              
              $18.55Third
                  quarter
              
              
              
              $24.50
              
              $21.10Fourth
                  quarter
              
              
              
              $25.59
              
              $20.02
 
 **Company
          Performance**
 
 The
        following graph compares the cumulative total return of the Company, the
        NASDAQ
        Stock Market Index, and the NASDAQ Retail Trade Stocks Index (assuming dividends
        reinvested at the end of each subsequent fiscal year). The graph assumes
        $100
        was invested on January 31, 2002 in Duckwall-ALCO Stores, Inc. Common Stock,
        the
        NASDAQ Stock Market Index, and the NASDAQ Retail Trade Stocks
        Index.
 
 
 
 Period
                  Ending at Fiscal Year EndIndex
              2002
              2003
              2004
              2005
              2006
              2007Duckwall-ALCO
                  Stores, Inc.
              100.00
              87.76
              136.94
              17.0.95
              233.93
              330.74NASDAQ
                  Composite Index
              100.00
              68.91
              107.25
              107.45
              120.87
              129.66NASDAQ
                  Retail Stock Index
              100.00
              80.38
              117.85
              142.58
              152.52
              166.46
 
 Based
        upon the data reflected in the table, a $100 investment in the Company's
        Common
        Stock would have a total return value of $330.74 at January 28, 2007, as
        compared to $129.66 for the Composite NASDAQ Index and $166.46 for the NASDAQ
        Retail Stock Index.
 
 **No
        Recent Dividend Payments; Restrictions on Payment of
        Dividends**
 
 As
        of
        April 23, 2007, there were approximately **** 1,216
        holders of record of the Common Stock of the Company. The Company has not
        paid
        cash dividends on its Common Stock during the last five fiscal years and
        it has
        no plans to commence paying cash dividends on the Common Stock. The terms
        of the
        Loan and Security Agreement, dated as of April 15, 2002, between the Company
        and
        Bank of America (formerly Fleet Retail Finance Inc.) allow for the payment
        of
        dividends unless certain loan covenants are triggered, which are not expected
        to
        occur during fiscal 2008.
  8
 **Company
        Repurchases of Common Stock**
  As
        shown
        in the following table, the Company did not repurchase any shares of the
        Common
        Stock during the three months ended January 28, 2007
 
 **Maximum
                  Number****Total
                  Number of**
              **(or
                  Approximate Dollar****shares
                  (or Units)**
              **Value)
                  of Shares (or****Total
                  Number Of**
              
              **Purchased
                  as Part**
              **Units)
                  that May Yet****Shares
                  (or Units)**
              **Average
                  Price Paid**
              **of
                  Publicly Announced**
              **Be
                  Purchased Under****Period**
              **Purchased**
              **per
                  Share (or Unit)**
              **Plans
                  or Programs**
              **the
                  Plans or Programs**November
                  1 - November 30, 2006
              -
              -
              -
              196,663December
                  1 - December 31, 2006
              -
              -
              -
              196,663January
                  1 - January 31, 2007
              -
              -
              -
              196,663
  (a)
              On
                  March 23, 2006, the Board of Directors approved a new plan authorizing
                  the
                  repurchase an additional 200,000 shares of the Company’s common stock, of
                  which 3,337 shares have been repurchased at an average cost of
                  $30.46. As
                  of January 28, 2007, 196,663 shares remain available to be
                  repurchased
  9
 **ITEM
        6.**   **SELECTED
        FINANCIAL DATA.**
 **SELECTED
        CONSOLIDATED FINANCIAL DATA**
 **(Dollars
        in thousands, except per share and store data)**
 
 The
        selected consolidated financial data presented below for, and as of the end
        of,
        each of the last five fiscal years under the captions Statements of Operations
        Data and Balance Sheet Data have been derived from the audited consolidated
        financial statements of the Company. This data should be read in conjunction
        with “Management's Discussion and Analysis of Financial Condition and Results of
        Operations” (Item 7) and the consolidated financial statements, related notes,
        and other financial information included herein (Item 8).
 **Fiscal
                  Year Ended**January
                  28,
              
              
              January
                  29,
              
              
              January
                  30,
              
              
              February
                  1,
              
              
              February
                  2,**Statement
                  of Operations Data**
              
              
              2007
              
              
              2006
              
              
              2005
              
              
              2004
              
              
              2003Net
                  sales
              
              $
              475,255
              
              
              433,319
              
              
              407,420
              
              
              396,517
              
              
              370,300Cost
                  of sales
              
              
              324,885
              
              
              295,488
              
              
              272,245
              
              
              264,073
              
              
              245,885Gross
                  margin
              
              
              150,370
              
              
              137,831
              
              
              135,175
              
              
              132,444
              
              
              124,415Selling,
                  general and administrative expenses
              
              
              132,165
              
              
              124,208
              
              
              121,154
              
              
              116,308
              
              
              108,428Depreciation
                  and amortization
              
              
              6,795
              
              
              5,940
              
              
              6,407
              
              
              6,807
              
              
              6,459Income
                  from continuing operations
              
              
              11,410
              
              
              7,683
              
              
              7,614
              
              
              9,329
              
              
              9,528Interest
                  expense
              
              
              2,730
              
              
              1,272
              
              
              1,230
              
              
              1,386
              
              
              1,609Earnings
                  from continuing operations beforeincome
                  taxes and discontinued operations
              
              
              8,680
              
              
              6,411
              
              
              6,384
              
              
              7,943
              
              
              7,919Income
                  tax expense
              
              
              3,046
              
              
              1,754
              
              
              2,192
              
              
              2,403
              
              
              2,904Earning
                  from continuing operations beforediscontinued
                  operations
              
              
              5,634
              
              
              4,657
              
              
              4,192
              
              
              5,540
              
              
              5,015(Loss)
                  income from discontinued operations, netof
                  income tax
              
              
              70
              
              
              (2,708
              )
              
              (269
              )
              
              973
              
              
              339Net
                  earnings (1)
              
              $
              5,704
              
              
              1,949
              
              
              3,923
              
              
              6,513
              
              
              5,354Per
                  Share InformationEarnings
                  per share - basic:Earnings
                  before discontinued operations
              
              $
              1.49
              
              
              1.14
              
              
              0.95
              
              
              1.30
              
              
              1.18Discontinued
                  operations
              
              
              0.01
              
              
              (0.66
              )
              
              (0.06
              )
              
              0.23
              
              
              0.08Net
                  earnings
              
              $
              1.50
              
              
              0.48
              
              
              0.89
              
              
              1.53
              
              
              1.26Earnings
                  (loss) per share - dilutedEarnings
                  (loss) before discontinued operations
              
              $
              1.48
              
              
              1.13
              
              
              0.94
              
              
              1.27
              
              
              1.15Discontinued
                  operations
              
              
              0.01
              
              
              (0.66
              )
              
              (0.06
              )
              
              0.23
              
              
              0.08Net
                  earnings
              
              $
              1.49
              
              
              0.47
              
              
              0.88
              
              
              1.50
              
              
              1.23Weighted
                  average shares outstanding:Basic
              
              
              3,792,202
              
              
              4,083,798
              
              
              4,391,538
              
              
              4,243,441
              
              
              4,235,911Diluted
              
              
              3,828,928
              
              
              4,117,922
              
              
              4,464,416
              
              
              4,343,381
              
              
              4,355,653**Operating
                  Data**Stores
                  open at year-end
              
              
              256
              
              
              251
              
              
              266
              
              
              264
              
              
              264Stores
                  in non-competitive markets at year-end (2)
              
              
              222
              
              
              222
              
              
              231
              
              
              230
              
              
              229Percentage
                  of total stores in non-competitivemarkets
                  (2)
              
              
              86.72
              %
              
              88.45
              %
              
              86.84
              %
              
              87.12
              %
              
              86.74
              %Net
                  Sales of stores in non-competitive markets(2)
              
              $
              404,196
              
              $
              381,863
              
              $
              366,637
              
              $
              363,634
              
              $
              334,811Percentage
                  of net sales from stores innon-competitive
                  markets (2)
              
              
              85.05
              %
              
              87.78
              %
              
              84.59
              %
              
              83.99
              %
              
              81.53
              %Comparable
                  stores sales increase for all stores (3)
              
              
              6.02
              %
              
              3.12
              %
              
              0.13
              %
              
              0.98
              %
              
              -0.05
              %Comparable
                  stores sales increase for stores innon-competitive
                  markets (2)(3)
              
              
              6.43
              %
              
              3.67
              %
              
              0.78
              %
              
              2.09
              %
              
              2.94
              %**Balance
                  Sheet Data**Total
                  Assets
              
              $
              195,420
              
              $
              178,922
              
              $
              163,118
              
              $
              167,493
              
              $
              169,900Total
                  Debt (includes capital leaseobligation
                  and current maturities)
              
              
              29,988
              
              
              26,240
              
              
              8,605
              
              
              10,876
              
              
              24,611Stockholders'
                  equity
              
              
              106,060
              
              
              102,147
              
              
              114,676
              
              
              109,193
              
              
              102,110
 
 10
 (1)
              Effective
                  January 29, 2006, the Company adopted SFAS no 123(R),*Share-Based
                  Payments*.
                  Included in selling, general and administrative expenses is $821
                  of stock
                  compensation expense in fiscal 2007. No expense was recorded for
                  stock
                  compensation in earlier
                  years.
 
 (2)
              “Non-competitive”markets
                  refer to those markets where there is not a national or regional
                  full-line
                  discount store located in the primary market served by the Company.
                  The
                  Company's stores in such non-competitive markets nevertheless face
                  competition from various sources. See Item 1 “Business-Competition”.
 
 (3)
              Percentages,
                  as adjusted to a comparable 52 week year, reflect the increase
                  or decrease
                  based upon a comparison of the applicable fiscal year with the
                  immediately
                  preceding fiscal year for stores open during the entirety of both
                  years.
  **ITEM
          7.**   **MANAGEMENT'S
          DISCUSSION AND ANALYSIS OF FINANCIAL** **CONDITION
          AND RESULTS OF OPERATION.**
 
 **Overview**
 
 *Operations* .
        The
        Company is a regional discount retailer operating in 21 states in the central
        United States.
 
 The
        Company’s fiscal year ends on the Sunday closest to January 31. Fiscal 2007,
        2006 and 2005 each consisted of 52 weeks. For purposes of this management's
        discussion and analysis of financial condition and results of operations,
        the
        financial numbers are presented in thousands.
 
 *Strategy.* The
        Company's overall business strategy involves identifying and opening stores
        in
        towns that will provide the Company with the highest return on investment.
        Although the Company prefers markets that don’t have direct competition from
        national or regional full-line discount stores, its strategy does not preclude
        it from entering competitive markets. Even in non-competitive markets,
        competition still exists, as the Company's customers still shop at retail
        discount stores and other retailers located in regional trade centers. The
        Company also competes for retail sales with other entities, such as mail
        order
        companies, specialty retailers, mass merchandisers, dollar stores,
        manufacturer's outlets, and the internet.
 
 The
        Company is constantly evaluating the appropriate mix of merchandise to improve
        sales and gross margin performance. The Company uses centralized purchasing,
        merchandising, pricing and warehousing to obtain volume discounts, improve
        efficiencies and achieve consistency among stores and the best overall results.
        The Company utilizes information obtained from its POS system and regular
        input
        from its store associates to determine its merchandise offerings.
 
 The
        Company, when appropriate, implements new merchandising and marketing
        initiatives in an effort to increase customer traffic and same-store sales.
        The
        Company is changing its focus from consumable products that carry a lower
        margin
        to higher margin soft goods. This includes more fashion apparel that will
        appeal
        to a broad base of customers. The Company is also adding new items to its
        assortments and has made changes to its advertising program that reduces
        the
        number of items advertised, but increases the frequency of the
        advertising.
 
 *Recent
        Events.* During
        fiscal 2007, the Company purchased and retired 3,337 shares of the Company’s
        Common Stock for an average price of $30.46. All shares repurchased were
        retired. On March 23, 2006, the Board of Directors approved a plan to repurchase
        200,000 shares of the Company’s common stock. There are 196,663 shares remaining
        under this plan.
 
 The
        Company completed the rollout of its new POS system in the fourth quarter
        of
        fiscal 2007.
 
 The
        Company entered into an agreement with Radio Shack to carry Radio Shack branded
        products. This merchandise was incorporated into the product mix in nine
        stores
        locations during fiscal 2007.
 
 On
        September 26, 2006, the Company announced its first store that would carry
        Bass
        Pro Shops® branded products. An additional store carrying these items was added
        in the first quarter of fiscal 2008.
 
 *Items
        Impacting Specific Periods.* The
        Company had items impacting specific periods. The Company analyzed its income
        tax liability account based on current information, and determined it was
        over-accrued with respect to certain tax matters arising in prior years.
        During
        the fourth quarter of fiscal 2006 the Company reversed this over-accrual
        of
        approximately $371. The Company completes an actuarial analysis of its
        self-insurance liabilities twice a year. In the third quarter of fiscal 2005,
        the Company increased its self-insurance reserves by $463 as a result of
        the
        actuarial analysis indicating higher than previously estimated claim activity.
        In the second quarter of fiscal 2006, the Company decreased its self-insurance
        reserves by $901 as a result of lower than estimated claim activity. In fiscal
        2007 there was not a significant change in the self-insurance reserves. In
        the
        fourth quarter of fiscal 2007, the Company recorded $795 in income due to
        a
        decrease in its LIFO reserve. During the fourth quarter of fiscal 2007 the
        Company experienced store physical inventory shrinkage $795 higher than
        expected.
  *Key
        Items in Fiscal 2007.* The
        Company measures itself against a number of financial metrics to assess its
        performance. Some of the important financial items during fiscal 2007
        were:
 
 ·
              Net
                  sales increased 9.7% to $475,255. Same store sales increased 6.0%
                  compared
                  to the prior year.
 ·
              Gross
                  margin decreased to 31.6% of sales, compared to 31.8% in the prior
                  year.
 ·
              Selling,
                  general and administrative expenses were 27.8% of sales, compared
                  to 28.7%
                  in the prior year.
 ·
              Earnings
                  per share was $1.49, compared to earnings of $0.47 per share in
                  the prior
                  year.
 ·
              Return
                  on average equity was 5.5%, compared to 1.8% in the prior
                  year.
  Same
        store sales growth is a measure which may indicate whether existing stores
        are
        maintaining their market share. Other factors, such as the overall economy,
        may
        also affect same store sales. The Company defines same stores as those stores
        that were open as of the first day of the prior fiscal year and remain open
        at
        the end of the reporting period (this may also be referred to as comparable
        stores).
 
 Gross
        margin percentage is a key measure of the Company's ability to maximize profit
        on the purchase and subsequent sale of merchandise, while minimizing promotional
        and clearance markdowns, shrinkage, damage, and returns. Gross margin percentage
        is defined as sales less cost of sales, expressed as a percentage of sales.
  Selling,
        general and administrative expenses are a measure of the Company’s ability to
        manage and control its expenses to purchase, distribute and sell
        merchandise.
 
 11
 Earnings
        per share ("EPS") growth is an indicator of the returns generated for the
        Company's stockholders. EPS from continuing operations was $1.48 per diluted
        share for fiscal 2007, compared to $1.13 per diluted share for the prior
        fiscal
        year. Return
        on
        average equity is a measure of how much income was produced on the average
        equity of the Company.
  *Results
        of Operations.* The
        following table sets forth, for the fiscal years indicated, the components
        of
        the Company's consolidated statements of operations expressed as a percentage
        of
        net sales:
 Fiscal
                  Year EndedJanuary
                  28,
              
              
              January
                  29,
              
              
              January
                  30,2007
              
              
              2006
              
              
              2005Net
                  sales
              
              
              100.0
              %
              
              100.0
              %
              
              100.0
              %Cost
                  of sales
              
              
              68.4
              
              
              68.2
              
              
              66.8Gross
                  margin
              
              
              31.6
              
              
              31.8
              
              
              33.2Selling,
                  general and administrative expenses
              
              
              27.8
              
              
              28.7
              
              
              29.7Depreciation
                  and amortization
              
              
              1.4
              
              
              1.4
              
              
              1.6Total
                  operating expenses
              
              
              29.2
              
              
              30.1
              
              
              31.3Income
                  from continuing operations
              
              
              2.4
              
              
              1.7
              
              
              1.9Interest
                  expense
              
              
              0.6
              
              
              0.3
              
              
              0.3Earnings
                  from continuing operations before incometaxes
                  and discontinued operations
              
              
              1.8
              
              
              1.4
              
              
              1.6Income
                  tax expense
              
              
              0.6
              
              
              0.4
              
              
              0.5Earnings
                  from continuing operations before discontinued operations
              
              
              1.2
              
              
              1.0
              
              
              1.1(Loss)
                  income from discontinued operations, net of income tax
              
              
              0.0
              
              
              (0.6
              )
              
              (0.1
              )Net
                  earnings
              
              
              1.2
              %
              
              0.4
              %
              
              1.0
              %
  **Critical
        Accounting Policies**
  Our
        analysis of operations and financial condition is based on our consolidated
        financial statements, prepared in accordance with U.S. generally accepted
        accounting principles (GAAP). Preparation of these consolidated financial
        statements requires us to make estimates and assumptions affecting the reported
        amounts of assets and liabilities at the date of the financial statements,
        reported amounts of revenues and expenses during the reporting period and
        related disclosures of contingent assets and liabilities. In the Notes to
        Consolidated Financial Statements, we describe our significant accounting
        policies used in preparing the consolidated financial statements. Our estimates
        are evaluated on an ongoing basis and are drawn from historical experience
        and
        other assumptions that we believe to be reasonable under the circumstances.
        Actual results could differ under different assumptions or conditions. The
        following items in our consolidated financial statements require significant
        estimation or judgment:
  *Inventory* :
        As
        discussed in Note 1(d) to the Consolidated Financial Statements, inventories
        are
        stated at the lower of cost or net realizable value with cost determined
        using
        the last-in, first-out (LIFO) method. The retail inventory method (“RIM”) used
        by the Company is an averaging method that has been widely used in the retail
        industry. This method calculates a cost to retail ratio that is applied to
        the
        retail value of inventory to calculate cost inventory and the resulting gross
        margin. Use of the RIM does not eliminate the use of management judgments
        and
        estimates, including markdowns and shrinkage, which significantly impact
        the
        ending inventory valuation at cost and the resulting gross margins. The Company
        continually evaluates product categories to determine if markdown action
        is
        appropriate, or if a markdown reserve should be established. The Company
        recognizes that the use of the RIM will result in valuing inventories at
        lower
        of cost or market if markdowns are currently taken as a reduction of the
        retail
        value of inventories. As of January 28, 2007 and January 29, 2006, the Company
        had recorded markdowns that had not been taken and which served to reduce
        inventories to lower of cost or market by approximately $354 and $597,
        respectively. Management believes that the RIM provides an inventory valuation
        which reasonably approximates cost and results in carrying inventory at the
        lower of cost or market. For LIFO, the Company determines lower of cost or
        market by pool. The Company has historically accrued its shrink reserve based
        on
        a three-year average shrink percentage at each of its store locations.
        Historically the three-year average has appropriately recorded estimated
        shrinkage on a monthly basis. At the end of fiscal 2007, the Company determined
        that this reserve was not sufficient due to the shrink results for the last
        month of fiscal 2007. The stores inventoried in January 2007 experienced
        $795
        more shrink at cost, than had previously been reserved. A 0.5% increase in
        this
        percentage would increase the recorded reserve by $257.
  *Insurance* :
        The
        Company retains significant deductibles on its insurance policies for workers
        compensation, general liability and medical claims. Due to the fact that
        it
        takes more than one year to determine the actual costs, these costs are
        estimated based on the Company’s historical loss experience and estimates from
        the insurance carriers and consultants. The Company completes an actuarial
        evaluation of its loss experience twice each year. In between actuarial
        evaluations, management monitors the cost and number of claims and compares
        those results to historical amounts. The Company’s actuarial method is the fully
        developed method. This method includes a loss conversion factor that includes
        administrative, legal and claims handling expenses. The Company records its
        reserves on an undiscounted basis. The Company’s prior estimates have varied
        based on changes in assumptions related to actual claims versus estimated
        ultimate loss calculations. Current and future estimates could be affected
        by
        changes in those same assumptions and are reasonably likely to occur. A 1%
        increase in the loss development factor would increase the recorded liability
        by
        $75.
 
 *Income
        Taxes:* The
        Company’s tax provision and establishment of reserves for potential tax
        liabilities involves the use of estimates and judgment. The Company has
        identified exposures for which they have established a reserve, such as
        differences in interpretation of tax laws at the federal, state, and local
        units
        of government. In the ordinary course of business, the Company analyzes its
        income accounts. During fiscal 2006, the Company determined that it was
        overaccrued with respect to certain matters arising in prior years. The Company
        reversed such overaccrual of approximately $371 during fiscal 2006.
 
 *Share-Based
        Payments:* Effective January 30, 2006, the Company adopted Statement of Financial
        Accounting Standards No. 123 " *Share-Based
        Payment* "
        ("SFAS
        123(R)") and began recognizing compensation expense for its share-based payments
        based on the fair value of the awards. Share-based payments consist of stock
        option grants. SFAS 123(R) requires share-based compensation expense recognized
        since January 30, 2006 to be based on the following: a) grant date fair value
        estimated in accordance with the original provisions of SFAS 123 for unvested
        options granted prior to the adoption date and b) grant date fair value
        estimated in accordance with the provisions of SFAS 123(R) for all share-based
        payments granted subsequent to the adoption date. For Executives and Directors,
        the Company estimates forfeitures will not occur. This is due to the fact
        that,
        historically, the Company does not experience material turnover of these
        two
        classes. Any turnover in these classes could have a significant impact on
        the
        stock option expense for the Company. For non-Executives, the Company estimates
        a higher forfeiture rate. An actual turnover rate, lower or higher than
        historical trends, and changes in estimated forfeiture rates would impact
        the
        stock option expense recorded by the Company.
 
 12
 **Fiscal
        2007 Compared to Fiscal 2006**
 
 Net
        sales
        for fiscal 2007 increased $42.0 million or 9.7% to $475.3 million compared
        to
        $433.3 million for fiscal 2006. During fiscal 2007, the Company opened seven
        ALCO stores. One ALCO was closed and one Duckwall store was closed and replaced
        by an ALCO store, resulting in a year end total of 256 stores. Net sales
        for all
        stores open the full year in both fiscal 2007 and 2006 (same stores), increased
        by $25.6 million or 6.0% in fiscal 2007 compared to fiscal 2006. The average
        sale for fiscal 2007 increased 7.2% compared to fiscal 2006. The Company
        had
        four of its merchandise departments experience greater than 15% increase
        in
        sales for fiscal 2007 when compared to fiscal 2006.
 
 Gross
        margin for fiscal 2007 increased $12.6 million, or 9.1%, to $150.4 million
        compared to $137.8 million in fiscal 2006. As a percentage of net sales,
        gross
        margin decreased to 31.6% in fiscal 2007 compared to 31.8% in fiscal 2006.
        Fiscal 2007 gross margin was positively impacted by a LIFO reserve reductions
        and increased vendor participation support, offset by a reduction in warehouse
        swell, additional shrinkage reserve and increased transportation
        costs.
 
 Selling,
        general and administrative expenses increased $8.0 million or 6.4% to $132.2
        million in fiscal 2007 compared to $124.2 million in fiscal 2006. As a
        percentage of net sales, selling, general and administrative expenses were
        27.8%
        in fiscal 2007 and 28.7% in fiscal 2006. The decrease in selling, general
        and
        administrative expenses as a percentage of net sales was due in part to an
        increase in vendor participation in CO-OP advertising, offset by increased
        payroll, increase in expenses related to stock options, increase in credit
        card
        fees, increase in advertising, professional services and software maintenance
        fees associated with rollout of IT initiative and increase in utilities and
        new
        store rents.
  Depreciation
        and amortization expense increased $860 or 14.5% to $6.8 million in fiscal
        2007
        compared to $5.9 million in fiscal 2006. The increase in depreciation and
        amortization expense was attributable to a full year’s depreciation on
        capitalized software which was purchased in the fourth quarter of fiscal
        2006.
  Income
        from continuing operations increased $3.7 million, or 48.1%, to $11.4 million
        in
        fiscal 2007 compared to $7.7 million in fiscal 2006. Income from continuing
        operations as a percentage of net sales was 2.4% in fiscal 2007 compared
        to 1.8%
        in fiscal 2006. The increase in gross margin, as described above, had the
        largest impact on the increased income from continuing operations.
 
 Interest
        expense increased $1.4 million or 107.7%, to $2.7 million in fiscal 2007
        compared to $1.3 million in fiscal 2006. The increase in interest expense
        was
        attributable to increased borrowings by the Company during fiscal 2007 compared
        to fiscal 2006. Interest expense may increase if interest rates continue
        to rise
        or if the Company expands its borrowing to fund capital expenditures or other
        programs.
 
 Income
        taxes on continuing operations were $3.0 million in fiscal 2007 compared
        to $1.8
        million in fiscal 2006. The Company's effective tax rate was 35.1% in fiscal
        2007 and 27.4% in fiscal 2006. The effective tax rate is higher due to permanent
        tax differences relating to stock compensation expense and reversal of
        over-accrual of approximately $371 during the fourth quarter of
        2006.
 
 Income
        from discontinued operations, net of income taxes was $70 in fiscal 2007,
        compared to a loss of $2.7 million in fiscal 2006.
 
 **Fiscal
        2006 Compared to Fiscal 2005**
 
 Fiscal
        2006 included a number of one-time costs and markdowns associated with the
        implementation of programs focused on improving long-term performance. The
        Company has outlined a number of initiatives that address the poor performance
        of each of the key performance measures, with the goal of improving performance
        in each area over the long term.
 
 Net
        sales
        for fiscal 2006 increased $25.9 million or 6.4% to $433.3 million compared
        to
        $407.4 million for fiscal 2005. During fiscal 2006, the Company opened seven
        ALCO and one Duckwall stores. Ten ALCO and thirteen Duckwall stores were
        closed,
        resulting in a year end total of 251 stores. Net sales for all stores open
        the
        full year in both fiscal 2006 and 2005 (same stores), increased by $12.6
        million
        or 3.1% in fiscal 2006 compared to fiscal 2005. During the second quarter
        of
        fiscal 2006, the Company began a process of eliminating seasonal carryover
        and
        distressed inventory. Markdowns that were taken to eliminate this inventory
        were
        completed in the third quarter, and affected gross margin as discussed below.
        A
        number of factors contributed to the same store sales growth, including
        liquidation of distressed inventory discussed above, as well as expanded
        store
        operating hours, better in-stock position and new product
        offerings.
  Gross
        margin for fiscal 2006 increased $2.6 million, or 2.0%, to $137.8 million
        compared to $135.2 million in fiscal 2005. As a percentage of net sales,
        gross
        margin decreased to 31.8% in fiscal 2006 compared to 33.2% in fiscal 2005.
        This
        decrease in the gross margin percentage was attributable to higher markdowns
        resulting from the Company’s efforts to reduce its seasonal inventory carryover.
        The impact of the additional markdowns was $6.6 million at cost, which reduced
        the gross margin percentage by 1.5%. Other factors affecting margin included
        higher transportation costs, offset in part by an improved mix of sales and
        higher markup on purchases.
 
 Selling,
        general and administrative expenses increased $3.0 million or 2.5% to $124.2
        million in fiscal 2006 compared to $121.2 million in fiscal 2005. As a
        percentage of net sales, selling, general and administrative expenses were
        28.7%
        in fiscal 2006 and 29.7% in fiscal 2005. Non-comparable stores accounted
        for
        $3.9 million of this increase. Other SG&A expense categories were subject to
        inflationary pressures, but those increases were offset by the Company’s cost
        containment initiatives.
  Depreciation
        and amortization expense decreased $468 or 7.3 % to $5.9 million in fiscal
        2006
        compared to $6.4 million in fiscal 2005. The decrease in depreciation and
        amortization expense was attributable to store fixtures and equipment becoming
        fully depreciated in the current fiscal year on a large number of ALCO stores
        that were opened in fiscal years 1997 and 1998.
  Income
        from continuing operations increased $69, or 0.9%, to $7.7 million in fiscal
        2006 compared to $7.6 million in fiscal 2005. Income from continuing operations
        as a percentage of net sales was 1.8% in fiscal 2006 compared to 1.9% in
        fiscal
        2005. The reduction in gross margin as described above had the largest impact
        on
        the reduced income from continuing operations.
 
 Interest
        expense increased $43, or 3.5%, to $1.3 million in fiscal 2006 compared to
        $1.2
        million in fiscal 2005. The increase in interest expense was attributable
        to
        increased borrowings by the Company during fiscal 2006 compared to fiscal
        2005.
        Interest expense may increase if interest rates continue to rise or if the
        Company expands its borrowing to fund capital expenditures or other programs.
 
 Income
        taxes on continuing operations were $1.8 million in fiscal 2006 compared
        to $2.2
        million in fiscal 2005. The Company's effective tax rate was 27.4% in fiscal
        2006 and 34.3% in fiscal 2005. The rate was lower in fiscal 2006 because,
        during
        the fourth quarter of fiscal 2006, the Company, based on current information,
        analyzed its income tax liability account and determined that it was
        over-accrued with respect to certain matters arising in prior years. The
        Company
        reversed such over-accrual of $371 during fiscal 2006.
 
 13
 Loss
        from
        discontinued operations, net of income taxes was $2.7 million in fiscal 2006,
        compared to a loss of $270 in fiscal 2005.
  **SG&A
        Detail; Certain Financial Matters**
 
 The
        Company has included EBITDA, a non-GAAP performance measure, as part of its
        disclosure as a means to enhance its communications with stockholders. Certain
        stockholders have specifically requested this information as a means of
        comparing the Company to other retailers that disclose similar non-GAAP
        performance measures. Further, management utilizes this measure in internal
        evaluation; review of performance and to compare the Company’s financial measure
        to that of its peers. EBITDA differs from the most comparable GAAP financial
        measure (earnings from continuing operations before discontinued operations)
        in
        that it does not include non-cash items. As a result, it may not reflect
        important aspects of the results of the Company’s operations.
 For
                  the Year Ended**SG&A
                  Expenses Breakout**
              
              
              January
                  28, 2007
              
              
              January
                  29, 2006General
                  Office
              
              $
              17,869
              
              
              16,668Distribution
                  Center
              
              
              8,742
              
              
              8,319SPD
                  Truck Lines
              
              
              -
              
              
              1,128401K/Profit
                  Sharing
              
              
              478
              
              
              -Asset
                  Impairment
              
              
              130
              
              
              -Comparable
                  Stores SG&A
              
              
              101,481
              
              
              96,870Non
                  Comp Stores SG&A #
              
              
              2,644
              
              
              1,223Stock
                  Option Expense
              
              
              821
              
              
              -Final
                  SG&A
              
              $
              132,165
              
              
              124,208Return
                  on Average Equity (ROE)****
              
              
              5.48
              %
              
              1.80
              %Net
                  Sales
              
              $
              475,255
              
              $
              433,319SG&A
                  as % of Sales
              
              
              27.81
              %
              
              28.66
              %SG&A
                  per average selling square foot
              
              $
              32.12
              
              $
              31.14EBITDA**
              
              $
              19,026
              
              $
              13,623EBITDA
                  per average selling square foot***
              
              $
              4.62
              
              $
              3.42Sales
                  per average selling square feet*ALCO
              
              $
              118.45
              
              $
              111.15Duckwall
              
              $
              85.15
              
              $
              82.84Total
              
              $
              115.49
              
              $
              108.64Average
                  Selling Square Feet*
              
              $
              4,115
              
              
              3,989Average
                  Square Feet % Change
              
              
              3.1
              %
              
              3.3
              %Total
                  Stores Operating beginning of Period
              
              
              251
              
              
              266Total
                  Stores Operating end of Period
              
              
              256
              
              
              251Supplemental
                  Data:Same
                  Store Sales Change
              
              
              6.0
              %
              
              3.1
              %Total
                  customer count change
              
              
              1.9
              %
              
              2.3
              %Average
                  sale per ticket change
              
              
              7.6
              %
              
              3.8
              %Average
                  annualized New Store Saleperformance
                  on prototype Stores
              
              $
              2,357Incremental
                  expenses related to IT initiative
              
              $
              749*
                  Average selling square feet is (beginning square feet plus ending
                  square
                  feet) divided by 2.**
                  EBITDA is earnings from continuing operations before interest,
                  taxes,
                  depreciation and amortization, and stock option
                  expense.***
                  EBITDA per selling square foot is a non-GAAP financial measure
                  and is
                  calculated as EBITDA divided by selling square feet.****
                  Return on average equity (ROE) is calculated as Net Earnings divided
                  by
                  average stockholders' equity.Average
                  Stockholders' Equity is calculated as (beginning of period stockholders'
                  equity plus end of periodstockholders'
                  equity) divided by 2#
                  Non Comp Stores are those stores opened in Fiscal 2006 & Fiscal
                  2007.
 
 **Fiscal
        2007 Compared to Fiscal 2006**
 
 General
        Office expenses for fiscal 2007 increased $1,201, or 7.2%. The majority of
        the
        increase was related to professional fees related to Sarbanes-Oxley, stock
        options expense and incremental IT expenses.
 
 14
 Distribution
        center expenses increased $423, or 5.1%.
 
 SPD
        Truck
        Line expenses did not exist in fiscal 2007 and were replaced with contract
        transportation expenses which are capitalized into inventory and included
        in
        cost of goods sold.
 
 Comparable
        store SG&A expenses increased $4,611, or 4.8%. Utilities, credit card fees,
        and advertising accounted for the majority of this increase.
 
 Non
        Comparable Stores SG&A expenses increased $1,421. The Company opened seven
        new stores during the year.
  **Reconciliation
        and Explanation of Non-GAAP Financial Measures**
 The
        following table shows the reconciliation of EBITDA and EBITDA per selling
        square
        foot to the earnings (loss) from continuing operations, the most directly
        comparable financial measure calculated and presented in accordance with
        GAAP:
 2007
              
              2006Earnings
                  from continuing operations
              
              $
              5,634
              
              
              4,657Plus
                  interest
              
              
              2,730
              
              
              1,272Plus
                  taxes
              
              
              3,046
              
              
              1,754Plus
                  depreciation and amortization
              
              
              6,795
              
              
              5,940Plus
                  stock option expense
              
              
              821
              
              
              -=EBITDA
              
              $
              19,026
              
              
              13,623Earnings
                  from continuing operations per square foot
              
              $
              1.37
              
              
              1.17Plus
                  interest per square foot
              
              
              0.66
              
              
              0.32Plus
                  taxes per square foot
              
              
              0.74
              
              
              0.44Plus
                  depreciation and amortization per square foot
              
              
              1.65
              
              
              1.49Plus
                  stock option expense per square foot
              
              
              0.20
              
              
              -=EBITDA
                  per selling square foot
              
              $
              4.62
              
              
              3.42
 
 
 **Seasonality
        and Quarterly Results**
 
 The
        following table sets forth the Company's net sales, gross margin, income
        from
        operations, and net earnings during each quarter of fiscal 2007 and 2006.
  First
                
                Second
                
                Third
                
                FourthQuarter
                
                Quarter
                
                Quarter
                
                Quarter(1)(2)Fiscal
                    2007Net
                    sales
                
                $
                108.8
                
                
                120.3
                
                
                110.1
                
                
                136.1Gross
                    margin
                
                
                32.4
                
                
                36.1
                
                
                34.3
                
                
                47.5Earnings
                    from continuing operations
                
                
                0.3
                
                
                1.4
                
                
                (0.5
                )
                
                4.2Net
                    Earnings (loss)
                
                
                0.5
                
                
                1.4
                
                
                (0.6
                )
                
                4.4Fiscal
                    2006Net
                    sales
                
                $
                98.0
                
                
                108.3
                
                
                100.7
                
                
                126.7Gross
                    margin
                
                
                30.4
                
                
                32.6
                
                
                32.5
                
                
                42.3Earnings
                    from continuing operations
                
                
                (1.2
                )
                
                0.7
                
                
                (0.1
                )
                
                5.1Net
                    Earnings (loss)
                
                
                (2.7
                )
                
                (0.3
                )
                
                (0.1
                )
                
                5.2
 
 (1)
              In
                  fiscal 2007, an increase in shrinkage of $795 in the fourth quarter
                  negatively impacted gross margin. A LIFO, lower or cost or market
                  adjustment of $795 positively impacted gross margin. A shrinkage
                  reserve
                  of $300 negatively impacted gross
                  margin.
 
 (2)
              In
                  fiscal 2006, the reduction in shrinkage related to a warehouse
                  inventory
                  adjustment contributed $1.3 million to the gross margin. A reversal
                  of an
                  over-accrual of income taxes of $371 positively impacted net
                  earnings.
 
 See
        Note
        10 of Notes to Consolidated Financial Statements for quarterly earnings per
        share information.
 
 The
        Company’s business is subject to seasonal fluctuations. The Company’s highest
        sales levels occur in the fourth quarter of its fiscal year which includes
        the
        Christmas holiday selling season. The Company's results of operations in
        any one
        quarter are not necessarily indicative of the results of operations that
        can be
        expected for any other quarter or for the full fiscal year. The Company's
        results of operations may also fluctuate from quarter to quarter as a result
        of
        the amount and timing of sales contributed by new stores and the integration
        of
        the new stores into the operations of the Company, as well as other factors.
        The
        addition of a large number of new stores can, therefore, significantly affect
        the quarterly results of operations.
  15
 **Inflation**
 
 Management
        does not believe that its merchandising operations have been materially affected
        by inflation over the past few years. The Company will continue to monitor
        costs, take advantage of vendor incentive programs, selectively buy from
        competitive vendors and adjust merchandise prices based on market
        conditions.
 
 The
        Company’s operating expenses have been impacted by increases in insurance
        expenses, as well as competitive pressures in wages in selected markets.
        See
        additional discussion of wages in the “Government Regulation”
section.
 
 The
        increase in the price of oil adversely affects the Company’s transportation
        costs, both on inbound shipments to the Company’s distribution center, and on
        outbound shipments of merchandise to the stores. The Company also believes
        the
        higher retail price of gasoline adversely affects the amount of discretionary
        spending dollars our customers have to spend at our stores.
 
 **Liquidity
        and Capital Resources**
 
 At
        the
        end of fiscal 2007, working capital (defined as current assets less current
        liabilities) was $106.4 million compared to $90.6 million at the end of fiscal
        2006 and $95.4 million at the end of fiscal 2005.
 
 The
        Company's primary sources of funds are cash flow from operations, borrowings
        under its revolving loan credit facility, vendor trade credit financing and
        lease financing. In fiscal 2007 the Company completed a sale-leaseback of
        a
        number of its owned stores. The proceeds from this transaction amounted to
        $12.6
        million. No sale-leaseback transactions were completed in fiscal 2006. In
        fiscal
        2005 the Company received proceeds from sale-leaseback transactions of $1.7
        million.
 
 Cash
        (used in) provided by operating activities aggregated ($4.0) million, $12.0
        million, and $5.5 million, in fiscal 2007, 2006 and 2005, respectively. The
        decrease in cash provided in fiscal 2007 relative to fiscal 2006 and fiscal
        2005
        resulted primarily from an increase in merchandise inventory. In addition
        to the
        seven new locations, the Company maintained a strategic program to remain
        in
        stock at all times.
 
 The
        Company uses its revolving loan credit facility and vendor trade credit
        financing to fund the build up of inventories periodically during the year
        for
        its peak selling seasons and to meet other short-term cash requirements.
        The
        revolving loan credit facility provides up to $70 million of financing in
        the
        form of notes payable and letters of credit. The loan agreement expires in
        April
        2010. The revolving loan note payable and letter of credit balance at January
        28, 2007 was $24.4 million, resulting in an available line of credit at that
        date of $45.6 million. Loan advances are secured by a security interest in
        the
        Company’s inventory. The loan agreement contains various restrictions that are
        applicable when outstanding borrowings exceed $42.5 million. Short-term trade
        credit represents a significant source of financing for inventory to the
        Company. Trade credit arises from the willingness of the Company's vendors
        to
        grant payment terms for inventory purchases.
 
 In
        fiscal
        2007, the Company had net cash borrowings of $4.0 million on its revolving
        credit facility, made cash payments of $2.1 million to reduce its capital
        lease
        obligations, and repurchased $2.0 million of Company stock. The Company received
        $113 in proceeds from the exercise of outstanding stock options. In fiscal
        2006,
        the Company had net cash borrowings on its revolving credit facility of $13.0
        million and made cash payments of $1.1 million to reduce its long-term debt
        and
        capital lease obligations, and repurchased $13.0 million of Company stock.
        The
        Company received $423 in proceeds from the exercise of outstanding stock
        options. In fiscal 2005, the Company made net cash payments on its revolving
        credit facility of $935 and made cash payments of $1.3 million to reduce
        its
        long-term debt and capital lease obligations, and repurchased $80 of Company
        stock. The Company received $1.3 million in proceeds from the exercise of
        outstanding stock options. The Company executed operating leases for 15
        additional stores during the three year period ending in fiscal 2007. The
        Company’s long-range plan assumes growth in the number of stores and, in
        accordance with this plan, seven new ALCO stores were opened in fiscal 2007,
        seven new ALCO and one new Duckwall stores were opened in fiscal 2006 and
        approximately 25 new ALCO stores are expected to be opened in fiscal 2008.
        The
        Company believes that with the $70 million line of credit, sufficient capital
        is
        available to fund the Company’s planned expansion.
 
 Cash
        used
        for acquisition of property and equipment in fiscal 2007, 2006 and 2005 totaled
        $7.6 million, $11.1 million, and $6.5 million, respectively. A sale-leaseback
        transaction of several store buildings was completed in fiscal 2007 in the
        amount of $12.6 million and $1.6 from the sale of other assets. In fiscal
        2005,
        the company owned surplus land was sold for $315 and the Company completed
        a
        sale-leaseback transaction for $1.7 million. Anticipated cash payments for
        acquisition of property and equipment in fiscal 2008, principally for fixtures
        and equipment, are $13.0 million. The net cash provided by investing activities
        was $6.5 million in fiscal 2007. The net cash used in investing activities
        in
        fiscal 2006 and 2005 was $11.1 million and $4.6 million, respectively.
 
 On
        March
        23, 2006, the Board of Directors approved a new plan authorizing the repurchase
        of 200,000 shares of the Company’s common stock, of which 3,337 shares have been
        repurchased at an average cost of $30.46. As of January 28, 2007, 196,663
        shares
        remain available to be repurchased.
  The
        following table summarizes the Company’s significant contractual obligations
        payable as of January 28, 2007 (in thousands):
 Payments
                      due by PeriodLess
                      than
                  
                  1
                      -
                      3
                  
                  4
                      -
                      5
                  
                  AfterContractual
                      Obligations
                  
                  
                  Total
                  
                  
                  1
                      year
                  
                  
                  years
                  
                  
                  years
                  
                  
                  5
                      yearsRevolving
                      Loan Credit Facility (1)
                  
                  $
                  21,077
                  
                  
                  -
                  
                  
                  21,077
                  
                  
                  -
                  
                  
                  -Capital
                      Lease Obligations
                  
                  
                  10,943
                  
                  
                  3,012
                  
                  
                  4,639
                  
                  
                  2,522
                  
                  
                  770Operating
                      Leases
                  
                  
                  65,797
                  
                  
                  12,590
                  
                  
                  19,726
                  
                  
                  11,064
                  
                  
                  22,417Transportation
                      Contract
                  
                  
                  247
                  
                  
                  247
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -Contingent
                      Rentals
                  
                  
                  13,247
                  
                  
                  1,561
                  
                  
                  3,246
                  
                  
                  3,376
                  
                  
                  5,064Total
                      contractual cash obligations
                  
                  
                  111,311
                  
                  
                  17,410
                  
                  
                  48,688
                  
                  
                  16,962
                  
                  
                  28,251
  16
 (1)
              The
                  principal amount of the Company’s Revolving Loan Credit Facility is shown
                  in its contractual obligations table as the amount being paid during
                  the
                  year that the current agreement on the credit facility expires.
                  Interest
                  related to the Revolving Loan Credit Facility is dependent on the
                  level of
                  borrowing and variable interest rates as more fully described in
                  Note 3 to
                  the consolidated financial statements and is not shown in this
                  table.
 
 **Expansion
        Plans**
 
 The
        continued growth of the Company is dependent, in large part, upon the Company’s
        ability to open and operate new stores on a timely and profitable basis.
        The
        Company plans to open approximately 25 ALCO stores in fiscal 2008. While
        the
        Company believes that adequate sites are currently available, the rate of
        new
        store openings is subject to various contingencies, many of which are beyond
        the
        Company’s control. These contingencies include the availability of acceptable
        communities for store locations, the Company’s ability to secure suitable store
        sites on a timely basis and on satisfactory terms, the Company’s ability to
        hire, train and retain qualified personnel, the availability of adequate
        capital
        resources and the successful integration of new stores into existing operations.
        There can be no assurance that the Company will be able to continue to
        successfully identify and obtain new store sites or that once obtained, the
        new
        stores will achieve satisfactory sales or profitability.
 
 **New
        Accounting Standard**
 
 In
        March
        2006, the Emerging Issues Task Force ("EITF") reached a consensus on EITF
        Issue
        No. 06-3, " *How
        Taxes Collected from Customers and Remitted to Governmental Authorities Should
        Be Presented in the Income Statement (That Is, Gross Versus Net
        Presentation)* ",
        which
        allows companies to adopt a policy of presenting taxes in the income statement
        on either a gross or net basis. Taxes within the scope of this EITF would
        include taxes that are imposed on a revenue transaction between a seller
        and a
        customer, for example, sales taxes, use taxes, value-added taxes, and some
        types
        of excise taxes. The Company has historically presented sales taxes in
        the income statement on a net basis and the adoption of  EITF 06-3 had
        no impact.
  In
        July 2006, the Financial Accounting Standards Board (FASB) issued FASB
        Interpretation No. 48, " *Accounting
        for Uncertainty in Income Taxes—an interpretation of FASB Statement
        No. 109* "
        (FIN
        48). FIN 48 prescribes the financial statement recognition and measurement
        criteria for tax positions taken in a tax return, clarifies when tax benefits
        should be recorded and how they should be classified in financial statements,
        and requires certain disclosures of uncertain tax matters. FIN 48 is effective
        at the beginning of fiscal 2008. We have not finalized evaluating the impact
        of
        the adoption of FIN 48 on our results of operations and financial position,
        but
        we estimate the effect will not be material to the financial statements.
  In
        September 2006, the FASB issued Statement of Financial Accounting Standards
        No. 157, " *Fair
        Value Measurement* "
        (SFAS 157). SFAS 157 provides a definition of fair value, provides
        guidance for measuring fair value in U.S. GAAP and expands disclosures about
        fair value measurements. SFAS 157 will be effective at the beginning of
        fiscal 2008. We are presently evaluating the impact of the adoption of
        SFAS 157 on our results of operations and financial position.
  In
        September 2006, the SEC staff published Staff Accounting Bulletin
        No. 108, " *Considering
        the Effects of Prior Year Misstatements when Quantifying Misstatements in
        Current Year Financial Statements* "
        (SAB
        108). SAB 108 addresses quantifying the financial statement effects of
        misstatements, specifically, how the effects of prior year uncorrected errors
        must be considered in quantifying misstatements in the current year financial
        statements. The Company adopted SAB 108 during the fourth quarter of 2007.
        Upon
        adoption of SAB 108, we recorded a one-time cumulative effect adjustment to
        beginning-of-year retained earnings of $2.7 million. See Note 13 for
        the Consolidated Financial Statements for additional information on the adoption
        of SAB 108.
  **CAUTIONARY
        STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS AND FACTORS THAT MAY AFFECT
        FUTURE RESULTS OF OPERATIONS, FINANCIAL CONDITION OR
        BUSINESS**
  Certain
        statements contained in this Annual Report on Form 10-K that are not statements
        of historical fact may constitute "forward-looking statements" within the
        meaning of Section 21E of the Exchange Act. These statements are subject
        to
        risks and uncertainties, as described below. Examples of forward-looking
        statements include, but are not limited to: (i) projections of
        revenues,
 income
        or
        loss, earnings or loss per share, capital expenditures, store openings, store
        closings, payment or non-payment of dividends, capital structure and other
        financial items, (ii) statements of plans and objectives of the Company’s
        management or Board of Directors, including plans or objectives relating
        to
        inventory, store development, marketing, competition, business strategy,
        store
        environment, merchandising, purchasing, pricing, distribution, transportation,
        store locations and information systems, (iii) statements of future economic
        performance, and (iv) statements of assumptions underlying the statements
        described in (i), (ii) and (iii). Forward-looking statements can often be
        identified by the use of forward-looking terminology, such as “believes,”
“expects,” “may,” “will,” “should,” “could,” “intends,” “plans,” “estimates”,
“projects” or “anticipates,” variations thereof or similar
        expressions.
 
 Forward-looking
        statements are not guarantees of future performance or results. They involve
        risks, uncertainties and assumptions. The Company’s future results of
        operations, financial condition and business operations may differ materially
        from the forward-looking statements or the historical information stated
        in this
        Annual Report on Form 10-K. Stockholders and investors are cautioned not
        to put
        undue reliance on any forward-looking statement.
  There
        are
        a number of factors and uncertainties that could cause actual results of
        operations, financial condition or business contemplated by the forward-looking
        statements to differ materially from those discussed in the forward-looking
        statements made herein or elsewhere orally or in writing, by, or on behalf
        of,
        the Company, including those factors described in “Item 1A. Risk Factors” above.
        Other factors not identified herein could also have such an effect.
  17
 **ITEM
        7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
        RISK.**
 
 The
        Company is subject to market risk from exposure to changes in interest rates
        based on its financing, investing and cash management activities. The Company
        maintains a secured line of credit at variable interest rates to meet the
        short-term needs of its expansion program and seasonal inventory increases.
        The
        credit line available is $70,000, which carries a variable rate of interest.
        On
        June 1, 2005, the Company agreed to extend the existing line of credit with
        Bank
        of America, which was due on April 15, 2006. The loan agreement is now due
        on
        April 15, 2010.
 
 The
        Company’s borrowing arrangement contains no limitation on the change in the
        variable interest rate paid by the Company. Based on the Company’s average
        borrowing outstanding during the year of approximately $23,636, a 1% change
        either up or down in the LIBOR rate would have changed the Company’s interest
        expense by approximately $236.
 
 
 
 
 18
 
  
 
 **ITEM
        8.  FINANCIAL STATEMENTS
        AND SUPPLEMENTARY DATA.**
 
  **INDEX
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **AND
        FINANCIAL STATEMENT SCHEDULES**
 
 
 *DUCKWALL-ALCO
        STORES, INC. AND SUBSIDIARIES*
 PageReport
                  of Independent Registered Public Accounting Firm..........................
              20Financial
                  Statements:Consolidated
                  Balance Sheets --January
                  28, 2007 and January 29, 2006......................................
              21Consolidated
                  Statements of Operations --Fiscal
                  Years Ended January 28, 2007,January
                  29, 2006 and January 30, 2005.....................................
              23Consolidated
                  Statements of Stockholders'Equity
                  -- Fiscal years Ended January 28, 2007,January
                  29, 2006 and January 30, 2005.....................................
              24Consolidated
                  Statements of Cash Flows --Fiscal
                  years Ended January 28, 2007,January
                  29, 2006 and January 30, 2005......................................
              25Notes
                  to Consolidated Financial Statements............................................
              26Financial
                  Statement Schedules:No
                  financial statement schedules are included as they arenot
                  applicable to the Company
 
 
 
 19
  Report
        of
        Independent Registered Public Accounting Firm
  The
          Board
          of Directors and Stockholders
 Duckwall-ALCO
          Stores, Inc.:
  We
          have
          audited the accompanying consolidated balance sheets of Duckwall-ALCO Stores,
          Inc. and subsidiaries (the Company) as of January 28, 2007 and January
          29, 2006,
          and the related consolidated statements of operations, stockholders’ equity, and
          cash flows for each of the years in the three-year period ended January
          28,
          2007. These consolidated financial statements are the responsibility of
          the
          Company’s management. Our responsibility is to express an opinion on these
          consolidated financial statements based on our audits.
  We
          conducted our audits in accordance with the standards of
          the
          Public Company Accounting Oversight Board ( United
          States ).
          Those
          standards require that we plan and perform the audit to obtain reasonable
          assurance about whether the financial statements are free of material
          misstatement. An audit includes examining, on a test basis, evidence supporting
          the amounts and disclosures in the financial statements. An audit also
          includes
          assessing the accounting principles used and significant estimates made
          by
          management, as well as evaluating the overall financial statement presentation.
          We believe that our audits provide a reasonable basis for our
          opinion.
  In
          our
          opinion, the consolidated financial statements referred to above present
          fairly,
          in all material respects, the financial position of Duckwall-ALCO Stores,
          Inc.
          and subsidiaries as of January 28, 2007 and January 29, 2006, and the results
          of
          their operations and their cash flows for each of the years in the three-year
          period ended January 28, 2007, in conformity with U.S. generally
          accepted  accounting
          principles .
  As
          discussed in Notes 1, 9, and 13 to the consolidated financial statements,
          effective January 30, 2006, the Company adopted the fair value method of
          accounting for stock-based compensation as required by Statement of Financial
          Accounting Standards No. 123(R), *Share-Based
          Payment* and
          adopted Staff Accounting Bulletin No. 108, *Considering
          the Effects of Prior Year Misstatements when Quantifying Misstatements
          in
          Current Year Financial Statements* .
  We
          also
          have audited, in accordance with the standards of the Public Company Accounting
          Oversight Board (United States), the effectiveness of Duckwall-ALCO Stores,
          Inc.
          and subsidiaries’ internal control over financial reporting as of January 28,
          2007, based on criteria established in *Internal
          Control—Integrated Framework* issued by the Committee of Sponsoring
          Organizations of the Treadway Commission (COSO) ,
          and our
          report dated April 19, 2007 expressed ** an
          unqualified opinion on management’s assessment of, and an adverse opinion on the
          effective operation of, internal control over financial reporting.
 /s/
        KPMG
        LLP
 
 Omaha,
        Nebraska
 April
        19,
        2007
 
 
  
 20
 
  
 **Duckwall-ALCO
                  Stores, Inc.****And
                  Subsidiaries****Consolidated
                  Balance Sheets**(Dollars
                  in Thousands)**Assets**January
                  28,
              
              
              January
                  29,2007
              
              
              2006Current
                  assets:Cash
                  and cash equivalents
              
              $
              2,983
              
              
              472Receivables
              
              
              3,059
              
              
              2,874Inventories
              
              
              151,406
              
              
              135,077Prepaid
                  expenses
              
              
              1,561
              
              
              2,621Property
                  held for sale
              
              
              -
              
              
              585Deferred
                  income taxes
              
              
              3,037
              
              
              -Total
                  current assets
              
              
              162,046
              
              
              141,629Property
                  and equipment, at cost:Land
                  and Land improvements
              
              
              1,719
              
              
              2,559Buildings
                  and building improvements
              
              
              12,023
              
              
              17,822Furniture,
                  fixtures and equipment
              
              
              56,703
              
              
              52,406Transportation
                  equipment
              
              
              1,491
              
              
              1,370Leasehold
                  Improvements
              
              
              15,410
              
              
              13,897Construction
                  work in progress
              
              
              138
              
              
              4,561Total
                  property and equipment
              
              
              87,484
              
              
              92,615Less
                  accumulated depreciation
              
              
              64,451
              
              
              63,591Net
                  property and equipment
              
              
              23,033
              
              
              29,024Property
                  under capital leases
              
              
              24,571
              
              
              23,228Less
                  accumulated amortization
              
              
              17,618
              
              
              16,367Net
                  property under capital leases
              
              
              6,953
              
              
              6,861Other
                  non-current assets
              
              
              44
              
              
              55Deferred
                  income taxes
              
              
              3,344
              
              
              1,353Total
                  assets
              
              $
              195,420
              
              
              178,922See
                  accompanying notes to consolidated financial
                  statements.
 
 
 21
  
 **Duckwall-ALCO
                  Stores, Inc.****And
                  Subsidiaries****Consolidated
                  Balance Sheets**(Dollars
                  in Thousands)**Liabilities
                  and Stockholders' Equity**January
                  28,
              
              January
                  29,2007
              
              2006Current
                  liabilities:Current
                  maturities of capital lease obligations
              
              $
              2,128
              
              
              1,879Accounts
                  payable
              
              
              35,263
              
              
              28,300Income
                  taxes payable
              
              
              1,915
              
              
              1,163Accrued
                  salaries and commissions
              
              
              4,180
              
              
              6,001Accrued
                  taxes other than income
              
              
              4,242
              
              
              4,743Self-insurance
                  claim reserves
              
              
              4,322
              
              
              3,915Stock
                  purchase payable
              
              
              -
              
              
              1,910Other
                  current liabilities
              
              
              3,634
              
              
              2,998Deferred
                  income taxes
              
              
              -
              
              
              86Total
                  current liabilities
              
              
              55,684
              
              
              50,995Notes
                  payable under revolving loan
              
              
              21,077
              
              
              17,062Capital
                  lease obligations - less current maturities
              
              
              6,783
              
              
              7,299Deferred
                  gain on leases
              
              
              5,372
              
              
              1,132Other
                  noncurrent liabilities
              
              
              444
              
              
              286Total
                  liabilities
              
              
              89,360
              
              
              76,775Stockholders'
                  equity:Common
                  stock, $.0001 par value, authorized20,000,000
                  shares; issued and outstanding3,794,303
                  shares and 3,786,953 shares respectively
              
              
              1
              
              
              1Additional
                  paid-in capital
              
              
              37,315
              
              
              36,411Retained
                  earnings
              
              
              68,744
              
              
              65,735Total
                  stockholders' equity
              
              
              106,060
              
              
              102,147Total
                  liabilities and stockholders' equity
              
              $
              195,420
              
              
              178,922
 
 
 
 22
 
  **Duckwall-ALCO
                  Stores, Inc.****And
                  Subsidiaries****Consolidated
                  Statements of Operations**Fiscal
                  Years ended January 28, 2007; January 29, 2006 and January 30,
                  2005(Dollars
                  in thousands, except per share amounts)2007
              
              
              2006
              
              
              2005Net
                  sales
              
              $
              475,255
              
              
              433,319
              
              
              407,420Cost
                  of sales
              
              
              324,885
              
              
              295,488
              
              
              272,245Gross
                  margin
              
              
              150,370
              
              
              137,831
              
              
              135,175Selling,
                  general and administrative
              
              
              132,165
              
              
              124,208
              
              
              121,154Depreciation
                  and amortization
              
              
              6,795
              
              
              5,940
              
              
              6,407Total
                  operating expenses
              
              
              138,960
              
              
              130,148
              
              
              127,561Income
                  from continuing operations
              
              
              11,410
              
              
              7,683
              
              
              7,614Interest
                  expense
              
              
              2,730
              
              
              1,272
              
              
              1,230Earnings
                  from continuing operations before income taxes and discontinued
                  operations
              
              
              8,680
              
              
              6,411
              
              
              6,384Income
                  tax expense
              
              
              3,046
              
              
              1,754
              
              
              2,192Earnings
                  from continuing operations before
              
              
              5,634
              
              
              4,657
              
              
              4,192discontinuing
                  operationsIncome
                  (loss) from discontinued operations, net of incometax
                  expense (benefit) of $42, ($1,470) and ($188) in2007,
                  2006 and 2005, respectively
              
              
              70
              
              
              (2,708
              )
              
              (269
              )Net
                  earnings
              
              
              5,704
              
              
              1,949
              
              
              3,923Earnings
                  (loss) per share:Basic:Earnings
                  before discontinued operations
              
              
              1.49
              
              
              1.14
              
              
              0.95Discontinued
                  operations
              
              
              0.01
              
              
              (0.66
              )
              
              (0.06
              )Net
                  earnings
              
              
              1.50
              
              
              0.48
              
              
              0.89Earnings
                  (loss) per share:Diluted:Earnings
                  before discontinued operations
              
              
              1.48
              
              
              1.13
              
              
              0.94Discontinued
                  operations
              
              
              0.01
              
              
              (0.66
              )
              
              (0.06
              )Net
                  earnings
              
              $
              1.49
              
              
              0.47
              
              
              0.88See
                  accompanying notes to consolidated financial statements.
 
 
 
 23
  **Duckwall-ALCO
                  Stores, Inc.****And
                  Subsidiaries****Consolidated
                  Statements of Stockholders' Equity**Fiscal
                  Years ended January 28, 2007; January 29, 2006 and January 30,
                  2005(Dollars
                  in thousands, except per share amounts)Commonstock
              
              
              
              
              
              Additional
              
              
              
              
              
              Totalshares
              
              
              Common
              
              
              paid-in
              
              
              Retained
              
              
              stockholders'outstanding
              
              
              stock
              
              
              capital
              
              
              earnings
              
              
              equityBalance,
                  February 1, 2004
              
              
              4,299,816
              
              $
              1
              
              
              49,329
              
              
              59,863
              
              
              109,193Net
                  earnings for the year endedJanuary
                  30, 2005
              
              
              -
              
              
              -
              
              
              -
              
              
              3,923
              
              
              3,923Repurchase
                  and retirement of common shares
              
              
              (5,000
              )
              
              -
              
              
              (80
              )
              
              -
              
              
              (80
              )Income
                  tax benefit related to exercise ofstock
                  options
              
              
              -
              
              
              -
              
              
              375
              
              
              -
              
              
              375Options
                  exercised to purchase shares
              
              
              180,263
              
              
              -
              
              
              1,265
              
              
              -
              
              
              1,265Balance,
                  January 30, 2005
              
              
              4,475,079
              
              
              1
              
              
              50,889
              
              
              63,786
              
              
              114,676Net
                  earnings for the year endedJanuary
                  29, 2006
              
              
              -
              
              
              -
              
              
              -
              
              
              1,949
              
              
              1,949Repurchase
                  and retirement of common shares
              
              
              (729,861
              )
              
              -
              
              
              (14,985
              )
              
              -
              
              
              (14,985
              )Income
                  tax benefit related to exercise ofstock
                  options
              
              
              -
              
              
              -
              
              
              84
              
              
              -
              
              
              84Options
                  exercised to purchase shares
              
              
              41,735
              
              
              -
              
              
              423
              
              
              -
              
              
              423Balance,
                  January 29, 2006
              
              
              3,786,953
              
              
              1
              
              
              36,411
              
              
              65,735
              
              
              102,147Net
                  earnings for the year endedJanuary
                  28, 2007
              
              
              -
              
              
              -
              
              
              -
              
              
              5,704
              
              
              5,704Cumulative
                  change for accounting for inventory
              
              
              -
              
              
              -
              
              
              -
              
              
              (2,695
              )
              
              (2,695
              )Repurchase
                  and retirement of common shares
              
              
              (3,337
              )
              
              -
              
              
              (102
              )
              
              -
              
              
              (102
              )Income
                  tax benefit related to exercise ofstock
                  options
              
              
              -
              
              
              -
              
              
              51
              
              
              -
              
              
              51Stock compensation
                  expense
              
              
              -
              
              
              -
              
              
              821
              
              
              -
              
              
              821Options
                  exercised to purchase shares
              
              
              10,687
              
              
              -
              
              
              134
              
              
              -
              
              
              134Balance,
                  January 28, 2007
              
              
              3,794,303
              
              $
              1
              
              
              37,315
              
              
              68,744
              
              
              106,060See
                  accompanying notes to consolidated financial statements.
 
 
 
 24
  **Duckwall-ALCO
                  Stores, Inc.****And
                  Subsidiaries****Consolidated
                  Statements of Cash Flows**Fiscal
                  Years ended January 28, 2007, January 29, 2006 and January 30,
                  2005(Dollars
                  in thousands)2007
              
              2006
              
              2005Cash
                  flows from operating activities:Net
                  earnings
              
              $
              5,704
              
              
              1,949
              
              
              3,923Adjustments
                  to reconcile net earnings to net cash provided by operating
                  activities:Depreciation
                  and amortization
              
              
              6,801
              
              
              6,006
              
              
              6,804Amortization
                  of debt financing costs
              
              
              11
              
              
              95
              
              
              75Amortization
                  of deferred gain on sale-leasebacks
              
              
              (270
              )
              
              (94
              )
              
              (94
              )(Loss)
                  gain on sale of assets
              
              
              (307
              )
              
              629
              
              
              572Stock
                  compensation expense
              
              
              821
              
              
              -
              
              
              -Tax
                  benefit of stock options exercised
              
              
              36
              
              
              -
              
              
              -Increase
                  in receivables
              
              
              (325
              )
              
              (291
              )
              
              (457
              )Decrease
                  (increase) in prepaid expenses
              
              
              1,060
              
              
              301
              
              
              (456
              )Decrease
                  (increase) in inventories
              
              
              (20,673
              )
              
              (5,591
              )
              
              2,175Increase
                  (decrease) in accounts payable
              
              
              6,963
              
              
              6,066
              
              
              (5,565
              )Increase
                  (decrease) in income taxes payable
              
              
              752
              
              
              896
              
              
              (1,218
              )Increase
                  (decrease) in accrued salaries and commissions
              
              
              (1,821
              )
              
              1,273
              
              
              (747
              )Increase
                  (decrease) in accrued taxes other than income
              
              
              (501
              )
              
              376
              
              
              (129
              )Increase
                  in self-insured claims reserves
              
              
              567
              
              
              550
              
              
              2,211Decrease
                  in deferred revenue
              
              
              -
              
              
              -
              
              
              (419
              )Change
                  in deferred income taxes
              
              
              (3,465
              )
              
              (831
              )
              
              (1,071
              )Increase
                  (decrease) in other assets and liabilities
              
              
              632
              
              
              633
              
              
              (78
              )Net
                  cash (used in) provided by operating activities
              
              
              (4,015
              )
              
              11,967
              
              
              5,526Cash
                  flows from investing activities:Proceeds
                  from sale-leasebacks
              
              
              12,563
              
              
              -
              
              
              1,700Proceeds
                  from the sale of assets
              
              
              1,563
              
              
              50
              
              
              277Acquisition
                  of:Buildings
                  and building components
              
              
              (15
              )
              
              (4,971
              )
              
              (346
              )Fixtures,
                  equipment and leasehold improvements
              
              
              (7,612
              )
              
              (6,150
              )
              
              (6,199
              )Net
                  cash provided by (used in) in investing activities
              
              
              6,499
              
              
              (11,071
              )
              
              (4,568
              )Cash
                  flows from financing activities:Net
                  borrowings (pay downs) under revolving loan credit
                  agreement
              
              
              4,015
              
              
              13,039
              
              
              (935
              )Refinancing
                  costs on revolving loan
              
              
              -
              
              
              (61
              )
              
              -Proceeds
                  from exercise of outstanding stock options
              
              
              113
              
              
              423
              
              
              1,265Excess
                  tax benefit on stock options exercised
              
              
              36
              
              
              -
              
              
              -Repurchase
                  of stock
              
              
              (2,012
              )
              
              (13,075
              )
              
              (80
              )Principal
                  payments on long-term debt
              
              
              -
              
              
              -
              
              
              (533
              )Principal
                  payments under capital lease obligations
              
              
              (2,125
              )
              
              (1,101
              )
              
              (803
              )Net
                  cash provided by (used in) financing activities
              
              
              27
              
              
              (775
              )
              
              (1,086
              )Net
                  increase (decrease) in cash and cash equivalents
              
              
              2,511
              
              
              121
              
              
              (128
              )Cash
                  and cash equivalents at beginning of year
              
              
              472
              
              
              351
              
              
              479Cash
                  and cash equivalents at end of year
              
              $
              2,983
              
              
              472
              
              
              351Supplemental
                  disclosure of non-cash activity:Tax
                  benefit related to stock options exercised
              
              
              -
              
              
              84
              
              
              375Assets
                  acquired under capital lease
              
              
              1,858
              
              
              5,697
              
              
              -See
                  accompanying notes to consolidated financial statements.
 
 
 
 25
  
 
 DUCKWALL-ALCO
        STORES, INC. AND SUBSIDIARIES
 Notes
        to
        Consolidated Financial Statements
 January
        28, 2007, January 29, 2006 and January 30, 2005
 (Dollars
        in thousand, except for per share amounts)
 
 1.
              **Summary
                  of Significant Accounting
                  Policies**
  ***(a)***
              ***Nature
                  of Business***
  Duckwall-ALCO
        Stores, Inc. and subsidiaries (the Company) is engaged in the business of
        retailing general merchandise throughout the central portion of the United
        States of America through discount department and variety store outlets.
        Merchandise is purchased for resale from many vendors, and transactions with
        individual vendors and customers do not represent a significant portion of
        total
        purchases and sales.
  ***(b)***
              ***Principles
                  of Consolidation***
  The
        consolidated financial statements include the accounts of the Company and
        its
        wholly owned subsidiaries. Intercompany account balances have been eliminated
        in
        consolidation.
  ***(c)***
              ***Basis
                  of Presentation***
  The
        Company’s fiscal year ends on the Sunday nearest to January 31.
        Fiscal 2007, 2006, and 2005 each consist of 52 weeks.
  ***(d)***
              ***Inventories***
  Store
        inventories are stated at the lower of cost or net realizable value as estimated
        by the retail inventory method. Warehouse inventories are stated at the lower
        of
        cost or net realizable value. The Company determines lower of cost or net
        realizable value on an individual pool basis.  The Company utilizes the
        last-in, first-out (LIFO) method of determining cost of store and warehouse
        inventories on-hand. In-transit inventories are recorded at cost on a first-in,
        first-out (FIFO) basis. The Company considers payments from vendors (i.e.
        vendor
        rebates and incentives) to be reductions in the cost of inventory unless
        the
        payments are for specific, incremental, identifiable costs incurred to sell
        the
        vendor’s products or services, in which case they are treated as a reduction of
        the related costs.
  ***(e)***
              ***Property
                  and Equipment***
  Depreciation
        is computed on a straight-line basis over the estimated useful lives of the
        assets. Amortization of capital leases is computed on a straight-line basis
        over
        the terms of the lease agreements. Leasehold improvements are amortized on
        a
        straight-line basis over the lesser of the remaining lease term, or
        10 years, unless the cost of the improvement is considered major and the
        lease is within three years of its remaining term, in which case one renewal
        term of the lease is considered. Estimated useful lives are as
        follows:
  Buildings
              
              
              25
                  yearsBuilding
                  improvements
              
              
              10
                  yearsCoolers
                  and freezers
              
              
              15
                  yearsSoftware
              
              
              3
                  - 5 yearsFurniture,
                  fixtures and equipment
              
              
              3
                  - 8 yearsTransportation
                  equipment
              
              
              3
                  - 5 yearsLeasehold
                  improvements
              
              
              2
                  - 10 years
 
  Major
        improvements are capitalized, while maintenance and repairs that do not extend
        the useful life of the asset are charged to expense as incurred.
  The
        Company has sold and leased back certain stores (land and buildings) and
        the
        resulting leases qualify and are accounted for as operating leases.  The
        Company does not have any retained or contingent interests in the
        stores, nor does the Company provide any guarantees, other than a
        guarantee of lease payments, in connection with the sale-leasebacks. The
        net
        proceeds from the sale-leaseback transactions amounted to approximately $12,563,
        $0, and $1,660 for fiscal 2007, 2006, and 2005, respectively. If a gain results
        from the sale-leaseback transaction, such gains are deferred and are being
        amortized over the term of the related leases (15 - 20 years).
  ***(*****f)**
              Operating Leases
  The
        Company accounts for operating leases over the initial lease term without
        regard
        to available renewal options. The Company considers free rent periods and
        scheduled rent increases in determining total rent expense for the initial
        lease
        term. Total rent expense is recognized on a straight-line basis over that
        term.
 
 26
 ***(g)***
              ***Insurance***
  The
        Company carries significant deductibles for its worker’s compensation, general
        liability, and medical insurance. Due to the fact that it takes more than
        one
        year to determine the actual costs under these plans, these costs are estimated
        based on the Company’s historical loss experience and estimates from the
        insurance carriers and consultants.
 
 ***(h)***
              ***Income
                  Taxes***
  The
        Company accounts for income taxes under the asset and liability method. Deferred
        tax assets and liabilities are recognized for the future tax consequences
        attributable to differences between the financial statement carrying amounts
        of
        existing assets and liabilities and their respective tax bases and operating
        loss and tax credit carryforwards. Deferred tax assets and liabilities are
        measured using enacted tax rates expected to apply to taxable income in the
        years in which those temporary differences are expected to be recovered or
        settled. The effect on deferred tax assets and liabilities of a change in
        tax
        rates is recognized in income in the period that includes the enactment date.
        The Company reflects changes in estimates related to prior period income
        taxes
        as a component of current period income tax expense.
  ***(i)***
              ***Net
                  Sales***
  Sales
        are
        recorded in the period of sale. The Company excludes sales taxes from revenue.
        The Company has established sales returns allowance based on the historical
        returns pattern experienced by the Company.
 
 ***(j)***
              ***Net
                  Earnings Per Share***
  Basic
        net
        earnings per share is computed by dividing net earnings by the weighted average
        number of shares outstanding. Diluted net earnings per share reflects the
        potential dilution that could occur if contracts to issue securities (such
        as
        stock options) were exercised. See note 8.
  ***(k)***
              ***Consolidated
                  Statements of Cash
                  Flows***
 For
          purposes of the consolidated statements of cash flows, the Company considers
          cash and cash equivalents to include currency on hand and money market
          funds.
          During fiscal 2007, 2006, and 2005, the following amounts were paid for
          interest and income taxes:
 **2007**
              
              **2006**
              
              **2005**Interest,
                  excluding interest oncapital lease obligations andamortization of debt financingcosts (net of capitalizedInterest of $0 in fiscal 2007, $54in fiscal 2006, and $16 in fiscal 2005)
              
              $
              1,713
              
              
              774
              
              
              648Income
                  taxes
              
              
              5,738
              
              
              584
              
              
              3,991
 
 The
        Company reclassified certain accounts receivable on its Consolidated Balance
        Sheets, which were previously presented as cash and cash equivalents. The
        amounts reclassified on the consolidated balance sheet totaled $1,094 and
        $848
        in 2006 and 2005, respectively. The related change in net cash provided by
        operating activities was ($246) and ($243) in 2006 and 2005, respectively.
 
 
 ***(l)***
              ***Use
                  of Estimates***
  Management
        of the Company has made certain estimates and assumptions in the reporting
        of
        assets and liabilities to prepare these consolidated financial statements
        in
        conformity with U.S. generally accepted accounting principles. Actual results
        could differ from those estimates.
  ***(*****m)**
              **Long-lived
                  Assets**
  Long-lived
        assets are reviewed for impairment whenever events or changes in circumstances
        indicate that the carrying amount of an asset may not be recoverable.
        Recoverability of assets to be held and used is measured by a comparison
        of the
        carrying amount of an asset to estimated future net cash flows expected to
        be
        generated by the asset. If such assets are considered to be impaired, the
        impairment to be recognized is measured by the amount by which the carrying
        amount of the assets exceeds the fair value of the assets. For purposes of
        determining impairment, the Company groups assets at the store level. Assets
        to
        be disposed of are reported at the lower of the carrying amount or fair value
        less costs to sell. Provisions for asset impairment of $130, $0, $0 in fiscal
        2007, 2006 and 2005, respectively, are included in selling, general and
        administrative expense in the consolidated statements of
        operations.
  27
 ***(n)***
              ***Store
                  Closings and Discontinued
                  Operations***
  A
        provision for store closure expenses is recorded when the Company discontinues
        using the facility. A summary of the expense and liability (included in other
        current liabilities) related to store closures as of and for the years ended
        January 28, 2007; January 29, 2006; and January 30, 2005 is as
        follows:
  **2007**
              
              **2006**
              
              **2005**Store
                  closure liability at beginningof
                  year
              
              $
              477
              
              
              107
              
              
              18Store
                  closure (income) expense (included indiscontinued
                  operations)
              
              
              (30
              )
              
              808
              
              
              109Payments
              
              
              (342
              )
              
              (438
              )
              
              (20
              )Store
                  closure liability atend
                  of year
              
              $
              105
              
              
              477
              
              
              107
 
  The
        Company has determined that generally each store is a component of the entity
        and that for each closed store (i) the operations and cash flows of the
        component have been eliminated from the ongoing operations of the entity
        and
        (ii) the entity will not have any significant continuing involvement in the
        operations of the component after the store is closed. This is a result of
        the
        Company’s stores being geographically disbursed. The results of operations for
        stores that have been closed by the Company (one, 23, and seven stores in
        fiscal
        years 2007, 2006, and 2005, respectively) have been reclassified to discontinued
        operations in the accompanying consolidated statements of operations for
        all
        periods presented. The Company does not allocate interest expense to
        discontinued operations.
  ***(o)***
              ***Advertising
                  Costs***
  The
        Company expenses advertising costs as incurred. The Company records payments
        from vendors representing reimbursements of specific identifiable costs as
        a
        reduction of that cost.  Net advertising expenses of $3,893, $6,130 and
        $5,594 in the fiscal years 2007, 2006, and 2005, respectively, are included
        in
        selling, general and administrative expenses.
  ***(p)***
              ***Stock-based
                  Compensation***
  Prior
        to
        January 30, 2006, the Company accounted for share-based payments using the
        intrinsic-value-based recognition method allowed by Accounting Principles
        Board
        Opinion No. 25, " *Accounting
        for Stock Issued to Employees* ,"
        ("APB
        25"). As stock options were granted at an exercise price equal to the fair
        market value of the underlying common stock on the date of grant, no stock-based
        employee compensation cost was reflected in operations prior to adopting
        Statement of Financial Accounting Standards No. 123(R) " *Share-Based
        Payment* "
        ("SFAS
        123(R)").
 
 Effective
        January 30, 2006, the Company adopted SFAS 123(R) and began recognizing
        compensation expense for its share-based payments based on the fair value
        of the
        awards. As the Company adopted SFAS 123(R) under the
        modified-prospective-transition method, results from prior periods have not
        been
        restated. The Company has elected to amortize the compensation expense on
        a
        straight-line basis over the requisite service period.
 
 The
        following table illustrates the effect on net income and earnings per share
        as
        if the Company applied the fair value recognition provisions of Statement
        123 to
        options granted under the Company's stock plans in all periods presented
        prior
        to the adoption of FAS 123(R). The periods represented are fiscal 2006 and
        fiscal 2005. For purposes of this pro forma disclosure, the value of the
        options
        is estimated using a Black-Scholes option pricing model for all option
        grants:
 
 2006
              
              2005Net
                  earnings as reported
              
              $
              1,949
              
              
              3,923Pro
                  forma stock-based employee compensation cost, net of tax
              
              
              (250
              )
              
              (29
              )Pro
                  forma net earnings
              
              
              1,699
              
              
              3,894Earnings per
                  share as reported:Basic
              
              
              0.48
              
              
              0.89Diluted
              
              
              0.47
              
              
              0.88Earnings per
                  share, pro forma:Basic
              
              
              0.42
              
              
              0.89Diluted
              
              $
              0.41
              
              
              0.87
  Under
        SFAS 123(R), forfeitures are estimated at the time of valuation and reduce
        expense ratably over the vesting period. This estimate is adjusted periodically
        based on the extent to which actual forfeitures differ, or are expected to
        differ, from the previous estimate. Under SFAS 123 and APB 25, the Company
        elected to account for forfeitures as they occurred.
  28
 ***(q)***
              ***Fair
                  Value of Financial
                  Instruments***
  The
        Company has determined the fair value of its financial instruments in accordance
        with SFAS No. 107, *Disclosures
        About Fair Value of Financial Instruments.* For
        notes
        payable under revolving loan credit facility, fair value approximates the
        carrying value due to the variable interest rate. For all other financial
        instruments including cash, receivables, accounts payable, and accrued expenses,
        the carrying amounts approximate fair value due to the short maturity of
        those
        instruments.
  ***(r)***
              ***Staff
                  Accounting Bulletin 108 (SAB
                  108)***
  In
        September 2006, the SEC staff published Staff Accounting Bulletin
        No. 108, " *Considering
        the Effects of Prior Year Misstatements when Quantifying Misstatements in
        Current Year Financial Statements* "
        (SAB
        108). SAB 108 addresses quantifying the financial statement effects of
        misstatements, specifically, how the effects of prior year uncorrected errors
        must be considered in quantifying misstatements in the current year financial
        statements. The Company adopted SAB 108 during the fourth quarter of 2007.
        Upon
        adoption of SAB 108, we recorded a one-time cumulative effect adjustment to
        beginning-of-year retained earnings of $2.7 million. See Note 12 for
        the Consolidated Financial Statements for additional information on the adoption
        of SAB 108.
  ***(s)***
              ***Future
                  Accounting
                  Pronouncements***
 In
        July 2006, the Financial Accounting Standards Board (FASB) issued FASB
        Interpretation No. 48, " *Accounting
        for Uncertainty in Income Taxes—an interpretation of FASB Statement
        No. 109* "
        (FIN
        48). FIN 48 prescribes the financial statement recognition and measurement
        criteria for tax positions taken in a tax return, clarifies when tax benefits
        should be recorded and how they should be classified in financial statements,
        and requires certain disclosures of uncertain tax matters. FIN 48 is effective
        at the beginning of fiscal 2008. We are presently evaluating the impact of
        the
        adoption of FIN 48 on our results of operations and financial
        position.
 
 In
        September 2006, the FASB issued Statement of Financial Accounting Standards
        No. 157, " *Fair
        Value Measurement* "
        (SFAS 157). SFAS 157 provides a definition of fair value, provides
        guidance for measuring fair value in U.S. GAAP and expands disclosures about
        fair value measurements. SFAS 157 will be effective at the beginning of
        fiscal 2008. We are presently evaluating the impact of the adoption of
        SFAS 157 on our results of operations and financial position.
 
 **2.**
              **Inventories**
  Inventories
        at January 28, 2007 and January 29, 2006 are stated at the lower of
        cost or net realizable value as determined under the LIFO method of accounting.
        Inventories at January 28, 2007 and January 29, 2006 are summarized as
        follows:
  2007
              
              2006FIFO
                  cost
              
              $
              155,153
              
              
              135,672Less
                  LIFO and markdown reserves
              
              
              (3,747
              )
              
              (595
              )LIFO
                  Cost
              
              $
              151,406
              
              
              135,077
 
  **3.**
              **Credit
                  Arrangements, Notes Payable, and Long-term
                  Debt**
  The
        Company has a loan agreement that provides a revolving loan credit facility
        of
        up to $70,000 of long-term financing which expires April 15, 2010. The amount
        advanced (through a note or letters of credit) to the Company bears interest
        at
        (i) the prime rate plus a margin, as defined, which varies based on the amount
        outstanding (Base Loan) or (ii) based on the Euro dollar rate plus a margin,
        as
        defined, (Index Loan). The amount advanced is generally limited to 70% of
        eligible inventory, as defined. Advances are secured by a security interest
        in
        the Company’s inventory. The loan agreement contains various restrictions that
        are applicable when outstanding borrowings reach certain thresholds, including
        limitations on additional indebtedness, acquisitions of assets, and payment
        of
        dividends.
  Notes
        payable outstanding at January 28, 2007 and January 29, 2006 under the
        revolving loan credit facility aggregated $21,077 and $17,062, respectively.
        The
        lender had also issued letters of credit aggregating $3,346 and $3,978,
        respectively, at such dates on behalf of the Company. The interest rates
        on
        outstanding borrowings at January 28, 2007 were 6.41%. The Company had
        additional borrowings available at January 28, 2007 under the revolving
        loan credit facility amounting to $45,577.
  Interest
        expense on notes payable and long-term debt in fiscal 2007, 2006, and 2005
        aggregated $1,713, $644, and $522, respectively.
  **4.**
              **Employee
                  Benefits**
  On
        February 1, 2006, the Company amended its Profit Sharing Plan to include
        a
        401(k) component. The Company matches the employee’s contribution to half of the
        first 4% contributed by the employee. Contributions by the Company vest with
        the
        participants over a seven-year period. Expense arising for Company matches
        for
        fiscal 2007 amounted to $478.
 
 For
        fiscal 2006 and before, the Company had a trusteed Profit Sharing Plan
        (the Plan) for the benefit of eligible employees. The Plan provides for an
        annual contribution of not more than 20% of earnings for the year before
        the
        profit sharing contribution and Federal and state income taxes, limited to
        15%
        of the annual compensation of the participants in the Plan. Contributions
        by the
        Company vest with the participants over a seven-year period. The Company
        reserves the right to discontinue its contributions at any time. Expense
        arising
        from profit sharing for fiscal 2007, 2006 and 2005 amounted to $0, $0 and
        $420,
        respectively.
  29
 **5.**
              
              **Leases**
  The
        Company is lessee under long-term capital leases expiring at various dates.
        The
        components of property under capital leases as of January 28, 2007 and
        January 29, 2006 are as follows:
  **2007**
              
              **2006**Buildings
              
              $
              14,375
              
              
              14,890Fixtures
              
              
              3,338
              
              
              3,338Software
              
              
              6,858
              
              
              5,00024,571
              
              
              23,228Less
                  accumulated amortization
              
              
              17,618
              
              
              16,367Net
                  property under capital leases
              
              $
              6,953
              
              
              6,861
 
  The
        Company also has noncancelable operating leases, primarily for buildings
        that
        expire at various dates.
  Future
        minimum lease payments under all noncancelable leases, together with the
        present
        value of the net minimum lease payments pursuant to capital leases, as of
        January 28, 2007 are as follows:
  
 
 **Capital**
              
              **Operating****leases**
              
              **leases**Fiscal
                  year:2008
              
              $
              3,012
              
              
              12,5902009
              
              
              2,376
              
              
              10,7782010
              
              
              2,263
              
              
              8,9482011
              
              
              1,930
              
              
              6,5192012
              
              
              592
              
              
              4,545Later
                  years
              
              
              769
              
              
              22,417Total
                  minimum lease payments
              
              
              10,942
              
              $
              65,797Less amount representing interest
              
              
              2,031Present
                  value of net minimum lease payments
              
              
              8,911Less current maturities
              
              
              2,128Capital
                  lease obligations, less current maturities
              
              $
              6,783
  Minimum
        payments have not been reduced by minimum sublease rentals of $20 under
        operating leases due in the future under noncancelable subleases. They also
        do
        not include contingent rentals, which may be paid under certain store leases
        on
        the basis of percentage of sales in excess of stipulated amounts. Contingent
        rentals applicable to capital leases amounted to $120, $100 and $88 for fiscal
        2007, 2006 and 2005, respectively.
  The
        Company entered into a software lease and a flexible lease financing proposal
        regarding the lease of POS hardware with General Electric Capital Corporation
        (“GECC”) on December 1, 2005 and December 5, 2005, respectively. The software
        lease, which is a capital lease, began on January 1, 2006 and has a term
        of five
        years. The hardware lease, which is an operating lease, began on September
        30,
        2006, and has a term of four years. The Company leased an additional $1,858
        during fiscal 2007 under this capital lease.
  The
        interest on capital lease obligations in fiscal 2007, 2006 and 2005 aggregated
        $381, $544 and $583, respectively.
  The
        following schedule presents the composition of total rent expense for all
        operating leases for fiscal 2007, 2006 and 2005:
  **2007**
              
              **2006**
              
              **2005**Minimum
                  rentals
              
              $
              12,261
              
              
              10,768
              
              
              10,973Contingent
                  rentals
              
              
              1,501
              
              
              1,120
              
              
              967Less
                  sublease rentals
              
              
              (51
              )
              
              (53
              )
              
              (58
              )$
              13,711
              
              
              11,835
              
              
              11,882
 
 30
  **6.**
              **Income
                  Taxes**
  
 The
        Company’s income tax expense consists of the following:
  **2007**
              
              **2006**
              
              **2005**Income
                  tax expense allocatedto
                  continuing operations
              
              $
              3,046
              
              
              1,754
              
              
              2,192Income
                  tax expense (benefit) allocatedto
                  discontinued operations
              
              
              42
              
              
              (1,470
              )
              
              (188
              )Total
                  income tax expense
              
              $
              3,088
              
              
              284
              
              
              2,004
 
  Income
        tax expense (benefit) attributable to continuing operations for fiscal 2007,
        2006, and 2005 consists of:
 **Current**
                
                **Deferred**
                
                **Total**2007:Federal
                
                $
                5,638
                
                
                (2,889
                )
                
                2,749State
                
                
                873
                
                
                (576
                )
                
                2976,511
                
                
                (3,465
                )
                
                3,0462006:Federal
                
                
                2,144
                
                
                (626
                )
                
                1,518State
                
                
                441
                
                
                (205
                )
                
                2362,585
                
                
                (831
                )
                
                1,7542005:Federal
                
                
                2,882
                
                
                (898
                )
                
                1,984State
                
                
                381
                
                
                (173
                )
                
                208$
                3,263
                
                
                (1,071
                )
                
                2,192
  
  Income
        tax expense attributable to continuing operations was $3,046, $1,754, and
        $2,192
        for fiscal 2007, 2006, and 2005, respectively, and differs from the amounts
        computed by applying the Federal income tax rate of 35% in 2007, 2006, and
        2005
        as a result of the following:
  **2007**
              
              
              **2006**
              
              
              **2005**Computed
                  “expected” tax expense
              
              $
              3,038
              
              
              2,244
              
              
              2,235State
                  income taxes, net of the Federalincome
                  tax benefit
              
              
              195
              
              
              215
              
              
              135Adjustment
                  for prior period taxes
              
              
              (36
              )
              
              (371
              )
              
              -Other,
                  net
              
              
              (151
              )
              
              (334
              )
              
              (178
              )$
              3,046
              
              
              1,754
              
              
              2,192
 
  The
        Company analyzes its income tax liability account based on current information.
        As a result of this analysis, the Company determined that it was overaccrued
        with respect to certain matters arising in prior years. The Company reversed
        this overaccrual of approximately $371 in the fourth quarter of fiscal 2006.
  31
 The
        tax
        effects of temporary differences that give rise to significant portions of
        deferred tax assets and liabilities at January 28, 2007 and
        January 29, 2006 are presented below:
  **2007**
                
                
                **2006**Deferred
                    tax assets:Capital
                    leases
                
                $
                449
                
                
                645Other
                    liabilities
                
                
                803
                
                
                948Insurance
                    reserves
                
                
                1,640
                
                
                1,486Vacation
                    and sick pay accrual
                
                
                862
                
                
                869Property
                    and equipment, due to differences in depreciation
                
                
                434
                
                
                133Inventory
                
                
                419
                
                
                -Deferred
                    gain property and equipment
                
                
                2,042
                
                
                412State
                    net operating loss carryforwards
                
                
                78
                
                
                1796,727
                
                
                4,672Less
                    valuation allowance
                
                
                -
                
                
                (122
                )Total
                    deferred tax assets
                
                
                6,727
                
                
                4,550Deferred
                    tax liabilities:Inventory
                
                
                -
                
                
                3,012Other
                    assets
                
                
                346
                
                
                271Total
                    deferred tax liabilities
                
                
                346
                
                
                3,283Net
                    deferred tax asset
                
                $
                6,381
                
                
                1,267
 
  At
        January 28, 2007, the Company has net operating loss carryforwards for
        state income tax purposes aggregating $870, which are available to offset
        future
        state taxable income in those states. These net operating losses begin expiring
        in fiscal 2020. At January 29, 2006 the Company had a valuation allowance
        against the net operating losses. Due to the history of earnings and projected
        future results the Company believes it is more likely than not those future
        operations will generate sufficient taxable income to realize the deferred
        tax
        assets. As such, at January 28, 2007 there is no valuation allowance on the
        net
        operating losses.
  The
        Company is not currently under exam by the Internal Revenue Service. Fiscal
        year
        February 2, 2003 was the most recent year examined by the Internal Revenue
        Service. The federal statute of limitations is open for fiscal years 2004
        through 2007.
  
 **7.**
              **Stockholders’
                  Equity**
  On
        March
        23, 2006, the Board of Directors approved a plan authorizing the repurchase
        200,000 shares of the Company’s common stock, of which 3,337 shares have been
        repurchased at an average cost of $30.46. As of January 28, 2007, 196,663
        shares
        remain available to be repurchased.
 
 **8.**
              **Earnings
                  Per Share**
  The
        following is a reconciliation of the outstanding shares utilized in the
        computation of earnings per share:
  **2007**
              
              **2006**
              
              **2005**Weighted
                  average shares outstanding(basic)
              
              
              3,792,202
              
              
              4,083,798
              
              
              4,391,538Effect
                  of dilutive options to purchasecommon
                  stock
              
              
              36,726
              
              
              34,124
              
              
              72,878As
                  adjusted for dilutedcalculation
              
              
              3,828,928
              
              
              4,117,922
              
              
              4,464,416
 
 **9.**
              **Share-Based
                  Compensation**
  In
        fiscal
        2007, compensation expense (a component of selling and general and
        administrative expenses) in the amount of $821 related to the Company's stock
        plans. This share-based compensation expense lowered pre-tax earnings by
        $821,
        lowered net income by $536, and lowered basic and diluted earnings per share
        by
        $0.14. SFAS 123(R) also requires the benefits of tax deductions in excess
        of
        recognized compensation cost to be reported as a financing activity, rather
        than
        as an operating activity in the statement of cash flows as required prior
        to
        SFAS 123(R). The change resulted in $36 being shown as a cash flow from
        financing activities rather than operating activities. The Company issues
        these
        grants from the unissued shares authorized.
 
 32
 Under
        the
        Company's 2003 Incentive Stock Option Plan, options may be granted to officers
        and key employees, not to exceed 500,000 shares. According to the terms of
        the
        plan, the per share exercise price of options granted shall not be less than
        the
        fair market value of the stock on the date of grant and such options will
        expire
        no later than five years from the date of grant. The options vest in equal
        amounts over a four year requisite service period beginning from the grant
        date.
        In the case of a stockholder owning more than 10% of the outstanding voting
        stock of the Company, the exercise price of an incentive stock option may
        not be
        less than 110% of the fair market value of the stock on the date of grant
        and
        such options will expire no later than five years from the date of grant.
        Also,
        the aggregate fair market value of the stock with respect to which incentive
        stock options are exercisable on a tax deferred basis for the first time
        by an
        individual in any calendar year may not exceed $100,000. In the event that
        the
        foregoing results in a portion of an option exceeding the $100,000 limitation,
        such portion of the option in excess of the limitation shall be treated as
        a
        nonqualified stock option. At January 28, 2007, the Company had 130,000 shares
        authorized for future option grants.
 
 Under
        the
        Company’s Non-Qualified Stock Option Plan for Non-Management Directors, options
        may be granted to Directors of the Company who are not otherwise officers
        or
        employees of the Company, not to exceed 120,000 shares. According to the
        terms
        of the plan, the per share exercise price of options granted shall not be
        less
        than the fair market value of the stock on the date of grant and such options
        will expire five years from the date of grant. The options vest in equal
        amounts
        over a four year requisite service period beginning from the grant date.
        All
        options under the plan shall be non-qualified stock options. There are no
        shares
        remaining to be issued under this plan. The Company issued these grants from
        the
        unissued shares authorized, which the Company registered during the fourth
        quarter of Fiscal 2007.
 
 The
        Company previously issued options under the 1993 Incentive Stock Option Plan.
        This plan was structured in the same fashion as the 2003 Incentive Stock
        Option
        Plan described above, however it did not specify the 10% ownership rules.
        There
        are no shares remaining to be issued under this plan. As of January 28, 2007,
        11,951 options were outstanding under this plan.
 
 The
        fair
        value of each option is recorded as compensation expense recorded a
        straight-line basis beginning with the grant date for the award over the
        requisite service. The Company has estimated the fair value of all stock
        option
        awards as of the date of the grant by applying a Black-Scholes pricing valuation
        model. The application of this valuation model involves assumptions that
        are
        judgmental and highly sensitive in the determination of the fair value. No
        options were issued in fiscal 2005. The weighted average for key assumptions
        used in determining the fair value of options granted in the fifty-two weeks
        ended January 28, 2007 and January 29, 2006 and a summary of the methodology
        applied to develop each assumption are as follows:
 
 January
                  28,
              
              January
                  29,2007
              
              2006Expected
                  price volatility
              
              
              37.40
              %
              
              38.40
              %Risk-free
                  interest rate
              
              
              5.00
              %
              
              4.00
              %Weighted
                  average expected lives in years
              
              
              3.8
              
              
              5Dividend
                  yield
              
              
              0.00
              %
              
              0.00
              %
 
 
 EXPECTED
        PRICE VOLATILITY -- This is a measure of the amount by which a price has
        fluctuated or is expected to fluctuate. The Company uses actual historical
        changes in the market value of its stock to calculate expected price volatility
        because management believes that this is the best indicator of future
        volatility. The Company calculates monthly market value changes from the
        date of
        grant over a past period to determine volatility. An increase in the expected
        volatility will increase compensation expense.
  RISK-FREE
        INTEREST RATE -- This is the U.S. Treasury rate for the date of the grant
        over
        the expected term. An increase in the risk-free interest rate will increase
        compensation expense.
  EXPECTED
        LIVES -- This is the period of time over which the options granted are expected
        to remain outstanding and is based on management’s expectations in relation to
        the holders of the options. Options granted have a maximum term of five years.
        An increase in the expected life will increase compensation
        expense.
  DIVIDEND
        YIELD --- The Company has not made any dividend payments nor does it have
        plans
        to pay dividends in the foreseeable future. An increase in the dividend yield
        will decrease compensation expense.
 
 A
        summary
        of stock option activity since the Company’s most recent fiscal year-end is as
        follows:
 
 Number
                of
                Shares
              
              Weighted
                Average
                Exercise
                Price
              
              Weighed
                Average
                Remaining
                Contractual
                Term
              
              Aggregate
                Intrinsic
                Value
                  (in thousands)Outstanding
                  January 29, 2006
              
              
              133,238
              
              $
              17.37Granted
              
              
              392,000
              
              
              30.35Exercised
              
              
              (10,687
              )
              
              12.50Forfeited/Expired
              
              
              (12,600
              )
              
              29.90Outstanding
                  January 28, 2007
              
              
              501,951
              
              $
              26.13
              
              
              4.0
              
              $
              4,500Expected
                  to vest at January 28, 2007
              
              
              492,951
              
              $
              27.30
              
              
              4.0
              
              $
              4,452Exercisable
                  at January 28, 2007
              
              
              39,451
              
              $
              16.61
              
              
              2.3
              
              $
              772
 
 33
 The
        aggregate intrinsic values in the table above represents the total difference
        between the Company's closing stock price on January 28, 2007 and the option
        exercise price, multiplied by the number of in-the-money options as of January
        28, 2007. As of January 28, 2007, total unrecognized compensation expense
        related to non-vested stock options is $3.5 million with a weighted average
        expense recognition period of 3.6 years.
 
 A
        summary
        of the status of the Company’s nonvested shares as of January 28, 2007 is
        presented below:
 
 Number
                  of Shares
              
              Weighted
                  Average
                Grant
                  Date
                Fair
                  Value (per share)Nonvested
                  at January 29, 2006
              
              
              118,920
              
              $
              7.20Granted
              
              
              392,000
              
              
              10.59Vested
              
              
              (36,332
              )
              
              6.84Forfeited
              
              
              (12,088
              )
              
              10.16Nonvested
                  at January 28, 2007
              
              
              462,500
              
              $
              10.02
 
 Other
        information relative to option activity during the fifty-two weeks ended
        January
        28, 2007 and January 29, 2006 is as follows:
 
 January
                  28,
              
              January
                  29,2007
              
              2006Weighted
                  average grant date fair value of stock options granted (per
                  share)
              
              $
              10.59
              
              
              7.36Total
                  fair value of stock options vested
              
              
              249
              
              
              54Total
                  intrinsic value of stock options exercised
              
              
              184
              
              
              458
  **10.**
              **Quarterly
                  Financial Information
                  (Unaudited)**
  Financial
        results by quarter are as follows:
 
 First
              
              Second
              
              Third
              
              FourthQuarter
              
              Quarter
              
              Quarter
              
              Quarter(1)(2)Fiscal
                  2007Net Sales
              
              $
              108,763
              
              
              120,252
              
              
              110,109
              
              
              136,131Gross
                  Margin
              
              
              32,466
              
              
              36,113
              
              
              34,285
              
              
              47,506Earnings
                  from continuing operations
              
              
              329
              
              
              1,436
              
              
              (558
              )
              
              4,427Net
                  Earnings (loss)
              
              
              540
              
              
              1,417
              
              
              (646
              )
              
              4,393Net
                  Earnings (loss) per share (3):Basic
              
              
              0.14
              
              
              0.37
              
              
              (0.17
              )
              
              1.16Diluted
              
              
              0.14
              
              
              0.37
              
              
              (0.17
              )
              
              1.14Fiscal
                  2006Net Sales
              
              $
              97,586
              
              
              108,282
              
              
              100,741
              
              
              126,710Gross
                  Margin
              
              
              30,396
              
              
              32,562
              
              
              32,541
              
              
              42,332Earnings
                  from continuing operations
              
              
              (1,157
              )
              
              727
              
              
              (51
              )
              
              5,138Net
                  Earnings (loss)
              
              
              (2,730
              )
              
              (294
              )
              
              (187
              )
              
              5,160Net
                  Earnings (loss) per share (3):Basic
              
              
              (0.62
              )
              
              (0.07
              )
              
              (0.05
              )
              
              1.34Diluted
              
              
              (0.62
              )
              
              (0.07
              )
              
              (0.05
              )
              
              1.33
  (1)
              In
                  fiscal 2007, an increase in shrinkage of $795 in the fourth quarter
                  negatively impacted gross margin. A LIFO, lower or cost or market
                  adjustment of $795 positively impacted gross margin. A shrinkage
                  reserve
                  of $300 negatively impacted gross
                  margin.
  (2)
              In
                  fiscal 2006, the reduction in shrinkage related to a warehouse
                  inventory
                  adjustment contributed $1.3 million to the gross margin. A reversal
                  of an
                  over-accrual of income taxes of $371 positively impacted net
                  earnings.
 
 (3)
              Earnings
                  per share amounts are computed independently for each of the quarters
                  presented. Therefore, the sum of the quarterly earnings per share
                  in
                  fiscal 2007 and fiscal 2006 does not equal the total computed for
                  the
                  year.
  34
 **11.**
              **Related
                  Party Transactions**
  Operating
        lease payments to related parties (board members and related companies) amounted
        to approximately $699, $680 and $673, in fiscal 2007, 2006 and 2005,
        respectively. All of these lease agreements were initiated prior to fiscal
        2005
        and have not been modified.
  During
        fiscal 2007, 2006 and 2005, the Company paid a consulting firm $0, $0 and
        $15,
        respectively, to develop certain retailing initiatives. A board member of
        the
        Company has an ownership interest in the consulting firm.
  **12.**
              **Business
                  Operations**
  The
        Company’s business activities include operation of ALCO discount stores and
        Duckwall variety stores. Even though the Company has two types of stores,
        it is
        operating them as a single segment. The Company has changed the reporting
        of
        information to the chief decision makers to look at the operation of the
        Company
        in total.
  The
        Company has many suppliers with which it conducts business. For fiscal 2007,
        only one vendor represented more than 5% of the Company merchandise purchases.
        This supplier is Proctor & Gamble. The loss of this one vendor would not
        have adverse effects on the ability to obtain like products and overall results
        of operations.
  For
        2007
        and 2006, the percentage of sales by product category were as
        follows:
 Percentage
                  of Sales2007
              
              2006Merchandise
                  Category:Consumables
                  and commodities
              
              
              30
              %
              
              30
              %Electronics,
                  entertainment, sporting goods, toys and outdoor living
              
              
              25
              %
              
              25
              %Apparel
                  and accessories
              
              
              20
              %
              
              19
              %Home
                  furnishings and decor
              
              
              14
              %
              
              15
              %Other
              
              
              11
              %
              
              11
              %Total
              
              
              100
              %
              
              100
              %
 
  **13.**
              **Staff
                  Accounting Bulletin 108 (SAB
                  108)**
  As
        discussed under New Accounting Standards in Note 1, in September 2006, the
        SEC released SAB 108. The transition provisions of SAB 108 permit the
        Company to adjust for the cumulative effect on retained earnings of errors
        relating to prior years. In accordance with SAB 108, the Company adjusted
        beginning retained earnings for fiscal 2006 in the accompanying consolidated
        financial statements for the items described below which had previously been
        considered immaterial.
 
 *Capitalized
        Cash Discounts:* The
        Company adjusted its beginning retained earnings for fiscal 2007 related
        to
        recording cash discounts taken directly to cost of goods sold rather than
        being
        shown as a reduction in inventory. It was determined that the Company had
        improperly excluded approximately $752 which should have been shown as a
        reduction in inventory.
 
 *LIFO:* The
        Company adjusted its beginning retained earnings for fiscal 2007 related
        to a
        historical difference between the previously established policy of determining
        lower of cost or market adjustments on the aggregate for all LIFO pools rather
        than on a pool by pool basis. It was determined that the Company had improperly
        not recorded a LIFO reserve of $4.2 million.
 
 The
        cumulative effect of each of the items noted above for fiscal 2007 beginning
        balances are presented below:
 
 Description
              
              
              Current
              
              
              Deferred
              
              
              RetainedAssets
              
              
              Income
                  Taxes
              
              
              EarningsInventory
              
              $
              (4,344
              )
              
              -
              
              
              4,344Deferred
                  Tax Asset
              
              
              -
              
              
              1,649
              
              
              (1,649
              )Total
              
              $
              (4,344
              )
              
              1,649
              
              
              2,695
 
 **ITEM
        9.**   **CHANGES
        IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
        AND** **FINANCIAL
        DISCLOSURE.**
  None
  35
 **ITEM
          9A.**  **CONTROLS
          AND PROCEDURES.**
 
 (a)
              Evaluation
                  of Disclosure Controls and Procedures 
 As
          of the
          end of the period covered by this report, management of the Company, with
          the
          participation of the Chief Executive Officer and the Chief Financial Officer,
          evaluated the effectiveness of the design and operation of the Company’s
          disclosure controls and procedures (as defined in Rule 13a-15(e) of the
          Securities and Exchange Act of 1934, as amended) as of January 28, 2007.
          Based
          upon this evaluation, the Chief Executive Officer and the Chief Financial
          Officer have concluded that the Company’s disclosure controls and procedures
          were not effective as of January 28, 2007 because of the material weaknesses
          described in internal control over financial reporting described below
          in Item
          9A(b).
 
 (b)
              Management’s
                  Report on Internal Control over Financial
                  Reporting 
 Management
          of the Company is responsible for establishing and maintaining adequate
          control
          over financial reporting as defined in Rule 13a-15(f) under the Securities
          and
          Exchange Act of 1934, as amended. The Company’s internal control system is a
          process designed to provide reasonable assurance regarding the reliability
          of
          financial reporting and the preparation of financial statements for external
          reporting purposes in accordance with U.S. generally accepted accounting
          principles. Because of its inherent limitations, internal control over
          financial
          reporting may not prevent or detect misstatements. Also, projections of
          any
          evaluation of effectiveness to future periods are subject to the risk that
          controls may become inadequate because of changes in conditions, or that
          the
          degree of compliance with the policies or procedures may deteriorate.
 
 A
          material weakness represents a significant deficiency (as defined in the
          Public
          Company Accounting Oversight Board’s Auditing Standard No. 2), or a combination
          of significant deficiencies, that results in more than a remote likelihood
          that
          a material misstatement of the annual or interim financial statements will
          not
          be prevented or detected by management or employees in the course normal
          course
          of performing their assigned functions.
 
 Management
          assessed the effectiveness of the Company’s internal control over financial
          reporting as of January 28, 2007 based on the criteria established in *Internal
          Control- Integrated Framework* issued ** by
          the
          Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). As a
          result of this assessment, management concluded that the Company’s internal
          control over financial reporting was not effective as of January 28, 2007.
 
 ·
              The
                  control environment influences the control consciousness of its
                  people,
                  and is the foundation of all other components of internal control
                  over
                  financial reporting. The Company's control environment did not
                  sufficiently promote effective internal control over financial
                  reporting
                  throughout the organization. Material weaknesses in the control
                  environment were a contributing factor in the material weaknesses
                  listed
                  below and resulted in more than a remote likelihood that material
                  misstatements of the annual or interim financial statements would
                  not be
                  prevented or detected. Specifically, the following material weaknesses
                  were identified in the Company’s control environment as of January 28,
                  2007: 
 ·
              A
                  sufficient complement of skilled finance, tax and accounting resources
                  did
                  not exist to perform supervisory reviews and monitoring activities
                  over
                  certain financial reporting
                matters
                  and controls. 
 ·
              An
                  adequate control consciousness did not exist to support effective
                  application of policies and the execution of procedures within
                  the daily
                  operation of financial reporting
                controls. 
 Management’s
          assessment identified the following additional material weaknesses in the
          Company’s internal control over financial reporting as of January 28,
          2007:
 
 ·
              The
                  Company did not maintain effective policies and procedures related
                  to
                  accounting for fixed assets to ensure such accounting complied
                  with U.S.
                  generally accepted accounting principles. Specifically, the Company’s
                  policies and procedures did not provide for a sufficient review
                  of the
                  reconciliation of the fixed asset system to the general ledger
                  and the
                  application of capitalization policies. As a result of this deficiency,
                  there were errors in fixed assets, accumulated depreciation, and
                  selling,
                  general & administrative expense in the Company’s financial statements
                  and there is more than a remote likelihood that a material misstatement
                  of
                  the annual or interim financial statement would not be prevented
                  or
                  detected. 
 ·
              The
                  Company did not maintain effective policies and procedures over
                  payroll
                  processing. Specifically, there was inadequate segregation of duties
                  between the human resources and payroll functions. In addition,
                  the
                  Company’s policies and procedures did not include a reconciliation of
                  employee payroll withholding amounts as reported on the payroll
                  register
                  to the amounts recorded in the general ledger. As a result of these
                  deficiencies, there is more than a remote likelihood that a material
                  misstatement of the annual or interim financial statement would
                  not be
                  prevented or detected. 
 ·
              The
                  Company did not maintain effective policies and procedures that
                  require a
                  sufficiently detailed review of the Company’s financial statements prior
                  to their issuance. As a result of this deficiency, there were material
                  errors in classification of deferred income taxes, and cash flows,
                  and
                  omission of required disclosures in the Company’s financial
                  statements. 
 ·
              The
                  Company did not maintain effective policies and procedures related
                  to
                  accounting for significant accrued liabilities to ensure such accounting
                  was in accordance with U.S. generally accepted accounting principles
                  on an
                  interim and annual basis. Specifically, the Company’s policies and
                  procedures did not provide for sufficient review of the assumptions
                  used
                  for vendor support and employee bonus accruals at interim financial
                  reporting periods to validate these estimates through comparison
                  to actual
                  activities upon which the estimates are based. As a result of this
                  deficiency, there were errors in accrued liabilities, cost of goods
                  sold,
                  and selling, general & administrative expense andthere
                  is more than a remote likelihood that a material misstatement of
                  the
                  annual or interim financial statement would not be prevented or
                  detected. 
 ·
              The
                  Company did not maintain effective policies and procedures related
                  to
                  accounting for inventory to ensure such accounting is in accordance
                  with
                  U.S. generally accepted accounting principles. Specifically, the
                  Company’s
                  policies and procedures did not provide for sufficient analysis
                  of the
                  policies applied to payment discounts, LIFO and lower of cost or
                  net
                  realizable value calculations to ensure that such accounting complies
                  with
                  U.S. generally accepted accounting principles. In addition, the
                  Company’s
                  policies and procedures did not provide for sufficient analysis
                  of the
                  most recently identified inventory shrinkage trends to determine
                  whether
                  the existing estimation techniques should modified. As a result
                  of this
                  deficiency, there were material errors in inventory and cost of
                  goods sold
                  in the Company’s financial statements. 
 36
 Our
          independent auditor, KPMG LLP, the independent registered public accounting
          firm
          that audited the financial statements included in this report on Form 10-K,
          has
          issued an audit report on management's assessment of the Company's internal
          control over financial reporting. Their audit report appears in Item
          8.
 
 (c)
              Changes
                  in Internal Control over Financial
                  Reporting 
 There
          were no changes in the Company’s internal control over financial reporting that
          occurred during the quarter ended January 28, 2007 that materially affected,
          or
          are reasonably likely to materially affect, the Company’s internal control over
          financial reporting.
 
 To
          address the material weaknesses described above the Company:
  ·
              in
                  evaluating the overall control environment, the Company recognizes
                  its
                  need in this area.  The Company began a process of evaluating its
                  level of skill in finance, tax and accounting prior to this year.  To
                  assist our staff, in fiscal 2006, the Company engaged an external
                  resource
                  to assist in analyzing and evaluating its internal control structure,
                  including development of additional controls and improvement of
                  existing
                  controls.  The Company began hiring and staffing an internal audit
                  department in the fourth quarter of fiscal 2007.  The Company
                  continues to evaluate the need for training in internal financial
                  control
                  procedures throughout the organization.  This will include the review
                  of the level of skill in finance, tax and accounting to adequately
                  assure
                  proper supervisory review and monitoring activities over certain
                  financial
                  reporting matters and controls.  Emphasis will be made to assure an
                  adequate control consciousness exists throughout the
                  organization. 
 ·
              has
                  begun a review and plans to document all policies and procedures
                  relating
                  to the accounting for fixed assets in a Capitalized Asset Policy,
                  which
                  will define controls to ensure compliance to U.S. generally accepted
                  accounting principles and to assure the accuracy of all fixed asset
                  activity. 
 ·
              is
                  currently in the process of establishing the appropriate segregation
                  between human resources and payroll. This process is planned to
                  be
                  completed by the second quarter of fiscal 2008. The reconciliation
                  of
                  employee payroll withholding amounts as reported on the payroll
                  register
                  to the amounts recorded in the general ledger is planned to be
                  reviewed by
                  management personnel on a monthly basis. Evaluation and training
                  of
                  personnel responsible for reconciliations to assure proper staffing
                  in
                  these areas have begun and is planned to be completed by the second
                  quarter of fiscal 2008. 
 ·
              has
                  initiated the development and implementation of controls over the
                  development and review of the financial statements and continues
                  to refine
                  and document those controls and procedures. The Company is currently
                  evaluating its staffing needs and will make adjustments and additions
                  in
                  personnel as necessary to adequately staff with skilled finance,
                  tax and
                  accounting resources to perform the necessary reviews of financial
                  statements. 
 ·
              has
                  developed and is testing procedures to analyze and monitor existing
                  accounting policies for significant accrued liabilities to ensure
                  that
                  those policies are in accordance with U.S. generally accepted accounting
                  principles. 
 ·
              has
                  developed and is testing procedures to analyze and monitor theLIFO
                  and lower of costornet
                  realizable valuecalculations
                  to ensure that those calculations are in accordance with U.S. generally
                  accepted accounting principles. The Company has also developed
                  and is
                  testing procedures to analyze and monitor the estimates used by
                  management
                  to ensure that those estimates accurately reflect current trends. .
 (d)
              Report
                  of Independent Registered Public Accounting
                  Firm
 
 The
          Board
          of Directors and Stockholders
 Duckwall-ALCO
          Stores, Inc.:
  
 We
          have
          audited management's assessment, included in Management’s Report on Internal
          Control over Financial Reporting (Item 9A(b)), that Duckwall-ALCO
          Stores, Inc. (the Company) did not maintain effective internal control over
          financial reporting as of January 28, 2007, because of the effect of material
          weaknesses identified in management's assessment, based on criteria established
          in *Internal
          Control—Integrated Framework* issued
          by
          the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
          The
          Company's management is responsible for maintaining effective internal
          control
          over financial reporting and for its assessment of the effectiveness of
          internal
          control over financial reporting. Our responsibility is to express an opinion
          on
          management's assessment and an opinion on the effectiveness of the Company's
          internal control over financial reporting based on our audit.
 
 We
          conducted our audit in accordance with the standards of the Public Company
          Accounting Oversight Board (United States). Those standards require that
          we plan
          and perform the audit to obtain reasonable assurance about whether effective
          internal control over financial reporting was maintained in all material
          respects. Our audit included obtaining an understanding of internal control
          over
          financial reporting, evaluating management's assessment, testing and evaluating
          the design and operating effectiveness of internal control, and performing
          such
          other procedures as we considered necessary in the circumstances. We believe
          that our audit provides a reasonable basis for our opinion.
 
 A
          company's internal control over financial reporting is a process designed
          to
          provide reasonable assurance regarding the reliability of internal controls
          over
          financial reporting and the preparation of financial statements for external
          purposes in accordance with U.S. generally accepted accounting principles.
          A
          company's internal control over financial reporting includes those policies
          and
          procedures that (1) pertain to the maintenance of records that, in reasonable
          detail, accurately and fairly reflect the transactions and dispositions
          of the
          assets of the company; (2) provide reasonable assurance that transactions
          are
          recorded as necessary to permit preparation of financial statements in
          accordance with U.S, generally accepted accounting principles, and that
          receipts
          and expenditures of the company are being made only in accordance with
          authorizations of management and directors of the company; and (3) provide
          reasonable assurance regarding prevention or timely detection of unauthorized
          acquisition, use, or disposition of the company's assets that could have
          a
          material effect on the financial statements.
 
 Because
          of its inherent limitations, internal control over financial reporting
          may not
          prevent or detect misstatements. Also, projections of any evaluation of
          effectiveness to future periods are subject to the risk that controls may
          become
          inadequate because of changes in conditions, or that the degree of compliance
          with the policies or procedures may deteriorate.
 
 37
 A
          material weakness is a control deficiency or combination of control
          deficiencies, that results in more than a remote likelihood that a material
          misstatement of the annual or interim financial statements will not be
          prevented
          or detected. The following material weaknesses have been identified and
          included
          in management's assessment as of January 28, 2007:
 ·
                  The
                      control environment influences the control consciousness of its
                      people, and is the foundation of all other components of internal
                      control
                      over financial reporting. The Company's control environment
                      did not
                      sufficiently promote effective internal control over financial
                      reporting
                      throughout the organization. Material weaknesses in the control
                      environment were a contributing factor in the material weaknesses
                      listed
                      below and resulted in more than a remote likelihood that material
                      misstatements of the annual or interim financial statements
                      would not be
                      prevented or detected. Specifically, the following material
                      weaknesses
                      were identified in the Company’s control environment as of January 28,
                      2007:
  ·
                  A
                      sufficient complement of skilled finance, tax and accounting
                      resources did
                      not exist to perform supervisory reviews and monitoring activities
                      over
                      certain financial reporting matters and
                      controls.
 
 ·
                  An
                      adequate control consciousness did not exist to support effective
                      application of policies and the execution of procedures within
                      the daily
                      operation of financial reporting
                      controls.
 
 ·
                  The
                      Company did not maintain effective policies and procedures
                      related to
                      accounting for fixed assets to ensure such accounting complied
                      with U.S.
                      generally accepted accounting principles. Specifically, the
                      Company’s
                      policies and procedures did not provide for a sufficient review
                      of the
                      reconciliation of the fixed asset system to the general ledger
                      and the
                      application of capitalization policies. As a result of this
                      deficiency,
                      there were errors in fixed assets, accumulated depreciation,
                      and selling,
                      general & administrative expense in the Company’s financial statements
                      and there is more than a remote likelihood that a material
                      misstatement of
                      the annual or interim financial statements would not be prevented
                      or
                      detected.
 
 ·
                  The
                      Company did not maintain effective policies and procedures
                      over payroll
                      processing. Specifically, there was inadequate segregation
                      of duties
                      between the human resources and payroll functions. In addition,
                      the
                      Company’s policies and procedures did not include a reconciliation
                      of
                      employee payroll withholding amounts as reported on the payroll
                      register
                      to the amounts recorded in the general ledger. As a result
                      of these
                      deficiencies, there is more than a remote likelihood that a
                      material
                      misstatement of the annual or interim financial statements
                      would not be
                      prevented or detected.
 
 ·
                  The
                      Company did not maintain effective policies and procedures
                      that require a
                      sufficiently detailed review of the Company’s financial statements prior
                      to their issuance. As a result of this deficiency, there were
                      material
                      errors in classification of deferred income taxes, and cash
                      flows, and
                      omission of required disclosures in the Company’s financial
                      statements.
 
 ·
                  The
                      Company did not maintain effective policies and procedures
                      related to
                      accounting for significant accrued liabilities to ensure such
                      accounting
                      was in accordance with U.S. generally accepted accounting principles
                      on an
                      interim and annual basis. Specifically, the Company’s policies and
                      procedures did not provide for sufficient review of the assumptions
                      used
                      for vendor support and employee bonus accruals at interim financial
                      reporting periods to validate these estimates through comparison
                      to actual
                      activities upon which the estimates are based. As a result
                      of this
                      deficiency, there were errors in accrued liabilities, cost
                      of goods sold,
                      and selling, general & administrative expense and there is more than a
                      remote likelihood that a material misstatement of the annual
                      or interim
                      financial statements would not be prevented or
                      detected.
 
 ·
                  The
                      Company did not maintain effective policies and procedures
                      related to
                      accounting for inventory to ensure such accounting is in accordance
                      with
                      U.S. generally accepted accounting principles. Specifically,
                      the Company’s
                      policies and procedures did not provide for sufficient analysis
                      of the
                      policies applied to payment discounts, LIFO and lower of cost
                      or net
                      realizable value calculations to ensure that such accounting
                      complies with
                      U.S. generally accepted accounting principles. In addition,
                      the Company’s
                      policies and procedures did not provide for sufficient analysis
                      of the
                      most recently identified inventory shrinkage trends to determine
                      whether
                      the existing estimation techniques should be modified. As a
                      result of this
                      deficiency, there were material errors in inventory and cost
                      of goods sold
                      in the Company’s financial
                      statements.
  We
          also
          have audited, in accordance with the standards of the Public Company Accounting
          Oversight Board (United States), the consolidated
          balance sheets of the Company as of January 28, 2007 and January 29, 2006,
          and
          the related consolidated statements of operations, stockholders’ equity and cash
          flows for each of the years in the three-year period ended January 28,
          2007. These
          material weaknesses were considered in determining the nature, timing,
          and
          extent of audit tests applied in our audit of the 2007
          consolidated financial statements ,
          and
          this report does not affect our report dated April 19, 2007, which expressed
          an unqualified
          opinion on those consolidated financial statements.
 
 In
          our
          opinion, management's assessment that the Company did not maintain effective
          internal control over financial reporting as of January 28, 2007, is fairly
          stated, in all material respects, based on criteria
          established in *Internal
          Control — Integrated Framework* issued by
          COSO. Also,
          in
          our opinion, because of the effect of the material weaknesses described
          above on
          the achievement of the objectives of the control criteria, the Company
          has not
          maintained effective internal control over financial reporting as of January
          28,
          2007, based on criteria established in *Internal
          Control — Integrated Framework* issued
          by COSO.
 /s/
        KPMG
        LLP
 Omaha, Nebraska
 April
        19,
        2007
  **ITEM
        9B.**   **OTHER
        INFORMATION** .
 
 None
 **PART
        III**
 **ITEM
        10.**   **DIRECTORS
        AND EXECUTIVE OFFICERS OF THE REGISTRANT.**
 
 The
        Registrant's Proxy Statement to be used in connection with the Annual Meeting
        of
        Stockholders to be held on June 6, 2007, contains under the caption “Election of
        Directors” certain information required by Item 10 of Form 10-K, and such
        information is incorporated herein by this reference. The information required
        by Item 10 of Form 10-K as to executive officers is set forth in Item 1 of
        this
        Form 10-K. The Registrant's Proxy Statement to be used in connection with
        the
        Annual Meeting of Stockholders to be held on June 6, 2007, contains under
        the
        caption “Section 16(a) Beneficial Ownership Reporting Compliance” certain
        information required by Item 10 of Form 10-K, and such information is
        incorporated herein by this reference. The Registrant's Proxy Statement also
        contains under the caption “Code of Ethics” certain information required by Item
        10 of Form 10-K, and such information is incorporated herein by this reference.
  38
 **ITEM
          11.**   **EXECUTIVE
          COMPENSATION.**
 
 The
        Registrant's Proxy Statement to be used in connection with the Annual Meeting
        of
        Stockholders to be held on June 6, 2007, contains under the caption “Executive
        Compensation and Other Information” the information required by Item 11 of Form
        10-K, and such information is incorporated herein by this reference (except
        that
        the information set forth under the following subcaptions is expressly excluded
        from such incorporation: “Compensation Committee Report”, “Audit Committee
        Report”, and “Company Performance”).
 
 **ITEM
        12.**   **SECURITY
        OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
        MATTERS.**
 
 The
        Registrant's Proxy Statement to be used in connection with the Annual Meeting
        of
        Stockholders to be held on June 6, 2007, contains under the caption “Ownership
        of Duckwall Common Stock” the information required by Item 12 of Form 10-K and
        such information is incorporated herein by this reference.
 
 **ITEM
        13.**   **CERTAIN
        RELATIONSHIPS AND RELATED TRANSACTIONS.**
 
 The
        Registrant's Proxy Statement to be used in connection with the Annual Meeting
        of
        Stockholders to be held on June 6, 2007, contains under the caption
“Compensation Committee Interlocks and Related Party Transactions” the
        information required by Item 13 of Form 10-K and such information is
        incorporated herein by this reference.
 
 **ITEM
        14.**   **PRINCIPAL
        ACCOUNTANT FEES AND SERVICES.**
 
 The
        Registrant's Proxy Statement to be used in connection with the Annual Meeting
        of
        Stockholders to be held on June 6, 2007, contains under the caption
“Ratification of Selection of Independent Accountants” the information required
        by Item 14 of Form 10-K and such information is incorporated herein by this
        reference.
  **PART
        IV**
 
 **ITEM
        15.**   **EXHIBITS
        AND FINANCIAL STATEMENT SCHEDULES.**
 
 (a)
              Financial
                  Statements, Financial Statement Schedules, and
                  Exhibits
 
 (1)   Consolidated
        Financial Statements
 The
        financial statements are listed in the index for Item 8 of this Form
        10-K.
 
 (2)   Financial
        Statement Schedules
 No
        financial statement schedules are included as they are not applicable to
        the
        Company.
 
 (3   Exhibits
 The
        exhibits filed with or incorporated by reference in this report are listed
        below:
 
 Number           Description
 
 3.1
              Amended
                  and Restated Articles of Incorporation (filed as Exhibit 3(a) to
                  Company’s
                  Registration Statement on Form S-1 and hereby incorporated herein
                  by
                  reference).
 
 3.2
              Certificate
                  of Amendment to the Articles of Incorporation (filed as Exhibit
                  3(b) to
                  Company’s Annual Report on Form 10-K for the fiscal year ended January
                  29,
                  1995, and incorporated herein by reference) (filed as Exhibit 3(b)
                  to
                  Company’s Annual Report on Form 10-K for the fiscal year ended January
                  29,
                  1995, and incorporated herein by
                  reference.)
 
 3.3
              Bylaws
                  (filed as Exhibit 3(b) to Company’s Registration Statement on Form S-1 and
                  hereby incorporated herein by
                  reference).
 
 4.1
              Specimen
                  Common Stock Certificates (filed as Exhibit 4.1 to Company’s Registration
                  Statement on Form S-1 and incorporated herein by
                  reference).
 
 4.2
              Reference
                  is made to the Amended and Restated Articles of Incorporation and
                  Bylaws
                  described above under 3(1) and 3(3), respectively (filed as Exhibit
                  4(a)
                  to Company’s Registration Statement on Form S-1 and hereby incorporated
                  herein by reference).
 
 4.3
              Reference
                  is made to the Certificate of Amendment to the Articles of Incorporation
                  described above under 3(2) (filed as Exhibit 3(2) to Company’s Annual
                  Report on Form 10-K for the fiscal year ended January 29, 1995,
                  and
                  incorporated herein by reference).
 
 4.4
              Form
                  of 10% Subordinated Notes (filed as Exhibit 4(c) to Company’s Registration
                  Statement on Form S-1 and herby incorporated herein by
                  reference).
  10.1
              Separation
                  Agreement and Release, dated as of December 27, 2004, between the
                  Company
                  and Glen L. Shank.
 
 10.2
              Employment
                  Agreement dated August 1, 2005 between the Company and Bruce C.
                  Dale is
                  incorporated by reference to Exhibit 10.1 to the Current Report
                  on Form
                  8-K of the Company dated August 1,
                  2005.
  10.3
              Employment
                  Agreement dated January 5, 2006 between the Company and Tom L.
                  Canfield,
                  Jr. is incorporated by reference to Exhibit 10.1 to the Current
                  Report on
                  Form 8-K of the Company dated January 9,
                  2006.
 
 10.4
              Employment
                  Agreement dated January 5, 2006 between the Company and James E.
                  Schoenbeck is incorporated by reference to Exhibit 10.5 to the
                  Current
                  Report on Form 8-K of the Company dated January 9,
                  2006.
  39
 10.5
              Employment
                  Agreement dated January 5, 2006 between the Company and Michael
                  J. Gawin
                  is incorporated by reference to Exhibit 10.3 to the Current Report
                  on Form
                  8-K of the Company dated January 9,
                  2006.
  10.6
              Employment
                  Agreement dated December 28, 2000 between the Company and Richard
                  A.
                  Mansfield (filed as Exhibit 10.14 to the Company’s Annual Report on Form
                  10-K for the fiscal year ended February 1, 2004 and hereby incorporated
                  by
                  reference).
  10.7
              Employment
                  Agreement dated January 5, 2006 between the Company and Robert
                  E. Swartz,
                  Jr. is incorporated by reference to Exhibit 10.4 to the Current
                  Report on
                  Form 8-K of the Company dated January 9,
                  2006.
  10.8
              Employment
                  Agreement dated January 5, 2006 between the Company and Anthony
                  C. Corradi
                  is incorporated by reference to Exhibit 10.2 to the Current Report
                  on Form
                  8-K of the Company dated January 9,
                  2006.
  10.9
              Employment
                  Agreement dated January 27, 2006 between the Company and John R.
                  Sturdivant is incorporated by reference to Exhibit 10.1 to the
                  Current
                  Report on Form 8-K of the Company dated January 31,
                  2006.
  10.10
              Employment
                  Agreement dated March 23, 2006 between the Company and Michael
                  S. Marcus
                  is incorporated by reference to Exhibit 10.1 to the Current Report
                  on Form
                  8-K of the Company dated March 28,
                  2006.
  10.11
              Loan
                  and Security Agreement, dated as of April 15, 2002, between the
                  Company
                  and Fleet Retail Finance Inc. (filed as Exhibit 10.16 to the Company’s
                  Annual Report on Form 10-K for the fiscal year ended February 2,
                  2003 and
                  hereby incorporated by reference).
  10.12
              Joinder
                  Agreement and First Amendment to Loan and Security Agreement dated
                  September 9, 2002 among the Company, Fleet Retail Finance Inc.,
                  and DA
                  Good Buys, Inc. (filed as Exhibit 10.17 to the Company’s Annual Report on
                  Form 10-K for the fiscal year ended February 2, 2003 and hereby
                  incorporated by reference).
  10.13
              Stock
                  Purchase Agreement dated April 19, 2005 with K&A Asset Management, LLC
                  on behalf of Kenneth A. Macke Revocable
                  Trust.
  21.1
              Amended
                  and Restated List of Subsidiaries of the Company (filed as Exhibit
                  21.1 to
                  the Company’s Annual Report on Form 10-K for the fiscal year ended
                  February 2, 2003 and hereby incorporated by reference).
  23.1
              Consent
                  of Independent Auditors.
  31.1
              Certification
                  of Chief Executive Officer of Duckwall-ALCO Stores, Inc. dated
                  April 23,
                  2007, pursuant to Rule 13a-4(a) under the Securities Exchange Act
                  of 1934,
                  as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
                  2003.
  31.2
              Certification
                  of Chief Financial Officer of Duckwall-ALCO Stores, Inc. dated
                  April 23,
                  2007, pursuant to Rule 13a-4(a) under the Securities Exchange Act
                  of 1934,
                  as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
                  2003.
  32.1
              Certification
                  of Chief Executive Officer of Duckwall-ALCO Stores, Inc, dated
                  April 23,
                  2007, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
                  Section
                  906 of the Sarbanes-Oxley Act of 2002, which is furnished with
                  this Annual
                  Report on Form 10-K for the year ended January 28, 2007 and is
                  not treated
                  as filed in reliance upon § 601(b)(32) of Regulations
                  S-K.
  32.2
              Certification
                  of Chief Financial Officer of Duckwall-ALCO Stores, Inc., dated
                  April 23,
                  2007, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
                  Section
                  906 of the Sarbanes-Oxley Act of 2002, which is furnished with
                  this Annual
                  Report on Form 10-K for the year ended January 28, 2007 and is
                  not treated
                  as filed in reliance upon § 601(b)(32) of Regulations
                  S-K.
   40
 **SIGNATURES**
 
 Pursuant
        to the requirements of Section 13 or 15(d) of the Securities and Exchange
        Act of
        1934, the registrant has duly caused this report to be signed on its behalf
        by
        the undersigned, thereunto duly authorized.
 
 DUCKWALL-ALCO
        STORES, INC.
 
 by */s/
        Bruce C. Dale*
 Bruce
        C.
        Dale, President and Chief Executive Officer
 
 Dated:
        April 23, 2007
 
 Pursuant
        to the requirement of the Securities Exchange Act of 1934, this report has
        been
        signed below by the following persons on behalf of the registrant and in
        the
        capacities and on the dates indicated:
 
 **Signature
                  and Title**
              
              **Date***/s/
                  Bruce C. Dale*
              
              
              April
                  23, 2007Bruce
                  C. DalePresident
                  and Chief Executive Officer(Principal
                  Executive Officer)*/s/
                  Michael S. Marcus*
              
              
              April
                  23, 2007Michael
                  S. MarcusVice
                  President-Finance and Treasurer(Principal
                  Financial and Accounting Officer)*/s/
                  Warren H. Gfeller*
              
              
              April
                  23, 2007Warren
                  H. GfellerDirector*/s/
                  Dennis A. Mullin*
              
              
              April
                  23, 2007Dennis
                  A. MullinDirector*/s/
                  Lolan C. Mackey*
              
              
              April
                  23, 2007Lolan
                  C. MackeyDirector*/s/
                  Jeffrey J. Macke*
              
              
              April
                  23, 2007Jeffrey
                  J. MackeDirector*/s/
                  Robert L. Ring*
              
              
              April
                  23, 2007Robert
                  L. RingDirector*/s/
                  Dennis E. Logue*
              
              
              April
                  23, 2007Dennis
                  E. LogueDirector