Annual Reports

  • 10-K (Oct 28, 2013)
  • 10-K (Oct 19, 2012)
  • 10-K (Oct 25, 2011)
  • 10-K (Oct 26, 2010)
  • 10-K (Oct 27, 2009)
  • 10-K (Oct 28, 2008)

 
Quarterly Reports

 
8-K

 
Other

Family Dollar Stores 10-K 2007

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-K

x                              Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended August 26, 2006

or

o                                 Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission File No. 1-6807

FAMILY DOLLAR STORES, INC.

(Exact name of registrant as 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 pursuant to 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

 

Securities registered 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 x No o

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes o No x

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

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

Large Accelerated Filer x

 

Accelerated Filer o

 

Non-Accelerated Filer o

 

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

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

The number of shares of the registrant’s Common Stock outstanding as of March 3, 2007, was 150,807,820.

DOCUMENTS INCORPORATED BY REFERENCE

None.

 




GENERAL INFORMATION

Information is provided herein with respect to the Company’s operations related to the Company’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 (“fiscal 2003”); on August 31, 2002 (“fiscal 2002”); and the fiscal year ending on September 1, 2007 (“fiscal 2007”).  The discussion and analysis in this Annual Report on Form 10-K (this “Report”) should be read in conjunction with, and is qualified by, the Consolidated Financial Statements and Notes to Consolidated Financial Statements included in this Report.

Explanatory Note

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.

Cautionary Statement Regarding Forward-Looking Statements

Certain statements contained in this Report, or in other public filings, press releases, or other written or oral communications made by the Company or its representatives, which are not historical facts are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.  These forward-looking statements address the Company’s plans, activities or events which the Company expects will or may occur in the future and may include express or implied projections of revenue or expenditures; statements of plans and objectives for future operations, growth or initiatives; statements of future economic performance; or statements regarding the outcome or impact of pending or threatened litigation.  These forward-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’s actual results to differ materially from those expressed or implied in any forward-looking statements.  Factors, uncertainties and risks that may result in actual results differing from such forward-looking information include, but are not limited to those listed in Part I, Item 1A below, as well as other factors discussed throughout this Report, including, without limitation, the factors described under “Critical Accounting Policies” in Part II, Item 7 below, or in other filings or statements made by the Company.  All of the forward-looking statements made by the Company in this Report and other documents or statements are qualified by these and other factors, risks and uncertainties.  Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Report.  The Company does not intend to publicly update or revise its forward-looking statements even if experience or future changes make it clear that projected results expressed or implied in such statements will not be realized, except as may be required by law.

2




PART I

ITEM 1.                  BUSINESS

General

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

The original predecessor of the Company was organized in 1959 to operate a self-service retail store in Charlotte, North Carolina.  In subsequent years, additional stores were opened, and separate corporations generally were organized to operate these stores.  Family Dollar Stores, Inc., was incorporated in Delaware in 1969, and all then-existing corporate entities became its wholly-owned subsidiaries.

Overview of Business Operations

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

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

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

As discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (“MD&A”) elsewhere in this Report, the Company focused on four primary initiatives during fiscal 2006: (i) the installation of refrigerated coolers in selected stores; (ii) the “Treasure Hunt” merchandise program; (iii) new store openings; and (iv) the Urban Initiative.

No single store accounted for more than one-quarter of one percent of sales during fiscal 2006.  The Company’s stores are open at least six days a week, with most open on Sundays.

Merchandise

The Company’s stores offer a variety of general merchandise.  The following table summarizes the percentage of net sales attributable to each product category over 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

%

 

3




The consumables category includes household chemical and paper products, candy, snacks and other food, health and beauty aids, hardware and automotive 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 includes men’s, women’s, boys’, girls’ and infants’ clothing and shoes.  The seasonal and electronics category includes toys, stationery and school supplies, seasonal goods and electronics, including pre-paid cellular phones and services.

During fiscal 2006, nationally advertised brand name merchandise accounted for approximately 37% of sales.  Family Dollar private label merchandise accounted for approximately 4% of sales, and merchandise sold under other labels, or which was unlabeled, accounted for the balance of sales.  During fiscal 2006, irregular merchandise accounted for less than one-half of 1% of sales, and closeout merchandise accounted for approximately 2% of sales.

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

During fiscal 2006, the Company expanded its food assortment to include perishable foods by installing refrigerated coolers in approximately 2,800 stores.  In fiscal 2007, the Company plans to install coolers in approximately 1,200 additional stores.

The Company purchases merchandise from approximately 1,400 suppliers and generally has not experienced difficulty in obtaining adequate quantities of merchandise.  Approximately 60% of the merchandise is manufactured in the U.S., and substantially all such merchandise is purchased directly from the manufacturer.  Purchases of imported merchandise are made directly from the manufacturer or from importers, and the Company’s vendor arrangements provide for 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.

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

Distribution and Logistics

During fiscal 2006, approximately 6.5% of the merchandise purchased by the Company was shipped directly to stores by the manufacturer or importer.  The balance of the merchandise was received at one of the Company’s nine distribution centers listed below.  Merchandise is delivered to stores from the Company’s distribution centers by Company-owned trucks and by common and contract carriers.  During fiscal 2006, approximately 86% of the merchandise delivered to stores was by common or contract carriers.  At the end of fiscal 2006, the average distance between the distribution centers and the stores served 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

 

 

4




Technology

The Company utilizes a variety of technological systems to manage its business including inventory management tools, supply chain systems and financial and human resource applications.

The Company maintains by-item inventories for all stores and employs a demand forecasting system for replenishment of its distribution centers.  The Company also utilizes software applications for automatic store replenishment of basic merchandise and for forecasting-based allocation of non-basic merchandise.  These systems give the Company tools designed to facilitate optimum merchandise in-stock positions in stores, reduce markdowns and improve inventory turnover.

To minimize transportation costs and maximize efficiency, the Company relies on a transportation system designed to maximize trailer loads and secure low rates from its trucking partners.  In addition, the Company utilizes voice-recognition software, radio-frequency technology and high-speed sortation systems to maximize the productivity of its distribution centers.

The Company also utilizes a hiring system designed to provide consistent pre-employment assessments and interviews for prospective employees in approximately 1,200 stores.  The Company also has begun a multi-year effort to upgrade point-of-sale technology to provide better customer service and to improve the communications infrastructure in stores to facilitate more efficient communication and provide more interactive training for store employees.

Competition

The industry in which the Company is engaged is highly competitive.  The principal competitive factors include store locations, price and quality of merchandise, in-stock consistency, merchandise assortment and presentation, and customer service.  The Company competes for sales and store locations in varying degrees with international, national, regional and local retailing establishments, including discount stores, department stores, variety stores, 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 retailers have stores in areas in which the Company operates.  The relatively small size of the Company’s stores permits it to open new stores in rural areas, small towns and in large urban markets, in locations convenient to the Company’s low and lower-middle income customer base.

Seasonality

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

Trademarks

The Company has registered with the U.S. Patent and Trademark Office the name “Family Dollar Stores” as a service mark and also has registered a number of other names as trademarks for certain merchandise sold in stores.

Employees

As of August 26, 2006, the Company had approximately 24,000 full-time employees and approximately 20,000 part-time employees.  None of the Company’s employees are covered by collective bargaining agreements.  The Company considers its employee relations generally to be good.

Available Information

The mailing 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 website address is www.familydollar.com.  Through a link on the Investors section of the website, the Company makes available the following filings as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission (the “SEC”):  Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934.  These reports and amendments also are available at the website of the SEC at www.sec.gov.  All such filings are available free of charge.

5




NYSE Certification

In accordance 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 the NYSE listing standards.  For the fiscal year ended August 26, 2006, each of the Company’s Chief Executive Officer and Chief Financial Officer executed the certifications required by Section 302 of the Sarbanes-Oxley Act of 2002, which certifications are filed as exhibits to this Report.

ITEM 1A.       RISK FACTORS

The risks described below could materially and adversely affect the Company’s business, financial condition and results of operations.  The Company may also be adversely affected by risks not currently known to management, or that management does not currently consider to be material.

Competitive factors in the retail industry could limit the Company’s growth opportunities and reduce profitability.

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

Pricing pressures, including inflation and energy prices, could affect the Company’s profitability.

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

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

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

The impact of acts of war or terrorism and transportation and distribution delays or interruptions could adversely affect the Company’s results of operations.

Significant acts of terrorism, existing U.S. military efforts, as well as the involvement of the U.S. in other military engagements, could have an adverse impact on the Company by, among other things, disrupting its distribution or information systems, causing dramatic increases in fuel prices which increase the cost of doing business, or impeding the flow of imports or domestic products to the Company.  Delays or interruptions in the transportation and distribution of products could have an adverse impact on the Company.

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

Extreme changes in weather patterns or other natural disasters as well as pandemic outbreaks influence customer trends and purchases and may negatively impact net sales, properties and/or operations of the Company.  Such events could result in physical damage to one or more of the Company’s properties; the temporary closure of one or more stores or distribution centers; the temporary lack of an adequate work force in a market; the temporary or long-term disruption in the transport of goods from overseas; delay in the delivery of goods to the Company’s distribution centers or stores; or the temporary reduction in the availability of products in the Company’s stores.  These factors could adversely affect the Company’s operations.

6




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

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

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

The Company undertakes new programs and refines existing programs to increase net sales and its customer base.  The Company may be adversely impacted if merchandise and marketing programs fail to attract customers into its stores or if the merchandising programs implemented by the Company are not attractive to its customers.

Operational difficulties could disrupt the Company’s business.

The Company’s stores are decentralized and are managed through a network of geographically dispersed management personnel.  Inability of the Company to effectively and efficiently operate its stores, including the ability to control losses resulting from inventory shrinkage, may negatively impact the Company’s sales and/or profitability.  In addition, the Company relies upon its distribution and logistics network to provide goods to stores in a timely and cost-effective manner.  Any disruption, unanticipated expense or operational failure related to this process could negatively impact store operations.  Finally, the Company’s operations are facilitated by the use of various technologies, the disruption or failure of which could negatively impact the Company’s operations.

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

The Company maintains a network of distribution facilities in its geographic territory and constructs new facilities to support its growth.  In addition, the Company expands its network of stores through opening new stores and remodeling existing stores each year.  Delays in opening distribution facilities or stores could adversely affect the Company’s future operations by slowing growth, which may in turn reduce revenue growth.  Adverse changes in the cost to operate distribution facilities and stores, such as changes in labor, utility and other operating costs, could have an adverse impact on the Company.  Adverse changes in inventory shrinkage at the store-level or in distribution facilities could have a negative impact on the Company.

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

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

The Company’s growth is dependent upon the success of its new store opening program.

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

7




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

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

Adverse impacts associated with legal proceedings and claims could negatively affect the Company’s business.

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

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

The growth of the Company could be adversely impacted by its inability to attract and retain employees at the store operations 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 the Company’s ability to achieve its operational and financial goals and to offer attractive benefit programs to its employees.

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

Unanticipated changes in the interpretation or application of accounting principles to the Company’s financial statements could result in material charges and/or restatements of the Company’s financial statements, which may further result in litigation and/or regulatory actions which could have a material adverse effect on the Company’s financial condition and results of operations.  Changes and developments in legal or regulatory guidance, particularly with regard to stock option matters, may negatively impact the Company’s position in related litigation matters.

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

The Company’s business is slightly seasonal, with the highest percentage of sales occurring during the second fiscal quarter (December, January, February).  The Company purchases significant amounts of seasonal inventory in anticipation of the holiday season.  Adverse events resulting in lower than planned sales during the holiday season could lead to unanticipated markdowns, negatively impacting the Company’s financial condition and results of operations.

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

The Company’s debt agreements contain certain restrictive covenants, which include a consolidated debt to consolidated capitalization ratio, a fixed charges coverage ratio, and a priority debt ratio.  If the Company fails to comply with such covenants as a result of one or more of the factors listed in this section, the Company may be forced to settle its outstanding debt obligations, negatively impacting cash flows.  The Company’s ability to obtain future financing may also be negatively impacted.

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

As described elsewhere in this Report, the Company is a nominal defendant in certain shareholder derivative actions alleging that certain of the Company’s stock option grants were “backdated” along with related claims.  Results of these legal proceedings cannot be predicted with certainty, and unfavorable results could adversely affect the price of the Company’s securities.  In addition, this litigation may become disruptive to the Company’s normal business operations.  See Item 3 — “Legal Proceedings” and Notes 8 and 10 to the Consolidated Financial Statements included in this Report for more information.

8




The determinations of the Special Committee of the Company’s Board of Directors regarding the Company’s stock option granting practices could have an adverse effect on the Company.

The Company’s Board of Directors created a Special Committee to conduct a comprehensive review of grants of stock options in response to certain shareholder derivative actions.  Based on the findings of the Special Committee, the Company determined that incorrect measurement dates were used for accounting purposes with respect to certain stock option grants  and the Company recorded a charge in the fourth quarter of fiscal 2006 to record additional non-cash stock-based compensation expense and related amounts.  As a result of these events, the Company has become subject to the following risks which could have an adverse effect on its business, financial condition and results of operations: (i) many members of the Company’s senior management team and Board of Directors have been and could be required to devote in the future a significant amount of time and resources on matters relating to remedial efforts and related litigation; (ii) the Company is subject to an informal inquiry by the SEC which could require management time and attention and cause the Company to incur additional accounting and legal expenses and which could require the Company to pay a fine or other penalties; (iii) the Company is subject to the risk of additional litigation and regulatory proceedings or actions; and (iv) the Company may incur substantial expenses related to the foregoing.  In addition, while the Company believes it has made appropriate judgments in determining the correct measurement dates for its stock option grants, the SEC may disagree with the manner in which the Company has accounted for and reported, or not reported, the financial impact of the findings of the Special Committee.  See Note 10 to the Consolidated Financial Statements included in this Report for more information.

ITEM 1B.       UNRESOLVED STAFF COMMENTS

None.

ITEM 2.          PROPERTIES

The Company operates a chain of self-service retail discount stores.  As of September 30, 2006, there were 6,208 stores 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

 

 

 

 

9




The number of stores operated by the Company at the end of each of its last five fiscal years is as follows: 6,173 stores for fiscal 2006; 5,898 stores for fiscal 2005; 5,466 stores for fiscal 2004; 5,027 stores for fiscal 2003; and 4,616 stores for fiscal 2002.

During fiscal 2006, 350 stores were opened, 75 stores were closed, 18 stores were relocated within the same shopping center or market area, 6 stores were expanded in size, and 12 stores were renovated.  From August 26, 2006, through September 30, 2006, the Company opened 38 new stores, closed 3 stores, and expanded 1 store.

As of September 30, 2006, the Company had, in the aggregate, approximately 52.4 million square feet of total store space (including receiving rooms and other non-selling areas) and approximately 43.5 million square feet of selling space.  The typical store has approximately 7,500 to 9,500 square feet of total area.

The Company’s stores are located in large urban, suburban and rural areas, and they are typically 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 with populations above 200,000), and approximately 26% of the Company’s stores were located in small urban markets (markets with populations greater than 75,000 but less than 200,000) or suburban areas.  During fiscal 2006, approximately 30% of new store locations were opened in large urban markets and 20% of new locations were opened in small urban or suburban markets.

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

Of the Company’s 5,719 leased stores at September 30, 2006, all but 421 leases grant the Company options to renew for additional terms, in most cases for a number of successive five-year periods.  The following table sets forth certain data, as of September 30, 2006, concerning the 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 the 489 Company-owned stores, 127 are located in Texas, with no more than 32 located in any other state.  In these owned stores, there are approximately 4.1 million total square feet of space.

The Company also owns its corporate headquarters and distribution center located on a 108-acre tract of land in Matthews, North Carolina, just outside of Charlotte, in two buildings containing approximately 1.13 million square feet.  Approximately 890,000 square feet are used for the distribution center which includes receiving, warehousing, shipping and storage facilities.  Approximately 240,000 square feet are used for the corporate headquarters.

10




The Company also owns eight additional full-service distribution centers described in 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.          LEGAL PROCEEDINGS

On January 30, 2001, Janice Morgan and Barbara Richardson, two individuals who have held the position of Store Manager for subsidiaries of the Company, filed a complaint against the Company in the United 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 current and former Store Managers holding the position on or after July 1, 1999.  Approximately 2,550 of those receiving such notice filed consent forms and joined the lawsuit as plaintiffs, including approximately 2,300 former Store Managers and approximately 250 then current employees.  After rulings by the Court on motions to dismiss certain plaintiffs filed by the Company and motions to reconsider filed by plaintiffs, 1,424 plaintiffs remained in the case at the commencement of trial.

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

A jury trial in this case was held in June 2005, in Tuscaloosa, Alabama, and ended with the judge declaring a mistrial after the jury was unable to reach a unanimous decision in the matter.  The case was subsequently retried beginning on February 21, 2006, to a jury in Tuscaloosa, Alabama, which found that the Company should have classified the Store Manager plaintiffs as hourly employees entitled to overtime pay rather than as salaried exempt managers and awarded damages. Subsequently, the Court ruled the 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 of personal bankruptcy by certain plaintiffs, the Court entered a judgment for approximately $33.3 million.  The Company and the plaintiffs have filed post-trial motions, which have suspended the entry of a final judgment.  The Company posted a bond to stay execution on 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 the Company’s appeal.  The Company plans to appeal if the Court denies the pending post-trial motions and enters a final judgment.

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

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

11




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

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

As previously disclosed, the Company has formed a Special Committee to investigate the Company’s stock option granting practices and make determinations regarding appropriate remedial measures and what actions the Company should take with respect to the pending shareholder derivative litigation.  In addition, as previously announced, the Company voluntarily advised the SEC of such litigation and the Special Committee’s review.  The Company is cooperating with the SEC’s informal inquiry regarding the Company’s stock option granting practices. See Note 10 to the Consolidated Financial Statements included in this Report for more information.

The Company is involved in numerous other legal proceedings and claims incidental to its business, including litigation related to 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 litigation related to alleged personal or property damage, as to which the Company carries insurance coverage and/or, pursuant to Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies,” has established reserves as set forth in the Company’s financial statements.  While the ultimate outcome cannot be determined, the Company currently believes that these proceedings and claims, both individually and in the aggregate, should not have a material adverse effect on the Company’s financial position, liquidity or results of operations.  However, the outcome of any litigation is inherently uncertain and, if decided adversely to the Company, the Company may be subject to liability that could have a material adverse effect on the Company’s financial position, liquidity or results of operations.

ITEM 4.          SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

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

12




PART II

ITEM 5.

MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

The Company’s common stock is traded on the New York Stock Exchange under the ticker symbol FDO.  At March 3, 2007, there were approximately 2,680 holders of record of the Company’s common stock.  The accompanying tables give the high and low sales prices of the common stock and the dividends declared per share for each quarter of fiscal 2006 and 2005.  The Company expects that dividends will continue to be declared quarterly for the foreseeable future.

Market Prices 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

 

 

The following table sets forth information with respect to purchases of shares of the 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 Rule 10b-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

 


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

13




Stock Performance Graph

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

COMPARISON OF FIVE YEAR CUMULATIVE TOTAL RETURN

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

 

14




ITEM 6.          SELECTED FINANCIAL 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 results for fiscal 2006 include a $45.0 million (approximately $0.18 per diluted share) litigation charge associated with an adverse litigation judgment in a case in Tuscaloosa, Alabama, (See Note 8 to the Consolidated Financial Statements included in this Report for more information) and cumulative charges of $10.5 million (approximately $0.04 per diluted share) to record non-cash stock-based compensation and income tax related interest expense (See Note 10 to the Consolidated Financial Statements included in this Report for more information).

(2)             These amounts have been reclassified to conform to the presentation for fiscal 2006.  During fiscal 2006, the Company began presenting interest income and interest expense separately on the Consolidated Statements of Income.  In prior years interest income and interest expense 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 6,200 general merchandise retail discount stores in 44 states, providing primarily low to lower-middle income consumers with a wide range of competitively priced basic merchandise in convenient neighborhood stores.

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

15




Fiscal 2006 Overview

For fiscal 2006, the Company’s sales were $6.4 billion, an increase of $570.0 million from fiscal 2005.  Net income declined $22.4 million in fiscal 2006 compared with fiscal 2005 and diluted net income per common 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 litigation judgment in a case in Tuscaloosa, Alabama, (see Note 8 to the Consolidated Financial Statements included in this Report for more information) and; (ii) cumulative charges of $10.5 million (approximately $0.04 per diluted share) to record non-cash stock-based compensation and related interest expense (see Note 10 to the Consolidated Financial Statements included in this Report for more information).  The various components affecting the Company’s results for fiscal 2006 are discussed in more detail in “Results of Operations” below.

During fiscal 2006, the Company continued to focus its efforts on four key initiatives designed to increase sales and profitability: the installation of refrigerated coolers in selected stores; the continued development of a “Treasure Hunt” merchandise program; the continuation of an aggressive store opening program; and the Urban Initiative.  These initiatives 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’ frequent fill-in food needs.  During fiscal 2006, the Company installed refrigerated coolers in approximately 2,800 stores.  The customer traffic generated by coolers has increased sales of food and other merchandise throughout the store.  At the end of fiscal 2006, approximately 3,800 stores had refrigerated coolers.

·                                          “Treasure Hunt” merchandise program — The Company has continued to supplement its basic assortment of merchandise with the purchase of certain items designed to create more excitement in stores throughout the year, with particular emphasis on holidays, spring and back-to-school seasons, and to balance gross margin pressure from increased sales of lower-margin consumable merchandise.  During fiscal 2006, the Company took a more process-oriented approach to this initiative by focusing on three key components: identifying and selecting exciting values for customers; informing customers of the compelling values through circulars and in-store handouts and signage; and effectively displaying the items in stores to attract customer attention.

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

·                                          Urban Initiative — The Urban Initiative is designed to improve the operating performance of high sales volume stores in large metropolitan markets through investments in people, process changes and technology, including organizational changes to support a more mobile and flexible workforce.  During fiscal 2006, the Company continued its investments in the Urban Initiative markets (approximately 1,400 stores at the end of fiscal 2006) and experienced an improvement in profitability in most markets, resulting from positive trends in comparable store sales, better expense control and improvements in inventory shrinkage and store manager retention.

During the first quarter of fiscal 2006, Hurricanes Katrina, Rita and Wilma struck the U.S. Gulf Coast and Florida, impacting numerous stores in the afflicted areas.  Because the Company’s stores are widely dispersed, lost sales due to closed stores resulting from damage or power outages were generally limited and were substantially offset by increased sales in other stores.  The most significant storm-related losses were related to the loss of merchandise inventories, furniture and fixtures and leasehold improvements at individual stores in the paths of the storms.  During fiscal 2006, the Company received payments from its insurance carrier covering a majority of the losses.  The net impact of these storms has not had, and is not expected to have, a material impact in the aggregate on the Company’s financial position, liquidity or results of operations.

Fiscal 2007 Outlook

Fiscal 2007 will be a 53-week year, compared with a 52-week year in fiscal 2006.  The second quarter of fiscal 2007 will include 14 weeks compared with 13 weeks in the second quarter of fiscal 2006.  During fiscal 2007, the Company plans to focus its efforts on the following initiatives designed to support sustainable and profitable growth and to make Family Dollar a more compelling place to shop, work, and invest.

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

·                                          In Urban Initiative markets, the Company plans to continue to focus on driving better returns and to implement a new technological platform designed to facilitate better customer service and make the stores easier to manage.

16




·                                          In support of the Treasure Hunt program, the Company plans to further develop an event-driven strategy that creates excitement for customers and employees; continue to focus on improving inventory flow and turns, resulting in better presentation of new products; and enhance the apparel assortment.

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

·                                          The Company will continue to enhance its research and development effort known as “Concept Renewal.”  The Concept Renewal effort involves developing new ideas and initiatives designed to sustain profitable growth.  The Company plans to continue testing new merchandising adjacencies and layouts through its Concept Renewal efforts.

·                                          The Company will initiate a multi-year investment designed to strengthen its merchandising and supply chain through a review of processes, personnel needs and technology tools.  This will include price optimization, store clustering, category management, space management, merchandise planning and improved assortment planning.

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

Results of Operations

Net Sales

Net sales 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% ($542.9 million) in fiscal 2005.  The increases in fiscal 2006 and in fiscal 2005 were attributable, in part, to increased sales in comparable stores (stores open more than 13 months) of 3.7% ($209.6 million) and 2.3% ($117.1 million), respectively, with the balance of the increases primarily relating to sales from new stores opened as part of the Company’s store growth program.  The comparable store sales calculation for fiscal 2006 excludes a limited number of stores that were closed for an extended period of time as a result of the hurricanes as discussed above.  The Urban Initiative, the installation of refrigerated coolers and the “Treasure Hunt” merchandise program all had positive impacts on sales in fiscal 2006 and fiscal 2005.  Sales of consumable merchandise and electronics, including pre-paid cellular phones and services in fiscal 2006, were the primary drivers of the sales increase.  See Item 1 — “Merchandise” elsewhere in this Report for a breakdown of the percentage of sales attributable to each product category during the last three fiscal years.

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

The Company distributed four advertising circulars in both fiscal 2006 and fiscal 2005 and one advertising circular in fiscal 2004.  The circulars are designed to stimulate traffic and inform customers about the Company’s Treasure Hunt merchandise, seasonal values and competitive prices on core consumables.

During fiscal 2006, the Company opened 350 stores and closed 75 stores for a net addition of 275 stores, compared with the opening of 500 stores and closing of 68 stores for a net addition of 432 stores during fiscal 2005.  The Company also expanded or relocated 24 stores in fiscal 2006, compared with 49 stores that were expanded or relocated in fiscal 2005.  In addition, approximately 12 stores in fiscal 2006 and 105 stores in fiscal 2005 were renovated.

Cost of Sales

Cost of sales increased approximately 9.4% ($367.9 million) in fiscal 2006 compared with fiscal 2005 and approximately 11.8% ($412.3 million) in fiscal 2005 compared with fiscal 2004.  These increases primarily 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 a percentage of net sales, during fiscal 2006 was due

17




primarily to a more favorable merchandise sales mix, better merchandise markup and improved inventory shrinkage.  These improvements were partially offset by higher freight costs resulting from higher fuel costs.  The opening of the Company’s eighth distribution center in Marianna, Florida, in the second quarter of fiscal 2005 and its continued ramp-up in fiscal 2006 have positively impacted freight costs by lowering the average distance to the stores from the distribution centers.  Increases in transportation productivity and efficiency also offset some of the cost increases.  However, these savings did not fully offset the impact of higher year-over-year fuel costs.  The Company expects that the opening of the ninth distribution center in Rome, New York, during the third quarter of fiscal 2006, will continue to lower the average distance to the stores from the distribution centers and will positively impact freight costs.

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

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 approximately 14.1% ($195.2 million) in fiscal 2005 compared with fiscal 2004.  The increases in these expenses were attributable primarily to additional costs arising from the continued growth in the number of stores in operation and the ramp-up of the ninth distribution center.  SG&A expenses, as a percentage of net sales, were 27.5% in fiscal 2006, 27.1% in fiscal 2005, and 26.2% in fiscal 2004.  The increase in SG&A expenses, as a percentage of net sales, in fiscal 2006 was due primarily to increased compensation expense related to the expensing of stock-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-based compensation expense (approximately 0.1% of net sales) as more fully described in Note 10 to the Consolidated Financial Statements included in this Report.  During fiscal 2006, the Company began recording stock-based compensation in connection with its adoption of Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004) “Share-Based Payment” (“SFAS 123R”).  See Note 9 to the Consolidated Financial Statements included in this Report for more information on SFAS 123R and its impact on the Company.  These increases were partially offset by a reduction in store payroll expenses (approximately 0.2% of net sales).  The reduction in store payroll expenses, as a percentage of net sales, resulted from the stabilization of store operations and the improved performance of Urban Initiative stores.  In addition, most other costs, as a percentage of net sales, were leveraged as a result of improved cost control and the comparable store sales growth.

The increase in SG&A expenses, as a percentage of net sales, in fiscal 2005 compared with fiscal 2004 was due primarily to planned payroll expenses incurred in connection with the urban and cooler initiatives; increased occupancy and store-related costs; and increased legal-related costs.  Each of these percentages was negatively impacted by a lower than planned increase in sales in comparable stores.  A cumulative charge to correct property tax accruals on leased properties and the incremental costs of three additional advertising circulars also impacted this percentage, but these amounts were offset by a reduction in bonus costs as the Company did not reach the earnings target necessary for payment of management bonuses.  In addition, most other costs, as a percentage of net sales, were negatively impacted by the lower than planned increase in sales in comparable stores.

Litigation Charge

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

Interest Income

Interest income increased 74.0% ($2.9 million) in fiscal 2006 compared with fiscal 2005.  The increase was due to an increase in interest rates and an increase in investment securities.

18




Interest Expense

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

Income Taxes

The effective tax rate was 37.3% in fiscal 2006, 36.5% in fiscal 2005, and 36.6% in fiscal 2004.  The increase in the effective tax rate in fiscal 2006, compared with fiscal 2005 was a result of the effect of changes in state income taxes and the expiration of certain federal jobs tax credits for employees hired after December 31, 2005.

Liquidity and Capital Resources

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

On August 24, 2006, the Company entered into an unsecured revolving credit facility with a syndicate of lenders for short-term borrowings of up to $350 million.  The credit facility replaced the Company’s then outstanding unsecured revolving credit facilities for short-term borrowings of up to $200 million.  The credit facility expires on August 24, 2011.  Any borrowings under the credit facility are at a variable interest rate based on short-term market interest rates.  Outstanding standby letters of credit reduce the borrowing capacity of the credit facility.  The Company had no borrowings against its credit facilities during fiscal 2006.  The credit facility contains certain restrictive financial covenants, which include a consolidated debt to consolidated capitalization ratio, a fixed charges coverage ratio, and a priority debt to consolidated net worth ratio.

Merchandise inventories at the end of fiscal 2006 were 4.9% lower than at the end of fiscal 2005.  The decrease in merchandise inventories was a result of the Company’s renewed focus on inventory productivity and a shift in the timing of holiday merchandise receipts, which more than offset additional inventory related to 275 net new stores and inventory associated with the cooler program.  Inventory on a per store basis at the end of fiscal 2006 was approximately 10% lower than at the end of fiscal 2005, excluding merchandise in transit to the distribution centers.  The Company’s focus on inventory productivity includes improved planning and flow of fashion merchandise and the use of more aggressive exit strategies.  As a result, inventories in the apparel and accessories category have shown the most significant improvement in productivity.  In addition, the continued expansion and refinement of the Company’s centralized replenishment system has resulted in lower inventory levels of basic merchandise and better in-stock levels.

The decrease in capital expenditures to $192.2 million in fiscal 2006 from $229.1 million in fiscal 2005 was due primarily to the decrease in the number of stores opened during fiscal 2006 as compared to fiscal 2005.  Offsetting some of the decrease was the installation of refrigerated coolers in approximately 2,800 stores.  Capital expenditures for fiscal 2007 are expected to be between $155 and $165 million and relate primarily to new store openings; existing store expansions, relocations and renovations; expenditures related to technology infrastructure investments; and the continued implementation of a refrigerated cooler program for perishable goods in selected stores.  The new store expansion will require additional investment in merchandise inventories.

Capital spending plans, including store opening plans, are continuously reviewed and are subject to change.  Cash flow from current operations is expected to be sufficient to meet planned liquidity and operational capital resource needs, including store expansion and other capital spending programs.  In addition, the Company has available a revolving credit facility as previously discussed.

During fiscal 2006, the Company purchased 15.4 million shares of its common stock at a cost of $367.3 million, as described below.  During fiscal 2005 and fiscal 2004, the Company purchased in the open market 3.3 million shares and 5.6 million shares, respectively, at a cost of $92.0 million and $176.7 million, respectively.

19




On September 27, 2005, the Company obtained $250 million in aggregate proceeds through the private placement of the Notes to a group of institutional accredited investors.  On October 4, 2005, the Company executed an overnight share repurchase transaction with a bank for the acquisition of 10 million shares of the Company’s outstanding common stock.  The transaction was financed with the proceeds of the Notes.  The total cost of the overnight share repurchase transaction was $234.2 million.  See Note 4 and Note 11 to the Consolidated Financial Statements included in this Report for more information on the Company’s outstanding debt and the overnight share repurchase transaction.

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

On December 19, 2006, the Company entered into separate agreements in connection with the Notes and its unsecured revolving credit facility.  The agreements extended the delivery date for the fiscal 2006 audited financial statements, the unaudited financial statements for the first quarter of fiscal 2007 and the corresponding compliance certificates to March 31, 2007, and waived any Defaults or Events of Default that would have occurred due to the failure of the Company to deliver such information in connection with the Notes and credit facility.  As discussed in Note 10 to the Consolidated Financial Statements included in this Report, the Company formed a Special Committee of the Board of Directors to investigate the Company’s stock option granting practices.  As a result, the Company was unable to file its Annual Report on Form 10-K for fiscal 2006 and its Quarterly Report on Form 10-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 compliance certificates and is in compliance with all covenants under both the Notes and credit facility.

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

The following table shows the Company’s obligations and commitments to make future payments under 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 the end of fiscal 2006, approximately $81.8 million of the merchandise letters of credit were included in accounts payable and accrued liabilities on the Company’s Consolidated Balance Sheet.  Most of the Company’s operating leases provide the Company with an option to extend the term of the lease at designated rates.  See Item 2 — “ Properties” in this Report.

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

Other Commercial Commitments (in thousands)

 

Total Amounts
Committed

 

Standby letters of credit

 

$

122,082

 

Surety bonds

 

44,934

 

Total

 

$

167,016

 

 

20




A substantial portion of the outstanding amount of standby letters of credit (which are primarily renewed on an annual basis) are used as surety for future premium and deductible payments to the Company’s workers’ compensation and general liability insurance carrier.  The Company accrues for these future payment liabilities as described in the “Critical Accounting Policies” section of this discussion.  Included in the outstanding amount of surety bonds is a $41.6 million bond obtained by the Company during the third quarter of fiscal 2006 in connection with an adverse litigation judgment, as discussed in Note 8 to the Consolidated Financial Statements included in this Report.

Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS 123R, which requires all companies to measure compensation cost for all share-based payments (including employee stock options) at fair value, effective for public companies for interim or annual periods beginning after June 15, 2005.  The FASB concluded that companies can adopt the new standard in one of two ways: the modified prospective transition method, in which the company would recognize share-based employee compensation from the beginning of the fiscal period in which the recognition provisions are first applied as if the fair-value-based accounting method had been used to account for all employee awards granted, modified, or settled after the effective date and to any awards that were not fully vested as of the effective date; or the modified retrospective transition method, in which a company would recognize employee compensation cost for periods presented prior to the adoption of SFAS 123R in accordance with the original provisions of SFAS 123 “Accounting for Stock-Based Compensation” (“SFAS 123”), pursuant to which a company would recognize employee compensation cost in the amounts reported in the pro forma disclosures provided in accordance with SFAS 123.  The Company adopted SFAS 123R during the first quarter of fiscal 2006 using the modified prospective transition method.  See Note 9 to the Consolidated Financial Statements included in this Report for more information.

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections” (“SFAS 154”).  SFAS 154 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 the accounting for and reporting of a change in accounting principle.  SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005.  The Company does not expect SFAS 154 to have a material impact on its Consolidated Financial Statements.

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

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

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

Critical Accounting Policies

Management believes the following accounting principles are critical because they involve significant judgments, assumptions and estimates used in the preparation of the Company’s Consolidated Financial Statements.

21




Merchandise Inventories:

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

Property and Equipment:

Property and equipment is stated at cost.  Depreciation for financial reporting purposes is calculated using the straight-line method over the estimated useful lives of the related assets.  For leasehold improvements, this depreciation is over the shorter of the term of the related lease (generally five years) or the asset’s useful economic life.  The valuation and classification of these assets and the assignment of useful depreciable lives involves significant judgments and the use of estimates.  The Company generally assigns no salvage value to property and equipment.  Property and equipment is reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.  Historically, impairment losses on fixed assets have not been material to the Company’s financial position and results of operations.

Insurance Liabilities:

The Company 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 the Company’s retail locations and employees.  Because the nature of these claims is such that there can be a significant lag from the incurrence of the claim (which is when the expense is accrued) until payment is made, the percentage increase in the accrual can be much more pronounced than the percentage increase in the expense.  The Company’s self-insurance liabilities are based on the total estimated costs of claims filed and estimates of claims incurred but not reported, less amounts paid against such claims, and are not discounted.  Management reviews current and historical claims data in developing its estimates.  The Company also uses information provided by outside actuaries with respect to medical, workers’ compensation and general liability claims.  If the underlying facts and circumstances of the claims change or the historical trend is not indicative of future trends, then the Company may be required to record additional expense or a reduction to expense which could be material to the reported financial condition and results of operations.

Contingent Income Tax Liabilities:

The Company is subject to routine income tax audits that occur periodically in the normal course of business.  The Company’s contingent income tax liabilities are estimated based on an assessment of the probability of the income tax related exposures and settlements and are influenced by the Company’s historical audit experiences with various state and federal taxing authorities as well as current income tax trends.  If circumstances change, the Company may be required to record adjustments that could be material to its reported financial condition and results of operations.

Contingent Legal Liabilities:

The Company is involved in numerous legal proceedings and claims.  The Company’s reserves, if any, related to these proceedings and claims are based on a determination of whether or not the loss is both probable and estimable.  The Company reviews outstanding claims and proceedings with external counsel to assess probability and estimates of loss.  The claims and proceedings are re-evaluated each quarter or as new and significant information becomes available, and the reserves are adjusted or established, if necessary.  If circumstances change, the Company may be required to record adjustments that could be material to its reported financial condition and results of operations.

22




Lease Accounting:

The Company leases substantially all of its store properties and accounts for store leases in accordance with SFAS 13, “Accounting for Leases” and related interpretations.  For purposes of recognizing incentives, premiums and minimum rental expenses on a straight-line basis over terms of the leases, the Company uses the date of initial possession to begin amortization, which is generally when the Company enters the space and begins to make improvements in preparation of intended use.  For tenant improvement allowances and rent holidays, the Company records a deferred rent liability at the inception of the lease term and amortizes the deferred rent over the terms of the leases as reductions to rent expense on the Consolidated Statements of Income.

Stock-based Compensation Expense:

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

ITEM 7A.                    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

23







Report of Independent Registered Public Accounting Firm

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

We have completed integrated audits of Family Dollar Stores, Inc.’s August 26, 2006 and August 27, 2005 consolidated financial statements and of its internal control over financial reporting as of August 26, 2006, and an audit of its August 28, 2004 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Our opinions, based on our audits, are presented below.

Consolidated financial statements

In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Family Dollar Stores, Inc., and its subsidiaries at August 26, 2006 and August 27, 2005, and the results of their operations and their cash flows for each of the three years in the period ended August 26, 2006 in conformity with accounting principles generally accepted in the United States of America.  These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these financial statements based on our audits.  We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit 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 by management, and evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

Internal control over financial reporting

Also, in our opinion, management’s assessment, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A, that the Company maintained effective internal control over financial reporting as of August 26, 2006 based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria.  Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of August 26, 2006, based on criteria established in Internal Control - Integrated Framework issued by the COSO.  The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting.  Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit.  We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.  An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances.  We believe that our audit provides a reasonable basis for our opinions.

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

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

PricewaterhouseCoopers LLP

Charlotte, North Carolina

March 28, 2007

25




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

 

 

The accompanying notes are an integral part of the consolidated financial statements.

26




FAMILY DOLLAR STORES, INC., AND SUBSIDIARIES

CONSOLIDATED BALANCE 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

 

 

The accompanying notes are an integral part of the consolidated financial statements.

27




FAMILY DOLLAR STORES, INC., AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

Years Ended August 26, 2006, August 27, 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 accompanying notes are an integral part of the consolidated financial statements.

28




FAMILY DOLLAR STORES, INC., AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

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 notes are an integral part of the consolidated financial statements.

 

29




NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years Ended August 26, 2006, August 27, 2005, and August 28, 2004

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

Description of business:

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

Principles of consolidation:

The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly owned.  All significant intercompany balances and transactions have been eliminated.

Fiscal year:

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

Use of estimates:

The preparation of the Company’s consolidated financial statements, in conformity with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions.  These estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from these estimates.

Cash equivalents:

The Company considers all highly liquid investments with an original maturity of three months or less to be “cash equivalents.”  The carrying amount of the Company’s cash equivalents approximates fair value due to the short maturities of these investments and consists primarily of money market funds and other overnight investments.  The Company maintains cash deposits with major banks, which from time to time may exceed federally insured limits.  The Company periodically assesses the financial condition of the institutions and believes that the risk of any loss is minimal.

Investment securities:

The items classified as investment securities are principally auction rate securities and variable rate demand notes.  The Company classifies all investment securities as available-for-sale.  Securities accounted for as available-for-sale are required to be reported at fair value with unrealized gains and losses, net of taxes, excluded from net income and shown separately as a component of accumulated other comprehensive income within shareholders’ equity.  The securities that the Company has classified as available-for-sale generally trade at par and as a result typically do not have any realized or unrealized gains or losses.

Merchandise inventories:

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

Property and equipment:

Property and equipment is stated at cost.  Depreciation for financial reporting purposes is calculated using the straight-line method over the estimated useful lives of the related assets.  For leasehold improvements, this depreciation is over the shorter of the term of the related lease (generally five years) or the 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 capitalizes certain costs incurred in connection with developing, obtaining and implementing software for internal use.  Capitalized costs are amortized over the expected economic life of the assets, generally ranging from five to eight years.

30




Property and equipment is reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.

Revenues:

The Company recognizes revenue, net of returns and sales tax, at the time the customer tenders payment for and takes possession of the merchandise.

Insurance liabilities:

The Company is primarily self-insured for health care, property loss, workers’ compensation and general liability costs.  These liabilities are based on the total estimated costs of claims filed and estimates of claims incurred but not reported, less amounts paid against such claims, and are not discounted.

Advertising costs:

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

Vendor allowances:

Cash consideration received from a vendor is presumed to be a reduction of the purchase cost of merchandise and is reflected as a reduction of cost of sales unless it can be demonstrated this offsets an incremental expense, in which case it is netted against that expense.

Store opening and closing costs:

The Company charges pre-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 expected sublease and lease termination recoveries, is expensed when the closing occurs.

Selling, general and administrative expenses:

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

Operating leases:

Except for its corporate headquarters and distribution centers, the Company generally conducts its operations from leased facilities.  Generally, store real estate leases are for initial terms of from five to ten years with multiple renewal options for additional five-year periods.  Certain leases provide for contingent rental payments based upon a percentage of store sales.

For purposes of recognizing incentives, premiums and minimum rental expenses on a straight-line basis over terms of the leases, the Company uses the date of initial possession to begin amortization, which is generally when the Company enters the space and begins to make improvements in preparation of intended use.  For tenant improvement allowances and rent holidays, the Company records a deferred rent liability at the inception of the lease term and amortizes the deferred rent over the terms of the leases as reductions to rent expense on the Consolidated Statements of Income.  The Company also has long-term leases for equipment generally with lease terms of five years or less.

Capitalized interest:

The Company capitalizes interest on borrowed funds during the construction of property and equipment 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 interest costs.  The Company did not incur any interest costs during fiscal 2005 and fiscal 2004.

Income taxes:

The Company records deferred income tax assets and liabilities for the expected future tax consequences of temporary differences between the financial reporting bases and the income tax bases of its assets and liabilities.

Stock-based compensation:

The Company recognizes compensation expense related to its stock-based awards based on the grant-date fair value estimated in accordance with SFAS No. 123 (revised 2004) “Share-Based Payment” (“SFAS 123R”).  The Company utilizes the Black-Scholes option-pricing model to estimate the grant-date fair value of its stock option awards.  The grant-date fair value of the Company’s performance share rights awards is based on the stock price on the grant date.  Compensation expense for the Company’s stock-based awards is recognized ratably, net of estimated forfeitures, over the service period of each award.  See Note 9 for more information on the Company’s stock-based compensation plans.

31




New accounting pronouncements:

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS 123R which requires all companies to measure compensation cost for all share-based payments (including employee stock options) at fair value, effective for public companies for interim or annual periods beginning after June 15, 2005.  The FASB concluded that companies can adopt the new standard in one of two ways: the modified prospective transition method, in which the company would recognize share-based employee compensation from the beginning of the fiscal period in which the recognition provisions are first applied as if the fair-value-based accounting method had been used to account for all employee awards granted, modified, or settled after the effective date and to any awards that were not fully vested as of the effective date; or the modified retrospective transition method, in which a company would recognize employee compensation cost for periods presented prior to the adoption of SFAS 123R in accordance with the original provisions of SFAS 123 “Accounting for Stock-Based Compensation” (“SFAS 123”), pursuant to which a company would recognize employee compensation cost in the amounts reported in the pro forma disclosures provided in accordance with SFAS 123.  The Company adopted SFAS 123R during the first quarter of fiscal 2006 using the modified prospective transition method.

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections” (“SFAS 154”).  SFAS 154 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 the accounting for and reporting of a change in accounting principle.  SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005.  The Company does not expect SFAS 154 to have a material impact on its Consolidated Financial Statements.

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

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

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

Reclassifications:

Certain reclassifications of the amounts for fiscal 2005 and fiscal 2004 have been made to conform to the presentation for fiscal 2006.  These include interest income, which was previously included in selling, general and administrative expenses.

2.             Investment Securities

The Company’s investments consist of the following short-term available-for-sale securities (in thousands):

 

 

 

 

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




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

The Company had no current or long-term debt as of the fiscal year ended August 27, 2005.  Current and long-term debt consisted 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 $250 million through a private placement of unsecured Senior Notes (the “Notes”) to a 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 other unsecured senior indebtedness.  The first tranche has an aggregate principal amount of $169 million, is payable in a single installment on September 27, 2015, and bears interest at a rate of 5.41% per annum from the date of issuance.  The second tranche has an aggregate principal amount of $81 million, matures on September 27, 2015, with amortization commencing in the sixth year, and bears interest at a rate of 5.24% per annum from the date of issuance.  The second tranche has a required principal payment of $16.2 million on September 27, 2011, and on each September 27 thereafter to and including September 27, 2015.  Interest on the Notes is payable semi-annually in arrears on the 27th day of March and September of each year commencing on March 27, 2006.  The sale of the Notes was effected in transactions not requiring registration under the Securities Act of 1933, as amended.  The Notes contain certain restrictive financial covenants, which include a consolidated debt to consolidated capitalization ratio, a fixed charges coverage ratio, and a priority debt to consolidated net worth ratio.  The proceeds of the Notes were used to repurchase the Company’s outstanding common stock, as discussed in Note 11 for more information.

On August 24, 2006, the Company entered into an unsecured revolving credit facility with a syndicate of lenders for short-term borrowings of up to $350 million.  The credit facility replaced the Company’s then outstanding unsecured revolving credit facilities for short-term borrowings of up to $200 million.  The credit facility expires on August 24, 2011.  Any borrowings under the credit facility are at a variable interest rate based on short-term market interest rates.  Outstanding standby letters of credit reduce the borrowing capacity of the credit facility.  The Company had no borrowings against its credit facilities during fiscal 2006.  The credit facility contains certain restrictive financial covenants, which include a consolidated debt to consolidated capitalization ratio, a fixed charges coverage ratio, and a priority debt to consolidated net worth ratio.

33




On December 19, 2006, the Company entered into separate agreements in connection with the Notes and its unsecured revolving credit facility.  The agreements extended the delivery date for the fiscal 2006 audited financial statements, the unaudited financial statements for the first quarter of fiscal 2007 and the corresponding compliance certificates to March 31, 2007, and waived any Defaults or Events of Default that would have occurred due to the failure of the Company to deliver such information in connection with the Notes and credit facility.  As discussed in Note 10 below, the Company formed a Special Committee of the Board of Directors to investigate the Company’s stock option granting practices.  As a result, the Company was unable to file its Annual Report on Form 10-K for fiscal 2006 and its Quarterly Report on Form 10-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 compliance certificates and is in compliance with all covenants under both the Notes and credit 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 of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities as of the end of fiscal 2006 and the end 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 income taxes 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




The following table summarizes the components of income tax expense in fiscal 2006, fiscal 2005 and fiscal 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

%

 

The Internal Revenue Service is currently examining the Company’s consolidated federal income tax returns for fiscal 2005, fiscal 2004 and fiscal 2003.  Although the ultimate outcome of the examination cannot be presently determined, the Company believes that it has made adequate provision for federal income taxes with respect to all open years.

7.             Employee Benefit Plans:

Incentive compensation plan:

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

Compensation deferral plans:

The Company has a voluntary compensation deferral plan, under Section 401(k) of the Internal Revenue Code, available to eligible employees.  At the discretion of the Board of Directors, the Company makes contributions to the plan which are allocated to participants, and in which they become vested, in accordance with formulas and schedules defined by the plan.  Company expenses for contributions to 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, the Company adopted a deferred compensation plan to provide certain key management employees the ability to defer a portion of their base compensation and bonuses.  The plan is an unfunded nonqualified plan.  The deferred amounts and earnings thereon are payable to participants, or designated beneficiaries, at specified future dates, upon retirement or death.  The Company does not make contributions to this plan or guarantee earnings.

8.             Commitments and Contingencies:

Operating leases:

Rental expenses on all operating leases, both cancelable and non-cancelable, for fiscal 2006, fiscal 2005 and fiscal 2004 were as follows:

 

(in thousands)

 

2006

 

2005

 

2004

 

Minimum rentals, net of minor sublease rentals

 

$

293,719

 

$

274,562

 

$

238,188