DOLLAR TREE STORES, INC. FORM 10K FOR FISCAL YEAR ENDED JANUARY 28, 2006
Table of Contents
Index to Consolidated Financial Statements

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended January 28, 2006


Commission File No.0-25464

DOLLAR TREE STORES, INC.
(Exact name of registrant as specified in its charter)

Virginia
54-1387365
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)

500 Volvo Parkway, Chesapeake, VA 23320
(Address of principal executive offices)

Registrant’s telephone number, including area code: (757) 321-5000

Securities Registered Pursuant to Section 12(b) of the Act:
Title of Each Class
Name of Each Exchange on Which Registered
None
None

Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock (par value $.01 per share)
(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes (X) No ( )

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

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

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

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

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

The aggregate market value of Common Stock held by non-affiliates of the Registrant on July 29, 2005, was $2,570,388,019 based on a $25.03 average of the high and low sales prices for the Common Stock on such date. For purposes of this computation, all executive officers and directors have been deemed to be affiliates. Such determination should not be deemed to be an admission that such executive officers and directors are, in fact, affiliates of the Registrant.

On April 7, 2006, there were 105,962,427 shares of the Registrant’s Common Stock outstanding.


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Index to Consolidated Financial Statements
DOCUMENTS INCORPORATED BY REFERENCE

The information regarding securities authorized for issuance under equity compensation plans called for in Item 5 of Part II and the information called for in Items 10, 11, 12, 13 and 14 of Part III are incorporated by reference to the definitive Proxy Statement for the Annual Meeting of Stockholders of the Company to be held June 14, 2006, which will be filed with the Securities and Exchange Commission not later than April 28, 2006.

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DOLLAR TREE STORES, INC.
TABLE OF CONTENTS


   
Page
   
     
BUSINESS
6
     
RISK FACTORS
10
     
UNRESOLVED STAFF COMMENTS
12
     
PROPERTIES
13
     
LEGAL PROCEEDINGS
14
     
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
14
     
 
PART II
 
     
MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
 
 
STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
15
     
SELECTED FINANCIAL DATA
15
     
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
 
 
CONDITION AND RESULTS OF OPERATIONS
17
     
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
28
     
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
30
     
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
 
 
ACCOUNTING AND FINANCIAL DISCLOSURE
55
     
CONTROLS AND PROCEDURES
55
     
OTHER INFORMATION
56
     
 
PART III
 
     
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
56
     
EXECUTIVE COMPENSATION
57
     
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
 
 
AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
57
     
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
57
     
PRINCIPAL ACCOUNTING FEES AND SERVICES
57
     
 
PART IV
 
     
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
57
     
 
58


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A WARNING ABOUT FORWARD LOOKING STATEMENTS: This document contains "forward-looking statements" as that term is used in the Private Securities Litigation Reform Act of 1995. Forward-looking statements address future events, developments and results. They include statements preceded by, followed by or including words such as "believe," "anticipate," "expect," "intend," "plan," "view," “target” or "estimate." For example, our forward-looking statements include statements regarding:

·  
our anticipated sales, including comparable store net sales, net sales growth and earnings growth;
·  
our growth plans, including our plans to add, expand or relocate stores, our anticipated square footage increase, and our ability to renew leases at existing store locations;
·  
the average size of our stores to be added in 2006 and beyond;
·  
the effect of a slight shift in mix to consumables and the increase of freezers and coolers on gross profit margin and sales;
·  
the effect that expanding tender types accepted by our stores will have on sales;
·  
the net sales per square foot, net sales and operating income attributable to smaller and larger stores and store-level cash payback metrics;
·  
the possible effect of inflation and other economic changes on our costs and profitability, including the possible effect of future changes in shipping rates, domestic and foreign freight costs, fuel costs, minimum wage rates and wage and benefit costs;
·  
our cash needs, including our ability to fund our future capital expenditures and working capital requirements;
·  
our gross profit margin, earnings, inventory levels and ability to leverage selling, general and administrative and other fixed costs;
·  
our seasonal sales patterns including those relating to the length of the holiday selling seasons;
·  
the capabilities of our inventory supply chain technology, planned labor management system and other new systems;
·  
the future reliability of, and cost associated with, our sources of supply, particularly imported goods such as those sourced from China;
·  
the capacity, performance and cost of our distribution centers, including opening and expansion schedules;
·  
our expectations regarding competition and growth in our retail sector;
·  
costs of pending and possible future legal claims;
·  
management's estimates associated with our critical accounting policies, including inventory valuation, accrued expenses, and income taxes;
·  
the adequacy of our internal controls over financial reporting;
·  
our integration and future operations of the recently acquired Deal$ stores;
·  
the possible effect on our financial results of changes in generally accepted accounting principles relating to accounting for stock-based compensation;

You should assume that the information appearing in this annual report is accurate only as of the date it was issued. Our business, financial condition, results of operations and prospects may have changed since that date.

For a discussion of the risks, uncertainties and assumptions that could affect our future events, developments or results, you should carefully review the risk factors described in “Item 1A. Risk Factors” beginning on page 10, as well as "Management’s Discussion and Analysis of Financial Condition and Results of Operations" beginning on page 17.

Our forward-looking statements could be wrong in light of these and other risks, uncertainties and assumptions. The future events, developments or results described in this report could turn out to be materially different. We have no obligation to publicly update or revise our forward-looking statements after the date of this annual report and you should not expect us to do so.

Investors should also be aware that while we do, from time to time, communicate with securities analysts and others, we do not, by policy, selectively disclose to them any material nonpublic information or other confidential commercial information. Accordingly, shareholders should not assume that we agree with any statement or report issued by any securities analyst regardless of the content of the statement or report. We generally do not issue financial forecasts or projections and we do not, by policy, confirm those issued by others. Thus, to the extent that reports issued by securities analysts contain any projections, forecasts or opinions, such reports are not our responsibility.
 
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 INTRODUCTORY NOTE: Unless otherwise stated, references to "we," "our" and "Dollar Tree" generally refer to Dollar Tree Stores, Inc. and its direct and indirect subsidiaries on a consolidated basis. Unless specifically indicated otherwise, any references to “2006” or “fiscal 2006,” “2005” or “fiscal 2005,” and “2004” or “fiscal 2004” relate to as of or for the years ended February 3, 2007, January 28, 2006 and January 29, 2005, respectively.

AVAILABLE INFORMATION
Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act are available free of charge on our website at www.dollartree.com as soon as reasonably practicable after electronic filing of such reports with the SEC.

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PART I
 
Item 1. BUSINESS

Overview
Since our founding in 1986, we have become the leading operator of discount variety stores offering merchandise at the fixed price of $1.00. We believe the variety and quality of products we sell for $1.00 sets us apart from our competitors. At January 28, 2006, we operated 2,914 single-price point stores under the names of Dollar Tree, Dollar Bills and Dollar Express.

Since 1986, we have evolved from opening primarily mall-based stores ranging between 1,500 and 2,500 selling square feet to opening primarily strip shopping center-based stores averaging 10,000 to 15,000 selling square feet. In the past five years, we have modified our average store size to reflect what we believe is our optimal store size of between 10,000 and 12,500 square feet. Our current store size reflects our expanded merchandise offerings and improved service to our customers. At December 31, 2001, we operated 1,975 stores in 37 states. At January 28, 2006, we operated 2,914 stores in 48 states. Our selling square footage increased from approximately 10.1 million square feet in December 2001 to 23.0 million square feet in January 2006. Our store growth since 2001 has resulted from opening new stores and completing mergers and acquisitions. We centrally manage our store and distribution operations from our corporate headquarters in Chesapeake, Virginia.

Business Strategy
Value Merchandise Offering. We strive to exceed our customers' expectations over the variety and quality of products that they can purchase for $1.00 by offering items that we believe typically sell for higher prices elsewhere. We buy approximately 60% of our merchandise domestically and import the remaining 40%. Our domestic purchases include closeouts. We believe our mix of imported and domestic merchandise affords our buyers flexibility that allows them to consistently exceed the customer's expectation. In addition, direct relationships with manufacturers permit us to select from a broad range of products and customize packaging and product sizes and package quantities that meet our customers' needs.

Mix of Basic Variety and Seasonal Merchandise. We maintain a balanced selection of products within traditional variety store categories. We offer a wide selection of everyday basic products and we supplement these basic, everyday items with seasonal and closeout merchandise. We attempt to keep certain basic consumable merchandise in our stores continuously to establish our stores as a destination. Closeout merchandise is purchased opportunistically and represents less than 10% of our purchases. National, regional and private-label brands have become a bigger part of our merchandise mix.

Our merchandise mix consists of:
   
·  
consumable merchandise, which includes candy and food, health and beauty care, and household consumables such as paper, plastics and household chemicals and in select stores, frozen and refrigerated food;
   
·  
variety merchandise, which includes toys, durable housewares, gifts, party goods, greeting cards, hardware, and other items; and
   
·  
seasonal goods include Easter, Halloween and Christmas merchandise, along with summer toys and lawn and garden merchandise.


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Our larger stores, which appeal to a broader demographic mix, carry more consumable merchandise than smaller stores. We have also added freezers and coolers to approximately 200 stores in 2005 and plan to add them to approximately 250 more Dollar Tree stores in 2006. As a result of our larger store size and the installation of freezers and coolers in select stores, consumable merchandise has grown as a percentage of purchases and sales and we expect this trend to continue. The following table shows the percentage of purchases of each major product group for the years ended January 28, 2006 and January 29, 2005:

 
January 28,
January 29,
Merchandise Type 
2006
2005
     
Variety categories
47.2%
49.9%
Consumable
44.9%
41.4%
Seasonal 
7.9%
8.7%

Customer Payment Methods. All of our stores accept cash and checks and approximately 700 stores accept MasterCard and Visa credit cards. In 2005, we expanded the tender types that we accept at our stores. Prior to May 2005, approximately 900 of our stores accepted debit cards. By the end of 2005, approximately 2,300 of our stores accepted debit cards as a result of the debit roll-out. We also began accepting food stamps at certain of our stores in 2005. We believe that expanding the tender types accepted at our stores helped increase the average size of transactions in the second half of 2005.

Convenient Locations and Store Size. We primarily focus on opening new stores in strip shopping centers anchored by mass merchandisers, whose target customers we believe to be similar to ours, and in neighborhood centers anchored by large grocery retailers. Our stores have proven successful in metropolitan areas, mid-sized cities and small towns. The range of our store sizes allows us to target a particular location with a store that best suits that market and takes advantage of available real estate opportunities. Our stores are attractively designed and create an inviting atmosphere for shoppers by using bright lighting, vibrant colors, decorative signs and background music. We enhance the store design with attractive merchandise displays. We believe this design attracts new and repeat customers and enhances our image as both a destination and impulse purchase store.

For more information on retail locations and retail store leases, see "Properties."

Profitable Stores with Strong Cash Flow. We maintain a disciplined, cost-sensitive approach to store site selection in order to minimize the initial capital investment required and maximize our potential to generate high operating margins and strong cash flows. We believe that our stores have a relatively small shopping radius, which allows us to profitably concentrate multiple stores within a single market. Our ability to open new stores is dependent upon, among other factors, locating suitable sites and negotiating favorable lease terms.

Our older, smaller stores continue to generate significant store-level operating income and operating cash flows and have some of the highest operating margin rates among our stores; however, the increased size of our newer stores allows us to offer a wider selection of products, including more basic consumable merchandise, thereby making them more attractive as a destination store.

The strong cash flows generated by our stores allow us to self-fund infrastructure investment and new stores. Over the past five years, cash flows from operating activities have exceeded capital expenditures.

For more information on our results of operations, see "Management's Discussion and Analysis - Results of Operations." For more information on seasonality of sales, see "Management's Discussion and Analysis - Seasonality and Quarterly Fluctuations."

Cost Control. We believe that substantial buying power at the $1.00 price point contributes to our successful purchasing strategy, which includes disciplined, targeted merchandise margin goals by category. We believe our disciplined buying and quality merchandise help to minimize markdowns. We buy products on an order-by-order basis and have no material long-term purchase contracts or other assurances of continued product supply or guaranteed product cost. No vendor accounted for more than 10% of total merchandise purchased in any of the past five years.

Our supply chain systems continue to provide us with valuable sales information to assist our buyers and improve merchandise allocation to our stores. Controlling our inventory levels has resulted in more efficient distribution and store operations.

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Information Systems. We believe that investments in technology help us to increase sales and control costs. Our inventory management system has allowed us to improve the efficiency of our supply chain, improve merchandise flow and control distribution and store operating costs.

Our automatic replenishment system automatically reorders key items, based on actual store level sales and inventory. In 2004 and 2005, we rolled out this system to additional stores and merchandise categories. At the end of 2005, we had over 600 basic, everyday items on automatic replenishment. At various times during the year, we also had approximately 200 more seasonal items on automatic replenishment during the applicable season. As we continue to utilize this system, our store management has more time to focus on customer service.

Point-of-sale data allows us to track sales by merchandise category at the store level and assists us in planning for future purchases of inventory. We believe that this information allows us to ship the appropriate product to stores at the quantities commensurate with selling patterns. During the first half of 2004, we completed the roll-out of our point-of-sale systems to most of our stores. Using this point-of-sale data for planning purchases of inventory has helped us reduce our inventory per store approximately 12% and increase inventory turns in the current year.

Corporate Culture and Values. We believe that honesty and integrity, doing the right things for the right reasons, and treating people fairly and with respect are core values within our corporate culture. We believe that running a business, and certainly a public company, carries with it a responsibility to be above reproach when making operational and financial decisions. Our management team visits and shops our stores like every customer; we have an open door policy for all our associates; and ideas and individual creativity are encouraged. We have standards for store displays, merchandise presentation, and store operations. Our distribution centers are operated based on objective measures of performance and virtually everyone in our store support center is available to assist associates in the stores and distribution centers.

Our disclosure committee meets at least quarterly and identifies and monitors our internal controls over financial reporting and ensures that our public filings contain discussions about the risks our business faces. We believe that we have the controls in place to be able to certify our financial statements. Additionally, we have complied with the updated listing requirements for the Nasdaq Stock Market.
 
Growth Strategy
Store Openings and Square Footage Growth. The primary factors contributing to our net sales growth have been new store openings, an active store expansion and remodel program, and selective mergers and acquisitions. From 2001 to 2005, net sales increased at a compound annual growth rate of 14.3%. We expect that the substantial majority of our future sales growth will come primarily from new store openings and secondarily from our store expansion and relocation program.

The following table shows the total selling square footage of our stores and the selling square footage per new store opened over the last five years. Our growth and productivity statistics are reported based on selling square footage because our management believes the use of selling square footage yields a more accurate measure of store productivity. The selling square footage statistics for 2001 through 2005 are estimates based on the relationship of selling to gross square footage.
 
Year
Number of Stores
Average Selling Square Footage Per Store
Average Selling Square Footage Per New Store Opened
2001
1,975
5,130
7,070
2002
2,263
5,763
7,783
2003
2,513
6,716
9,948
2004
2,735
7,475
10,947
2005
2,914
7,900
9,756

We expect to increase our selling square footage in the future by opening new stores in underserved markets and strategically increasing our presence in our existing markets via new store openings and store expansions (expansions include store relocations). In fiscal 2006 and beyond, we plan to predominantly open stores that are approximately 10,000 selling square feet and we believe this size allows us to achieve our objectives in the markets in which we plan to expand. At January 28, 2006, 673 of our stores, totaling 39.1% of our selling square footage, were 10,000 selling square feet or larger.

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In addition to new store openings, we plan to continue our store expansion program to increase our net sales per store and take advantage of market opportunities. We target stores for expansion based on the current sales per selling square foot and changes in market opportunities. Stores targeted for expansion are generally less than 6,000 selling square feet in size. Store expansions generally increase the existing store size by approximately 6,000 selling square feet.

Since 1995 through the end of fiscal 2005, we have added a total of 471 stores through four mergers and several small acquisitions. Our acquisition strategy has been to target companies with a similar single price point concept that have shown success in operations or provide a strategic advantage. We evaluate potential acquisition opportunities in our retail sector as they become available.

On March 26, 2006, we completed our acquisition of 138 Deal$ stores for approximately $30.5 million of store related assets and $22.2 million of store and distribution center inventory. These amounts are subject to post-closing adjustments based on the results of physical inventory counts. These stores are primarily in the Midwest part of the United States and we have existing logistics capacity to service these stores with no additional capital expenditure. This acquisition also includes a few “combo” stores that offer an expanded assortment of merchandise including items that sell for more than $1. Substantially all Deal$ stores acquired will continue to operate under the Deal$ banner while providing us an opportunity to leverage our Dollar Tree infrastructure in the testing of new merchandise concepts, including higher price points without disrupting the single-price point model in our Dollar Tree stores.

In 2005, we also acquired the rights to 35 store leases through bankruptcy proceedings of certain discount retailers. We will take advantage of these opportunities as they arise in the future.

Merchandising and Distribution. Expanding our customer base is important to our growth plans. We plan to continue to stock our new stores with the ever-changing merchandise that our current customers have come to appreciate. In addition, we are opening larger stores that contain more basic consumable merchandise to attract new customers. Consumable merchandise typically leads to more frequent return trips to our stores resulting in increased sales. The presentation and display of merchandise in our stores are critical to communicating value to our customers and creating a more exciting shopping experience. We believe our approach to visual merchandising results in high store traffic, high sales volume and an environment that encourages impulse purchases.

A strong and efficient distribution network is critical to our ability to grow and to maintain a low-cost operating structure. We opened two new distribution centers in 2004, Ridgefield, Washington and Joliet, Illinois, while replacing our Chicago distribution center. We currently operate nine distribution centers. We believe, these distribution centers in total are capable of supporting approximately $4.5 billion in annual sales. We expect to continue to add distribution capacity to support our store opening plans, with the aim of remaining approximately one year ahead of our distribution needs. Based on current plans, we will not need to add any distribution capacity until at least 2007. New distribution sites are strategically located to reduce stem miles, maintain flexibility and improve efficiency in our store service areas.

Our stores receive approximately 95% of their inventory from our distribution centers via contract carriers. The remaining store inventory, primarily perishable consumable items and other vendor-maintained display items, are delivered directly to our stores from vendors. For more information on our distribution center network, see “Properties.”

Competition
The retail industry is highly competitive and we expect competition to increase in the future. Our value discount retail competitors include Family Dollar, Dollar General, 99 Cents Only and Big Lots. The principal methods of competition include closeout merchandise, convenience and the quality of merchandise offered to the customer. Though we are a fixed-price point retailer, we also compete with mass merchandisers, such as Wal-Mart and Target, and regional discount retailers. In addition, several mass merchandisers and grocery store chains carry "dollar store" or “dollar zone” concepts in their stores, which will increase competition. Our sales and profits could be reduced by increases in competition, especially because there are no significant economic barriers for others to enter our retail sector.

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Trademarks
We are the owners of federal service mark registrations for "Dollar Tree," the "Dollar Tree" logo, "1 Dollar Tree" together with the related design, and "One Price...One Dollar." A small number of our stores operate under the name "Only One Dollar," for which we have not obtained a service mark registration. We also own a concurrent use registration for "Dollar Bill$" and the related logo. During 1997, we acquired the rights to use trade names previously owned by Everything's A Dollar, a former competitor in the $1.00 price point industry. Several trade names were included in the purchase, including the marks "Everything's $1.00 We Mean Everything," and "Everything's $1.00," the registration of which is pending. With the acquisition of Dollar Express, we became the owner of the service marks "Dollar Express" and "Dollar Expres$." We became the owners of the "Greenbacks All A Dollar" and "All A Dollar" service marks, with the acquisition of Greenbacks. We have applied for federal trademark registrations for various private labels that we use to market some of our product lines.

Employees
We employed approximately 11,400 full-time and 26,000 part-time associates on January 28, 2006. The number of part-time associates fluctuates depending on seasonal needs. We consider our relationship with our associates to be good, and we have not experienced significant interruptions of operations due to labor disagreements. None of our employees are subject to collective bargaining agreements.

Item 1A. RISK FACTORS

An investment in our common stock involves a high degree of risk. You should carefully consider the specific risk factors listed below together with all other information included or incorporated in this report. Any of the following risks may materialize, and additional risks not known to us, or that we now deem immaterial, may arise. In such event, our business, financial condition, results of operations or prospects could be materially adversely affected. If that occurs, the market price of our common stock could fall, and you could lose all or part of your investment.

Our profitability is especially vulnerable to cost increases.

  Future increase in costs such as the cost of merchandise, shipping rates, freight costs, fuel costs, wage levels and store occupancy costs may reduce our profitability. As a fixed price retailer, we cannot raise the sales price of our merchandise to offset cost increases. Unlike multi-price retailers, we are primarily dependent on our ability to operate more efficiently or increase our comparable store net sales in order to offset inflation. We expect comparable store net sales will be about flat to slightly positive in 2006. We can give you no assurance that we will be able to operate more efficiently or increase our comparable store net sales in the future. Please see Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations," of this Form 10-K for further discussion of the effect of Inflation and Other Economic Factors on our operations.

Our profitability is affected by the mix of products we sell.

Our gross profit could decrease if we increase the proportion of higher cost goods we sell in the future. In recent years, the percentage of our sales from higher cost consumable products has increased, and is likely to increase in 2006. Our gross profit will decrease unless we are able to increase the amount of our net sales sufficiently to offset any decrease in our product margin percentage. We can give you no assurance that we will be able to do so.

We may be unable to expand our square footage as profitably as planned.

We plan to expand our selling square footage by approximately 12% to 14% in 2006 to increase our sales and profits. Expanding our square footage profitably depends on a number of uncertainties, including our ability to locate, lease, build out and open or expand stores in suitable locations on a timely basis under favorable economic terms. We must also open or expand stores within our established geographic markets, where new or expanded stores may draw sales away from our existing stores. We may not manage our expansion effectively, and our failure to achieve our expansion plans could materially and adversely affect our business, financial condition and results of operations.

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A downturn in economic conditions could adversely affect our sales.
 
Economic conditions, such as those caused by recession, inflation, adverse weather conditions, or terrorism, could reduce consumer spending or cause customers to shift their spending to products we either do not sell or do not sell as profitably. For example, we believe customers visited our stores less frequently last year as a result of increased gasoline prices. Adverse economic conditions could disrupt consumer spending and significantly reduce our sales.

Our sales and profits rely on imported merchandise, which may increase in cost or become unavailable.

Merchandise imported directly from overseas accounts for approximately 40% of our total purchases at retail. In addition, we believe that a small portion of our goods purchased from domestic vendors is imported. China is the source of a substantial majority of our imports. Imported goods are generally less expensive than domestic goods and increase our profit margins. A disruption in the flow of our imported merchandise or an increase in the cost of those goods may significantly decrease our profits. Risks associated with our reliance on imported goods include:

§  
disruptions in the flow of imported goods because of factors such as:
o  
raw material shortages, work stoppages, strikes and political unrest;
o  
problems with oceanic shipping, including shipping container shortages;
o  
economic crises and international disputes

§  
increases in the cost of purchasing or shipping foreign merchandise, resulting from:
o  
increases in shipping rates imposed by the trans-Pacific ocean carriers;
o  
changes in currency exchange rates and local economic conditions, including inflation in the country of origin.
o  
failure of the United States to maintain normal trade relations with China; and
o  
import duties, import quota and other trade sanctions;

We could encounter disruptions or additional costs in receiving and distributing merchandise.

Our success depends on our ability to transport merchandise from our suppliers to our distribution centers and then ship it to our stores in a timely and cost-effective manner. We may not anticipate, respond to or control all of the challenges of operating our receiving and distribution systems. Some of the factors that could have an adverse effect on our shipping and receiving systems or costs are:

§  
Shipping. Our oceanic shipping schedules may be disrupted or delayed from time to time. We also have experienced shipping rate increase over the last several years imposed by the trans-Pacific ocean carriers.
§  
Vulnerability to natural or man-made disasters. A fire, explosion or natural disaster at any of our distribution facilities could result in a loss of merchandise and impair our ability to adequately stock our stores. Some of our facilities are especially vulnerable to earthquakes, hurricanes and tornadoes.
§  
Labor disagreement. Labor disagreements or disruptions may result in delays in the delivery of merchandise to our stores and increase costs.
§  
War, terrorism and other events. War and acts of terrorism in the United States, or in China or other parts of Asia where we buy a significant amount of our imported merchandise, could disrupt our supply chain.

Sales below our expectations during peak seasons may cause our operating results to suffer materially.

Our highest sales periods are the Christmas and Easter seasons. We generally realize a disproportionate amount of our net sales and a substantial majority of our operating and net income during the fourth quarter. In anticipation, we stock extra inventory and hire many temporary employees to supplement our stores. An economic downturn during these periods could adversely affect our operating results, particularly operating and net income, to a greater extent than if a downturn occurred at other times of the year. Untimely merchandise delays due to receiving or distribution problems could have a similar effect.

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Pressure from competitors may reduce our sales and profits.

The retail industry is highly competitive. The marketplace is highly fragmented as many different retailers compete for market share by utilizing a variety of store formats and merchandising strategies. We expect competition to increase in the future because there are no significant economic barriers for others to enter our retail sector. Many of our current or potential competitors have greater financial resources than we do. We cannot guarantee that we will continue to be able to compete successfully against existing or future competitors. Please see Item 1 “Business,” of this Form 10-K for further discussion of the effect of competition on our operations.

The resolution of certain legal matters could have a material adverse effect on our results of operations, accrued liabilities and cash.

For a discussion of current legal matters, please see Item 3. Legal Proceedings of this Form 10-K. Resolution of certain matters described in that item, if decided against the Company, could have a material adverse effect on our results of operations, accrued liabilities and cash.


Certain provisions in our articles of incorporation and bylaws could delay or discourage a takeover attempt that may be in a shareholder's best interest
 
Our articles of incorporation and bylaws contain provisions that may delay or discourage a takeover attempt that a shareholder might consider in his best interest, including takeover attempts that might result in a premium being paid for shares of our common stock. These provisions, among other things:
 
·  
classify our board of directors into three classes, each of which serves for different three-year periods;
·  
provide that only the board of directors, chairman or president may call special meetings of the shareholders;
·  
establish certain advance notice procedures for nominations of candidates for election as directors and for shareholder proposals to be considered at shareholders' meetings;
·  
require a vote of the holders of more than two-thirds of the shares entitled to vote in order to remove a director, change the number of directors, or amend the foregoing and certain other provisions of the articles of incorporation and bylaws; and
·  
permit the board of directors, without further action of the shareholders, to issue and fix the terms of preferred stock, which may have rights senior to those of the common stock.

Item 1B. UNRESOLVED STAFF COMMENTS
None.


12

Table of Contents
Index to Consolidated Financial Statements
 
Item 2. PROPERTIES

Stores
As of January 28, 2006, we operated 2,914 stores in 48 states as detailed below:

               
Alabama
77
 
Maine
13
 
Ohio
109
Arizona
43
 
Maryland
69
 
Oklahoma
41
Arkansas
45
 
Massachusetts
32
 
Oregon
62
California
209
 
Michigan
106
 
Pennsylvania
175
Colorado
28
 
Minnesota
35
 
Rhode Island
9
Connecticut
21
 
Mississippi
47
 
South Carolina
68
Delaware
16
 
Missouri
54
 
South Dakota
3
Florida
195
 
Montana
8
 
Tennessee
77
Georgia
116
 
Nebraska
10
 
Texas
193
Idaho
18
 
Nevada
21
 
Utah
31
Illinois
109
 
New Hampshire
13
 
Vermont
6
Indiana
77
 
New Jersey
62
 
Virginia
124
Iowa
24
 
New Mexico
19
 
Washington
50
Kansas
24
 
New York
136
 
West Virginia
30
Kentucky
54
 
North Carolina
142
 
Wisconsin
54
Louisiana
54
 
North Dakota
2
 
Wyoming
3

We currently lease our stores and expect to continue to lease new stores as we expand. Our leases typically provide for a short initial lease term (generally five years) with options to extend. We believe this leasing strategy enhances our flexibility to pursue various expansion opportunities resulting from changing market conditions.

As current leases expire, we believe that we will be able to obtain lease renewals, if desired, for present store locations, or to obtain leases for equivalent or better locations in the same general area. From time to time we may not comply with certain provisions of our store operating leases. We maintain good relations with our landlords and believe that violation of these provisions, if any, will not have a material effect on our operations.

Distribution Centers
The following table includes information about the distribution centers that we currently operate. We believe our distribution center network is capable of supporting approximately $4.5 billion in annual sales.

 
Location
 
Own/Lease
 
Lease Expires
Size in
Square Feet
       
Chesapeake, Virginia
Own
N/A
400,000
Olive Branch, Mississippi
Own
N/A
425,000
Joliet, Illinois
Own
N/A
1,200,000
Stockton, California
Own
N/A
525,000
Briar Creek, Pennsylvania
Own
N/A
603,000
Savannah, Georgia
Own
N/A
603,000
Marietta, Oklahoma
Own
N/A
603,000
Salt Lake City, Utah
Lease
April 2010
252,000
Ridgefield, Washington
Own
N/A
665,000

In addition to our distribution centers noted above, during the past several years we have used off-site facilities to accommodate limited quantities of seasonal merchandise.

With the exception of our Salt Lake City and Ridgefield facilities, each of our distribution centers contains advanced materials handling technologies, including automated conveyor and sorting systems, radio-frequency inventory tracking equipment and specialized information systems.

For more information on financing of our distribution centers, see "Management's Discussion and Analysis - Funding Requirements."

13

Table of Contents
Index to Consolidated Financial Statements
 

Item 3. LEGAL PROCEEDINGS

From time to time, we are defendants in ordinary, routine litigation and proceedings incidental to our business, including allegations regarding:
   
·  
employment related matters;
   
·  
infringement of intellectual property rights;
   
·  
product safety matters, which may include product recalls in cooperation with the Consumer Products Safety Commission; and
   
·  
personal injury claims.

In 2003, we were served with a lawsuit in California state court by a former employee who alleged that employees did not properly receive sufficient meal breaks and paid rest periods. He also alleged other wage and hourly violations. The suit requested that the California state court certify the case as a class action. This suit was dismissed with prejudice in May 2005, and the dismissal has been appealed. In May 2005, a new suit alleging similar claims was filed in California.  
 
In 2005, we were served with a lawsuit by former employees in Oregon who allege that they did not properly receive sufficient meal breaks and paid rest periods. They also allege other wage and hour violations. The plaintiffs have requested the Oregon state court to certify the case as a class action.
 
In 2006, we were served with a lawsuit by former employees in Washington who allege that they did not properly receive sufficient meal breaks and paid rest periods. They also allege other wage and hour violations. The plaintiffs have requested the Washington state court to certify the case as a class action.
 
We will vigorously defend ourselves in these lawsuits. We do not believe that any of these matters will, individually or in the aggregate, have a material adverse effect on our business or financial condition. We cannot give assurance, however, that one or more of these lawsuits will not have a material adverse effect on our results of operations for the period in which they are resolved.
 
We were served in another lawsuit that alleged various intellectual property violations. We settled the lawsuit in May 2005. The terms of the settlement are confidential and we are indemnified by a supplier. The settlement was not significant to the financial statements.
 

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

No matters were submitted to a vote of security holders during the fourth quarter of our 2005 fiscal year.

14

Table of Contents
Index to Consolidated Financial Statements
 

PART II

Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock has been traded on The Nasdaq Stock Market® under the symbol "DLTR" since our initial public offering on March 6, 1995. The following table gives the high and low sales prices of our common stock as reported by Nasdaq for the periods indicated.

   
High
 
Low
 
Fiscal year ended January 29, 2005:
             
               
First Quarter
 
$
33.97
 
$
26.82
 
Second Quarter
   
29.20
   
24.50
 
Third Quarter
   
29.28
   
22.29
 
Fourth Quarter
   
30.29
   
26.40
 
               
Fiscal year ended January 28, 2006:
             
               
First Quarter
 
$
29.04
 
$
23.95
 
Second Quarter
   
26.01
   
22.77
 
Third Quarter
   
25.65
   
20.56
 
Fourth Quarter
   
25.48
   
20.66
 

On April 7, 2006, the last reported sale price for our common stock, as quoted by Nasdaq, was $27.67 per share. As of April 7, 2006, we had approximately 580 shareholders of record.

We had no stock repurchases in the fourth quarter of 2005. In March 2005, our Board of Directors authorized the repurchase of up to $300.0 million of our common stock during the next three years and concurrently terminated the previous November 2002, $200.0 million authorization. For 2005 and 2004, we repurchased 7,024,450 shares and 1,809,953 shares, respectively, for approximately $180.4 million and $48.6 million, respectively. As of January 28, 2006, we had approximately $174.9 million remaining under the March 2005 authorization. From January 29, 2006 through March 31, 2006, we have repurchased additional shares totaling $22.6 million under this authorization.

We anticipate that substantially all of our cash flow from operations in the foreseeable future will be retained for the development and expansion of our business, the repayment of indebtedness and, as authorized by our Board of Directors, the repurchase of stock. Management does not anticipate paying dividends on our common stock in the foreseeable future. In addition, our credit facilities contain financial covenants that restrict our ability to pay cash dividends.

Item 6. SELECTED FINANCIAL DATA

The following table presents a summary of our selected financial data for the fiscal years ended January 28, 2006, January 29, 2005, and January 31, 2004 and the calendar years ended December 31, 2002 and 2001. In January 2003, we changed our fiscal year end to a retail fiscal year ending on the Saturday closest to January 31. The selected income statement and balance sheet data have been derived from our consolidated financial statements that have been audited by our independent registered public accounting firm. This information should be read in conjunction with the consolidated financial statements and related notes, "Management’s Discussion and Analysis of Financial Condition and Results of Operations" and our financial information found elsewhere in this report.

Comparable store net sales compare net sales for stores open throughout each of the two periods being compared, including expanded stores. Net sales per store and net sales per selling square foot are calculated for stores open throughout the period presented.

Amounts in the following tables are in thousands, except per share data, number of stores data, and net sales per selling square foot data. Prior year gross profit and selling, general and administrative amounts have been reclassified to conform to the 2004 lease accounting changes. For more information on the lease accounting changes, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Footnote 1 in the “Notes to the Consolidated Financial Statements.”
15

Table of Contents
Index to Consolidated Financial Statements
 

   
Years Ended
 
   
January 28,
 
January 29,
 
January 31,
 
December 31,
 
December 31,
 
 
 
2006
 
2005
 
2004
 
2002
 
2001
 
Income Statement Data:
                     
Net sales
 
$
3,393,924
 
$
3,126,009
 
$
2,799,872
 
$
2,329,188
 
$
1,987,271
 
Gross profit
   
1,172,363
   
1,112,539
   
1,018,413
   
851,974
   
718,830
 
Selling, general and administrative expenses
   
889,124
   
818,988
   
724,816
   
598,053
   
512,092
 
Operating income
   
283,239
   
293,551
   
293,597
   
253,921
   
203,865
 
Net income
   
173,918
   
180,250
   
177,583
   
154,647
   
123,081
 
                                 
Margin Data (as a percentage of net sales):
                               
Gross profit
   
34.5
%
 
35.6
%
 
36.4
%
 
36.6
%
 
36.0
%
Selling, general and administrative expenses
   
26.2
%
 
26.2
%
 
25.9
%
 
25.7
%
 
25.7
%
Operating income
   
8.3
%
 
9.4
%
 
10.5
%
 
10.9
%
 
10.3
%
Net income
   
5.1
%
 
5.8
%
 
6.3
%
 
6.6
%
 
6.2
%
                                 
Per Share Data:
                               
                                 
Diluted net income per share
 
$
1.60
 
$
1.58
 
$
1.54
 
$
1.35
 
$
1.09
 
Diluted net income per share increase
   
1.3
%
 
2.6
%
 
14.1
%
 
23.9
%
 
0.9
%

   
As of
 
   
January 28
 
January 29,
 
January 31,
 
December 31,
 
December 31,
 
 
 
2006
 
2005
 
2004
 
2002
 
2001
 
Balance Sheet Data:
                     
Cash and cash equivalents
                     
and short-term investments
 
$
339,784
 
$
317,807
 
$
168,685
 
$
335,972
 
$
236,653
 
Working capital
   
648,220
   
675,532
   
450,279
   
509,629
   
360,757
 
Total assets
   
1,798,400
   
1,792,672
   
1,501,519
   
1,116,377
   
902,048
 
Total debt
   
269,948
   
281,746
   
185,151
   
54,429
   
62,371
 
Shareholders' equity
   
1,172,275
   
1,164,212
   
1,014,522
   
855,404
   
651,736
 
 
   
Years Ended  
 
   
January 28, 
 
 
January 29,
 
 
January 31,
 
 
December 31,
 
 
December 31,
 
 
 
 
2006
 
 
2005
 
 
2004
 
 
2002
 
 
2001
 
Selected Operating Data:
                               
Number of stores open at end of period
   
2,914
   
2,735
   
2,513
   
2,263
   
1,975
 
Gross square footage at end of period
   
29,238
   
25,948
   
21,416
   
16,527
   
12,791
 
Selling square footage at end of period
   
23,021
   
20,444
   
16,878
   
13,042
   
10,129
 
Selling square footage annual growth
   
12.6
%
 
21.1
%
 
27.5
%
 
28.8
%
 
29.6
%
Net sales annual growth
   
8.6
%
 
11.6
%
 
18.7
%
 
17.2
%
 
17.7
%
Comparable store net sales increase (decrease)
   
(0.8
%)
 
0.5
%
 
2.9
%
 
1.0
%
 
0.1
%
Net sales per selling square foot
 
$
152
 
$
169
 
$
180
 
$
199
 
$
217
 
Net sales per store
 
$
1,183
 
$
1,163
 
$
1,134
 
$
1,083
 
$
1,043
 
Selected Financial Ratios:
                               
Return on assets
   
9.7
%
 
10.9
%
 
13.7
%
 
15.3
%
 
14.9
%
Return on equity
   
14.9
%
 
16.5
%
 
19.0
%
 
20.5
%
 
21.0
%
Inventory turns
   
3.7
   
3.5
   
3.7
   
4.5
   
4.6
 
16

Table of Contents
Index to Consolidated Financial Statements
 

Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

In Management’s Discussion and Analysis, we explain the general financial condition and the results of operations for our company, including:
   
·  
what factors affect our business;
   
·  
what our earnings, gross margins and costs were in 2005 and 2004;
   
·  
why those earnings, gross margins and costs were different from the year before;
   
·  
how all of this affects our overall financial condition;
   
·  
what our expenditures for capital projects were in 2005 and what we expect them to be in 2006; and
   
·  
where funds will come from to pay for future expenditures.

As you read Management’s Discussion and Analysis, please refer to our consolidated financial statements, included in Item 8 of this Form 10-K, which present the results of operations for the fiscal years ended January 28, 2006, January 29, 2005 and January 31, 2004. In Management’s Discussion and Analysis, we analyze and explain the annual changes in some specific line items in the consolidated financial statements for the fiscal year 2005 compared to the comparable fiscal year 2004 and the fiscal year 2004 compared to the comparable fiscal year 2003.

Key Events and Recent Developments
Several key events have had or are expected to have a significant effect on our results of operations. You should keep in mind that:

·  
In March 2006, we completed our acquisition of 138 Deal$ stores and related assets. We paid approximately $30.5 million for store related assets and $22.2 million for store and distribution center inventory. These amounts are subject to post-closing adjustments based on the results of physical inventory counts.
·  
On December 15, 2005, the Compensation Committee of our Board of Directors approved the acceleration of the vesting date of all previously issued, outstanding and unvested options under all current stock option plans, effective as of December 15, 2005. This decision eliminated non-cash compensation expense that would have been recorded in future periods following our adoption of Statement of Financial Accounting Standards No. 123, Share-Based Payment (revised 2004) (FAS 123R), on January 29, 2006. Future compensation expense has been reduced by approximately $14.9 million over a period of four years during which the options would have vested, as a result of the option acceleration program.
·  
In March 2005, our Board of Directors authorized the repurchase of up to $300 million of our common stock during the next three years. This authorization superseded the previous repurchase program authorized by the Board in November 2002. As of January 28, 2006, we had $174.9 million remaining under this authorization.
·  
In 2004, we completed construction and began operations in two new distribution centers. In June 2004, we began operations in our new distribution center in Joliet, Illinois. The Joliet distribution center is a 1.2 million square foot, fully automated facility that replaced our Chicago distribution center. In February 2004, we began operations in our Ridgefield, Washington distribution center. The Ridgefield distribution center is a 665,000 square foot facility that can be expanded to accommodate future growth needs. With the completion of these two distribution centers, we now have nine distribution centers that will support approximately $4.5 billion in sales annually. We do not plan to expand our distribution center capacity until at least fiscal 2007.
·  
In March 2004, we entered into a five-year $450.0 million Unsecured Revolving Credit Facility (Facility). We used availability under this Facility to repay the $142.6 million of variable rate debt. This Facility also replaced our previous $150.0 million revolving credit facility.
·  
In June 2003, we completed our acquisition of Greenbacks, Inc., based in Salt Lake City, Utah. Greenbacks operated 100 stores in 10 western states and an expandable 252,000 square foot distribution center in Salt Lake City. We accounted for this acquisition under the purchase method of accounting and as a result, Greenbacks is included in our results since the date of acquisition, which was June 29, 2003.

17

Table of Contents
Index to Consolidated Financial Statements
 
Overview
Our net sales are derived from the sale of merchandise. Two major factors tend to affect our net sales trends. First is our success at opening new stores or adding new stores through acquisitions. Second, sales vary at our existing stores from one year to the next. We refer to this change as a change in comparable store net sales, because we compare only those stores that are open throughout both of the periods being compared. We include sales from stores expanded during the year in the calculation of comparable store net sales, which has the effect of increasing our comparable store net sales. The term 'expanded' also includes stores that are relocated.

In fiscal 2005, we increased our selling square footage by approximately 13%. Of the 2.6 million selling square foot increase in 2005, approximately 0.5 million was added by expanding existing stores. The increase in selling square footage fell slightly below our planned square footage growth of 14%-16% as we closed more stores than planned in fiscal 2005 and our average new store size was slightly below target. The average size of our stores opened in 2005 was approximately 10,000 selling square feet (or about 12,400 gross square feet). In 2006, we expect to open stores slightly smaller than in 2005. These stores generate higher sales and operating income per store than our smaller stores and we believe that they create an improved shopping environment that invites customers to shop longer and buy more.

For fiscal 2005, we experienced a decrease in comparable store net sales of 0.8%. This had a negative effect on sales as we had planned to have comparable store net sales to be flat or slightly positive for 2005. Our comparable store net sales results were positively affected by the addition of 0.5 million selling square feet due to expanded and relocated stores during the year. The decrease in comparable store net sales was the result of a decline of 2.6% in the number of transactions, partially offset by an increase of 1.9% in transaction size. We believe comparable store net sales were primarily affected by the impact of higher fuel costs, which leave our customers with less disposable income, causing them to make fewer shopping trips and the shift in the timing of Easter from April 11 in 2004 to March 27 in 2005. Most retailers have the ability to increase their merchandise prices or alter the mix of their merchandise to favor higher-priced items in order to increase their comparable store net sales. As a fixed-price point retailer, we do not have the ability to raise our prices. Generally, our comparable store net sales will increase only if we sell more units per transaction or experience an increase in the number of transactions.

In 2005, we put initiatives in place that we believe are helping to offset some of the effect that higher fuel costs are having on our sales, including increased advertising of featured products and continued expansion of forms of payment accepted by our stores. Currently, over 2,300 of our stores accept debit cards, including over 1,400 stores which began accepting debit cards beginning with the roll-out in May 2005. We began to see positive effects from these initiatives in the second half of 2005 and believe that they will help increase comparable store net sales, despite continued high fuel costs.

We experienced a slight shift in the mix of merchandise sold to more consumables, which have lower margin, in 2005. We believe that higher fuel costs in 2005, which left our customers with less disposable income, contributed to the shift to more consumables as our customers bought more consumable and everyday items as opposed to our other merchandise categories. The shift in mix to more consumables is also the result of the roll-out of freezers and coolers to approximately 200 stores in 2005. As we continue to roll-out freezers and coolers to approximately 250 more stores in 2006, we expect to continue to see the pressure on margins in 2006. However, we believe that this will enable us to increase sales and earnings in the future by increasing the number of shopping trips made by our customers.

We expect the substantial majority of our future net sales growth to come from square footage growth resulting from new store openings and expansion of existing stores. We expect the average size of new stores opened in fiscal 2006 to be approximately 9,200 selling square feet per store (or about 11,400 gross square feet). We believe this size allows us to achieve our objectives in the markets in which we plan to expand. Larger stores take longer to negotiate, build out and open and generally have lower net sales per square foot than our smaller stores. While our newer, larger stores have lower sales per square foot than older, smaller stores, they generate higher sales and operating income dollars per store and create an improved shopping environment that invites customers to shop longer and buy more.

We must control our merchandise costs, inventory levels and our general and administrative expenses. Increases in these expenses could negatively impact our operating results because we cannot pass on increased expenses to our customers by increasing our merchandise-selling price above the $1.00 price point in our Dollar Tree stores.

18

During the first half of fiscal 2004, we completed the rollout of our point-of-sale systems to most of our stores. Our point-of-sale technology provides us with valuable sales information to assist our buyers and to improve merchandise allocation to the stores. We believe that it has enabled us to better control our inventory, which has resulted in more efficient distribution and store operations. Using the data from this system to better plan our inventory purchases has helped us reduce inventory per store by almost 12% as of January 28, 2006 and increase inventory turnover in the current year.

Our plans for fiscal 2006 anticipate comparable store net sales increases of about flat to slightly positive yielding net sales in the $3.845 to $3.940 billion range and diluted earnings per share of $1.68 to $1.80. We also expect a shift in the seasonality of our earnings in 2006. Easter is 20 days later in the current year, positively impacting the first quarter of 2006, and there is an extra shopping day between Thanksgiving and Christmas, which will impact the fourth quarter as compared to the prior year. Also, the retail calendar provides us with one extra week of sales in fiscal 2006. This guidance for 2006 is based on 12%-14% selling square footage growth, which includes the acquisition of 138 Deal$ stores, or about 5% of the overall increase (See Deal$ discussion below).

On March 26, 2006, we completed our acquisition of 138 Deal$ stores for approximately $30.5 million of store related assets and $22.2 million of store and distribution center related inventory. These amounts are subject to post-closing adjustments based on the results of physical inventory counts. These stores are primarily in the Midwest part of the United States and we have existing logistics capacity to service these stores with no additional capital expenditure required. This acquisition also includes a few “combo” stores that offer an expanded assortment of merchandise including items that sell for more than $1. Substantially all Deal$ stores acquired will continue to operate under the Deal$ banner while providing us an opportunity to leverage our Dollar Tree infrastructure in the testing of new merchandise concepts, including higher price points without disrupting the single-price point model in our Dollar Tree stores.

In the fourth quarter of 2004, we recognized a one-time non-cash, after-tax adjustment of approximately $5.7 million, or $0.05 per diluted share, to reflect the cumulative impact of a correction of our accounting practices related to leased properties. Of the aforementioned amount, approximately $1.2 million, or $0.01 per diluted share, related to 2004. This adjustment was made in light of the views of the Office of the Chief Accountant of the Securities and Exchange Commission, expressed in a letter of February 7, 2005, to the American Institute of Certified Public Accountants regarding the application of generally accepted accounting principles to operating lease accounting matters. Consistent with the then current industry practices, we had reported straight-line expenses for leases beginning on the earlier of the store opening date or the commencement date of the lease in prior periods. This had the effect of excluding the pre-opening or build-out period of our stores (generally 60 days) from the calculation of the period over which we expense rent. In addition, amounts received as tenant allowances or rent abatements were reflected in the balance sheet as a reduction to store leasehold improvement costs instead of being classified as deferred lease credits. The adjustment made to correct these practices does not affect historical or future net cash flows or the timing of payments under related leases. Rather, this change affected the classification of costs on the consolidated statement of operations and cash flows by increasing depreciation and decreasing rent expense, which is included as cost of sales. In addition, fixed assets and deferred liabilities increased due to the net cumulative unamortized allowances and abatements. These new lease accounting practices had an approximate $0.02 per diluted share negative effect on 2005 earnings.


19

Table of Contents
Index to Consolidated Financial Statements
 

Results of Operations 
The following table expresses items from our consolidated statements of operations, as a percentage of net sales:

   
Year Ended
 
Year Ended
 
Year Ended
 
 
 
January 28,
 
January 29,
 
January 31,
 
 
 
2006
 
2005
 
2004
 
               
Net sales
   
100.0
%
 
100.0
%
 
100.0
%
Cost of sales
   
65.5
%
 
64.4
%
 
63.6
%
Gross profit
   
34.5
%
 
35.6
%
 
36.4
%
                     
Selling, general and administrative
                   
expenses
   
26.2
%
 
26.2
%
 
25.9
%
                     
Operating income
   
8.3
%
 
9.4
%
 
10.5
%
                     
Interest income
   
0.2
%
 
0.1
%
 
0.1
%
Interest expense
   
(0.4
%)
 
(0.3
%)
 
(0.3
%)
                     
Income before income taxes
   
8.1
%
 
9.2
%
 
10.3
%
                     
Provision for income taxes
   
(3.0
%)
 
(3.4
%)
 
(4.0
%)
                     
Net income
   
5.1
%
 
5.8
%
 
6.3
%


Fiscal year ended January 28, 2006 compared to fiscal year ended January 29, 2005
 
Net Sales. Net sales increased 8.6% in 2005 compared to 2004. We attribute this $267.9 million increase in net sales primarily to new stores in 2005 and 2004 (which are not included in our comparable store net sales calculation) partially offset by a slight decrease in comparable store net sales of 0.8% in 2005. Our comparable store net sales are positively affected by our expanded and relocated stores, which we include in the calculation, and, to a lesser extent, are negatively affected when we open new stores or expand stores near existing stores. Our stores larger than 10,000 gross square feet continue to produce our best comparable store net sales results.

The following table summarizes the components of the changes in our store count for fiscal years ended January 28, 2006 and January 29, 2005.

   
January 28, 2006
 
January 29, 2005
 
           
New stores
   
197
   
209
 
Acquired leases
   
35
   
42
 
Expanded or relocated stores
   
93
   
129
 
Closed stores
   
(53
)
 
(29
)

Of the 2.6 million selling square foot increase in 2005, approximately 0.5 million in selling square feet was added by expanding existing stores.

Gross Profit. Gross profit margin decreased to 34.5% in 2005 compared to 35.6% in 2004. The decrease is primarily due to the following:

·  
Merchandise cost, including inbound freight, increased approximately 55 basis points, due to a slight shift in mix to more consumables, which have a lower margin and increased inbound freight costs due to higher fuel costs.
·  
Occupancy costs increased approximately 45 basis points due primarily to deleveraging associated with the negative comparable store net sales for the year.


20

Table of Contents
Index to Consolidated Financial Statements
 

Selling, General and Administrative Expenses. Selling, general and administrative expenses, as a percentage of net sales, were 26.2% for 2005 and 2004. However, several components had increases or decreases as noted below:

·  
Operating and corporate expenses decreased approximately 25 basis points primarily due to decreased store supplies expense as a result of better pricing, decreased professional fees and the receipt of insurance proceeds resulting from a fire at one of our locations, partially offset by increased interchange fees resulting from the rollout of our debit card program in 2005.
·  
Payroll related costs decreased approximately 10 basis points due to a reduction in incentive compensation accruals that are based on 2005 earnings and lower workers’ compensation and health care claims in the current year.
·  
These decreases were partially offset by an approximate 25 basis point increase in store operating costs primarily due to higher utility costs due to higher rates and consumption in the current year.
·  
Depreciation expense for stores also increased 10 basis points primarily due to the deleveraging associated with negative comparable store net sales for the current year.
 
Operating Income. Due to the reasons discussed above, operating income margin decreased to 8.3% in 2005 compared to 9.4% for 2004.

Interest Income. Interest income increased $2.2 million in 2005 compared to 2004 because of higher investment balances in the current year and increased interest rates.

Interest Expense. Interest expense increased $4.8 million in 2005 as compared to 2004. This increase is primarily due to increased rates on our revolver in the current year.

Income Taxes. Our effective tax rate was 36.8% in 2005 compared to 37.5% in 2004. The decreased tax rate for 2005 was due primarily to the resolution of tax uncertainties in the current year and increased tax-exempt interest on certain of our investments.

Fiscal year ended January 29, 2005 compared to fiscal year ended January 31, 2004
 
Net Sales. Net sales increased 11.6% in 2004 compared to 2003. We attribute this $326.1 million increase in net sales primarily to new stores in 2004 and 2003 which are not included in our comparable store net sales calculation and to a slight increase in comparable store net sales of 0.5% in 2004. Our comparable store net sales are positively affected by our expanded and relocated stores, which we include in the calculation, and, to a lesser extent, are negatively affected when we open new stores or expand stores near existing stores. If not for the positive effect of relocated stores, our comparable store net sales results would have been negative in 2004.

The following table summarizes the components of the changes in our store count for fiscal years ended January 29, 2005 and January 31, 2004.

   
January 29, 2005
 
January 31, 2004
 
           
New stores
   
209
   
183
 
Acquired stores
   
-
   
100
 
Acquired leases
   
42
   
-
 
Expanded or relocated stores
   
129
   
124
 
Closed stores
   
(29
)
 
(42
)

Of the 3.6 million selling square foot increase in 2004, approximately 0.9 million in selling square feet was added by expanding existing stores.

21

Table of Contents
Index to Consolidated Financial Statements
 

Gross Profit. Gross profit margin decreased to 35.6% in 2004 compared to 36.4% in 2003. The decrease is primarily due to the following:

·  
Merchandise cost, including inbound freight, increased approximately 20 basis points, primarily due to increases in inbound freight costs. Inbound freight costs increased due to higher fuel costs and higher import rates.
·  
Markdown expense increased approximately 15 basis points due primarily to hurricane related markdowns in the third quarter of 2004. Also, markdowns taken on lower than planned seasonal sell through of Christmas merchandise and a longer post Christmas holiday sale than in 2003 resulted in higher promotional markdowns.
·  
Occupancy costs increased approximately 65 basis points due to deleveraging associated with the low comparable store net sales increase and the increase in rent expense in 2004 due to lease accounting changes noted in the “Overview.”
·  
Partially offsetting these increases was an approximate 20 basis point decrease in shrink expense due to the overall improvement in the shrink rate in 2004.

Selling, General and Administrative Expenses. Selling, general and administrative expenses, as a percentage of net sales, increased to 26.2% in 2004 compared to 25.9% in 2003. The increase is primarily due to the following:

·  
Depreciation expense increased approximately 30 basis points as a result of our larger new and expanded stores and the continued installation of our point-of-sales systems and other technology assets.
·  
Advertising costs increased approximately 15 basis points due to increased electronic media and print advertising in certain markets in 2004.
·  
Insurance and benefits expense increased approximately 10 basis points due to increased health care and workers’ compensation expenses in 2004.
·  
Partially offsetting these rate increases was an approximate 15 basis point decrease in store payroll costs in 2004 due to continued improvements in store-level labor productivity.
 
Operating Income. Due to the reasons discussed above, operating income margin decreased to 9.4% in 2004 compared to 10.5% for 2003.

Interest Expense. Interest expense increased $1.9 million in 2004 as compared to 2003. This increase is due to increased debt in the current year and $0.7 million of deferred financing costs that were charged to interest expense as a result of the refinancing of the $150.0 million credit facility and the repayment of the $142.6 million of variable rate debt in March 2004.

Income Taxes. Our effective tax rate was 37.5% in 2004 compared to 38.5% in 2003. The decreased tax rate for 2004 was due primarily to a tax benefit of $2.3 million, or 80 basis points, related to the resolution of a tax uncertainty and approximately $0.6 million, or 20 basis points, related to tax exempt interest on our investments.

Liquidity and Capital Resources
Our business requires capital to build and open new stores, expand our distribution network and operate existing stores. Our working capital requirements for existing stores are seasonal and usually reach their peak in September and October. Historically, we have satisfied our seasonal working capital requirements for existing stores and have funded our store opening and distribution network expansion programs from internally generated funds and borrowings under our credit facilities.

The following table compares cash-related information for the years ended January 28, 2006, January 29, 2005, and January 31, 2004:

   
Year Ended
 
Year Ended
 
Year Ended
 
 
 
January 28,
 
January 29,
 
January 31,
 
(in millions)
 
2006
 
2005
 
2004
 
Net cash provided by (used in):
             
Operating activities
 
$
365.1
 
$
276.5
 
$
243.7
 
Investing activities
   
(235.5
)
 
(315.4
)
 
(282.4
)
Financing activities
   
(170.3
)
 
61.3
   
(35.5
)

22

Table of Contents
Index to Consolidated Financial Statements
 

The $88.6 million increase in cash provided by operating activities in 2005 was primarily due to an approximate 12% decrease in inventory per store at January 28, 2006 compared to January 29, 2005. The inventory per store decrease is the result of an initiative to lower backroom inventory levels and increase inventory turns through a reduction in current year purchases. The aforementioned net cash provided was partially offset by a decrease in deferred tax liabilities chiefly as a result of the elimination of bonus depreciation.

The $79.9 million decrease in cash used in investing activities in 2005 compared to 2004 was the result of a $34.2 million decrease in net purchases of investments resulting from more cash used to repurchase stock in the current year. The net purchases of investments in the current year include $29.9 million of investments that are in a restricted account to collateralize certain long-term insurance obligations. These investments replaced higher cost stand-by letters of credit and surety bonds. Capital expenditures also decreased $42.5 million in the current year after two distribution center projects and point-of-sale installations were completed in 2004.

The $231.6 million change in cash used in financing activities in 2005 compared to 2004 primarily resulted from $180.4 million in stock repurchases in the current year compared to $48.6 million in the prior year. Also in the prior year, we entered into a five-year $450.0 million Revolving Credit Facility, under which we received proceeds of $250.0 million. We used a portion of these proceeds to repay $142.6 million of variable rate debt for our distribution centers and invested the balance in short-term tax exempt municipal bonds. As of January 28, 2006, we had $250.0 million outstanding and $200.0 million available under this facility. This facility bears interest at LIBOR, plus 0.475% spread.
 
The $32.8 million increase in cash provided by operating activities in 2004 was primarily due to increased profitability before non-cash depreciation and amortization expense. Increased non-cash depreciation expense was primarily attributed to our square footage growth in 2004, two new distribution centers in 2004 and our continued installation of our point-of-sale systems and other technology assets.

Cash used in investing activities is generally expended to open new stores and to expand or relocate existing stores. The $33.0 million increase in 2004 compared to 2003 was primarily due to the following:

·  
increased investment of cash from borrowings under our Facility in 2004;
   
·  
this increase was partially offset by the acquisition of Greenbacks for approximately $100.5 million in 2003; and
   
·  
decreased capital expenditures due to higher expenditures in 2003 on our distribution center projects that were completed in the first half of 2004

The $96.8 million change in cash provided by financing activities in 2004 compared to 2003 was primarily the result of the following:

·  
increased borrowings under our Facility, net of the repayment of our variable rate debt for our distribution centers;
   
·  
partially offsetting this increase in cash is a $10.6 million increase in stock repurchases in 2004 under a $200.0 million authorization granted by our Board of Directors in November 2002 and a $7.1 million decrease in cash proceeds from stock issued under stock-based compensation plans

At January 28, 2006, our long-term borrowings were $269.0 million and our capital lease commitments were $0.9 million. We also have a $125.0 million and a $50.0 million Letter of Credit Reimbursement and Security Agreement, under which approximately $81.6 million were committed to letters of credit issued for routine purchases of imported merchandise at January 28, 2006.

In March 2005, our Board of Directors authorized the repurchase of up to $300.0 million of our common stock during the next three years. This authorization terminated the previous November 2002, $200.0 million authorization. For 2005 and 2004, we repurchased 7,024,450 shares and 1,809,953 shares, respectively, for approximately $180.4 million and $48.6 million, respectively. As of January 28, 2006, we have approximately $174.9 million remaining under the March 2005 authorization. From January 29, 2006 through March 31, 2006, we have repurchased additional shares totaling $22.6 million under this authorization.

23

Table of Contents
Index to Consolidated Financial Statements
 
Funding Requirements

Overview
In 2005, the average investment per new store, including capital expenditures, initial inventory and pre-opening costs, was approximately $508,000. We expect our cash needs for opening new stores and expanding existing stores in fiscal 2006 to total approximately $136.0 million, which includes capital expenditures, initial inventory and pre-opening costs. Our estimated capital expenditures for fiscal 2006 are between $145.0 and $155.0 million, including planned expenditures for our new and expanded Dollar Tree stores, improvements to the acquired Deal$ stores and investments in technology. We believe that we can adequately fund our working capital requirements and planned capital expenditures for the next few years from net cash provided by operations and borrowings under our existing credit facilities.

The following tables summarize our material contractual obligations, including both on- and off-balance sheet arrangements, and our commitments (in millions):

Contractual Obligations
 
Total
 
2006
 
2007
 
2008
 
2009
 
2010
 
Thereafter
 
Lease Financing
                             
Operating lease obligations
 
$
1,015.1
 
$
243.2
 
$
212.9
 
$
174.5
 
$
138.5
 
$
96.2
 
$
149.8
 
Capital lease obligations
   
1.1
   
0.4
   
0.3
   
0.2
   
0.1
   
0.1
   
--
 
                                             
Long-term Borrowings
                                           
Revolving credit facility
   
250.0
   
--
   
--
   
--
   
250.0
   
--
   
--
 
Revenue bond financing
   
19.0
   
19.0
   
--
   
--
   
--
   
--
   
--
 
                                             
Total obligations
 
$
1,285.2
 
$
262.6
 
$
213.2
 
$
174.7
 
$
388.6
 
$
96.3
 
$
149.8
 

Commitments
 
Total
 
Expiring in 2006
 
Expiring in 2007
 
Expiring in 2008
 
Expiring in 2009
 
Expiring in 2010
 
Thereafter
 
                               
Letters of credit and surety bonds
 
$
124.7
 
$
122.7
 
$
2.0
 
$
--
 
$
--
 
$
--
 
$
--
 
Freight contracts
   
47.2
   
31.8
   
13.5
   
1.9
   
--
   
--
   
--
 
Technology assets
   
6.5
   
6.5
   
--
   
--
   
--
   
--
   
--
 
Total commitments
 
$
178.4
 
$
161.0
 
$
15.5
 
$
1.9
 
$
--
 
$
--
 
$
--
 

Lease Financing
Operating Lease Obligations. Our operating lease obligations are primarily for payments under noncancelable store leases. The commitment includes amounts for leases that were signed prior to January 28, 2006 for stores that were not yet open on January 28, 2006.

Capital Lease Obligations. Our capital lease obligations are primarily for payments for distribution center equipment and computer equipment at the store support center.

Long-Term Borrowings
Revolving Credit Facility. In March 2004, we entered into a five-year Revolving Credit Facility (the Facility). The Facility provides for a $450.0 million line of credit, including up to $50.0 million in available letters of credit, bearing interest at LIBOR, plus 0.475%. The Facility, among other things, requires the maintenance of certain specified financial ratios, restricts the payment of certain distributions and prohibits the incurrence of certain new indebtedness. We used availability under this Facility to repay the $142.6 million of variable-rate debt and to purchase short-term investments. As of January 28, 2006, we had $250.0 million outstanding on this Facility.

Revenue Bond Financing. In May 1998, we entered into an agreement with the Mississippi Business Finance Corporation under which it issued $19.0 million of variable-rate demand revenue bonds. We used the proceeds from the bonds to finance the acquisition, construction and installation of land, buildings, machinery and equipment for our distribution facility in Olive Branch, Mississippi. At January 28, 2006, the balance outstanding on the bonds was $19.0 million. These bonds are due to be repaid in June 2018. The bonds do not have a prepayment penalty as long as the interest rate remains variable. The bonds contain a demand provision and, therefore, outstanding amounts are classified as current liabilities. We pay interest monthly based on a variable interest rate, which was 4.6% at January 28, 2006.

24

Table of Contents
Index to Consolidated Financial Statements
 

Commitments
Letters of Credit and Surety Bonds. In March 2001, we entered into a Letter of Credit Reimbursement and Security Agreement, which provides $125.0 million for letters of credit. In December 2004, we entered into an additional Letter of Credit Reimbursement and Security Agreement, which provides $50.0 million for letters of credit. Both of these letters of credit are generally issued for the routine purchase of imported merchandise. Approximately $81.6 million was committed to letters of credit at January 28, 2006. We also have letters of credit or surety bonds outstanding for our insurance programs and certain utility payment obligations at some of our stores.

Freight Contracts. We have contracted outbound freight services from various carriers with contracts expiring through April 2008. The total amount of these commitments is approximately $47.2 million.

Technology Assets. We have commitments totaling approximately $6.5 million to primarily purchase store technology assets for our stores during 2006.

Derivative Financial Instruments
We are party to two interest rate swaps, which allow us to manage the risk associated with interest rate fluctuations on the demand revenue bonds and a portion of our revolving credit facility. The swaps are based on notional amounts of $19.0 million and $25.0 million. Under the $19.0 million agreement, as amended, we pay interest to the bank that provided the swap at a fixed rate. In exchange, the financial institution pays us at a variable-interest rate, which is similar to the rate on the demand revenue bonds. The variable-interest rate on the interest rate swap is set monthly. No payments are made by either party under the swap for monthly periods with an established interest rate greater than a predetermined rate (the knock-out rate). The swap may be canceled by the bank or us and settled for the fair value of the swap as determined by market rates and expires in 2009.

The $25.0 million interest rate swap agreement is used to manage the risk associated with interest rate fluctuations on a portion of our revolving credit facility. Under this agreement, we pay interest to a financial institution at a fixed rate of 5.43%. In exchange, the financial institution pays us at a variable-interest rate, which approximates the floating rate on the debt, excluding the credit spread. The interest rate on the swap is subject to adjustment monthly. The swap is effective through March 2006, but it may be canceled by the bank or us and settled for the fair value of the swap as determined by market rates.

Because of the knock-out provision in the $19.0 million swap, changes in the fair value of that swap are recorded in earnings. Changes in fair value on our $25.0 million interest rate swap are recorded as a component of "accumulated other comprehensive income" in the consolidated balance sheets because the swap qualifies for hedge accounting treatment in accordance with Statement of Financial Accounting Standards No. 133, as amended by Statement of Financial Accounting Standards No. 138. The amounts recorded in accumulated other comprehensive income are subsequently reclassified into earnings in the same period in which the related interest affects earnings.

For more information on the interest rate swaps, see "Quantitative and Qualitative Disclosures About Market Risk - Interest Rate Risk."

Critical Accounting Policies
The preparation of financial statements requires the use of estimates. Certain of our estimates require a high level of judgment and have the potential to have a material effect on the financial statements if actual results vary significantly from those estimates. Following is a discussion of the estimates that we consider critical.

Inventory Valuation
As discussed in Note 1 to the Consolidated Financial Statements, inventories at the distribution centers are stated at the lower of cost or market with cost determined on a weighted-average basis. Cost is assigned to store inventories using the retail inventory method on a weighted-average basis. Under the retail inventory method, the valuation of inventories at cost and the resulting gross margins are computed by applying a calculated cost-to-retail ratio to the retail value of inventories. The retail inventory method is an averaging method that has been widely used in the retail industry and results in valuing inventories at lower of cost or market when markdowns are taken as a reduction of the retail value of inventories on a timely basis.

Inventory valuation methods require certain significant management estimates and judgments, including estimates of future merchandise markdowns and shrink, which significantly affect the ending inventory valuation at cost as well as the resulting gross margins. The averaging required in applying the retail inventory method and the estimates of shrink and markdowns could, under certain circumstances, result in costs not being recorded in the proper period.

25

Table of Contents
Index to Consolidated Financial Statements
 
We estimate our markdown reserve based on the consideration of a variety of factors, including, but not limited to, quantities of slow moving or carryover seasonal merchandise on hand, historical markdown statistics and future merchandising plans. The accuracy of our estimates can be affected by many factors, some of which are outside of our control, including changes in economic conditions and consumer buying trends. Historically, we have not experienced significant differences in our estimated reserve for markdowns compared with actual results.

Our accrual for shrink is based on the actual, historical shrink results of our most recent physical inventories adjusted, if necessary, for current economic conditions. These estimates are compared to actual results as physical inventory counts are taken and reconciled to the general ledger. Our physical inventory counts are generally taken between January and August of each year; therefore, the shrink accrual recorded at January 28, 2006 is based on estimated shrink for most of 2005, including the fourth quarter. We have not experienced significant fluctuations in historical shrink rates in our Dollar Tree stores for the last two years. However, we have sometimes experienced higher than typical shrink in acquired stores in the year following an acquisition. We periodically adjust our shrink estimates to address these factors as they become apparent.

Our management believes that our application of the retail inventory method results in an inventory valuation that reasonably approximates cost and results in carrying inventory at the lower of cost or market on a year-to-year and consistent basis.

Accrued Expenses
On a monthly basis, we estimate certain expenses in an effort to record those expenses in the period incurred. Our most material estimates include domestic freight expenses, self-insurance programs, store-level operating expenses, such as property taxes and utilities, and certain other expenses. Our freight and store-level operating expenses are estimated based on current activity and historical results. Our workers' compensation and general liability insurance accruals are recorded based on actuarial valuations which are adjusted annually based on a review performed by a third-party actuary. These actuarial valuations are estimates based on historical loss development factors. Certain other expenses are estimated and recorded in the periods that management becomes aware of them. The related accruals are adjusted as management’s estimates change. Differences in management's estimates and assumptions could result in an accrual materially different from the calculated accrual. Our experience has been that some of our estimates are too high and others are too low. Historically, the net total of these differences has not had a material effect on our financial condition or results of operations.

Income Taxes
On a quarterly basis, we estimate our required income tax liability and assess the recoverability of our deferred tax assets. Our income taxes payable are estimated based on enacted tax rates, including estimated tax rates in states where our store base is growing applied to the income expected to be taxed currently. The current tax liability includes a liability for resolution of tax uncertainties. Management assesses the recoverability of deferred tax assets based on the availability of carrybacks of future deductible amounts and management’s projections for future taxable income. We cannot guarantee that we will generate taxable income in future years. Historically, we have not experienced significant differences in our estimates of our tax accrual. However, in 2005 and 2004, we recognized approximately $1.5 million and $2.1 million, respectively, of tax benefits related to the resolution of tax uncertainties.

26

Table of Contents
Index to Consolidated Financial Statements
 

Seasonality and Quarterly Fluctuations
We experience seasonal fluctuations in our net sales, comparable store net sales, operating income and net income and expect this trend to continue. Our results of operations may also fluctuate significantly as a result of a variety of factors, including:
   
·  
shifts in the timing of certain holidays, especially Easter;
   
·  
the timing of new store openings;
   
·  
the net sales contributed by new stores;
   
·  
changes in our merchandise mix; and
   
·  
competition.

Our highest sales periods are the Christmas and Easter seasons. Easter was observed on April 11, 2004, March 27, 2005 and will be observed on April 16, 2006. Due to the 20-day longer Easter selling season in 2006, we expect a larger portion of our annual earnings to be realized in the first quarter of 2006 as compared to 2005. We generally realize a disproportionate amount of our net sales and a substantial majority of our operating and net income during the fourth quarter. In anticipation of increased sales activity during these months, we purchase substantial amounts of inventory and hire a significant number of temporary employees to supplement our continuing store staff. Our operating results, particularly operating and net income, could suffer if our net sales were below seasonal norms during the fourth quarter or during the Easter season for any reason, including merchandise delivery delays due to receiving or distribution problems or consumer sentiment.

Our unaudited results of operations for the eight most recent quarters are shown in a table in Footnote 13 of the Consolidated Financial Statements in Item 8 of this Form 10-K.

Inflation and Other Economic Factors
Our ability to provide quality merchandise at a fixed price and on a profitable basis may be subject to economic factors and influences that we cannot control. Consumer spending could decline because of economic pressures, including rising fuel prices. Reductions in consumer confidence and spending could have an adverse effect on our sales. National or international events, including war or terrorism, could lead to disruptions in economies in the United States or in foreign countries where we purchase some of our merchandise. These and other factors could increase our merchandise costs and other costs that are critical to our operations, such as shipping and wage rates.

Shipping Costs. In the past, we have experienced annual increases of as much as 33% in our trans-Pacific shipping rates due primarily to rate increases imposed by the trans-Pacific ocean carriers. Currently, trans-Pacific shipping rates are negotiated with individual freight lines and are subject to fluctuation based on supply and demand for containers and current fuel costs. We imported 18,838 forty-foot equivalent containers in 2005 and expect this number to increase in fiscal 2006 proportionately to sales growth. As a result, our trans-Pacific shipping costs in fiscal 2006 may increase compared with fiscal 2005 when we renegotiate our import shipping rates effective May 2006. We can give no assurances as to the amount of the increase, as we are in the early stages of our negotiations.

Because of the increase in fuel costs throughout 2005 and the threat of continued increases in 2006, we expect increased fuel surcharges from our domestic contract carriers compared with past years. Based on current fuel prices, we estimate that the costs resulting from increased fuel surcharges may approximate $2.0 to $3.0 million in 2006. We expect to offset a portion of this potential increase with improved operational efficiencies. 

Minimum Wage. Although our average hourly wage rate is significantly higher than the federal minimum wage, an increase in the mandated minimum wage could significantly increase our payroll costs. In prior years, proposals increasing the federal minimum wage by $1.00 per hour have narrowly failed to pass both houses of Congress. However, if the federal minimum wage were to increase by $1.00 per hour, we believe that our annual payroll expenses would increase by approximately 40 basis points, unless we realize offsetting cost reductions.


27

Table of Contents
Index to Consolidated Financial Statements
 

New Accounting Pronouncements
Effective January 29, 2006 (the first day of fiscal 2006), the Company adopted FAS 123R. This statement is a revision of FAS 123, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board Opinion No. 25. FAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. The Company adopted FAS 123R using the modified prospective method, which requires expensing of all share-based payments granted on or after January 29, 2006 and for all awards granted to employees that were unvested as of January 29, 2006.

On December 15, 2005, the Compensation Committee of the Board of Directors of the Company approved the acceleration of the vesting date of all previously issued, outstanding and unvested options under all current stock option plans, including the 1995 Stock Incentive Plan, the 2003 Equity Incentive Plan and the 2004 Executive Officer Equity Plan, effective as of December 15, 2005. At the effective date, almost all of these options had exercise prices higher than the actual stock price. The Company made the decision to accelerate vesting of these options to give employees increased performance incentives and to enhance current retention. This decision also eliminated non-cash compensation expense that would have been recorded in future periods following the Company’s adoption of FAS 123R on January 29, 2006. Future compensation expense has been reduced by $14.9 million, over a period of four years during which the options would have vested, as a result of the option acceleration program. This amount is net of compensation expense of $150,000 recognized in fiscal 2005 for estimated forfeiture of certain (in the money) options. 

In March 2006, the Compensation Committee of our Board of Directors granted approximately 317,500 options. The grant date for these options is March 31, 2006. The fair value of these options of approximately $3.5 million will be recognized over the three-year vesting period.

Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to various types of market risk in the normal course of our business, including the impact of interest rate changes and foreign currency rate fluctuations. We may enter into interest rate swaps to manage exposure to interest rate changes, and we may employ other risk management strategies, including the use of foreign currency forward contracts. We do not enter into derivative instruments for any purpose other than cash flow hedging purposes and we do not hold derivative instruments for trading purposes.

Interest Rate Risk
 
We use variable-rate debt to finance certain of our operations and capital improvements. These obligations expose us to variability in interest payments due to changes in interest rates. If interest rates increase, interest expense increases. Conversely, if interest rates decrease, interest expense also decreases. We believe it is beneficial to limit the variability of our interest payments. 

To meet this objective, we entered into derivative instruments in the form of interest rate swaps to manage fluctuations in cash flows resulting from changes in the variable-interest rates on the obligations. The interest rate swaps reduce the interest rate exposure on these variable-rate obligations. Under the interest rate swap, we pay the bank at a fixed-rate and receive variable-interest at a rate approximating the variable-rate on the obligation, thereby creating the economic equivalent of a fixed-rate obligation. Under the $19.0 million interest rate swap, no payments are made by parties under the swap for monthly periods in which the variable-interest rate is greater than the predetermined knock-out rate.

The following table summarizes the financial terms of our interest rate swap agreements and the fair value of each interest rate swap at January 28, 2006:

Hedging
Instrument
Receive Variable
Pay
Fixed
Knock-out
Rate
Expiration
Fair
Value
$19.0 million
interest rate swap
LIBOR
4.88%
7.75%
4/1/09
($0.1 million)
$25.0 million
interest rate swap
LIBOR
5.43%
N/A
3/12/06
($0.04 million)

28

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Index to Consolidated Financial Statements
 
Hypothetically, a 1% change in interest rates results in approximately a $0.4 million change in the amount paid or received under the terms of the interest rate swap agreements on an annual basis. Due to many factors, management is not able to predict the changes in fair value of our interest rate swaps. The fair values are the estimated amounts we would pay or receive to terminate the agreements as of the reporting date. These fair values are obtained from an outside financial institution.

29

Table of Contents
 

Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Page
   
31
   
 
January 28, 2006, January 29, 2005 and January 31, 2004
32
   
Consolidated Balance Sheets as of January 28, 2006 and
 
January 29, 2005
33
   
 
for the years ended January 28, 2006, January 29, 2005 and
 
January 31, 2004
34
   
 
January 28, 2006, January 29, 2005 and January 31, 2004
35
   
37

30

Table of Contents
Index to Consolidated Financial Statements

 
Report of Independent Registered Public Accounting Firm
 
The Board of Directors and Stockholders
Dollar Tree Stores, Inc.:

We have audited the accompanying consolidated balance sheets of Dollar Tree Stores, Inc. and subsidiaries (the Company) as of January 28, 2006 and January 29, 2005, and the related consolidated statements of operations, shareholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended January 28, 2006. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of January 28, 2006 and January 29, 2005, and the results of their operations and their cash flows for each of the years in the three-year period ended January 28, 2006, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of January 28, 2006, based on the criteria established in Internal Control—Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated April 5, 2006, expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.

Norfolk, Virginia
April 5, 2006
31

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Index to Consolidated Financial Statements


DOLLAR TREE STORES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS 

   
 Year Ended
 
Year Ended
 
Year Ended
 
 
 
 January 28,
 
January 29,
 
January 31,
 
(In thousands, except per share data)
 
 2006
 
2005
 
2004
 
Net sales
 
$
3,393,924
 
$
3,126,009
 
$
2,799,872
 
Cost of sales (Note 4)
   
2,221,561
   
2,013,470
   
1,781,459
 
Gross profit
   
1,172,363
   
1,112,539
   
1,018,413
 
                     
Selling, general and administrative
                   
expenses (Notes 8 and 9)
   
889,124
   
818,988
   
724,816
 
                     
Operating income
   
283,239
   
293,551
   
293,597
 
                     
Interest income
   
6,020
   
3,860
   
2,648
 
Interest expense (Note 6)
   
(14,041
)
 
(9,241
)
 
(7,493
)
                     
Income before income taxes
   
275,218
   
288,170
   
288,752
 
                     
Provision for income taxes (Note 3)
   
101,300
   
107,920
   
111,169
 
                     
Net income
 
$
173,918
 
$
180,250
 
$
177,583
 
                     
Basic net income per share (Note 7):
                   
                     
Net income
 
$
1.61
 
$
1.59
 
$
1.55
 
                     
Diluted net income per share (Note 7):
                   
                     
Net income
 
$
1.60
 
$
1.58
 
$
1.54
 




See accompanying Notes to Consolidated Financial Statements.
32

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Index to Consolidated Financial Statements


DOLLAR TREE STORES, INC.
AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)
 
January 28, 2006
 
January 29, 2005
 
ASSETS
         
Current assets:
         
Cash and cash equivalents
 
$
65,834
 
$
106,532
 
Short-term investments
   
273,950
   
211,275
 
Merchandise inventories
   
576,545
   
615,483
 
Deferred tax assets (Note 3)
   
10,829
   
8,072
 
Prepaid expenses and other current assets (Note 2)
   
16,518
   
28,525
 
Total current assets
   
943,676
   
969,887
 
               
Property, plant and equipment, net (Note 2)
   
681,801
   
685,386
 
Intangibles, net (Notes 2 and 10)
   
129,348
   
129,032
 
Other assets, net (Notes 2, 5, 8 and 11)
   
43,575
   
8,367
 
               
TOTAL ASSETS
 
$
1,798,400
 
$
1,792,672
 
               
LIABILITIES AND SHAREHOLDERS' EQUITY
             
Current liabilities:
             
Current portion of long-term debt (Note 5)
 
$
19,000
 
$
19,000
 
Current installments of obligations under
             
capital leases (Note 2)
   
337
   
12,212
 
Accounts payable
   
135,555
   
124,195
 
Other current liabilities (Notes 2 and 8)
   
98,866
   
105,279
 
Income taxes payable
   
41,698
   
33,669
 
Total current liabilities
   
295,456
   
294,355
 
               
Long-term debt, excluding current portion (Note 5)
   
250,000
   
250,000
 
Obligations under capital leases, excluding
             
current installments (Note 2)
   
611
   
534
 
Deferred tax liabilities (Note 3)
   
23,553
   
42,075
 
Other liabilities (Notes 6 and 8)
   
56,505
   
41,496
 
               
Total liabilities
   
626,125
   
628,460
 
               
Shareholders' equity (Notes 6, 7 and 9):
             
Common stock, par value $0.01. 300,000,000 shares
             
authorized, 106,552,054 and 113,020,941 shares
             
issued and outstanding at January 28, 2006
             
and January 29, 2005, respectively
   
1,065
   
1,130
 
Additional paid-in capital
   
11,438
   
177,684
 
Accumulated other comprehensive income(loss)
   
61
   
(294
)
Unearned compensation
   
-
   
(101
)
Retained earnings
   
1,159,711
   
985,793
 
Total shareholders' equity
   
1,172,275
   
1,164,212
 
               
Commitments, contingencies
             
and subsequent event (Notes 4 and 12)
   
-
   
-
 
               
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
 
$
1,798,400
 
$
1,792,672
 


See accompanying Notes to Consolidated Financial Statements.
33

Table of Contents
Index to Consolidated Financial Statements

DOLLAR TREE STORES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME
YEARS ENDED JANUARY 28, 2006, JANUARY 29, 2005 AND JANUARY 31, 2004
 
   
 
 
 
 
 
 
Accumulated
 
 
 
 
 
 
 
 
 
Common
 
 
 
Additional
 
Other
 
 
 
 
 
Share-
 
 
 
Stock
 
Common
 
Paid-in
 
Comprehensive
 
Unearned
 
Retained
 
holders'
 
(in thousands)
 
Shares
 
Stock
 
Capital
 
Income(Loss)
 
Compensation
 
Earnings
 
Equity
 
                               
Balance at February 1, 2003
   
114,231
 
$
1,142
 
$
218,106
 
$
(1,277
)
$
(112
)
$
627,960
 
$
845,819
 
                                             
Net income for the year ended
                                           
January 31, 2004
   
-
   
-
   
-
   
-
   
-
   
177,583
   
177,583
 
Other comprehensive income (Note 7)
   
-
   
-
   
-
   
307
   
-
   
-
   
307
 
Total comprehensive income
                                       
177,890
 
Issuance of stock under Employee Stock
                                           
Purchase Plan (Note 9)
   
132
   
1
   
2,724
   
-
   
-
   
-
   
2,725
 
Exercise of stock options, including
                                           
income tax benefit of $5,620 (Note 9)
   
994
   
10
   
25,060
   
-
   
-
   
-
   
25,070
 
Repurchase and retirement of shares (Note 7)
   
(1,265
)
 
(12
)
 
(38,041
)
 
-
   
-
   
-
   
(38,053
)
Restricted stock amortization (Note 9)
   
-
   
-
   
-
   
-
   
50
   
-
   
50
 
Settlement of merger-related contingencies
   
(8
)
 
-
   
1,021
   
-
   
-
   
-
   
1,021
 
Balance at January 31, 2004
   
114,084
   
1,141
   
208,870
   
(970
)
 
(62
)
 
805,543
   
1,014,522
 
                                             
Net income for the year ended
                                           
January 29, 2005
   
-
   
-
   
-
   
-
   
-
   
180,250
   
180,250
 
Other comprehensive income (Note 7)
   
-
   
-
   
-
   
676
   
-
   
-
   
676
 
Total comprehensive income
                                       
180,926
 
Issuance of stock under Employee Stock
                                           
Purchase Plan (Note 9)
   
139
   
1
   
3,285
   
-
   
-
   
-
   
3,286
 
Exercise of stock options, including
                                           
income tax benefit of $2,144 (Note 9)
   
608
   
6
   
13,957
   
-
   
-
   
-
   
13,963
 
Repurchase and retirement of shares (Note 7)
   
(1,810
)
 
(18
)
 
(48,593
)
 
-
   
-
   
-
   
(48,611
)
Restricted stock issuance
                                           
and amortization (Note 9)
   
-
   
-
   
165
   
-
   
(39
)
 
-
   
126
 
Balance at January 29, 2005
   
113,021
   
1,130
   
177,684
   
(294
)
 
(101
)
 
985,793
   
1,164,212
 
                                             
Net income for the year ended
                                           
January 28, 2006
   
-
   
-
   
-
   
-
   
-
   
173,918
   
173,918
 
Other comprehensive income (Note 7)
   
-
   
-
   
-
   
355
   
-
   
-
   
355
 
Total comprehensive income
                                       
174,273
 
Issuance of stock under Employee Stock
                                           
Purchase Plan (Note 9)
   
148
   
1
   
3,013
   
-
   
-
   
-
   
3,014
 
Exercise of stock options, including
                                           
income tax benefit of $1,176 (Note 9)
   
407
   
4
   
8,825
   
-
   
-
   
-
   
8,829
 
Repurchase and retirement of shares (Note 7)
   
(7,024
)
 
(70
)
 
(180,328
)
 
-
   
-
   
-
   
(180,398
)
Restricted stock issuance
                                           
and amortization (Note 9)
   
-
   
-
   
2,244
   
-
   
101
   
-
   
2,345
 
Balance at January 28, 2006
   
106,552
 
$
1,065
 
$
11,438
 
$
61
 
$