Strategy

Dollar General’s mission statement is “Serving Others.” To carry out this mission, the Company has developed a business strategy of providing its customers with a focused assortment of fairly priced, consumable merchandise in a convenient, small-store format.

Our Customers . The Company serves the basic consumable needs of customers primarily in the low and middle-income brackets and those on fixed incomes. According to AC Nielsen’s 2005 Homescan® data, in 2005 approximately 48% of the Company’s customers earned less than $30,000 per year and approximately 26% earned less than $20,000 per year. The Company’s merchandising and operating strategies are primarily designed to meet the need for basic consumable products of the consumers in these lower income groups.

Our Stores . The traditional Dollar General store has, on average, approximately 6,800 square feet of selling space and generally serves customers who live within five miles of the store. Of the Company’s 8,019 stores operating as of March 3, 2006, approximately 4,580 serve communities with populations of 20,000 or less. The Company believes that its target customers prefer the convenience of a small, neighborhood store. The Company believes that Dollar General’s convenient discount store format will continue to attract customers and provide the Company with a competitive advantage.

In 2003, the Company began testing a Dollar General Market concept. Dollar General Markets are larger than the average Dollar General store and carry, among other items, an expanded assortment of grocery products and perishable items. At March 3, 2006, the Company’s 8,019 total stores included 44 Dollar General Market stores with an average of 17,400 square feet of selling space. The Company plans to open at least 30 Dollar General Market stores in 2006.

Our Merchandise . The Company is committed to offering a focused assortment of quality, consumable merchandise in a number of core categories, such as health and beauty aids, packaged food and refrigerated products, home cleaning supplies, housewares, stationery, seasonal goods, basic clothing and domestics. This focused merchandise assortment allows customers to shop at Dollar General stores for their everyday household needs. In 2005, the average customer purchase was $9.03.

Our Prices . The Company distributes quality, consumable merchandise at everyday low prices. Its strategy of a low-cost operating structure and a focused assortment of merchandise allows the Company to offer quality merchandise at competitive prices. As part of this strategy, the Company emphasizes even-dollar prices on many of its items. In the typical Dollar General store, the majority of the products are priced at $10 or less, with approximately 30% of the products priced at $1 or less.

Our Cost Controls . The Company emphasizes aggressive management of its overhead cost structure. Additionally, the Company seeks to locate stores in neighborhoods where rental and operating costs are relatively low. The Company attempts to control operating costs by implementing new technology where feasible. Examples of this strategy in recent years include the implementation of “EZstore”, the Company’s initiative designed to improve inventory flow from distribution centers to consumers; other improvements to the Company’s supply chain and warehousing systems; an automatic inventory replenishment system at the store level; and the implementation of a new merchandise planning system designed to assist the Company’s merchants with their purchasing and store allocation decisions.

Growth Strategy

The Company has experienced a rapid rate of expansion in recent years, increasing its number of stores from 5,000 as of February 2, 2001, to 8,019 as of March 3, 2006. In addition to growth from new store openings, the Company recorded same-store sales increases of 2.0% and 3.2% in 2005 and 2004, respectively. Same-store sales calculations for 2005 and prior include only those stores that were open both at the end of that period and at the beginning of the preceding fiscal year, based on the comparable calendar weeks in the prior year. As further described below in Part II, Item 7, 2005 was a 53-week accounting period while 2004 was a 52-week accounting period. Accordingly, the same store sales percentage for 2005 discussed above excludes sales from the 53 rd week as there was no comparable week in 2004. In addition, the Company has revised its method for determining the stores that are included in its publicly released same-store sales calculations beginning in 2006. Management will continue to seek to grow the Company’s business and believes that this future growth will come from a combination of new store openings, infrastructure investments and merchandising initiatives, each as discussed more fully below.

New Store Growth . Management believes that the Company’s convenient, small-store format is adaptable to small towns and neighborhoods throughout the country. The majority of the Company’s stores are located in these small towns (defined by the Company as communities with populations of 20,000 or less). In 2005, slightly over half of the Company’s new stores were opened in small towns while the remainder were opened either in rural or in more densely populated areas. The Company expects a similar mix of new store openings between small

towns and other areas in 2006. New store openings in 2006 will include the Company’s existing market area as well as certain other geographic areas where management believes the Company has the potential to expand its store base. Opening stores in its existing market areas allows the Company to take advantage of brand awareness and to maximize its operating efficiencies.

In 2005, 2004 and 2003, the Company opened 734, 722 and 673 new stores, and remodeled or relocated 82, 80 and 76 stores, respectively. The Company currently plans to open approximately 800 new Dollar General stores and at least 30 new Dollar General Market stores in 2006. Some of the new Dollar General Markets may replace existing traditional stores.

Infrastructure Investments . The Company’s distribution network is an integral component of the Company’s efforts to reduce transportation expenses and effectively support the Company’s growth. In recent years, the Company has made significant investments in its distribution network. As of March 3, 2006, the Company operated eight distribution centers (“DCs”), one of which opened during 2005. The Company’s ninth DC in Marion, Indiana is expected to be completed and fully operational in mid-2006. In addition, the Company is currently in the planning stages for its tenth DC. Also, in recent years, the Company has expanded its DCs in South Boston, Virginia and Ardmore, Oklahoma by completing the conversion of these DCs from single to dual sortation systems, which enables them to serve more stores.

The Company’s investments in technology in recent years are outlined below. In 2005, new systems for store operating statements, store labor scheduling, supplier communications and transportation and claims management were installed. In addition, the Company enhanced its store systems to sell Dollar General gift cards. In 2004, a merchandising data warehouse was added, the rollout of credit/debit and/or electronic benefit transfer (“EBT”) capabilities was completed and an automatic inventory replenishment system was installed in all stores. In addition, a new stock ledger and sales flash system were completed. Also, for the first time, store district managers were equipped with personal computers to enable them to access daily merchandising information. In 2003, the Company implemented an improved warehouse management system, a DC appointment scheduling system, and an inventory reconciliation system, and completed allocation system improvements, shortage analysis reporting, and improvements to automated DC replenishment systems.

Merchandising Initiatives . The Company’s merchandising initiatives are designed to promote same-store sales increases. The Company continually evaluates the performance of its merchandise mix and makes adjustments when appropriate. In recent years, the Company has increased its emphasis on the highly consumable category by adding items in the food, paper, pet products, household chemicals, and health and beauty aids categories. Also in recent years, the Company began offering perishable products, which include a selection of dairy products, luncheon meats, frozen foods and ice cream. Other recent initiatives include prepaid phone cards and branded apparel.

Beginning in the fourth quarter of 2003, and principally at the conclusion of the holiday selling season, the Company began taking end-of-season markdowns materially in excess of what it had historically taken to appropriately value year-end inventory and to help dispose of certain holiday-related items that had not sold in sufficient quantities. Prior to 2003, the

Company would have carried that inventory forward and would have attempted to adjust future inventory purchases to account for the carryover product. In 2004 and 2005, the Company again executed end-of-season markdowns throughout the year as it deemed appropriate. The Company continues to aggressively identify, evaluate, merchandise and markdown aged inventory to minimize seasonal inventory carried forward to the next fiscal year.

Merchandise

Dollar General stores offer a focused assortment of quality merchandise in a number of core categories. The Company separates its merchandise into the following four categories for reporting purposes: highly consumable, seasonal, home products, and basic clothing. The Company maintains approximately 4,600 core stock-keeping units (“SKUs”) per store.

The percentage of total sales of each of the four categories tracked by the Company for the preceding three years is as follows:

2005

Highly consumable

65.3

%

63.0

%

61.2

%

Seasonal

15.7

%

16.5

%

16.8

%

Home products

10.6

%

11.5

%

12.5

%

Basic clothing

8.4

%

9.0

%

9.5

%

Of the four categories, the seasonal category typically accounts for the highest gross profit rate and the highly consumable category typically accounts for the lowest gross profit rate.

The Company purchases its merchandise from a wide variety of suppliers. Approximately 11% of the Company’s purchases in 2005 were from Procter and Gamble. No other supplier accounted for more than 3% of the Company’s purchases in 2005. The Company directly imported approximately 13% of its retail receipts in 2005.

Through 2005, the Company generally did not print weekly advertising circulars but instead advertised to support new traditional store openings primarily with targeted circulars and in-store signage. Advertising expenses were less than 1% of sales. In 2005, the Company initiated a marketing program as the sponsor of a National Association for Stock Car Auto Racing (“NASCAR”) Busch Series car. The Company participated in the Busch Series racing season, which ran from February to November and served as the title sponsor of the Dollar General 300 NASCAR Busch Series race at Lowe’s Motor Speedway in Concord, North Carolina.

Seasonality

The Company’s business is modestly seasonal in nature. The Company expects to continue to experience seasonal fluctuations, with a larger percentage of its net sales, operating profit and net income being realized in the fourth quarter. In addition, the Company’s quarterly results can be affected by the timing of new store openings and store closings, the amount of sales contributed by new and existing stores, as well as the timing of certain holidays. The Company purchases substantial amounts of inventory in the third quarter and incurs higher

shipping costs and higher payroll costs in anticipation of the increased sales activity during the fourth quarter. In addition, the Company carries merchandise during its fourth quarter that it does not carry during the rest of the year, such as gift sets, trim-a-tree, certain baking items, and a broader assortment of toys and candy.

The following table reflects the seasonality of net sales, operating profit, and net income by quarter. All of the quarters reflected below are comprised of 13 weeks with the exception of the fourth quarter of the year ended February 3, 2006, which was comprised of 14 weeks.

1 st
Quarter

2 nd
Quarter

3 rd
Quarter

4 th
Quarter

Year Ended February 3, 2006

Net sales

23.0

%

24.1

%

24.0

%

28.9

%

Operating profit

19.0

%

21.5

%

18.1

%

41.3

%

Net income

18.5

%

21.6

%

18.4

%

41.5

%

Year Ended January 28, 2005

Net sales

22.8

%

24.0

%

24.5

%

28.7

%

Operating profit

20.6

%

19.4

%

20.5

%

39.6

%

Net income

19.7

%

20.7

%

20.7

%

38.9

%

Year Ended January 30, 2004

Net sales

22.8

%

24.0

%

24.5

%

28.6

%

Operating profit

20.3

%

20.0

%

25.9

%

33.8

%

Net income

20.2

%

20.0

%

26.1

%

33.7

%

The Dollar General Store

The typical Dollar General store is operated by a manager, an assistant manager and two or more sales clerks. Approximately 52% of the Company’s stores are located in strip shopping centers, 46% are in freestanding buildings and 2% are in downtown buildings. The Company generally has not encountered difficulty locating suitable store sites in the past, and management does not currently anticipate experiencing material difficulty in finding suitable locations.

The Company’s recent store growth is summarized in the following table:

Year

Stores at
Beginning
of Year

Stores
Opened

Stores
Closed

Net
Store
Increase

Stores at
End of Year

6,113

6,700

6,700

7,320

7,320

(a)

7,929

(a) Includes 41 stores closed as a result of hurricane damage.

Employees

As of March 3, 2006, the Company employed approximately 64,500 full-time and part-time employees, including divisional and regional managers, district managers, store managers, and DC and administrative personnel, compared with approximately 63,200 employees on April 1, 2005. Management believes the Company’s relationship with its employees is generally good and the Company is not a party to any collective bargaining agreements.

Competition

The Company operates in the discount retail merchandise business, which is highly competitive with respect to price, store location, merchandise quality, assortment and presentation, in-stock consistency, and customer service. The Company competes with discount stores and with many other retailers, including mass merchandise, grocery, drug, convenience, variety and other specialty stores. These other retail companies operate stores in many of the areas where the Company operates and many of them engage in extensive advertising and marketing efforts. The Company’s direct competitors in the dollar store retail category include Family Dollar, Dollar Tree, Fred’s and various local, independent operators. Competitors from other retail categories include Wal-Mart and Walgreens, among others. Certain of the Company’s competitors have greater financial, distribution, marketing and other resources than the Company.

The dollar store category differentiates itself from other forms of retailing by offering consistently low prices in a convenient, small-store format. The Company believes that its prices are competitive due in part to its low cost operating structure and the relatively limited assortment of products offered. Historically, labor and marketing expenses have been minimized by fewer price points, relying on simple merchandise presentation, and limited marketing efforts. The Company attempts to locate primarily in second-tier locations, either in small towns or in the neighborhoods of more densely populated areas where occupancy expenses are relatively low. The Company maintains a strong purchasing power position due to its leadership position in the dollar store retail category, which centers on a focused assortment of merchandise.

Trademarks

The Company, through its affiliate, Dollar General Merchandising, Inc., has registered with the United States Patent and Trademark Office the trademarks Dollar General®, Dollar General Market®, Clover Valley®, American Value®, DG Guarantee® and the Dollar General price point designs, along with certain other trademarks. The Company attempts to obtain registration of its trademarks whenever possible and to pursue vigorously any infringement of those marks.

Available Information

The Company’s website address is www.dollargeneral.com . The Company makes available through this address, without charge, its annual report 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 Exchange Act as soon as reasonably practicable after they are electronically filed or furnished to the Securities and Exchange Commission (“SEC”).

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 Dollar General’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 Dollar General securities could decline, and investors might lose all or part of their investment.

The Company’s business is moderately seasonal with the highest portion of sales occurring during the fourth quarter. Adverse events during the fourth quarter could, therefore, materially affect the Company’s financial statements as a whole . The Company realizes a significant portion of its net sales and net income during the Christmas selling season in the fourth quarter. In anticipation of this holiday, the Company purchases substantial amounts of seasonal inventory and hires many temporary employees. A seasonal merchandise inventory imbalance could result if for any reason the Company’s net sales during the Christmas selling season were to fall below seasonal norms. If such an imbalance were to occur, more markdowns than anticipated might be required to minimize the imbalance. The Company’s profitability and operating results could be adversely affected by unanticipated markdowns and by lower than anticipated sales. Lower than anticipated sales in the Christmas selling season would also negatively impact the Company’s ability to leverage the increased labor costs.

Competition in the retail industry could limit the Company’s growth opportunities and reduce its profitability . The Company operates in the discount retail merchandise business, which is highly competitive. This competitive environment subjects the Company to the risk of reduced profitability because of the lower prices, and thus the lower margins, required to maintain the Company’s competitive position. The Company competes with discount stores and with many other retailers, including mass merchandise, grocery, drug, convenience, variety and other specialty stores. These other retail companies operate stores in many of the areas where the Company operates. The Company’s direct competitors in the dollar store retail category include, without limitation, Family Dollar, Dollar Tree, Fred’s, and various local, independent operators. Competitors from other retail categories include Wal-Mart and Walgreens, among others. Some of the Company’s competitors utilize aggressive promotional activities, advertising programs, and pricing discounts and the Company’s results of operations could be adversely affected if the Company does not respond effectively to these efforts.

The discount retail merchandise business is subject to excess capacity, and some of the Company’s competitors are much larger and have substantially greater resources than the Company. The competition for customers has intensified in recent years as larger competitors, such as Wal-Mart, have moved into, or increased their presence in, the Company’s geographic markets. The Company remains vulnerable to the marketing power and high level of consumer recognition of these major national discount chains and to the risk that these chains or others could venture into the “dollar store” industry in a significant way. Generally, the Company expects an increase in competition.

The Company’s financial performance is highly sensitive to changes in overall economic conditions that may impact consumer spending and the Company’s costs of doing business . A general slowdown in the United States economy or rising personal debt levels may adversely affect the spending of the Company’s consumers, which would likely result in lower net sales than expected on a quarterly or annual basis. Economic conditions affecting disposable consumer income, such as employment levels, business conditions, fuel and energy costs, inflation, interest rates, and tax rates, could also adversely affect the Company’s business by reducing consumer spending or causing consumers to shift their spending to other products. The Company might be unable to anticipate these buying patterns and implement appropriate inventory strategies, which would adversely affect its sales and gross profit performance. In addition, continued increases in fuel and energy costs would increase the Company’s transportation costs and overall cost of doing business and could adversely affect the Company’s financial statements as a whole.

Natural disasters or unusually adverse weather conditions could adversely affect the Company’s net sales and supply chain efficiency. Unusually adverse weather conditions, natural disasters or similar disruptions, especially during the peak Christmas selling season, but also at other times, could significantly reduce the Company’s net sales. In addition, these disruptions could also adversely affect the Company’s supply chain efficiency and make it more difficult for the Company to obtain sufficient quantities of merchandise from its suppliers.

Existing military efforts and the possibility of war and acts of terrorism could disrupt the Company’s information or distribution systems or increase our costs of doing business. Existing U.S. military efforts, as well as the involvement of the United States in other military engagements, or a significant act of terrorism on U.S. soil or elsewhere, could have an adverse impact on the Company by, among other things, disrupting its information or distribution systems; causing dramatic increases in fuel prices thereby increasing the costs of doing business; or impeding the flow of imports or domestic products to the Company.

The Company’s business is dependent on its ability to obtain attractive pricing and other terms from its vendors . The Company believes that it has generally good relations with its vendors and that it is generally able to obtain attractive pricing and other terms from vendors. However, if the Company fails to maintain good relations with its vendors, it may not be able to obtain attractive pricing with the consequence that its net sales or profit margins would be reduced. Also, prolonged or repeated price increases of certain raw materials could affect our vendors’ product costs and, ultimately, the Company’s profitability. The Company’s ability to pass on incremental pricing changes may be limited due to operational and competitive factors, which could negatively affect the Company’s profitability and sales.

The efficient operation of the Company’s business is heavily dependent on its information systems . The Company depends on a variety of information technology systems for the efficient functioning of its business. The Company relies on certain software vendors to maintain and periodically upgrade many of these systems so that they can continue to support the Company’s business. The software programs supporting many of the Company’s systems were licensed to the Company by independent software developers. The inability of these developers or the Company to continue to maintain and upgrade these information systems and software programs would disrupt or reduce the efficiency of the Company’s operations if it were unable to convert

to alternate systems in an efficient and timely manner. In addition, costs and potential problems and interruptions associated with the implementation of new or upgraded systems and technology or with maintenance or adequate support of existing systems could also disrupt or reduce the efficiency of the Company’s operations. The Company also relies heavily on its information technology staff. If the Company cannot meet its staffing needs in this area, the Company may not be able to fulfill its technology initiatives while continuing to provide maintenance on existing systems.

The Company is dependent upon the smooth functioning of its distribution network, the capacity of its DCs, and the timely receipt of inventory . The Company relies upon the ability to replenish depleted inventory through deliveries to its DCs from vendors and from the DCs to its stores by various means of transportation, including shipments by air, sea and truck. Labor shortages in the transportation industry could negatively affect transportation costs. In addition, long-term disruptions to the national and international transportation infrastructure that lead to delays or interruptions of service would adversely affect the Company’s business. The Company also may face difficulty in obtaining needed inventory from its vendors because of interruptions in production, adverse weather conditions, foreign trade restrictions or government regulations, or for other reasons, which would adversely affect the Company’s sales. Moreover, if the Company were unable to achieve functionality of new DCs in the time frame expected, the Company’s ability to achieve the expected growth could be inhibited.

Construction and expansion projects relating to the Company’s DCs entail risks which could cause delays and cost overruns, such as: shortages of materials; shortages of skilled labor or work stoppages; unforeseen construction, scheduling, engineering, environmental or geological problems; weather interference; fires or other casualty losses; and unanticipated cost increases. The completion dates and ultimate costs of these projects could differ significantly from initial expectations due to construction-related or other reasons. The Company cannot guarantee that any project will be completed on time or within established budgets.

The Company’s success depends to a significant extent upon the abilities of its senior management team and the performance of its employees . The loss of services of key members of the Company’s senior management team or of certain other key employees could negatively affect the Company’s business. The risk of key employee turnover intensifies as a greater number of public corporations locate in the vicinity of the Company’s headquarters. In addition, future performance will depend upon the Company’s ability to attract, retain and motivate qualified employees to keep pace with its expansion schedule. The inability to do so may limit the Company’s ability to effectively penetrate new market areas. Also, the Company’s stores are decentralized and are managed through a network of geographically dispersed management personnel. The inability of the Company to effectively and efficiently operate its stores, including the ability to control losses resulting from inventory and cash shrinkage, may negatively impact the Company’s sales and/or operating margins.

If the Company cannot open new stores on schedule, its growth will be impeded which would adversely affect sales . The Company’s growth is dependent on both increases in sales in existing stores and the ability to open new stores. Delays in store openings could adversely affect the Company’s future operations by slowing new store growth, which may in turn reduce its revenue growth. The Company’s ability to timely open new stores and to expand into additional

market areas depends in part on the following factors: the availability of attractive store locations; the ability to negotiate favorable lease terms; the ability to hire and train new personnel, especially store managers; the ability to identify customer demand in different geographic areas; general economic conditions; and the availability of sufficient funds for expansion. Many of these factors are beyond the Company’s control. In addition, the Company may not anticipate all of the challenges imposed by the expansion of its operations and, as a result, may not meet its targets for opening new stores or expanding profitably.

The inability to execute operating initiatives could negatively affect the Company’s future operating results . The Company is involved in a significant number of operating initiatives that have the potential to be disruptive in the short term if they are not implemented effectively. Ineffective implementation or execution of some or all of these initiatives could also negatively impact the Company’s operating results. Please reference the discussion of the initiatives in the “Results of Operations – Executive Overview” section included in Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operation” below.

The Company’s cost of doing business could increase as a result of changes in federal, state or local regulations . Unanticipated changes in the federal or state minimum wage or living wage requirements or changes in other wage or workplace regulations could adversely affect the Company’s ability to meet financial targets. In addition, changes in federal, state or local regulations governing the sale of the Company’s products, particularly “over-the-counter” medications or health products, could increase the Company’s cost of doing business and could adversely affect the Company’s sales results. Also, the Company’s inability to comply with these regulatory changes in a timely fashion or to adequately execute a required recall could result in significant fines or penalties that could affect the Company’s financial statements as a whole.

Unanticipated increases in insurance costs or loss experience could negatively impact profitability . The costs of some insurance (workers’ compensation insurance, general liability insurance, health insurance and property insurance) and loss experience have risen in recent years. Higher than expected increases in these costs or other insurance costs or unexpected escalations in the Company’s loss rates could have an unanticipated negative impact on the Company’s profitability.

The Company is subject to certain legal proceedings that may adversely affect its financial statements as a whole. The Company is involved in a number of legal proceedings, which include, for instance, consumer, employment, tort and other litigation. Certain of these lawsuits, if decided adversely to the Company or settled by the Company, may result in liability material to the Company’s financial statements as a whole or may negatively impact the Company’s operating results if changes to the operation of the business are required. Please see Note 7 to the Consolidated Financial Statements included in Part II, Item 8 below for further details regarding certain of these pending matters.

The Company may be unable to rely on liability indemnities given by foreign vendors which could adversely affect its financial statements as a whole. The Company imports approximately 13% of its merchandise globally. Sources of supply may prove to be unreliable, or the quality of the globally sourced products may vary from the Company’s expectations. The

Company’s ability to obtain indemnification from the manufacturers of these products may be hindered by the manufacturers’ lack of understanding of U.S. product liability laws, which may make it more likely that the Company may have to respond to claims or complaints from its customers as if the Company were the manufacturer of the products. Any of these circumstances could have a material adverse effect on the Company’s business and its financial statements as a whole.

The Company is subject to interest rate risk which could impact profitability . The Company is subject to market risk from exposure to changes in interest rates based on its financing, investing and cash management activities. Changes in interest rates could have an unanticipated negative impact on the Company’s profitability.

ITEM 1B.

UNRESOLVED STAFF COMMENTS