MANAGEMENT’S DISCUSSION & ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS inventories. The retail inventory method is an averaging method that has been widely used in the retail industry and results in valuing inventories at lower of cost or market when markdowns are taken as a reduction of the retail value of inventories on a timely basis. Inventory valuation methods require certain significant management estimates and judgments, including estimates of merchandise markdowns and shrink, which significantly affect the ending inventory valuation at cost as well as the resulting gross margins. The averaging required in applying the retail inventory method and the estimates of shrink and markdowns could, under certain circumstances, result in costs not being recorded in the proper period. We estimate our markdown reserve based on the consideration of a variety of factors, including but not limited to quantities of slow moving or carryover seasonal merchandise on hand, historical markdown statistics and future merchandising plans. The accuracy of our estimates can be affected by many factors, some of which are outside of our control, including changes in economic conditions and consumer buying trends. Historically, we have not experienced significant differences in our estimates of markdowns compared with actual results. Our accrual for shrink is based on the actual historical shrink results of our most recent physical inventories adjusted, if necessary, for current economic conditions. These estimates are compared to actual results as physical inventory counts are taken and reconciled to the general ledger. The majority of our counts are taken between January and May of each year; therefore, the shrink accrual recorded at January 29, 2005 is based on estimated shrink for most of 2004, including the fourth quarter. We have not experienced significant fluctuations in historical shrink rates in our Dollar Tree stores. However, we have sometimes experienced higher than typical shrink in acquired stores in the year following an acquisition. We periodically adjust our shrink estimates  to address these factors as they become apparent. Our management believes that our application of the retail inventory method results in an inventory valuation that reasonably approximates cost and results in carrying inventory at the lower of cost or market. On a monthly basis, we estimate certain material expenses in an effort to record those expenses in the We experience seasonal fluctuations in our net sales, comparable store net sales, operating income and net income and expect this trend to continue. Our results of operations may also fluctuate significantly as a result of  a variety of factors, including: On a quarterly basis, we estimate our required tax liability and assess the recoverability of our deferred tax assets. Our taxes payable are estimated based on enacted tax rates, including estimated tax rates in states where our store base is growing applied to the income expected  to be taxed currently. The current tax liability includes a liability for resolution of tax uncertainties. Management assesses the realizability of our deferred tax assets based on the availability of carrybacks of future deductible amounts and management’s projections for future taxable income. We cannot guarantee that we will generate income in future years. Historically, we have not experi- enced significant differences in our estimates of our tax accrual. However, in 2004 we recognized a one time tax benefit related to the resolution of a tax uncertainty. period incurred. Our most material estimates relate to domestic freight, expenses related to our self-insurance programs, certain store level operating expenses, such as property taxes and utilities, and other expenses. Our freight and store-level operating expenses are estimated based on current activity and historical results. Our workers’ compensation and general liability insurance accruals are recorded based on actuarial valuation methods which are adjusted annually based on a review performed by a third-party actuary. These actuarial valuations are estimates based on historical loss develop- ment factors. Other expenses are estimated and recorded in the periods that management becomes aware of them. The related accruals are adjusted as management’s estimates change. Differences in management’s estimates and assumptions could result in an accrual materially different from the calculated accrual. Our experience has been that some of our estimates are too high and others are too low. Historically, the net total of these differences has not had a material effect on our financial condition or results of operations. Income Taxes Seasonality and Quarterly Fluctuations Accrued Expenses • shifts in the timing of certain holidays, especially Easter; DOLLAR TREE STORES, INC. • 2004 ANNUAL REPORT 23