Dollar Tree Stores, Inc. Form 10K Annual Report for Fiscal Year ended February 3, 2007
Go Directly to Table of Contents
 
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 February 3, 2007
 
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 28, 2006, was $2,536,628,738 based on a $26.18 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 March 30, 2007, there were 98,251,291 shares of the Registrant’s Common Stock outstanding.
 

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 21, 2007, which will be filed with the Securities and Exchange Commission not later than June 1, 2007.

2
DOLLAR TREE STORES, INC.
TABLE OF CONTENTS

   
Page
 
PART I
  
     
6
     
10
     
12
     
13
     
14
     
14
     
 
PART II
  
     
 
 
15
     
16
     
 
 
18
     
27
     
29
     
 
 
54
     
54
     
55
     
 
PART III
  
     
55
     
56
     
 
 
56
     
56
     
56
     
 
PART IV
  
     
56
     
 
57
 
3
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 2007 and beyond;
·  
the effect of a slight shift in merchandise 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 minimum wage rates, shipping rates, domestic and foreign freight costs, fuel costs 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 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 possible effect on our financial results of changes in generally accepted accounting principles relating to accounting for income tax uncertainties.

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 18.

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.
4

 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 “2007” or “fiscal 2007”, “2006” or “fiscal 2006,” “2005” or “fiscal 2005,” and "2004" or "fiscal 2004,"  relate to as of or for the years ended February 2, 2008, 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.
 
 
Table of Contents

5
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 February 3, 2007, we operated 3,219 discount variety retail stores. Approximately 3,100 of these stores sell substantially all items for $1.00 or less. The remaining stores, operating as Deal$, which were acquired in March 2006, sell many items for $1.00 or less but also sell items at prices greater than $1.00. Our stores operate under the names of Dollar Tree, Deal$, Dollar Bills and Dollar Express.

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. At February 3, 2007, approximately 17% of our stores are less than 6,000 square feet, which is down from approximately 47% of our stores at December 31, 2002. These smaller stores are comprised of mall and older strip shopping center locations and are candidates for relocation as their leases expire. Our current store size reflects our expanded merchandise offerings and improved service to our customers. As we have been expanding our merchandise offerings, we have added freezers and coolers to approximately 700 stores during the past two years to increase traffic and transaction size. At December 31, 2002, we operated 2,263 stores in 40 states. At February 3, 2007, we operated 3,219 stores in 48 states. Our selling square footage increased from approximately 13.0 million square feet in December 2002 to 26.3 million square feet in February 2007. Our store growth since 2002 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 of 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% to 65% of our merchandise domestically and import the remaining 35% to 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, 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 and increased slightly the mix of consumable merchandise in order to increase the traffic in our stores. 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, basic 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, fashion health and beauty care, party goods, greeting cards, apparel, and other items; and
   
·  
seasonal goods, which include Easter, Halloween and Christmas merchandise, along with summer toys and lawn and garden merchandise.


Table of Contents
6
We have added freezers and coolers to certain stores which have increased the consumable merchandise carried by our stores. We believe this initiative helps us drive additional transactions and allows us to appeal to a broader demographic mix, and these stores will carry more consumable merchandise than stores without freezers. We have added freezers and coolers to approximately 400 more stores in 2006. Therefore, as of February 3, 2007, we have freezers and coolers in approximately 700 of our stores. We plan to add them to approximately 250 more stores in 2007. As a result of 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 February 3, 2007 and January 28, 2006:

   
February 3,
  
January 28,
  
Merchandise Type 
  
2007
  
2006
  
           
Variety categories
    
48.9%
 
 
47.2%
 
Consumable
    
45.3%
 
 
44.9%
 
Seasonal 
    
 5.8%
 
 
 7.9%
 

Customer Payment Methods. All of our stores accept cash and checks and approximately 700 stores accept Visa and MasterCard credit cards. 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 and as of the end of 2006, all of our stores accept debit cards. Along with the shift to more consumables, the rollout of freezers and coolers and the acceptance of pin-based debit transactions, we increased the number of stores accepting Electronic Benefits Transfer cards and food stamps at qualified stores in the current year. We believe that expanding our tender types has helped increase both the traffic and the average size of transactions at our stores in the current year.

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.
 
Table of Contents
7
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.

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 2005 and 2006, we rolled out this system to additional stores and merchandise categories. At the end of 2006, we had over 800 basic, everyday items on automatic replenishment. As we continue to utilize this system, our store management has more time to focus on customer focused activities.

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. Using this point-of-sale data for planning purchases of inventory has helped us reduce our inventory per store approximately 12% in 2005 as compared to 2004 and an additional 5% in 2006 compared to 2005. Our inventory turns also increased 70 basis points 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 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 2002 to 2006, 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 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 2002 through 2006 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
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
2006
3,219
8,160
8,780



Table of Contents
8
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 2007 and beyond, we plan to predominantly open stores that are approximately 9,000 selling square feet and we believe this size allows us to achieve our objectives in the markets in which we plan to expand. At February 3, 2007, 1,094 of our stores, totaling 50.5% of our selling square footage, were 9,000 selling square feet or larger.

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, we have added a total of 609 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 25, 2006, we completed our acquisition of 138 Deal$ stores and paid $32.0 million for store-related and other assets and $22.1 million for inventory. These stores are located primarily in the Midwest part of the United States and we have existing logistics capacity to service these stores. This acquisition also included a few “combo” stores that offer an expanded assortment of merchandise including items that sell for more than $1. Substantially all Deal$ stores acquired 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 2006, we also acquired the rights to 21 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 higher store traffic, higher 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 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. In 2007, we are planning to add capacity to our Briar Creek distribution center which services the northeast part of the country. We believe these distribution centers, including the planned expansion of the Briar Creek distribution center, in total are capable of supporting approximately $5.0 billion in annual sales. Based on current plans, we will not need to add any additional distribution capacity until at least 2008. 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 and 99 Cents Only. Family Dollar and Dollar General sell items for more than $1 while 99 Cents only sells items at the $0.99 price point or below. The principal methods of competition include closeout merchandise, convenience and the quality of merchandise offered to the customer. Though we are predominantly 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 increases 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.
 
Table of Contents
9
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." 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 also became the owners of “Deal$” and “Deal$ Nothing Over A Dollar” trademarks, with the acquisition of Deal$. 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 12,700 full-time and 29,500 part-time associates on February 3, 2007. 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, wage levels, shipping rates, freight costs, fuel costs 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 increase approximately 1% to 3% in 2007. 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 the first half of 2007. Our gross profit will decrease, primarily in the first two quarters in 2007, 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 10% in 2007 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.
 
Table of Contents
10
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. 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 35% to 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; and
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 quotas 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 increases over the last several years imposed by the trans-Pacific ocean carriers.
§    Diesel fuel costs.  We have experienced increases in diesel fuel costs over the past few years.
§  
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 or 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. Sales during the Easter selling season are materially affected by the timing of the Easter holiday. Easter in fiscal 2006 was on April 16th, while in fiscal 2007, it will be one week earlier on April 8th.
 
Table of Contents
11
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 or cash flows.
 
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. 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.

Table of Contents
12
Item 2. PROPERTIES

Stores
As of February 3, 2007, we operated 3,219 stores in 48 states as detailed below:

Alabama
81
 
Maine
16
 
Ohio
148
Arizona
50
 
Maryland
74
 
Oklahoma
50
Arkansas
48
 
Massachusetts
41
 
Oregon
65
California
222
 
Michigan
118
 
Pennsylvania
178
Colorado
37
 
Minnesota
39
 
Rhode Island
11
Connecticut
25
 
Mississippi
49
 
South Carolina
68
Delaware
16
 
Missouri
80
 
South Dakota
4
Florida
200
 
Montana
8
 
Tennessee
83
Georgia
129
 
Nebraska
11
 
Texas
200
Idaho
20
 
Nevada
24
 
Utah
31
Illinois
134
 
New Hampshire
13
 
Vermont
6
Indiana
94
 
New Jersey
69
 
Virginia
125
Iowa
27
 
New Mexico
22
 
Washington
58
Kansas
31
 
New York
148
 
West Virginia
32
Kentucky
68
 
North Carolina
145
 
Wisconsin
59
Louisiana
55
 
North Dakota
3
 
Wyoming
4

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, however in some cases we have initial lease terms of seven to ten years. 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.

Distribution Centers
The following table includes information about the distribution centers that we currently operate. We plan to expand the Briar Creek distribution center in 2007. This expansion will increase the square footage of the Briar Creek distribution center to 1.0 million square feet. We believe our distribution center network, including this planned expansion, is capable of supporting approximately $5.0 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."
 
Table of Contents
13
Item 3. LEGAL PROCEEDINGS

From time to time, we are defendants in ordinary, routine litigation or 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;
   
·  
personal injury/wrongful death claims; and
   
·  
real estate matters related to store leases.

In 2003, we were served with a lawsuit in a California state court by a former employee who alleged that employees did not properly receive sufficient meal breaks and paid rest periods, along with other alleged 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 was appealed. A California appeals court granted the appeal and our petition for review to the California Supreme Court was denied. The case has been remanded to the trial court where it will likely be consolidated with a companion suit which had been filed in the same court following the trial court’s earlier dismissal. We anticipate that the plaintiff will seek class certification which we will oppose.
 
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 requested the Court to certify classes for their various claims and the presiding judge did so with respect to two classes, one alleging that our Oregon employees, in violation of that state’s labor laws, were not paid for rest breaks and the other that upon termination of employment, employees were not tendered their final pay in a timely manner. Other claims of the plaintiffs were dismissed by an earlier Order of the Court and are being appealed by the plaintiffs. Discovery will ensue on the certified class issues; no trial is anticipated before the end of 2007.
 
In 2006, we were served with a lawsuit by a former employee in a California state court alleging that she was paid for wages with a check drawn on a bank which did not have any branches in the state, an alleged violation of the state's labor code; that she was paid less for her work than other similar employees with the same job title based on her gender; and that we did not pay her final wages in a timely manner, also an alleged violation of the labor code. The plaintiff requested the court to certify the case as a class action. We have been successful in removing the case from state to the federal court level. The parties have reached a settlement and executed an Agreement which will be presented to the Court for its approval on April 24, 2007. The estimated settlement amount has been accrued in the accompanying consolidated financial statements as of February 3, 2007.
 
In 2006, we were served with a lawsuit filed in federal court in the state of Alabama by a former store manager. She claims that she should have been classified as a non-exempt employee under the Fair Labor Standards Act and, therefore, should have received overtime compensation and other benefits. She filed the case as a collective action on behalf of herself and all other employees (store managers) similarly situated. Our motion requesting that the case be transferred from Alabama to Virginia has been denied. The plaintiff now seeks entry of an Order allowing nationwide notice to be sent to all store managers employed by us now or within the past three years. We are contesting entry of such an Order.
 
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.
 

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 2006 fiscal year.
 
Table of Contents
14
PART II

Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, 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 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
  
               
Fiscal year ended February 3, 2007:
              
               
First Quarter
  
$
28.68
  
$
24.34
  
Second Quarter
    
27.89
    
23.90
  
Third Quarter
    
32.00
    
25.62
  
Fourth Quarter
    
32.78
    
29.34
  

On March 30, 2007, the last reported sale price for our common stock, as quoted by Nasdaq, was $38.24 per share. As of March 30, 2007, we had approximately 550 shareholders of record.

The following table presents our share repurchase activity for the 14 weeks ended February 3, 2007.

 
 
 
 
 
 
 
 
Approximate
 
 
 
 
 
 
 
 
 
dollar value
 
 
 
 
 
 
 
Total number
 
of shares that
 
 
 
 
 
 
 
of shares
 
may yet be
 
 
 
 
 
 
 
purchased as
 
purchased under
 
 
 
Total number
 
Average
 
part of publicly
 
the plans or
 
 
 
of shares
 
price paid
 
announced plans
 
programs
 
Period
 
purchased
 
per share
 
or programs
 
(in millions)
 
October 29, 2006 to November 25, 2006
    
-
 
$
-
    
-
 
$
26.7
  
November 26, 2006 to December 30, 2006
    
3,156,881
   
30.80
   
3,156,881
   
426.7
 
December 31, 2006 to February 3, 2007
    
-
   
-
   
-
   
426.7
 
Total
    
3,156,881
 
$
30.80
    
3,156,881
 
$
426.7
  

In March 2005, our Board of Directors authorized the repurchase of up to $300.0 million of our common stock through March 2008. During fiscal 2006, we repurchased 5,650,871 shares for approximately $148.2 million under the March 2005 authorization.

In November 2006, our Board of Directors authorized the repurchase of up to $500.0 million of our common stock. This amount was in addition to the $26.7 million remaining on the March 2005 authorization. In December 2006, we entered into two agreements with a third party to repurchase approximately $100.0 million of the Company’s common shares under an Accelerated Share Repurchase Agreement (ASR). The $100.0 million is reflected in the table above. As of February 3, 2007, of the $100.0 million that is recorded as a reduction to stockholders’ equity, approximately $3.8 million is pending final settlement of the ASR. See additional discussion of the ASR in the Liquidity and Capital Resource section of, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” found elsewhere in this report.

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.
 
Table of Contents
15
Item 6. SELECTED FINANCIAL DATA

The following table presents a summary of our selected financial data for the fiscal years ended February 3, 2007, January 28, 2006, January 29, 2005, and January 31, 2004 and the calendar year ended December 31, 2002. In January 2003, we changed our fiscal year end to a retail fiscal year ending on the Saturday closest to January 31. Fiscal 2006 included 53 weeks, commensurate with the retail calendar, while all other fiscal years reported in the table contain 52 weeks. 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 millions, except per share data, number of stores data, net sales per selling square foot data and inventory turns.

   
Years Ended
 
 
 
February 3,
 
January 28,
 
January 29,
 
January 31
 
December 31,
 
 
 
2007
 
2006
 
2005
 
2004
 
2002
 
Income Statement Data:
                      
Net sales
  
$
3,969.4
  
$
3,393.9
  
$
3,126.0
  
$
2,799.9
  
$
2,329.2
  
Gross profit
    
1,357.2
   
1,172.4
   
1,112.5
   
1,018.4
   
852.0
 
Selling, general and administrative expenses
    
1,046.4
   
888.5
   
819.0
   
724.8
   
598.1
 
Operating income
    
310.8
   
283.9
   
293.5
   
293.6
   
253.9
 
Net income
    
192.0
   
173.9
   
180.3
   
177.6
   
154.6
 
                                 
Margin Data (as a percentage of net sales):
                                
Gross profit
    
34.2
%
  
34.5
%
  
35.6
%
  
36.4
%
  
36.6
%
Selling, general and administrative expenses
    
26.4
%
  
26.2
%
  
26.2
%
  
25.9
%
  
25.7
%
Operating income
    
7.8
%
  
8.4
%
  
9.4
%
  
10.5
%
  
10.9
%
Net income
    
4.8
%
  
5.1
%
  
5.8
%
  
6.3
%
  
6.6
%
                                 
Per Share Data:
                                
                                 
Diluted net income per share
  
$
1.85
  
$
1.60
  
$
1.58
  
$
1.54
  
$
1.35
  
Diluted net income per share increase
    
15.6
%
  
1.3
%
  
2.6
%
  
14.1
%
  
23.9
%
 
Table of Contents
16

   
As of
 
 
 
February 3,
 
January 28,
 
January 29,
 
January 31
 
December 31,
 
 
 
2007
 
2006
 
2005
 
2004
 
2002
 
Balance Sheet Data:
                      
Cash and cash equivalents
                      
and short-term investments
  
$
306.8
  
$
339.8
  
$
317.8
  
$
168.7
  
$
336.0
  
Working capital
    
575.7
   
648.2
   
675.5
   
450.3
   
509.6
 
Total assets
    
1,873.3
   
1,798.4
   
1,792.7
   
1,501.5
   
1,116.4
 
Total debt, including capital lease obligations
    
269.5
   
269.9
   
281.7
   
185.1
   
54.4
 
Shareholders' equity
    
1,167.7
   
1,172.3
   
1,164.2
   
1,014.5
   
855.4
 
                                 
 
    
Years Ended  
 
 
 
February 3,
 
 
January 28,
 
 
January 29,
 
 
January 31
 
 
December 31,
 
 
 
 
2007
 
 
2006
 
 
2005
 
 
2004
 
 
2002
 
Selected Operating Data:
                                
Number of stores open at end of period
    
3,219
   
2,914
   
2,735
   
2,513
   
2,263
 
Gross square footage at end of period
    
33.3
   
29.2
   
25.9
   
21.4
   
16.5
 
Selling square footage at end of period
    
26.3
   
23.0
   
20.4
   
16.9
   
13.0
 
Selling square footage annual growth
    
14.3
%
  
12.6
%
  
21.1
%
  
27.5
%
  
28.8
%
Net sales annual growth
    
16.9
%
  
8.6
%
  
11.6
%
  
18.7
%
  
17.2
%
Comparable store net sales increase (decrease)
    
4.6
%
  
(0.8
%)
  
0.5
%
  
2.9
%
  
1.0
%
Net sales per selling square foot
  
$
161
  
$
156
  
$
168
  
$
187
  
$
201
  
Net sales per store
  
$
1.3
  
$
1.2
  
$
1.2
  
$
1.2
  
$
1.1
  
Selected Financial Ratios:
                                
Return on assets
    
10.2
%
  
9.7
%
  
10.9
%
  
13.7
%
  
15.3
%
Return on equity
    
16.4
%
  
14.9
%
  
16.5
%
  
19.0
%
  
20.5
%
Inventory turns
    
4.4
   
3.7
   
3.5
   
3.7
   
4.5
 
 
Table of Contents
17
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 2006 and 2005;
   
·  
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 2006 and what we expect them to be in 2007; 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 February 3, 2007, January 28, 2006 and January 29, 2005. 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 2006 compared to the comparable fiscal year 2005 and the fiscal year 2005 compared to the comparable fiscal year 2004.

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 November 2006, our Board of Directors authorized the repurchase of up to $500 million of our common stock. This amount was in addition to the $26.7 million remaining on the $300.0 million March 2005 authorization. As of February 3, 2007, we had approximately $427.0 million remaining under this authorization.
·  
In March 2006, we completed our acquisition of 138 Deal$ stores and related assets. We paid approximately $32.0 million for store related assets and $22.1 million for inventory.
·  
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. 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 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. 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. In 2007, we are planning to expand our Briar Creek distribution center by 400,000 square feet. Upon completion of this expansion, our nine distribution centers will support approximately $5.0 billion in sales annually.
·  
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 variable rate debt. This Facility also replaced our previous $150.0 million revolving credit facility.

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.
 
Table of Contents
18
At February 3, 2007, we operated 3,219 stores in 48 states, with 26.3 million selling square feet compared to 2,914 stores with 23.0 million selling square feet at January 28, 2006. During fiscal 2006, we opened 211 stores, expanded 85 stores and closed 44 stores, compared to 232 new stores opened, 93 stores expanded and 53 stores closed during fiscal 2005. In addition, we acquired 138 Deal$ stores on March 25, 2006. Including the Deal$ acquisition, we achieved the high end of our square footage growth target of 12%-14% for the fiscal year. In fiscal 2006, we increased our selling square footage by approximately 3.3 million square feet, or approximately 14%. Of the 3.3 million selling square foot increase in 2006, approximately 1.2 million resulted from the acquisition of the Deal$ stores and 0.4 million was added by expanding existing stores. The average size of our stores opened in 2006 was approximately 9,000 selling square feet (or about 11,000 gross square feet). The average new store size decreased in 2006 from approximately 10,000 selling square feet (or about 12,400 gross square feet) for new stores in 2005. For 2007, we continue to plan to open stores around 9,000 selling square feet (or about 11,000 gross square feet). We believe that the 11,000-12,500 gross square foot store size is our optimal size operationally and that this size also gives the customer an improved shopping environment that invites them to shop longer and buy more. We expect the substantial majority of our future net sales growth to come from the square footage growth resulting from new store openings and expansion of existing stores.
 
Fiscal 2006 ended on February 3, 2007 and included 53 weeks, commensurate with the retail calendar. The 53rd week in 2006 added approximately $70 million in sales. Fiscal 2005 ended on January 28, 2006 and included 52 weeks.

In fiscal 2006, comparable store net sales increased by 4.6%. This increase was based on 53 weeks for both periods. The comparable store net sales increase was the result of increases of 1.9% in the number of transactions and 2.7% in transaction size, compared to fiscal 2005. We believe comparable store net sales were positively affected by the initiatives we began putting in place in 2005, including expansion of forms of payment accepted by our stores and the roll-out of freezers and coolers to more of our stores. During 2006, we completed the roll-out of debit card acceptance to all of our stores, which has enabled us to accept Electronic Benefit Transfer cards and we now accept food stamps in approximately 600 qualified stores. We believe the expansion of forms of payment accepted by our stores has helped increase the average transaction size in our stores.

In 2006, we continued to experience a slight shift in the mix of merchandise sold to more consumables, which we believe increases the traffic in our stores but have lower margin. The planned shift in mix to more consumables is the result of the roll-out of freezers and coolers to more stores in 2005 and 2006. At February 3, 2007, we had freezers and coolers in approximately 700 stores, compared to approximately 250 stores at January 28, 2006. We plan to add freezers and coolers to approximately 250 more stores in 2007, which we believe will continue to pressure margins, as a percentage of sales, in 2007. 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.

Our point-of-sale technology is now in all of our stores, and this technology provides us with valuable sales and inventory information to assist our buyers and improve our merchandise allocation to our stores. We believe that this has enabled us to better control our inventory, resulting in more efficient distribution and store operations and increased inventory turnover. Using the data captured at the point of sale has enabled us to better plan our inventory purchases and helped us reduce our inventory investment per store by approximately 5.0% at February 3, 2007 compared to January 28, 2006. In addition, inventory turnover has increased 70 basis points in 2006 as compared to 2005.

We must continue to control our merchandise costs, inventory levels and our general and administrative expenses. Increases in these expenses could negatively impact our operating results.

Our plans for fiscal 2007 anticipate comparable store net sales increases of approximately 1% to 3% yielding net sales in the $4.22 billion to $4.33 billion range and diluted earnings per share of $1.96 to $2.10. This guidance for 2007 is predicated on selling square footage growth of approximately 10%.
 
Table of Contents
19
On March 25, 2006, we completed our acquisition of 138 Deal$ stores. These stores are located primarily in the Midwest part of the United States and we have existing logistics capacity to service these stores. This acquisition also included a few “combo” stores that offer an expanded assortment of merchandise including items that sell for more than $1. Substantially all Deal$ stores acquired 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. At February 3, 2007, 121 of these stores were selling items priced at over $1.00.

We paid approximately $32.0 million for store-related and other assets and $22.1 million for inventory. The results of Deal$ store operations are included in our financial statements since the acquisition date and did not have a significant impact on our operating results through February 3, 2007. This acquisition is immaterial to our operations as a whole and therefore no proforma disclosure of financial information has been presented.

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
 
 
 
February 3,
 
January 28,
 
January 29,
 
 
 
2007
 
2006
 
2005
 
               
Net sales
   
100.0
%
  
100.0
%
  
100.0
%
Cost of sales
   
65.8
%
  
65.5
%
  
64.4
%
Gross profit
   
34.2
%
  
34.5
%
  
35.6
%
                     
Selling, general and administrative
                    
expenses
   
26.4
%
  
26.2
%
  
26.2
%
                     
Operating income
   
7.8
%
  
8.3
%
  
9.4
%
                     
Interest income
    
0.2
%
  
0.2
%
  
0.1
%
Interest expense
    
(0.4
%)
  
(0.4
%)
  
(0.3
%)
                     
Income before income taxes
    
7.6
%
  
8.1
%
  
9.2
%
                     
Provision for income taxes
    
(2.8
%)
  
(3.0
%)
  
(3.4
%)
                     
Net income
    
4.8
%
  
5.1
%
  
5.8
%

Fiscal year ended February 3, 2007 compared to fiscal year ended January 28, 2006
 
Net Sales. Net sales increased 16.9%, or $575.5 million, in 2006 compared to 2005, resulting from sales in our new and expanded stores, including 138 Deal$ stores acquired in March 2006 and the 53 weeks of sales in 2006 versus 52 weeks in 2005, which accounted for approximately $70 million of the increase. Our sales increase was also impacted by a 4.6% increase in comparable store net sales for the year. This increase is based on a 53-week comparison for both periods. 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 ones.

The following table summarizes the components of the changes in our store count for fiscal years ended February 3, 2007 and January 28, 2006.

   
February 3, 2007
 
January 28, 2006
  
           
New stores
    
190
 
 
197
  
Deal$ acquisition
    
138
 
 
--
  
Acquired leases
    
21
 
 
35
  
Expanded or relocated stores
    
85
 
 
93
  
Closed stores
    
(44)
 
 
(53)
 
 
Table of Contents
20
    Of the 3.3 million selling square foot increase in 2006, approximately 1.2 million resulted from the acquisition of the Deal$ stores and 0.4 million was added by expanding existing stores.

Gross Profit. Gross profit margin decreased to 34.2% in 2006 compared to 34.5% in 2005. The decrease was primarily due to a 35 basis point increase in merchandise cost, including inbound freight. This increase in merchandise cost was due to a slight shift in mix to more consumables, which have a lower margin, higher cost merchandise at our Deal$ stores and increased inbound domestic freight costs.

Selling, General and Administrative Expenses. Selling, general and administrative expenses, as a percentage of net sales, increased to 26.4% for 2006 as compared to 26.2% for 2005. The increase is primarily due to the following:
 
·  
Payroll and benefit related costs increased 35 basis points due to increased incentive compensation costs resulting from better overall company performance in the current year as compared to the prior year and increased stock compensation expense, partially offset by lower workers' compensation costs in the current year.
·  
Operating and corporate expenses decreased 10 basis points primarily as the result of payments received for early lease terminations in the current year.
 
Operating Income. Due to the reasons discussed above, operating income margin decreased to 7.8% in 2006 compared to 8.4% in 2005.

Income Taxes. Our effective tax rate was 36.6% in 2006 compared to 36.8% in 2005. The decreased tax rate for 2006 was due primarily to increased tax-exempt interest on certain of our investments in the current year.

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.

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.

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 debit card acceptance in 2005.
·  
Payroll related costs decreased approximately 10 basis points due to a reduction in incentive compensation accruals that are based on lower than budgeted 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.
 
Table of Contents
21
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.

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 February 3, 2007, January 28, 2006, and January 29, 2005:

   
Year Ended
 
Year Ended
 
Year Ended
 
 
 
February 3,
 
January 28,
 
January 29,
 
(in millions)
 
2007
 
2006
 
2005
  
Net cash provided by (used in):
              
Operating activities
  
$
412.8
  
$
365.1
  
$
276.5
  
Investing activities
    
(190.7
)
  
(235.5
)
  
(315.4
)
Financing activities
    
(202.9
)
  
(170.3
)
  
61.2
 

The $47.7 million increase in cash provided by operating activities in 2006 was primarily due to increased earnings before depreciation in the current year and better payables management in the current year, partially offset by approximately $20.0 million of rent payments for February 2007 made prior to the end of fiscal 2006.

The $44.8 million decrease in cash used in investing activities in 2006 compared to 2005 was the result of a $114.9 million increase in net proceeds from short-term investments which were used to help fund stock repurchases and the Deal$ acquisition in the current year. In the current year, we purchased an additional $9.3 million of investments in a restricted account to collateralize certain long-term insurance obligations. Additional uses of cash for investing activities consisted of $54.1 million for the Deal$ acquisition in the current year and an increase of $36.1 million in capital expenditures due primarily to new store growth and the installation of freezers and coolers to certain stores in the current year.

The $32.6 million increase in cash used in financing activities in 2006 compared to 2005 primarily resulted from $248.2 million in stock repurchases in the current year compared to $180.4 million in the prior year. This increase was partially offset by increased proceeds from stock option exercises in the current year resulting from our higher stock prices in 2006 as compared to 2005.

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 2005 purchases. The aforementioned net cash provided by operating activities was partially offset by a decrease in deferred tax liabilities chiefly as a result of the elimination of bonus depreciation.
 
Table of Contents
22
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 2005 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 2005 after two distribution center projects and point-of-sale installations were completed in 2004.

The $231.5 million change in cash used in financing activities in 2005 compared to 2004 primarily resulted from $180.4 million in stock repurchases in 2005 compared to $48.6 million in 2004. Also in 2004, we entered into a five-year $450.0 million Revolving Credit Facility, under which we received net proceeds of $248.9 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.

At February 3, 2007, our long-term borrowings were $268.8 million and our capital lease commitments were $0.7 million. We also have $125.0 million and $50.0 million Letter of Credit Reimbursement and Security Agreements, under which approximately $84.8 million were committed to letters of credit issued for routine purchases of imported merchandise at February 3, 2007.

In March 2005, our Board of Directors authorized the repurchase of up to $300.0 million of our common stock through March 2008. During fiscal 2006, we repurchased 5,650,871 shares for approximately $148.2 million under the March 2005 authorization.

In November 2006, our Board of Directors authorized the repurchase of up to $500.0 million of our common stock. This amount was in addition to the $27.0 million remaining on the March 2005 authorization. In December 2006, we entered into two agreements with a third party to repurchase approximately $100.0 million of the Company’s common shares under an Accelerated Share Repurchase Agreement (ASR).

The first $50.0 million was executed in an “uncollared” agreement. In this transaction, we initially received 1,656,178 shares based on the market price of our stock of $30.19 as of the trade date (December 8, 2006). A weighted average price was calculated using stock prices from December 16, 2006 - March 8, 2007. This represents the calculation period and based on the weighted average price during this period, a settlement took place in March 2007 resulting in additional funding of $3.3 million.
 
The remaining $50.0 million relates to a “collared” agreement in which we initially received 1,500,703 shares representing the minimum number of shares under the agreement. The maximum number of shares that can be repurchased under the agreement is 1,693,101. The number of shares was determined based on the weighted average market price of our common stock during the same calculation period as defined in the “uncollared” agreement. The weighted average market price as of February 3, 2007 as defined in the “collared” agreement was $30.80. Therefore, as of February 3, 2007, we would receive an additional 122,742 shares under the “collared” agreement. Based on the applicable accounting literature, these additional shares were not included in the weighted average diluted earnings per share calculation because their effect would be antidilutive. The weighted average stock price of our common stock as defined in the “collared” agreement as of March 8, 2007 (termination date) was $31.97. We received an additional 63,325 shares on March 8, 2007 under this agreement.
 
On March 29, 2007, we entered into an agreement with a third party to repurchase approximately $150.0 million of our common shares under another ASR.  The entire $150.0 million was executed under a "collared" agreement.  Within two weeks of the March 29, 2007 execution date, we will receive the minimum number of shares. Up to four months after the initial execution date, we will receive additional shares from the third party depending on the volume weighted average price of our common shares during that period, subject to the maximum share delivery provisions of the agreement.
 
Table of Contents
23
Funding Requirements

Overview
We expect our cash needs for opening new stores and expanding existing stores in fiscal 2007 to total approximately $160.7 million, which includes capital expenditures, initial inventory and pre-opening costs. Our estimated capital expenditures for fiscal 2007 are between $170.0 and $190.0 million, including planned expenditures for our new and expanded stores, the addition of freezers and coolers to approximately 250 stores, an expansion of the Briar Creek Distribution Center and an expansion to our home office and data center in Chesapeake, Va. 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 potential 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, excluding interest on long-term borrowings (in millions):

Contractual Obligations
  
Total
  
2007
  
2008
  
2009
  
2010
  
2011
  
Thereafter
  
Lease Financing
                              
Operating lease obligations
 
$
1,177.0
  
$
284.2
  
$
246.0
  
$
207.2
  
$
161.5
  
$
110.6
  
$
167.5
  
Capital lease obligations
   
0.8
    
0.4
    
0.3
    
0.1
    
--
    
--
    
--
  
                                             
Long-term Borrowings
                                           
Revolving credit facility
    
250.0
    
--
    
--
    
250.0
    
--
    
--
    
--
  
Revenue bond financing
    
18.8
    
18.8
    
--
    
--
    
--
    
--
    
--
  
                                             
Total obligations
  
$
1,446.6
  
$
303.4
  
$
246.3
  
$
457.3
  
$
161.5
  
$
110.6
  
$
167.5
  


Commitments
  
Total
  
Expiring in 2007
  
Expiring in 2008
  
Expiring in 2009
  
Expiring in 2010
  
Expiring in 2011
  
Thereafter
  
                               
Letters of credit and surety bonds
  
$
116.3
  
$
115.6
  
$
0.7
  
$
--
  
$
--
  
$
--
  
$
--
  
Freight contracts
    
57.1
    
38.6
    
9.9
    
8.6
    
--
    
--
    
--
  
Technology assets
    
3.8
    
3.8
    
--
    
--
    
--
    
--
    
--
  
Total commitments
  
$
177.2
  
$
158.0
  
$
10.6
  
$
8.6
  
$
--
  
$
--
  
$
--
  


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 February 3, 2007 for stores that were not yet open on February 3, 2007.

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.  Interest is assessed under the line based on matrix pricing which currently approximates 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 February 3, 2007, we had $250.0 million outstanding on this Facility.
 
Table of Contents
24
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 February 3, 2007, the balance outstanding on the bonds was $18.8 million. These bonds are due to be fully 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 5.4% at February 3, 2007.

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. Letters of credit are generally issued for the routine purchase of imported merchandise and we had approximately $84.8 million of purchases committed under these letters of credit at February 3, 2007. We also have approximately $31.5 million of 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 2009. The total amount of these commitments is approximately $57.1 million.

Technology Assets. We have commitments totaling approximately $3.8 million to primarily purchase store technology assets for our stores during 2007.

Derivative Financial Instruments
We are party to one interest rate swap, which allows us to manage the risk associated with interest rate fluctuations on the demand revenue bonds. The swap is based on a notional amount of $18.8 million. Under the $18.8 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.

Because of the knock-out provision in the $18.8 million swap, changes in the fair value of that swap are recorded in 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.

We estimate our markdown reserve based on the consideration of a variety of factors, including, but not limited to, quantities of slow moving or seasonal, carryover 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.
 
Table of Contents
25
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 September of each year; therefore, the shrink accrual recorded at February 3, 2007 is based on estimated shrink for most of 2006, including the fourth quarter. We have not experienced significant fluctuations in historical shrink rates beyond 10 to 15 basis points 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 each year on a 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 trends and 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 also 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. In 2006 and 2005, we recognized approximately $0.7 million and $1.5 million, respectively, of tax benefits related to the resolution of tax uncertainties in certain states.
 
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 March 27, 2005, April 16, 2006 and will be observed on April 8, 2007. We generally realize a disproportionate amount of our net sales and 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. Fiscal 2006 consisted of 53 weeks, commensurate with the retail calendar. This extra week contributed approximately $70.0 million of sales in 2006. Fiscal 2007 will consist of 52 weeks.
 
Table of Contents
26
Our unaudited results of operations for the eight most recent quarters are shown in a table in Footnote 12 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. 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.  As a result, our trans-Pacific shipping costs in fiscal 2007 may increase compared with fiscal 2006 when we renegotiate our import shipping rates effective May 2007. We can give no assurances as to the amount of the increase, as we are in the early stages of our negotiations.

Minimum Wage. Although our average hourly wage rate is significantly higher than the federal minimum wage, an increase in the mandated minimum wage could increase our payroll costs. In early 2007, proposals increasing the federal minimum wage to $7.25 per hour over a three-year period have passed both houses of Congress. If the federal minimum wage were to increase over the next three years to $7.25 per hour, we believe that it would not have a material effect on our annual payroll expenses.

New Accounting Pronouncements
In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48 ("FIN 48"), Accounting for Uncertainty in Income Taxes -- an interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. We do not expect that the adoption of FIN 48 will have a material impact on our consolidated financial position, results of operations or cash flows.

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 a derivative instrument in the form of an interest rate swap to manage fluctuations in cash flows resulting from changes in the variable-interest rates on the Demand Revenue Bonds. The interest rate swap reduces the interest rate exposure on this variable-rate obligation. 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 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.
 
27

The following table summarizes the financial terms of our interest rate swap agreement and the fair value of the interest rate swap at February 3, 2007:

Hedging
Instrument
Receive Variable
Pay
Fixed
Knock-out
Rate
Expiration
Fair
Value
$18.8 million
interest rate swap
LIBOR
4.88%
7.75%
4/1/09
--

At February 3, 2007, the fair value of this interest rate swap is less than $0.1 million. Hypothetically, a 1% change in interest rates results in approximately a $0.2 million change in the amount paid or received under the terms of the interest rate swap agreement on an annual basis. Due to many factors, management is not able to predict the changes in fair value of our interest rate swap. The fair values are the estimated amounts we would pay or receive to terminate the agreement as of the reporting date. These fair values are obtained from an outside financial institution.




Table of Contents
28
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Index to Consolidated Financial Statements
Page
   
30
   
 
February 3, 2007, January 28, 2006 and January 29, 2005
31
   
Consolidated Balance Sheets as of February 3, 2007 and
 
January 28, 2006
32
   
 
for the years ended February 3, 2007, January 28, 2006 and
 
January 29, 2005
33
   
 
February 3, 2007, January 28, 2006 and January 29, 2005
34
   
35
 
29
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 February 3, 2007 and January 28, 2006, and the related consolidated statements of operations, shareholders’ equity and comprehensive income, and cash flows for each of the fiscal years in the three-year period ended February 3, 2007. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of February 3, 2007 and January 28, 2006, and the results of their operations and their cash flows for each of the fiscal years in the three-year period ended February 3, 2007, in conformity with U.S. generally accepted accounting principles.

As discussed in note 1 to the consolidated financial statements, effective January 29, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment.

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 February 3, 2007, 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 2, 2007, expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.

 
/s/ KPMG LLP
Norfolk, Virginia
April 2, 2007
 
30
DOLLAR TREE STORES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS 


   
 Year Ended
 
Year Ended
 
Year Ended
 
 
 
 February 3,
 
January 28,
 
January 29,
 
(In millions, except per share data)
 
 2007
 
2006
 
2005
 
Net sales
 
$
3,969.4
  
$
3,393.9
  
$
3,126.0
  
Cost of sales (Note 4)
    
2,612.2
   
2,221.5
   
2,013.5
 
Gross profit
   
1,357.2
   
1,172.4
   
1,112.5
 
                     
Selling, general and administrative
                    
expenses (Notes 8 and 9)
    
1,046.4
   
888.5
   
819.0
 
                     
Operating income
    
310.8
   
283.9
   
293.5
 
                     
Interest income
    
8.6
   
6.8
   
3.9
 
Interest expense (Notes 5 and 6)
    
(16.5
)
  
(15.5
)
  
(9.2
)
                     
Income before income taxes
   
302.9
   
275.2
   
288.2
 
                     
Provision for income taxes (Note 3)
    
110.9
   
101.3
   
107.9
 
                     
Net income
  
$
192.0
  
$
173.9
  
$
180.3
  
                     
Basic net income per share (Note 7)
  
$
1.86
  
$
1.61
  
$
1.59
  
                     
Diluted net income per share (Note 7)
  
$
1.85
  
$
1.60
  
$
1.58
  

 
See accompanying Notes to Consolidated Financial Statements.
 
31
DOLLAR TREE STORES, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

(In millions, except share data)
  
February 3, 2007
 
January 28, 2006
  
ASSETS
          
Current assets:
          
Cash and cash equivalents
 
$
85.0
  
$
65.8
  
Short-term investments
   
221.8
   
274.0
 
Merchandise inventories
   
605.0
   
576.6
 
Deferred tax assets (Note 3)
   
10.7
   
10.8
 
Prepaid expenses and other current assets
    
36.5
   
16.5
 
Total current assets
   
959.0
   
943.7
 
               
Property, plant and equipment, net (Note 2)
    
715.3
   
681.8
 
Intangibles, net (Notes 2 and 10)
   
146.6
   
129.3
 
Other assets, net (Notes 2, 8 and 11)
    
52.4
   
43.6
 
               
TOTAL ASSETS
 
$
1,873.3
  
$
1,798.4
  
               
LIABILITIES AND SHAREHOLDERS' EQUITY
              
Current liabilities:
              
Current portion of long-term debt (Note 5)
 
$
18.8
  
$
19.0
  
Accounts payable
   
189.2
   
135.6
 
Other current liabilities (Note 2)
   
132.0
   
99.2
 
Income taxes payable
   
43.3
   
41.7
 
Total current liabilities
   
383.3
   
295.5
 
               
Long-term debt, excluding current portion (Note 5)
    
250.0
   
250.0
 
Deferred tax liabilities (Note 3)
   
1.5
   
23.5
 
Other liabilities (Notes 6 and 8)
    
70.8
   
57.1
 
               
Total liabilities
   
705.6
   
626.1
 
               
Shareholders' equity (Notes 6, 7 and 9):
              
Common stock, par value $0.01. 300,000,000 shares
              
authorized, 99,663,580 and 106,552,054 shares
              
issued and outstanding at February 3, 2007
              
and January 28, 2006, respectively
    
1.0
   
1.1
 
Additional paid-in capital
   
-
   
11.4
 
Accumulated other comprehensive income (loss)
   
0.1
   
0.1
 
Retained earnings
   
1,166.6
   
1,159.7
 
Total shareholders' equity
   
1,167.7
   
1,172.3
 
               
Commitments, contingencies snd subsequent event  (Notes 4 and 12)
    
-
   
-
 
               
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
  
$
1,873.3
  
$
1,798.4
  

See accompanying Notes to Consolidated Financial Statements.
 
32
DOLLAR TREE STORES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME
YEARS ENDED FEBRUARY 3, 2007, JANUARY 28, 2006 AND JANUARY 29, 2005
 
   
 
  
 
  
 
  
Accumulated
  
 
  
 
  
 
  
 
  
Common
  
 
  
Additional
  
Other
 
 
  
 
  
Share-
  
 
  
Stock
  
Common
  
Paid-in
  
Comprehensive
  
Unearned
  
Retained
  
holders'
  
(in millions)
  
Shares
  
Stock
  
Capital
  
Income (Loss)
  
Compensation
  
Earnings
  
Equity
  
                               
Balance at January 31, 2004
    
114.1
 
$
1.1
  
$
208.9
  
$
(0.9
)
$
(0.1
)
$
805.5
  
$
1,014.5
  
                                             
Net income for the year ended
                                            
January 29, 2005
    
-
   
-
   
-
   
-
   
-
   
180.3
   
180.3
 
Other comprehensive income (Note 7)
   
-
   
-
   
-
   
0.6
   
-
   
-
   
0.6
 
Total comprehensive income
                                       
180.9
 
Issuance of stock under Employee Stock
                                            
Purchase Plan (Note 9)
   
0.1
   
-
   
3.3
   
-
   
-
   
-
   
3.3
 
Exercise of stock options, including
                                           
income tax benefit of $2.1 (Note 9)
   
0.6
   
-
   
14.0
   
-
   
-
   
-
   
14.0
 
Repurchase and retirement of shares (Note 7)
   
(1.8
)
  
-
   
(48.6
)
  
-
   
-
   
-
   
(48.6
)
Restricted stock amortization (Note 9)
   
-
   
-
   
0.1
   
-
   
-
   
-
   
0.1
 
Balance at January 29, 2005
    
113.0
   
1.1
   
177.7
   
(0.3
)
  
(0.1
)
  
985.8
   
1,164.2
 
                                             
Net income for the year ended
                                            
January 28, 2006
    
-
   
-
   
-
   
-
   
-
   
173.9
   
173.9
 
Other comprehensive income (Note 7)
   
-
   
-
   
-
   
0.4
   
-
   
-
   
0.4
 
Total comprehensive income
                                       
174.3
 
Issuance of stock under Employee Stock
                                            
Purchase Plan (Note 9)
   
0.1
   
-
   
3.0
   
-
   
-
   
-
   
3.0
 
Exercise of stock options, including
                                           
income tax benefit of $1.2 (Note 9)
   
0.4
   
-
   
8.8
   
-
   
-
   
-
   
8.8
 
Repurchase and retirement of shares (Note 7)
   
(7.0
)
  
-
   
(180.3
)
  
-
   
-
   
-
   
(180.3
)
Stock-based compensation (Notes 1 and 9)
    
-
   
-
   
2.2
   
-
   
0.1
   
-
   
2.3
 
Balance at January 28, 2006
   
106.5
   
1.1
   
11.4
   
0.1
   
-
   
1,159.7
   
1,172.3
 
                                             
Net income for the year ended
                                            
February 3, 2007
    
-
   
-
   
-
   
-
   
-
   
192.0
   
192.0
 
Other comprehensive income (Note 7)
   
-
   
-
   
-
   
-
   
-
   
-
   
-
 
Total comprehensive income
                                       
192.0
 
Issuance of stock under Employee Stock
                                            
Purchase Plan (Note 9)
   
0.1
   
-
   
2.8
   
-
   
-
   
-
   
2.8
 
Exercise of stock options, including
                                           
income tax benefit of $5.6 (Note 9)
   
1.7
   
-
   
43.1
   
-
   
-
   
-
   
43.1
 
Repurchase and retirement of shares (Note 7)
   
(8.8
)
  
(0.1
)
  
(63.0
)
        
-
   
(185.1
)
  
(248.2
)
Stock-based compensation, net (Notes 1 and 9)
    
0.1
   
-
   
5.7
   
-
   
-
   
-
   
5.7
 
 Balance at February 3, 2007    
99.6
 
$
1.0
  
$
-
  
$
0.1
  
$
-
  
$
1,166.6
  
$
1,167.7
  

See accompanying Notes to Consolidated Financial Statements.
 
33

DOLLAR TREE STORES, INC.
AND SUBSIDIARIES
 
   
Year Ended
 
Year Ended
 
Year Ended
 
 
 
February 3,
 
January 28,
 
January 29,
 
(In millions)
 
2007
 
2006
 
2005
  
Cash flows from operating activities:
              
Net income
 
$
192.0
  
$
173.9
  
$
180.3
  
Adjustments to reconcile net income to net cash
                   
provided by operating activities:
                    
Depreciation and amortization
   
159.0
   
140.7
   
129.3
 
Provision for deferred income taxes
   
(21.9
)
  
(21.5
)
  
15.6
 
Tax benefit of stock option exercises
   
-
   
1.2
   
2.1
 
Stock based compensation expense
    
6.7
   
2.4
   
-
 
Other non-cash adjustments to net income
   
5.1