**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

**FORM 10-K**

**x**                              AnnualReport Pursuant to Section 13 or 15(d) of the Securities Exchange Act of1934

**Forthe fiscal year ended August 26, 2006**

**or**

**o**                                 TransitionReport Pursuant to Section 13 or 15(d) of the Securities Exchange Act of1934

**CommissionFile No. 1-6807**

**FAMILY DOLLAR STORES, INC.**

(Exact name of registrantas specified in its charter)

| **Delaware**                                                    |   | **56-0942963**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |   | (I.R.S. Employer  Identification No.) |

 

| **10401 Monroe Road, Matthews, North Carolina** |   | **28105**  |
|-------------------------------------------------|--------|------------|
| (Address of  principal executive offices)       |   | (Zip Code) |

 

| **P. O. Box 1017, Charlotte, North Carolina 28201-1017** |
|----------------------------------------------------------|
| (Mailing  address)                                       |

 

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

 

Securities registered pursuantto Section 12(b) of the Act:

|                               | ** ** | **Name of each exchange** |
|-------------------------------|------------|---------------------------|
| **Title of each class**       | ** ** | **on which registered**   |
| Common Stock,  $.10 Par Value |       | New York Stock  Exchange  |

 

Securitiesregistered pursuant to Section 12(g) of the Act: **None**

Indicate by check mark if the registrant is a well-known seasoned issuer,as defined in Rule 405 of the Securities Act. Yes xNo o

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 orSection 15(d) of the Act. Yes oNo x

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes oNo x

Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-Kis not contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

| Large Accelerated  Filer x |   | Accelerated  Filer o |   | Non-Accelerated  Filer o |
|---------------------------------|--------|---------------------------|--------|-------------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes oNo x

The aggregatemarket value of voting and non-voting common equity held by non-affiliates ofthe registrant based on the closing price on March 3, 2007, was approximately$4.0 billion.

The number ofshares of the registrant’s Common Stock outstanding as of March 3, 2007, was150,807,820.

DOCUMENTS INCORPORATED BY REFERENCE

None.

 

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**GENERAL INFORMATION**

Informationis provided herein with respect to the Company’s operations related to theCompany’s fiscal years ended on August 26, 2006 (“fiscal 2006”); on August 27,2005 (“fiscal 2005”); on August 28, 2004 (“fiscal 2004”); on August 30, 2003 (“fiscal2003”); on August 31, 2002 (“fiscal 2002”); and the fiscal year ending onSeptember 1, 2007 (“fiscal 2007”).  Thediscussion and analysis in this Annual Report on Form 10-K (this “Report”)should be read in conjunction with, and is qualified by, the ConsolidatedFinancial Statements and Notes to Consolidated Financial Statements included inthis Report.

**ExplanatoryNote**

The Company was named as a nominal defendant in certain litigation filed in September 2006, alleging that the Company “backdated” certain stock option grants.  In connection with that lawsuit, the Board of Directors appointed a Special Committee to conduct an independent investigation of the Company’s stock option granting practices, evaluate the lawsuit and take such actions with respect to the lawsuit and related matters as the Committee deemed appropriate.  Following the completion of the Special Committee’s investigation and the Company’s receipt of their factual findings, the Company determined that it did not properly account for certain stock options issued during fiscal 1995 to fiscal 2006 and therefore incurred a cumulative charge in the fourth quarter of fiscal 2006 of $10.5 million.  As the impact of the resulting accounting adjustments attributable to any prior reporting periods was not material to any of such periods and as the cumulative impact of the adjustments was not material to the current year, the Company did not restate previously issued financial statements.  However, as a result of such investigation, the Company was unable to complete and timely file its fiscal 2006 Annual Report on Form 10-K.  See Note 10 to the Consolidated Financial Statements included in this Report for more information regarding the findings of the Special Committee.

# **CautionaryStatement Regarding Forward-Looking Statements**

Certainstatements contained in this Report, or in other public filings, pressreleases, or other written or oral communications made by the Company or itsrepresentatives, which are not historical facts are forward-looking statementsmade pursuant to the safe harbor provisions of the Private SecuritiesLitigation Reform Act of 1995.  Theseforward-looking statements address the Company’s plans, activities or eventswhich the Company expects will or may occur in the future and may includeexpress or implied projections of revenue or expenditures; statements of plansand objectives for future operations, growth or initiatives; statements offuture economic performance; or statements regarding the outcome or impact ofpending or threatened litigation.  Theseforward-looking statements may be identified by the use of the words “plan,” “estimate,”“expect,” “anticipate,” “probably,” “should,” “project,” “intend,” “continue,”and other similar terms and expressions. Various risks, uncertainties and other factors may cause the Company’sactual results to differ materially from those expressed or implied in anyforward-looking statements.  Factors,uncertainties and risks that may result in actual results differing from suchforward-looking information include, but are not limited to those listed inPart I, Item 1A below, as well as other factors discussed throughout thisReport, including, without limitation, the factors described under “CriticalAccounting Policies” in Part II, Item 7 below, or in other filings orstatements made by the Company.  All ofthe forward-looking statements made by the Company in this Report and otherdocuments or statements are qualified by these and other factors, risks anduncertainties.  Readers are cautioned notto place undue reliance on these forward-looking statements, which speak onlyas of the date of this Report.  TheCompany does not intend to publicly update or revise its forward-looking statementseven if experience or future changes make it clear that projected resultsexpressed or implied in such statements will not be realized, except as may berequired by law.

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**PART I**

**ITEM 1.                  BUSINESS**

**General**

Family Dollar Stores,Inc., (together with its wholly-owned subsidiaries and entities referred toherein as the “Company”) operates a chain of more than 6,200 generalmerchandise retail discount stores in 44 states, providing primarily low tolower-middle income consumers with a wide range of competitively priced basicmerchandise in convenient neighborhood stores. The goods offered by the Company generally have price points that rangefrom under one dollar to ten dollars and include apparel, food, cleaning andpaper products, home décor, beauty and health aids, toys, pet products, automotiveproducts, domestics, seasonal goods and electronics.

Theoriginal predecessor of the Company was organized in 1959 to operate aself-service retail store in Charlotte, North Carolina.  In subsequent years, additional stores wereopened, and separate corporations generally were organized to operate thesestores.  Family Dollar Stores, Inc., wasincorporated in Delaware in 1969, and all then-existing corporate entitiesbecame its wholly-owned subsidiaries.

**Overviewof Business Operations**

TheCompany owns or leases and operates all of its retail discount stores locatedin 44 states of the United States.  TheCompany’s stores are operated on a self-service basis, and low overhead permitsthe sale of merchandise at a relatively moderate markup.  As discussed below, the Company’s merchandiseconsists of a variety of general merchandise. The Company’s stores are located in urban, suburban, small town andrural markets.  See Item 2 — “Properties”herein.  The Company’s relatively smallstore size allows the Company to select store locations that provideneighborhood convenience to its customers in each of these areas.  The Company generally prices merchandiseuniformly in all of its stores, but some merchandise may carry higher prices instores in less competitive markets where operating costs are higher.  Most items are priced under ten dollars.

TheCompany’s “everyday low price” strategy relies on offering consistently lowprices on its products and utilizing limited advertising and promotional activity.  The Company traditionally advertises throughcirculars available in stores or, occasionally, circulars that are inserted innewspapers or mailed directly to consumers’ residences.  In fiscal 2006, the Company distributedcirculars in November and December 2005; and, in February and August 2006.  The Company continues to utilize circularsthat are passed out in stores monthly, and limited advertising is used tosupport the opening of new stores.

TheCompany accepts cash, checks and PIN-based debit cards but does not currentlyaccept credit cards.  As part of theCompany’s multi-year “store of the future” initiative, the Company isinstalling new point-of-sale systems that will allow it to accept a broaderrange of tender types, including food stamps.

Asdiscussed in “Management’s Discussion and Analysis of Financial Condition andResults of Operations” (“MD&A”) elsewhere in this Report, the Companyfocused on four primary initiatives during fiscal 2006: (i) the installation ofrefrigerated coolers in selected stores; (ii) the “Treasure Hunt” merchandiseprogram; (iii) new store openings; and (iv) the Urban Initiative.

Nosingle store accounted for more than one-quarter of one percent of sales duringfiscal 2006.  The Company’s stores areopen at least six days a week, with most open on Sundays.

**Merchandise**

The Company’s stores offer a variety of generalmerchandise.  The following tablesummarizes the percentage of net sales attributable to each product categoryover the last three fiscal years:

| Product Category     | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|----------|------------|
| Consumables               |       | 57.9     | %          | 57.9     | %          | 56.7     | %          |
| Home products             |       | 15.2     | %          | 15.5     | %          | 16.2     | %          |
| Apparel and  accessories  |       | 14.4     | %          | 15.1     | %          | 15.9     | %          |
| Seasonal and  electronics |       | 12.5     | %          | 11.5     | %          | 11.2     | %          |

 

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Theconsumables category includes household chemical and paper products, candy,snacks and other food, health and beauty aids, hardware and automotivesupplies, and pet food and supplies.  Thehome products category includes domestic items such as blankets, sheets andtowels as well as housewares and giftware. The apparel and accessories category includes men’s, women’s, boys’,girls’ and infants’ clothing and shoes. The seasonal and electronics category includes toys, stationery andschool supplies, seasonal goods and electronics, including pre-paid cellularphones and services.

Duringfiscal 2006, nationally advertised brand name merchandise accounted forapproximately 37% of sales.  FamilyDollar private label merchandise accounted for approximately 4% of sales, andmerchandise sold under other labels, or which was unlabeled, accounted for thebalance of sales.  During fiscal 2006,irregular merchandise accounted for less than one-half of 1% of sales, andcloseout merchandise accounted for approximately 2% of sales.

Duringfiscal 2006, the Company continued to supplement its basic assortment ofmerchandise with the purchase of certain “Treasure Hunt” items designed tocreate more excitement in stores and attract customers throughout the year,with particular emphasis on the holiday seasons.  In fiscal 2007, the Company expects tocontinue to develop this merchandising strategy.

Duringfiscal 2006, the Company expanded its food assortment to include perishablefoods by installing refrigerated coolers in approximately 2,800 stores.  In fiscal 2007, the Company plans to installcoolers in approximately 1,200 additional stores.

TheCompany purchases merchandise from approximately 1,400 suppliers and generallyhas not experienced difficulty in obtaining adequate quantities of merchandise.  Approximately 60% of the merchandise ismanufactured in the U.S., and substantially all such merchandise is purchaseddirectly from the manufacturer. Purchases of imported merchandise are made directly from themanufacturer or from importers, and the Company’s vendor arrangements providefor payment for such merchandise in U.S. Dollars.  No single supplier accounted for more than 9%of the merchandise sold by the Company in fiscal 2006.

TheCompany maintains a substantial variety and depth of merchandise inventory instock in its stores (and in its distribution centers for weekly storereplenishment) to attract customers and meet their shopping needs.  Vendors’ trade payment terms are negotiatedto help finance the cost of carrying this inventory.  The Company must balance the value ofmaintaining high inventory levels to meet customer demand with the potentialcost of having inventories at levels that exceed such demand and that may needto be marked down in price in order to sell.

**Distributionand Logistics**

Duringfiscal 2006, approximately 6.5% of the merchandise purchased by the Company wasshipped directly to stores by the manufacturer or importer.  The balance of the merchandise was receivedat one of the Company’s nine distribution centers listed below.  Merchandise is delivered to stores from theCompany’s distribution centers by Company-owned trucks and by common andcontract carriers.  During fiscal 2006,approximately 86% of the merchandise delivered to stores was by common orcontract carriers.  At the end of fiscal2006, the average distance between the distribution centers and the storesserved by each facility was as follows:

| Distribution Center | ** ** | **Number of Stores  Served** | ** ** | **Average Distance  (Miles)** | ** ** |
|--------------------------|------------|----------------------------------------|------------|------------------------------------|------------|
| Matthews, NC             |       | 708                                    |       | 159                                |       |
| West Memphis, AR         |       | 679                                    |       | 264                                |       |
| Front Royal, VA          |       | 756                                    |       | 200                                |       |
| Duncan, OK               |       | 779                                    |       | 314                                |       |
| Morehead, KY             |       | 701                                    |       | 201                                |       |
| Maquoketa, IA            |       | 781                                    |       | 294                                |       |
| Odessa, TX               |       | 662                                    |       | 566                                |       |
| Marianna, FL             |       | 628                                    |       | 267                                |       |
| Rome, NY                 |       | 479                                    |       | 222                                |       |
| Total                    |       | 6,173                                  |       | 277                                |       |

 

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**Technology**

TheCompany utilizes a variety of technological systems to manage its businessincluding inventory management tools, supply chain systems and financial andhuman resource applications.

TheCompany maintains by-item inventories for all stores and employs a demandforecasting system for replenishment of its distribution centers.  The Company also utilizes softwareapplications for automatic store replenishment of basic merchandise and forforecasting-based allocation of non-basic merchandise.  These systems give the Company tools designedto facilitate optimum merchandise in-stock positions in stores, reducemarkdowns and improve inventory turnover.

Tominimize transportation costs and maximize efficiency, the Company relies on atransportation system designed to maximize trailer loads and secure low ratesfrom its trucking partners.  In addition,the Company utilizes voice-recognition software, radio-frequency technology andhigh-speed sortation systems to maximize the productivity of its distributioncenters.

The Companyalso utilizes a hiring system designed to provide consistent pre-employmentassessments and interviews for prospective employees in approximately 1,200stores.  The Company also has begun amulti-year effort to upgrade point-of-sale technology to provide bettercustomer service and to improve the communications infrastructure in stores tofacilitate more efficient communication and provide more interactive trainingfor store employees.

**Competition**

Theindustry in which the Company is engaged is highly competitive.  The principal competitive factors includestore locations, price and quality of merchandise, in-stock consistency,merchandise assortment and presentation, and customer service.  The Company competes for sales and storelocations in varying degrees with international, national, regional and localretailing establishments, including discount stores, department stores, varietystores, dollar stores, discount clothing stores, drug stores, grocery stores,convenience stores, outlet stores, warehouse stores and other stores.  Many of the nation’s other large retailershave stores in areas in which the Company operates.  The relatively small size of the Company’sstores permits it to open new stores in rural areas, small towns and in largeurban markets, in locations convenient to the Company’s low and lower-middleincome customer base.

**Seasonality**

TheCompany’s sales are slightly seasonal. Historically, sales have been highest in the second fiscal quarter(December, January, and February), representing approximately 27% of totalannual sales.

**Trademarks**

TheCompany has registered with the U.S. Patent and Trademark Office the name “FamilyDollar Stores” as a service mark and also has registered a number of othernames as trademarks for certain merchandise sold in stores.

**Employees**

As ofAugust 26, 2006, the Company had approximately 24,000 full-time employees andapproximately 20,000 part-time employees. None of the Company’s employees are covered by collective bargainingagreements.  The Company considers itsemployee relations generally to be good.

**AvailableInformation**

Themailing address of the Company’s executive offices is P.O. Box 1017, Charlotte,North Carolina 28201-1017, and the telephone number at that location is (704)847-6961.  The Company’s internet websiteaddress is www.familydollar.com. Through a link on the Investors section of the website, the Companymakes available the following filings as soon as reasonably practicable afterthey are electronically filed with or furnished to the Securities and ExchangeCommission (the “SEC”):  Annual Reportson Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K andany amendments to these reports filed or furnished pursuant toSection 13(a) or 15(d) of the Securities Exchange Act of 1934.  These reports and amendments also areavailable at the website of the SEC at www.sec.gov.  All such filings are available free ofcharge.

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**NYSECertification**

Inaccordance with New York Stock Exchange (the “NYSE”) rules, on February 1, 2006,the Company filed the annual certification by the Chief Executive Officer that,as of the date of the certification, the Company was in compliance with theNYSE listing standards.  For the fiscalyear ended August 26, 2006, each of the Company’s Chief Executive Officer andChief Financial Officer executed the certifications required by Section 302 ofthe Sarbanes-Oxley Act of 2002, which certifications are filed as exhibits tothis Report.

**ITEM 1A.       RISKFACTORS**

Therisks described below could materially and adversely affect the Company’sbusiness, financial condition and results of operations.  The Company may also be adversely affected byrisks not currently known to management, or that management does not currentlyconsider to be material.

*Competitive factors in the retail industry could limit the Company’sgrowth opportunities and reduce profitability.*

The Company is in a highly competitive sector of thediscount retail merchandise sector with numerous competitors, some of whom mayhave greater resources than the Company. The Company competes for customers, merchandise, real estate locationsand employees.  This competitiveenvironment subjects the Company to various risks, including the ability tocontinue its store and sales growth and provide attractive merchandise to itscustomers at competitive prices that allow the Company to maintain itsprofitability.  See Item 1 — “Competition”for further discussion of the Company’s competitive position.

*Pricing pressures, including inflation and energy prices, could affectthe Company’s profitability.*

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

*Changes in consumer demand and product mix and changes in overalleconomic conditions could adversely affect the Company’s results of operations.*

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

*The impact of acts of war or terrorism and transportation anddistribution delays or interruptions could adversely affect the Company’sresults of operations.*

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

*Unusual weather, natural disasters or pandemic outbreaks couldadversely affect the Company’s net sales and operations.*

Extreme changes in weather patterns or other naturaldisasters as well as pandemic outbreaks influence customer trends and purchasesand may negatively impact net sales, properties and/or operations of theCompany.  Such events could result inphysical damage to one or more of the Company’s properties; the temporaryclosure of one or more stores or distribution centers; the temporary lack of anadequate work force in a market; the temporary or long-term disruption in thetransport of goods from overseas; delay in the delivery of goods to the Company’sdistribution centers or stores; or the temporary reduction in the availabilityof products in the Company’s stores. These factors could adversely affect the Company’s operations.

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*Merchandise supply and pricing and the interruption of and dependenceon imports could negatively impact the Company’s business.*

The Company has generally been able to obtainsufficient quantities of attractive merchandise at prices that allow theCompany to profitably sell such merchandise. Any disruption in that supply and/or the pricing of such merchandisecould negatively impact the Company’s operations and results ofoperations.  A significant amount of thegoods sold by the Company are imported, and changes to the flow of these goodsfor any reason could have an adverse impact on the Company.  Political and economic instability in thecountries in which foreign suppliers are located, the financial instability ofsuppliers, labor problems experienced by the Company’s suppliers, theavailability of raw materials to suppliers, merchandise quality issues,currency exchange rates, transport availability and cost, inflation, and otherfactors relating to the suppliers and the countries in which they are locatedare beyond the Company’s control.  Theseand other factors affecting the Company’s suppliers and the Company’s access toproducts could adversely affect the Company’s financial performance.

*The Company’s results of operations are dependent upon the success ofits merchandising and marketing programs.*

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

*Operational difficulties could disrupt the Company’s business.*

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

*Delays associated with the building and opening of distributionfacilities and stores, and the costs of operating distribution facilities andstores could adversely impact the Company’s business.*

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

*Changes in state or federal legislation or regulations, including theeffects of legislation and regulations on wage levels and entitlement programsand changes in currency exchange rates, trade restrictions, tariffs, quotas andfreight rates could increase the Company’s cost of doing business.*

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

*The Company’s growth is dependent upon the success of its new storeopening program.*

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

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*Higher costs and/or failure to achieve targeted results associated withthe implementation of new programs, systems and technology could adverselyaffect the Company’s results of operations.*

The Company is undertaking a variety of operatinginitiatives and infrastructure initiatives related to merchandising and supplychain systems, store technology, cooler installations and related foodprograms, Urban Initiative programs, and real estate expansion goals.  The failure to properly execute any of theseinitiatives could have an adverse impact on the future operating results of theCompany.

*Adverse impacts associated with legal proceedings and claims couldnegatively affect the Company’s business.*

The Company is a party to a variety of legalproceedings and claims, including those described in Item 3 — “LegalProceedings” and elsewhere in this Report. Operating results for the Company could be adversely impacted if suchlegal proceedings and claims result in the Company’s obligation to make eithermaterial damage or settlement payments which are not insured or which have notbeen reserved against, or changes to the operation of the business.

*The Company’s ability to attract and retain employees, and changes inhealth care and other insurance costs could affect the Company’s business.*

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

*Changes in interpretations or applications ofaccounting principles and/or developments in legal or regulatory guidance,could adversely affect the Company’s financial performance.*

Unanticipated changes in the interpretation orapplication of accounting principles to the Company’s financial statementscould result in material charges and/or restatements of the Company’s financialstatements, which may further result in litigation and/or regulatory actionswhich could have a material adverse effect on the Company’s financial conditionand results of operations.  Changes anddevelopments in legal or regulatory guidance, particularly with regard to stockoption matters, may negatively impact the Company’s position in relatedlitigation matters.

*The Company’s business is slightly seasonal and adverse events duringthe holiday season could negatively impact the Company’s results of operations.*

The Company’s business is slightly seasonal, withthe highest percentage of sales occurring during the second fiscal quarter(December, January, February).  TheCompany purchases significant amounts of seasonal inventory in anticipation ofthe holiday season.  Adverse eventsresulting in lower than planned sales during the holiday season could lead tounanticipated markdowns, negatively impacting the Company’s financial conditionand results of operations.

*The Company’s failure to comply with its debt covenants could adverselyaffect the Company’s capital resources, financial condition and liquidity.*

The Company’s debtagreements contain certain restrictive covenants, which include a consolidateddebt to consolidated capitalization ratio, a fixed charges coverage ratio, anda priority debt ratio.  If the Companyfails to comply with such covenants as a result of one or more of the factorslisted in this section, the Company may be forced to settle its outstandingdebt obligations, negatively impacting cash flows.  The Company’s ability to obtain futurefinancing may also be negatively impacted.

*Litigation relating to stock option matters is pending, the scope andoutcome of which could adversely affect the price of the Company’s securities.*

As described elsewhere in this Report, the Companyis a nominal defendant in certain shareholder derivative actions alleging thatcertain of the Company’s stock option grants were “backdated” along withrelated claims.  Results of these legalproceedings cannot be predicted with certainty, and unfavorable results couldadversely affect the price of the Company’s securities.  In addition, this litigation may becomedisruptive to the Company’s normal business operations.  See Item 3 — “Legal Proceedings” and Notes 8and 10 to the Consolidated Financial Statements included in this Report formore information.

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*The determinations of the Special Committee of the Company’s Board ofDirectors regarding the Company’s stock option granting practices could have anadverse effect on the Company.*

The Company’s Board of Directors created a SpecialCommittee to conduct a comprehensive review of grants of stock options inresponse to certain shareholder derivative actions.  Based on the findings of the SpecialCommittee, the Company determined that incorrect measurement dates were usedfor accounting purposes with respect to certain stock option grants  and the Company recorded a charge in thefourth quarter of fiscal 2006 to record additional non-cash stock-basedcompensation expense and related amounts. As a result of these events, the Company has become subject to thefollowing risks which could have an adverse effect on its business, financialcondition and results of operations: (i) many members of the Company’s seniormanagement team and Board of Directors have been and could be required todevote in the future a significant amount of time and resources on mattersrelating to remedial efforts and related litigation; (ii) the Company issubject to an informal inquiry by the SEC which could require management timeand attention and cause the Company to incur additional accounting and legalexpenses and which could require the Company to pay a fine or other penalties;(iii) the Company is subject to the risk of additional litigation andregulatory proceedings or actions; and (iv) the Company may incur substantialexpenses related to the foregoing.  Inaddition, while the Company believes it has made appropriate judgments indetermining the correct measurement dates for its stock option grants, the SECmay disagree with the manner in which the Company has accounted for andreported, or not reported, the financial impact of the findings of the SpecialCommittee.  See Note 10 to theConsolidated Financial Statements included in this Report for more information.

**ITEM 1B.       UNRESOLVEDSTAFF COMMENTS**

None.

**ITEM 2.          PROPERTIES**

TheCompany operates a chain of self-service retail discount stores.  As of September 30, 2006, there were 6,208stores in 44 states and the District of Columbia as follows:

| Texas          | 780 |   | Missouri             | 94     |
|----------------|-----|--------|----------------------|--------|
| Ohio           | 389 |   | Massachusetts        | 92     |
| Florida        | 330 |   | Maryland             | 90     |
| North Carolina | 327 |   | New Mexico           | 87     |
| Michigan       | 324 |   | New Jersey           | 73     |
| Georgia        | 296 |   | Minnesota            | 62     |
| New York       | 271 |   | Utah                 | 58     |
| Pennsylvania   | 241 |   | Connecticut          | 51     |
| Illinois       | 222 |   | Maine                | 43     |
| Louisiana      | 218 |   | Iowa                 | 35     |
| Virginia       | 205 |   | Kansas               | 33     |
| Tennessee      | 198 |   | Idaho                | 28     |
| Kentucky       | 185 |   | Nebraska             | 26     |
| South Carolina | 183 |   | Nevada               | 22     |
| Indiana        | 177 |   | Delaware             | 21     |
| Alabama        | 144 |   | New Hampshire        | 20     |
| Wisconsin      | 139 |   | Rhode Island         | 20     |
| Arizona        | 125 |   | Wyoming              | 19     |
| Oklahoma       | 123 |   | South Dakota         | 16     |
| West Virginia  | 113 |   | Vermont              | 11     |
| Mississippi    | 108 |   | North Dakota         | 7      |
| Colorado       | 99  |   | District of Columbia | 5      |
| Arkansas       | 98  |   |                 |   |

 

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Thenumber of stores operated by the Company at the end of each of its last fivefiscal years is as follows: 6,173 stores for fiscal 2006; 5,898 stores forfiscal 2005; 5,466 stores for fiscal 2004; 5,027 stores for fiscal 2003; and4,616 stores for fiscal 2002.

During fiscal2006, 350 stores were opened, 75 stores were closed, 18 stores were relocatedwithin the same shopping center or market area, 6 stores were expanded in size,and 12 stores were renovated.  FromAugust 26, 2006, through September 30, 2006, the Company opened 38 newstores, closed 3 stores, and expanded 1 store.

As of September30, 2006, the Company had, in the aggregate, approximately 52.4 million squarefeet of total store space (including receiving rooms and other non-sellingareas) and approximately 43.5 million square feet of selling space.  The typical store has approximately 7,500 to9,500 square feet of total area.

The Company’sstores are located in large urban, suburban and rural areas, and they aretypically freestanding or located in shopping centers.  At the end of fiscal 2006, approximately 20%of the Company’s stores were located in large urban markets (markets withpopulations above 200,000), and approximately 26% of the Company’s stores werelocated in small urban markets (markets with populations greater than 75,000but less than 200,000) or suburban areas. During fiscal 2006, approximately 30% of new store locations were openedin large urban markets and 20% of new locations were opened in small urban orsuburban markets.

All ofthe Company’s stores are leased except for 489 stores which are owned by theCompany.  Most leases have an initial termof five years and provide for fixed rentals. Most of the leases require additional payments based upon a percentageof sales, property taxes, insurance premiums or common area maintenancecharges.

Of theCompany’s 5,719 leased stores at September 30, 2006, all but 421 leases grantthe Company options to renew for additional terms, in most cases for a numberof successive five-year periods.  Thefollowing table sets forth certain data, as of September 30, 2006, concerningthe expiration dates of all leases with renewal options:

| Fiscal Years   | ** ** | **Approximate Number  of Leases Expiring  Assuming No Exercise  of Renewal Options** | ** ** | **Approximate Number of  Leases Expiring  Assuming Full Exercise  of Renewal Options** | ** ** |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------|------------|
| 2007                |       | 336                                                                                                                     |       | 0                                                                                                                         |       |
| 2008-2010           |       | 2,493                                                                                                                   |       | 6                                                                                                                         |       |
| 2011-2013           |       | 1,733                                                                                                                   |       | 163                                                                                                                       |       |
| 2014-2016           |       | 701                                                                                                                     |       | 455                                                                                                                       |       |
| 2017 and thereafter |       | 35                                                                                                                      |       | 4,674                                                                                                                     |       |

 

Of the489 Company-owned stores, 127 are located in Texas, with no more than 32located in any other state.  In theseowned stores, there are approximately 4.1 million total square feet of space.

TheCompany also owns its corporate headquarters and distribution center located ona 108-acre tract of land in Matthews, North Carolina, just outside ofCharlotte, in two buildings containing approximately 1.13 million square feet.  Approximately 890,000 square feet are usedfor the distribution center which includes receiving, warehousing, shipping andstorage facilities.  Approximately240,000 square feet are used for the corporate headquarters.

10

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TheCompany also owns eight additional full-service distribution centers describedin the table below:
| ** **               | ** ** | **Facility Size** | ** ** | ** **                |
|--------------------------|------------|-------------------|------------|---------------------------|
| **Distribution  Center** | ** ** | **Land**          | ** ** | **Building**              | ** ** | **Date Operational** |
| West Memphis, AR         |       | 75 acres          |       | 550,000 sq. ft.           |   | April 1994 |
|                     |       |              |       | 300,000 sq. ft.  addition |   | August 1996 |
| Front Royal, VA          |       | 108 acres         |       | 907,000 sq. ft.           |   | January 1998 |
| Duncan, OK               |       | 85 acres          |       | 907,000 sq. ft.           |   | July 1999 |
| Morehead, KY             |       | 94 acres          |       | 907,000 sq. ft.           |   | June 2000 |
| Maquoketa, IA            |       | 74 acres          |       | 907,000 sq. ft.           |   | March 2002 |
| Odessa, TX               |       | 89 acres          |       | 907,000 sq. ft.           |   | July 2003 |
| Marianna, FL             |       | 76 acres          |       | 907,000 sq. ft.           |   | January 2005 |
| Rome, NY                 |       | 87 acres          |       | 907,000 sq. ft.           |   | April 2006 |

 

**ITEM 3.          LEGALPROCEEDINGS**

On January 30, 2001, JaniceMorgan and Barbara Richardson, two individuals who have held the position ofStore Manager for subsidiaries of the Company, filed a complaint against theCompany in the United States District Court for the Northern District ofAlabama.  Thereafter, pursuant to theCourt’s ruling, notice of the pendency of the lawsuit was sent to approximately13,000 current and former Store Managers holding the position on or after July1, 1999.  Approximately 2,550 of thosereceiving such notice filed consent forms and joined the lawsuit as plaintiffs,including approximately 2,300 former Store Managers and approximately 250 thencurrent employees.  After rulings by theCourt on motions to dismiss certain plaintiffs filed by the Company and motionsto reconsider filed by plaintiffs, 1,424 plaintiffs remained in the case at thecommencement of trial.

The case has proceeded as acollective action under the Fair Labor Standards Act (“FLSA”).  The complaint alleged that the Companyviolated the FLSA by classifying the named plaintiffs and other similarlysituated current and former Store Managers as “exempt” employees who are notentitled to overtime compensation.

A jury trial in this casewas held in June 2005, in Tuscaloosa, Alabama, and ended with the judgedeclaring a mistrial after the jury was unable to reach a unanimous decision inthe matter.  The case was subsequentlyretried beginning on February 21, 2006, to a jury in Tuscaloosa, Alabama, whichfound that the Company should have classified the Store Manager plaintiffs ashourly employees entitled to overtime pay rather than as salaried exemptmanagers and awarded damages. Subsequently, the Court ruled the Company did notact in good faith in classifying the plaintiffs as exempt, and after makingadjustments to the damages award based upon the filing of personal bankruptcyby certain plaintiffs, the Court entered a judgment for approximately $33.3million.  The Company and the plaintiffshave filed post-trial motions, which have suspended the entry of a final judgment.  The Company posted a bond to stay executionon any judgment which may be finally entered. In addition, the Court ruled that it will consider the plaintiffs’motion for an award of attorneys’ fees and expenses at the conclusion of theCompany’s appeal.  The Company plans toappeal if the Court denies the pending post-trial motions and enters a finaljudgment.

The Company recognized $45.0million as a litigation charge in the second quarter of fiscal 2006 withrespect to this litigation.  During theappellate process, the Company will not be required to pay the amount of thejudgment.  Accordingly, this charge willnot have any impact on cash flow while the Company pursues its appellate rightswith respect to this judgment.

In general, the Companycontinues to believe that the Store Managers are “exempt” employees under theFLSA and have been properly compensated and that the Company has meritoriouspositions on appeal that should enable it ultimately to prevail.  However, the outcome of any litigation isinherently uncertain.  Resolution of thismatter could have a material adverse effect on the Company’s financialposition, liquidity or results of operation.

11

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

On December 15, 2006, ashareholder derivative complaint was filed in the United States District Courtfor the Western District of North Carolina, Case No. 3:06CV510-W, by Dorothy M.Lee against the Company as a nominal defendant and certain of its current andformer officers and directors, Howard R. Levine, Leon Levine, R. James Kelly,R. David Alexander, Jr., Charles S. Gibson, Jr., C. Martin Sowers, George R.Mahoney, Jr., Mark R. Bernstein, Sharon Allred Decker, Edward C. Dolby, GlennA. Eisenberg, James G. Martin, and Dale C. Pond, as individual defendants.  The complaint asserted claims under state andfederal law in connection with allegations that certain of the Company’s stockoption grants were “backdated.”  OnDecember 20, 2006, a second, nearly identical complaint was filed by StanfordH. Arden in the United States District Court for the Western District of NorthCarolina, Case No. 3:06CV523-C.  Thecomplaints each contain claims for violations of section 14(a) of the ExchangeAct, an accounting, breach of fiduciary duty, abuse of control, grossmismanagement, constructive fraud, corporate waste, unjust enrichment,recission, and breach of fiduciary duty for insider selling andmisappropriation of information in connection with the Company’s allegedbackdating of stock option grants.  Thecomplaints each seek unspecified money damages, an accounting, corporategovernance and internal control reforms, imposition of a constructive trustover the defendants’ stock options, punitive damages, and costs, includingattorneys’ fees. On March 23, 2007, the Court advised that these twofederal actions were to be consolidated under the caption In re Family DollarStores, Inc. Derivative Litigation, Case No. 3:06CV510-W.

As previously disclosed, the Company has formed aSpecial Committee to investigate the Company’s stock option granting practicesand make determinations regarding appropriate remedial measures and whatactions the Company should take with respect to the pending shareholderderivative litigation.  In addition, aspreviously announced, the Company voluntarily advised the SEC of suchlitigation and the Special Committee’s review. The Company is cooperating with the SEC’s informal inquiry regarding theCompany’s stock option granting practices. See Note 10 to the ConsolidatedFinancial Statements included in this Report for more information.

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

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

Therewere no matters submitted to a vote of security holders through thesolicitation of proxies or otherwise during the fourth quarter of fiscal 2006.

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**PART II**
| **ITEM 5.** | **MARKET FOR REGISTRANT’S COMMON EQUITY AND  RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES** |
|-------------|---------------------------------------------------------------------------------------------------------------------------|

 

The Company’s commonstock is traded on the New York Stock Exchange under the ticker symbolFDO.  At March 3, 2007, there wereapproximately 2,680 holders of record of the Company’s common stock.  The accompanying tables give the high and lowsales prices of the common stock and the dividends declared per share for eachquarter of fiscal 2006 and 2005.  TheCompany expects that dividends will continue to be declared quarterly for theforeseeable future.

**MarketPrices and Dividends**
| **2006**       | ** ** | **High** | ** ** | **Low** | ** ** | **Dividend** | ** ** |
|----------------|------------|----------|------------|---------|------------|--------------|------------|
| First Quarter  |       | $        | 24.50      |    | $          | 19.40        |       | $ | .09 1/2 |   |
| Second Quarter |       | 26.07    |       | 21.85   |       | .10 1/2      |       |
| Third Quarter  |       | 27.94    |       | 24.37   |       | .10 1/2      |       |
| Fourth Quarter |       | 26.25    |       | 21.57   |       | .10 1/2      |       |
|                |            |          |            |         |            |              |            |  |  |  |

 
| **2005**       | ** ** | **High** | ** ** | **Low** | ** ** | **Dividend** | ** ** |
|----------------|------------|----------|------------|---------|------------|--------------|------------|
| First Quarter  |       | $        | 32.30      |    | $          | 25.54        |       | $ | .08 1/2 |   |
| Second Quarter |       | 35.25    |       | 28.25   |       | .09 1/2      |       |
| Third Quarter  |       | 33.64    |       | 23.68   |       | .09 1/2      |       |
| Fourth Quarter |       | 27.15    |       | 20.10   |       | .09 1/2      |       |
|                |            |          |            |         |            |              |            |  |  |  |

 

Thefollowing table sets forth information with respect to purchases of shares ofthe Company’s common stock made during the quarter ended August 26, 2006,by or on behalf of the Company or any “affiliated purchaser” as defined by Rule10b-18(a)(3) of the Securities Exchange Act of 1934.
| ** **                | ** ** | ** **            | ** ** | ** **                   | ** ** | **Total Number of**     | ** ** | **Maximum Number**               | ** ** |
|---------------------------|------------|-----------------------|------------|------------------------------|------------|-----------------------------------|------------|---------------------------------------|------------|
| ** **                | ** ** | ** **            | ** ** | ** **                   | ** ** | **Shares Purchased as** | ** ** | **of Shares that May** | ** ** |
| ** **                | ** ** | **Total Number** | ** ** | ** **                   | ** ** | **Part of Publicly**    | ** ** | **Yet Be Purchased**        | ** ** |
| ** **                | ** ** | **of Shares**    | ** ** | **Average Price**       | ** ** | **Announced Plans**          | ** ** | **Under the Plans**         | ** ** |
| **Period**                | ** ** | **Purchased**         | ** ** | **Paid per Share** | ** ** | **or Programs **(1)     | ** ** | **or Programs **(1)         | ** ** |
| June  (5/28/06-7/1/06)    |       | —                |       | —                       |       | —                            |       | 2,571,254                             |       |
| July  (7/2/06-7/29/06)    |       | 1,500,000             |       | $                            | 22.09      |                              | 1,500,000  |                                  | 1,071,254  |   |
| August  (7/30/06-8/26/06) |       | —                |       | —                       |       | —                            |       | 6,071,254                             |       |
| Total                     |       | 1,500,000             |       | $                            | 22.09      |                              | 1,500,000  |                                  | 6,071,254  |   |

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(1)  On April 13, 2005, the Company announced thatthe Board of Directors authorized the purchase of up to five million shares ofits outstanding common stock from time to time as market conditions warrant.  As of August 26, 2006, the Company had 1.1million shares remaining under this authorization.  On August 19, 2005, the Company announcedthat the Board of Directors authorized the purchase of an additional $300million of the Company’s common stock from time to time as market conditionswarrant.  The Company fully utilized the$300 million authorization during the third quarter of fiscal 2006 inconnection with the overnight share repurchase transaction and other sharerepurchases.  See Note 11 to theConsolidated Financial Statements included in this Report for moreinformation.  On August 18, 2006, theCompany announced that the Board of Directors authorized the purchase of up tofive million shares of its outstanding common stock from time to time as marketconditions warrant.  As of August 26,2006, the Company had not purchased any shares under this authorization.  There is no expiration date governing theperiod during which the Company can make share repurchases pursuant to theabove referenced authorizations.

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**StockPerformance Graph**

Thefollowing graph sets forth the yearly percentage change in the cumulative totalshareholder return on the Company’s common stock during the five fiscal yearsended August 26, 2006, compared with the cumulative total returns of theS&P 500 Index and the S&P General Merchandise Stores Index.  The comparison assumes that $100 was investedin the Company’s common stock on August 25, 2001, and, in each of the foregoingindices on August 31, 2001, and that dividends were reinvested.

**COMPARISONOF FIVE YEAR CUMULATIVE TOTAL RETURN**

**Among Family Dollar Stores, Inc., the S&P 500Index and the S&P General Merchandise Stores Index**
|  |
|--|

 

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**ITEM 6.          SELECTEDFINANCIAL DATA**

**SUMMARY OF SELECTED FINANCIAL DATA**

 
| ** **                                              | ** ** | **Years Ended** | ** ** |
|---------------------------------------------------------|------------|----------------------|------------|
| **(in thousands, except per share** | ** ** | **August 26,**  | ** ** | **August 27,** | ** ** | **August 28,** | ** ** | **August 30,** | ** ** | **August 31,** | ** ** |
| **amounts and store data)**              | ** ** | **2006**(1)          | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net sales                                               |       | $                    | 6,394,772  |   | $ | 5,824,808 |   | $ | 5,281,888 |   | $ | 4,750,171 |   | $ | 4,162,652 |   |
| Cost of sales  and operating expenses                   |       | $                    | 6,077,467  |   | $  | 5,485,998 | (2) | $  | 4,878,526 | (2) | $  | 4,370,278 | (2) | $  | 3,829,798 | (2) |
| Income before  income taxes                             |       | $                    | 311,144    |   | $ | 342,795 |   | $ | 406,662 |   | $ | 383,144 |   | $ | 335,070 |   |
| Income taxes                                            |       | $                    | 116,033    |   | $ | 125,286 |   | $ | 148,758 |   | $ | 139,835 |   | $ | 122,288 |   |
| Net income                                              |       | $                    | 195,111    |   | $ | 217,509 |   | $ | 257,904 |   | $ | 243,309 |   | $ | 212,782 |   |
|                                                    |       |                 |       |   |   |   |   |   |   |   |   |
| Diluted net  income per common share                    |       | $                    | 1.26       |   | $ | 1.30 |   | $ | 1.50 |   | $ | 1.40 |   | $ | 1.22 |   |
| Dividends  declared                                     |       | $                    | 62,757     |   | $ | 61,538 |   | $ | 56,077 |   | $ | 49,890 |   | $ | 44,106 |   |
| Dividends  declared per common share                    |       | $                    | 0.41       |   | $ | 0.37 |   | $ | 0.33 |   | $ | 0.29 |   | $ | .251¤2 |   |
|                                                    |       |                 |       |   |   |   |   |   |   |   |   |
| Total assets                                            |       | $                    | 2,523,029  |   | $ | 2,409,501 |   | $ | 2,224,361 |   | $ | 2,065,392 |   | $ | 1,818,541 |   |
| Working capital                                         |       | $                    | 432,737    |   | $ | 460,157 |   | $ | 489,727 |   | $ | 541,913 |   | $ | 507,945 |   |
| Long-term debt                                          |       | $                    | 250,000    |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Shareholders’  equity                              |       | $                    | 1,208,393  |   | $ | 1,428,066 |   | $ | 1,337,082 |   | $ | 1,292,432 |   | $ | 1,140,577 |   |
|                                                    |       |                 |       |   |   |   |   |   |   |   |   |
| Stores opened                                           |       | 350                  |       | 500 |   | 500 |   | 475 |   | 525 |   |
| Stores closed                                           |       | 75                   |       | 68 |   | 61 |   | 64 |   | 50 |   |
| Number of stores - end  of year                         |       | 6,173                |       | 5,898 |   | 5,466 |   | 5,027 |   | 4,616 |   |

----

(1)             The Company’s resultsfor fiscal 2006 include a $45.0 million (approximately $0.18 per diluted share)litigation charge associated with an adverse litigation judgment in a case inTuscaloosa, Alabama, (See Note 8 to the Consolidated Financial Statements includedin this Report for more information) and cumulative charges of $10.5 million(approximately $0.04 per diluted share) to record non-cash stock-basedcompensation and income tax related interest expense (See Note 10 to theConsolidated Financial Statements included in this Report for moreinformation).

(2)             These amounts havebeen reclassified to conform to the presentation for fiscal 2006.  During fiscal 2006, the Company began presenting interest income and interestexpense separately on the Consolidated Statements of Income.  In prior years interest income and interestexpense were included in selling, general and administrative expenses.
| **ITEM 7.** | ** ** | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS** |
|-------------|------------|-------------------------------------------------------------------------------------------------|

 

The Company operates a chain of more than 6,200general merchandise retail discount stores in 44 states, providing primarilylow to lower-middle income consumers with a wide range of competitively pricedbasic merchandise in convenient neighborhood stores.

This discussion summarizes the significant factorsaffecting the consolidated results of operations and financial condition of theCompany for fiscal 2006, fiscal 2005 and fiscal 2004.  This discussion should be read in conjunctionwith, and is qualified by, the Consolidated Financial Statements and Notes toConsolidated Financial Statements included in this Report.  This discussion should also be read inconjunction with the “Cautionary Statement Regarding Forward Looking Statements”in the General Information section of this Report and the “Risk Factors” listedin Part I, Item 1A of this Report.

15

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**Fiscal2006 Overview**

For fiscal 2006,the Company’s sales were $6.4 billion, an increase of $570.0 million fromfiscal 2005.  Net income declined $22.4million in fiscal 2006 compared with fiscal 2005 and diluted net income percommon share declined $0.04 in fiscal 2006 compared with fiscal 2005.  Included in the results for fiscal 2006 are:  (i) a litigation charge of $45.0 million(approximately $0.18 per diluted share) associated with an adverse litigationjudgment in a case in Tuscaloosa, Alabama, (see Note 8 to the ConsolidatedFinancial Statements included in this Report for more information) and; (ii)cumulative charges of $10.5 million (approximately $0.04 per diluted share) torecord non-cash stock-based compensation and related interest expense (see Note10 to the Consolidated Financial Statements included in this Report for moreinformation).  The various componentsaffecting the Company’s results for fiscal 2006 are discussed in more detail in“Results of Operations” below.

During fiscal2006, the Company continued to focus its efforts on four key initiativesdesigned to increase sales and profitability: the installation of refrigeratedcoolers in selected stores; the continued development of a “Treasure Hunt”merchandise program; the continuation of an aggressive store opening program;and the Urban Initiative.  Theseinitiatives are discussed in detail below.

·                                          Coolers— To drive incremental traffic and to increase the average transaction value,the Company is enhancing its food assortment to meet customers’ frequentfill-in food needs.  During fiscal 2006,the Company installed refrigerated coolers in approximately 2,800 stores.  The customer traffic generated by coolers hasincreased sales of food and other merchandise throughout the store.  At the end of fiscal 2006, approximately3,800 stores had refrigerated coolers.

·                                          “TreasureHunt” merchandise program — The Company has continued to supplement its basicassortment of merchandise with the purchase of certain items designed to createmore excitement in stores throughout the year, with particular emphasis onholidays, spring and back-to-school seasons, and to balance gross margin pressurefrom increased sales of lower-margin consumable merchandise.  During fiscal 2006, the Company took a moreprocess-oriented approach to this initiative by focusing on three keycomponents: identifying and selecting exciting values for customers; informing customersof the compelling values through circulars and in-store handouts and signage;and effectively displaying the items in stores to attract customer attention.

·                                          NewStores — During fiscal 2006, the Company opened 350 stores and closed 75 storeswhile continuing to improve its site selection and development processes.

·                                          UrbanInitiative — The Urban Initiative is designed to improve the operatingperformance of high sales volume stores in large metropolitan markets throughinvestments in people, process changes and technology, including organizationalchanges to support a more mobile and flexible workforce.  During fiscal 2006, the Company continued itsinvestments in the Urban Initiative markets (approximately 1,400 stores at theend of fiscal 2006) and experienced an improvement in profitability in mostmarkets, resulting from positive trends in comparable store sales, betterexpense control and improvements in inventory shrinkage and store managerretention.

During the firstquarter of fiscal 2006, Hurricanes Katrina, Rita and Wilma struck the U.S. GulfCoast and Florida, impacting numerous stores in the afflicted areas.  Because the Company’s stores are widelydispersed, lost sales due to closed stores resulting from damage or poweroutages were generally limited and were substantially offset by increased salesin other stores.  The most significantstorm-related losses were related to the loss of merchandise inventories,furniture and fixtures and leasehold improvements at individual stores in thepaths of the storms.  During fiscal 2006,the Company received payments from its insurance carrier covering a majority ofthe losses.  The net impact of thesestorms has not had, and is not expected to have, a material impact in theaggregate on the Company’s financial position, liquidity or results ofoperations.

**Fiscal2007 Outlook**

Fiscal 2007 will be a 53-week year, compared with a52-week year in fiscal 2006.  The secondquarter of fiscal 2007 will include 14 weeks compared with 13 weeks in thesecond quarter of fiscal 2006.  Duringfiscal 2007, the Company plans to focus its efforts on the followinginitiatives designed to support sustainable and profitable growth and to makeFamily Dollar a more compelling place to shop, work, and invest.

·                                          To support an enhanced food strategy, theCompany plans to expand the cooler program to an additional 1,200 stores;increase its food assortment in approximately 2,000 stores; and installtechnology to facilitate the acceptance of food stamps in approximately 1,000stores.

·                                          In Urban Initiative markets, the Companyplans to continue to focus on driving better returns and to implement a newtechnological platform designed to facilitate better customer service and makethe stores easier to manage.

16

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·                                          In support of the Treasure Hunt program, theCompany plans to further develop an event-driven strategy that createsexcitement for customers and employees; continue to focus on improvinginventory flow and turns, resulting in better presentation of new products; andenhance the apparel assortment.

·                                          During fiscal 2007, the Company plans to openapproximately 300 stores and close 45 stores. The Company also plans to continue to build its site-acquisitioncapabilities and increase its cross-functional focus on new store performance.

·                                          The Company will continue to enhance itsresearch and development effort known as “Concept Renewal.”  The Concept Renewal effort involvesdeveloping new ideas and initiatives designed to sustain profitablegrowth.  The Company plans to continuetesting new merchandising adjacencies and layouts through its Concept Renewalefforts.

·                                          The Company will initiate a multi-yearinvestment designed to strengthen its merchandising and supply chain through areview of processes, personnel needs and technology tools.  This will include price optimization, storeclustering, category management, space management, merchandise planning andimproved assortment planning.

For fiscal 2007, the Company expects net sales to increase 7-9% andcomparable store sales to increase 1-3%. As a result of the ongoing rollout of the Company’s food strategy, theimpact from “Treasure Hunt” merchandise sales and a continued focus on drivingbetter returns in the Urban Initiative markets, the Company expects sales toaccelerate modestly through the year. The Company believes that sales growth in lower-margin consumables andlow single-digit comparable store sales will pressure its operating margin butexpects to largely offset this pressure with better merchandise markups, lowerinventory shrinkage, lower freight expense and the benefits from a continuedrefinement of operational and administrative processes.  Using these assumptions, the Company expectsthat earnings per share for fiscal 2007 will be between $1.63 and $1.69.

# **Results of Operations**

# *NetSales*

Netsales in fiscal 2006 were $6.4 billion, an increase of approximately 9.8%($570.0 million), as compared with an increase of approximately 10.3% ($542.9million) in fiscal 2005.  The increasesin fiscal 2006 and in fiscal 2005 were attributable, in part, to increasedsales in comparable stores (stores open more than 13 months) of 3.7% ($209.6million) and 2.3% ($117.1 million), respectively, with the balance of theincreases primarily relating to sales from new stores opened as part of theCompany’s store growth program.  Thecomparable store sales calculation for fiscal 2006 excludes a limited number ofstores that were closed for an extended period of time as a result of thehurricanes as discussed above.  The UrbanInitiative, the installation of refrigerated coolers and the “Treasure Hunt”merchandise program all had positive impacts on sales in fiscal 2006 and fiscal2005.  Sales of consumable merchandiseand electronics, including pre-paid cellular phones and services in fiscal2006, were the primary drivers of the sales increase.  See Item 1 — “Merchandise” elsewhere in thisReport for a breakdown of the percentage of sales attributable to each productcategory during the last three fiscal years.

Infiscal 2006, the customer count, as measured by the number of registertransactions in comparable stores, decreased approximately 1.2%, and theaverage transaction increased approximately 4.8% to $9.66.  The Company believes that customers continuedto reduce their shopping frequency in response to higher energy costs byconsolidating trips around pay cycles. In fiscal 2005, the customer count decreased approximately 0.7%, and theaverage transaction increased approximately 2.9% to $9.22.

The Companydistributed four advertising circulars in both fiscal 2006 and fiscal 2005 andone advertising circular in fiscal 2004. The circulars are designed to stimulate traffic and inform customersabout the Company’s Treasure Hunt merchandise, seasonal values and competitiveprices on core consumables.

Duringfiscal 2006, the Company opened 350 stores and closed 75 stores for a netaddition of 275 stores, compared with the opening of 500 stores and closing of68 stores for a net addition of 432 stores during fiscal 2005.  The Company also expanded or relocated 24stores in fiscal 2006, compared with 49 stores that were expanded or relocatedin fiscal 2005.  In addition, approximately12 stores in fiscal 2006 and 105 stores in fiscal 2005 were renovated.

*Cost ofSales*

Cost of salesincreased approximately 9.4% ($367.9 million) in fiscal 2006 compared withfiscal 2005 and approximately 11.8% ($412.3 million) in fiscal 2005 comparedwith fiscal 2004.  These increasesprimarily reflected the additional sales volume in each of the years.  Cost of sales, as a percentage of net sales,was 66.9% in fiscal 2006, 67.1% in fiscal 2005 and 66.2% in fiscal 2004.  The decrease in cost of sales, as apercentage of net sales, during fiscal 2006 was due

17

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primarily to a morefavorable merchandise sales mix, better merchandise markup and improvedinventory shrinkage.  These improvementswere partially offset by higher freight costs resulting from higher fuel costs.  The opening of the Company’s eighthdistribution center in Marianna, Florida, in the second quarter of fiscal 2005and its continued ramp-up in fiscal 2006 have positively impacted freight costsby lowering the average distance to the stores from the distribution centers.  Increases in transportation productivity andefficiency also offset some of the cost increases.  However, these savings did not fully offsetthe impact of higher year-over-year fuel costs. The Company expects that the opening of the ninth distribution center inRome, New York, during the third quarter of fiscal 2006, will continue to lowerthe average distance to the stores from the distribution centers and willpositively impact freight costs.

Theincrease in cost of sales, as a percentage of net sales, during fiscal 2005compared with fiscal 2004 was due primarily to the shift in the merchandise mixto more lower-margin consumables and fewer higher-margin discretionary goods,increased inventory shrinkage and increased freight costs due to higher fuelexpense.

*Selling,General and Administrative Expenses*

Selling,general and administrative (“SG&A”) expenses increased approximately 11.3%($178.6 million) in fiscal 2006 compared with fiscal 2005, and approximately14.1% ($195.2 million) in fiscal 2005 compared with fiscal 2004.  The increases in these expenses wereattributable primarily to additional costs arising from the continued growth inthe number of stores in operation and the ramp-up of the ninth distributioncenter.  SG&A expenses, as apercentage of net sales, were 27.5% in fiscal 2006, 27.1% in fiscal 2005, and26.2% in fiscal 2004.  The increase inSG&A expenses, as a percentage of net sales, in fiscal 2006 was dueprimarily to increased compensation expense related to the expensing ofstock-based compensation and an increase in annual bonus compensation(approximately 0.4% of net sales), increased utility costs (approximately 0.2%of net sales), and a cumulative charge to adjust non-cash stock-basedcompensation expense (approximately 0.1% of net sales) as more fully describedin Note 10 to the Consolidated Financial Statements included in thisReport.  During fiscal 2006, the Company beganrecording stock-based compensation in connection with its adoption of Statementof Financial Accounting Standards (“SFAS”) No. 123 (revised 2004) “Share-BasedPayment” (“SFAS 123R”).  See Note 9 tothe Consolidated Financial Statements included in this Report for moreinformation on SFAS 123R and its impact on the Company.  These increases were partially offsetby a reduction in store payroll expenses (approximately 0.2% of netsales).  The reduction in store payrollexpenses, as a percentage of net sales, resulted from the stabilization ofstore operations and the improved performance of Urban Initiative stores.  In addition, most other costs, as apercentage of net sales, were leveraged as a result of improved cost controland the comparable store sales growth.

Theincrease in SG&A expenses, as a percentage of net sales, in fiscal 2005compared with fiscal 2004 was due primarily to planned payroll expensesincurred in connection with the urban and cooler initiatives; increasedoccupancy and store-related costs; and increased legal-related costs.  Each of these percentages was negativelyimpacted by a lower than planned increase in sales in comparable stores.  A cumulative charge to correct property taxaccruals on leased properties and the incremental costs of three additionaladvertising circulars also impacted this percentage, but these amounts were offsetby a reduction in bonus costs as the Company did not reach the earnings targetnecessary for payment of management bonuses. In addition, most other costs, as a percentage of net sales, werenegatively impacted by the lower than planned increase in sales in comparablestores.

*LitigationCharge*

During the second quarter of fiscal 2006, theCompany recorded a $45.0 million (approximately $0.18 per diluted share)litigation charge associated with an adverse litigation judgment in a case inTuscaloosa, Alabama.  See Note 8 to theConsolidated Financial Statements included in this Report for moreinformation.  All other legal expensesduring fiscal 2006, fiscal 2005 and fiscal 2004, including the Company’sdefense costs related to the above-referenced case, were recorded in SG&A.

*InterestIncome*

Interestincome increased 74.0% ($2.9 million) in fiscal 2006 compared with fiscal2005.  The increase was due to anincrease in interest rates and an increase in investment securities.

18

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*InterestExpense*

OnSeptember 27, 2005, the Company obtained $250 million in aggregate proceedsthrough a private placement of unsecured Senior Notes (the “Notes”) to a groupof institutional accredited investors. During fiscal 2006, the Company incurred $11.4 million in interest expenserelated to the Notes.  See Note 4 to theConsolidated Financial Statements included in this Report for information onthe Company’s current and long-term debt. Also during fiscal 2006, the Company recorded $1.4 million of interestexpense relating to income tax adjustments as a result of changes to themeasurement dates of certain stock option grants.  See Note 10 to the Consolidated FinancialStatements included in this Report for more information.  The Company did not incur any interestexpense during fiscal 2005 or fiscal 2004.

*IncomeTaxes*

The effective taxrate was 37.3% in fiscal 2006, 36.5% in fiscal 2005, and 36.6% in fiscal2004.  The increase in the effective taxrate in fiscal 2006, compared with fiscal 2005 was a result of the effect ofchanges in state income taxes and the expiration of certain federal jobs taxcredits for employees hired after December 31, 2005.

**Liquidityand Capital Resources**

TheCompany has consistently maintained a strong liquidity position.  Cash provided by operating activities duringfiscal 2006 was $451.0 million as compared to $299.4 million in fiscal 2005,and $376.5 million in fiscal 2004.  Theseamounts have enabled the Company to fund its regular operating needs, capitalexpenditure program, cash dividend payments, and interest payments.

OnAugust 24, 2006, the Company entered into an unsecured revolving creditfacility with a syndicate of lenders for short-term borrowings of up to $350million.  The credit facility replacedthe Company’s then outstanding unsecured revolving credit facilities forshort-term borrowings of up to $200 million. The credit facility expires on August 24, 2011.  Any borrowings under the credit facility areat a variable interest rate based on short-term market interest rates.  Outstanding standby letters of credit reducethe borrowing capacity of the credit facility. The Company had no borrowings against its credit facilities duringfiscal 2006.  The credit facilitycontains certain restrictive financial covenants, which include a consolidateddebt to consolidated capitalization ratio, a fixed charges coverage ratio, anda priority debt to consolidated net worth ratio.

Merchandiseinventories at the end of fiscal 2006 were 4.9% lower than at the end of fiscal2005.  The decrease in merchandiseinventories was a result of the Company’s renewed focus on inventoryproductivity and a shift in the timing of holiday merchandise receipts, whichmore than offset additional inventory related to 275 net new stores andinventory associated with the cooler program. Inventory on a per store basis at the end of fiscal 2006 wasapproximately 10% lower than at the end of fiscal 2005, excluding merchandisein transit to the distribution centers. The Company’s focus on inventory productivity includes improved planningand flow of fashion merchandise and the use of more aggressive exitstrategies.  As a result, inventories inthe apparel and accessories category have shown the most significantimprovement in productivity.  Inaddition, the continued expansion and refinement of the Company’s centralizedreplenishment system has resulted in lower inventory levels of basicmerchandise and better in-stock levels.

Thedecrease in capital expenditures to $192.2 million in fiscal 2006 from $229.1million in fiscal 2005 was due primarily to the decrease in the number ofstores opened during fiscal 2006 as compared to fiscal 2005.  Offsetting some of the decrease was theinstallation of refrigerated coolers in approximately 2,800 stores.  Capital expenditures for fiscal 2007 areexpected to be between $155 and $165 million and relate primarily to new storeopenings; existing store expansions, relocations and renovations; expendituresrelated to technology infrastructure investments; and the continuedimplementation of a refrigerated cooler program for perishable goods inselected stores.  The new store expansionwill require additional investment in merchandise inventories.

Capitalspending plans, including store opening plans, are continuously reviewed andare subject to change.  Cash flow fromcurrent operations is expected to be sufficient to meet planned liquidity andoperational capital resource needs, including store expansion and other capitalspending programs.  In addition, theCompany has available a revolving credit facility as previously discussed.

During fiscal2006, the Company purchased 15.4 million shares of its common stock at a costof $367.3 million, as described below. During fiscal 2005 and fiscal 2004, the Company purchased in the openmarket 3.3 million shares and 5.6 million shares, respectively, at a cost of$92.0 million and $176.7 million, respectively.

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On September 27,2005, the Company obtained $250 million in aggregate proceeds through theprivate placement of the Notes to a group of institutional accreditedinvestors.  On October 4, 2005, theCompany executed an overnight share repurchase transaction with a bank for theacquisition of 10 million shares of the Company’s outstanding commonstock.  The transaction was financed withthe proceeds of the Notes.  The totalcost of the overnight share repurchase transaction was $234.2 million.  See Note 4 and Note 11 to the ConsolidatedFinancial Statements included in this Report for more information on theCompany’s outstanding debt and the overnight share repurchase transaction.

Upon completion ofthe overnight share repurchase transaction the Company continued to purchaseshares of its common stock pursuant to Rule 10b5-1 of the Exchange Act.  During the third quarter of fiscal 2006, theCompany purchased 3.9 million shares of its common stock at a cost of $100.0million.  During the fourth quarter offiscal 2006, the Company purchased in the open market 1.5 million shares of itscommon stock at a cost of $33.1 million.

OnDecember 19, 2006, the Company entered into separate agreements in connectionwith the Notes and its unsecured revolving credit facility.  The agreements extended the delivery date forthe fiscal 2006 audited financial statements, the unaudited financialstatements for the first quarter of fiscal 2007 and the correspondingcompliance certificates to March 31, 2007, and waived any Defaults or Events ofDefault that would have occurred due to the failure of the Company to deliversuch information in connection with the Notes and credit facility.  As discussed in Note 10 to the ConsolidatedFinancial Statements included in this Report, the Company formed a SpecialCommittee of the Board of Directors to investigate the Company’s stock option grantingpractices.  As a result, the Company wasunable to file its Annual Report on Form 10-K for fiscal 2006 and its QuarterlyReport on Form 10-Q for the first quarter of fiscal 2007 by the requireddeadlines.  As of the date of the filingof this Report, the Company has delivered the appropriate financial statementsand compliance certificates and is in compliance with all covenants under boththe Notes and credit facility.

As of August 26,2006, the Company had outstanding authorizations to purchase a total ofapproximately 6.1 million shares, consisting of 1.1 million shares remainingunder an authorization approved by the Board of Directors on April 13, 2005,and 5.0 million shares remaining under an authorization approved by the Boardof Directors on August 18, 2006.

The followingtable shows the Company’s obligations and commitments to make future paymentsunder contractual obligations at the end of fiscal 2006:
| ** **                       | ** ** | **Payments Due During the Period Ending** | ** ** |
|----------------------------------|------------|--------------------------------------------------------------------|------------|
| **(in thousands)**          | ** ** | ** **                                                         | ** ** | **August** | ** ** | **August** | ** ** | **August** | ** ** | **August** | ** ** | **August** | ** ** | ** ** | ** ** |
| **Contractual Obligations** | ** ** | **Total**                                                          | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **Thereafter** | ** ** |
| Long-term debt                   |       | $                                                                  | 250,000    |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 250,000 |   |
| Interest                         |       | 118,691                                                            |       | 13,387 |   | 13,387 |   | 13,387 |   | 13,387 |   | 13,387 |   | 51,756 |   |
| Merchandise  letters of credit   |       | 152,189                                                            |       | 152,189 |   | — |   | — |   | — |   | — |   | — |   |
| Operating leases                 |       | 1,211,611                                                          |       | 271,811 |   | 241,484 |   | 203,066 |   | 159,912 |   | 114,104 |   | 221,234 |   |
| Construction  obligations        |       | 5,393                                                              |       | 5,393 |   | — |   | — |   | — |   | — |   | — |   |
| Total                            |       | $                                                                  | 1,737,884  |   | $ | 442,780 |   | $ | 254,871 |   | $ | 216,453 |   | $ | 173,299 |   | $ | 127,491 |   | $ | 522,990 |   |

 

At theend of fiscal 2006, approximately $81.8 million of the merchandise letters ofcredit were included in accounts payable and accrued liabilities on the Company’sConsolidated Balance Sheet.  Most of theCompany’s operating leases provide the Company with an option to extend theterm of the lease at designated rates. See Item 2 — “ Properties” in this Report.

The followingtable shows the Company’s other commercial commitments at the end of fiscal2006:

| Other Commercial Commitments (in thousands) | ** ** | **Total Amounts  Committed** | ** ** |
|-----------------------------------------------------------------|------------|-----------------------------------|------------|
| Standby letters  of credit                                      |       | $                                 | 122,082    |   |
| Surety bonds                                                    |       | 44,934                            |       |
| Total                                                           |       | $                                 | 167,016    |   |

 

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Asubstantial portion of the outstanding amount of standby letters of credit(which are primarily renewed on an annual basis) are used as surety for futurepremium and deductible payments to the Company’s workers’ compensation andgeneral liability insurance carrier.  TheCompany accrues for these future payment liabilities as described in the “CriticalAccounting Policies” section of this discussion.  Included in the outstanding amount of suretybonds is a $41.6 million bond obtained by the Company during the third quarterof fiscal 2006 in connection with an adverse litigation judgment, as discussed in Note 8 to the Consolidated Financial Statementsincluded in this Report.

**RecentAccounting Pronouncements**

In December 2004, the Financial Accounting StandardsBoard (“FASB”) issued SFAS 123R, which requires all companies to measurecompensation cost for all share-based payments (including employee stockoptions) at fair value, effective for public companies for interim or annualperiods beginning after June 15, 2005. The FASB concluded that companies can adopt the new standard in one oftwo ways: the modified prospective transition method, in which the companywould recognize share-based employee compensation from the beginning of thefiscal period in which the recognition provisions are first applied as if thefair-value-based accounting method had been used to account for all employeeawards granted, modified, or settled after the effective date and to any awardsthat were not fully vested as of the effective date; or the modifiedretrospective transition method, in which a company would recognize employeecompensation cost for periods presented prior to the adoption of SFAS 123R inaccordance with the original provisions of SFAS 123 “Accounting for Stock-BasedCompensation” (“SFAS 123”), pursuant to which a company would recognizeemployee compensation cost in the amounts reported in the pro forma disclosuresprovided in accordance with SFAS 123. The Company adopted SFAS 123R during the first quarter of fiscal 2006using the modified prospective transition method.  See Note 9 to the Consolidated FinancialStatements included in this Report for more information.

In May 2005, the FASB issued SFAS No. 154, “AccountingChanges and Error Corrections” (“SFAS 154”). SFAS 154 replaces Accounting Principles Board Opinion No. 20, “AccountingChanges,” and SFAS No. 3, “Reporting Accounting Changes in Interim FinancialStatements.”  SFAS 154 changes therequirements for the accounting for and reporting of a change in accountingprinciple.  SFAS 154 is effective foraccounting changes and corrections of errors made in fiscal years beginningafter December 15, 2005.  The Companydoes not expect SFAS 154 to have a material impact on its ConsolidatedFinancial Statements.

In July 2006, the FASB issued Interpretation No. 48, “Accountingfor Uncertainty in Income Taxes” (“FIN 48”). FIN 48 provides guidance regarding the recognition and measurement oftax positions and the related reporting and disclosure requirements and will beeffective for the Company beginning with its first quarter of fiscal 2008.  The Company has not yet determined theimpact, if any, that FIN 48 will have on its Consolidated Financial Statements.

In September 2006, the FASB issued SFAS No. 157, “FairValue Measurements” (“SFAS 157”).  SFAS157 defines fair value, establishes a framework for measuring fair value ingenerally accepted accounting principles and expands disclosures about fairvalue measurements.  SFAS 157 iseffective for the first annual period ending after November 15, 2007.  The Company has not yet determined theimpact, if any, that SFAS 157 will have on its Consolidated FinancialStatements.

In September 2006, the SEC issued Staff AccountingBulletin No. 108, “Considering the Effects of Prior Year Misstatements whenQuantifying Misstatements in Current Year Financial Statements” (“SAB 108”).  SAB 108 provides guidance on theconsideration of the effects of prior year misstatements in quantifying currentyear misstatements for the purpose of a materiality assessment.  SAB 108 requires quantification of financialstatement errors based on the effects of the error on each of the company’sfinancial statements and the related financial statement disclosures.  This approach is referred to as the “dualapproach” because it requires both the carryover and reversing effects of prioryear misstatements to be quantified.  SAB108 is effective for the first annual period ending after November 15,2006.  The Company is currently assessingthe impact that SAB 108 will have on its Consolidated Financial Statements.

**CriticalAccounting Policies**

Managementbelieves the following accounting principles are critical because they involvesignificant judgments, assumptions and estimates used in the preparation of theCompany’s Consolidated Financial Statements.

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*MerchandiseInventories:*

Inventoriesare valued using the retail method, based on retail prices less markonpercentages, which approximates the lower of first-in, first-out (FIFO) cost ormarket.  The Company records adjustmentsto inventory through cost of goods sold when retail price reductions, or markdowns,are taken against on-hand inventory.  Inaddition, management makes estimates and judgments regarding, among otherthings, initial markups, markdowns, future demand for specific productcategories and market conditions, all of which can significantly impactinventory valuation.  If actual demand ormarket conditions are different than those projected by management, additionalmarkdowns may be necessary.  This risk isgenerally higher for seasonal merchandise than for non-seasonal goods.  The Company also provides for estimatedinventory losses for damaged, lost or stolen inventory for the period from thelatest physical inventory to the financial statement date.  These estimates are based on historicalexperience and other factors.

*Propertyand Equipment:*

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

*InsuranceLiabilities:*

TheCompany is primarily self-insured for health care, property loss, workers’compensation and general liability costs. These costs are significant primarily due to the large number of theCompany’s retail locations and employees. Because the nature of these claims is such that there can be asignificant lag from the incurrence of the claim (which is when the expense isaccrued) until payment is made, the percentage increase in the accrual can bemuch more pronounced than the percentage increase in the expense.  The Company’s self-insurance liabilities arebased on the total estimated costs of claims filed and estimates of claimsincurred but not reported, less amounts paid against such claims, and are notdiscounted.  Management reviews currentand historical claims data in developing its estimates.  The Company also uses information provided byoutside actuaries with respect to medical, workers’ compensation and generalliability claims.  If the underlyingfacts and circumstances of the claims change or the historical trend is notindicative of future trends, then the Company may be required to recordadditional expense or a reduction to expense which could be material to thereported financial condition and results of operations.

*Contingent Income Tax Liabilities:*

The Company is subject toroutine income tax audits that occur periodically in the normal course ofbusiness.  The Company’s contingentincome tax liabilities are estimated based on an assessment of the probabilityof the income tax related exposures and settlements and are influenced by theCompany’s historical audit experiences with various state and federal taxingauthorities as well as current income tax trends.  If circumstances change, the Company may berequired to record adjustments that could be material to its reported financialcondition and results of operations.

*Contingent Legal Liabilities:*

The Company is involvedin numerous legal proceedings and claims. The Company’s reserves, if any, related to these proceedings and claimsare based on a determination of whether or not the loss is both probable andestimable.  The Company reviewsoutstanding claims and proceedings with external counsel to assess probabilityand estimates of loss.  The claims andproceedings are re-evaluated each quarter or as new and significant informationbecomes available, and the reserves are adjusted or established, if necessary.  If circumstances change, the Company may berequired to record adjustments that could be material to its reported financialcondition and results of operations.

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*LeaseAccounting:*

TheCompany leases substantially all of its store properties and accounts for storeleases in accordance with SFAS 13, “Accounting for Leases” and relatedinterpretations.  For purposes ofrecognizing incentives, premiums and minimum rental expenses on a straight-linebasis over terms of the leases, the Company uses the date of initial possessionto begin amortization, which is generally when the Company enters the space andbegins to make improvements in preparation of intended use.  For tenant improvement allowances and rentholidays, the Company records a deferred rent liability at the inception of thelease term and amortizes the deferred rent over the terms of the leases asreductions to rent expense on the Consolidated Statements of Income.

*Stock-based Compensation Expense:*

The Company adopted SFAS 123R during the firstquarter of fiscal 2006.  SFAS 123R requiresthe measurement and recognition of compensation expense for all stock-basedawards made to employees based on estimated fair values.  The determination of the fair value of theCompany’s stock options on the date of grant using an option-pricing model isaffected by the Company’s stock price as well as assumptions regarding a numberof complex and subjective variables. These variables include, but are not limited to, the expected stockprice volatility over the term of the awards, and actual and projected employeestock option exercise behaviors.  TheCompany also grants performance share rights and adjusts compensation expenseeach quarter based on the ultimate number of shares expected to be issued.** **If factors changeand the Company employs different assumptions in the application of SFAS 123Rin future periods, the compensation expense recorded under SFAS 123R may differsignificantly from the amount recorded in the current period.

**ITEM 7A.****                    QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

The Company issubject to market risk from exposure to changes in interest rates based on itsfinancing, investing and cash management activities.  The Company maintains an unsecured revolvingcredit facility at a variable rate of interest to meet the short-term needs ofits expansion program and seasonal inventory increases.  The Company had no borrowings against itscredit facilities during fiscal 2006. The Company’s long-term debt associated with the Notes bears interest atfixed rates.

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**ITEM 8.          FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA**

**INDEX TO CONSOLIDATED FINANCIAL STATEMENTS**

**FAMILY DOLLAR STORES, INC.**

 
| Report of Independent  Registered Public Accounting Firm                                            |
|-----------------------------------------------------------------------------------------------------|
|                                                                                                |
| Consolidated  Statements of Income for fiscal 2006, fiscal 2005 and fiscal 2004                     |
|                                                                                                |
| Consolidated Balance  Sheets as of August 26, 2006 and August 27, 2005                              |
|                                                                                                |
| Consolidated  Statements of Shareholders’ Equity for fiscal 2006, fiscal 2005 and fiscal  2004 |
|                                                                                                |
| Consolidated  Statements of Cash Flows for fiscal 2006, fiscal 2005 and fiscal 2004                 |
|                                                                                                |
| Notes to  Consolidated Financial Statements                                                         |

 

 

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**Report of Independent Registered Public AccountingFirm**

To the Board ofDirectors and Shareholders of Family Dollar Stores, Inc:

We have completedintegrated audits of Family Dollar Stores, Inc.’s August 26, 2006 and August27, 2005 consolidated financial statements and of its internal control overfinancial reporting as of August 26, 2006, and an audit of its August 28, 2004consolidated financial statements in accordance with the standards of thePublic Company Accounting Oversight Board (United States).  Our opinions, based on our audits, arepresented below.

*Consolidatedfinancial statements*

In our opinion,the consolidated financial statements listed in the accompanying index presentfairly, in all material respects, the financial position of Family DollarStores, Inc., and its subsidiaries at August 26, 2006 and August 27, 2005, andthe results of their operations and their cash flows for each of the threeyears in the period ended August 26, 2006 in conformity with accountingprinciples generally accepted in the United States of America.  These financial statements are theresponsibility of the Company’s management. Our responsibility is to express an opinion on these financialstatements based on our audits.  Weconducted our audits of these statements in accordance with the standards ofthe Public Company Accounting Oversight Board (United States).  Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit of financial statements includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements,assessing the accounting principles used and significant estimates made bymanagement, and evaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

*Internalcontrol over financial reporting*

Also, in ouropinion, management’s assessment, included in Management’s Report on Internal ControlOver Financial Reporting appearing under Item 9A, that the Company maintainedeffective internal control over financial reporting as of August 26, 2006 basedon criteria established in Internal Control - Integrated Framework issued bythe Committee of Sponsoring Organizations of the Treadway Commission (COSO), isfairly stated, in all material respects, based on those criteria.  Furthermore, in our opinion, the Companymaintained, in all material respects, effective internal control over financialreporting as of August 26, 2006, based on criteria established in InternalControl - Integrated Framework issued by the COSO.  The Company’s management is responsible formaintaining effective internal control over financial reporting and for itsassessment of the effectiveness of internal control over financialreporting.  Our responsibility is toexpress opinions on management’s assessment and on the effectiveness of theCompany’s internal control over financial reporting based on our audit.  We conducted our audit of internal controlover financial reporting in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtainreasonable assurance about whether effective internal control over financialreporting was maintained in all material respects.  An audit of internal control over financialreporting includes obtaining an understanding of internal control over financialreporting, evaluating management’s assessment, testing and evaluating thedesign and operating effectiveness of internal control, and performing suchother procedures as we consider necessary in the circumstances.  We believe that our audit provides areasonable basis for our opinions.

A company’sinternal control over financial reporting is a process designed to providereasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance withgenerally accepted accounting principles. A company’s internal control over financial reporting includes thosepolicies and procedures that (i) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (ii) provide reasonable assurancethat transactions are recorded as necessary to permit preparation of financialstatements in accordance with generally accepted accounting principles, andthat receipts and expenditures of the company are being made only in accordancewith authorizations of management and directors of the company; and (iii)provide reasonable assurance regarding prevention or timely detection ofunauthorized acquisition, use, or disposition of the company’s assets thatcould have a material effect on the financial statements.

Because of itsinherent limitations, internal control over financial reporting may not preventor detect misstatements.  Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

PricewaterhouseCoopersLLP

Charlotte, North Carolina

March 28, 2007

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

**CONSOLIDATED STATEMENTS OF INCOME**
| ** **                                                            | ** ** | **Years Ended**          | ** ** |
|-----------------------------------------------------------------------|------------|-------------------------------|------------|
| **(in thousands, except per share amounts)** | ** ** | **August 26, 2006** | ** ** | **August 27, 2005** | ** ** | **August 28, 2004** | ** ** |
| Net sales                                                             |       | $                             | 6,394,772  |   | $ | 5,824,808 |   | $ | 5,281,888 |   |
|                                                                  |       |                          |       |   |   |   |   |
| Cost and expenses:                                                    |       |                          |       |   |   |   |   |
| Cost of sales                                                         |       | 4,276,466                     |       | 3,908,569 |   | 3,496,278 |   |
| Selling, general and administrative                                   |       | 1,756,001                     |       | 1,577,429 |   | 1,382,248 |   |
| Litigation charge (Note 8)                                            |       | 45,000                        |       | — |   | — |   |
| Cost of sales  and operating expenses                                 |       | 6,077,467                     |       | 5,485,998 |   | 4,878,526 |   |
|                                                                  |       |                          |       |   |   |   |   |
| Operating profit                                                      |       | 317,305                       |       | 338,810 |   | 403,362 |   |
|                                                                  |       |                          |       |   |   |   |   |
| Interest income                                                       |       | 6,934                         |       | 3,985 |   | 3,300 |   |
|                                                                  |       |                          |       |   |   |   |   |
| Interest expense  (Note 4)                                            |       | 13,095                        |       | — |   | — |   |
|                                                                  |       |                          |       |   |   |   |   |
| Income before  income taxes                                           |       | 311,144                       |       | 342,795 |   | 406,662 |   |
|                                                                  |       |                          |       |   |   |   |   |
| Income taxes  (Note 6)                                                |       | 116,033                       |       | 125,286 |   | 148,758 |   |
|                                                                  |       |                          |       |   |   |   |   |
| Net income                                                            |       | $                             | 195,111    |   | $ | 217,509 |   | $ | 257,904 |   |
|                                                                  |       |                          |       |   |   |   |   |
| Net income per  common share — basic (Note 11)                   |       | $                             | 1.26       |   | $ | 1.30 |   | $ | 1.51 |   |
| Average shares — basic (Note 11)                                 |       | 154,967                       |       | 166,791 |   | 170,770 |   |
|                                                                  |       |                          |       |   |   |   |   |
| Net income per  common share — diluted (Note 11)                 |       | $                             | 1.26       |   | $ | 1.30 |   | $ | 1.50 |   |
| Average shares —  diluted (Note 11)                              |       | 155,124                       |       | 167,092 |   | 171,624 |   |

 

Theaccompanying notes are an integral part of the consolidated financialstatements.

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

**CONSOLIDATEDBALANCE SHEETS**
| ** **                                                                                                                                                                                                                                                              | ** ** | **August 26,** | ** ** | **August 27,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|---------------------|------------|
| **(in thousands, except per share and share amounts)**                                                                                                                                                                               | ** ** | **2006**            | ** ** | **2005**            | ** ** |
| **Assets**                                                                                                                                                                                                                                                              |       |                |       |                |       |
| Current assets:                                                                                                                                                                                                                                                         |       |                |       |                |       |
| Cash and cash equivalents                                                                                                                                                                                                                                               |       | $                   | 79,727     |                | $          | 105,175 |   |
| Investment securities (Note 2)                                                                                                                                                                                                                                          |       | 136,505             |       | 33,530              |       |
| Merchandise inventories                                                                                                                                                                                                                                                 |       | 1,037,859           |       | 1,090,791           |       |
| Deferred income taxes (Note 6)                                                                                                                                                                                                                                          |       | 133,468             |       | 100,493             |       |
| Income tax refund receivable                                                                                                                                                                                                                                            |       | 2,397               |       | —              |       |
| Prepayments and other current assets                                                                                                                                                                                                                                    |       | 28,892              |       | 24,779              |       |
| Total current assets                                                                                                                                                                                                                                                    |       | 1,418,848           |       | 1,354,768           |       |
|                                                                                                                                                                                                                                                                    |       |                |       |                |       |
| Property and  equipment, net (Note 3)                                                                                                                                                                                                                                   |       | 1,077,608           |       | 1,027,475           |       |
| Other assets                                                                                                                                                                                                                                                            |       | 26,573              |       | 27,258              |       |
|                                                                                                                                                                                                                                                                    |       | $                   | 2,523,029  |                | $          | 2,409,501 |   |
|                                                                                                                                                                                                                                                                    | ** ** | ** **          | ** ** | ** **          | ** ** |
| **Liabilities  and Shareholders’ Equity**                                                                                                                                                                                                                          |       |                |       |                |       |
| Current  liabilities:                                                                                                                                                                                                                                                   |       |                |       |                |       |
| Accounts payable                                                                                                                                                                                                                                                        |       | $                   | 556,531    |                | $          | 574,831 |   |
| Accrued liabilities (Note 5)                                                                                                                                                                                                                                            |       | 429,580             |       | 315,508             |       |
| Income taxes payable                                                                                                                                                                                                                                                    |       | —              |       | 4,272               |       |
| Total current liabilities                                                                                                                                                                                                                                               |       | 986,111             |       | 894,611             |       |
|                                                                                                                                                                                                                                                                    |       |                |       |                |       |
| Long-term debt  (Note 4)                                                                                                                                                                                                                                                |       | 250,000             |       | —              |       |
| Deferred income  taxes (Note 6)                                                                                                                                                                                                                                         |       | 78,525              |       | 86,824              |       |
| Commitments and  contingencies                                                                                                                                                                                                                                          |       |                |       |                |       |
|                                                                                                                                                                                                                                                                    |       |                |       |                |       |
| Shareholders’  equity: (Notes 9, 10 and 11)                                                                                                                                                                                                                        |       |                |       |                |       |
| Preferred stock, $1 par; authorized and unissued  500,000 shares                                                                                                                                                                                                        |       |                |       |                |       |
| Common stock, $.10 par; authorized 600,000,000  shares; issued 178,559,411 shares at August 26, 2006, and 188,871,738 shares  at August 27, 2005, and outstanding 150,210,484 shares at August 26, 2006,  and 165,262,513 shares at August 27, 2005 |       | 17,856              |       | 18,887              |       |
| Capital in excess of par                                                                                                                                                                                                                                                |       | 140,829             |       | 133,743             |       |
| Retained earnings                                                                                                                                                                                                                                                       |       | 1,546,366           |       | 1,654,861           |       |
|                                                                                                                                                                                                                                                                    |       | 1,705,051           |       | 1,807,491           |       |
| Less: common  stock held in treasury, at cost (28,348,927 shares at August 26, 2006, and  23,609,225 shares at August 27, 2005)                                                                                                                                         |       | 496,658             |       | 379,425             |       |
| Total shareholders’ equity                                                                                                                                                                                                                                         |       | 1,208,393           |       | 1,428,066           |       |
| ** **                                                                                                                                                                                                                                                              |       | $                   | 2,523,029  |                | $          | 2,409,501 |   |

 

Theaccompanying notes are an integral part of the consolidated financialstatements.

27

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

**CONSOLIDATED STATEMENTS OFSHAREHOLDERS’ EQUITY**

**Years Ended August 26, 2006, August27, 2005, and August 28, 2004**

 
| **(in thousands, except per share and share amounts)**               | ** ** | **Common  stock** | ** ** | **Capital in  excess of par** | ** ** | **Retained  earnings** | ** ** | **Treasury  stock** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|-------------------|------------|----------------------------------------------|------------|------------------------|------------|---------------------|------------|
| **Balance,  August 30, 2003**                                                                           |       |              | ** ** | ** **                                   |       |                   |       |                |       |
| (186,909,993 shares common stock; 14,701,283 shares  treasury stock)                                    |       | $                 | 18,691     |                                         | $          | 87,457                 |       | $                   | 1,297,063  |   | $ | 110,779 |   |
| Net income for  the year                                                                                |       |              |       |                                         |       | 257,904                |       |                |       |
| Issuance of  761,325 common shares under employee stock option plan, including tax  benefits (Note 9)   |       | 76                |       | 19,318                                       |       |                   |       |                |       |
| Purchase of  5,576,100 common shares for treasury                                                       |       |              |       |                                         |       |                   |       | 176,674             |       |
| Issuance of  3,063 shares of treasury stock under the Family Dollar 2000 Outside Directors  Plan        |       |              |       | 78                                           |       |                   |       | (25                 | )          |
| Less dividends  on common stock, $.33 per share                                                         |       |              |       |                                         |       | (56,077                | )          |                |       |
| **Balance,  August 28, 2004**                                                                           |       |              |       |                                         |       |                   |       |                |       |
| (187,671,318 shares common stock; 20,274,320 shares  treasury stock)                                    |       | 18,767            |       | 106,853                                      |       | 1,498,890              |       | 287,428             |       |
| Net income for  the year                                                                                |       |              |       |                                         |       | 217,509                |       |                |       |
| Issuance of  1,200,420 common shares under employee stock option plan, including tax  benefits (Note 9) |       | 120               |       | 26,829                                       |       |                   |       |                |       |
| Purchase of  3,338,500 common shares for treasury                                                       |       |              |       |                                         |       |                   |       | 92,049              |       |
| Issuance of  3,595 shares of treasury stock under the Family Dollar 2000 Outside Directors  Plan        |       |              |       | 61                                           |       |                   |       | (52                 | )          |
| Less dividends  on common stock, $.37 per share                                                         |       |              |       |                                         |       | (61,538                | )          |                |       |
| **Balance,  August 27, 2005**                                                                           |       |              |       |                                         |       |                   |       |                |       |
| (188,871,738 shares common stock; 23,609,225 shares  treasury stock)                                    |       | 18,887            |       | 133,743                                      |       | 1,654,861              |       | 379,425             |       |
| Net income for  the year                                                                                |       |              |       |                                         |       | 195,111                |       |                |       |
| Issuance of  297,595 common shares under employee stock option plan, including tax  benefits (Note 9)   |       | 30                |       | 7,344                                        |       |                   |       |                |       |
| Purchase of  4,745,293 common shares for treasury                                                       |       |              |       |                                         |       |                   |       | 117,323             |       |
| Issuance of  5,591 shares of treasury stock under the Family Dollar 2000 Outside Directors  Plan        |       |              |       | 46                                           |       |                   |       | (90                 | )          |
| Purchase and  cancellation of 10,609,922 common shares                                                  |       | (1,061            | )          | (8,092                                       | )          | (240,849               | )          |                |       |
| Stock-based  compensation (Notes 9 and 10)                                                              |       |              |       | 7,788                                        |       |                   |       |                |       |
| Less dividends  on common stock, $.41 per share                                                         |       |              |       |                                         |       | (62,757                | )          |                |       |
| **Balance,  August 26, 2006**                                                                           |       |              |       |                                         |       |                   |       |                |       |
| (178,559,411  shares common stock; 28,348,927 shares treasury stock)                                    |       | $                 | 17,856     |                                         | $          | 140,829                |       | $                   | 1,546,366  |   | $ | 496,658 |   |

 

The accompanyingnotes are an integral part of the consolidated financial statements.

28

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

**CONSOLIDATED STATEMENTS OF CASHFLOWS**
| ** **                                                                                         | ** ** | **Years Ended**          | ** ** |
|----------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| **(in thousands)**                                                                            | ** ** | **August 26, 2006** | ** ** | **August 27, 2005** | ** ** | **August 28, 2004** | ** ** |
| **Cash  flows from operating activities:**                                                         |       |                          |       |   |   |   |   |
| Net income                                                                                         |       | $                             | 195,111    |   | $ | 217,509 |   | $ | 257,904 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities:                 |       |                          |       |   |   |   |   |
| Depreciation and amortization                                                                      |       | 134,637                       |       | 114,733 |   | 102,010 |   |
| Deferred income taxes                                                                              |       | (41,274                       | )          | (16,279 | ) | (4,268 | ) |
| Stock-based compensation expense, including tax benefits                                           |       | 7,931                         |       | 3,700 |   | 4,476 |   |
| Loss on disposition of property and equipment                                                      |       | 5,603                         |       | 3,306 |   | 4,311 |   |
| Changes in operating assets and liabilities:                                                       |       |                          |       |   |   |   |   |
| Merchandise inventories                                                                            |       | 52,932                        |       | (110,667 | ) | (125,754 | ) |
| Income tax refund receivable                                                                       |       | (2,397                        | )          | 1,304 |   | (1,304 | ) |
| Prepayments and other current assets                                                               |       | (4,113                        | )          | (7,842 | ) | 16,685 |   |
| Other assets                                                                                       |       | 1,968                         |       | (11,658 | ) | 1,480 |   |
| Accounts payable and accrued liabilities                                                           |       | 104,867                       |       | 100,974 |   | 121,608 |   |
| Income taxes payable                                                                               |       | (4,272                        | )          | 4,272 |   | (671 | ) |
|                                                                                               |       | 450,993                       |       | 299,352 |   | 376,477 |   |
| **Cash  flows from investing activities:**                                                         |       |                          |       |   |   |   |   |
| Purchases of investment securities                                                                 |       | (374,765                      | )          | (280,100 | ) | (282,265 | ) |
| Sales of investment securities                                                                     |       | 271,790                       |       | 367,410 |   | 365,924 |   |
| Capital expenditures                                                                               |       | (192,173                      | )          | (229,065 | ) | (218,748 | ) |
| Proceeds from dispositions of property and equipment                                               |       | 1,800                         |       | 2,000 |   | 1,550 |   |
|                                                                                               |       | (293,348                      | )          | (139,755 | ) | (133,539 | ) |
| **Cash  flows from financing activities:**                                                         |       |                          |       |   |   |   |   |
| Issuance of long-term debt                                                                         |       | 250,000                       |       | — |   | — |   |
| Payment of debt issuance costs                                                                     |       | (1,283                        | )          | — |   | — |   |
| Repurchases of common stock                                                                        |       | (367,324                      | )          | (91,997 | ) | (176,649 | ) |
| Change in cash overdrafts                                                                          |       | (9,171                        | )          | (12,675 | ) | (20,501 | ) |
| Proceeds from exercise of stock options                                                            |       | 7,126                         |       | 23,310 |   | 14,996 |   |
| Excess tax benefits from stock-based compensation                                                  |       | 240                           |       | — |   | — |   |
| Payment of dividends                                                                               |       | (62,681                       | )          | (60,083 | ) | (54,755 | ) |
|                                                                                               |       | (183,093                      | )          | (141,445 | ) | (236,909 | ) |
|                                                                                               |       |                          |       |   |   |   |   |
| **Net  increase (decrease) in cash and cash equivalents**                                          |       | (25,448                       | )          | 18,152 |   | 6,029 |   |
| **Cash  and cash equivalents at beginning of year**                                                |       | 105,175                       |       | 87,023 |   | 80,994 |   |
| **Cash  and cash equivalents at end of year**                                                      |       | $                             | 79,727     |   | $ | 105,175 |   | $ | 87,023 |   |
|                                                                                               |       |                          |       |   |   |   |   |
| **Supplemental  disclosures of cash flow information:**                                            |       |                          |       |   |   |   |   |
| Purchases of property and equipment awaiting  processing for payment, included in accounts payable |       | $                             | 1,985      |   | $ | 12,239 |   | $ | 14,272 |   |
| Cash paid during the period for:                                                                   |       |                          |       |   |   |   |   |
| Interest, net of amounts capitalized                                                               |       | 5,797                         |       | — |   | — |   |
| Income taxes                                                                                       |       | 175,058                       |       | 132,288 |   | 150,525 |   |

 

The accompanying notesare an integral part of the consolidated financial statements.

 

29

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**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

# **YearsEnded August 26, 2006, August 27, 2005, and August 28, 2004**

**1.            ****Description of Business and Summary of Significant Accounting Policies:**

**Descriptionof business:**

The Company operates achain of neighborhood retail discount stores in 44 contiguous states.  The Company manages its business on the basisof one reportable segment.  The Company’s products include apparel, food,cleaning and paper products, home décor, beauty and health aids, toys, petproducts, automotive products, domestics, seasonal goods and electronics.

**Principlesof consolidation:**

The consolidatedfinancial statements include the accounts of the Company and its subsidiaries,all of which are wholly owned.  Allsignificant intercompany balances and transactions have been eliminated.

**Fiscalyear:**

The Company’sfiscal year generally ends on the Saturday closest to August 31.

**Use ofestimates:**

The preparation of theCompany’s consolidated financial statements, in conformity with accountingprinciples generally accepted in the United States of America, requiresmanagement to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assetsand liabilities, the disclosure of contingent assets and liabilities at the dateof the financial statements, and the reported amounts of revenues and expensesduring the reporting period.  Actualresults could differ from these estimates.

**Cashequivalents:**

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

**Investmentsecurities:**

The itemsclassified as investment securities are principally auction rate securities andvariable rate demand notes.  The Companyclassifies all investment securities as available-for-sale.  Securities accounted for asavailable-for-sale are required to be reported at fair value with unrealizedgains and losses, net of taxes, excluded from net income and shown separatelyas a component of accumulated other comprehensive income within shareholders’equity.  The securities that the Companyhas classified as available-for-sale generally trade at par and as a resulttypically do not have any realized or unrealized gains or losses.

**Merchandiseinventories:**

Inventories are valuedusing the retail method, based on retail prices less markon percentages, whichapproximates the lower of first-in, first-out (FIFO) cost or market.

**Propertyand equipment:**

Property and equipment isstated at cost.  Depreciation forfinancial reporting purposes is calculated using the straight-line method overthe estimated useful lives of the related assets.  For leasehold improvements, this depreciationis over the shorter of the term of the related lease (generally five years) orthe asset’s useful economic life.

 

| Estimated useful lives are  as follows: | ** ** | ** **  |
|-----------------------------------------|------------|-------------|
| Buildings and  building improvements    |       | 10-40 years |
| Furniture,  fixtures and equipment      |       | 3-10 years  |
| Transportation  equipment               |       | 3-10 years  |
| Leasehold  improvements                 |       | 5-10 years  |

 

The Company capitalizescertain costs incurred in connection with developing, obtaining andimplementing software for internal use. Capitalized costs are amortized over the expected economic life of theassets, generally ranging from five to eight years.

30

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Property and equipment isreviewed for impairment whenever events or changes in circumstances indicatethat the carrying amount of an asset may not be recoverable.

**Revenues:**

The Company recognizesrevenue, net of returns and sales tax, at the time the customer tenders paymentfor and takes possession of the merchandise.

**Insuranceliabilities:**

The Company is primarilyself-insured for health care, property loss, workers’ compensation and generalliability costs.  These liabilities arebased on the total estimated costs of claims filed and estimates of claimsincurred but not reported, less amounts paid against such claims, and are notdiscounted.

**Advertisingcosts:**

Advertising costs, net ofco-op recoveries from vendors, are expensed on the commencement of theadvertisement and amounted to $3.3million, $4.7 million and $2.0 million in fiscal 2006, fiscal 2005 andfiscal 2004, respectively.

**Vendorallowances:**

Cash considerationreceived from a vendor is presumed to be a reduction of the purchase cost ofmerchandise and is reflected as a reduction of cost of sales unless it can be demonstratedthis offsets an incremental expense, in which case it is netted against thatexpense.

**Storeopening and closing costs:**

The Company chargespre-opening costs against operating results when incurred.  For properties under operating lease agreements,the present value of any remaining liability under the lease, net of expectedsublease and lease termination recoveries, is expensed when the closing occurs.

**Selling,general and administrative expenses:**

Buying, distributioncenter and occupancy costs, including depreciation, are included in selling,general and administrative expenses.

**Operating leases:**

Except for its corporateheadquarters and distribution centers, the Company generally conducts itsoperations from leased facilities. Generally, store real estate leases are for initial terms of from fiveto ten years with multiple renewal options for additional five-yearperiods.  Certain leases provide forcontingent rental payments based upon a percentage of store sales.

For purposes ofrecognizing incentives, premiums and minimum rental expenses on a straight-linebasis over terms of the leases, the Company uses the date of initial possessionto begin amortization, which is generally when the Company enters the space andbegins to make improvements in preparation of intended use.  For tenant improvement allowances and rentholidays, the Company records a deferred rent liability at the inception of thelease term and amortizes the deferred rent over the terms of the leases asreductions to rent expense on the Consolidated Statements of Income.  The Company also has long-term leases forequipment generally with lease terms of five years or less.

**Capitalized interest:**

The Companycapitalizes interest on borrowed funds during the construction of property andequipment in accordance with Statement of Financial Accounting Standards (“SFAS”)No. 34, “Capitalization of Interest Cost.” During fiscal 2006, the Company capitalized $0.9 million of interestcosts.  The Company did not incur anyinterest costs during fiscal 2005 and fiscal 2004.

**Incometaxes:**

The Company recordsdeferred income tax assets and liabilities for the expected future taxconsequences of temporary differences between the financial reporting bases andthe income tax bases of its assets and liabilities.

**Stock-based compensation:**

The Company recognizescompensation expense related to its stock-based awards based on the grant-datefair value estimated in accordance with SFAS No. 123 (revised 2004) “Share-BasedPayment” (“SFAS 123R”).  The Companyutilizes the Black-Scholes option-pricing model to estimate the grant-date fairvalue of its stock option awards.  Thegrant-date fair value of the Company’s performance share rights awards is basedon the stock price on the grant date.  Compensation expense for the Company’sstock-based awards is recognized ratably, net of estimated forfeitures, overthe service period of each award.  SeeNote 9 for more information on the Company’s stock-based compensation plans.

31

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**New accounting pronouncements:**

InDecember 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS123R which requires all companies to measure compensation cost for allshare-based payments (including employee stock options) at fair value,effective for public companies for interim or annual periods beginning afterJune 15, 2005.  The FASB concluded thatcompanies can adopt the new standard in one of two ways: the modifiedprospective transition method, in which the company would recognize share-basedemployee compensation from the beginning of the fiscal period in which therecognition provisions are first applied as if the fair-value-based accountingmethod had been used to account for all employee awards granted, modified, orsettled after the effective date and to any awards that were not fully vestedas of the effective date; or the modified retrospective transition method, inwhich a company would recognize employee compensation cost for periodspresented prior to the adoption of SFAS 123R in accordance with the originalprovisions of SFAS 123 “Accounting for Stock-Based Compensation” (“SFAS 123”),pursuant to which a company would recognize employee compensation cost in theamounts reported in the pro forma disclosures provided in accordance with SFAS123.  The Company adopted SFAS 123Rduring the first quarter of fiscal 2006 using the modified prospectivetransition method.

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes andError Corrections” (“SFAS 154”).  SFAS154 replaces Accounting Principles Board Opinion No. 20, “Accounting Changes,”and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements.”  SFAS 154 changes the requirements for theaccounting for and reporting of a change in accounting principle.  SFAS 154 is effective for accounting changesand corrections of errors made in fiscal years beginning after December 15,2005.  The Company does not expect SFAS154 to have a material impact on its Consolidated Financial Statements.

InJuly 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertaintyin Income Taxes” (“FIN 48”).  FIN 48provides guidance regarding the recognition and measurement of tax positionsand the related reporting and disclosure requirements and will be effective forthe Company beginning with its first quarter of fiscal 2008.  The Company has not yet determined theimpact, if any, that FIN 48 will have on its Consolidated Financial Statements.

In September 2006, the FASB issued SFAS No. 157, “Fair ValueMeasurements” (“SFAS 157”).  SFAS 157defines fair value, establishes a framework for measuring fair value ingenerally accepted accounting principles and expands disclosures about fairvalue measurements.  SFAS 157 iseffective for the first annual period ending after November 15, 2007.  The Company has not yet determined theimpact, if any, that SFAS 157 will have on its Consolidated FinancialStatements.

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

**Reclassifications:**

Certain reclassificationsof the amounts for fiscal 2005 and fiscal 2004 have been made to conform to thepresentation for fiscal 2006.  Theseinclude interest income, which was previously included in selling, general andadministrative expenses.

**2.             Investment Securities**

The Company’s investmentsconsist of the following short-term available-for-sale securities (inthousands):
| ** **                                                                                    | ** ** | ** **    | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | ** **          | ** ** |
|-----------------------------------------------------------------------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|---------------------|------------|
| ** **                                                                                    | ** ** | ** **    | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | ** **          | ** ** |
| ** **                                                                                    | ** ** | **Amortized** | ** ** | **Holding**    | ** ** | **Holding**    | ** ** | ** **          | ** ** |
| **Auction Rate Securities And Variable Rate Demand Notes** | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **Losses**     | ** ** | **Fair Value** | ** ** |
| August 26, 2006                                                                               |       | $             | 136,505    |           | —     |           | —     |                | $          | 136,505 |   |
| August 27, 2005                                                                               |       | $             | 33,530     |           | —     |           | —     |                | $          | 33,530 |   |

 

32

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Proceeds from sales ofshort-term investment securities available-for-sale during fiscal 2006, fiscal2005 and fiscal 2004 were $271,790, $367,410, and $365,924, respectively.  No gains or losses were realized on thosesales for fiscal 2006, fiscal 2005 and fiscal 2004.

**3.             Property and Equipment:**

 
| **(in thousands)**                         | ** ** | **August 26, 2006** | ** ** | **August 27, 2005** | ** ** |
|-------------------------------------------------|------------|-------------------------------|------------|-------------------------------|------------|
| Buildings and  building improvements            |       | $                             | 496,569    |                          | $          | 445,826 |   |
| Furniture,  fixtures and equipment              |       | 880,755                       |       | 779,895                       |       |
| Transportation  equipment                       |       | 75,934                        |       | 68,173                        |       |
| Leasehold  improvements                         |       | 300,376                       |       | 270,156                       |       |
| Construction in  progress                       |       | 17,981                        |       | 38,871                        |       |
|                                            |       | 1,771,615                     |       | 1,602,921                     |       |
| Less accumulated  depreciation and amortization |       | 762,318                       |       | 642,190                       |       |
|                                            |       | 1,009,297                     |       | 960,731                       |       |
| Land                                            |       | 68,311                        |       | 66,744                        |       |
|                                            |       | $                             | 1,077,608  |                          | $          | 1,027,475 |   |

 

**4.             Current and Long-Term Debt**

TheCompany had no current or long-term debt as of the fiscal year ended August 27,2005.  Current and long-term debtconsisted of the following at August 26, 2006:

 

| (in thousands)    | ** ** | **August 26, 2006** | ** ** |
|------------------------|------------|-------------------------------|------------|
| 5.24% Notes            |       | $                             | 81,000     |   |
| 5.41% Notes            |       | 169,000                       |       |
|                   |       | 250,000                       |       |
| Less: current  portion |       | —                        |       |
| Long-term portion      |       | $                             | 250,000    |   |

 

On September 27, 2005, the Company obtained $250million through a private placement of unsecured Senior Notes (the “Notes”) toa group of institutional accredited investors. The Notes were issued in two tranches at par and rank *pari passu* in right of payment with the Company’s otherunsecured senior indebtedness.  The firsttranche has an aggregate principal amount of $169 million, is payable in asingle installment on September 27, 2015, and bears interest at a rate of 5.41%per annum from the date of issuance.  Thesecond tranche has an aggregate principal amount of $81 million, matures on September27, 2015, with amortization commencing in the sixth year, and bears interest ata rate of 5.24% per annum from the date of issuance.  The second tranche has a required principalpayment of $16.2 million on September 27, 2011, and on each September 27thereafter to and including September 27, 2015. Interest on the Notes is payable semi-annually in arrears on the 27thday of March and September of each year commencing on March 27, 2006.  The sale of the Notes was effected intransactions not requiring registration under the Securities Act of 1933, asamended.  The Notes contain certainrestrictive financial covenants, which include a consolidated debt to consolidated capitalizationratio, a fixed charges coverage ratio, and a priority debt to consolidated networth ratio.  The proceeds of the Notes were used torepurchase the Company’s outstanding common stock, as discussed in Note 11 formore information.

On August 24, 2006, theCompany entered into an unsecured revolving credit facility with a syndicate oflenders for short-term borrowings of up to $350 million.  The credit facility replaced the Company’sthen outstanding unsecured revolving credit facilities for short-termborrowings of up to $200 million.  Thecredit facility expires on August 24, 2011. Any borrowings under the credit facility are at a variable interest ratebased on short-term market interest rates. Outstanding standby letters of credit reduce the borrowing capacity ofthe credit facility.  The Company had noborrowings against its credit facilities during fiscal 2006.  The credit facility contains certainrestrictive financial covenants, which include a consolidated debt toconsolidated capitalization ratio, a fixed charges coverage ratio, and apriority debt to consolidated net worth ratio.

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On December 19, 2006, theCompany entered into separate agreements in connection with the Notes and itsunsecured revolving credit facility.  Theagreements extended the delivery date for the fiscal 2006 audited financialstatements, the unaudited financial statements for the first quarter of fiscal2007 and the corresponding compliance certificates to March 31, 2007, andwaived any Defaults or Events of Default that would have occurred due to thefailure of the Company to deliver such information in connection with the Notesand credit facility.  As discussed inNote 10 below, the Company formed a Special Committee of the Board of Directorsto investigate the Company’s stock option granting practices.  As a result, the Company was unable to fileits Annual Report on Form 10-K for fiscal 2006 and its Quarterly Report on Form10-Q for the first quarter of fiscal 2007 by the required deadlines.  As of the date of the filing of this Report,the Company has delivered the appropriate financial statements and compliancecertificates and is in compliance with all covenants under both the Notes andcredit facility.

**5.             Accrued Liabilities:**

 

| (in thousands)            | ** ** | **August 26, 2006** | ** ** | **August 27, 2005** | ** ** |
|--------------------------------|------------|-------------------------------|------------|-------------------------------|------------|
| Compensation                   |       | $                             | 66,158     |                          | $          | 44,397 |   |
| Self-insurance  liabilities    |       | 184,218                       |       | 157,134                       |       |
| Taxes other than  income taxes |       | 42,248                        |       | 43,217                        |       |
| Deferred rent                  |       | 47,965                        |       | 42,728                        |       |
| Litigation  charge             |       | 45,000                        |       | —                        |       |
| Other                          |       | 43,991                        |       | 28,032                        |       |
| ** **                     |       | $                             | 429,580    |                          | $          | 315,508 |   |

 

**6.             Income Taxes:**

The tax effects oftemporary differences that give rise to significant portions of the deferredtax assets and deferred tax liabilities as of the end of fiscal 2006 and theend of fiscal 2005, were as follows:

 
| ** **                                               | ** ** | **August 26, 2006** | ** ** | **August 27, 2005** | ** ** |
|----------------------------------------------------------|------------|-------------------------------|------------|-------------------------------|------------|
| Deferred income  tax liabilities:                        |       |                          |       |                          |       |
| Excess of book over tax basis of property and  equipment |       | $                             | 78,525     |                          | $          | 86,824 |   |
|                                                     |       |                          |       |                          |       |
| Deferred income  tax assets:                             |       |                          |       |                          |       |
| Excess of tax over book basis of inventories             |       | $                             | 15,216     |                          | $          | 14,901 |   |
| Currently nondeductible accruals for:                    |       |                          |       |                          |       |
| Self-insurance                                           |       | 67,123                        |       | 60,308                        |       |
| Compensation                                             |       | 13,768                        |       | 8,980                         |       |
| Deferred rent                                            |       | 15,906                        |       | 12,227                        |       |
| Litigation charge                                        |       | 16,569                        |       | —                        |       |
| Other                                                    |       | 4,886                         |       | 4,077                         |       |
| Total deferred income  tax assets                        |       | $                             | 133,468    |                          | $          | 100,493 |   |

 

The provisions for incometaxes in fiscal 2006, fiscal 2005 and fiscal 2004 were as follows:

 

| (in thousands) | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------|------------|----------|------------|----------|------------|----------|------------|
| Current:            |       |     |       |     |       |     |       |
| Federal             |       | $        | 137,329    |     | $          | 126,497  |       | 138,508 |   |
| State               |       | 19,096   |       | 15,068   |       | 14,518   |       |
| ** **          |       | 156,425  |       | 141,565  |       | 153,026  |       |
|                |       |     |       |     |       |     |       |
| Deferred:           |       |     |       |     |       |     |       |
| Federal             |       | (40,831  | )          | (14,463  | )          | (3,782   | )          |
| State               |       | 439      |       | (1,816   | )          | (486     | )          |
| ** **          |       | (40,392  | )          | (16,279  | )          | (4,268   | )          |
| Total               |       | $        | 116,033    |     | $          | 125,286  |       | 148,758 |   |

 

34

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The following tablesummarizes the components of income tax expense in fiscal 2006, fiscal 2005 andfiscal 2004:

 
| ** **                                             | ** ** | **2006**                           | ** ** | **2005**                                 | ** ** | **2004**                           | ** ** |
|--------------------------------------------------------|------------|------------------------------------|------------|------------------------------------------|------------|------------------------------------|------------|
| **(in thousands) **                          | ** ** | **Income tax  expense ** | ** ** | **% of pre-tax  income ** | ** ** | **Income tax  expense ** | ** ** | **% of pre-tax  income ** | ** ** | **Income tax  expense ** | ** ** | **% of pre-tax  income ** | ** ** |
| Computed federal  income tax                           |       | $                                  | 108,900    |                                     | 35.0       | %                                  | $          | 119,978 |   | 35.0 | % | $ | 142,331 |   | 35.0 | % |
| State income  taxes, net of federal income tax benefit |       | 12,073                             |       | 3.9                                      |       | 8,632                              |       | 2.5 |   | 9,391 |   | 2.3 |   |
| Other                                                  |       | (4,940                             | )          | (1.6                                     | )          | (3,324                             | )          | (1.0 | ) | (2,964 | ) | (0.7 | ) |
| Actual income tax  expense                             |       | $                                  | 116,033    |                                     | 37.3       | %                                  | $          | 125,286 |   | 36.5 | % | $ | 148,758 |   | 36.6 | % |

 

TheInternal Revenue Service is currently examining the Company’s consolidatedfederal income tax returns for fiscal 2005, fiscal 2004 and fiscal 2003.  Although the ultimate outcome of theexamination cannot be presently determined, the Company believes that it hasmade adequate provision for federal income taxes with respect to all openyears.

**7.             Employee Benefit Plans:**

**Incentivecompensation plan:**

The Company has anincentive profit-sharing plan which provides that, at the discretion of theBoard of Directors, the Company may pay certain employees and officers anaggregate amount not to exceed 5% of the Company’s consolidated income beforeincome taxes.  Expenses under the profit-sharing plan were $13.8 millionin fiscal 2006 and $5.5 million in fiscal 2004. There were no expenses under the profit-sharing plan in fiscal 2005.

**Compensationdeferral plans:**

The Company has avoluntary compensation deferral plan, under Section 401(k) of the InternalRevenue Code, available to eligible employees. At the discretion of the Board of Directors, the Company makescontributions to the plan which are allocated to participants, and in whichthey become vested, in accordance with formulas and schedules defined by theplan.  Company expenses for contributionsto the plan were $2.4 million in fiscal 2006, $3.0 million in fiscal 2005, and$2.7 million in fiscal 2004.

In fiscal 2003, theCompany adopted a deferred compensation plan to provide certain key managementemployees the ability to defer a portion of their base compensation andbonuses.  The plan is an unfundednonqualified plan.  The deferred amountsand earnings thereon are payable to participants, or designated beneficiaries,at specified future dates, upon retirement or death.  The Company does not make contributions tothis plan or guarantee earnings.

**8.             Commitments and Contingencies:**

**Operatingleases:**

Rental expenses on alloperating leases, both cancelable and non-cancelable, for fiscal 2006, fiscal2005 and fiscal 2004 were as follows:

 
| **(in thousands)**                         | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Minimum rentals,  net of minor sublease rentals |       | $        | 293,719    |     | $          | 274,562  |       | $ | 238,188 |   |
| Contingent  rentals                             |       | 4,643    |       | 4,670    |       | 4,722    |       |
|                                            |       | $        | 298,362    |     | $          | 279,232  |       | $ | 242,910 |   |

 

The following table showsthe Company’s obligations and commitments to make future payments undercontractual obligations, including future minimum rental payments requiredunder operating leases that have initial or remaining non-cancelable leaseterms in excess of one year at the end of fiscal 2006:

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| ** **                       | ** ** | **Payments Due During One Year Fiscal Period Ending** | ** ** |
|----------------------------------|------------|------------------------------------------------------------------------------------------|------------|
| **(in thousands)**          | ** ** | ** **                                                                               | ** ** | **August** | ** ** | **August** | ** ** | **August** | ** ** | **August** | ** ** | **August** | ** ** | ** ** | ** ** |
| **Contractual Obligations** | ** ** | **Total**                                                                                | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **Thereafter** | ** ** |
| Long-term debt                   |       | $                                                                                        | 250,000    |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 250,000 |   |
| Interest                         |       | 118,691                                                                                  |       | 13,387 |   | 13,387 |   | 13,387 |   | 13,387 |   | 13,387 |   | 51,756 |   |
| Merchandise  letters of credit   |       | 152,189                                                                                  |       | 152,189 |   | — |   | — |   | — |   | — |   | — |   |
| Operating leases                 |       | 1,211,611                                                                                |       | 271,811 |   | 241,484 |   | 203,066 |   | 159,912 |   | 114,104 |   | 221,234 |   |
| Construction  obligations        |       | 5,393                                                                                    |       | 5,393 |   | — |   | — |   | — |   | — |   | — |   |
| Total                            |       | $                                                                                        | 1,737,884  |   | $ | 442,780 |   | $ | 254,871 |   | $ | 216,453 |   | $ | 173,299 |   | $ | 127,491 |   | $ | 522,990 |   |

 

At the end of fiscal2006, approximately $81.8 million of the merchandise letters of credit areincluded in accounts payable on the Company’s Consolidated Balance Sheet.  Most of the Company’s operating leasesprovide the Company with an option to extend the term of the lease atdesignated rates.

The following table showsthe Company’s other commercial commitments at the end of fiscal 2006:

 

|                                                                     | ** ** | **Total Amounts** | ** ** |
|---------------------------------------------------------------------|------------|------------------------|------------|
| **Other Commercial Commitments (in thousands)** | ** ** | **Committed**          | ** ** |
| Standby letters  of credit                                          |       | $                      | 122,082    |   |
| Surety bonds                                                        |       | 44,934                 |       |
| Total                                                               |       | $                      | 167,016    |   |

 

A substantialportion of the outstanding amount of standby letters of credit (which areprimarily renewed on an annual basis) are used as surety for future premium anddeductible payments to the Company’s workers’ compensation and generalliability insurance carrier.  The Company accrues for these liabilitiesbased on the total estimated costs of claims filed and claims incurred but notreported, and are not discounted. Included in the outstanding amount of surety bonds is a $41.6 millionbond obtained by the Company during the third quarter of fiscal 2006 inconnection with an adverse litigation judgment, as discussed below.

**Litigation**

On January 30, 2001, Janice Morgan and BarbaraRichardson, two individuals who have held the position of Store Manager forsubsidiaries of the Company, filed a complaint against the Company in theUnited States District Court for the Northern District of Alabama.  Thereafter, pursuant to the Court’s ruling,notice of the pendency of the lawsuit was sent to approximately 13,000 currentand former Store Managers holding the position on or after July 1, 1999.  Approximately 2,550 of those receiving suchnotice filed consent forms and joined the lawsuit as plaintiffs, includingapproximately 2,300 former Store Managers and approximately 250 then currentemployees.  After rulings by the Court onmotions to dismiss certain plaintiffs filed by the Company and motions toreconsider filed by plaintiffs, 1,424 plaintiffs remained in the case at thecommencement of trial.

The case has proceeded as a collective action underthe Fair Labor Standards Act (“FLSA”). The complaint alleged that the Company violated the FLSA by classifyingthe named plaintiffs and other similarly situated current and former StoreManagers as “exempt” employees who are not entitled to overtime compensation.

A jury trial in this case was held in June 2005, inTuscaloosa, Alabama, and ended with the judge declaring a mistrial after thejury was unable to reach a unanimous decision in the matter.  The case was subsequently retried beginningon February 21, 2006, to a jury in Tuscaloosa, Alabama, which found that theCompany should have classified the Store Manager plaintiffs as hourly employeesentitled to overtime pay rather than as salaried exempt managers and awardeddamages.  Subsequently, the Court ruledthe Company did not act in good faith in classifying the plaintiffs as exempt,and after making adjustments to the damages award based upon the filing ofpersonal bankruptcy by certain plaintiffs, the Court entered a judgment forapproximately $33.3 million.  The Companyand the plaintiffs have filed post-trial motions, which have suspended the entryof a final judgment.  The Company posted a bond to stay executionon any judgment which may be finally entered. In addition, the Court ruled that it will consider the plaintiffs’motion for an award of attorneys’ fees and expenses at the conclusion of theCompany’s appeal.  The Company plans toappeal if the Court denies the pending post-trial motions and enters a finaljudgment.

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

In general, the Company continues to believe thatthe Store Managers are “exempt” employees under the FLSA and have been properlycompensated and that the Company has meritorious positions on appeal thatshould enable it ultimately to prevail. However, the outcome of any litigation is inherently uncertain.  Resolution of this matter could have amaterial adverse effect on the Company’s financial position, liquidity orresults of operation.

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

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

Aspreviously disclosed, the Company has formed a Special Committee to investigatethe Company’s stock option granting practices and to make determinationsregarding appropriate remedial measures and what actions the Company shouldtake with respect to the pending shareholder derivative litigation. See Note 10for more information.

The Company is involved in numerous other legalproceedings and claims incidental to its business, including litigation relatedto alleged failures to comply with various state and federal employment laws,some of which are or may be pled as class or collective actions, and litigationrelated to alleged personal or property damage, as to which the Company carriesinsurance coverage and/or, pursuant to Statement of Financial AccountingStandards No. 5, “Accounting for Contingencies,” has established reserves asset forth in the Company’s financial statements.  While the ultimate outcome cannot bedetermined, the Company currently believes that these proceedings and claims,both individually and in the aggregate, should not have a material adverse effecton the Company’s financial position, liquidity or results of operations.  However, the outcome of any litigation isinherently uncertain and, if decided adversely to the Company, the Company maybe subject to liability that could have a material adverse effect on theCompany’s financial position, liquidity or results of operations.

**9.             Stock-Based Compensation:**

At the Company’s Annual Meeting of Shareholders heldon January 19, 2006, the Company’s shareholders approved the Family DollarStores, Inc. 2006 Incentive Plan (the “2006 Plan”).  The 2006 Plan permits the granting of avariety of compensatory award types.  TheCompany currently grants non-qualified stock options and performance sharerights under the 2006 Plan.  Prior to theadoption of the 2006 Plan, the Company issued non-qualified stock options underthe Company’s 1989 Non-Qualified Stock Option Plan (the “1989 Plan”).  As a result of the adoption of the 2006 Plan,no further awards can

37

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be granted under the 1989 Plan.  Shares issued under the 2006 Plan representnew issuances of common stock.  A totalof 12.0 million common shares are reserved and available for issuance under the2006 Plan, plus any shares awarded under the 1989 Plan that expire or arecanceled or forfeited after January 19, 2006. As of August 26, 2006, there were 11.9 million remaining sharesavailable for granting under the 2006 Plan.

Effective August 28, 2005, the Company adopted theprovisions of SFAS 123R for its stock-based compensation plans.  Under SFAS 123R, all stock-based compensationcost is measured at the grant date, based on the estimated fair value of theaward, and is recognized as an expense in the income statement over therequisite service period.  On March 29,2005, the SEC staff issued Staff Accounting Bulletin (“SAB”) No. 107 to expressthe views of the staff regarding the interaction between SFAS 123R and certainSEC rules and regulations and to provide the staff’s views regarding thevaluation of stock-based compensation arrangements for public companies.  The SAB 107 guidance was taken intoconsideration with the implementation of SFAS 123R.

Prior to August 28, 2005, the Companyaccounted for stock-based compensation using the intrinsic value methodprescribed in APB Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB25”), and related Interpretations, as permitted by the original provisions ofSFAS 123.  Except for the items detailedin Note 10, the Company did not record compensation expense under APB 25 since theexercise price of the stock options equaled the fair market value of theunderlying common stock on the grant date. The Company instead utilized the disclosure-only provisions of SFAS No.148, “Accounting for Stock-Based Compensation-Transition and Disclosure.”

The Company adopted SFAS 123R using the modifiedprospective transition method.  Under themodified prospective transition method, the Company is required to recordstock-based compensation expense for all awards granted after the adoption dateand for the unvested portion of previously granted awards outstanding on theadoption date.  Compensation cost relatedto the unvested portion of previously granted awards is based on the grant-datefair value estimated in accordance with the original provisions of SFAS123.  Compensation cost for awardsgranted after the adoption date is based on the grant-date fair value estimatedin accordance with the provisions of SFAS 123R. Results for prior periods have not been restated and do not reflect therecognition of stock-based compensation.

The Company has elected to adopt the alternativetransition method, as permitted by FASB Staff Position No. FAS 123R-3 “TransitionElection Related to Accounting for Tax Effects of Share-Based Payment Awards,”to calculate the tax effects of stock-based compensation pursuant to SFAS 123Rfor those employee awards that were outstanding upon adoption of SFAS123R.  The alternative transition methodallows the use of simplified methods to calculate the beginning capital inexcess of par pool related to the tax effects of employee stock-basedcompensation and to determine the subsequent impact of the tax effects ofemployee stock-based compensation awards on the capital in excess of par pooland the Consolidated Statements of Cash Flows.  Prior to the adoption of SFAS 123R, theCompany reported all tax benefits resulting from the exercise of stock optionsas operating cash flows in the Consolidated Statements of Cash Flows.  SFAS 123R requires cash flows resulting fromthe tax deductions in excess of the related compensation cost recognized in thefinancial statements (excess tax benefits) to be classified as financing cashflows.  In accordance with SFAS 123R,excess tax benefits recognized in periods after the adoption date have beenproperly classified as financing cash flows. Excess tax benefits recognized in periods prior to the adoption date areclassified as operating cash flows. Tax benefits relating to SFAS 123Rrecognized during fiscal 2006 were not material.

The Company’s results for fiscal 2006 includestock-based compensation expense of $17.6 million which is included withinselling, general, and administrative expenses on the Consolidated Statements ofIncome.  This amount is comprised of $8.5million resulting from the adoption of SFAS 123R (related to stock options andperformance share rights) and a $9.1 million ($5.7 million after taxes)cumulative charge to record non-cash stock-based compensation expense as aresult of new measurement date determinations for certain historical stockoption grants.  See Note 10 for moreinformation.

 

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The following table illustrates the effect on netincome and net income per share if the Company had adopted the fair valuerecognition provisions of SFAS 123 during fiscal 2005 and fiscal 2004:

 

|                                                                       | ** ** | **Years Ended**          | ** ** |
|-----------------------------------------------------------------------|------------|-------------------------------|------------|
| **(in thousands, except per share amounts)** | ** ** | **August 27, 2005** | ** ** | **August 28, 2004** | ** ** |
| Net income — as reported                                         |       | $                             | 217,509    |   | $ | 257,904 |   |
| Pro forma stock-based compensation cost                               |       | (15,374                       | )          | (8,062 | ) |
| Net income — pro forma                                           |       | $                             | 202,135    |   | $ | 249,842 |   |
|                                                                  |       |                          |       |   |   |
| Net income per share — as reported                               |       |                          |       |   |   |
| Basic                                                                 |       | $                             | 1.30       |   | $ | 1.51 |   |
| Diluted                                                               |       | $                             | 1.30       |   | $ | 1.50 |   |
| Net income per share — pro forma                                 |       |                          |       |   |   |
| Basic                                                                 |       | $                             | 1.21       |   | $ | 1.46 |   |
| Diluted                                                               |       | $                             | 1.21       |   | $ | 1.46 |   |

 

The increase in pro formastock-based compensation cost in fiscal 2005 was a result of the accelerationof certain “underwater” (i.e. the options have an exercise price in excess ofthe market value of the stock, determined as of August 26, 2005)options.  On August 18, 2005, theCompensation Committee of the Board of Directors of the Company approved theacceleration of the vesting date of certain previously issued and outstandingoptions under the 1989 Plan, effective as of August 26, 2005.  Theaccelerated vesting program applies to: (i) all unvested options as of theeffective date that had an exercise price in excess of $40.00/share, includingoptions held by the five most highly compensated executive officers of theCompany, and (ii) all unvested options as of the effective date that wereunderwater and were held by employees at the level of manager or below.

The Company implementedthe acceleration program to enhance retention incentives for current employeesand to reduce the compensation expense the Company would have otherwise beenrequired to recognize as a result of the Company’s adoption of SFAS 123R infiscal 2006.  The future expenseeliminated as a result of the option acceleration program was approximately$12.9 million, or $8.2 million net of taxes, over a period of four years duringwhich the options would have vested.

The Company’s stock option plans contain retirementprovisions, effective January 20, 2005, that allow options held by certainqualifying retirees to continue to vest after retirement without requiringadditional service.  The retirementprovisions apply to all non-vested stock options as of the effective date, allvested stock options that were “underwater” (i.e. the options had an exerciseprice in excess of the market value of the stock) on the effective date, andall new options granted thereafter.  UnderSFAS 123R, compensation cost should be recognized over the shorter of thestated vesting period or the period from the grant date to the retirementeligibility date, if the employee is able to retire without providingadditional service.  For awards grantedprior to the adoption of SFAS 123R, the Company recognizes compensation costover the stated vesting period.  If theCompany had accounted for these awards in accordance with the provisions ofSFAS 123R, compensation expense would have been $0.6 million higher duringfiscal 2005 (for pro-forma disclosure purposes only).  The impact on fiscal 2006 is not material.

**Stock Options**

The Company’s stock option plans provide for grantsof stock options to key employees at prices not less than the fair market valueof the Company’s common stock on the grant date.  The Company’s practice for a number of yearshas been to make a single annual grant to all employees participating in thestock option program and to generally make other grants only in connection withemployment or promotions.  See Note 10below for a discussion of the Company’s stock option granting practices.  Options expire five years from the grant dateand are exercisable to the extent of 40% after the second anniversary of thegrant and an additional 30% at each of the following two anniversary dates on acumulative basis.  Compensation cost isrecognized on a straight-line basis, net of estimated forfeitures, over therequisite service period.  The Companyused the Black-Scholes option-pricing model to estimate the grant-date fairvalue of each option granted before and after the adoption of SFAS 123R onAugust 28, 2005.  The fair values ofoptions granted were estimated using the following weighted-averageassumptions:

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| ** **                               | ** ** | **Years Ended**     | ** ** |
|------------------------------------------|------------|---------------------|------------|
| ** **                               | ** ** | **August 26, 2006** | ** ** | **August 27, 2005** | ** ** | **August 28, 2004** | ** ** |
| Expected dividend yield                  |       | 1.64                | %          | 1.25 | % | 0.75 | % |
| Expected stock price volatility          |       | 30.00               | %          | 31.82 | % | 36.49 | % |
| Weighted average risk-free interest rate |       | 4.19                | %          | 3.52 | % | 3.06 | % |
| Expected life of options (years)         |       | 4.57                |       | 3.50 |   | 3.50 |   |

 

The expected dividend yield is based on theprojected annual dividend payment per share divided by the stock price on thegrant date.  Expected stock pricevolatility is derived from an analysis of the historical and implied volatilityof the Company’s publicly traded stock. The risk-free interest rate is based on the U.S. Treasury rates on thegrant date with maturity dates approximating the expected life of the option onthe grant date.  The expected life of theoptions is based on an analysis of historical and expected future exercisebehavior, as well as certain demographic characteristics.  These assumptions are evaluated and revisedfor future grants, as necessary, to reflect market conditions andexperience.  There were nosignificant changes made to the methodology used to determine the assumptionsduring fiscal 2006.  Theweighted-average grant-date fair value of stock options granted was $5.62during fiscal 2006, $6.85 during fiscal 2005 and $11.47 during fiscal2004.  The following table summarizes thetransactions under the stock option plans during fiscal 2006:

 
| ** **                                   | ** ** | ** **      | ** ** | ** **           | ** ** | **Weighted-Average** | ** ** | ** **          | ** ** |
|----------------------------------------------|------------|-----------------|------------|----------------------|------------|----------------------|------------|---------------------|------------|
| ** **                                   | ** ** | ** **      | ** ** | ** **           | ** ** | **Remaining**        | ** ** | ** **          | ** ** |
| ** **                                   | ** ** | **Options**     | ** ** | **Weighted-Average** | ** ** | **Contractual Life** | ** ** | **Aggregate**       | ** ** |
| **(in thousands, except per share amounts)** | ** ** | **Outstanding** | ** ** | **Exercise Price**   | ** ** | **in Years**         | ** ** | **Intrinsic Value** | ** ** |
| Balance at August 27, 2005                   |       | 6,062           |       | $30.44               |       |                 |       |                |       |
| Granted                                      |       | 839             |       | 20.42                |       |                 |       |                |       |
| Exercised                                    |       | (298            | )          | 23.95                |       |                 |       |                |       |
| Canceled                                     | ** ** | (846            | )          | 28.93                |       |                 |       |                |       |
| Balance at August 26, 2006                   |       | 5,757           |       | $29.54               |       | 2.33                 |       | $                   | 2,812      |   |
| Exercisable at August 26, 2006               |       | 3,354           |       | $32.63               |       | 1.67                 |       | $                   | 9          |   |

 

The total intrinsic valueof stock options exercised during fiscal 2006, fiscal 2005 and fiscal 2004 was$0.7 million, $9.9 million and $12.0 million, respectively.  As of August 26, 2006, there wasapproximately $8.8 million of unrecognized compensation cost related tooutstanding stock options.  Theunrecognized compensation cost will be recognized over a weighted-averageperiod of 1.3 years.

# **Performance Share Rights**

During the second quarter of fiscal 2006, theCompany began granting performance share rights to key employees.  Grants of performance share rights are madeannually and generally, in connection with employment or promotion ofparticipants in the 2006 Plan. Performance share rights give employees the right to receive shares ofthe Company’s common stock at a future date based on the Company’s performancerelative to a peer group.  Performance ismeasured based on two pre-tax metrics: Return on Equity and Income Growth.  The Compensation Committee of the Board ofDirectors establishes the peer group and performance metrics.  The performance share rights vest at the endof the performance period (generally three years) and the shares are issuedshortly thereafter.  The actual number ofshares issued can range from 0% to 200% of the employee’s target awarddepending on the Company’s performance relative to the peer group.

During fiscal 2006, theCompany granted 0.3 million performance share rights to employees at aweighted-average grant-date fair value of $24.16.  The grant-date fair value of the performanceshare rights is based on the stock price on the grant date.  As of August 26, 2006, there were 0.3million performance share rights outstanding. Compensation cost is recognized on a straight-line basis, net of estimatedforfeitures, over the requisite service period and adjusted quarterly toreflect the ultimate number of shares expected to be issued.  As of August 26, 2006, there wasapproximately $3.9 million of unrecognized compensation cost related tooutstanding performance share rights, based on the Company’s most recentperformance analysis.  The unrecognizedcompensation cost will be recognized over a weighted-average period of 2.0years.  None of the performance sharerights vested during fiscal 2006.

40

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**10.          SpecialCommittee Review of Historical Stock Option Granting Procedures**

On September 25, 2006,the Company filed a Form 8-K with the SEC in which the Company advised that itwas named as a nominal defendant in a lawsuit filed in the Superior Court ofNorth Carolina, Mecklenburg County, alleging that certain of the Company’sstock option grants were “backdated.”  Inconnection with the lawsuit, the Company’s Board of Directors (the “Board”)formed a Special Committee (the “Special Committee”), consisting solely ofindependent directors who were not named as defendants in the lawsuit, toconduct an independent investigation of the Company’s stock option granting practices,evaluate the lawsuit, and take such actions with respect to the lawsuit andrelated matters as the Special Committee deemed appropriate.  The Special Committee was advised in itsreview by independent legal counsel, Richards, Layton & Finger, P.A., andby independent accounting experts.  TheSpecial Committee’s five month review included 35 interviews of 21 current orformer officers, directors and employees of the Company, as well as the reviewof documents and electronically-stored information amounting to hundreds ofthousands of pages of documents and data.

On March 7, 2007, theCompany filed a Form 8-K announcing that, based on its review of the principalfactual findings of the Special Committee, the Company determined it did notproperly account for certain stock options granted during the period fromfiscal 1995 to fiscal 2006.  As a result,the Company determined that a total charge of $10.5 million on a cumulativepretax basis was required, with $9.1 million being to record non-cash equitybased compensation charges (the “Stock Option Charge”) and the balance relatingto certain income tax related adjustments. The income tax effect of the cumulative charge was a tax benefit of $3.9million.

Utilizing the materialityguidelines set forth in SEC Staff Accounting Bulletin No. 99, “Materiality,”and the factual findings of the Special Committee, the Company has determinedthat the impact of the resulting accounting adjustments attributable to anyprior reporting periods is not material to any such periods and that thecumulative impact of recording the Stock Option Charge is not material to thecurrent year.  Therefore, the Company hasnot restated its previously issued financial statements, but rather recordedthe Stock Option Charge and tax related adjustments in the fourth quarter offiscal 2006.

**Company’s Historical Process forGranting Options**

Several key findings ofthe Special Committee relating to the Company’s historical stock optiongranting practices are summarized below.

·                  Based upon theterms of the Company’s Non-Qualified Stock Option Plan (as amended from time totime, the “1989 Plan”) the Company’s Stock Option Committee or in later years,the Compensation Committee (in each case, the “Option Committee”) was vestedwith the authority to administer the 1989 Plan and to grant stock options underthe 1989 Plan.  During the reportingperiods to which the Stock Option Charge is attributed, stock option grantswere approved by the Option Committee, acting in virtually all cases byunanimous written consents.  In approvingthe issuance of stock options, the Option Committee relied heavily uponrecommendations of management with respect to matters such as recipients ofoptions, the effective date and exercise price, and the number of sharesunderlying the options to be awarded. However, the Option Committee did not delegate to any member ofmanagement the authority to make or approve stock option grants.  Although management followed a relativelyconsistent process in proposing the terms of the option grants, there were nospecific guidelines approved by the Option Committee by reference to which theOption Committee could have ascertained whether any recipient had received theappropriate number of option shares or whether the guidelines had beenfollowed.

·                  Annual grants ofstock options were made to employees, including officers, in conjunction withthe Company’s annual merit review process, which generally occurred over a fewweeks following the Company’s fiscal year end (“annual grants”).  From fiscal 1995 through fiscal 2004, thestated effective date of the annual grant was selected by a senior officer ofthe Company, in consultation with, and with the agreement of, either theCompany’s chief executive officer or president.

·                  Stock optiongrants were also made throughout the year to newly hired and promoted employees(“non-annual grants”).  New hire grantswere made in accordance with a consistently applied practice providing thatgrants made to new employees would be priced using the lowest average dailystock price within the ten-day window following an employee’s hire date.  The use of the ten-day window was generallywell known among members of management involved in the stock option grantprocess and was not concealed.  Thepractice of using the ten-day window was applied in rare instances to grantsmade to newly promoted employees.

·                  All stock optiongrants made by the Company between fiscal 1995 and fiscal 2006 (options toacquire a total of almost 16 million shares) were either annual grants ornon-annual grants except for a single instance in which options to acquire20,000 shares were granted to two officers in fiscal 1997.

41

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**Changes in Process**

The Special Committeefound that the Company made changes to the stock option grant process beginningin fiscal 2005.

·                  Beginning infiscal 2005, the Option Committee delegated its authority to the chiefexecutive officer for the granting of options to rank and file employees.  In fiscal 2005 and fiscal 2006, the annualgrants to recipients at or above the level of vice president were approved bythe Option Committee, with the annual grant for all employees in fiscal 2007being approved at a meeting of the Option Committee.  In October of 2006, the Option Committeeadopted guidelines establishing an annual grant date following the Company’sannual earnings release.

·                  The practice ofusing the ten-day window for grants to newly hired employees continued untilSeptember 2005, at which time the Company adopted procedures under which newhire grants would be priced on a specified date following an employee’s hiredate.  In October 2006, the Company beganmaking new hire and promotion grants on a monthly basis, on a pre-determineddate following the Company’s monthly sales release.

**Determination of MeasurementDates for Stock Options**

To determine the correctmeasurement dates under applicable accounting principles for the options, theCompany followed the guidance in Accounting Principles Board Opinion No. 25 (“APBNo. 25”), which deems the “measurement date” as the first date on whichall of the following are known: (1) the individual employee who is entitled toreceive the option grant; (2) the number of options that an individual employeeis entitled to receive; and (3) the option’s exercise price.  In instances where the Company determined itcould not rely on the original stock option grant date, the Company determinedcorrected measurement dates based on its ability to establish or confirm,whether through other documentation, consistent or established Company practiceor processes, or other credible information, that all requirements for theproper granting of an option had been satisfied under applicable accountingprinciples.

Management’s conclusionswith respect to the measurement date of the annual grants and non-annual grantsmade during the reporting periods to which the Stock Option Charge isattributed, along with the Special Committee’s principal findings of facthaving a direct bearing on such conclusions, are summarized below.

*Annual Grants*

For the period fromfiscal 1995 to fiscal 2006, in most cases, the Special Committee found thatunanimous written consents (each, a “Consent”) of the Option Committee for theannual grant were generally not signed by all members of the Option Committeeuntil some time after the stated effective date of the relevant grant.  The Special Committee was unable to determinethe dates on which Consents were fully executed in accordance with Delawarelaw.  The Special Committee made certainfactual findings regarding the time at which the annual grants in fiscal years1997, 2005 and 2006 were approved.

The Special Committeefound the evidence to be insufficient to establish that any person involved inthe annual grant process intentionally “backdated” any annual grant (i.e.,selected the date of grant with the benefit of hindsight).  However, the Special Committee concluded thatthe process by which the grant dates were selected in certain years was farfrom satisfactory.  The Special Committeefound that the absence of contemporaneous documentation of the selection ofgrant dates and the failure to contemporaneously communicate the proposed grantdate to the Option Committee led to the process being less transparent thandesirable.  The selection of the grantdate was not linked to the date on which the other principal terms of theannual grant (i.e., the identity of the option recipients and the number ofshares underlying the options to be issued to each recipient) were arrived atby management and in some cases occurred prior to such date.  The Special Committee found that the lack ofadequate controls in the annual grant process resulted in the creation of anenvironment in which the stated effective date of the annual grant could havebeen selected with the benefit of hindsight, without such selection beingreadily detectable.  The Special Committeefurther found that if the date of the annual grant was backdated in any year,the record does not demonstrate that such backdating was for the purpose offraudulently manipulating the Company’s financial statements.  The Special Committee found it appeared thatbackdating, if any, would have resulted from a belief that it was appropriateto select a grant date at a relatively low price in order to increase thebenefit conferred by the 1989 Plan upon the Company’s employees and indirectly,upon the Company and its shareholders. The Special Committee also has determined that the stated effective dateof the annual grant in fiscal year 2001 likely was selected in order to fix alower exercise price prior to an increase in the price of the common stockexpected to result from the release of favorable sales results.  The Special Committee made no finding thatthe Option Committee or management acted in a fraudulent manner in connectionwith the Company’s stock option grants.

42

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The Company’s availabledocumentation of the selection of the principal terms of the annual grant (i.e.the identity of the option recipients, the number of options to be issued andthe selection of the grant date) and of the date of execution of the Consentswas incomplete or not conclusive in most years. Because the stated effective date of certain annual grants occurredprior to the completion of all required granting actions and/or relateddocumentation, the Company determined that a new measurement date was requiredfor such grants.  However, the Companyconsistently provided written stock option agreements to all employeesreceiving stock options on a date that occurred shortly after the completion ofthe annual review process.  Theseagreements set forth the grant date, exercise price and the number of sharesunderlying the option.  As a result, theCompany has determined that the correct measurement date for accountingpurposes for the options issued pursuant to most annual grants was the date ofthe delivery of the stock option agreements to its employees, rather than theoriginal grant date recognized by the Company and reflected in the Consentsrelating to those annual grants. Approximately $7.9 million of the $9.1 million Stock Option Chargerelates to corrections to the measurement date of the stock options issuedpursuant to the annual grants made in fiscal years 1995 to 2004 to all stockoption participants.

*Grants to Newly Hired Employees*

The Special Committeefound that the Company’s policy of using the lowest price within a ten-daywindow following an employee’s hire date constituted “backdating,” but thatsuch backdating was not the result of any intent to manipulate the Company’sfinancial statements.  However, as aresult of this practice, the measurement date for options issued pursuant tosuch non-annual grants for accounting purposes was actually subsequent to thestated grant date, resulting in new measurement dates for the related options.

The Company determinedthat the correct measurement date for such non-annual grants was the datereflected in the Company’s records as the date on which there was a finaldetermination of the grant date and exercise price, which was generally thetenth day after an employee commenced employment or, in a few instances, thetenth day after an employee was promoted. Approximately $1.2 million of the $9.1 million Stock Option Chargerelates to non-annual grants made in fiscal 1995 through fiscal 2006.

**Other Matters**

The Company has evaluatedwhether or not previously deducted compensation expense related to exercisedstock options may be non-deductible.  TheCompany recorded a related tax liability and $1.4 million of interest expensethereon, which is included in the total $10.5 million cumulative pre-taxcharge.

The Company is currentlyassessing whether any negative tax consequences will impact the Company’semployees as a result of this matter. When this determination is reached, the Board of Directors may decide tocompensate the impacted employees in an amount sufficient to offset anynegative tax consequences that they may incur. The Company does not expect such additional compensation expense to bematerial.

**11.          Common Stock:**

Basic net income percommon share is computed by dividing net income by the weighted average numberof shares outstanding during each period. Diluted net income per common share gives effect to all securitiesrepresenting potential common shares that were dilutive and outstanding duringthe period.  The exercise prices forcertain of the outstanding stock options that the Company has awarded exceedthe average market price of the Company’s common stock.  Such stock options are antidilutive (optionsfor 5.0 million, 3.4 million and 2.0 million at the end of fiscal 2006, fiscal2005 and fiscal 2004, respectively) and were not included in the computation ofdiluted net income per common share.  Inthe calculation of diluted net income per common share, the denominatorincludes the number of additional common shares that would have been outstandingif the Company’s outstanding dilutive stock options and performance sharerights had been exercised.

During fiscal2006, the Company purchased 15.4 million shares of its common stock at a costof $367.3 million, as described below. During fiscal 2005 and fiscal 2004, the Company purchased in the openmarket 3.3 million shares and 5.6 million shares, respectively, at a cost of$92.0 million and $176.7 million, respectively.

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OnOctober 4, 2005, the Company executed an overnight share repurchase transactionwith a bank for the acquisition of 10 million shares, or approximately 6%, ofthe Company’s then outstanding common stock for an initial purchase price of$19.97 per share.  The transaction wasfinanced with the proceeds of the Notes, as discussed in Note 4 above.  As part of the overnight share repurchasetransaction, the Company simultaneously entered into a forward contract withthe bank that matured on March 6, 2006. In connection with the forward contract, the bank purchased shares ofthe Company’s common stock in the open market in order to fulfill itsobligation related to shares it borrowed from third parties and sold to theCompany.  At the end of the purchaseperiod, the Company could have received from or paid to the bank a priceadjustment based on the volume weighted average purchase price of the Company’scommon stock during the purchase period compared to the initial purchaseprice.  Such price adjustment could beeither in cash or common stock at the discretion of the Company.  On March 9, 2006, the Company paid $32.7million in cash to the bank to settle the forward contract.

The sharesrepurchased in connection with the overnight share repurchase transaction wereimmediately canceled and returned to the status of authorized but unissued shares.  The total cost of the initial purchase wasapproximately $201.2 million, including a $1.3 million cap premium and $0.2million in commissions and other fees. In accordance with Accounting Principles Board (APB) Opinion 6, “Statusof Accounting Research Bulletins,” the Company reduced common stock, capital inexcess of par, and retained earnings by approximately $1.0 million, $8.1million, and $192.1 million, respectively. In addition, the Company reduced retained earnings by approximately $0.3million in connection with a dividend fee paid to the bank on January 17,2006.  The forward contract associatedwith the overnight share repurchase transaction was accounted for in accordancewith EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to,and Potentially Settled in, a Company’s Own Stock,” as an equityinstrument.  The $32.7 million paymentmade on March 9, 2006, to settle the forward contract was recorded as anadjustment to retained earnings in the third quarter of fiscal 2006.  The total cost of the overnight sharerepurchase transaction was $234.2 million.

Upon completion of theovernight share repurchase transaction and related forward contract, theCompany continued to purchase shares of its common stock pursuant to Rule 10b5-1of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  During the third quarter of fiscal 2006, theCompany purchased 3.9 million shares of its common stock at a cost of $100.0million.  During the fourth quarter offiscal 2006 the Company purchased in the open market 1.5 million shares of itscommon stock at a cost of $33.1 million.

All shares arepurchased pursuant to share repurchase authorizations approved by the Board ofDirectors.  As of August 26, 2006, theCompany had outstanding authorizations to purchase a total of approximately 6.1million shares, consisting of 1.1 million shares remaining under anauthorization approved by the Board of Directors on April 13, 2005, and 5.0million shares remaining under an authorization approved by the Board ofDirectors on August 18, 2006.  Sharespurchased under the share repurchase authorizations, with the exception ofshares purchased with the proceeds of the Notes, are held in treasury or havebeen reissued under the Family Dollar 2000 Outside Directors Plan.  Shares purchased with the proceeds of theNotes were canceled and returned to the status of authorized but unissuedshares.

The following table setsforth the computation of basic and diluted net income per common share:

 
| **(in thousands, except per share amounts)** | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|-----------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| **Basic Net Income Per Share:**                                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                            |       | $          | 195,111    |       | $          | 217,509    |       | $ | 257,904 |   |
| Weighted average number  of shares outstanding                        |       | 154,967    |       | 166,791    |       | 170,770    |       |
| Net income per common  share — basic                             |       | $          | 1.26       |       | $          | 1.30       |       | $ | 1.51 |   |
|                                                                  |       |       |       |       |       |       |       |
| **Diluted Net Income Per share:**                                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                            |       | $          | 195,111    |       | $          | 217,509    |       | $ | 257,904 |   |
| Weighted average number  of shares outstanding                        |       | 154,967    |       | 166,791    |       | 170,770    |       |
| Effect of dilutive  securities — stock options                   |       | 31         |       | 301        |       | 854        |       |
| Effect of dilutive  securities — performance share rights        |       | 126        |       | —     |       | —     |       |
| Average shares —  diluted                                        |       | 155,124    |       | 167,092    |       | 171,624    |       |
| Net income per common share — diluted                            |       | $          | 1.26       |       | $          | 1.30       |       | $ | 1.50 |   |

 

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**12.          SegmentInformation**

The Company manages its business on the basis of one reportablesegment.  All of the Company’s operationsare located in the United States.  Thefollowing information regarding classes of similar products is presented inaccordance with SFAS No. 131, “Disclosures about Segments of an Enterprise andRelated Information.”

 
| ** **                    | ** ** | **Years Ended**          | ** ** |
|-------------------------------|------------|-------------------------------|------------|
| **(in thousands)**       | ** ** | **August 26, 2006** | ** ** | **August 27, 2005** | ** ** | **August 28, 2004** | ** ** |
| Classes of similar  products: |       |                          |       |   |   |   |   |
| Consumables                   |       | $                             | 3,702,573  |   | $ | 3,372,564 |   | $ | 2,994,831 |   |
| Home products                 |       | 972,005                       |       | 902,845 |   | 855,666 |   |
| Apparel and  accessories      |       | 920,847                       |       | 879,546 |   | 839,820 |   |
| Seasonal and  electronics     |       | 799,347                       |       | 669,853 |   | 591,571 |   |
| Net sales                     |       | $                             | 6,394,772  |   | $ | 5,824,808 |   | $ | 5,281,888 |   |

 

The consumables category includes household chemical and paperproducts, candy, snacks and other food, health and beauty aids, hardware andautomotive supplies, and pet food and supplies. The home products category includes domestic items such as blankets,sheets and towels as well as housewares and giftware.  The apparel and accessories category includesmen’s, women’s, boys’, girls’ and infants’ clothing and shoes.  The seasonal and electronics categoryincludes toys, stationery and school supplies, seasonal goods and electronics,including pre-paid cellular phones and services.

**13.          Unaudited Summaries of QuarterlyResults:**
| **(In thousands, except per share amounts)** | ** ** | **First Quarter** | ** ** | **Second Quarter** | ** ** | **Third Quarter** | ** ** | **Fourth Quarter** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------|------------|-------------------------|------------|------------------------|------------|-------------------------|------------|
| **2006**                                                              | ** ** | ** **             | ** ** | ** **              | ** ** | ** **             | ** ** | ** **              | ** ** |
| Net sales                                                             |       | $                      | 1,511,457  |                    | $          | 1,735,683              |       | $                       | 1,569,516  |   | $ | 1,578,116 |   |
| Gross margin                                                          |       | 508,203                |       | 570,489                 |       | 527,727                |       | 511,887                 |       |
| Net income                                                            |       | 51,389                 |       | 54,529                  | (1)        | 56,914                 |       | 32,279                  | (2)        |
| Net income per common  share(4)                                       |       | $                      | 0.32       |                    | $          | 0.35                   | (1)        | $                       | 0.37       |   | $ | 0.21 | (2) |
|                                                                  |       |                   |       |                    |       |                   |       |                    |       |
| **2005**                                                              |       |                   |       |                    |       |                   |       |                    |       |
| Net sales                                                             |       | $                      | 1,380,245  |                    | $          | 1,586,754              |       | $                       | 1,427,966  |   | $ | 1,429,843 |   |
| Gross margin                                                          |       | 460,352                |       | 520,919                 |       | 479,352                |       | 455,616                 |       |
| Net income                                                            |       | 54,429                 |       | 80,073                  |       | 53,774                 |       | 29,233                  | (3)        |
| Net income per common share(4)                                        |       | $                      | 0.32       |                    | $          | 0.48                   |       | $                       | 0.32       |   | $ | 0.18 | (3) |

----

(1)           Includesthe impact of a $45.0 million pre-tax litigation charge associated with anadverse litigation judgment.  See Note 8for more information.

(2)           Includesthe impact of a $10.5 million cumulative pre-tax charge to adjust non-cashstock-based compensation expense and related interest expense.  See Note 10 for more information.

(3)             Includes the impactof an $8.4 million cumulative pre-tax charge to correct property tax accrualson leased properties.

(4)           Figures representdiluted earnings per share.  The sum ofthe quarterly net income per common share may not equal the annual net incomeper common share due to rounding.

**14.****          Related Party Transactions:**

The Company purchased avariety of merchandise in the ordinary course of business from entities ownedor represented by non-employee family members of the Company’s Chairman of theBoard and Chief Executive Officer.  These transactions totaled approximately$1.3 million, $1.2 million and$1.2 million, in fiscal 2006, in fiscal 2005 and fiscal 2004, respectively.

 

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| **ITEM 9.** | ** ** | **CHANGES  IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE** |
|-------------|------------|-------------------------------------------------------------------------------------------|

 

None.
| **ITEM 9A** | ** ** | **CONTROLS  AND PROCEDURES** |
|-------------|------------|------------------------------|

 

**Review ofHistorical Stock Option Grant Procedures**

Asdiscussed in Note 10 to the Consolidated Financial Statements included in thisReport, a Special Committee of the Board of Directors has reviewed the Company’shistorical stock option granting practices and, as a result of such review, theCompany recorded a charge in the fourth quarter of fiscal 2006 for certainnon-cash stock-based compensation expense and related interest expense.  Management has reviewed the Special Committee’sfactual findings regarding the Company’s stock option granting practices,including findings regarding changes in the Company’s stock option grantingprocess instituted in fiscal 2005.  TheSpecial Committee has not made its determinations concerning remediation orwhat actions the Company should take with respect to the pending shareholderderivative litigation.

**DisclosureControls and Procedures**

Basedon an evaluation by management of the Company (with the participation of theCompany’s Chief Executive Officer and Chief Financial Officer), includingconsideration of the matters set forth in the preceding paragraph, as of theend of the period covered by this report, the Company’s Chief Executive Officerand Chief Financial Officer concluded that the Company’s disclosure controlsand procedures (as defined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934, as amended, (the “Exchange Act”)) wereeffective to provide reasonable assurance that information required to bedisclosed by the Company in reports that the Company files or submits under theExchange Act is recorded, processed, summarized and reported within the timeperiods specified in SEC rules and forms and that such information isaccumulated and communicated to the Company’s management, including the ChiefExecutive Officer and Chief Financial Officer, to allow timely decisionsregarding required disclosures. Consistent with the suggestion of the SEC, the Company has formed aDisclosure Committee consisting of key Company personnel designed to review theaccuracy and completeness of all disclosures made by the Company.

**Management’sReport on Internal Control Over Financial Reporting**

Managementis responsible for establishing and maintaining adequate internal control overfinancial reporting for the Company. Internal control over financial reporting is a process designed toprovide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordancewith generally accepted accounting principles. Internal control over financial reporting includes those policies andprocedures that: (i) pertain to the maintenance of records that in reasonabledetail accurately and fairly reflect the transactions and dispositions of theassets of the company; (ii) provide reasonable assurance that transactions arerecorded as necessary to permit preparation of financial statements inaccordance with generally accepted accounting principles, and that receipts andexpenditures of the company are being made only in accordance withauthorizations of management and directors of the company; and (iii) providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of the company’s assets that could have amaterial effect on the financial statements.

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements.  Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

Management(with the participation of the principal executive officer and principalfinancial officer) conducted an evaluation of the effectiveness of the Company’sinternal control over financial reporting based on the framework in *Internal Control — Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO).  Based on this evaluation,management concluded that the Company’s internal control over financialreporting was effective as of August 26, 2006.

Management’sassessment of the effectiveness of the Company’s internal control overfinancial reporting as of August 26, 2006, has been audited byPricewaterhouseCoopers LLP, an independent registered public accounting firm,as stated in their attestation report which is included under Item 8 of thisReport.

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**AttestationReport of the Registered Public Accounting Firm**

Includedin Item 8 of this Report.

**Changesin Internal Control over Financial Reporting**

Therewere no changes in the Company’s internal control over financial reportingduring the Company’s fourth fiscal quarter that have materially affected, orare reasonably likely to materially affect, the Company’s internal control overfinancial reporting.

**ITEM 9B.****           OTHERINFORMATION**

None

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**PART III**

**ITEM 10.****                                  DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT AND CORPORATE GOVERNANCE**

**Board ofDirectors of the Registrant**

Thefollowing information is furnished with respect to each of the directors of theCompany as of March 3, 2007:

| Name                                  | ** ** | **Committee**                                                                                      | ** **   | **Age** |
|---------------------------------------|------------|----------------------------------------------------------------------------------------------------|--------------|---------|
| Mark R.  Bernstein (1)      |       | Lead Director   Chairman, Nominating/ Corporate      Governance Committee           |         | 76      |
|                                  |       |                                                                                               |         |    |
| Sharon Allred  Decker (2)   |       | Compensation Committee   Nominating/ Corporate Governance      Committee            |         | 50      |
|                                  |       |                                                                                               |         |    |
| Edward C. Dolby (3)              |       | Audit Committee   Compensation Committee                                                           |         | 62      |
|                                  |       |                                                                                               |         |    |
| Glenn A.  Eisenberg (4)               |       | Chairman, Audit Committee                                                                          |         | 45      |
|                                  |       |                                                                                               |         |    |
| Howard R. Levine  (5)                 |       | Chairman of the Board  Equity Award Committee                                                      |         | 48      |
|                                  |       |                                                                                               |         |    |
| George Mahoney(6)                     |       | —                                                                                             |         | 64      |
|                                  |       |                                                                                               |         |    |
| James G. Martin (7)         |       | Chairman, Compensation Committee   Nominating/ Corporate Governance      Committee  |    | 71      |
|                                  |       |                                                                                               |         |    |
| Dale C. Pond (8)                 |       | Audit Committee   Compensation Committee                                                           |         | 60      |

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(1)                Mark R. Bernsteinhas served as a director since 1980.  Heis Of Counsel with the law firm of Parker, Poe, Adams & BernsteinL.L.P.  Prior to his January 2002retirement, he was a partner in the law firm for more than the preceding fiveyears.  Mr. Bernstein was elected as theLead Director of the Board of Directors in August 2004.

(2)                Sharon AllredDecker has served as a director since 1999. Mrs. Decker has been the Chief Executive Officer of The Tapestry Group,LLC, a consulting, communications and marketing firm since September 2004.  From April 2003 to August 2004, she wasPresident of The Tanner Companies, a manufacturer and retailer of apparel.  From August 1999 to March 2003, she wasPresident of Doncaster, a division of The Tanner Companies.  Doncaster is a direct sales organizationselling a high-end line of women’s apparel. From January 1997 to July 1999, she was President and Chief ExecutiveOfficer of The Lynnwood Foundation, which created and now manages a conferencefacility and leadership institute.  Mrs.Decker also is a director of Coca-Cola Bottling Co. Consolidated and SCANACorporation.

(3)                Edward C. Dolbyhas served as a director since 2003.  Hehas been the President of The Edward C. Dolby Strategic Consulting Group, LLCsince September 2002, when he established the company to engage in businessconsulting.  Prior to his retirement inDecember 2001, Mr. Dolby was employed by Bank of America Corporation for 32years, where his positions included President of the North Carolina and SouthCarolina Consumer and Commercial Bank.

(4)                GlennA. Eisenberg has served as a director since 2002.  He is the Executive Vice President - Financeand Administration of  The TimkenCompany, a position he has held since January 2002.  The Timken Company is an internationalmanufacturer of highly engineered bearings and alloy steels and a provider ofrelated products and services.  From 1990to 2001, Mr. Eisenberg was employed by United Dominion Industries, aninternational manufacturer of proprietary engineered products, where he heldvarious positions, including President and Chief Operating Officer fromDecember 1999 to May 2001.  He is also adirector of Alpha Natural Resources, Inc.

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(5)                Howard R. Levinehas served as a director since 1997.  Hewas employed by the Company in various capacities in the MerchandisingDepartment from 1981-1987, including employment as Senior Vice President —Merchandising and Advertising.  From 1988to 1992, Mr. Levine was President of Best Price Clothing Stores, Inc., a chainof ladies’ apparel stores.  From 1992 toApril 1996, he was self-employed as an investment manager.  He rejoined the Company in April 1996, andwas elected Vice President-General Merchandise Manager: Softlines in April1996, Senior Vice President-Merchandising and Advertising in September 1996,President and Chief Operating Officer in April 1997, Chief Executive Officer (“CEO”)in August 1998, and Chairman of the Board in January 2003.  Mr. Levine is the son of Leon Levine, theformer Chairman of the Board and founder of the Company, who retired in January2003.

(6)                George R. Mahoney,Jr. has served as a director since 1987. He was employed by the Company as General Counsel in 1976 and served asthe Executive Vice President, General Counsel and Secretary of the Company from1991 until his retirement in May 2005.

(7)                James G. Martinhas served as a director since 1996.  Hehas been associated with the Carolinas HealthCare System since January 1993,where he currently serves as a Corporate Vice President.  He served as Governor of the State of NorthCarolina from 1985 to 1992 and was a member of the United States House ofRepresentatives, representing the Ninth District of North Carolina, from 1973 until1984.  Dr. Martin is also a director ofPalomar Medical Technologies, Inc. and the North Carolina Capital ManagementTrust.

(8)                DaleC. Pond was appointed to the Board in April 2006.  He retired in June 2005 as Senior ExecutiveVice President-Merchandising/Marketing after serving twelve years with Lowe’sCompanies, Inc., the second largest home improvement retailer in theworld.  Prior to joining Lowe’s, he helda series of senior management positions at leading retailers and homeimprovement companies. Mr. Pond also is a director of Bassett FurnitureIndustries Inc., and Home Safety Council.

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**ExecutiveOfficers of the Registrant**

Thefollowing information is furnished with respect to each of the executiveofficers of the Company as of March 3, 2007:

| Name                              | ** ** | **Position and  Office**                                                         | ** ** | **Age** |
|-----------------------------------|------------|----------------------------------------------------------------------------------|------------|---------|
| Howard R. Levine  (1)        |       | Chairman of the  Board and   Chief Executive Officer                             |       | 48      |
|                              |       |                                                                             |       |    |
| R. James Kelly (2)      |       | President and   Chief Operating Officer,   Interim Chief Financial Officer  |       | 59      |
|                              |       |                                                                             |       |    |
| Robert A. George  (3)        |       | Executive Vice  President-   Merchandising                                       |       | 44      |
|                              |       |                                                                             |       |    |
| Charles S.  Gibson, Jr. (4)  |       | Executive Vice  President-   Supply Chain                                        |       | 45      |
|                              |       |                                                                             |       |    |
| Kathi S. Child (5)           |       | Senior Vice  President-  Human Resources                                         |       | 55      |
|                              |       |                                                                             |       |    |
| Dorlisa K. Flur (6)          |       | Senior Vice President-    Strategy and Business Development                      |       | 41      |
|                              |       |                                                                             |       |    |
| Janet G. Kelley (7)          |       | Senior Vice  President-   General Counsel and Secretary                          |       | 53      |
|                              |       |                                                                             |       |    |
| C. Martin Sowers  (8)        |       | Senior Vice  President-   Finance                                                |       | 49      |
|                              |       |                                                                             |       |    |
| Barry Sullivan (9)           |       | Senior Vice  President-   Store Operations                                       |       | 43      |

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(1)             Mr. Howard R. Levinewas employed by the Company in various capacities in the MerchandisingDepartment from 1981 to 1987, including employment as Senior VicePresident-Merchandising and Advertising. From 1988 to 1992, Mr. Levine was President of Best Price ClothingStores, Inc., a chain of ladies’ apparel stores.  From 1992 to April 1996, he was self-employedas an investment manager.  He rejoinedthe Company in April 1996, and was elected Vice President-General MerchandiseManager: Softlines in April 1996, Senior Vice President-Merchandising andAdvertising in September 1996, President and Chief Operating Officer in April1997, Chief Executive Officer in August 1998, and Chairman of the Board inJanuary 2003.  He is the son of LeonLevine, the founder and Chairman Emeritus of the Company.

(2)             Mr. R. James Kellywas employed by the Company as Vice Chairman-Chief Financial and AdministrativeOfficer in January 1997 and was promoted to President and Chief OperatingOfficer in August 2006.  Mr. Kellycontinues to serve as Interim Chief Financial Officer.

(3)             Mr. Robert A. Georgewas employed by the Company as Executive Vice President-Merchandising in August2005.  Prior to his employment by theCompany, he was employed by Staples Corporation, an office supply retailer,from 1986 to July 2005, where his last position was Senior Vice President,General Merchandise Manager — Office Products.

(4)             Mr. Charles S.Gibson, Jr., was employed by the Company as Vice President-Logistics inSeptember 1997 and was promoted to Senior Vice President-Distribution andLogistics in October 1999 and to Executive Vice President-Supply Chain inSeptember 2003.

(5)             Ms. Kathi S. Childwas employed by the Company as Senior Vice President-Human Resources inMarch 2006.  Prior to her employmentby the Company, she was employed by JC Penney, Inc., a chain of departmentstores, from 1988 to 2005, where her last position was Senior Vice President,Director of Human Resources.

(6)             Ms.Dorlisa K. Flur was employed by the Company as Senior Vice President-Strategyand Business Development in June 2004. Prior to her employment by the Company, she was employed by McKinsey& Company, a global management consulting firm, from 1988 to May 2004,where her last position was Principal with responsibility for McKinsey’s RetailPractice in the Southeast.

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(7)             Ms. Janet G. Kelleywas employed by the Company as Senior Vice President-Senior Counsel inJanuary 2004 and promoted to Senior Vice President-General Counsel in May2005.  Prior to her employment by theCompany, she was employed by Kmart Corporation, a chain of discount stores,from April 2001 to January 2003, where her last position wasExecutive Vice President and General Counsel. Kmart Corporation filed a petition for reorganization under Chapter 11of the federal bankruptcy laws in January 2002 and emerged from bankruptcyin May 2003.  From June 1999 toApril 2001, she was employed by Limited Brands, Inc., a chain of specialtyapparel and personal beauty stores, as Vice President and Senior Counsel.

(8)             Mr. C. Martin Sowerswas employed by the Company as an accountant in October 1984 and waspromoted to Assistant Controller in January 1985.  He was elected Controller inJanuary 1986, Vice President-Controller in July 1989 and Senior VicePresident-Finance in December 1991.

(9)             Mr. Barry Sullivanwas employed by the Company as Vice President-Store Operations inSeptember 2002 and was promoted to Senior Vice President-Store Operationsin May 2005.  Prior to his employmentwith the Company, he was employed by Eckerd Corporation, a regional drug storechain, from 1986 to 2002, where his last position was Vice President-StoreOperations.

Allexecutive officers of the Company are elected annually by and serve at thepleasure of the Board of Directors until their successors are duly elected.

**Section16(a) Beneficial Ownership Reporting Compliance**

Section16(a) of the Securities Exchange Act of 1934 requires the Company’s directorsand executive officers and persons who own more than ten percent of the Company’scommon stock (collectively, “Reporting Persons”) to file with the SEC and theNYSE initial reports of ownership and reports of changes in ownership of theCompany’s common stock and to furnish the Company with copies of suchreports.  To the Company’s knowledge,which is based solely on a review of the copies of such reports furnished tothe Company and written representations from Reporting Persons that no otherreports were required, all Reporting Persons complied with all applicablefiling requirements during fiscal 2006, except that as a result of anadministrative oversight, Dorlisa K. Flur, Robert A. George, Charles S. GibsonJr., Janet G. Kelley, R. James Kelly, Howard R. Levine, C. Martin Sowers andBarry Sullivan each were approximately two weeks late in filing their Form 4reports with respect to the acquisition of employee stock options granted onSeptember 28, 2005.  Additionally, Mr. Levinefiled a Form 5 on October 10, 2006, reporting the gift of 50,000shares on December 27, 2004.

**Code ofEthics**

TheCompany has adopted: (i) a Code of Ethics that applies to the Chief ExecutiveOfficer and senior financial officers, including the Chief Financial Officer,the principal accounting officer and the controller; (ii) a Code of BusinessConduct that governs the actions of all Company employees, including officers;and (iii) a Board of Directors Code of Business Conduct applicable to alldirectors (collectively the “Codes of Conduct”).  The Codes of Conduct are posted within theInvestors section of the Company’s Internet website at www.familydollar.com.  The Company will provide a copy of the Codesof Conduct to any stockholder upon request. Any amendments to and/or any waiver from a provision of any of the Codesof Conduct granted to any director, executive officer or any senior financialofficer, must be approved by the Board of Directors and will be disclosed onthe Company’s Internet website within three business days following theamendment or waiver.  The informationcontained on or connected to the Company’s Internet website is not incorporatedby reference into this Form 10-K and should not be considered part of this orany other report that the Company files with or furnishes to the SEC.

**AuditCommittee**

TheCompany has a standing Audit Committee. The Board of Directors has determined that all members of the AuditCommittee are independent and are financially literate as required by the NYSElisting standards, and that the Chairman of the Audit Committee, Mr. Glenn A.Eisenberg, is an “audit committee financial expert,” as defined by the SECguidelines, and has accounting or related financial management expertise, asrequired by the NYSE’s listing requirements.

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**ITEM 11.****           EXECUTIVECOMPENSATION**

**Compensation Discussion andAnalysis**

***CompensationObjectives***

The primary objectives ofthe Company’s executive compensation program are to:

·                                         Provide competitive compensation packagesthat enable the Company to attract and retain key executives who cansuccessfully implement the objectives, goals, and strategic initiatives theBoard and executive management have established for the Company;

 

·                                         Align the interests of the Company’sexecutives with those of the stockholders by directly linking a significantportion of executive compensation to the short-term and long-termfinancial performance of the Company;

 

·                                         Ensureexecutive compensation is fair, equitable and consistent as to each componentof compensation; and

 

·                                         Provide a totalcompensation program that recognizes individual contributions as well asoverall business results.

To meet these goals, the Company provides the following to its chief executiveofficer, principal financial officer and three additional most highlycompensated executive officers (the “Named Executive Officers” or “NEOs”):

·                                         Base salary;

 

·                                         Annual cash bonus;

 

·                                         Performance-based share awards;

 

·                                         Stock options;

 

·                                         Certain perquisites;

 

·                                         Severance and change in control benefits;and

 

·                                         401(k) savings and deferred compensationplans.

***CompensationEvaluation and Award Process***

Compensation forthe Company’s NEOs is reviewed and approved by the Compensation Committee on anannual basis.  The Compensation Committeeof the Company approves the Company’s various short-term and long-termcompensation plans, as described below, which form the basis for all officercompensation packages.  To assist indetermining the proper NEO compensation levels, the Committee has engaged HayGroup, Inc. to analyze each NEO’s position, looking at factors such as the sizeof the Company, scope of responsibility, importance of the role and its impacton organizational results, in order to identify comparable positions at bothretail and non-retail companies.  Oncesuch comparable positions are identified, Hay Group, Inc. provides theCommittee with information regarding both the total compensation package forcompetitive positions and components of compensation.

The CompensationCommittee also considers tally sheets prepared by management when consideringNEO compensation packages.  The tallysheets set forth the total dollar value of each NEO’s annual compensation forthe past three years, including salary, short and long-term incentivecompensation, the cost to the Company of various health and insurance benefits,perquisites, and other compensation.  Thetally sheets also provide information with respect to accumulated realized andunrealized stock option gains, grants of stock made pursuant to the Company’sperformance share rights program and amounts payable to NEOs upon terminationof employment under various different circumstances, including retirement andtermination in connection with a change of control.

As a part of theannual compensation review process, the Committee meets with, and receives therecommendations of the Chief Executive Officer (“CEO”) as to the appropriatecompensation packages for each NEO, other than the CEO.  The Chairman of the Compensation Committeemeets with the CEO to discuss his compensation package and conveys informationobtained to the Committee.  Managementand outside consultants also provide the Compensation Committee with materialsthat describe retail industry compensation trends and best practices to helpthe Compensation Committee make informed compensation decisions and to ensurethat the Compensation Committee is aware of recent developments in the field ofexecutive compensation.  Once theCommittee has reviewed all of such information, the Committee establishes botha total compensation level for each NEO and establishes or approves the variouselements of the total compensation package using the information provided byHay Group, Inc., advice from Steven Hall & Partners, advice of managementand other information such as the performance, experience and longevity of theindividual officer, existing pay levels and external market demands.  Steven Hall & Partners does not providecompensation advice to the Company’s management.

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The Committee hasnot established a formula or pre-established methodology for determining totaldirect compensation or for the allocation of compensation among salary,short-term and long-term incentive compensation.  However, the Committee has generallyestablished the total direct compensation level of each NEO, other than theCEO, at the 50th percentile for similar positions at retailcompanies.  The total direct compensationof the CEO for the current fiscal year is between the 25th   and 50th percentiles forcomparable positions at retail companies. The Committee has weighted the compensation packages of the NEOs towardperformance based compensation, with short-term bonus opportunities meeting orexceeding comparable retail positions while long-term incentives approximatethe 50th percentile or higher of comparable retail positions,except for the CEO, who has long term incentives between the 25th and 50th percentiles ofcomparable retail positions.

The Company’s CEO,assisted by other executive officers, reviews similar materials in determiningthe compensation packages of the Senior Vice Presidents who are not NEOs.  The CEO reviews such compensation packageswith the Compensation Committee and obtains their approval of all equity grantsmade to any officer at the level of Vice President or above.  Based on all information available to it, theCompany believes that the total compensation packages offered to all of theCompany’s executive officers are reasonable, competitive and designed toachieve the Company’s compensation goals.

*Factors for Determining Compensation Mix*

To determine the propermix of compensation types, the Compensation Committee considers a number offactors, including:

·                                         *Historical information*  The Committee relies on historicalinformation to show the Committee which compensation designs have been most successfulin helping the Company achieve its business strategy.  Historical information is also relevant indetermining what compensation designs and what mixes of compensation have aidedthe Company’s executive officer retention efforts.

 

·                                         *Current market practices*  As discussed above, the Committee comparesboth total direct compensation and each element of the Company’s compensationpackage against a peer group of similar retail and non-retail companies, with aspecial emphasis on the compensation practices of the Company’s most directcompetitors.  The Committee relies oncompensation consultants and executive recruiters to provide informationregarding the compensation practices of the Company’s peers.  Recent successes or failures of the Company’sexecutive recruitment efforts are also factors in the establishment ofcompensation levels.

 

·                                         *Management recommendations*  The Committee considers managementrecommendations, including individual performance ratings as prepared byexecutive management when making compensation awards at the end of each fiscalyear.

 

·                                         *Consideration of All Elements of Compensation*  In setting compensation levels, the Committeeconsiders all elements of the compensation program in total as well as eachelement in isolation.

 

·                                         *Balance *The Company’s compensation program is intended to be balanced.  The Committee considers the need to providesufficient guaranteed short-term income via base salary and benefits, but alsoperformance-based short and longer-term financial rewards which will promoteachievement of the Company’s goals when making compensation decisions.  Further, the Committee believes that as anindividual’s level of responsibility and ability to contribute to the Company’sfinancial results increases, such individual’s total compensation should alsoincrease.  As an individual’s totalcompensation increases, the Committee believes that the ratio of both equity tonon-equity compensation and performance-based compensation to totalcompensation should also increase.

 

·                                         *Compensation best practices*  The Committee believes that compensationdecisions should be reasonable, responsible and tied to the best interests ofthe Company’s stockholders.  The Company’sstockholders should understand the Company’s compensation philosophy andprogram goals.  Therefore, the Companyconsistently monitors developments in executive compensation “best-practices”to assist the Committee in achieving these objectives.

 

·                                         *Internal equity*  The Company’s compensation program isintended to be internally fair.  TheCommittee monitors the relationship between the CEO’s total compensation tothat of the Company’s other executive officers.

***Elements ofCompensation***

The following describesthe different types of employee compensation, as well as the rationale for eachelement.

*Base Salary* NEO salary ranges are determined by reviewing compensation surveys, aswell as market information provided by recruiters and the Committee’sconsultants for similar positions, with special consideration given to compensationat retail companies with sales exceeding $1 billion.  Generally, the Company targets base salariesat the 50th percentile of this group of competitors.  The Committee believes that setting salariesat a lower level would prevent the 

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Company fromattracting and retaining top-notch executive talent, and setting salaries at ahigher level would over-compensate executives without requiring correspondingperformance.  A NEO’s particular salarywithin the established range is determined by considering his or herexperience, internal review of pay relative to other officers, competitiveinformation provided by the Committee’s consultants, and contribution to theCompany’s objectives, as well as the Company’s operating performance.

For fiscal 2007, theCommittee has approved annual compensation packages for the NEOs including thefollowing base salaries:  Mr. Howard R.Levine — $800,000, Mr. Robert George — $375,000, Mr. Charlie Gibson — $340,000and Ms. Janet Kelley — $300,000.  Basesalary adjustments reflect market conditions and the Company’s objective ofestablishing salaries at the 50th percentile for competitive companies, plus anevaluation of individual performances. In connection with his promotion from Chief Financial Officer to ChiefOperating Officer, at its August 17, 2006 meeting, the Committee approved abase salary of $600,000 for Mr. R. James Kelly in recognition of his expandedrole and competitive market data for such new role.

*Short-Term Incentive Awards*  TheCompany provides short-term (annual) cash incentive awards to NEOs to encouragethem to meet individual and Company performance goals.  The Committee uses the procedures describedabove under “Compensation Evaluation and Award Process” to determine theappropriate bonus potential, as well as the overall design of compensationplans, in order to establish a market competitive bonus opportunity.  The Company strives to ensure that similarpositions across the Company have similar bonus potential.

In fiscal 2006, theCommittee made awards to the NEOs under the Company’s Incentive Profit SharingPlan.  Under this plan, executiveofficers and other supervisory personnel were eligible to receive a cash bonusequal to a percentage of their base salary (the “Target Bonus”), based on theCompany’s achieving certain pre-tax earnings goals as established by theCommittee.  The amount of an executiveofficer’s potential bonus award was based on his or her salary.  For NEOs, potential target bonus paymentsranged from 35% to 100% of annual salary. The bonus potential was greater for senior executives than for otherparticipants in the program, because the Company endeavors to tie more of thoseexecutives’ compensation to the achievement of earnings goals.  2006 Target Bonus amounts approved by theCommittee for the NEOs were as follows:

| Name             | ** ** | **Target Bonus Percentage** | ** ** |
|------------------|------------|---------------------------------------|------------|
| Howard R. Levine |       | 100                                   | %          |
| R. James Kelly   |       | 75                                    | %          |
| Robert George    |       | 50                                    | %          |
| Charlie Gibson   |       | 50                                    | %          |
| Janet G. Kelley  |       | 35                                    | %          |

 

The Target Bonus underthe Incentive Profit Sharing Plan is generally set at a level which wouldrequire the Company to perform consistent with, or beyond its publicly statedfinancial goals.  Target Bonus paymentsare considered an integral part of the Company’s compensation structure.  Therefore, while Target Bonus goals arelinked to the Company’s performance goals, the levels are intended to be withina reasonable range of achievement each year.

The Incentive Profit Sharing Plan is designed so that (1) if theCompany exceeds its pre-tax earnings goals, the potential bonus is increased by2% for each 1% by which the goal was exceeded, up to a maximum of 50%additional bonus if the Company exceeds its earnings goals by 25% and (2) ifthe Company does not meet its pre-tax earnings goals, the potential bonus isdecreased by 5% for each 1% by which the goal is missed, with no bonuses paidat all if pre-tax earnings are below 90% of the stated goal.  With the exception of Mr. Levine and Mr.Kelly, executive officers’ individual performance ratings could also increaseor decrease their potential bonus based on achievement of individualperformance goals set at the beginning of the year, including:

·                                         The NEO’s success in executing his or hermanagerial responsibilities; and

·                                         The NEO’s impact on the operating goals of the Company(including sales, pre-tax earnings and return to stockholders).

Based on the Company exceedingthe target pre-tax earnings goal by approximately 9% (excluding the impact of a$45 million litigation charge and a $10.5 million charge related to stockoption expenses, as permitted by the Incentive Profit Sharing Plan and approvedby the Compensation Committee) and factoring in the individual performanceratings for the NEOs other than Mr. Levine and Mr. Kelly, the NEOs earned thefollowing bonus amounts under the Incentive Profit Sharing Plan for fiscal 2006performance:

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| Name             | ** ** | **Bonus Amount** | ** ** |
|------------------|------------|-----------------------|------------|
| Howard R. Levine |       | $                     | 857,537    | (1) |
| R. James Kelly   |       | $                     | 408,950    | (1) |
| Robert George    |       | $                     | 214,343    | (2) |
| Charlie Gibson   |       | $                     | 193,840    | (3) |
| Janet G. Kelley  |       | $                     | 132,771    | (4) |

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(1)             Represents 118% of Target Bonus

(2)             Represents 122% of Target Bonus

(3)             Represents 125% of Target Bonus

(4)             Represents 132% of Target Bonus

At a meeting on October3, 2006, the Committee adopted The Family Dollar Stores, Inc. 2006 IncentivePlan Guidelines for Annual Cash Bonus Awards (the “Cash Bonus Award Guidelines”),pursuant to the 2006 Plan.  The CashBonus Award Guidelines are effective for fiscal 2007 and replace the annualbonuses paid under the Company’s Incentive Profit Sharing Plan for fiscal 2006on substantially the same terms.  2007target bonus awards under the Cash Bonus Award Guidelines approved by theCommittee for the NEOs are as follows:

| Name             | ** ** | **Target Bonus Percentage** | ** ** |
|------------------|------------|---------------------------------------|------------|
| Howard R. Levine |       | 100                                   | %          |
| R. James Kelly   |       | 75                                    | %          |
| Robert George    |       | 50                                    | %          |
| Charlie Gibson   |       | 50                                    | %          |
| Janet G. Kelley  |       | 40                                    | %          |

 

*Long-Term Incentive Awards* The Committee believes that a substantial portion of each NEO’scompensation should be both performance-based and in the form of equityawards.  The Company’s long-termincentive awards are designed to closely align the interests of management andexecutives with those of the Company’s stockholders.  The Company offers two types of long-termincentive compensation: stock optionsand performance share rights (“PSRs”). Both types of equity compensation are awarded under the Company’s 2006Plan, which was approved by the stockholders on January 19, 2006.

The Committee uses theprocedures described above under “Compensation Evaluation and Award Process” todetermine the appropriate total dollar value of long-term incentivecompensation to award each NEO.  This dollar value is reviewed eachyear, and can change based on the executive officer’s performance and marketconditions.  Once the dollar value isestablished, it is divided equally between stock options and PSRs.  Option and PSR awards are denominated inshares.  The number of options and PSRsawarded is set so that the grant date fair value of the awards determined in accordance with FinancialAccounting Standards Board Statement of Financial Accounting Standards No. 123(revised 2004), “Share Based Payment”**(“FAS 123R”) equals the total dollar value of long-termincentive compensation approved by the Committee for the NEO.

The Committee believesthat awarding a balanced mix of stock options and PSRs reduces the Company’shistorical dependence on stock options and more firmly ties executive officer****compensation to performance.  The communication of these grants in terms ofdollar value at the time of grant helps the executive officer understand thetrue value of equity compensation and also helps the Company understand itscompensation costs for each executive officer.

The Company has adopted apolicy of making equity awards on pre-established dates in order to avoid anypotential issues regarding the selection of grant dates based upon the releaseof material information about the Company’s performance.  Annual equity awards are presented to theCommittee for approval at a scheduled Committee meeting on the first Tuesdayafter the Company’s fiscal year end earnings release.  Equity awards are also given to employeesthroughout the year, as they are hired or promoted into positions eligible forthose awards.  For newly hired orpromoted employees below the level of Vice President, equity awards arereviewed and approved by the Equity Award Committee of the Board on the firstTuesday after the Company’s monthly sales release.  For newly hired or promoted employees at orabove the level of 

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Vice President,equity awards are approved by the Committee at a meeting held the sameday.  The exercise price for all stockoptions is determined by the closing price of Family Dollar stock on the datethe option grant is approved.

Performance Share RightsAwards  PSRs were awarded under the 2006 Plan, andaccording to the terms of the 2006 Incentive Plan Guidelines for Long TermIncentive Performance Share Rights Awards. When an employee is awarded PSRs, that employee receives a right to beissued shares of the Company’s common stock if the Company performs at acertain level, as compared to a selected peer group of companies, over therelevant performance period.  Performanceis determined by analyzing the Company’s net income growth (“earnings growth”)and average annual return on equity (“ROE”). Each of these factors is given equal weight.  Performance share rights are generallydetermined using a three-year performance period.  However, the Company made one-year performanceperiod awards in fiscal 2006 and in fiscal 2007 to help employees understandthe metrics of these awards.

Each participatingemployee is awarded a “target” number of shares.  These shares are awarded to the employee atthe end of a performance period if the Company is at the 50th percentile inrelation to its peer group for earnings growth and ROE.  If the Company’s performance is above orbelow the 50th percentile, the number of shares will beadjusted upward or downward, respectively. No awards are made if the Company’s performance is below the 30th percentile, andawards are increased to a maximum of twice the “target” award if the Company’srelative performance is above the 90th percentile, as follows:

| Performance Against   Selected Peer Group | ** ** | **Percent of Award   Adjustment  (to Target Award)** | ** ** |
|---------------------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|
| 100th Percentile                                         |       | 200                                                                           | %          |
| 75th Percentile                                          |       | 150                                                                           | %          |
| 50th Percentile                                          |       | 100                                                                           | %          |
| 40th Percentile                                          |       | 75                                                                            | %          |
| 30th Percentile                                          |       | 25                                                                            | %          |
| <30th Percentile                                      |       | 0                                                                             | %          |

 

For fiscal 2006, the peergroup consisted of the following companies: 7-Eleven, 99 Cent Only Stores, Big Lots, Casey’s General Stores, Cato,CVS, Dollar General, Dollar Tree Stores, Fred’s, Kohl’s Department Stores,Longs Drug Stores, Office Depot, Payless ShoeSource, Shopko, SuperValu, TargetCorporation, TJX Companies, Inc., The Pantry, Inc., Walgreens and Wal-MartStores, Inc.  For fiscal 2007, the peer group consists of the same companies with theexception of 7-Eleven and Shopko.

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For fiscal 2006, targetPSR awards approved by the Committee for the NEOs were as follows:

| Name                            | ** ** | **Target PSR Grant** | ** ** |
|---------------------------------|------------|--------------------------------|------------|
| Howard R. Levine                |       |                           |       |
| 1 Year  Performance Share Award |       | 12,500                         |       |
| 3 Year  Performance Share Award |       | 37,500                         |       |
|                            |       |                           |       |
| R. James Kelly                  |       |                           |       |
| 1 Year  Performance Share Award |       | 8,000                          |       |
| 3 Year  Performance Share Award |       | 24,000                         |       |
|                            |       |                           |       |
| Robert George                   |       |                           |       |
| 1 Year  Performance Share Award |       | 2,917                          |       |
| 3 Year  Performance Share Award |       | 8,750                          |       |
|                            |       |                           |       |
| Charlie Gibson                  |       |                           |       |
| 1 Year  Performance Share Award |       | 2,500                          |       |
| 3 Year  Performance Share Award |       | 7,500                          |       |
|                            |       |                           |       |
| Janet G. Kelley                 |       |                           |       |
| 1 Year  Performance Share Award |       | 1,333                          |       |
| 3 Year Performance  Share Award |       | 4,000                          |       |

 

Based on the Company’sachieving at the 56th percentile in relation to its peer group forearnings growth and ROE in fiscal 2006, the NEOs earned the following number ofshares of common stock pursuant to the 1-year  PSR awards:

| Name             | ** ** | **PSRs Earned** | ** ** |
|------------------|------------|----------------------|------------|
| Howard R. Levine |       | 14,000               |       |
| R. James Kelly   |       | 8,960                |       |
| Robert George    |       | 3,268                |       |
| Charlie Gibson   |       | 2,800                |       |
| Janet G. Kelley  |       | 1,495                |       |

 

In October 2006, theCommittee approved the following target PSR awards to the NEOs for fiscal 2007:

| Name                            | ** ** | **Target PSR Grant** | ** ** |
|---------------------------------|------------|--------------------------------|------------|
| Howard R. Levine                |       |                           |       |
| 1 Year Performance  Share Award |       | 12,500                         |       |
| 3 Year  Performance Share Award |       | 37,500                         |       |
|                            |       |                           |       |
| R. James Kelly                  |       |                           |       |
| 1 Year  Performance Share Award |       | 9,167                          |       |
| 3 Year  Performance Share Award |       | 27,500                         |       |
|                            |       |                           |       |
| Robert George                   |       |                           |       |
| 1 Year  Performance Share Award |       | 2,229                          |       |
| 3 Year Performance  Share Award |       | 6,687                          |       |
|                            |       |                           |       |
| Charlie Gibson                  |       |                           |       |
| 1 Year  Performance Share Award |       | 2,178                          |       |
| 3 Year  Performance Share Award |       | 6,532                          |       |
|                            |       |                           |       |
| Janet G. Kelley                 |       |                           |       |
| 1 Year  Performance Share Award |       | 1,199                          |       |
| 3 Year Performance  Share Award |       | 3,595                          |       |

 

57

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**Stock Option Awards**  Awards of stockoptions under the Company’s 2006 Non-Qualified Stock Option Grant Programgenerally have the following terms:

·                                         The exercise price for each option is the closingprice of the Company’s stock on the date the option grant is approved.

·                                         Options have a term of five years and may not beexercised for at least two years from the date of the grant.

·                                         Each option becomes exercisable in cumulativeinstallments of not more than 40% of the number of shares subject to the optionafter two years, 70% after three years and 100% after four years.  This vesting schedule encourages executivesto remain employed by the Company and helps to ensure an appropriate link tostockholder total return.

·                                         Grants do not include reload provisions and repricingof options is prohibited without stockholder approval.

In October 2006, theCompensation Committee approved the following stock option awards to thefollowing NEOs for fiscal 2006 performance: Mr. Levine — 150,000, Mr. Kelly —110,000, Mr. George — 21,845, Mr. Gibson — 21,340 and for Ms. Kelley — 11,746.

***Perquisites**** *NEOs(along with selected other senior executives) participate in a Medical ExpenseReimbursement Plan and are offered executive disability insurance coverage paidfor by the Company.  Pursuant to hisemployment agreement with the Company, Mr. Levine is entitled to non-exclusivepersonal use of the Company’s aircraft, subject to certain limits establishedby the Board each year.  For the 2007fiscal year, the Board has limited Mr. Levine’s personal usage of the Company’saircraft to 70 hours.  The Committeeconsiders the incremental cost to the Company and the benefit to Mr. Levine ofthis perquisite when setting his total compensation each year.

The Company believes itis necessary to offer these benefits in order to support the Company’srecruitment and retention efforts because many of the Company’s competitorsoffer similar benefits.  Because theCompany does not offer NEOs any other perquisites other than those benefitsgenerally available to all Company employees, or as further described in Note 5to the “Summary Compensation Table” set forth below, the Company views theseperquisites as reasonable and necessary to its compensation program.

***Employment Agreements**** *TheCompany has entered into employment agreements with the Chairman of the Boardand CEO, Howard R. Levine; President, Chief Operating Officer and Interim ChiefFinancial Officer, R. James Kelly; Executive Vice President, Robert A. George;and Executive Vice President, Charles S. Gibson, Jr. under which each suchexecutive officer is entitled to certain compensation and benefits.  Under these agreements the above named executiveofficers also agree to certain non-competition and non-solicitationcovenants.  See “Employment Agreementswith Named Executive Officers” set forth below.

Presently, no otherexecutive officer is party to an employment agreement with the Company.

***Severance andChange in Control Benefits***

The Company has enteredinto employment agreements and/or maintains incentive plans that will requirethe Company to provide compensation or other benefits to the NEOs in connectionwith certain events related to a termination of employment or change ofcontrol.  For a description of the termsof these arrangements see “Potential Payments Upon Termination Or Change OfControl” set forth below.

The Company hasestablished these arrangements for the following reasons:

·                                         the Company believes that it is in thebest interests of the Company and its stockholders to assure that the Companywill have the continued dedication of its executive officers notwithstandingthe possibility, threat or occurrence of a change of control;

 

·                                         the Company believes it is imperative todiminish the inevitable distraction to the Company’s executive officers byvirtue of the personal uncertainties and risks created by a pending orthreatened change of control; and

 

·                                         the Company believes providing executive officerscompensation and benefits arrangements upon a change of control is necessary inorder for the Company to be competitive with compensation packages of othersimilarly-situated companies.

***StockOwnership Guidelines***

The Company believes thatits executive officers should hold a substantial equity interest in the Companyin order to closely link the interests of the Company’s stockholders withmanagement.  Consequently, the Board hasestablished stock ownership guidelines for all of the Company’s officers whohold the position of Vice-President or above. Under these guidelines, those officers are expected to achieve ownershipof the Company’s common stock valued at a multiple of the 

58

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officer’s annualbase compensation, ranging from one times salary for Vice Presidents to fivetimes salary for the CEO.  Pendingachievement of these ownership goals, officers will be required to retain 25%of the net value (after the exercise price of any options and after applicabletaxes) of any equity award.

***Incentive PlanRetirement Provisions***

The Family Dollar Stores, Inc. 1989 Non-Qualified Stock Option Plan (the “1989 Plan”) and the 2006 Plan each contain retirement provisions which provide that stock options granted to and held by qualifying retirees at the date of retirement shall continue to vest and be exercisable in accordance with the terms of each plan.  In order to qualify as a “retiree” under each Plan, an employee must voluntarily terminate his or her employment at age sixty years or older after a period of at least ten years of service to the Company.  Additionally, retirees must agree to abide by certain non-compete and solicitation provisions for a period of five years.  This provision of the 1989 Plan only applies to options that were (i) unvested as of January 20, 2005, or (ii) any vested stock options that were “underwater” on such date.

***Deferred CompensationPlan***

The Family DollarCompensation Deferral Plan (the “Deferred Compensation Plan”) allows certainemployees, including NEOs, to defer receipt of up to 50% of their salary and75% of their bonus payments.  The Companyprovides this benefit to aid retention and recruitment, as most of thecompanies with whom the Company competes provide a similar benefit to theirexecutive officers.  For a description ofthe material terms of the Deferred Compensation Plan see “Nonqualified DeferredCompensation” set forth below.

*401(k)Plan*

The Company offers a401(k) savings plan for all eligible employees. The Company’s matching contribution is 50% of employee contributions upto 3% of base salary or bonus pay, subject to plan and Internal Revenue Codelimits.

***Tax and Accounting***

*Deductibilityof Compensation*  Section 162(m) of the Internal Revenue Codeprovides that publicly held companies may not deduct in any taxable yearcompensation in excess of $1 million paid to the CEO or any of the four otherhighest paid executive officers which is not “performance-based,” as defined inSection 162(m).  The Company’sstockholders have approved the 1989 Plan, the 2006 Plan and the IncentiveProfit Sharing Plan for the purpose of preserving the future deductibility of allcompensation paid under these plans.  TheCommittee fully considers Section 162(m) when determining executivecompensation packages and believes that all applicable executive officercompensation paid in fiscal 2006 met the deductibility requirements of Section162(m).

*FAS 123(R) * The Companybegan accounting for share-based payments including stock options and PSRspursuant to FAS 123(R) on August 27, 2006.

59

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**2006 Summary CompensationTable**

The following table sets forth information concerningthe compensation earned during fiscal 2006 by the NEOs.
| Name and Principal Position                      | ** ** | **Year**    | ** ** | **Salary  ($)**(1) | ** ** | **Bonus  ($)** | ** ** | **Stock  Awards  ($)**(2) | ** ** | **Option  Awards  ($)**(3) | ** ** | **Non-Equity  Incentive  Plan  Comp-  ensation  (1)**(4) | ** ** | **All Other   Comp-  ensation  ($)**(5) | ** ** | **Total ($)** | ** ** |
|-----------------------------------------------------------------|------------|-------------|------------|--------------------|------------|----------------|------------|---------------------------|------------|----------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------|------------|--------------------|------------|
| Howard R. Levine                                                |       |        |       |               |       |           |       |                      |       |                       |       |                                                     |       |                                              |       |               |       |
| Chairman of the Board and Chief  Executive Officer              |       | 2006   |       | 728,585       |       | —    |       | 499,842              |       | 874,617               |       | 857,537                                             |       | 99,360                                            | (6)        | 3,059,941     |       |
|                                                            |       |        |       |               |       |           |       |                      |       |                       |       |                                                     |       |                                              |       |               |       |
| R. James Kelly                                                  |       |        |       |               |       |           |       |                      |       |                       |       |                                                     |       |                                              |       |               |       |
| President, Chief  Operating Officer and Chief Financial Officer |       | 2006   |       | 465,774       |       | —    |       | 319,899              |       | 659,228               |       | 408,950                                                  |       | 20,725                                       |       | 1,874,576          |       |
|                                                            |       |        |       |               |       |           |       |                      |       |                       |       |                                                     |       |                                              |       |               |       |
| Robert A. George                                                |       |        |       |               |       |           |       |                      |       |                       |       |                                                     |       |                                              |       |               |       |
| Executive Vice President - Chief  Merchandising Officer         |       | 2006   |       | 353,711       |       | 50,000         | (7)        | 116,637              |       | 143,327               |       | 214,343                                                  |       | 41,222                                       |       | 919,240            |       |
|                                                            |       |        |       |               |       |           |       |                      |       |                       |       |                                                     |       |                                              |       |               |       |
| Charles S. Gibson, Jr.                                          |       |        |       |               |       |           |       |                      |       |                       |       |                                                     |       |                                              |       |               |       |
| Executive Vice  President - Supply Chain                        |       | 2006   |       | 308,901       |       | —    |       | 99,968               |       | 243,574               |       | 193,840                                             |       | 15,475                                            |       | 861,758       |       |
|                                                            |       |        |       |               |       |           |       |                      |       |                       |       |                                                     |       |                                              |       |               |       |
| Janet G. Kelley                                                 |       |        |       |               |       |           |       |                      |       |                       |       |                                                     |       |                                              |       |               |       |
| Senior Vice President - General  Counsel and Secretary          |       | 2006   |       | 282,806       |       | —    |       | 53,332               |       | 206,133                    |       | 132,771                                             |       | 15,311                                            |       | 690,353       |       |

----

(1)             Includes amounts deferred by certain of the NEOspursuant to the Deferred Compensation Plan.

(2)             The amounts shown in this column indicatethe dollar amount of compensation cost recognized by the Company in fiscal 2006pursuant to FAS 123R for PSRs.  Pursuantto SEC regulations, the amounts shown exclude the impact of estimatedforfeitures related to service-based vesting conditions.  See Note 9 to the Consolidated FinancialStatements included in this Report for a discussion of the relevant assumptionsmade in these valuations.

(3)             The amounts shown in this column indicatethe dollar amount of compensation cost recognized by the Company in fiscal 2006pursuant to FAS 123R for option awards. Pursuant to SEC regulations, the amounts shown exclude the impact ofestimated forfeitures related to service-based vesting conditions.  See Note 9 to the Consolidated FinancialStatements included in this Report for a discussion of the relevant assumptionsmade in these valuations.

(4)             Represents amounts earned under theCompany’s Incentive Profit Sharing Plan (“Profit Sharing Plan”) in fiscal 2006but paid in fiscal 2007.  For informationregarding the Company’s Profit Sharing Plan, see the discussion in “CompensationDiscussion and Analysis” set forth above.

(5)                Foreach NEO, All Other Compensation for fiscal 2006 included premiums paid for thenamed executive officers in the following amounts: (i) $39 for the provision ofshort term disability insurance coverage, (ii) $2,820 for the provision of longterm disability insurance coverage (except for Ms. Kelley, for whom the premiumwas $2,655), and (iii) $6,297 for personal umbrella liability insurancecoverage for Mr. Levine.  Also includes$25,078 in customary relocation expenses for which Mr. George was reimbursed infiscal 2006.  For each NEO, this column alsoincludes Company contributions to the 401(k) plan, premiums for term life insurance(including accidental death and dismemberment coverage), premiums paid forexecutive disability insurance coverage and the Company’s Medical ExpenseReimbursement Program (“MERP”), as follows:

60

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| Name             | ** ** | **401(k) ($)** | ** ** | **Term Life  Insurance ($)** | ** ** | **Executive  Disability ($)** | ** ** | **MERP Plan ($)** | ** ** |
|------------------|------------|---------------------|------------|-----------------------------------|------------|------------------------------------|------------|-----------------------------|------------|
| Howard R. Levine |       | 3,300               |       | 2,360                             |       | 4,589                              |       | 6,522                       |       |
| R. James Kelly   |       | 3,300               |       | 2,186                             |       | 5,814                              |       | 6,566                       |       |
| Robert George    |       | 2,813               |       | 1,669                             |       | 3,034                              |       | 5,769                       |       |
| Charlie Gibson   |       | 3,461               |       | 1,450                             |       | 1,909                              |       | 5,796                       |       |
| Janet G. Kelley  |       | 3,443               |       | 1,333                             |       | 2,045                              |       | 5,796                       |       |

 

                           All such amounts weredetermined by reference to the cash costs paid by the Company for the item.

(6)                Includesthe incremental cost to the Company of Mr. Levine’s personal use of Companyaircraft which amounted to $73,433 in fiscal 2006.**** The Company determines the incremental cost ofMr. Levine’s personal use of the Company’s aircraft by multiplying the total ofMr. Levine’s personal flight hours in fiscal 2006 (including “dead head”hours), by the per hour incremental cost of all Company aircraft. Theincremental aircraft cost per hour is determined by adding the cost of fuel,repairs, supplies, crew travel and meals, landing and trip-related hangar andparking costs, and then dividing that figure by the Company’s total annualflight hours for all Company aircraft.

(7)                Representsa signing bonus paid in connection with Mr. George’s employment.

**2006Grants Of Plan-Based Awards**

The followingtable sets forth information concerning grants of plan-based awards made to theNEOs during fiscal 2006.
| ** **        | ** ** | ** ** | ** ** | ** **         | ** ** | ** **            | ** ** | **Estimated Future Payouts  Under Non-Equity  Incentive Plan Awards** | ** ** | **Estimated Future Payouts  Under Equity Incentive  Plan Awards** | ** ** | **Exercise  or Base  Price of  Option** | ** ** | **Grant  Date Fair  Value of  Stock  and  Option** | ** ** |
|-------------------|------------|------------|------------|--------------------|------------|-----------------------|------------|------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------------------|------------|
| **Name**          | ** ** | **Plan**   | ** ** | **Grant  Date**(5) | ** ** | **Approval  Date**(5) | ** ** | **Threshold**($)                                                                               | ** ** | **Target **($)                                                                        | ** ** | **Maximum**($)                                    | ** ** | **Threshold**(#)                                             | ** ** | **Target**(#) | ** ** | **Maximum**(#) | ** ** | **Awards**($/Sh) | ** ** | **Awards**($)(6) | ** ** |
| Howard R. Levine  |       | (1         | )          | 09/28/05           |       | 09/28/05              |       |                                                                                           |       |                                                                                       |       |                                              |       |                                                         |       | 150,000 |   |   |   | 19.75 |   | 814,500 |   |
|              |       | (2         | )          | 09/28/05           |       | 09/28/05              |       | 362,500                                                                                        |       | 725,000                                                                                    |       | 1,000,000                                         |       |                                                         |       |   |   |   |   |   |   |   |   |
|              |       | (3         | )          | 09/28/05           |       | 01/19/06              |       |                                                                                           |       |                                                                                       |       |                                              |       | 3,125                                                        |       | 12,500 |   | 25,000 |   |   |   | 300,750 |   |
|              |       | (4         | )          | 09/28/05           |       | 01/19/06              |       |                                                                                           |       |                                                                                       |       |                                              |       | 9,375                                                        |       | 37,500 |   | 75,000 |   |   |   | 902,250 |   |
|              |       |       |       |               |       |                  |       |                                                                                           |       |                                                                                       |       |                                              |       |                                                         |       |   |   |   |   |   |   |   |   |
| R. James Kelly    |       | (1         | )          | 09/28/05           |       | 09/28/05              |       |                                                                                           |       |                                                                                       |       |                                              |       |                                                         |       | 95,000 |   |   |   | 19.75 |   | 515,850 |   |
|              |       | (2         | )          | 09/28/05           |       | 09/28/05              |       | 172,500                                                                                        |       | 345,000                                                                                    |       | 517,500                                           |       |                                                         |       |   |   |   |   |   |   |   |   |
|              |       | (3         | )          | 09/28/05           |       | 01/19/06              |       |                                                                                           |       |                                                                                       |       |                                              |       | 2,000                                                        |       | 8,000 |   | 16,000 |   |   |   | 192,480 |   |
|              |       | (4         | )          | 09/28/05           |       | 01/19/06              |       |                                                                                           |       |                                                                                       |       |                                              |       | 6,000                                                        |       | 24,000 |   | 48,000 |   |   |   | 577,440 |   |
|              |       |       |       |               |       |                  |       |                                                                                           |       |                                                                                       |       |                                              |       |                                                         |       |   |   |   |   |   |   |   |   |
| Robert A. George  |       | (1         | )          | 09/28/05           |       | 09/28/05              |       |                                                                                           |       |                                                                                       |       |                                              |       |                                                         |       | 35,000 |   |   |   | 19.75 |   | 190,050 |   |
|              |       | (2         | )          | 09/28/05           |       | 09/28/05              |       | 87,500                                                                                         |       | 175,000                                                                                    |       | 281,050                                           |       |                                                         |       |   |   |   |   |   |   |   |   |
|              |       | (3         | )          | 09/28/05           |       | 01/19/06              |       |                                                                                           |       |                                                                                       |       |                                              |       | 729                                                          |       | 2,917 |   | 5,834 |   |   |   | 70,183 |   |
|              |       | (4         | )          | 09/28/05           |       | 01/19/06              |       |                                                                                           |       |                                                                                       |       |                                              |       | 2,188                                                        |       | 8,750 |   | 17,500 |   |   |   | 210,525 |   |
|              |       |       |       |               |       |                  |       |                                                                                           |       |                                                                                       |       |                                              |       |                                                         |       |   |   |   |   |   |   |   |   |
| Charles S. Gibson |       | (1         | )          | 09/28/05           |       | 09/28/05              |       |                                                                                           |       |                                                                                       |       |                                              |       |                                                         |       | 35,000 |   |   |   | 19.75 |   | 190,050 |   |
|              |       | (2         | )          | 09/28/05           |       | 09/28/05              |       | 77,500                                                                                         |       | 155,000                                                                                    |       | 248,930                                           |       |                                                         |       |   |   |   |   |   |   |   |   |
|              |       | (3         | )          | 09/28/05           |       | 01/19/06              |       |                                                                                           |       |                                                                                       |       |                                              |       | 625                                                          |       | 2,500 |   | 5,000 |   |   |   | 60,150 |   |
|              |       | (4         | )          | 09/28/05           |       | 01/19/06              |       |                                                                                           |       |                                                                                       |       |                                              |       | 1,875                                                        |       | 7,500 |   | 15,000 |   |   |   | 180,450 |   |
|              |       |       |       |               |       |                  |       |                                                                                           |       |                                                                                       |       |                                              |       |                                                         |       |   |   |   |   |   |   |   |   |
| Janet G. Kelley   |       | (1         | )          | 09/28/05           |       | 09/28/05              |       |                                                                                           |       |                                                                                       |       |                                              |       |                                                         |       | 22,000 |   |   |   | 19.75 |   | 119,460 |   |
|              |       | (2         | )          | 09/28/05           |       | 09/28/05              |       | 49,525                                                                                         |       | 99,050                                                                                     |       | 169,517                                           |       |                                                         |       |   |   |   |   |   |   |   |   |
|              |       | (3         | )          | 09/28/05           |       | 01/19/06              |       |                                                                                           |       |                                                                                       |       |                                              |       | 334                                                          |       | 1,334 |   | 2,668 |   |   |   | 32,096 |   |
|              |       | (4         | )          | 09/28/05           |       | 01/19/06              |       |                                                                                           |       |                                                                                       |       |                                              |       | 1,000                                                        |       | 4,000 |   | 8,000 |   |   |   | 96,240 |   |

 

61

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(1)             Represents stock option awards grantedpursuant to the 1989 Plan in fiscal 2006 for performance in fiscal 2005.

(2)             Represents threshold, target and maximum payout levels pursuant to theawards granted under the Profit Sharing Plan. Pursuant to the Profit Sharing Plan, the amount of any cash bonusotherwise payable to any employee may not exceed $1,000,000.  The actual amount earned by each NEO in 2006is reported under the Non-Equity Incentive Plan Compensation column in theSummary Compensation Table.  For moreinformation regarding the Profit Sharing Plan, see the discussion in “CompensationDiscussion and Analysis” set forth above.

(3)             Represents threshold, target and maximum payout levels pursuant to 1 yearPSR awards granted in fiscal 2006 for performance in fiscal 2005.  See “Option Exercises and Stock Vested” tablebelow for information on the shares issued pursuant to these awards.

(4)             Represents threshold and target payout levels pursuant to 3 year PSRawards granted in fiscal 2006 for performance in fiscal 2005.

(5)             PSR awards were contingently approved bythe Compensation Committee on September 28, 2005, subject to stockholderapproval of the 2006 Plan, which approval was obtained on January 19, 2006.

(6)             The amounts shown in this column indicatethe grant date fair value of stock (PSRs) and option awards computed inaccordance with FAS 123R.  See Note 9 tothe Consolidated Financial Statements included in this Report for a discussionof the relevant assumptions made in these valuations.

**EmploymentAgreements with Named Executive Officers**

TheCompany has entered into employment agreements with the Chairman of the Board andCEO Howard R. Levine; President, Chief Operating Officer and Interim ChiefFinancial Officer R. James Kelly; Executive Vice President Robert A. George,and Executive Vice President Charles S. Gibson, Jr.  The employment agreements each provide for aone-year rolling term, which automatically extends each month for an additionalmonth; provided, that either party may terminate the extensions by writtennotice to the other party.  Theemployment agreements provide for a weekly base salary, subject to annualreview by the Board, and for participation in the Company’s annual cash bonusplan, now currently pursuant to the 2006 Plan. Subject to certain terms andconditions contained therein, the employment agreements provide that theCompany will pay severance of one year’s base salary if the Company terminatesthe Agreement prior to its expiration; provided that such termination is notfor Cause or a result of Medical Disability (as defined in the employmentagreements).  The employment agreementsalso provide for payments of pro-rata bonus amounts under the 2006 Plan upon atermination that is not for Cause.  Theemployment agreements prohibit the officers from engaging in activities thatcompete with the Company (with the definition of competitive companies for suchpurpose being narrower in scope in Messrs. George and Gibson’s agreement) andfrom soliciting employees of the Company for one year after the termination oftheir respective agreements, regardless of the reason for termination.

Mr.Levine’s employment agreement was amended in August 2006 to memorialize theCompany’s approval of the non-exclusive personal use of the Company’s aircraftby Mr. Levine, subject to certain limits and conditions as established by theBoard each year.  The Board has presentlylimited Mr. Levine’s personal usage of the aircraft to 70 hours for the 2007fiscal year.

Presently,no other executive officer is party to an employment agreement with theCompany.

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**2006Outstanding Equity Awards At Fiscal Year End**

Thefollowing table sets forth information concerning option awards and stockawards held by the NEOs as of August 26, 2006.
| ** **             | ** ** | **Option Awards**                                                                    | ** **    | **Stock Awards**                                                                       | ** **           |
|------------------------|------------|-------------------------------------------------------------------------------------------|---------------|---------------------------------------------------------------------------------------------|----------------------|
| **Name**               | ** ** | **Number of  Securities  Underlying  Unexercised  Options **(#)  Exercisable(1) | ** **    | **Number of  Securities  Underlying  Unexercised  Options (**#)  Unexercisable(1) | ** **           | **Option  Exercise  Price **($) | ** ** | **Option  Expiration  Date** | ** ** | **Equity Incentive  Plan Awards:  Number of  Unearned Shares,  Units or Other  Rights That Have  Not Vested **(#)(2) | ** ** | **Incentive Plan  Awards: Market  or Payout Value  of Unearned  Shares, Units or  Other Rights  That Have Not  Vested **($)(3) | ** ** |
| Howard R. Levine       |       | 150,000

122,500

200,000

 —

 —                                     | (4)  (5)  (6) | —

52,500

—

200,000

150,000                                                    | (5)  (7)  (8)        | 24.25 28.25 40.75 27.00  19.75 |   | 09/16/06 09/26/07 09/28/08  10/04/09 09/27/10 |   | 42,000 |   | 990,360 |   |
|                   |       |                                                                                      |          |                                                                                        |                 |   |   |   |   |   |   |   |   |
| R. James Kelly         |       | 85,000

70,000

110,000

—

—                                                   | (4)  (5)  (6) | —

30,000

—

110,000

95,000                                                     | (5)  (7)  (8)        | 24.25 28.25 40.75 27.00  19.75 |   | 09/16/06 09/26/07 09/28/08  10/04/09 09/27/10 |   | 26,880 |   | 633,830 |   |
|                   |       |                                                                                      |          |                                                                                        |                 |   |   |   |   |   |   |   |   |
| Robert A. George       |       | —

—                                                                            |          | 75,000

35,000                                                                              | (9)  (8)             | 21.25 19.75 |   | 08/17/10 09/27/10 |   | 9,803 |   | 231,152 |   |
|                   |       |                                                                                      |          |                                                                                        |                 |   |   |   |   |   |   |   |   |
| Charles S. Gibson, Jr. |       | 35,000

60,000

—

—                                                            | (5) (6)       | 15,000

—

60,000

35,000                                                              | (5)  (7)  (8)        | 28.25 40.75 27.00 19.75 |   | 09/26/07 09/28/08 10/04/09  09/27/10 |   | 8,400 |   | 198,072 |   |
|                   |       |                                                                                      |          |                                                                                        |                 |   |   |   |   |   |   |   |   |
| Janet G. Kelley        |       | 16,000  —  —  —                                                            | (10)          | 24,000

20,000

25,000

22,000                                                              | (10)  (7)  (11)  (8) | 34.25 27.00 32.25 19.75 |   | 01/03/09 10/04/09 03/06/10 09/27/10 |   | 4,486 |   | 105,780 |   |

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(1)             Represents stock options granted pursuantto the 1989 Plan.  Options vest inincrements of 40% on the second anniversary of the grant date and an additional30% on each of the third and fourth grant date anniversaries.

(2)             Represents award of PSRs that were madein fiscal 2006 for performance in fiscal 2005 under a 3-year performanceperiod.  PSRs are earned and convert tothe right to receive shares of the Company’s Common Stock based on the Company’saverage annual return on equity (“ROE”) and pre-tax net income growth raterelative to a selected peer group of companies over the performanceperiod.  The number of shares reflectedassumes achievement against the performance goals equivalent to 2006 fiscalyear performance at the 56th percentile in relation to the Company’s peergroup for earnings growth and ROE.  Doesnot include award of PSRs that were made in fiscal 2006 for performance infiscal 2005 under a 1-year performance period. Such PSRs vested and shares of Common Stock were issued to the Company’sNEOs on October 3, 2006.  See**“Option Exercises and Stock Vested” table, set forth below.

(3)             Indicatesmarket value of unearned PSRs by reference to the closing price of the Company’scommon stock on the last trading day in 2006, August 25, 2006, of $23.58 pershare.

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(4)             This option was granted on September 17,2001, under the 1989 Plan, and no portion of the option could be exerciseduntil September 17, 2003.  Thereafter,the option became exercisable in cumulative installments of not more than 40%of the number of shares subject to the option on or after September 17, 2003;70% on or after September 17, 2004; and 100% on or after September 17,2005.  The option was fully vested as ofSeptember 17, 2005, and expired unexercised on September 16, 2006.

(5)             This option was granted on September 27,2002, under the 1989 Plan, and no portion of the option could be exerciseduntil September 27, 2004.  Thereafter,the option became exercisable in cumulative installments of not more than 40%of the number of shares subject to the option on or after September 27, 2004;70% on or after September 27, 2005; and 100% on or after September 27, 2006.

(6)             This option was granted on September 29,2003, under the 1989 Plan, and became fully vested on September 29, 2005, as aresult of the Company’s stock option acceleration program.  This program was described on the Company’sForm 8-K report, filed with the SEC on August 24, 2005.

(7)             This option was granted on October 5,2004, under the 1989 Plan, and no portion of the option could be exerciseduntil October 5, 2006.  The option becameexercisable in cumulative installments of not more than 40% of the number ofshares subject to the option on or after October 5, 2006, and will continue tovest on the following schedule: 70% on or after October 5, 2007; and 100% on orafter October 5, 2008.

(8)             This option was granted on September 28,2005, under the 1989 Plan, and no portion of the option may be exercised priorto September 28, 2007.  Thereafter, theoption will become exercisable in cumulative installments of not more than 40%of the number of shares subject to the option on or after September 28, 2007;70% on or after September 28, 2008; and 100% on or after September 28, 2009.

(9)             This option was granted on August 18,2005, under the 1989 Plan in connection with Mr. George’s employment, and noportion of the option may be exercised prior to August 18, 2007.  Thereafter, the option will becomeexercisable in cumulative installments of not more than 40% of the number ofshares subject to the option on or after August 18, 2007; 70% on or afterAugust 18, 2008; and 100% on or after August 18, 2009.

(10)        This option was granted on January 4,2004, under the 1989 Plan in connection with Ms. Kelley’s employment, and no portionof the option could be exercised until January 4, 2006.  The option became exercisable in cumulativeinstallments of not more than 40% of the number of shares subject to the optionon or after January 4, 2006, and will continue to vest on the followingschedule: 70% on or after January 4, 2007; and 100% on or after January 4,2008.

(11)        Thisoption was granted on March 7, 2005, under the 1989 Plan in connection with Ms.Kelley’s promotion to General Counsel, and no portion of the option could be exerciseduntil March 7, 2007.  The option becameexercisable in cumulative installments of not more than 40% of the number ofshares subject to the option on or after March 7, 2007, and will continue tovest on the following schedule: 70% on or after March 7, 2008; and 100% on orafter March 7, 2009.

**OptionExercises And Stock Vested**

Thefollowing table sets forth stock option exercises by the NEOs in fiscal 2006and stock awards earned by the NEOs in fiscal 2006.

|                    | ** ** | **Option Awards**                                              | ** ** | **Stock Awards**                                 | ** ** |
|--------------------|------------|---------------------------------------------------------------------|------------|-------------------------------------------------------|------------|
| **Name**           | ** ** | **Number of Shares  Acquired on  Exercise **(#) | ** ** | **Value Realized  on Exercise **($)(1) | ** ** | **Number of Shares  Acquired on  Vesting **(#)(2) | ** ** | **Value Realized  on Vesting **($)(3) | ** ** |
| Howard R. Levine   |       | —                                                              |       | —                                                |       | 14,000 |   | 411,740 |   |
| R. James Kelly     |       | —                                                              |       | —                                                |       | 8,960 |   | 263,514 |   |
| Charles S.  Gibson |       | 35,000                                                              |       | 100,800                                               |       | 2,800 |   | 82,348 |   |
| Robert George      |       | —                                                              |       | —                                                |       | 3,268 |   | 96,112 |   |
| Janet G. Kelley    |       | —                                                              |       | —                                                |       | 1,495 |   | 43,968 |   |

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(1)             Reflects the value as calculated by thedifference between the market price of the Company’s common stock on the dateof exercise, and the exercise price of the stock options.

(2)             Represents shares issued under theone-year PSR program for fiscal 2006 performance.

(3)             Determined by reference to the closing price of theCompany’s common stock on October 3, 2006, the date such shares vested.  The closing price on such date was $29.41.

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**Nonqualified DeferredCompensation**

The DeferredCompensation Plan allows certain employees, including NEOs, to defer receipt ofup to 50% of their salary and 75% of their bonus payments.  The Company does not match amounts that aredeferred by any employee, and the Company does not fund the DeferredCompensation Plan or provide any interest rate subsidy.  Ingeneral, participants in the Deferred Compensation Plan can elect to havebenefits paid in either a specified year, or following separation fromservice.  The benefit payments can betaken in either a lump sum payment or in annual installments over five or tenyears.  Payments under the plan begin assoon as administratively feasible six months after an employee’s separationfrom service, unless an employee has elected to receive payments prior toseparation from service in a specified year.

The investment options available under the Deferred Compensation Planare as follows:

·                                          Vanguard Prime Money Market Fund

·                                          Harbor Bond Fund

·                                          T. Rowe Price Balanced Fund

·                                          Dodge and Cox Stock Fund

·                                          Fidelity Blue Chip Growth Fund

·                                          Vanguard Index 500 Fund

·                                          Royce Total Return Fund

·                                          Vanguard Explorer Fund

·                                          FidelityDiversified International Fund

The following table showsinformation about the participation by each NEO in the Company’s DeferredCompensation Plan.

| Name             | ** ** | **Executive  Contributions  in Last FY **($)(1) | ** ** | **Aggregate  Earnings in  Last FY **($) | ** ** | **Aggregate  Balance at  Last FYE **($) | ** ** |
|------------------|------------|----------------------------------------------------------------|------------|--------------------------------------------------------|------------|--------------------------------------------------------|------------|
| Howard R. Levine |       | 36,429                                                         |       | 14,911                                                 |       | 392,550                                                |       |
| R. James Kelly   |       | 110,425                                                        |       | 58,064                                                 |       | 1,092,769                                              |       |
| Robert George    |       | 21,772                                                         |       | 141                                                    |       | 21,913                                                 |       |
| Charlie Gibson   |       | 20,280                                                         |       | 7,046                                                  |       | 146,511                                                |       |
| Janet G. Kelley  |       | —                                                         |       | —                                                 |       | —                                                 |       |

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(1)             Reflects amounts which are also reportedas compensation in the Summary Compensation Table set forth above.

**PotentialPayments Upon Termination Or Change Of Control**

TheCompany has entered into employment agreements and maintains incentive plansthat will require the Company to provide compensation or other benefits to theNEOs in connection with certain events related to a termination of employmentor change of control.

*EmploymentAgreements*

Undertheir employment agreements, as described in the narrative following the Grantsof Plan-Based Awards table, the NEOs (with the exception of Ms. Kelley, who isnot party to an employment agreement) would, upon termination other than for “Cause”or “Medical Disability” (as defined in the employment agreements), receivecertain severance benefits.

Underthe employment agreements, upon termination of an NEO other than for Cause orMedical Disability, the NEO would become entitled to receive:

·                                          oneyear of base salary payable in twelve monthly installments; and

·                                          apro rata payout under the Company’s annual cash bonus plan.

Undereach employment agreement, the Company’s obligations to provide the severancebenefits described above to any NEO are contingent on the NEO’s compliance withthe non-competition, non-solicitation and confidentiality covenants containedin the employment agreement, as described in the narrative following the Grantsof Plan-Based Awards table.  In addition,upon the NEO’s obtaining new employment during the severance period the monthlyseverance payment would be reduced by the amount of monthly compensationpayable to the NEO under the new employment arrangement.

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*2006 Plan*

Underthe 2006 Plan, in the event of a “Change in Control” (as defined in the 2006Plan), if the acquiring company does not assume the obligation to perform underthe 2006 Plan with respect to outstanding awards, or if within two yearsfollowing the change in control, a participating employee is terminated fromemployment without “Cause” (as defined in the 2006 Plan) or the participantresigns for “Good Reason” (as defined in the 2006 Plan), then:

·                                          outstandingoptions and PSRs would immediately vest; and

·                                          thetarget payout opportunities attainable under the Cash Bonus Award Guidelinesand outstanding PSRs would be deemed to have been fully earned as of theeffective date of the Change in Control based upon the greater of (1) anassumed achievement of all relevant performance goals at the “target” level, or(2) the actual level of achievement of all relevant performance goals againstthe target, as of the Company’s fiscal quarter end preceding such Change inControl.

Ineither such case, participants would be paid a prorated award based upon thelength of the performance period that has elapsed prior to the date of theChange in Control or termination of employment. In addition, if a PSR award isnot assumed by the acquiring company, the participant will have the opportunityto earn the remaining portion of the award not paid out upon the change incontrol.

Inaddition, if a participant’s employment is terminated as a result of death, Disabilityor Retirement (as defined in the 2006 Plan), or without Cause (as defined inthe employment agreements for all NEOs other than Ms. Kelley; as defined in the2006 Plan for Ms. Kelley), awards of PSRs will be made based on actual Companyperformance at the end of the fiscal year immediately preceding the date oftermination or, if nearer, the end of the fiscal year immediately following thedate of termination and prorated for the performance period completed prior tosuch termination.

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*EstimatedPost-Employment Compensation and Benefits*

Thefollowing table sets forth the estimated post-employment compensation andbenefits that would have been payable to each of the NEOs under theiremployment agreements and the Company’s various incentive plans, assuming thateach covered circumstance under such arrangements occurred on August 26, 2006.
| Name             | ** ** | **Benefits and Payments **(1) | ** ** | **Termination  without Cause **($) | ** ** | **Change of  Control **($) | ** ** | **Medical  Disability **($) | ** ** | **Death **($) | ** ** |
|------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|--------------------------------------|------------|----------------------------------|------------|--------------------|------------|
| Howard R. Levine |       | Severance  Pay(2)                            |       | 725,000                                      |       | —                               |       | —                           |       | —             |       |
|                  |       | Target  Bonus Award(3)                       |       | 857,537                                      |       | —                               |       | 857,537                          |       | 857,537            |       |
|                  |       | Performance  Share Rights(4)                 |       | 660,240                                      |       | 660,240                              |       | 660,240                          |       | 660,240            |       |
|                  |       | **Total**                                    |       | **2,242,777**                                |       | **660,240**                          |       | **1,517,777**                    |       | **1,517,777**      |       |
|             |       |                                         |       |                                         |       |                                 |       |                             |       |               |       |
| R. James Kelly   |       | Severance  Pay(2)                            |       | 600,000                                      |       | —                               |       | —                           |       | —             |       |
|                  |       | Target  Bonus Award(3)                       |       | 408,950                                      |       | —                               |       | 408,950                          |       | 408,950            |       |
|                  |       | Performance  Share Rights(4)                 |       | 422,554                                      |       | 422,554                              |       | 422,554                          |       | 422,554            |       |
|                  |       | **Total**                                    |       | **1,431,504**                                |       | **422,554**                          |       | **831,504**                      |       | **831,504**        |       |
|             |       |                                         |       |                                         |       |                                 |       |                             |       |               |       |
| Robert George    |       | Severance  Pay(2)                            |       | 350,000                                      |       | —                               |       | —                           |       | —             |       |
|                  |       | Target  Bonus Award(3)                       |       | 214,343                                      |       | —                               |       | 214,343                          |       | 214,343            |       |
|                  |       | Performance  Share Rights(4)                 |       | 154,119                                      |       | 154,119                              |       | 154,119                          |       | 154,119            |       |
|                  |       | **Total**                                    |       | **718,462**                                  |       | **154,119**                          |       | **368,462**                      |       | **368,462**        |       |
|             |       |                                         |       |                                         |       |                                 |       |                             |       |               |       |
| Charlie Gibson   |       | Severance  Pay(2)                            |       | 310,000                                      |       | —                               |       | —                           |       | —             |       |
|                  |       | Target  Bonus Award(3)                       |       | 193,840                                      |       | —                               |       | 193,840                          |       | 193,840            |       |
|                  |       | Performance  Share Rights(4)                 |       | 132,048                                      |       | 132,048                              |       | 132,048                          |       | 132,048            |       |
|                  |       | **Total**                                    |       | **635,888**                                  |       | **132,048**                          |       | **325,888**                      |       | **325,888**        |       |
|             |       |                                         |       |                                         |       |                                 |       |                             |       |               |       |
| Janet G. Kelley  |       | Severance Pay                                |       | —                                       |       | —                               |       | —                           |       | —             |       |
|                  |       | Target Bonus Award(3)                        |       | —                                       |       | —                               |       | —                           |       | —             |       |
|                  |       | Performance Share  Rights(4)                 |       | 70,504                                       |       | 70,504                               |       | 70,504                           |       | 70,504             |       |
|                  |       | **Total**                                    |       | **70,504**                                   |       | **70,504**                           |       | **70,504**                       |       | **70,504**         |       |

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(1)             Stock options granted under the 1989 Plan do notaccelerate for Death, Disability, Termination without Cause or any Change inControl.  All stock options granted priorto August 26, 2006, were made pursuant to the 1989 Plan.

(2)             Represents severance pay equal to 12 months of theexecutive’s base salary in effect on the date of termination.

(3)             Represents the 2006 award granted under the ProfitSharing Plan, as set forth in the Summary Compensation table, pursuant to theNEO’s Employment Agreement.

(4)             In each case, except in the event of a Change inControl, the target payout opportunities under the PSRs are paid on a ratablebasis as of the date of the participant’s Termination without Cause, MedicalDisability or Death.  Under the 2006Plan, the executive would receive the amounts set forth under the column “Changeof Control” *only* if: (a) the awards are not assumedby the surviving entity; *or* (b) theawards are assumed by the surviving entity, but the executive is terminatedwithin two years of the Change in Control. The target payout opportunities under the PSRs on a Change of Controlare determined by the greater of (a) an assumed achievement of all relevantperformance goals at the “target” level, or (b) the actual level of achievementof all relevant performance goals against the target, as of the Company’sfiscal quarter end preceding such event.

**DirectorCompensation**

TheCompany’s Directors (other than Howard R. Levine, who is an employee of theCompany) were paid $3,500 for each Board meeting attended and $750 for eachAudit, Compensation and Nominating/Corporate Governance Committee meetingattended in fiscal 2006.  The Chairman ofthe Audit Committee received an additional $500 per meeting and the Chairman ofeach of the Compensation and Nominating/Corporate Governance Committeesreceived an additional $250 per 

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meeting.  The Lead Director of the Board received anadditional annual cash retainer of $12,000. Pursuant to the Family Dollar 2000 Outside Directors Plan (the “DirectorsStock Plan”), in fiscal 2006, directors (other than Mr. Levine) received anannual grant of shares of the Company’s common stock with a fair market valueat the time of the grant of $20,000.  TheBoard of Directors believes that the payment of a portion of the director’sfees in the form of an annual grant of shares of the Company’s common stocksupports the alignment of the directors’ interests with the interests of the Company’sstockholders.  Each of the currentnon-employee directors received a grant of 831 shares of the Company’s commonstock upon their re-election as directors in January 2006 (except for Mr. Pond,who was not a director at the time).  Mr.Pond received a grant of 605 shares of the Company’s common stock upon hisappointment to the Board in April 2006. Additionally, non-employee directors were reimbursed for reasonableexpenses incurred by them in connection with attendance at Board and related functions.

Thefollowing table summarizes compensation paid by the Company to non-employeedirectors in fiscal 2006:

| Name                    | ** ** | **Fees Earned or  Paid in Cash **($) | ** ** | **Stock  Awards **($)(1) | ** ** | **Total **($) | ** ** |
|-------------------------|------------|---------------------------------------------------------------|------------|-------------------------------|------------|--------------------|------------|
| Mark R.  Bernstein      |       | 42,500                                                        |       | 20,000                        |       | 62,500             |       |
| Sharon Allred  Decker   |       | 29,500                                                        |       | 20,000                        |       | 49,500             |       |
| Edward C. Dolby         |       | 26,500                                                        |       | 20,000                        |       | 46,500             |       |
| Glenn A.  Eisenberg     |       | 28,750                                                        |       | 20,000                        |       | 48,750             |       |
| George A.  Mahoney, Jr. |       | 17,500                                                        |       | 20,000                        |       | 37,500             |       |
| James G. Martin         |       | 36,250                                                        |       | 20,000                        |       | 56,250             |       |
| Dale C. Pond            |       | 13,500                                                        |       | 15,666                        |       | 29,166             |       |

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(1)       The amounts shown in this column indicatethe dollar amount of compensation cost recognized by the Company in fiscal 2006pursuant to FAS 123R for stock awards granted in fiscal 2006.  See Note 9 to the Consolidated FinancialStatements included in this Report for a discussion of the relevant assumptionsmade in these valuations.  For eachdirector, the grant date fair value of stock awards granted in fiscal 2006computed in accordance with FAS 123R was identical to the total compensationcost recognized.  For the total number ofshares of common stock held by each non-employee director as of March 3, 2007, see“Ownership of the Company’s Securities” in Item 12 below.

Non-employeedirectors are required to maintain a level of equity interest in the Companyequal to at least one-half of the cumulative number of shares of the Company’scommon stock awarded under the Directors Stock Plan since August 2004.  The Company encourages, but does not require,that directors maintain an equity interest in the Company in excess of suchminimum amounts.

InAugust 2006, the Board of Directors adjusted the compensation arrangements fornon-employee directors.  Beginning infiscal 2007, directors (other than Mr.  Levine) will be paid an annual retainer of$40,000 per fiscal year, payable quarterly in arrears.  The Chairman of each of theNominating/Corporate Governance Committee and the Compensation Committee willreceive an additional annual retainer of $5,000, and the Chairman of the AuditCommittee will receive an additional annual retainer of $10,000, payablequarterly in arrears.  The Company’s LeadDirector will be paid an additional annual retainer of $10,000 per fiscal year,payable quarterly in arrears. Non-employee directors will be paid $1,500 for each meeting of the Boardattended and $1,000 for each committee meeting attended, except that a directorwill receive $500 for any meeting attended telephonically.  Additionally, such non-employee directorswill receive an annual grant of the Company’s common stock with a value of$30,000 pursuant to the Family Dollar Stores, Inc. 2006 Incentive Plan (the “2006Plan”) and in accordance with the terms of the Directors’ Share Awards Guidelines,which were adopted pursuant to the 2006 Plan, beginning with the AnnualMeeting.  The Company will reimbursedirectors for all reasonable expenses incurred by them in connection withattendance at any meeting of the Board or its committees and for travel andother expenses incurred in connection with their duties as directors.

**CompensationCommittee Report**

TheCompensation Committee of the Board of Directors has reviewed and discussed theabove section titled “Executive Compensation—Compensation Discussion andAnalysis” with management, and, based on such review and discussions,recommended to the Board of Directors that the section be included in theAnnual Report on Form 10-K for the fiscal year ended August 26, 2006.

Thisreport is submitted by Sharon Allred Decker, Edward C. Dolby, James G. Martinand Dale C. Pond as the members of the Compensation Committee, and Mark R.Bernstein who was a member of the Compensation Committee until April 2006.

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| **ITEM 12.** | ** ** | **SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER  MATTERS** |
|--------------|------------|------------------------------------------------------------------------------------------------------|

 

**EquityCompensation Plan Information**

Thefollowing table provides information with respect to the shares of the Company’scommon stock that may be issued under the 1989 Plan, the Directors Stock Planand the 2006 Plan, which are the only equity compensation plans that theCompany currently maintains, as of August 26, 2006.

| Plan Category                                  | ** ** | **(a) Number of  Securities to be  Issued Upon  Exercise of  Outstanding  Options, Warrants  and Rights**(1) | ** ** | **(b) Weighted  Average Exercise  Price of  Outstanding  Options, Warrants  and Rights**(2) | ** **  | **(c) Number of  Securities  Remaining  Available for  Future Issuance**(3) | ** ** |
|-----------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|-------------|-------------------------------------------------------------------------------------------------|------------|
| Equity  Compensation Plans Approved by Stockholders |       | 6,017,835                                                                                                                                            |       | $                                                                                                                    | 29.54/share |                                                                                            | 12,005,117 |   |
|                                                     |            |                                                                                                                                                      |            |                                                                                                                      |             |                                                                                                 |            |  |

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(1)**               **Consists of4,974,359 shares issuable upon exercise of options granted under the 1989 Planand 1,043,476 shares issuable upon exercise of options and the award of commonstock pursuant to PSRs based on “target” performance granted under the 2006Plan.

(2)                Theweighted average exercise price is for options only and does not account forPSRs.

(3)**               **Consists of 65,368 shares availableto be granted under the Directors Stock Plan and 11,939,749 shares availablefor awards of options and other stock-based awards under the 2006 Plan.

**Ownership Of The Company’sSecurities**

*Ownership by Directors andOfficers*

The followingtable sets forth, for each of the Company’s directors, each of the NamedExecutive Officers, and all of the Company’s executive officers and directorsas a group, the number of shares beneficially owned and the percent of theCompany’s common stock so owned, all as of March 3, 2007,  and based on 150,807,820 shares outstandingas of that date:

| Name                                                                         | ** ** | **Amount  and Nature of   Beneficial ownership**(1) | ** ** | **Percent of  Common Stock** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------|------------|
| Mark R. Bernstein                                                            |       | 16,452                                              | (2)        | *****                                  | ** ** |
| Sharon Allred Decker                                                         |       | 2,644                                               | ** ** | *****                                  | ** ** |
| Edward C. Dolby                                                              |       | 3,135                                               | ** ** | *****                                  | ** ** |
| Glenn A. Eisenberg                                                           |       | 2,735                                               | ** ** | *****                                  | ** ** |
| Howard R. Levine                                                             |       | 10,198,773                                          | (3)        | 6.7                                    | %          |
| George R. Mahoney, Jr.                                                       |       | 529,253                                             | ** ** | *****                                  | ** ** |
| James G. Martin                                                              |       | 4,017                                               | ** ** | *****                                  | ** ** |
| Dale C. Pond                                                                 |       | 605                                                 | ** ** | *****                                  | ** ** |
| R. James Kelly                                                               |       | 483,053                                             | ** ** | *****                                  | ** ** |
| Robert A. George                                                             |       | 7,208                                               | ** ** | *****                                  | ** ** |
| Charles S. Gibson, Jr.                                                       |       | 148,642                                             | ** ** | *****                                  | ** ** |
| Janet G. Kelley                                                              |       | 47,210                                              | ** ** | *****                                  | ** ** |
| All Executive Officers and Directors of the Company as a Group (16  persons) |       | 11,662,523                                          |       | 7.7                                    | %          |

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* Less than one percent

(1)             All shares areheld with sole voting and investment power, except that Mr. Levine does nothave voting or investment power with respect to 5,679,494 shares held inirrevocable trusts for his benefit by Bank of America, N.A., as Trustee, as setforth in note (3) below.  These numbersinclude shares for which the following persons have the right to acquire 

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beneficial ownership, as ofMarch 3, 2007, or within 60 days thereafter, pursuant to the exercise of stockoptions:  (i) Mr. Levine — 455,000shares; (ii) Mr. Mahoney — 170,000 shares; (iii) Mr. Kelly — 254,000 shares;(iv) Mr. Gibson — 134,000 shares; (v) Ms. Kelley — 46,000 shares; and (vi) allexecutive officers and directors as a group — 1,161,800 shares.  These numbers also include certain optionsthat are vested as a result of the Company’s stock option acceleration program,as further described on the Company’s Form 8-K report filed with the SEC onAugust 24, 2005.

(2)             This number does not include 16,050 shares owned byMr. Bernstein’s wife.  Mr. Bernsteindisclaims beneficial ownership of the shares owned by his wife.

(3)             This number includes 5,679,494 sharesincluded in the table “Ownership by Others,” which appears below as being heldin irrevocable trusts for the benefit of Mr. Levine by Bank of America, N.A. asTrustee.  They do not include 187,284shares listed in said table which are held in irrevocable trusts for thebenefit of Mr. Levine’s child by Bank of America, N.A. as Trustee, or 1,025shares owned by Mr. Levine’s wife.  Mr.Levine disclaims beneficial ownership of the shares owned by his wife.

*Ownership by Certain OtherBeneficial Owners*

Based on filingswith the SEC and other information, the Company believes that, as of the datesset forth below, the following stockholders beneficially owned more than 5% ofthe Company’s common stock:

| Name and Address        | ** ** | **Amount and Nature of  Beneficial Ownership** | ** ** | **Percent of  Common  Stock**(1) | ** ** |
|-----------------------------------|------------|--------------------------------------------------------------------|------------|---------------------------------------|------------|
| FMR Corp                          |       | 13,490,551                                                         | (2)        | 8.9                                   | %          |
| 82 Devonshire Street              |       |                                                               |       |                                  |       |
| Boston, MA 02109                  |       |                                                               |       |                                  |       |
|                              |       |                                                               |       |                                  |       |
| Bank of America Corporation       |       | 8,688,728                                                          | (3)        | 5.8                                   | %          |
| 100 North Tryon Street            |       |                                                               |       |                                  |       |
| Bank of America Corporate  Center |       |                                                               |       |                                  |       |
| Charlotte, NC 28255               |       |                                                               |       |                                  |       |
|                              |       |                                                               |       |                                  |       |
| Barclays Global Investors,  NA    |       | 7,692,090                                                          | (4)        | 5.1                                   | %          |
| 45 Freemont Street                |       |                                                               |       |                                  |       |
| San Francisco, CA 94105           |       |                                                               |       |                                  |       |
|                              |       |                                                               |       |                                  |       |
| Franklin Resources, Inc.          |       | 7,673,703                                                          | (5)        | 5.1                                   | %          |
| One Franklin Parkway              |       |                                                               |       |                                  |       |
| San Mateo, CA 94403               |       |                                                               |       |                                  |       |

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(1)             Based on the number of shares of common stock owned byeach stockholder as set forth above and 150,807,820 shares of the Company’scommon stock outstanding as of March 3, 2007.

(2)             Based solely on the Schedule 13G/A filedby FMR Corp., Edward C. Johnson 3d and Fidelity Management Research Company (“Fidelity”),as of December 31, 2006.  All of suchshares are held by FMR Corp. with sole dispositive power; 2,824,651 of suchshares are held by FMR Corp. with sole voting power.  Fidelity, a wholly-owned subsidiary of FMRCorp., is the beneficial owner of 10,865,439 of such shares listed as a resultof acting as investment adviser to various funds.  Edward C. Johnson 3d and FMR Corp., throughits control of Fidelity, and the funds each has sole power to dispose of the10,865,439 shares owned by the funds. Neither FMR Corp. nor Edward C. Johnson 3d, Chairman of FMR Corp., hasthe sole power to vote or direct the voting of the shares owned directly by thefunds, which power resides with the funds’ Boards of Trustees.  Fidelity Management Trust Company, awholly-owned subsidiary of FMR Corp, is the beneficial owner of 37,000 of suchshares listed as a result of its serving as investment manager of institutionalaccount(s).  Edward C. Johnson 3d and FMRCorp., through its control of Fidelity Management Trust Company, each has soledispositive power over 37,000 shares and sole power to vote or to direct thevoting of the 37,000 shares owned by the institutional account(s) as reportedabove.  Strategic Advisors, Inc., awholly-owned subsidiary of FMR Corp., is the beneficial owner of 825 of suchshares listed.  Pyramis Global Advisors,LLC (“PGALLC”), an indirect wholly-owned 

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subsidiary of FMR Corp. is the beneficial owner of12,000 shares of such shares listed as a result of serving as an investmentadviser to institutional accounts and funds. Edward C. Johnson 3d and FMR Corp., through its control of PGALLC, eachhas sole dispositive power over 12,000 shares and sole power to vote 12,000 ofsuch shares listed that are owned by the accounts or funds advised byPGALLC.  Pyramis Global Advisors TrustCompany (“PGATC”), an indirect wholly-owned subsidiary of FMR Corp., is thebeneficial owner of 785,829 of such shares listed as a result of its serving asinvestment manager of institutional accounts. Edward C. Johnson 3d and FMR Corp., through its control of PGATC, eachhas sole dispositive power over 785,829 shares and sole power to vote 712,629of such shares listed that are owned by the accounts managed by PGATC.  Fidelity International Limited is thebeneficial owner of 1,789,458 of such shares listed.

(3)             Based solely on the Schedule 13G/A filed by Bank ofAmerica Corporation and its affiliates, as of December 31, 2006, 8,629,118 ofsuch shares were held with shared voting power and 8,688,728 of such shareswere held with shared dispositive power by Bank of America Corporation;8,629,118 of such shares were held with shared voting power and 8,688,728 ofsuch shares were held with shared dispositive power by NB Holdings Corporation;8,489,870 of such shares were held with sole voting power, 94,405 of suchshares were held with shared voting power, 8,477,170 of such shares were heldwith sole dispositive power and 165,974 of such shares were held with shareddispositive power by Bank of America, N.A.; 44,843 of such shares were heldwith shared voting and shared dispositive power by Bank of America SecuritiesHoldings Corporation; 44,843 of such shares were held with sole voting and soledispositive power by Bank of America Securities, LLC; 85,325 of such shareswere held with shared voting power and 138,325 of such shares were held withshared dispositive power by Columbia Management Group, LLC; 85,325 of suchshares were held with sole voting power and 138,325 of such shares were heldwith sole dispositive power by Columbia Management Advisors, LLC; 2,206 of suchshares were held with shared voting and shared dispositive power by Bank ofAmerica Investment Advisors, Inc.  Theseshares include 5,679,494 shares held in trusts, as of March 3, 2007, for thebenefit of Mr. Levine, as noted in “Ownership by Directors and Officers,”above.

(4)             Based solely on theSchedule 13G/A filed by Barclays Global Investors, NA. (“BGI”) and itsaffiliates as of December 31, 2006. 4,434,019 of such shares were held with sole voting power and 5,851,629of such shares were held with sole dispositive power by BGI; 977,550 of suchshares were held with sole voting and sole dispositive power by Barclays GlobalFund Advisors; 643,773 of such shares were held with sole voting and soledispositive power by Barclays Global Investors, LTD; 146,373 of such shareswere held with sole voting and sole dispositive power by Barclays GlobalInvestors Japan Trust and Banking Company Limited; and 72,765 of such shareswere held with sole voting and sole dispositive power by Barclays GlobalInvestors Japan Limited.

(5)             Basedsolely on the Schedule 13G/A filed by Franklin Resources Inc. (“FRI”) and itsaffiliates as of December 31, 2006, 7,666,100 of such shares were held with sole voting and sole dispositivepower by Franklin Advisory Services, LLC; 4,460 of such shares were held withsole voting and sole dispositive power by Fiduciary Trust CompanyInternational; 3,000 of such shares were held with sole voting and soledispositive power by Franklin Templeton Portfolio Advisors, Inc.; and 143 ofsuch shares were held with sole voting and sole dispositive power by FranklinAdvisers, Inc.  Charles B. Johnson andRupert H. Johnson, Jr. each owns in excess of 10% of the outstanding commonstock of FRI and are the principal stockholders of FRI and may be deemed to bebeneficial owners of such securities pursuant to SEC rules.

**ITEM 13.****                                  CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE**

**TransactionsWith Related Persons**

*Policyand Procedures*

TheBoard of Directors adopted a Board of Directors Code of Conduct in 2005 whichset forth the Company’s policy of prohibiting certain transactions in which theCompany’s directors or their family members have an interest which could raisea conflict of interest with the Company. The Board of Directors Code of Conduct is available on the Company’swebsite at www.familydollar.com under the tab “Investors.”  The Board of Directors Code requires thatdirectors fully disclose any relationship or interest which may create anactual or potential conflict of interest to the Board’s Nominating/CorporateGovernance Committee (the “Governance Committee”).  The Governance Committee reviews allpotential conflict of interest situations and advises the Board of itsdetermination regarding such matters. All such consideration, discussions and votes regarding such matters areconducted in accordance with Delaware law, including provisions related tocorporate opportunities.

TheCompany has also maintained a Code of Conduct applicable to all of its employeesfor a number of years. The Code was amended by the Board in 2005 and is alsoposted on the Company’s website.  TheCode sets forth the Company’s policy of prohibiting participation by anemployee (or his/her family members) in any transaction that could create anactual or 

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apparent conflictof interest with the Company, including transactions for services or productsbetween the Company and an entity in which the employee has any interest orserves on the entities’ Board; having a material interest in a competitivecompany; taking advantage of any opportunity learned of in the course ofemployment with the Company;  orarranging for ex-employees to engage in business with the Company within twoyears of their departure.  Employees arerequired to obtain the prior written approval of the Company’s ComplianceCommittee before entering into any situation that could create a conflict ofinterest under the Code with determinations regarding such conflicts being madeby the Governance Committee with respect to the Company’s executive officers.

TheGovernance Committee has also adopted written procedures for the review,approval and monitoring of transactions between the Company and its directorsand/or executive officers (or his/her immediate family members) that would besubject to disclosure in the Company’s proxy statement pursuant to the SECrules (generally transactions involving amounts exceeding $120,000 in which arelated party has a material interest). Under these procedures, the GovernanceCommittee is to be informed of transactions subject to review before their implementation.  The procedures establish Company practicesfor obtaining and reporting information to the Governance Committee regardingsuch transactions on a periodic and an as-needed basis.  The policy provides that such transactionsare to be submitted for approval before they are initiated but also providesfor ratification of such transactions. No director who is interested in a transaction may participate in theGovernance Committee’s determinations as to the appropriateness of suchtransaction.  In certain situations, theChairman of the Governance Committee has been delegated the authority to makedeterminations regarding the approval of such transactions.  The policy also pre-approves certaintransactions excluded from the SEC’s disclosure rules and transactions arisingsolely from ownership of the Company’s stock in which all stockholders areequally treated.  The GovernanceCommittee and/or the Board have previously approved certain related partytransactions, as described below.  Theprocedures established by the Governance Committee provide for continuingmonitoring and annual review of these pre-approved transactions.

*RelatedParty Transactions*

TheCompany purchased apparel for use by the Company’s store employees and othermerchandise, at a cost of approximately $1.3 million during fiscal 2006 from acompany owned by Eric Lerner, Howard R. Levine’s brother-in-law.  The Company expects to engage in similartransactions during the balance of fiscal 2007 and fiscal 2008.  The Company believes that these purchaseswere made on terms comparable to those that would be obtained in independentarms-length transactions with unrelated parties.

TheBoard of Directors approved a Retirement Agreement dated as of September 30,2002, between the Company and Mr. Leon Levine, the former Chairman of the Boardof the Company and the father of Howard R. Levine, in connection with Mr. LeonLevine’s retirement.  Pursuant to theRetirement Agreement, the Company is committed to and does provide certainoffice space to Mr. Leon Levine (or, in the event of his death, to his wife)and to certain of his assistants and/or advisors; continuing health carecoverage for Mr. Leon Levine and certain of his family members; Company-paidpersonal liability umbrella insurance coverage; and use of the Company’sairplanes for up to 30 hours per year. The Company accrued approximately $1,285,000 in fiscal 2002 for thetotal value of these benefits to be received over the term of the Agreement.  The incremental cost to the Company ofproviding these benefits and services was approximately $76,000 during fiscal2006.  In addition, with the knowledgeand consent of the Board of Directors, the Company provides office space andequipment to certain of Mr. Levine’s assistants and allows Company employees toprovide personal administrative, clerical or other incidental services to Mr.Levine.  Mr. Levine partially reimbursedthe Company for such services.

Pursuantto the provisions of the Company’s Bylaws and Delaware law, during the firstquarter of fiscal 2007, the Company began advancing defense costs incurred inconnection with derivative shareholder actions filed against the Company, as a nominaldefendant, and against certain current or former officers and/or directors. SeeNote 8 to the Consolidated Financial Statements included in this Report for adiscussion of such derivative litigation and the parties involved and Note 10to the Consolidated Financial Statements included in this Report for adiscussion of the Company’s stock option investigation. As of March 26, 2007,the Company has advanced approximately $600,000 for such expenses incurred bythe individual defendants, including certain of the Company’s current officersand directors who are parties to such litigation, and plans to continue toadvance such defense costs during fiscal 2007.

**Director Independence And CommitteesOf The Board Of Directors**

The Board hasdetermined, after a review of the relationships between and among each of thedirectors, the Company and its officers, that Mark R. Bernstein, Sharon AllredDecker, Edward C. Dolby, Glenn A. Eisenberg, James G. Martin and Dale C. Pond,who constitute all the members of the Board’s current standing committees,other than the Equity Award Committee, are independent, as defined by the NYSElisting standards, and that no material relationships exists between any ofsuch independent directors and the Company other than by virtue of their beingdirectors and stockholders.  Mark R.Bernstein, the Company’s Lead Director, was a partner in the law firm ofParker, Poe, Adams & Bernstein L.L.P. until his retirement in January 2002,and currently is Of Counsel to the law firm. Prior to fiscal 2005, the Company had paid legal fees to the law firmfor legal services.  The Board ofDirectors has considered the relationship of Mr. Bernstein and the law firm tothe Company.  Based on the fact that thelaw firm did not provide legal advice to the Company in fiscal 2005 and fiscal2006, and is not expected to provide such advice to the Company in the future;the nominal amounts paid by the Company to the law firm in prior fiscal years;the small percentage of these payments relative to the total revenues of thelaw firm; and the 

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retirement of Mr.Bernstein from the law firm, the Board of Directors has determined that suchprior relationship is immaterial and that Mr. Bernstein qualifies as anindependent director.  In addition, Ms.Decker is a member of the Board of Directors of Coca-Cola Bottling Co. Consolidated,with which the Company conducted business in the ordinary course in fiscal2006.  The Company considered Ms.Decker’s service on the Board of Directors of Coca-Cola Bottling Co.Consolidated in making its independence determinations.

**ITEM 14.****           PRINCIPAL ACCOUNTINGFEES AND SERVICES**

**Independent Registered PublicAccounting Firm’s Fees and Services**

The following sets forthfees billed in fiscal 2006 and fiscal 2005 for the audit and other servicesprovided by PricewaterhouseCoopers LLP (“PwC”), the Company’s independentregistered public accountants for fiscal 2006 and fiscal 2005:

| Fee Category  | ** ** | **Fiscal 2006 Fees** | ** ** | **Fiscal 2005 Fees** | ** ** |
|--------------------|------------|--------------------------------|------------|--------------------------------|------------|
| Audit Fees         |       | $                         | 580,000    | (1)                            | $     | 602,686 | (1) |
| Audit-Related Fees |       | $                         | 66,187     | (2)                            | $     | 70,261 | (3) |
| Tax Fees           |       | $                              | 0          |                           | $          | 0 |   |
| All Other Fees     |       | $                         | 1,500      | (4)                            | $          | 0 |   |
| Total              |       | $                              | 647,687    |                           | $          | 672,947 |   |

----

(1)                Includes (i) feesfor audits of annual financial statements, (ii) reviews of the relatedquarterly financial statements, and (iii) review of the Company’s internalcontrols.

(2)                Includes fees foraudit related work in connection with employee benefit plans of the Company,audit work relating to the implementation of FAS 123R and audit work relatingto the Company’s Notes and related overnight share repurchase transaction.

(3)                Includes fees foraudit related work in connection with employee benefit plans of the Company,review of an SEC comment letter received by the Company in the ordinary courseof business and consultation related to the Company’s restatement to reflectadjustments made in the Company’s lease accounting methods, as reported onForms 10-K/A and 10-Q/A, filed with the SEC on April 15, 2005.

(4)                Representsfees paid for access to Comperio accounting research database.

All services rendered byPwC are permissible under applicable laws and regulations, and all suchservices were pre-approved by the Audit Committee. The Audit Committee Charterrequires that the Committee pre-approve the services to be provided by PwC; theAudit Committee delegated that approval authority to the Chairman of the AuditCommittee with respect to all matters other than the annual engagement of theindependent registered public accountants.

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**PART IV**

**ITEM 15.****                             EXHIBITSAND FINANCIAL STATEMENT SCHEDULES**

(a)                           Documentsfiled as part of this report:

1.                         ConsolidatedFinancial Statements (See Item 8):

2.                         Allschedules for which provision is made in the applicable accounting regulationsof the SEC are not required under the related instructions, are inapplicable orthe information is included in the Consolidated Financial Statements, andtherefore, have been omitted.

The Financial Statements of Family Dollar Stores,Inc., (Parent Company) are omitted because the registrant is primarily aholding company and all subsidiaries included in the consolidated financialstatements being filed, in the aggregate, do not have minority equity and/orindebtedness to any person other than the registrant or its consolidatedsubsidiaries in amounts which together exceed 5 percent of the total assets asshown by the most recent year-end consolidated balance sheet.

3.                         TheExhibits listed below in item (b).

(b)                          Theaccompanying Index to Exhibits is incorporated herein by reference.

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**SIGNATURES**

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.
|                                 | FAMILY DOLLAR STORES, INC. |                      |   |
|---------------------------------|----------------------------|---------------------------|--------|
|                            | (Registrant)               |                      |   |
|                            |                       |                      |   |   |
| Date   March 28, 2007 | By                         | /s/ Howard R. Levine      |
|                            |                       | Howard R. Levine          |
|                            |                       | Chairman of the Board     |
|                            |                       | (Chief Executive Officer) |
|                                 |                            |                           |        |  |  |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned by the following persons on behalf of the registrant and in thecapacities and on the date indicated.
| Signature                  | ** **             | **Title**                              | ** **                      | **Date**       |
|----------------------------|------------------------|----------------------------------------|---------------------------------|----------------|
| ** **                 | ** **             | ** **                             | ** **                      | ** **     |
| /s/ Howard R. Levine       |                   | Chairman of the Board, Chief           |                            | March 28, 2007 |
|                       | Howard R. Levine       |                                   | Executive Officer and Director  |           |   |
|                       |                   |                                   | (Principal Executive Officer)   |           |   |
|                       |                   |                                   |                            |           |   |
| /s/ R. James Kelly         |                   | President and Chief Operating Officer- |                            | March 27, 2007 |
|                       | R. James Kelly         |                                   | Interim Chief Financial Officer |           |   |
|                       |                   |                                   | (Principal Financial Officer)   |           |   |
|                       |                   |                                   |                            |           |   |
| /s/ C. Martin Sowers       |                   | Senior Vice President-Finance          |                            | March 27, 2007 |
|                       | C. Martin Sowers       |                                   | (Principal Accounting Officer)  |           |   |
|                       |                   |                                   |                            |           |   |
| /s/ Mark R. Bernstein      |                   | Director                               |                            | March 27, 2007 |
|                       | Mark R. Bernstein      |                                   |                            |           |   |
|                       |                   |                                   |                            |           |   |
| /s/ Sharon Allred Decker   |                   | Director                               |                            | March 27, 2007 |
|                       | Sharon Allred Decker   |                                   |                            |           |   |
|                       |                   |                                   |                            |           |   |
| /s/ Edward C. Dolby        |                   | Director                               |                            | March 27, 2007 |
|                       | Edward C. Dolby        |                                   |                            |           |   |
|                       |                   |                                   |                            |           |   |
| /s/ Glenn A. Eisenberg     |                   | Director                               |                            | March 27, 2007 |
|                       | Glenn A. Eisenberg     |                                   |                            |           |   |
|                       |                   |                                   |                            |           |   |
| /s/ George R. Mahoney, Jr. |                   | Director                               |                            | March 27, 2007 |
|                       | George R. Mahoney, Jr. |                                   |                            |           |   |
|                       |                   |                                   |                            |           |   |
| /s/ James G. Martin        |                   | Director                               |                            | March 27, 2007 |
|                       | James G. Martin        |                                   |                            |           |   |
|                       |                   |                                   |                            |           |   |
| /s/ Dale C. Pond           |                   | Director                               |                            | March 27, 2007 |
|                       | Dale C. Pond           |                                   |                            |           |   |

 

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## **EXHIBITINDEX**

Exhibitsincorporated by reference:
|        | 3.2    | Bylaws, as amended on January 19, 2006 (filed as  Exhibit 3.2 to the Company’s Report on Form 8-K filed January 25, 2006)                                                                                                                                                                                                |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                          |
|   | 4.1    | Sections FOURTH, SIXTH and SEVENTH of the Company’s  Restated Certificate of Incorporation (included as Exhibits 3.1.1 — 3.1.8)  and Articles II, VII, VIII, XII and XIV of the Company’s Bylaws (included as  Exhibit 3.2)                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                          |
|   | 4.2    | Form of certificate representing shares of the  Company’s Common Stock (filed as Exhibit 4.2 to the Company’s Form 10-K filing  for the fiscal year ended August 27, 2005)                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                          |
| *      | 10.1   | Family Dollar Employee Savings and Retirement Plan  and Trust, amended and restated as of January 1, 2002 (filed as Exhibit 10  (iii) to the Company’s Form 10-Q for the quarter ended March 2, 2002)                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                          |
|   | 10.2   | Amended and Restated Credit Agreement, dated as of  May 31, 2001, between the Company and Family Dollar, Inc., as Borrower, and  Bank of America, N.A. (filed as Exhibit 10 to the Company’s Form 10-Q for the  quarter ended June 2, 2001)                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                          |
|   | 10.3   | Amendment dated as of May 29, 2003, between the  Company and Family Dollar, Inc., as Borrower, and Bank of America, N.A.,  amending the Amended and Restated Credit Agreement dated as of May 31, 2001  (filed as Exhibit 10(i) to the Company’s Form10-Q for the quarter ended May  31, 2003)                           |
|   |   |                                                                                                                                                                                                                                                                                                                          |
|   | 10.4   | Second Amendment dated as of May 27, 2004, between  the Company and Family Dollar, Inc., as Borrower, and Bank of America, N.A.,  amending the Amended and Restated Credit Agreement dated as of May 31, 2001  (filed as Exhibit 10(a) to the Company’s Report on Form 8-K filed May 27,  2004)                          |
|   |   |                                                                                                                                                                                                                                                                                                                          |
|   | 10.5   | Credit Agreement, dated as of August 7, 2001,  between the Company and Family Dollar, Inc., as Borrower, and First Union  National Bank (filed as Exhibit 10(i) to the Company’s Form 10-K for the year  ended September 1, 2001)                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                          |
|   | 10.6   | First Amendment dated as of May 29, 2003, between  the Company and Family Dollar, Inc., as Borrower, and Wachovia Bank, N.A.,  amending the Credit Agreement dated as of August 7, 2001 (filed as Exhibit  10(ii) to the Company’s Form 10-Q for the quarter ended May 31, 2003)                                         |
|   |   |                                                                                                                                                                                                                                                                                                                          |
|   | 10.7   | Second Amendment dated as of May 27, 2004, between  the Company and Family Dollar, Inc., as Borrower, and Wachovia Bank, N.A.,  amending the Credit Agreement dated as of August 7, 2001 (filed as Exhibit  10(b) to the Company’s Report on Form 8-K filed May 27, 2004)                                           |
|   |   |                                                                                                                                                                                                                                                                                                                          |
|   | 10.8   | Third Amendment to Amended and Restated Credit  Agreement between the Company and Family Dollar, Inc., as Borrower, and  Bank of America, N.A., dated as of May 16, 2005 (filed as Exhibit 10(a)  to the Company’s Report on Form 8-K filed May 17, 2005)                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                          |
|   | 10.9   | Third Amendment to Credit Agreement between the  Company and Family Dollar, Inc., as Borrower, and Wachovia Bank,  National Association, dated as of May 16, 2005 (filed as Exhibit 10(b)  to the Company’s Report on Form 8-K filed May 17, 2005)                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                          |
|   | 10.10  | $350,000,000 Credit Agreement between the Company  and Family Dollar, Inc., as Borrowers, and Wachovia Bank, Nation Association,  as Administrative Agent, Swingline Lender and Fronting Bank, and various  other Lenders named therein (filed as Exhibit 10 to the Company’s Report on  Form 8-K filed August 28, 2006) |

 

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| *      | 10.11  | Amendment dated August 29, 2004, to the Employment  Agreement dated August 25, 2000, as amended, between the Company and R. David  Alexander, Jr. (filed as Exhibit 10(iv) to the Company’s Form 10-K for the  year ended August 28, 2004)             |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                        |
| *      | 10.12  | Retirement Agreement dated September 30, 2002,  between the Company and Leon Levine (filed as Exhibit 10 to the Company’s  Report on Form 8-K filed October 2, 2002)                                                                                   |
|   |   |                                                                                                                                                                                                                                                        |
| *      | 10.13  | Family Dollar 2000 Outside Directors Plan, as  amended as of November 5, 2003 (filed as Exhibit 10(iv) to the Company’s Form  10-K for the year ended August 30, 2003)                                                                                 |
|   |   |                                                                                                                                                                                                                                                        |
|   | 10.14  | Enhanced Overnight Share Repurchase Agreement dated  October 3, 2005, between Family Dollar Stores, Inc., and Bank of America,  N.A. (filed as Exhibit 10 to the Company’s Report on Form 8-K filed October  4, 2005)                                  |
|   |   |                                                                                                                                                                                                                                                        |
| *      | 10.15  | Employment Agreement dated August 18, 2005, between  the Company and Howard R. Levine (filed as Exhibit 10.2 to the Company’s  Report on Form 8-K filed August 24, 2005)                                                                               |
|   |   |                                                                                                                                                                                                                                                        |
| *      | 10.16  | First Amendment to Employment Agreement dated August  17, 2006 between the Company and Howard R. Levine (filed as Exhibit 10.2 to  the Company’s Report on Form 8-K filed August 21, 2006)                                                             |
|   |   |                                                                                                                                                                                                                                                        |
| *      | 10.17  | Employment Agreement dated August 18, 2005, between  the Company and R. James Kelly (filed as Exhibit 10.3 to the Company’s Report  on Form 8-K filed August 24, 2005)                                                                                 |
|   |   |                                                                                                                                                                                                                                                        |
| *      | 10.18  | First Amendment to Employment Agreement dated August  17, 2006, between the Company and R. James Kelly (filed as Exhibit 10.3 to  the Company’s Report on Form 8-K filed August 21, 2006)                                                              |
|   |   |                                                                                                                                                                                                                                                        |
| *      | 10.19  | Incentive Profit Sharing Plan, amended as of January  17, 2002 (filed as Exhibit 10(i) to the Company’s Form 10-K for the year  ended August 28, 2004)                                                                                                 |
|   |   |                                                                                                                                                                                                                                                        |
| *      | 10.20  | Medical Expense Reimbursement Plan amended as of  November 2, 2004, (filed as Exhibit 10(v) to the Company’s Form 10-K for the  year ended August 28, 2004)                                                                                            |
|   |   |                                                                                                                                                                                                                                                        |
| *      | 10.21  | Family Dollar Stores, Inc., 1989 Non-Qualified Stock  Option Plan, amended as of August 17, 2004 (filed as Exhibit 10(i) to the  Company’s Report on Form 8-K filed January 21, 2005)                                                                  |
|   |   |                                                                                                                                                                                                                                                        |
| *      | 10.22  | Resolution of the Board of Directors of Family  Dollar Stores, Inc., adopted January 20, 2005, regarding compensation of the  Directors (filed as Exhibit 10.2 to the Company’s Report on Form 8-K filed  January 21, 2005)                            |
|   |   |                                                                                                                                                                                                                                                        |
| *      | 10.23  | Resolution of the Board of Directors of Family Dollar  Stores, Inc., adopted August 18, 2005, regarding compensation of  the Company’s Lead Director (filed as Exhibit 10.1 to the Company’s Report on  Form 8-K filed August 24, 2005) |
|   |   |                                                                                                                                                                                                                                                        |
| *      | 10.24  | 2006 Incentive Plan Guidelines for Long Term  Incentive Performance Share Rights Awards (filed as Exhibit 10.1 to the  Company’s Report on Form 8-K filed September 29, 2005)                                                                          |
|   |   |                                                                                                                                                                                                                                                        |
| *      | 10.25  | Form of Performance Share Rights Award Certificate  Awards (filed as Exhibit 10.2 to the Company’s Report on Form 8-K filed  September 29, 2005)                                                                                                       |

 

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| *      | 10.26  | Letter Agreement dated August 2, 2005, by and  between Family Dollar Stores, Inc., and R. David Alexander, Jr. (filed as  Exhibit 10 to the Company’s Report on Form 8-K filed August 5, 2005)                                                                                                                                                                                                                                            |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   | 10.27  | Note Purchase Agreement dated as of September 27,  2005, between Family Dollar Stores, Inc., Family Dollar, Inc., and the  various purchasers named therein, relating to $169,000,000 5.41% Series  2005-A Senior Notes, Tranche A, due September 27, 2015; and, $81,000,000  5.24% Series 2005-A Senior Notes, Tranche B, due September 27, 2015 (filed as  Exhibit 10.24 to the Company’s Form 10-K for the year ended August 27, 2005) |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| *      | 10.28  | Summary of Family Dollar Stores, Inc., Executive  Supplemental Disability Income Plan (filed as Exhibit 10.25 to the Company’s  Form 10-K for the year ended August 27, 2005)                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| *      | 10.29  | Family Dollar Stores, Inc., Executive Life Plan  (filed as Exhibit 10.26 to the Company’s Form 10-K for the year ended August  27, 2005)                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| *      | 10.30  | Relocation Policy applicable to executive officers  of the Company (filed as Exhibit 10.27 to the Company’s Form 10-K for the  year ended August 27, 2005)                                                                                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| *      | 10.31  | Letter agreement between the Company and Irving  Neger dated July 21, 2000 (filed as Exhibit 10.28 to the Company’s Form 10-K  for the year ended August 27, 2005)                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| *      | 10.32  | Separation agreement between the Company and Irving  Neger dated November 1, 2005 (filed as Exhibit 10.29 to the Company’s Form  10-K for the year ended August 27, 2005)                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| *      | 10.33  | Summary of compensation arrangements of the  Company’s named executive officers (set forth under Item 1.01 in the  Company’s Report on Form 8-K filed October 6, 2006)                                                                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| *      | 10.34  | Letter agreement between the Company and Robert A.  George dated July 19, 2005 (filed as Exhibit 10.31 to the Company’s Form 10-K  for the year ended August 27, 2005)                                                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| *      | 10.35  | Employment Agreement dated November 4, 2005, between  the Company and Charles S. Gibson, Jr. (filed as Exhibit 10.32 to the  Company’s Form 10-K for the year ended August 27, 2005)                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| *      | 10.36  | Amended and Restated Family Dollar Compensation  Deferral Plan (filed as Exhibit 10.33 to the Company’s Form 10-K for the year  ended August 27, 2005)                                                                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| *      | 10.37  | Employment Agreement dated November 22, 2005,  between the Company and Robert A. George (filed as Exhibit 10 to the  Company’s Report on Form 8-K filed November 25, 2005)                                                                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| *      | 10.38  | Family Dollar Stores, Inc. 2006 Incentive Plan  (filed as Exhibit 10.1 to the Company’s Report on Form 8-K filed January 25,  2006)                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| *      | 10.39  | 2006 Incentive Plan Guidelines for Long Term  Incentive Performance Share Rights Awards (filed as Exhibit 10.2 to the  Company’s Report on Form 8-K filed January 25, 2006)                                                                                                                                                                                                                                                               |

 

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| *      | 10.40  | 2006 Non-Qualified Stock Option Grant Program (filed  as Exhibit 10.3 to the Company’s Report on Form 8-K filed January 25, 2006)                                                                                                                                            |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                              |
|   | 10.41  | Fourth Amendment to Amended and Restated Credit  Agreement between the Company and Family Dollar, Inc., as Borrower, and Bank  of America, N.A., dated as of March 21, 2006 (filed as Exhibit 10(a) to the  Company’s Report on Form 8-K filed March 23, 2006)               |
|   |   |                                                                                                                                                                                                                                                                              |
|   | 10.42  | Fourth Amendment to Credit Agreement between the  Company and Family Dollar, Inc., as Borrower, and Wachovia Bank, National  Association, dated as of March 21, 2006 (filed as Exhibit 10(b) to the  Company’s Report on Form 8-K filed March 23, 2006)                      |
|   |   |                                                                                                                                                                                                                                                                              |
|   | 10.43  | Fifth Amendment to Amended and Restated Credit  Agreement between the Company and Family Dollar, Inc., as Borrower, and Bank  of America, N.A., dated as of May 19, 2006 (filed as Exhibit 10(a) to the  Company’s Report on Form 8-K filed May 24, 2006)                    |
|   |   |                                                                                                                                                                                                                                                                              |
|   | 10.44  | Fifth Amendment to Credit Agreement between the  Company and Family Dollar, Inc., as Borrower, and Wachovia Bank, National  Association, dated as of May 19, 2006 (filed as Exhibit 10(b) to the  Company’s Report on Form 8-K filed May 24, 2006)                           |
|   |   |                                                                                                                                                                                                                                                                              |
| *      | 10.45  | Directors’ Share Awards Guidelines (filed as Exhibit  10.1 to the Company’s Report on Form 8-K filed August 21, 2006)                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                              |
|   | 10.46  | Letter Agreement dated December 8, 2006, between the  Company, Family Dollar, Inc., Wachovia Bank, National Association as the  Administrative Agent and the Lenders (filed as Exhibit 10 to the Company’s  Report on Form 8-K filed December 14, 2006)                      |
|   |   |                                                                                                                                                                                                                                                                              |
|   | 10.47  | Consent dated December 19, 2006, between the  Company, Family Dollar, Inc., the Subsidiary Guarantors, Wachovia Bank,  National Association as the Administrative Agent and the Lenders (filed as  Exhibit 10.1 to the Company’s Report on Form 8-K filed December 22, 2006) |
|   |   |                                                                                                                                                                                                                                                                              |
|   | 10.48  | Letter Agreement dated December 19, 2006, between  the Company, Family Dollar, Inc. and various institutional accredited  investors (filed as Exhibit 10.2 to the Company’s Report on Form 8-K filed  December 22, 2006)                                                     |
|   |   |                                                                                                                                                                                                                                                                              |
| *      | 10.49  | The Family Dollar Stores, Inc. 2006 Incentive Plan  Guidelines for Annual Cash Bonus Awards (filed as Exhibit 10 to the Company’s  Report on Form 8-K filed October 6, 2006)                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                              |
|   | 14     | Code of Ethics for Chief Executive and Senior  Financial Officers (filed as Exhibit 14 to the Company’s Form 10-K for the  year ended August 30, 2003)                                                                                                                       |

 

Exhibits filedherewith:
|        | 3.1    | Restated Certificate of Incorporation, dated  November 8, 2006                                                                                                                                |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                          |
| *      | 10.50  | Summary of compensation arrangements of the  Company’s named executive officers (also previously filed under Item 1.01 in  the Company’s Report on Form 8-K filed October 6, 2006.) |
|   |   |                                                                                                                                                                                          |
|   | 21     | Subsidiaries of the Company                                                                                                                                                                   |
|   |   |                                                                                                                                                                                          |
|   | 31.1   | Certification pursuant to Section 302 of the  Sarbanes-Oxley Act of Chief Executive Officer                                                                                                   |

 

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|        | 31.2   | Certification pursuant to Section 302 of the  Sarbanes-Oxley Act of Chief Financial Officer         |
|--------|--------|-----------------------------------------------------------------------------------------------------|
|   |   |                                                                                                |
|   | 32.1   | Certification pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 of Chief Executive Officer |
|   |   |                                                                                                |
|   | 32.2   | Certification pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 of Chief Financial Officer |

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*        Exhibit represents a management contractor compensatory plan

 

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