Alco Stores (ALCSQ) 10-Q 2007 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 29, 2006
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 0-20269

DUCKWALL-ALCO STORES, INC.

(Exact name of registrant as specified in its charter)

Kansas	48-0201080
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
401 Cottage Street, Abilene, Kansas	67410-2832
(Address of principal executive offices)	(Zip Code)

(785) 263-3350

(Registrant’s telephone number including area code)

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

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

Large accelerated filer o          Accelerated filer x         Non-accelerated filer o

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

APPLICABLE ONLY TO CORPORATE ISSUERS:

3,793,528 shares of common stock, $.0001 par value (the issuer’s only class of common stock), were outstanding as of October 29, 2006.

PART I — FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

Duckwall-ALCO Stores, Inc.

And Subsidiaries

Consolidated Balance Sheets

(Dollars in Thousands)

Assets

	October 29,		January 29,
	2006		2006
	(Unaudited)
Current assets:
Cash and cash equivalents	$	4,847	$	472
Receivables	3,745		2,874
Refundable income tax	2,973		—
Inventories	164,621		135,077
Prepaid expenses	2,880		2,621
Property held for sale	—		585
Total current assets	179,066		141,629
Property and equipment	89,261		92,615
Less accumulated depreciation	66,432		63,591
Net property and equipment	22,829		29,024
Property under capital leases	25,086		23,228
Less accumulated amortization	17,604		16,367
Net property under capital leases	7,482		6,861
Other non-current assets	53		55
Deferred income taxes	2,413		1,353
Total assets	$	211,843	$	178,922

See accompanying notes to unaudited consolidated financial statements.

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Duckwall-ALCO Stores, Inc.

And Subsidiaries

Consolidated Balance Sheets

(Dollars in Thousands)

Liabilities and Stockholders’ Equity

	October 29,		January 29,
	2006		2006
	(Unaudited)
Current liabilities:
Current maturities of capital lease obligations	$	2,192	$	1,879
Accounts payable	43,493		28,300
Income taxes payable	—		1,163
Accrued salaries and commissions	3,990		6,001
Accrued taxes other than income	5,084		4,743
Self-insurance claim reserves	4,413		3,915
Stock purchase payable	—		1,910
Other current liabilities	3,036		2,998
Deferred income taxes	283		86
Total current liabilities	62,491		50,995
Notes payable under revolving loan	32,664		17,062
Capital lease obligations - less current maturities	7,363		7,299
Other noncurrent liabilities	5,254		1,419
Total liabilities	107,772		76,775
Stockholders’ equity:
Common stock, $.0001 par value, authorized 20,000,000 shares; issued and outstanding 3,793,528 shares and 3,786,953 shares respectively	1		1
Additional paid-in capital	37,024		36,411
Retained earnings	67,046		65,735
Total stockholders’ equity	104,071		102,147
Total liabilities and stockholders’ equity	$	211,843	$	178,922

See accompanying notes to unaudited consolidated financial statements.

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Duckwall-ALCO Stores, Inc.

And Subsidiaries

Consolidated Statements of Operations

(Dollars in Thousands Except Per Share Amounts)

(Unaudited)

	For the Thirteen Week					For the Thirty-Nine Week
	Period Ended						Period Ended
	October 29,			October 30,			October 29,		October 30,
	2006			2005			2006		2005
Net sales	$	110,109		$	100,740		$	339,124	$	306,609
Cost of sales	75,815			68,184			236,214		210,947
Gross margin	34,294			32,556			102,910		95,662
Selling, general and administrative	32,953			31,077			94,059		91,312
Depreciation and amortization	1,647			1,427			4,919		4,363
Total operating expenses	34,600			32,504			98,978		95,675
Operating income (loss) from continuing operations	(306		)	52			3,932		(13		)
Interest expense	809			354			2,010		809
Earnings (loss) from continuing operations before income taxes	(1,115		)	(302		)	1,922		(822		)
Income tax expense (benefit)	(564		)	(412		)	684		(186		)
Earnings (loss) from continuing operations	(551		)	110			1,238		(636		)
Earnings (loss) from discontinued operations, net of income taxes	(97		)	(297		)	72		(2,575		)
Net earnings (loss)	($648		)	($187		)	$	1,310	($3,211		)
Earnings (loss) per share
Basic
Continuing operations	($0.15		)	$	0.03		$	0.33	($0.15		)
Discontinued operations	($0.03		)	($0.08		)	$	0.02	($0.62		)
Net earnings (loss)	($0.18		)	($0.05		)	$	0.35	($0.77		)
Diluted
Continuing operations	($0.15		)	$	0.03		$	0.32	($0.15		)
Discontinued operations	($0.03		)	($0.08		)	$	0.02	($0.62		)
Net earnings (loss)	($0.18		)	($0.05		)	$	0.34	($0.77		)

See accompanying notes to unaudited consolidated financial statements.

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Duckwall-ALCO Stores, Inc.

And Subsidiaries

Consolidated Statements of Cash Flows

Dollars in Thousands

(Unaudited)

	For Thirty-Nine Week
	Period Ended
	October 29,			October 30,
	2006			2005
Cash flows from operating activities:
Net earnings	$	1,310		($3,211		)
Tax benefit of stock options exercised	14			—
Adjustments to reconcile net earnings to net cash provided by operating activities:
Increase in receivables	(1,010		)	(634		)
Increase in prepaid expenses	(259		)	(949		)
Increase in inventories	(29,544		)	(9,115		)
Depreciation and amortization	4,919			4,373
(Gain) loss on sale of assets	(335		)	617
Stock compensation expense	541			—
Increase in accounts payable	15,193			12,493
Decrease in income taxes payable	(4,136		)	(2,466		)
Decrease in accrued salaries and commissions	(2,011		)	(362		)
Increase in accrued taxes other	342			1,116
Change in deferred income taxes	(863		)	(49		)
Increase in other assets and liabilities	647			1,548
Net cash (used in) provided by operating activities	(15,192		)	3,361
Cash flows from investing activities:
Proceeds from the sale of assets	12,925			—
Capital expenditures	(5,625		)	(12,216		)
Net cash provided by (used in) investing activities	7,300			(12,216		)
Cash flows from financing activities:
Net borrowings under revolving loan credit agreement	15,602			23,281
Refinancing costs on revolving loan	—			(61		)
Proceeds from exercise of outstanding stock options	125			382
Excess tax benefit on stock options exercises	35			—
Repurchase of stock	(2,012		)	(12,638		)
Principal payments under capital lease obligations	(1,483		)	(643		)
Net cash provided by financing activities	12,267			10,321
Net increase in cash and cash equivalents	4,375			1,466
Cash and cash equivalents at beginning of period	472			352
Cash and cash equivalents at end of period	$	4,847		$	1,818
Cash paid during the period for:
Interest	$	1,829		$	645
Income taxes	$	3,548		$	568
Supplemental disclosure of non-cash activity:
Tax benefit related to stock options exercised	—			$	48
Assets acquired under capital lease	$	1,859
Deferred gain on sale/leaseback	$	3,833

See accompanying notes to unaudited consolidated financial statements.

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Duckwall-ALCO Stores, Inc.

And Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in Thousands Except Per Share Amounts)

(1)           Basis of Presentation

The accompanying unaudited consolidated financial statements are for interim periods and, consequently, do not include all disclosures required by generally accepted accounting principles for annual financial statements.  It is suggested that the accompanying unaudited consolidated financial statements be read in conjunction with the consolidated financial statements included in the Company’s fiscal 2006 Annual Report.  In the opinion of management of Duckwall-ALCO Stores, Inc., the accompanying unaudited consolidated financial statements reflect all adjustments (consisting of normal recurring accruals) necessary to present fairly the financial position of the Company and the results of its operations and cash flows for the interim periods.  Because the Company’s business is moderately seasonal, the results from interim periods are not necessarily indicative of the results to be expected for the entire year.

(2)           Reclassification

The Company reclassified certain accounts receivable on its Consolidated Balance Sheets, which were previously presented as cash and cash equivalents.  The amounts reclassified on the Consolidated Balance Sheet totaled $1,094, $848, and $605 in 2006, 2005 and 2004, respectively.  The related change in net cash provided by operating activities was ($246), ($243), and ($124) in 2006, 2005 and 2004, respectively.

(3)           Principles of Consolidation

The consolidated financial statements include the accounts of Duckwall-ALCO Stores, Inc. and its wholly owned subsidiaries.  All significant intercompany transactions and balances have been eliminated in consolidation.

(4)           Stock-based Compensation

Effective January 30, 2006, the Company adopted Statement of Financial Accounting Standards No. 123(R) “Share-Based Payment” (“SFAS 123(R)”) and began recognizing compensation expense for its share-based payments based on the fair value of the awards. Share-based payments consist of stock option grants. SFAS 123(R) requires share-based compensation expense recognized since January 30, 2006 to be based on the following: a) grant date fair value estimated in accordance with the original provisions of SFAS 123 for unvested options granted prior

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to the adoption date and b) grant date fair value estimated in accordance with the provisions of SFAS 123(R) for all share-based payments granted subsequent to the adoption date.

For the thirty-nine weeks ended October 30, 2006, the SFAS 123(R)’s fair value method resulted in share-based expense (a component of selling and general and administrative expenses) in the amount of $541 related to the Company’s stock plans that the Company would not have recognized if it had continued to account for share-based compensation under APB 25 (defined hereafter). This share-based compensation lowered pre-tax earnings by $541, lowered net income by $317, and lowered basic and diluted earnings per share by $0.08. SFAS 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing activity, rather than as an operating activity in the statement of cash flow as required prior to SFAS 123(R). The change resulted in $35 being shown as a cash flow from financing activities rather than operating activities.  The impact of SFAS 123(R) on future results will depend on, among other things, levels of share-based payments granted in the future, actual forfeiture rates and the timing of option exercises.

Prior to January 30, 2006, the Company accounted for share-based payments using the intrinsic-value-based recognition method prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” (“APB 25”). As options were granted at an exercise price equal to the market value of the underlying common stock on the date of grant, no stock-based employee compensation cost was reflected in net income prior to adopting SFAS 123(R). As the Company adopted SFAS 123(R) under the modified-prospective-transition method, results from prior periods have not been restated.

The following table illustrates the effect on net income and earnings per share as if the Company applied the fair value recognition provisions of Statement 123 to options granted under the Company’s stock plans in all periods presented prior to the adoption of FAS 123(R).   The periods represented include the third quarter of Fiscal 2006 and the thirty-nine week period of Fiscal 2006.  For purposes of this pro forma disclosure, the value of the options is estimated using a modified Black-Scholes option pricing model for all option grants:

	For The Thirteen Week		For The Thirty-Nine Week
	Period Ended		Period Ended
	October 30,		October 30,
	2005		2005
Net loss as reported	(187	)	(3,211	)
Pro forma stock-based employee compensation cost, net of tax	(58	)	(137	)
Pro forma net loss	(245	)	(3,348	)
Loss per share as reported:
Basic	(0.05	)	(0.77	)
Diluted	(0.05	)	(0.77	)
Loss per share, pro forma:
Basic	(0.06	)	(0.81	)
Diluted	(0.06	)	(0.81	)

Under SFAS 123(R), forfeitures are estimated at the time of valuation and reduce expense ratably over the vesting period. This estimate is adjusted periodically based on the extent to which actual forfeitures differ, or are expected to differ, from the previous estimate. Under SFAS 123 and APB 25, the Company elected to account for forfeitures as they occurred.

Under the Company’s 2003 Incentive Stock Option Plan, options may be granted to officers and key employees, not to exceed 500,000 shares.  According to the terms of the plan, the per share exercise price of options

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granted shall not be less than the fair market value of the stock on the date of grant and such options will expire no later than five years from the date of grant. The options vest in equal amounts over a four year requisite service period beginning from the grant date. In the case of a stockholder owning more than 10% of the outstanding voting stock of the Company, the exercise price of an incentive stock option may not be less than 110% of the fair market value of the stock on the date of grant and such options will expire no later than five years from the date of grant.  Also, the aggregate fair market value of the stock with respect to which incentive stock options are exercisable on a tax deferred basis for the first time by an individual in any calendar year may not exceed $100,000. In the event that the foregoing results in a portion of an option exceeding the $100,000 limitation, such portion of the option in excess of the limitation shall be treated as a nonqualified stock option.  At October 29, 2006, the Company had 143,000 shares authorized for future option grants.  The Company issues these grants from the unissued shares authorized.

Under the Company’s Non-Qualified Stock Option Plan for Non-Management Directors, options may be granted to Directors of the Company who are not otherwise officers or employees of the Company, not to exceed 120,000 shares.  According to the terms of the plan, the per share exercise price of options granted shall not be less than the fair market value of the stock on the date of grant and such options will expire five years from the date of grant.  The options vest in equal amounts over a four year requisite service period beginning from the grant date.  All options under the plan shall be non-qualified stock options.  There are no shares remaining to be issued under this plan.  The Company issued these grants from the unissued shares authorized, which the Company intends to register these during the fourth quarter 2007.

The Company previously issued options under the 1993 Incentive Stock Option Plan.  This plan was structured in the same fashion as the 2003 Incentive Stock Option Plan described above, however it did not specify the 10% ownership rules.  There are no shares remaining to be issued under this plan.  As of October 29, 2006, 12,726 options were outstanding under this plan.

The fair value of each option grant is separately estimated for each grant. The fair value of each option is amortized into compensation expense on a straight-line basis from the grant date for the award over the requisite service period as discussed above.  The Company has estimated the fair value of all stock option awards as of the date of the grant by applying a modified Black-Scholes pricing valuation model.  The application of this valuation model involves assumptions that are judgmental and highly sensitive in the determination of compensation expense. The weighted average for key assumptions used in determining the fair value of options granted in the thirty-nine weeks ended October 29, 2006 and October 30, 2005 and a summary of the methodology applied to develop each assumption are as follows:

	October 29,		October 30,
	2006		2005
Expected price volatility	37.4	%	38.4	%
Risk-free interest rate	5.0	%	4.0	%
Weighted average expected lives in years	3.8		5.0
Forfeiture rate	5.6	%	0.0	%
Dividend yield	0.0	%	0.0	%

EXPECTED PRICE VOLATILITY — This is a measure of the amount by which a price has fluctuated or is expected to fluctuate. The Company uses actual historical changes in the market value of its stock to calculate expected price volatility because management believes that this is the best indicator of future volatility. The Company calculates monthly market value changes from the date of grant over a past period to determine volatility. An increase in the expected volatility will increase compensation expense.

RISK-FREE INTEREST RATE — This is the U.S. Treasury rate for the date of the grant over the expected term.  An increase in the risk-free interest rate will increase compensation expense.

EXPECTED LIVES — This is the period of time over which the options granted are expected to remain outstanding and is based on management’s expectations in relation to the holders of the

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options. Options granted have a maximum term of five years. An increase in the expected life will increase compensation expense.

FORFEITURE RATE — This is the estimated percentage of options granted that are expected to be forfeited or cancelled before becoming fully vested. This estimate is based on management’s expectations in relation to the holders of the options. An increase in the forfeiture rate will decrease compensation expense.

DIVIDEND YIELD --- The Company has not made any dividend payments nor does it have plans to pay dividends in the foreseeable future. An increase in the dividend yield will decrease compensation expense.

A summary of stock option activity since the Company’s most recent fiscal year-end is as follows:

	Number of Shares		Weighted Average Exercise Price		Weighed Average Remaining Contractual Term	Aggregate Intrinsic Value
Outstanding January 29, 2006	133,238		$	17.37
Granted	377,000		30.01
Exercised	(9,912	)	12.50
Forfeited/Expired	(10,600	)	29.74
Outstanding October 29, 2006	489,726		$	26.93	4.2	$	5,631
Expected to vest at October 29, 2006	479,508		$	26.91	4.2	$	5,614
Exercisable at October 29, 2006	40,226		$	16.53	2.5	$	881

The aggregate intrinsic values in the table above represents the total difference between the Company’s closing stock price on October 29, 2006 and the option exercise price, multiplied by the number of in-the-money options as of October 29, 2006. As of October 29, 2006, total unrecognized compensation expense related to non-vested stock options is $3.7 million with a weighted average expense recognition period of 3.6 years.

A summary of the status of the Company’s nonvested shares as of October 29, 2006 is presented below:

	Number of  Shares		Weighted Average Grant Date Fair Value  (per share)
Nonvested at January 29, 2006	118,920		$	7.20
Granted	377,000		$	10.52
Vested	(36,332	)	$	6.84
Forfeited	(10,088	)	$	9.99
Nonvested at October 29, 2006	449,500		$	9.95

Other information relative to option activity during the thirty-nine weeks ended October 29, 2006 and October 30, 2005 is as follows (in 000’s, except per share data):

	October 29,		October 30,
	2006		2005
Weighted average grant date fair value of stock options granted (per share)	$	10.52	$	7.36
Total fair value of stock options vested	$	249	$	54
Total intrinsic value of stock options exercised	$	163	$	395

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(5)           Earnings Per Share

Basic net earnings per share is computed by dividing net earnings by the weighted average number of shares outstanding.  Diluted net earnings per share reflects the potential dilution that could occur if contracts to issue securities (such as stock options) were exercised.

The average number of shares used in computing earnings per share was as follows:

Thirteen Weeks Ended	Basic	Diluted
October 29, 2006	3,793,252	3,793,252
October 30, 2005	3,969,754	3,969,754
Thirty-Nine Weeks Ended	Basic	Diluted
October 29, 2006	3,791,579	3,831,533
October 30, 2005	4,158,068	4,158,068

(6)           Subsequent Events

The sale-leaseback of one location was completed on November 2, 2006.  The cash proceeds from the transaction amounted to $950.

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Dollars in Thousands Except Per Share Amounts)

OVERVIEW

Operations.  The Company is a regional discount retailer operating 253 stores in 21 states in the central United States, with two business divisions, consisting of:

·The ALCO division which, as of October 29, 2006, operated 186 ALCO Stores which offer a wide variety of general merchandise and a limited variety of food products and accounted for 94% of the Company’s sales for the third quarter of fiscal 2007.

·The Duckwall division which, as of October 29, 2006, operated 67 Duckwall Stores which offer a more limited general merchandise selection, but serve the needs of a community that is not large enough to support a full-line retail discount store, and accounted for 6% of the Company’s sales for the third quarter of fiscal 2007.

The thirteen weeks ended October 29, 2006 and October 30, 2005 are referred to herein as the third quarter of fiscal 2007 and 2006, respectively.  For purposes of this management’s discussion and analysis of financial condition and results of operations, the financial numbers are presented in thousands.

Strategy.  The Company’s overall business strategy involves identifying and opening stores in towns that will provide the Company with the highest return on investment.  The Company competes for retail sales with other entities, such as mail order companies, specialty retailers, mass merchandisers, dollar stores, manufacturer’s outlets, and the internet.

The Company is routinely evaluating the appropriate mix of merchandise to improve sales and gross margin performance. The Company uses centralized purchasing, merchandising, pricing and warehousing to obtain volume discounts, improve efficiencies and achieve consistency among stores and the best overall results.  The Company utilizes information obtained from its point-of-sale system and regular input from its store associates to determine its merchandise offerings.

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The Company went live on a new POS system in 152 stores during the second and third quarters of fiscal 2007, and will rollout this system to the remaining Alco stores in the fourth quarter of fiscal 2007.

Recent Events.

Key Items in Third Quarter Fiscal 2007

The Company measures itself against a number of financial metrics to assess its performance.  Some of the important financial items during the third quarter of fiscal 2007 were:

·Net sales increased 9.3% to $110,109.  Same store sales increased 5.9% compared to the prior year third quarter.

·Gross margin percentage decreased to 31.2% of sales, when compared to 32.3% in the prior year third quarter.

·Loss per share was ($0.18) in the third quarter of fiscal 2007 compared to ($.05) per share in the prior year third quarter.

·The Company’s earnings before interest, taxes, depreciation and amortization (“EBITDA”) from continuing operations for the third quarter 2007 were $1,608.

·The Company’s return on average equity (“ROE”) for the third quarter 2007 was 1.4%.

Same store sales growth is a measure which may indicate whether existing stores are maintaining their market share.  Other factors, such as the overall economy, may also affect same store sales.  The Company defines same stores as those stores that were open as of the first day of the prior fiscal year and remain open at the end of the reporting period.  The same store sales for all Company stores increased 5.9% compared to the third quarter last year, the ALCO stores same store sales increased 6.0%, and the Duckwall same stores sales increased 4.5% during the third quarter of fiscal 2007.  In the third quarter ended October 29, 2006, the Company closed one ALCO store.

Gross margin percentage is a key measure of the Company’s ability to maximize profit on the purchase and subsequent sale of merchandise, while minimizing promotional and clearance markdowns, shrinkage, damage, and returns.  Gross margin percentage is defined as sales less cost of sales, expressed as a percentage of sales.  Gross margin percent decreased to 31.2% of sales in the third quarter of fiscal 2007, compared to 32.3% in the third quarter of fiscal 2006.

Earnings per share (“EPS”) growth are an indicator of the returns generated for the Company’s stockholders.  EPS from continuing operations was reduced to ($0.15) per diluted share for the third quarter of fiscal 2007, compared to $0.03 per diluted share for the third quarter of the prior fiscal year.

 The Company’s EBITDA and ROE are discussed under SG&A Detail; Certain Financial Measures below.

New Accounting Standard

In June 2006, the Financial Accounting Standards Board, or FASB, issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, or FIN 48, an interpretation of FASB No. 109, Accounting for Income Taxes.”  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 and 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, disclosure, and transition.  FIN 48 is effective for fiscal years beginning after December 15, 2006.  The Company is in the process of determining the impact of the adoption of this Interpretation on our consolidated financial statements.

In March 2006, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross Versus Net Presentation)”, which allows companies to adopt a policy of presenting

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taxes in the income statement on either a gross or net basis. Taxes within the scope of this EITF would include taxes that are imposed on a revenue transaction between a seller and a customer, for example, sales taxes, use taxes, value-added taxes, and some types of excise taxes. EITF 06-3 is effective for interim and annual reporting periods beginning after December 15, 2006. EITF 06-3 will not impact the method for recording and reporting these sales taxes in the Company’s consolidated financial statements as the Company’s policy is to exclude all such taxes from revenue.

In September 2006, the SEC staff issued SAB Topic 1N, “Financial Statements — Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current year Financial Statements”  (SAB 108), which addresses how to quantify the effect of an error on the financial statements.  SAB 108 is effective for our fiscal year ending January 28, 2007.  We are currently reviewing the applicability of SAB 108 to our operations and its potential impact on our consolidated financial statements.

CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS AND FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS, FINANCIAL CONDITION OR BUSINESS

Certain statements contained in this Quarterly Report on Form 10-Q that are not statements of historical fact may constitute “forward-looking statements” within the meaning of Section 21E of the Exchange Act. These statements are subject to risks and uncertainties, as described below. Examples of forward-looking statements include, but are not limited to: (i) projections of revenues, income or loss, earnings or loss per share, capital expenditures, store openings, store closings, payment or non-payment of dividends, capital structure and other financial items, (ii) statements of plans and objectives of the Company’s management or Board of Directors, including plans or objectives relating to inventory, store development, marketing, competition, business strategy, store environment, merchandising, purchasing, pricing, distribution, transportation, store locations and information systems, (iii) statements of future economic performance, and (iv) statements of assumptions underlying the statements described in (i), (ii) and (iii). Forward-looking statements can often be identified by the use of forward-looking terminology, such as “believes,” “expects,” “may,” “will,” “should,” “could,” “intends,” “plans,” “estimates”, “projects” or “anticipates,” variations thereof or similar expressions.

Forward-looking statements are not guarantees of future performance or results.  They involve risks, uncertainties and assumptions.  The Company’s future results of operations, financial condition and business operations may differ materially from the forward-looking statements or the historical information stated in this Quarterly Report on Form 10-Q.  Stockholders and investors are cautioned not to put undue reliance on any forward-looking statement.

There are a number of factors and uncertainties that could cause actual results of operations, financial condition or business contemplated by the forward-looking statements to differ materially from those discussed in the forward-looking statements made herein or elsewhere orally or in writing, by, or on behalf of, the Company, including those factors described below. Other factors not identified herein could also have such an effect. Factors that could cause actual results to differ materially from those discussed in the forward-looking statements and from historical information include, but are not limited to, those factors described below.

CRITICAL ACCOUNTING POLICIES

Inventory:  As discussed in Note 1 (d) to the Consolidated Financial Statements, inventories are stated at the lower of cost or net realizable value with cost determined using the last-in, first-out (LIFO) method.  The retail inventory method (“RIM”) used by the Company is an averaging method that has been widely used in the retail industry.  This method calculates a cost to retail ratio that is applied to the retail value of inventory to calculate cost inventory and the resulting gross margin.  Use of the RIM method does not eliminate the use of management judgments and estimates, including markdowns and shrinkage, which significantly impact the ending inventory valuation at cost and the resulting gross margins.  The Company continually evaluates product categories to determine if markdown action is appropriate, or if a markdown reserve should be established.  The Company recognizes that the use of the RIM will result in valuing inventories at lower of cost or market if markdowns are currently taken as a reduction of the retail value of inventories.  Management believes that the RIM provides an inventory valuation which reasonably approximates cost and results in carrying inventory at the lower of cost or market.

Insurance:  The Company considers determination of overall insurance costs a critical accounting policy. As described below, the Company is essentially self insured for its workers compensation, medical insurance and general liability insurance.  Due to the fact that it takes more than one year to determine the actual costs under these

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plans, these costs are estimated based on the Company’s historical loss experience and estimates from the insurance carriers and consultants.

Workers Compensation and General Liability.  The Company is essentially self insured for workers compensation and general liability claims due to large deductibles on its policies.  The Company records estimates for expense accruals.

Medical.  The Company is also essentially self insured for medical insurance and covers all claims in a plan year related to an individual until they exceed $125.

Income Taxes:  The Company’s tax provision and establishment of reserves for potential tax liabilities involves the use of estimates and professional judgment.  The Company has identified exposures for which they have established a reserve, such as differences in interpretation of tax laws at the federal, state, and local units of government.

RESULTS OF OPERATIONS

Thirteen Weeks Ended October 29, 2006 Compared to Thirteen Weeks Ended October 30, 2005.

Net Sales

Net sales for the third quarter of fiscal 2007 increased $9,369, or 9.3%, to $110,109 compared to $100,740 for the third quarter of fiscal 2006.  Same store sales increased 5.9% when compared with the prior quarter.  The sales were favorably impacted by customer acceptance of the current merchandise strategy that focuses on soft-lines, a 1.4% increase in customer count and 7.1% increase in average sale generated.  Fuel sales also contributed to same store sales increases.

Gross Margin

Gross margin for the third quarter of fiscal 2007 increased $1,738, or 5.3%, to $34,294 compared to $32,556 in the third quarter of fiscal 2006.  Gross margin as a percentage of sales was 31.2% for the third quarter of fiscal 2007, which decreased when compared to 32.3% for the third quarter of fiscal 2006.   The decrease in gross margin as a percentage of sales was due to higher other markdowns, higher freight costs which accounted for 44 basis points of the erosion and lower margin on increased sales at the fuel centers which accounted for 82 basis points of the erosion.  The Company believes the erosion of margin due to increase freight costs will continue through the end of the year.  The margin was further impacted by the markdowns associated with the clearance of patio and garden products that had not sold.  This clearance, which reduced margin by 50 basis points, while normal to running a retail business, has resulted in the Company changing its method of managing these categories in an effort to avoid this same problem in the future.

SG&A

Selling, general and administrative expense increased $1,876 or 6.0%, to $32,953 in the third quarter of fiscal 2007 compared to $31,077 in the third quarter of fiscal 2006.  As a percentage of net sales, selling, general and administrative expenses in the third quarter of fiscal 2007 were 30.0%, compared to 30.9% in the third quarter of fiscal 2006.  The increase in selling, general and administrative expenses was due in part to an increase in store level wages, increase in expenses related to stock options, professional fees and software maintenance associated with rollout of IT initiative, increase in insurance and utilities, store level professional fees, offset by increased vendor participation in CO-OP advertising.

Depreciation and Amortization

Depreciation and amortization expense increased $220, or 15.4%, to $1,647 in the third quarter of fiscal 2007 compared to $1,427 in the third quarter of fiscal 2006.  The increase is primarily due to new stores opened in the fourth quarter of fiscal 2006 and the first quarter of fiscal 2007 and items related to IT initiative.

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Interest Expense

Interest expense increased $455, or 128.5%, to $809 in the third quarter of fiscal 2007 compared to $354 in the third quarter of fiscal 2006.  The increase in interest expense was due to higher levels of borrowing and an increase in the interest rate for fiscal 2007.

Income Taxes

The Company’s effective tax rate on earnings from continuing operations in the third quarter of fiscal 2007 was 41.42%, compared to 35.4% in the third quarter of fiscal 2006.  The effective tax rate is higher due to the expiration of work opportunity employment tax credits and permanent tax differences relating to stock compensation expense.

Earnings (Loss) from Discontinued Operations

Loss from discontinued operations, net of income tax, was $97 in the third quarter of fiscal 2007, compared to a loss from discontinued operations of $297 in the third quarter of fiscal 2006.  Stores closed where the Company has exited the market are reflected in discontinued operations in all periods presented.

Thirty-Nine Weeks Ended October 29, 2006 Compared to Thirty-Nine Weeks Ended October 30, 2005.

Net Sales

Net sales for the thirty-nine week period of fiscal 2007 increased $32,515, or 10.6%, to $339,124 compared to $306,609 for the thirty-nine period of fiscal 2006.  Same store sales increased 6.6% when compared with the prior year.  The sales were favorably impacted by customer acceptance of its current merchandise strategy that focuses on soft-lines, a 3.3% increase in customer count and a 7.0% increase in average sale generated.  Fuel sales also contributed to same store sales increases.

Gross Margin

Gross margin for the thirty-nine week period of fiscal 2007 increased $7,248, or 7.6%, to $102,910 compared to $95,662 in the thirty-nine week period of fiscal 2006.  Gross margin as a percentage of sales was 30.4% for the thirty-nine week period of fiscal 2007 compared to 31.20% for the thirty-nine week period of fiscal 2006.  The decrease in the gross margin as percentage of sales was due to higher promotional and other markdowns in the normal course of business, higher freight costs resulting from higher fuel prices (a 23.2% increase compared to the thirty-nine week period of fiscal 2006), and lower margin achieved on the increased sales at the fuel centers.

SG&A

Selling, general and administrative expense increased $2,747, or 3.0%, to $94,059 in the thirty-nine week period of fiscal 2007 compared to $91,312 in the thirty-nine week period of fiscal 2006.  As a percentage of net sales, selling, general and administrative expenses in the thirty-nine week period of fiscal 2007 were 27.8%, compared to 29.8% in the thirty-nine week period of fiscal 2006.  The decrease in selling, general and administrative expenses as a percentage of net sales was due in part to one time costs of approximately $734 associated with the Company’s restructuring and workforce reduction in fiscal 2006 that was not repeated in fiscal 2007 and an increase in vendor participation in CO-OP advertising, offset by increased payroll, increase in expenses related to stock options, increase in credit card fees, increase in advertising, professional services and software maintenance fees associated with rollout of IT initiative, increase in utilities, travel and new store rents.

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Depreciation and Amortization

Depreciation and amortization expense increased $556, or 12.7%, to $4,919 in the thirty-nine week period of fiscal 2007 compared to $4,363 in the thirty-nine week period of fiscal 2006.  The increase is primarily due to new stores opened in the fourth quarter of fiscal 2006 and the first quarter of fiscal 2007.

Interest Expense

Interest expense increased $1,201, or 148.30%, to $2,009 in the thirty-nine week period of fiscal 2007 compared to $809 in the thirty-nine week period of fiscal 2006.  The increase in interest expense was due to higher levels of borrowing and increase in the interest rate for the thirty-nine week period of fiscal 2007.

Income Taxes

The Company’s effective tax rate on earnings from continuing operations for the thirty-nine week period of fiscal 2007 was 41.4%, compared to 35.3% in the thirty-nine week period of fiscal 2006.  The effective tax rate is higher due to the expiration of work opportunity employment tax credits and permanent tax differences relating to stock compensation expense.

Earnings (Loss) from Discontinued Operations

Earnings from discontinued operations, net of income tax, was $72 in the thirty-nine week period of fiscal 2007, compared to a loss from discontinued operations of $2,575 in the thirty-nine week period of fiscal 2006.  The increase in earnings from discontinued operations relates to the Company’s closing of 20 unprofitable stores in the thirty-nine week period of fiscal 2006 compared with one store closing in the thirty-nine week period of fiscal 2007.  Additionally, the Company sold a property held for sale in relation to the closings in fiscal 2006 in the thirty-nine week period of fiscal 2007 resulting in a gain of $351. Stores closed where the Company has exited the market are reflected in discontinued operations in all periods presented.

SG&A Detail; Certain Financial Measures

The Company believes the following detailed information is useful in analyzing its business results.  All information presented is from continuing operations.

	For the Thirteen Week Period Ended						For the Thirty-Nine Week Period Ended
SG&A Expenses Breakout	October 29, 2006			October 30, 2005			October 29, 2006			October 30, 2005
General Office	2,224			3,268			7,361			11,605
Distribution Center	2,411			2,080			6,369			6,041
SPD Truck Lines	—			297			—			810
401K/Profit Sharing	124			—			358			—
Comparable Stores SG&A	25,887			24,505			74,323			71,208
Non Comp Stores SG&A #	2,039			927			5,108			1,647
Stock Option Expense	268			—			541			—
Final SG&A as reported on 3rd Qtr 10Q	32,953			31,077			94,059			91,312
Return on Average Equity****	1.40		%	-0.29		%	1.94		%	-2.82		%
(ROE)
Net Sales	$	110,109		$	100,740		$	339,124		$	306,609

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SG&A as % of Sales	29.93		%	30.85		%	27.74		%	29.78		%
SG&A per average selling square foot	$	7.89		$	7.89		$	22.77		$	23.32
SG&A per average selling square foot	$	7.89		$	7.89		$	22.77		$	23.32
EBITDA**	$	1,608		$	1,479		$	9,389		$	4,350
EBITDA per average selling square foot***	$	.39		$	0.38		$	2.27		$	1.11
Sales per average selling square feet*
ALCO	$	27.35		$	26.59		$	84.17		$	80.22
Duckwall	$	19.56		$	19.05		$	60.68		$	59.73
Total	$	26.37		$	25.58		$	82.10		$	78.31
Average Selling Square Feet*	4,176			3,939			4,131			3,915
Average Square Feet% Change	6.5		%	2.1		%	5.5		%	2.1		%
Total Stores Operating beginning of Period	254			245			251			266
Total Stores Operating end of Period	253			249			253			249
Supplemental Data:
Same Store Sales Change	5.9		%	4.3		%	6.6		%	2.5		%
Total customer count change	1.4		%	2.0		%	3.3		%	1.8		%
Average sale per ticket change	7.1		%	4.9		%	7.0		%	3.5		%
Average annualized New Store Sale performance on prototype Stores	$	2,227
Incremental expenses related to IT initiative	$	274					$	694

*Average selling square feet is (beginning square feet plus ending square feet) divided by 2.

**EBITDA is earnings from continuing operations before interest, taxes, depreciation and amortization, and stock option expense.

***EBITDA per selling square foot is a non-GAAP financial measure and is calculated as EBITDA divided by selling square feet.

****Return on average equity (ROE) is calculated as Net Earnings divided by average stockholders’ equity. Average Stockholders’ Equity is calculated as (beginning of period stockholders’ equity plus end of  period stockholders’ equity) divided by 2.

#Non Comp Stores are those stores opened in Fiscal 2006 & Fiscal 2007.

Fiscal 2007 Compared to Fiscal 2006

General Office expenses for fiscal 2007 decreased $4,244 or 36.6%.  The decrease was due in part to one time costs of approximately $734 associated with the Company’s restructuring and workforce reduction in fiscal 2006 not repeated in fiscal 2007 and the related payroll savings in fiscal 2007 relating to these reductions, and a $4,778 increase in vendor participation in CO-OP advertising programs, offset by increased utility costs.

SPD Truck Line is no longer in operation as the Company has contracted with a dedicated service provider.

Comparable store SG&A expenses increased $3,115 or 4.4%.  Advertising, insurance, wages, rent, utilities and credit card fees accounted for the majority of this increase.

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Non Comparable Stores SG&A expenses increased $3,461 or 210.1%.  The Company has opened 15 stores since the first quarter of fiscal 2006.

Reconciliation and Explanation of Non-GAAP Financial Measures

The following table shows the reconciliation of EBITDA per selling square foot to earnings (loss) from continuing operations, the most directly comparable financial measure calculated and presented in accordance with GAAP:

	For the Thirteen Week Period Ended						For the Thirty-nine Week Period Ended
	October 29, 2006			October 30, 2005			October 29, 2006		October 30, 2005
Earnings from continuing operations	(551		)	110			1,238		(636		)
Plus interest	809			354			2,010		809
Plus taxes	(564		)	(412		)	684		(186		)
Plus depreciation and amortization	1,647			1,427			4,919		4,363
Plus stock option expense	268			—			541		—
=EBITDA	1,609			1,479			9,392		4,350
Earnings from continuing operations per sq foot	$	(0.13	)	$	0.03		$	0.30	$	(0.16	)
Plus interest per sq foot	$	0.19		$	0.09		$	0.49	$	0.21
Plus taxes per sq foot	$	(0.14	)	$	(0.10	)	$	0.17	$	(0.05	)
Plus depreciation and amortization per sq foot	$	0.39		$	0.36		$	1.19	$	1.11
Plus stock option expense per sq foot	$	0.06		$	0.00		$	0.13	$	0.00
=EBITDA per selling sq foot	$	0.37		$	0.38		$	2.28	$	1.11

LIQUIDITY AND CAPITAL RESOURCES

The Company’s primary sources of funds are cash flows from operations, borrowings under its revolving loan credit facility, and vendor trade credit financing (increases in accounts payable).

At October 29, 2006 working capital (defined as current assets less current liabilities) was $116,575 compared to $90,634 at the end of fiscal 2006.  The increase in working capital was attributable to increases in inventory, accounts receivable, accounts payable, income tax receivable and cash and cash equivalents; and decreases stock purchase payments and accrued salaries and commissions.

The Company has a loan agreement with its lenders that provides a revolving loan credit facility of up to $70,000 of long-term financing.  The amount advanced (through a note or letters of credit) to the Company under the credit facility bears interest at (i) the prime rate plus a margin, as defined, which varies based on the amount outstanding (Base Loan) or (ii) based on the Euro dollar rate plus a margin, as defined, (Index Loan).  Based upon its projected financial requirements, the Company uses a combination of short term Euro dollar contracts and borrowing at prime.  The amount advanced is generally limited to 70% of eligible inventory, as defined in the loan agreement.  Advances are secured by a security interest in the Company’s inventory.  The loan agreement contains various restrictions that are applicable if the Company fails to maintain excess availability of at a least $27,500, including limitations on additional indebtedness, acquisitions of assets and payment of dividends.  The loan agreement expires on April 15, 2010.  As of October 29, 2006, the Company has borrowed $32,664 under this facility.  The lender had

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also issued letters of credit aggregating $4,083 at such date on behalf of the Company.  Availability under this facility as of October 29, 2006 was $33,253.

Cash (used in) provided by operating activities in the thirty-nine week period of fiscal 2007 and 2006 was ($15,192) and $3,361 respectively.  The decrease in the amount of cash provided by operating activities in the thirty-nine week period of fiscal 2007 compared to the thirty-nine week period of fiscal 2006 was primarily due to a increase in inventory relating to the stores opened since fiscal 2006, a decrease in accrued salaries and wages, and a decrease in income taxes payable; offset by an increase in accounts payable from renegotiated vendor terms.

Total anticipated cash payments for acquisition of property and equipment in fiscal 2007, principally for improvements, store buildings and store and warehouse fixtures and equipment are approximately $9,000.  Cash provided by (used in) investing activities (including acquisitions and remodeling) in the thirty-nine week period of fiscal 2007 and 2006 totaled $7,300 and ($12,216), respectively, which were used primarily for the acquisition of property and equipment, offset in fiscal 2007 by the proceeds from the sale of assets.  During the thirty-nine week period ended October 29, 2006, the Company completed sales/leaseback transactions on 11 ALCO retail locations for $11,229.  The remaining amount is due to the sale of a previously closed location.

The Company provided by cash from financing activities in the thirty-nine week period of fiscal 2007 and 2006 of $12,267 and $10,321 respectively.  Net borrowings on the revolving loan generated $15,602 during the thirty-nine week ended October 29, 2006, compared to $23,281 during the thirty-nine week period of the prior fiscal year.  Cash used to purchase and retire 3,337 and 399,362 shares of Common Stock was $2,012 and $12,638 for the thirty-nine week period of fiscal 2007 and 2006, respectively.  The Board of Directors of the Company has authorized the Company to repurchase up to 2,014,461 shares of Common Stock, of which 1,817,798 shares had been purchased as of October 29, 2006.  The Company continues to evaluate the timing and pricing of future share repurchases.

BUSINESS OPERATIONS AND SEGMENT INFORMATION

The Company’s business activities include operation of ALCO discount stores in towns with populations which are typically less than 5,000 not served by other regional or national full-line discount chains and Duckwall variety stores that offer a more limited selection of merchandise which are primarily located in communities of less than 2,500 residents.

For financial reporting purposes, the Company has established two operating segments: “ALCO Discount Stores”, and “All Other”, which includes the Duckwall variety stores and other business activities, such as general office, warehouse and distribution activities.

	For The Thirteen Week Period Ended				For The Thirty-Nine Week Period Ended
	October 29,		October 30,		October 29,		October 30,
	2006		2005		2006		2005
Segment Information
Net Sales:
ALCO Discount Stores	$	102,979	$	93,748	$	317,001	$	284,847
All Other
External	7,130		6,992		22,123		21,762
Intercompany	71,908		71,837		195,480		185,619
	$	182,017	$	172,577	$	534,604	$	492,228
Depreciation and Amortization
ALCO Discount Stores	$	808	$	921	$	2,493	$	2,750
All Other	839		506		2,426		1,613
	$	1,647	$	1,427	$	4,919	$	4,363

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Income (expense) from Operations:
ALCO Discount Stores	$	5,400		$	6,282		$	20,397		$	20,839
All Other	(5,648		)	(6,146		)	(16,238		)	(20,598		)
	$	(248	)	$	136		$	4,159		$	241
Capital Expenditures:
ALCO Discount Stores	$	649		$	3,309		$	3,392		$	6,027
All Other	1,076			5,204			2,233			6,189
	$	1,725		$	8,513		$	5,625		$	12,216
Identifiable Assets:
ALCO Discount Stores	$	148,122		$	139,366		$	148,122		$	139,366
All Other	59,365			45,297			59,365			45,297
	$	207,487		$	184,663		$	207,487		$	184,663

Income from operations as reflected in the above segment information has been determined differently than income from operations in the accompanying consolidated statements of operations as follows:

Intercompany Sales

Intercompany sales represent transfers of merchandise from the warehouse to ALCO discount stores and Duckwall variety stores.

Intercompany Expense Allocations

General and administrative expenses incurred at the general office have not been allocated to the ALCO Discount Stores for purposes of determining income from operations for the segment information.

Warehousing and distribution costs, including freight applicable to merchandise purchases, have been allocated to the ALCO Discount Stores segment based on the Company’s customary method of allocation for such costs.

Inventories

LIFO reserves are allocated to the ALCO and other for the segment reporting based on ALCO and Duckwall proportionate inventory levels.

Leases

All leases are accounted for as operating leases for purposes of determining income from operations for purposes of determining the segment information for the ALCO Discount Stores whereas capital leases are accounted for as such in the consolidated statements of operations.

Identifiable assets as reflected in the above segment information include cash and cash equivalents, receivables, inventory, property and equipment, and property under capital leases.

A reconciliation of the segment information to the amounts reported in the consolidated financial statements is presented below:

	For The Thirteen Week Period Ended					For The Thirty-Nine Week Period Ended
	October 29,			October 30,		October 29,		October 30,
	2006			2005		2006		2005
Net sales per above segment information	$	182,017		$	172,577	$	534,604	$	492,228
Intercompany elimination	71,908			71,837		195,480		185,619
Net sales per consolidated statements of operations	$	110,109		$	100,740	$	339,124	$	306,609
Income (loss) from operations per above segment information	$	(248	)	$	136	$	4,159	$	241
Leases	58			84		227		254
Income (loss) from operations per consolidated statements of operations	$	(306	)	$	52	$	3,932	$	(13	)

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ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

INSTRUMENTS ENTERED INTO OTHER THAN FOR TRADING — INTEREST RATE RISK

The Company is exposed to various types of market risk in the normal course of its business, including the impact of interest rate changes.  The Company may enter into interest rate swaps to manage its exposure to interest rate changes, and we may employ other risk management strategies, including the use of foreign currency forward contracts.  The Company does not currently hold any derivative instruments and would enter into such instruments solely for cash flow hedging purposes and not for trading purposes.

As described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources,” the Company has a variable interest rate debt facility that is subject to interest rate risk.  The Company uses this facility to meet the short-term needs of its capital improvements and inventory purchases and other operating activities.  These obligations expose the Company 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. Based on the Company’s current borrowings under its revolving credit facility, if interest rates were to increase 1% on an annual basis interest expense would increase $327.

The Company has and continues to analyze its debt structure in relation to interest rate risk.  The Company believes that with the mix of debt instruments it is using — revolving line of credit, capital leases and operating leases — that its current structure adequately addresses these risk issues.  This process of evaluation is continuous and the Company will adjust its debt structure as is appropriate to the market situation.

ITEM 4.   CONTROLS AND PROCEDURES

(a)   Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, the Company evaluated the design and operation of its disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities and Exchange Act of 1934, or the “Exchange Act”) for the quarter ended October 29, 2006.

Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were not effective as of October 29, 2006 because of the material weaknesses discussed below.

To address the material weaknesses described below, the Company performed additional analysis and other post-closing procedures to ensure that the consolidated financial statements were prepared in accordance with generally accepted accounting principles.  Accordingly, management, including the Chief Executive Officer and Chief Financial Officer, believe the consolidated financial statements included in this report present, in all material respects, the Company’s financial condition, results of operations and cash flows for the quarter ended October 29, 2006.

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(b)   Management’s Report on Internal Control Over Financial Reporting

Management of the Company is responsible for establishing and maintaining adequate control over financial reporting as defined in Rules 13a-15(f) under the Securities and Exchange Act of 1934, as amended. The Company’s internal control system is a process designed to provide reasonable assurance to the Company’s management, Board of Directors and shareholders regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles.  Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

A material weakness represents a significant deficiency (as defined in the Public Company Accounting Oversight Board’s Auditing Standard No. 2), or a combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis.

Management assessed the effectiveness of the Company’s internal control over financial reporting as of October 29, 2006 based on the criteria established in Internal Control- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).  As a result of this assessment, management concluded that the Company’s internal control over financial reporting was not effective as of October 29, 2006.

 Management’s assessment identified the following material weaknesses in the Company’s internal control over financial reporting as of October 29, 2006:

1.The Company has not established controls to require a review of certain information prepared for inclusion in the Company’s financial statements.  Specifically:

·The Company’s information system generates a report of all changes in or additions to its accounts payable vendor master file.  The Company does not have a control that requires a review of this report by personnel independent of the accounts payable function to assure that all changes were properly authorized.

·The Company makes manual journal entries as part of its reconciliation and closing process.  The Company does not have a control that requires a review of these journal entries and supporting analysis by someone other than the preparer prior to being recorded in the general ledger.

·The Company does not have a control that requires a sufficiently detailed review of the Company’s financial statements prior to their issuance.

·The Company records vendor support based on management estimates. The Company has not established controls to validate this estimate through comparison to actual purchasing activity upon which the vendor support is based.

As a result of this deficiency, adjustments were made to cash, inventory and accrued liabilities.  Furthermore, there is a more than a remote likelihood that a material misstatement of our annual or interim financial statements would not have been prevented or detected.

2.The Company has insufficient controls to ensure that warehouse inventory and cost of sales are properly reported in the interim financial statements.  Specifically, warehouse inventory is only reconciled to the general ledger annually.  This deficiency resulted in more than a remote likelihood that a material misstatement of our interim financial statements would not have been prevented or detected.

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(c)   Changes in Internal Control over Financial Reporting

The Company is currently implementing procedures to establish and maintain controls which will result in all necessary reviews being performed. To date, the Company has moved the responsibility for updating the vendor master file to a department independent of accounts payable.  The procedures for secondary review of journal entries and supporting analysis have been modified to assure adequate review.  The Company is currently implementing procedures to ensure that detailed reconciliations are being prepared.  The Company initiated the development and implementation of controls over the development of the financial statements in the fourth quarter of fiscal 2006.  The Company has designed and implemented procedures to reconcile the warehouse inventory to the general ledger on a quarterly basis.  The Company will continue to review these processes and reevaluate and test these controls to determine that these weaknesses have been remediated.

There were no changes in the Company’s internal control over financial reporting that occurred during the quarter ended October 29, 2006 that materially affected, or are reasonably likely to material affect, the Company’s internal control over financial reporting.

PART II - OTHER INFORMATION

ITEM 1.   LEGAL PROCEEDINGS

The Company is a party to routine litigation from time to time in the ordinary course of business.

ITEM 1A.   RISK FACTORS

The Company encourages investors to carefully consider the risks described below and other information contained in this document when considering an investment decision with respect to he Company’s securities. Additional risks and uncertainties not presently known to management, or that management currently deems immaterial, may also impair the Company’s business operations. Any of the events discussed in the risk factors below may occur. If one or more of these events do occur, business, results of operations or financial condition could be materially adversely affected. In that instance, the trading price of the Company’s securities could decline, and investors might lose part or all of their investment.

Economic Conditions

Similar to other retail businesses, the Company’s operations may be affected adversely by general economic conditions and events which result in reduced consumer spending in the markets served by its stores. Also, smaller communities where the Company’s stores are located may be dependent upon a few large employers or may be significantly affected by economic conditions in the industry upon which the community relies for its economic viability, such as the agricultural industry. This may make the Company’s stores more vulnerable to a downturn in a particular segment of the economy than the Company’s competitors, which operate in markets which are larger metropolitan areas where the local economy is more diverse.

Competition

The Company operates in the discount retail business, which is highly competitive. Although the Company prefers markets that don’t have direct competition from national or regional full-line discount stores, competition still exists. Even in non-competitive markets, the Company’s customers shop at retail discount stores and other retailers located in regional trade centers. The Company also competes for retail sales with other entities, such as mail order companies, specialty retailers, mass merchandisers, dollar stores, manufacturer’s outlets, and the internet. This competitive environment subjects the Company to the risk of reduced profitability because the Company may be forced to lower its prices, resulting in lower margins, in order to maintain its competitive position.

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Store Expansion

The growth in the Company’s sales and operating net income depends to a substantial degree on its expansion program. This expansion strategy is dependent upon the Company’s ability the open and operate new stores effectively, efficiently, and on a profitable basis. The Company prefers to locate its ALCO stores in smaller retail markets where no competing full-line discount retail store is located within the primary trade area. The Company’s ability to timely open new stores and to expand into additional market areas depends in part on the following factors: availability of store locations, the ability to hire and train new store personnel, the ability to react to consumer needs and trends on a timely basis, and the availability of sufficient capital for expansion.

Information Technology

The Company’s ability to implement and train employees on the new POS software, its ability to utilize technology upgrades, and to meet the timetables for rolling out the new technology to the stores could have a material impact on the Company’s results of operations.

Government Regulation

The Company is subject to numerous federal, state and local government laws and regulations, including those relating to the development, construction and operation of the Company’s stores. The Company is also subject to laws governing its relationship with employees, including minimum wage requirements, laws and regulations relating to overtime, working and safety conditions, and citizenship requirements. Material increases in the cost of compliance with any applicable law or regulation and similar matters could materially and adversely affect the Company.

Quarterly Fluctuations

Quarterly results of operations have historically fluctuated as a result of retail consumers purchasing patterns, with the highest quarter in terms of sales and profitability being the fourth quarter. Quarterly results of operations will likely continue to fluctuate significantly as a result of such patterns and may fluctuate due to the timing of new store openings.

Dependence on Officers

The development of the Company’s business is largely dependent on the efforts of its current management team headed by Bruce C. Dale and seven other executive officers. The loss of the services of one or more of these officers could have a material adverse effect on the Company.

Interest Rate Risk

The Company is subject to market risk from exposure to changes in interest rates based on its financing requirements. Changes in interest rates could have a negative impact on the Company’s profitability.

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ITEM 2.   UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The Board of Directors of the Company has authorized the Company to repurchase up to 2,014,461 shares of Common Stock, of which 1,817,798 shares had been purchased as of October 29, 2006.  The following are details of repurchases under this program for the period covered by this report:

					Maximum Number
				Total Number of	(or Approximate
				shares (or Units)	Dollar Value)
				Purchased as Part	of Shares (or
	Total Number Of	Average Price		of Publicly	Units) that May Yet
	Shares (or Units)	Paid per Share		Announced	Be Purchased Under
Period	Purchased	(or Unit)		Plans or Programs	the Plans or Programs
February 1 – February 28, 2006	0	0		0	200,000
March 1 – March 31, 2006	0	0		0	200,000
April 1 – April 30, 2006	0	0		0	200,000
May 1 – May 31, 2006	0	0		0	200,000
June 1 – June 30, 2006	0	0		0	200,000
July 1 – July 30, 2006	3,337	$	30.46	3,337	196,663
August 1 – August 31, 2006	0	0		0	196,663
September 1 – September 30, 2006	0	0		0	196,663
October 1 – October 31, 2006	0	0		0	196,663

ITEM 3.   DEFAULTS UPON SENIOR SECURITIES

Not applicable.

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

None

ITEM 5.   OTHER INFORMATION

None.

ITEM 6.   EXHIBITS

See the Exhibit Index immediately following the signature page hereto.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934 the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	DUCKWALL-ALCO STORES, INC.
	(Registrant)
Date, December 8, 2006	/s/ Michael S. Marcus
	Michael S. Marcus
	Vice President — Finance, Chief Financial Officer
	Signing on behalf of the registrant and as principal financial officer

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EXHIBIT INDEX

2Stock Purchase Agreement dated April 19, 2005 with K&A Asset Management, LLC on behalf of Kenneth A. Macke Revocable Trust (filed as Exhibit 10.20 to the Company’s Annual Report on 10-K for the fiscal year ended January 30, 2005 and incorporated herein by reference)

3.1Articles of Incorporation of Duckwall-ALCO Stores, Inc., amended as of June 13, 1994 and restated solely for filing with the Securities and Exchange Commission (filed as Exhibit 3.1 to Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended August 1, 2004 and incorporated herein by reference).

3.2Bylaws of Duckwall-ALCO Stores, Inc. (filed as Exhibit 3.2 to Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended August 1, 2004 and incorporated herein by reference).

4.1Specimen of Duckwall-ALCO Stores, Inc. Common Stock Certificate. (filed as Exhibit 4.1 to Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended August 1, 2004 and incorporated herein by reference).

4.2        Reference is made to the Amended and Restated Articles of Incorporation described under 3.1 above and Bylaws described under 3.2 above.

4.3Loan and Security Agreement, dated as of April 15, 2002, between the Company and Fleet Retail Finance Inc. (filed as Exhibit 10.16 to the Company’s Annual Report on Form 10-K for the fiscal year ended February 2, 2003 and hereby incorporated by reference).

4.4Loan and Security Agreement, dated as of April 15, 2002, between the Company and Fleet Retail Finance, Inc. (filed as Exhibit 10.16 to the Company’s Annual Report on Form 10-K for the fiscal year ended February 2, 2003 and hereby incorporated by reference).

4.5Joinder Agreement and First Amendment to Loan and Security Agreement dated September 9, 2002 among the Company, Fleet Retail Finance Inc., and DA Good Buys, Inc. (filed as Exhibit 10.17 to the Company’s Annual Report on Form 10-K for the fiscal year ended February 2, 2003 and hereby incorporated by reference).

31.1Certification of Chief Executive Officer of Duckwall-ALCO Stores, Inc. dated December 8, 2006, pursuant to Rule 13a-4(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2Certification of Chief Financial Officer of Duckwall-ALCO Stores, Inc. dated December 8, 2006, pursuant to Rule 13a-4(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1Certification of Chief Executive Officer of Duckwall-ALCO Stores, Inc, dated December 8, 2006, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, which is furnished with this Quarterly Report on Form 10-Q for the quarter ended October 29, 2006 and is not treated as filed in reliance upon § 601(b)(32) of Regulations S-K.

32.2Certification of Chief Financial Officer of Duckwall-ALCO Stores, Inc., dated December 8, 2006, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, which is furnished with this Quarterly Report on Form 10-Q for the quarter ended October 29, 2006 and is not treated as filed in reliance upon § 601(b)(32) of Regulations S-K.

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