STATER BROS HOLDINGS INC - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


		[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
		EXCHANGE ACT OF 1934

For the quarterly period ended June 27, 2004


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

For the transition from ____ to ____

Commission file number 001-13222

STATER BROS. HOLDINGS INC.

(Exact name of registrant as specified in its charter)


Delaware		33-0350671

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


21700 Barton Road Colton, California		92324

(Address of principal executive offices)		(Zip Code)


Registrant’s telephone number, including area code		(909) 783-5000

Not Applicable

(Former name, former address and former fiscal year, if changed since last report.)

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 [ ].

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [ ] No [X].

As of August 11, 2004, there were issued and outstanding
38,301 shares of the registrant’s Class A Common Stock.

PART I - FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

STATER BROS. HOLDINGS INC.

CONSOLIDATED BALANCE SHEETS
(In thousands)

ASSETS


	Sept. 28,		June 27,
	2003		2004
			(Unaudited)
Current assets
Cash and cash equivalents	$	111,152	$	326,911
Restricted cash		—		20,000
Receivables		23,217		36,277
Income tax receivables		4,354		9,285
Inventories		172,267		190,248
Prepaid expenses		6,962		11,442
Deferred income taxes		14,793		14,793

Total current assets		332,745		608,956
Investment in unconsolidated affiliate		16,910		—
Property and equipment
Land		50,930		68,120
Buildings and improvements		200,349		250,659
Store fixtures and equipment		242,562		327,230
Property subject to capital leases		24,670		25,891

		518,511		671,900
Less accumulated depreciation and amortization		216,366		265,981

		302,145		405,919
Deferred debt issuance costs, net		10,486		22,722
Other assets		5,540		6,282

		16,026		29,004

Total assets	$	667,826	$	1,043,879

See accompanying notes to unaudited consolidated financial statements.

STATER BROS. HOLDINGS INC.
CONSOLIDATED BALANCE SHEETS (Continued)
(In thousands, except share amounts)

LIABILITIES AND STOCKHOLDER’S DEFICIT


	Sept. 28,			June 27,
	2003			2004
				(Unaudited)
Current liabilities
Accounts payable	$	112,458		$	146,785
Accrued payroll and related expenses		44,362			55,976
Other accrued liabilities		50,352			39,883
Current portion of capital lease obligations and long term debt		1,056			42,250

Total current liabilities		208,228			284,894
Deferred income taxes		6,708			12,424
Long-term debt		458,750			700,000
Capital lease obligations, less current portion		9,926			9,823
Long-term portion of self-insurance and other reserves		27,941			43,420
Other long-term liabilities		20,267			43,163

Total liabilities		731,820			1,093,724

Stockholder’s deficit
Common Stock, $.01 par value:
Authorized shares - 100,000
Issued and outstanding shares - 0		—			—
Class A Common Stock, $.01 par value:
Authorized shares - 100,000
Issued and outstanding shares - 38,301		—			—
Additional paid-in capital		9,740			9,740
Retained deficit		(73,734	)		(59,585	)

Total stockholder’s deficit		(63,994	)		(49,845	)

Total liabilities and stockholder’s deficit	$	667,826		$	1,043,879

See accompanying notes to unaudited consolidated financial statements.

STATER BROS. HOLDINGS INC.

CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In thousands, except per share and share amounts)


	39 Weeks Ended
	June 29,			June 27,
	2003			2004
Sales	$	2,046,776		$	2,863,955
Cost of goods sold		1,484,710			2,038,011

Gross profit		562,066			825,944
Operating expenses:
Selling, general and administrative expenses		491,437			631,145
Depreciation and amortization		19,615			23,331

Total operating expenses		511,052			654,476

Operating profit		51,014			171,468
Interest income		770			1,005
Interest expense		(39,898	)		(39,416	)
Interest expense related to debt purchase		—			(34,017	)
Equity in earnings from unconsolidated affiliate		1,196			929
Other expenses — net		(756	)		(1,017	)

Income before income taxes		12,326			98,952
Income taxes		4,798			39,803

Net income	$	7,528		$	59,149

Earnings per share	$	196.55		$	1,544.32

Dividends per share	$	—		$	1,174.90

Average common shares outstanding		38,301			38,301

Shares outstanding at end of period		38,301			38,301

See accompanying notes to unaudited consolidated financial statements.

STATER BROS. HOLDINGS INC.

CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share and share amounts)


	13 Weeks Ended
	June 29,			June 27,
	2003			2004
Sales	$	688,071		$	847,984
Cost of goods sold		498,838			623,261

Gross profit		189,233			224,723
Operating expenses:
Selling, general and administrative expenses		168,194			188,365
Depreciation and amortization		6,869			8,145

Total operating expenses		175,063			196,510

Operating profit		14,170			28,213
Interest income		244			157
Interest expense		(13,339	)		(13,103	)
Interest expense related to debt purchase		—			(25,495	)
Equity in earnings from unconsolidated affiliate		217			—
Other expenses — net		(129	)		(308	)

Income (loss) before income taxes (benefit)		1,163			(10,536	)
Income taxes (benefit)		394			(4,763	)

Net income (loss)	$	769		$	(5,773	)

Earnings (loss) per share	$	20.08		$	(150.73	)

Dividends per share	$	—		$	1,174.90

Average common shares outstanding		38,301			38,301

Shares outstanding at end of period		38,301			38,301

See accompanying notes to unaudited consolidated financial statements.

STATER BROS. HOLDINGS INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)


	39 Weeks Ended
	June 29,			June 27,
	2003			2004
Operating activities:
Net income	$	7,528		$	59,149
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		25,237			30,557
Gain from litigation settlement		—			(22,371	)
Deferred income taxes		—			(707	)
Loss on disposals of assets		756			1,115
Net undistributed gain in investment in unconsolidated affiliate		(1,196	)		(929	)
Changes in operating assets and liabilities:
Increase in restricted cash		—			(20,000	)
Decrease in receivables		1,133			1,276
(Increase) decrease in income tax receivables		5,849			(4,931	)
(Increase) decrease in inventories		5,146			(15,285	)
Increase in prepaid expenses		(1,071	)		(3,311	)
Decrease in other assets		2,724			12,944
Increase in accounts payable		7,486			26,693
Increase in accrued liabilities, long-term portion of self-insurance reserves and other liabilities		22,276			52,401

Net cash provided by operating activities		75,868			116,601

Investing activities:
Purchase of property and equipment		(37,659	)		(45,389	)
Proceeds from sale of property and equipment		85			124

Net cash used in investing activities		(37,574	)		(45,265	)

Financing activities:
Proceeds from long-term debt		—			700,000
Proceeds from equipment financing		—			718
Debt issuance costs		—			(22,318	)
Amortization of debt issuance costs related to debt purchase		—			8,599
Premium and fees paid on debt purchase		—			(16,897	)
Make whole payment on redemption of debt		—			(8,521	)
Principal payments on long-term debt		—			(471,300	)
Principal payments on capital lease obligations		(859	)		(858	)
Payment of dividends		—			(45,000	)

Net cash provided by (used in) financing activities		(859	)		144,423

Net increase in cash and cash equivalents		37,435			215,759
Cash and cash equivalents at beginning of period		81,043			111,152

Cash and cash equivalents at end of period	$	118,478		$	326,911

Interest paid	$	25,519		$	66,505
Income taxes paid	$	750		$	42,200

See accompanying notes to unaudited consolidated financial statements.

STATER BROS. HOLDINGS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
JUNE 27, 2004

Note 1 — Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the thirteen and thirty-nine weeks ended June 27, 2004 are not necessarily indicative of the results that may be expected for the year ending September 26, 2004.

The consolidated balance sheet at September 28, 2003 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s report on Form 10-K for the year ended September 28, 2003.

Note 2 — Reclassifications

Certain amounts in the prior period have been reclassified to conform to the current period financial statements presentation.

Note 3 — Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

Note 4 — Restricted Cash

Restricted cash represents cash that has been contractually set aside as collateral for certain workers’ compensation and general liability self-insurance reserves. Interest earned on the restricted cash is controlled by the Company and is included in cash and cash equivalents.

STATER BROS. HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
JUNE 27, 2004

Note 5 — Retirement Plans

The Company has a noncontributory defined benefit pension plan covering substantially all non-union employees. The plan provides for benefits based on an employee’s compensation during the eligibility period while employed with the Company. The Company’s funding policy for this plan is to contribute annually at a rate that is intended to provide sufficient assets to meet future benefit payment requirements.

Net periodic pension cost included the following components:


	13 Weeks Ended						39 Weeks Ended
	June 29,			June 27,			June 29,			June 27,
	2003			2004			2003			2004
				(In thousands)
Service cost — benefits earned during the period	$	524		$	521		$	1,572		$	1,664
Interest cost on projected benefit obligation		564			641			1,692			1,867
Actual return on assets		(512	)		(462	)		(1,535	)		(1,458	)
Net amortization and deferral		6			7			19			20
Recognized gains or losses		117			225			350			540
Prior service cost recognized		—			(1	)		(1	)		(1	)

Net periodic pension cost	$	699		$	931		$	2,097		$	2,632

Note 6 — Santee

In 1997, in connection with the construction of a new dairy facility in City of Industry, California, Stater Bros. Markets (“Markets”) and Hughes Markets (“Hughes”), the owners of Santee Dairies, Inc. (“Santee”) contributed the outstanding shares of Santee to a new entity Santee Dairies, LLC (“SDL”) with each company owning 50% of SDL. Markets and Hughes each entered into separate product purchase agreements (“PPA”) with Santee for the purchase of fluid milk and other products. Financing for the new dairy was provided through the issuance of $80 million Senior Secured 9.36% Notes due 2008 (“Santee Notes”). One of the covenants of the Santee Notes was a covenant that required the payment of the outstanding Santee Notes in the event of change in control of Santee.

STATER BROS. HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
JUNE 27, 2004

Note 6 — Santee (contd.)

Certain disagreements arose regarding the PPA’s and other matters between Markets and Ralphs, the parent company of Hughes, and Ralphs and Santee. In order to settle the resulting litigation, Markets, Hughes, Santee and SDL entered into three separate but interconnected agreements “Settlement Agreement and Release of all Claims”, “Dissolution and Transfer Agreement” and “Assignment and Assumption Agreement” all three agreements collectively known as the “Settlement Agreement”. Under the Settlement Agreement, the Ralphs Guaranty was terminated, a new purchase of products schedule for Ralphs was established, Hughes agreed to pay $1,550,000 to Markets, SDL was dissolved and the shares of Santee, previously held by SDL, were transferred equally to Markets and Hughes. Concurrently with this transfer, Hughes immediately transferred Hughes’ Santee shares to Santee for cancellation and retirement.

Through the Settlement Agreement, Hughes relinquished its interest in Santee to Markets. The consideration received by Markets under the Settlement Agreement was $1,550,000 in cash and the value of the additional 50% ownership interest in Santee. The value assigned to the additional 50% interest in Santee is $21.8 million which was determined by management based upon the present value of the most probable future cash flows. The Settlement Agreement’s effective date was the close of business on February 6, 2004. In the second quarter of fiscal 2004, the Company incurred legal fees of $500,000 related to the Settlement Agreement. In addition, the Company, through Santee, made payments, aggregating $500,000, to four Directors of Santee who had been named by Hughes as defendants in litigation settled by the Settlement Agreement. Three of the four Directors are related parties to the Company. The net consideration received by the Company under the Settlement Agreements was $22.4 million which was recorded as a gain in the second quarter of fiscal 2004 in the Consolidated Statements of Income (unaudited) under the line item “Selling, general and administrative expenses.”

The following table is a condensed balance sheet that discloses the value assigned to the Santee assets acquired and the liabilities assumed as a result of the Settlement Agreement:


	Feb 6, 2004
	(in thousands)
Current assets	$	13,246
Property and equipment		47,630
Other long-term assets		550

Total assets acquired		61,426
Current liabilities		14,005
Long-term liabilities		25,600

Total liabilities assumed		39,605

Net assets acquired	$	21,821

STATER BROS. HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
JUNE 27, 2004

Note 6 — Santee (contd.)

Previously, Markets accounted for Santee under the equity method of accounting as Markets owned 50% of the stock and did not exercise control over Santee. The dissolution of SDL and the retirement of the Hughes’ shares gave Markets 100% direct ownership of Santee and caused a change in control of Santee. The change in control triggered the early payment requirement of the Santee Notes, which included a make whole provision. In order to finance the payment of the Santee Notes and the make whole payment, Markets loaned Santee $55.0 million. On February 6, 2004, Santee redeemed $53.5 million of Santee Notes, all the notes outstanding, and paid a make whole fee of $8.5 million. The make whole fee has been recorded as a component of interest expense in the Consolidated Statements of Income (unaudited) of the Company.

Santee has been included in the consolidated financial statements of the Company as a wholly-owned subsidiary as of the effective date of the Settlement Agreement. The following table provides supplemental pro forma results of operations presented as though Santee had been consolidated as of the beginning of the reporting periods.


	Condensed Pro Forma Results of Operations
	(in thousands, except per share amounts)
	13 Weeks Ended					39 Weeks Ended
	June 29,		June 27,			June 29,		June 27,
	2003		2004			2003		2004
Sales	$	714,301	$	847,983		$	2,127,598	$	2,910,348

Income (loss) before income taxes (benefit)	$	1,669	$	(10,536	)	$	14,761	$	100,873

Net income (loss)	$	1,074	$	(5,773	)	$	8,929	$	60,311

Earnings (loss) per share	$	28.04	$	(150.73	)	$	233.13	$	1,574.66

Note 7 — Issue of New Debt and Early Extinguishment of Debt

On June 17, 2004, the Company issued $525.0 million of 8.125% Senior Notes due June 15, 2012 and $175.0 million Floating Rate Senior Notes due June 15, 2010. Both the 8.125% Senior Notes and the Floating Rate Senior Notes are unregistered. The interest rate on the Floating Rate Senior Notes as of June 27, 2004 was 5.06%. The Company incurred $22.3 million of debt issuance cost related to the issuance of these notes which will be amortized over the term of the respective notes.

On June 17, 2004 the Company used part of the proceeds from the issuance of these notes for the purchase of $397.8 million of the 10.75% Senior Notes due August 2006, the payment of $16.9 million for tender premium and fees on the purchased 10.75% Senior Notes, the early retirement of the $20.0 million 5.0% Subordinated Note due March 2007 and to pay accrued interest on the purchased 10.75% Senior Notes and the retired 5.0% Subordinated Note.

STATER BROS. HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
JUNE 27, 2004

Note 7 — Issue of New Debt and Early Extinguishment of Debt (contd.)

On June 29, 2004, the Company advised the trustee of the 10.75% Senior Notes that the Company has elected to redeem the remaining outstanding 10.75% Notes on August 16, 2004 at a price of $1,026.875 per $1,000 plus accrued interest.

Note 8 — Dividend Payment

On June 17, 2004, the Company paid a $45.0 million dividend to La Cadena Investments, the sole stockholder of the Company.

Note 9 — Corporate Office and Warehouse Facilities

Markets is currently in negotiations to acquire approximately 160 acres located on the former Norton Air Force Base in the City of San Bernardino, California. Markets has reached an agreement with the Inland Valley Development Agency (“IVDA”), which is the entity responsible for the redevelopment of the former Norton Air Force Base, on an Owner Participation Agreement. The IVDA owns approximately 93 acres of the project property and is negotiating with another governmental agency for an additional 51 acres that would be transferred to Markets or leased with a purchase option. Additionally, Markets is negotiating the acquisition of four privately held parcels consisting of approximately 16 acres. The agreement with the IVDA requires Markets to acquire those parcels not owned by the IVDA, to relocate all tenants and other business owners requiring relocation, to commit to construct and complete the corporate and warehouse facilities and to obtain all City of San Bernardino building permits and entitlements required for the facility. Markets has reached an agreement with Hillwood/San Bernardino LLC (“Hillwood”), the master developer of the former Norton Air Force Base for infrastructure improvements. Under the Hillwood agreement, upon closing, Markets will share costs associated with the infrastructure improvements for water, sewer, streets and utilities which will be required by the City of San Bernardino. Markets, after completion of the acquisition of the project property, will secure its commitment with Hillwood for infrastructure improvements by the posting of either cash or letters of credits in the amount of $10.8 million. The agreements with the IVDA and Hillwood are contingent upon Markets successfully negotiating the acquisition of all needed property.

This site will be used to relocate and consolidate the Company’s corporate headquarters and all warehousing and distribution facilities to a single integrated facility from the 13 warehouse buildings at 7 different locations currently in use. This site is located within eight miles of the main distribution facility in Colton and therefore there will be no change in the average distance between the new facility and the retail supermarkets. The facility will consist of approximately 2.1 million square feet and will include the Company’s corporate headquarters, truck maintenance and other support facilities required for consolidation of all of its Southern California retail grocery operations. The net projected cost of the facility is approximately $200 million and completion of the construction of the facility is planned for the fall of 2006.

STATER BROS. HOLDINGS INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

PART I — FINANCIAL INFORMATION (contd.)

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


		CRITICAL ACCOUNTING POLICIES

		The Company’s discussion and analysis of financial condition and results of operations are based upon the Company’s unaudited consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States. The preparation of the financial statements requires the use of estimates and judgements on the part of management. The Company based its estimates on the Company’s historical experience combined with management’s understanding of current facts and circumstances. The Company believes that the following critical accounting policies are the most important to the Company’s consolidated financial statements presentation and require the most difficult, subjective and complex judgements on the part of management.

		*Revenue Recognition*

		Markets, the Company’s principal operating entity, recognizes revenue from the sale of its products at the point of sale to the customer. Sales are recognized net of any discounts given to the customer. Santee recognizes revenue as shipments are received by its customers. Sales are recognized net of promotional discounts.

		*Cost of Goods Sold*

		Included in cost of goods sold are all manufacturing cost, direct product purchase costs, except for certain salary, wages and administration cost associated with the procurement of purchased products; all in-bound freight costs; all direct receiving and inspection costs; all quality assurance costs; all warehousing costs and all costs associated with transporting goods from the Company’s warehouses to its stores, net of earned vendor rebates and allowances. The Company recognizes, as a reduction to cost of goods sold, certain rebates and allowances (“allowances”) from its vendors as the allowances are earned. Allowances are earned by promoting certain products or by purchasing specified amounts of product. The Company records a liability for allowance funds that have been received but not yet earned.

		Within the supermarket industry, there are a wide range of differences in the disclosure of costs related to the purchasing and distribution of products sold. Some companies include all of their purchasing and distribution costs in cost of goods sold while others include a portion of the costs in selling, general and administrative expenses. Therefore, the Company’s gross margins and selling, general and administrative expenses may not be comparable to those of other companies within the supermarket industry.

		*Inter-Company Eliminations*

		Markets is a significant customer of Santee, which supplies Markets with a significant portion of its fluid milk and dairy products. Santee pays interest and principal payments to Markets on a $55.0 million 5.25% Inter-Company Note due 2008. All inter-company transactions are eliminated in consolidation.

STATER BROS. HOLDINGS INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS


		CRITICAL ACCOUNTING POLICIES (contd.)

		*Selling, General and Administrative Expenses*

		Included in selling, general and administrative expenses are all store operating costs which includes all store labor costs associated with receiving, displaying and selling the Company’s products at the store level; all advertising costs, net of the portion of co-operative advertising allowances directly related to the fair value of the advertising; certain salary, wages and administrative costs associated with the purchasing of the Company’s products and all security, management information services, accounting and corporate management costs.

		As noted under “Cost of Goods Sold”, the Company includes all purchasing and distribution costs to deliver the product for sale to its stores in cost of goods sold, except for certain salary, wages and administrative costs associated with the procurement of purchased products. As certain salary, wages and administrative costs associated with the purchase of the Company’s products is included in selling, general and administrative expenses, the Company’s gross margin and selling, general and administrative expenses may not be comparable to companies who disclose these costs differently.

		*Vendor Rebates and Allowances*

		The Company receives certain allowances from its vendors that relate to the purchase and promotion of certain products. All allowances, except for advertising allowances described under “Advertising Allowances”, are recognized as a reduction in cost of goods sold as the performance is completed and inventory sold. Allowances, such as slotting fees, which are tied to the promotion of certain products, are recognized as reductions in cost of goods sold as the Company meets the required performance criteria. Allowances that are based upon purchase or sales volumes are recognized as reductions in cost of goods sold as the products are sold. The Company receives lump-sum payments from vendors for the promotion or purchase of products over multi-year periods. The Company records a liability for unearned allowances and recognizes, as a reduction in cost of goods sold, these allowances over time as the criteria of these contracts are met.

		*Advertising Allowances*

		The Company receives co-operative advertising allowances from vendors for advertising specific vendor products over specific periods of time. The Company recognizes the portion of co-operative advertising allowances directly related to the fair value of the advertising as a reduction in advertising costs. A significant portion of the Company’s advertising expenditures is in the form of twice weekly print advertisements. The Company distributes its print ads through inserts in local newspapers, in direct mailers and as handouts distributed in its stores. The Company analyzes, on a monthly basis, the direct out-of-pocket costs for printing and distributing its print ads. Using the number of ads in a typical twice weekly advertisement, the actual direct cost of an individual advertisement is determined. The cost determined is deemed to be the fair value of advertising. The amount of co-operative advertising allowances in excess of the direct fair value of the advertising is recognized as a reduction in cost of goods sold.

STATER BROS. HOLDINGS INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS


		CRITICAL ACCOUNTING POLICIES (contd.)

		*Advertising*

		The Company’s advertising costs, net of vendor allowances for co-operative advertising, are recognized in the period the advertising is incurred and are included in selling, general and administrative expenses.

		*Leases*

		Certain of the Company’s operating leases provide for minimum annual payments that change over the life of the lease. The aggregate minimum annual payments are expensed on a straight-line basis over the minimum lease term. The Company recognizes a liability for minimum step rents when the amount of straight-line rent expense exceeds the actual lease payment and it reduces the step rent liability when the actual lease payment exceeds the amount of straight-line rent expense.

		*Self-Insurance Reserves*

		The Company is primarily self-insured, subject to certain retention levels for workers’ compensation, automobile and general liability costs. The Company is covered by umbrella insurance policies for catastrophic events. The Company records its self-insurance liability based on the claims filed and an estimate of claims incurred but not yet reported. The estimates used by management are based on the Company’s historical experiences as well as current facts and circumstances. The Company uses third party actuarial analysis in making its estimates. Actuarial projections and the Company’s estimate of ultimate losses are subject to a high degree of variability. The variability in the projections and estimates are subject to, but not limited to, such factors as judicial and administrative rulings, legislative actions, and changes in compensation benefits structure. In recent years, the Company and employers within the State of California as a whole have seen significant increases in the severity of workers’ compensation claims. While the Company has factored these increases into its estimates of ultimate loss, no assurance can be given that future events will not require a change in these estimates. The Company discounts its workers’ compensation, automobile and general liability insurance reserves at a discount rate of approximately 7.5%.

		*Inventories*

		Inventories are stated at the lower of cost (first-in, first-out) or market. Management believes that its inventory turns and inventory controls are sufficient and that reserves are not needed for excess, obsolete or discontinued inventory.

		*Deferred Debt Issuance Costs*

		Direct costs incurred as a result of financing transactions are capitalized and amortized to expense over the term of the applicable debt agreements.

		*Deferred Income Taxes*

		Although there can be no assurances as to future taxable income of the Company, the Company believes that its expectations of future taxable income, when combined with the income taxes paid in prior years, will be adequate to realize its deferred tax assets.

		*Phantom Stock Plan*

		It is the Company’s policy to expense phantom stock units to the extent that they vest and appreciate during the accounting period.

STATER BROS. HOLDINGS INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS


		OWNERSHIP OF THE COMPANY

		La Cadena Investments (“La Cadena”) is the sole shareholder of the Company and holds all of the shares of the Company’s Class A Common Stock. La Cadena is a California General Partnership whose partners include Jack H. Brown, Chairman of the Board, President and Chief Executive Officer of the Company and a former member of Senior Management of the Company. Jack H. Brown has a majority interest in La Cadena and is the managing general partner with the power to vote the shares of the Company held by La Cadena.

		RESULTS OF OPERATIONS

		The following table sets forth certain income statement components expressed as a percent of sales for the thirteen and thirty-nine weeks ended June 29, 2003 and June 27, 2004.


	Thirteen Weeks						Thirty-Nine Weeks
	2003			2004			2003			2004
Sales		100.00	%		100.00	%		100.00	%		100.00	%
Gross profit		27.50			26.50			27.46			28.84
Operating expenses:
Selling, general and administrative expenses		24.44			22.21			24.01			22.04
Depreciation and amortization		1.00			0.96			0.96			0.81
Operating profit		2.06			3.33			2.49			5.99
Interest income		0.04			0.02			0.04			0.04
Interest expense		(1.94	)		(4.55	)		(1.95	)		(2.56	)
Equity in unconsolidated affiliate		0.03			—			0.06			0.03
Other expenses — net		(0.02	)		(0.04	)		(0.04	)		(0.04	)
Income (loss) before income taxes (benefit)		0.17	%		(1.24	)%		0.60	%		3.46	%


		As of February 6, 2004, the results of Santee Dairies, Inc. (“Santee”), previously accounted for under the equity method of accounting, have been consolidated in the Company’s results of operations and all inter-company transactions have been eliminated (see Notes to Consolidated Financial Statements (unaudited) of the Company contained in this report on Form 10-Q).

		The labor dispute involving three of Stater Bros.’ principal competitors from October 11, 2003 through February 29, 2004, had a materially positive effect on Stater Bros.’ results of operations in the period. On October 11, 2003, the United Food and Commercial Workers Union (“UFCW”) declared a strike against Safeway, Inc. (“Vons”); in turn, Albertson’s, Inc. (“Albertson’s”) and Ralphs Grocery Company (“Ralphs”) locked out all of their UFCW employees. The UFCW did not strike against Stater Bros. as a result of an agreement whereby Stater Bros. agreed to accept the same contract terms that the UFCW negotiated with Vons, Albertson’s and Ralphs.

STATER BROS. HOLDINGS INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS


		RESULTS OF OPERATIONS (contd.)

		On February 29, 2004, members of the UFCW in Southern California ratified new collective bargaining agreements and ended their strike. Under the new collective bargaining agreements, Stater Bros. made special contributions to the UFCW’s health and welfare fund totaling $29.3 million, and made strike ratification bonus payments to its employees totaling $4.7 million.

		During the labor dispute, many of the former Vons, Albertson’s and Ralphs customers chose to honor the picket lines and took their business to Stater Bros. Markets and other grocery retailers. Subsequent to the labor dispute, the Company has been able to retain some of these additional customers. The labor dispute had both a significant and material effect on the Company’s sales volume, results of operations and financial position.

		The increased sales volume has had a positive effect on results of operations as the Company has been able to realize some economics of scale from the increased sales volume. As a result, cost of goods sold, labor and other operating expenses, as a percentage of sales, have decreased for the thirty-nine weeks ended June 27, 2004 when compared with the corresponding period of fiscal 2003.

		The impact of the labor dispute on the Company was unprecedented and is not expected to be repeated in the future. As of June 27, 2004, the Company has been able to retain some of the increased volume gained during the labor dispute. Management has taken steps through price promotions, customer service and attention to detail to retain as much of the increased volume as possible. The ultimate amount of increased volume retained, if any, cannot be forecast with any degree of certainty; although, management anticipates retaining some of the increased sales volume.

		Like store sales are calculated by comparing year-to-year sales for stores that are opened in both years. For stores that were not opened for the entire previous year periods, only the current year’s weekly sales that correspond to the weeks the stores were opened in the previous year are used. All of the current year’s replacement stores’ sales are included in the like store sale calculation.

		Sales for the thirteen weeks ended June 27, 2004, the third quarter of fiscal 2004, increased $159.9 million or 23.24% and amounted to $848.0 million compared to $688.1 million for the same period in the prior year. The consolidation of Santee in fiscal 2004 increased sales by $30.6 million or 4.45% over prior year sales. Like store sales increased $117.9 million or 17.13% over the prior year. The increase in like store sales for the thirteen weeks ended June 27, 2004 is primarily the result of the Company’s ability to retain some of the increased sales volume generated during the labor dispute. The remaining increase in total sales is due to the opening of a new store in Corona, California in June of 2003 and the opening of a new store in Moreno Valley, California in March of 2004.

STATER BROS. HOLDINGS INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS


		RESULTS OF OPERATIONS (contd.)

		Sales for the thirty-nine weeks ended June 27, 2004, increased $817.2 million or 39.93% and amounted to $2.864 billion compared to $2.047 billion for the same period in the prior year. The consolidation of Santee in fiscal 2004 increased sales by $47.0 million or 2.30% over prior year sales. Like store sales increased $739.8 million or 36.15% over the prior year. The increase in like store sales for the thirty-nine weeks ended June 27, 2004 is due primarily to the increased sales volume during the labor dispute and to the Company’s ability to retain some of the increased sales volume after the labor dispute. For the portion of the thirty-nine week period during the labor dispute, like store sales increased $576.2 million or 54.52% over the same time frame of fiscal 2003. For the portion of the thirty-nine week period after the labor dispute, like store sales increased $158.9 million or 17.75% over the same time frame of fiscal 2003. The remaining increase in sales is due to the opening of a new store in Corona, California in June of 2003 and the opening of a new store in Moreno Valley, California in March of 2004.

		Gross profit for the thirteen weeks ended June 27, 2004, amounted to $224.7 million or 26.50% of sales compared to $189.2 million or 27.50% of sales in the same period of the prior year. Gross profit, as a percentage of sales, in the current year compared to the prior year decreased 1.00%. Store gross margins, as a percentage of sales, decreased 0.87% compared to the prior year and is attributed to pricing steps taken by the Company to retain volume gained during the labor dispute. Offsetting the reduction in store margins from pricing were favorable reductions in warehousing and transportation costs, as a percentage of sales, of approximately 0.52% attributed to the leveraging of fixed costs over the increased sales volume. The consolidation of Santee in fiscal 2004 contributed to a reduction in gross profit, as a percentage of sales, of approximately 0.51%.

		Gross profit for the thirty-nine weeks ended June 27, 2004, amounted to $825.9 million or 28.84% of sales compared to $562.1 million or 27.46% of sales in the same period of the prior year. Gross profit, as a percentage of sales, for the thirty-nine week period increased 1.38% compared to the prior year. The increase in the year-to-date gross profit is comprised of increased store gross profit of 0.93% attributed primarily to reduced shrink in the perishable departments during the labor dispute, a reduction, as a percentage of sales, of 0.88% in warehouse and transportation costs attributed to the leveraging of fixed costs over the increased sales volume offset by the consolidation of Santee in fiscal 2004 which created a reduction in gross profit, as a percentage of sales, for the year-to-date period of 0.27%.

		Operating expenses include selling, general and administrative expenses, and depreciation and amortization. For the thirteen weeks ended June 27, 2004, selling, general and administrative expenses amounted to $188.4 million or 22.21% of sales compared to $168.2 million or 24.44% of sales for the thirteen weeks ended June 29, 2003. For the thirty-nine weeks ended June 27, 2004, selling, general and administrative expenses amounted to $631.1 million or 22.04% of sales compared to $491.4 million or 24.01% of sales for the thirty-nine weeks ended June 29, 2003.

STATER BROS. HOLDINGS INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS


		RESULTS OF OPERATIONS (contd.)

		The reduction in selling, general and administrative expenses, as a percentage of sales, for the thirteen week period of the current year compared to the prior year included a 0.53% reduction, as a percentage of sales, in labor expense due to changes to the new collective bargaining agreement with the UCFW and the ability to leverage labor expense against increased sales volume; a 0.40% reduction, as a percentage of sales, in workers compensation costs; and a 0.41% reduction, as a percentage of sales, in utility cost due both to reduced electric rates and continued energy conservations programs by the Company. The consolidation of Santee in fiscal 2004 caused a reduction in selling general and administrative expenses, as a percentage of sales, of 0.56% in the current thirteen week period compared to the thirteen week period of the previous year.

		Included in selling, general and administrative expenses for the thirty-nine week fiscal 2004 is a $22.4 million gain from a settlement agreement reached with Ralphs (see Notes to Consolidated Financial Statements (unaudited) of the Company contained in this report on Form 10-Q). The gain from litigation settlement reduced selling, general and administrative expenses, as a percentage of sales, by 0.81% for the thirty-nine week fiscal 2004.

		Also, included in the thirty-nine week fiscal 2004 selling, general and administrative expenses is $34.0 million for special payments related to the labor dispute and contract ratification. The Company made special payments of approximately $29.3 million to UFCW union trust funds to bring the funds up to levels negotiated during collective bargaining contract negotiations. Under the new negotiated collective bargaining agreement, future union insurance payments by the Company are proscribed at specified hourly rates. In addition, the Company paid approximately $4.7 million to UFCW union members as a contract ratification bonus. The reduction in selling, general and administrative expenses, as a percentage of sales, for the thirty-nine week period is also attributed to the Company being able to leverage direct labor costs and fixed facility costs over the increased sales volume resulting from the labor dispute.

		The amount of salaries, wages and administrative costs associated with the purchase of the Company’s products included in selling, general and administrative expenses for the fiscal third quarters of fiscal 2004 and fiscal 2003 is $245,000 and $217,000, respectively, and the amount in the thirty-nine week fiscal 2004 and fiscal 2003 is $767,000 and $658,000, respectively.

		Depreciation and amortization expenses amounted to $8.1 million for the thirteen weeks ended June 27, 2004 and $6.9 million for the thirteen weeks ended June 29, 2003. Depreciation and amortization expense was $23.3 million and $19.6 million for the thirty-nine week periods ended June 27, 2004 and June 29, 2003, respectively. The increase in depreciation and amortization expense in fiscal 2004 was primarily due to an increase in fixed assets. Included in cost of goods sold is $3.1 million and $1.9 million of depreciation in the third quarters of fiscal 2004 and fiscal 2003, respectively, and $7.2 million and $5.6 million of depreciation in the thirty-nine week fiscal 2004 and fiscal 2003, respectively, related to dairy production and warehousing and distribution activities for the stores.

STATER BROS. HOLDINGS INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

RESULTS OF OPERATIONS (contd.)

Interest expense amounted to $13.1 million for the third quarter of 2004 compared to $13.3 million for the third quarter of 2003. For the fiscal year-to-date of 2004 and 2003, interest expense amounted to $39.4 million and $39.9 million, respectively. Interest expense related to debt purchase was $25.5 million and $34.0 million for the thirteen and thirty-nine weeks ended June 27, 2004, respectively. Interest expense related to debt purchase for the thirteen weeks ended June 27, 2004 included a $16.9 million payment for tender premium and fees on the purchase of $397.8 million of the 10.75% Notes and an $8.6 million charge for the write-off of deferred offering cost related to i) the purchase of $397.8 million of the 10.75% Senior Notes due 2006, ii) the early retirement of the $20.0 million 5.0% Subordinated Note due 2007 and iii) the redemption of the Santee Notes. In addition to the above items, interest expense related to debt purchase for the thirty-nine weeks of fiscal 2004 included a make whole payment by Santee of $8.5 million related to Santee’s redemption of all outstanding Santee Notes (see Notes to Consolidated Financial Statements (unaudited) of the Company contained in this report on Form 10-Q).

The Company’s equity in earnings from unconsolidated affiliate amounted to $217,000 for the third quarter of fiscal 2003. There was no equity in earnings from unconsolidated affiliate in the third quarter of fiscal 2004. For the fiscal year-to-date periods of 2004 and 2003, the Company’s equity in earnings from unconsolidated affiliate amounted to $929,000 and $1,196,000, respectively. On February 6, 2004, the Company acquired 100% ownership of Santee as part of a litigation settlement and Santee has been consolidated into the Company’s results of operations subsequent to that date.

Income (loss) before income taxes (benefit) amounted to a loss of $10.5 million in the third quarter of 2004 and income of $1.2 million for the third quarter of 2003, respectively. Income before income taxes amounted to $99.0 million and $12.3 million for the thirty-nine weeks year-to-date periods of 2004 and 2003, respectively.

Net income (loss) for the third quarter of 2004 amounted to a loss of $5.8 million and net income of $769,000 for the third quarter of 2003, respectively. Net income for the fiscal year-to-date periods amounted to $59.1 million and $7.5 million for 2004 and 2003, respectively.

LIQUIDITY AND CAPITAL RESOURCES

The Company historically has funded its daily cash flow requirements through funds provided by operations and through borrowings from short-term revolving credit facilities. The Company’s credit agreement, as amended and restated on June 17, 2004 expires in March 2007 and consists of a revolving loan facility for working capital and letters of credit of $75.0 million. As of June 27, 2004, the Company had $46.9 million of outstanding letters of credit and had $28.1 million available under the revolving loan facility. The letter of credit facility is maintained pursuant to the Company’s workers’ compensation and general liability self-insurance requirements.

Santee’s credit agreement, as amended, became effective December 1999, expires on September 1, 2004 and consists of a revolving loan facility for working capital of $5.0 million of which $2.0 million may be used to secure letters of credit issued to support workers’ compensation liabilities. The revolver is limited to a borrowing base equivalent to 75% of Santee’s outstanding accounts receivable, excluding balances owed by Markets, less the total amount of outstanding letters of credit. Borrowings under the revolver are secured by the receivables of Santee. Advances under the revolver bear interest at Bank of America’s prime rate plus 0.5% with interest due monthly or, if elected by Santee, at the Interbank Offered Rate plus 1.75%. The outstanding undrawn portion of the workers’ compensation letter of credit is subject to an annual commitment fee of 1.25%. As of June 27, 2004, Santee had $1.4 million of outstanding letters of credit and had $3.6 million available under the revolving loan facility.

STATER BROS. HOLDINGS INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS


		LIQUIDITY AND CAPITAL RESOURCES (contd.)

		The following table sets forth the Company’s contractual cash obligations and commercial commitments as of June 27, 2004.


	Contractual Cash Obligations (In thousands)
			Less than						After
	Total		1 Year		1-3 Years		4-5 Years		5 Years
8.125% Senior Notes due June 2012
Principal	$	525,000	$	—	$	—	$	—	$	525,000
Interest		341,013		42,419		85,313		85,313		127,968

		866,013		42,419		85,313		85,313		652,968
Floating Rate Senior Notes due June 2010 ⁽¹⁾
Principal		175,000		—		—		—		175,000
Interest		53,081		8,806		17,710		17,710		8,855

		228,081		8,806		17,710		17,710		183,855
10.75% Senior Notes due August 2006⁽²⁾
Principal		40,950		40,950		—		—		—
Interest		3,314		3,314		—		—		—

		44,264		44,264		—		—		—
Capital Lease Obligations⁽³⁾
Principal		11,123		1,300		2,353		2,063		5,407
Interest		8,433		1,623		2,716		2,126		1,968

		19,556		2,923		5,069		4,189		7,375
Operating Leases⁽³⁾		240,247		33,354		56,979		39,532		110,382

Total Contractual Cash Obligations	$	1,398,161	$	131,766	$	165,071	$	146,744	$	954,580


	Other Commercial Commitments (In thousands)
			Less than						After
	Total		1 Year		1-3 Years		4-5 Years		5 Years
Standby Letters of Credit⁽⁴⁾	$	48,240	$	48,240	$	—	$	—	$	—

Total Other Commercial Commitments	$	48,240	$	48,240	$	—	$	—	$	—

(1) Interest on the Floating Rate Notes is based on the Three-month LIBOR plus 3.50% and is set quarterly based on the Three-month LIBOR rate for the second London Banking Day proceeding each interest period. The floating interest rate at June 27, 2004 was 5.06%.

Notes continued on next page

STATER BROS. HOLDINGS INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

LIQUIDITY AND CAPITAL RESOURCES (contd.)

Contractual Cash Obligations (contd.)

⁽²⁾ On June 29, 2004, the Company elected to redeem the remaining $41.0 million outstanding 10.75% Senior Notes due August 2006 on August 16, 2004. The outstanding notes will be redeemed at a price of $1,026.875 per $1,000 plus accrued interest. The redemption premium has been included with interest for purposes of this contractual cash obligations disclosure.

⁽³⁾ The Company leases the majority of its retail stores, offices, warehouses and distribution facilities. Certain leases provide for additional rents based on sales. Primary lease terms range from 3 to 55 years and substantially all leases provide for renewal options.

⁽⁴⁾ Standby letters of credit are committed as security for workers’ compensation obligations. Outstanding letters of credit expire between September 2004 and February 2005.


		Working capital amounted to $324.1 million at June 27, 2004 and $124.5 million at September 28, 2003, and the Company’s current ratios were 2.14:1, and 1.60:1, respectively. Fluctuations in working capital and current ratios are not unusual in the industry.

		Net cash provided by operating activities in the thirty-nine weeks ended June 27, 2004 improved significantly over the thirty-nine weeks ended June 29, 2003, primarily as a result of the increase in net income for such period attributable mainly to the labor dispute. Net cash provided by operating activities for the thirty-nine weeks ended June 27, 2004 amounted to $116.6 million compared to $75.9 million for the thirty-nine weeks ended June 29, 2003. In addition to the substantial increase in net income of $59.1 million in the current year compared to $7.5 million in the prior year, cash provided by operating activities in fiscal 2004 of $116.6 million reflected a $52.4 million increase in accrued liabilities, self-insurance reserves and other liabilities, an increase of $26.7 million in accounts payable, a $12.9 million decrease in other assets and $30.6 million of depreciation and amortization; partially offset by a $20.0 million increase in restricted cash, a $15.3 million increase in inventory and a $22.4 million gain from litigation settlement. Cash provided by operating activities in fiscal 2003 of $75.9 million consisted of a $22.3 million increase in accrued liabilities, self-insurance reserves and other liabilities, an increase of $7.5 million in accounts payable, a decrease in income tax receivables of $5.8 million, a decrease of $5.1 million in inventory and $25.2 million of depreciation and amortization. Fluctuations in cash provided by operating activities are not unusual in the industry.

STATER BROS. HOLDINGS INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS


		LIQUIDITY AND CAPITAL RESOURCES (contd.)

		Net cash used in investing activities for the thirty-nine weeks ended June 27, 2004, amounted to $45.3 million compared to $37.6 million for the thirty-nine weeks ended June 29, 2003. The difference in net cash used in investing activities between the comparable periods is due to the Company’s capital expenditures during such periods, net of proceeds from asset disposals. Capital expenditures amounted to $45.4 million in the fiscal year-to-date of 2004 compared to $37.7 million in the fiscal year-to-date of 2003.

		Net cash provided by financing activities amounted to $144.4 million for the thirty-nine weeks ended June 27, 2004 and net cash used in financing activities amounted to and $0.9 million in the thirty-nine weeks ended June 29, 2003. In the thirty-nine weeks to date of 2004, the Company issued $525.0 million of 8.125% Senior Notes due June 2012, issued $175.0 million of Floating Rate Senior Notes due June 2010, purchased $397.8 million of 10.75% Senior Notes due August 2006, retired the $20 million 5.0% Subordinated Note due March 2007, redeemed $53.5 million of outstanding Santee Notes, paid $16.9 million in tender premium and fees for the purchase of the 10.75% Senior Notes, paid a make whole payment of $8.5 million for the redemption of the Santee Notes, paid a dividend of $45.0 million to La Cadena, incurred fees of $22.3 million associated with the issuance of the 8.125% Senior Notes and Floating Rate Senior Notes and amortized remaining deferred offering costs of $8.6 million related to i) the purchase 10.75% Notes, ii) the early retirement of the 5.0% Subordinated Note and iii) the redemption of the Santee Notes, (see Notes to Consolidated Financial Statements (unaudited) of the Company contained in this report on Form 10-Q), executed a new capital lease for $0.7 million and had payments on capitalized leases of $0.9 million. The cash used in financing activities in the thirty-nine weeks to date of 2003 of $0.9 million consisted of payments on the Company’s capitalized lease obligations.

		*Issuance of Debt and Early Retirement of Debt*

		On June 17, 2004, the Company issued $525.0 million of 8.125% Senior Notes due June 15, 2012 and $175.0 million Floating Rate Senior Notes due June 15, 2010. The 8.125% Senior Notes and the Floating Rate Senior Notes are unregistered. The interest rate on the Floating Rate Senior Notes as of June 27, 2004 was 5.06%. The Company incurred $22.3 million of debt issuance cost related to the issuance of these notes which will be amortized over the term of the respective notes.

		On June 17, 2004 the Company used part of the proceeds from the issue of these notes for the purchase of $397.8 million of the 10.75% Senior Notes due August 2006, the payment of $16.9 million for tender premium and fees on the purchased 10.75% Senior Notes, the early retirement of the $20.0 million 5.0% Subordinated Note due March 2007 and to pay accrued interest on the purchased 10.75% Senior Notes and the retired 5.0% Subordinated Note. On June 29, 2004 the Company advised the trustee of the 10.75% Senior Notes that the Company has elected to redeem the remaining outstanding 10.75% Notes due August 2006 at a price of $1,026.875 per $1,000 plus accrued interest.

STATER BROS. HOLDINGS INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS


		LIQUIDITY AND CAPITAL RESOURCES (contd.)

		*The Credit Facilities* On June 17, 2004, the Company entered into an amended and restated credit facility (the “New Credit Facility”) with Bank of America N.A. (“Bank of America”) as sole and exclusive administrative agent, and sole initial lender, consisting of a three-year revolving credit facility in a principal amount of up to $75.0 million, with the right to increase, under certain circumstances, the size of the New Credit Facility to an aggregate principal amount of $100.0 million. The New Credit Facility amended and restated the existing credit facility in its entirety. Subject to certain restrictions, the entire amount of the New Credit Facility may be used for loans, letters of credit, or a combination thereof. Borrowings under the New Credit Facility are unsecured and will be used for certain working capital, capital expenditures and other corporate purposes. Letters of credit under the letter of credit facility are expected to be used to support obligations incurred in connection with the construction of stores, construction of new warehouse facilities and workers’ compensation insurance obligations. The availability of the loans and letters of credit are subject to certain borrowing restrictions.

		The New Credit Facility is guaranteed by the Company and all of its existing and future material subsidiaries, including Stater Bros. Development, Inc. and Santee (subject, in the case of Santee, to termination upon certain specified events).

		Loans under the New Credit Facility bear interest at a rate based upon either (i) the “Base Rate” (defined as the higher of (a) the federal funds rate plus 0.50% and (b) the rate of interest publicly announced by Bank of America as its “reference rate”), plus 1.00%, or (ii) the “Offshore Rate” (defined as the average British Bankers Association Interest Settlement Rate for deposits in dollars, adjusted for the maximum reserve requirement for Eurocurrency funding), plus 1.75%. For Offshore Rate Loans, the Offshore Rate will be applied in consecutive periods of the earlier of (a) the maturity date of the loan or (b) periods, as selected by Markets of one, two, three or six months.

		The New Credit Facility will cease to be available and will be payable in full on May 31, 2007. Notwithstanding such maturity date, at any time prior thereto Markets shall be entitled to request the issuance of standby letters of credit having a term which is up to one year following such maturity date, and commercial letters of credit having a term which is up to six months following such maturity date. Loans under the New Credit Facility must be repaid for a period of ten consecutive days semi-annually.

		Loans under the New Credit Facility may be repaid and re-borrowed. The loans under the New Credit Facility may be prepaid at any time without penalty, subject to certain minimums and payment of any breakage and re-deployment costs in the case of loans based on the offshore rate. The commitments under the New Credit Facility may be reduced by Markets. Markets will be required to pay a commitment fee equal to 0.25% per annum on the actual daily unused portion of the revolving loan facility and the letter of credit facility, payable quarterly in arrears. Outstanding letters of credit under the credit facility are subject to a fee of 1.25% per annum on the face amount of such letters of credit, payable quarterly in arrears. Markets will be required to pay standard fees charged by Bank of America with respect to the issuance, negotiation, and amendment of commercial letters of credit issued under the letter of credit facility.

STATER BROS. HOLDINGS INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS


		LIQUIDITY AND CAPITAL RESOURCES (contd.)
		*The Credit Facilities (contd.)*

		The New Credit Facility requires Markets to meet certain financial tests, including minimum net worth and other tests. The New Credit Facility contains covenants which, among other things, limit the ability of Markets and its subsidiaries to (i) incur indebtedness, grant liens and guarantee obligations, (ii) enter into mergers, consolidations, liquidations and dissolutions, asset sales, investments, leases and transactions with affiliates, and (iii) make restricted payments. The New Credit Facility also contains covenants that apply to the Company and its subsidiaries, and the Company is a party to the New Credit Facility for purposes of these covenants. These covenants, among other things, limit the ability of the Company and its subsidiaries to incur indebtedness, make restricted payments, enter into transactions with affiliates, and make amendments to the Indenture governing the 8.125% Senior Notes due June 15, 2012 and the Floating Rate Senior Notes due June 15, 2010.

		The New Credit Facility contains customary events of default, including payment defaults; material inaccuracies in representations and warranties; covenant defaults; cross-defaults to certain other indebtedness; certain bankruptcy events; certain ERISA events; judgment defaults; invalidity of any guaranty; and change of control.

		In December 1999, Santee entered into a revolving line of credit with Bank of America (“the Revolver”) Under the Revolver, Santee may borrow up to $5.0 million of which $2.0 million may be used to secure letters of credit issued to support workers’ compensation liabilities. The Revolver is limited to a borrowing base equivalent to 75% of Santee’s outstanding accounts receivable, excluding balances owed by Markets, less the total amount of outstanding letters of credit. Borrowings under the Revolver are secured by the receivables of Santee. The Revolver is scheduled to expire September 1, 2004 and is currently being negotiated for renewal.

		Advances under the Revolver bear interest at Bank of America’s prime rate plus 0.5% with interest due monthly or, if elected by Santee, at the Interbank Offered Rate plus 1.75%. The outstanding undrawn portion of the workers’ compensation letter of credit is subject to an annual commitment fee of 1.25%.

		Under the Revolver, Santee is required to comply with certain financial covenants, which include certain financial ratios.

		As of June 27, 2004, for purposes of the credit facilities with Bank of America, Santee, Markets and the Company were in compliance with all restrictive covenants. The Company is also subject to certain covenants associated with its 10.75% Senior Notes due 2006, its 8.125% Senior Notes due 2012 and its Floating Rate Senior Notes due 2010. As of June 27, 2004, the Company was in compliance with all such covenants. However, there can be no assurance that Santee, Markets or the Company will be able to achieve the expected operating results or implement the capital expenditure strategy upon which future compliance with such covenants is based.

STATER BROS. HOLDINGS INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS


		*Labor Relations*

		The Company’s collective bargaining contract with the UFCW was ratified during the second quarter of fiscal 2004 and extends through March 2007. The Company’s collective bargaining agreement with the International Brotherhood of Teamsters was renewed in September 2002 and expires in September 2005. Santee’s collective bargaining agreement with the International Brotherhood of Teamsters was renewed in March 2004 and expires in March 2007. Management believes it has good relations with its employees.

		EFFECT OF INFLATION AND COMPETITION

		The Company’s performance is affected by inflation. In recent years the impact of inflation on the operations of the Company has been moderate. As inflation has increased expenses, the Company has recovered, to the extent permitted by competition, the increase in expenses by increasing prices over time. However, the economic and competitive environment in Southern California continues to challenge the Company to become more cost efficient as its ability to recover increases in expenses through price increases is diminished. The future results of operations of the Company will depend upon the ability of the Company to adapt to the current economic environment as well as the current competitive conditions.

		The Company’s primary business function is the operation of retail food supermarkets, which offer for sale to the public most merchandise typically found in supermarkets. The supermarket industry is highly competitive and is characterized by low profit margins. The Company’s primary competitors include Vons, Albertson’s, Ralphs and a number of independent supermarket operators. Competitive factors typically include the price, quality and selection of products offered for sale, customer service, and the convenience and location of retail facilities. Through its wholly-owned subsidiary Santee, the Company operates one of the largest dairy operations in California. Markets is the primary customer of Santee. Santee also sells to Ralphs, unaffiliated supermarkets, independent food distributors, military bases and food service providers in southern California. The Company’s captive purchases limit the effect of competition on dairy operations. However, sells to non-related parties is highly competitive with competitive factors including price, quality and timely delivery of product. The Company monitors competitive activity and Senior Management regularly reviews the Company’s marketing and business strategy and periodically adjusts them to adapt to changes in the Company’s primary trading area.

		CAUTIONARY STATEMENT FOR PURPOSES OF “SAFE HARBOR PROVISIONS” OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.

		The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements. Certain information contained in the Company’s filings with the Securities and Exchange Commission (as well as information included in oral statements or other written statements made or to be made by the Company) includes statements that are forward-looking, such as statements relating to plans for future activities. Such forward-looking information involves important risks and uncertainties that could significantly affect results in the future and, accordingly, such results may differ from those expressed in any forward-looking statements made by or on behalf of the Company. These risks and uncertainties include, but are not limited to, those relating to domestic economic conditions, seasonal and weather fluctuations, expansion and other activities of competitors, changes in federal or state laws and the administration of such laws and the general condition of the economy.

STATER BROS. HOLDINGS INC.
JUNE 27, 2004

PART I — FINANCIAL INFORMATION (contd.)

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

The Company is subject to interest rate risk on its Floating Rate Senior Notes due June 2010. The Company’s interest expense on the Floating Rate Senior Notes due June 2010 will increase as interest rates rise and will decrease as interest rates decline. Interest on the Floating Rate Senior Notes due June 2010 is based upon the Three-month LIBOR plus 3.50%. As of June 27, 2004, the floating interest rate was 5.06%. In addition, the Company is subject to interest rate risk on its fixed interest rate debt obligations. The Company’s fixed rate debt obligations are comprised of the 8.125% Senior Notes due June 2012 and the 10.75% Senior Notes due August 2006 and capital lease obligations. In general, the fair value of fixed rate debt will increase as the market rate of interest decreases and will decrease as the market rate of interest increases. The Company has not engaged in any interest rate swap agreements, derivative financial instruments or other type of financial transactions to manage interest risk.

Item 4. CONTROLS AND PROCEDURES

As of the quarter ended June 27, 2004, the Company carried out an evaluation, under the supervision of the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have each concluded that those controls and procedures were effective in making known to them, on a timely basis, the material information needed for the preparation of this Report on Form 10-Q. During the quarter and fiscal year-to-date periods ended June 27, 2004, there were no significant changes in the Company’s internal control over financial reporting or in other factors that could significantly affect the internal control over financial reporting since the date of their evaluation, nor did they find any significant deficiencies or material weaknesses that would have required corrective actions to be taken.

STATER BROS. HOLDINGS INC.
JUNE 27, 2004

PART II — OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS


		Various legal actions and claims are pending against the Company in the ordinary course of business. In the opinion of management and its general legal counsel, the ultimate resolution of such pending legal actions and claims will not have a material adverse effect on the Company’s consolidated financial position or its results of operations.

		For a description of legal proceedings, please refer to the footnote entitled “Litigation Matters” contained in the Notes to Consolidated Financial Statements section of the Company’s Form 10-K for the fiscal year ended September 28, 2003.

		On February 6, 2004, a final settlement agreement became effective between Markets and Hughes to resolve litigation matters and control of Santee. For a description of the Settlement Agreement see the footnote entitled “Santee” in the notes to the Consolidated Financial Statements (unaudited) contained in this Report on Form 10-Q.

Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

On May 27, 2004, the Company entered into a Second Supplemental Indenture to the Indenture dated as of August 6, 1999 governing the Company’s 10 3/4% Senior Notes due 2006 (as amended, the “10 3/4% Senior Notes Indenture”). The Second Supplemental Indenture eliminated substantially all of the restrictive covenants contained in the 10 3/4% Senior Notes Indenture, and became operative as of June 17, 2004. The description of the Second Supplemental Indenture contained herein is qualified by reference to the terms of the Second Supplemental Indenture, a copy of which is attached as an Exhibit to this Form 10-Q.

Item 3. DEFAULTS UPON SENIOR SECURITIES

None

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

None

Item 5. OTHER INFORMATION

None

STATER BROS. HOLDINGS INC.
JUNE 27, 2004

PART II — OTHER INFORMATION (contd.)

Item 6. EXHIBITS AND REPORTS ON FORM 8-K


(a)		Exhibits

10.34		Second Supplemental Indenture, dated as of May 27, 2004 between Stater Bros. Holdings Inc. and The Bank of New York, as successor in interest to IBJ Whitehall Bank & Trust Company, as Trustee for the 10.75% Senior Notes due 2006.

10.35		Owner Participation Agreement, dated as of April 14, 2004 between Stater Bros. Markets and the Inland Valley Development Agency.

10.36		Development Parcel Disposition Agreement, dated as of June 16, 2004 between Stater Bros. Markets and Hillwood/San Bernardino, LLC.

31.1		Certification of Principal Executive Officer pursuant to Section 302 (a) of the Sarbanes-Oxley Act of 2002.

31.2		Certification of Principal Financial Officer pursuant to Section 302 (a) of the Sarbanes-Oxley Act of 2002.

32.1		Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(b)		Reports on Form 8-K Current Report on Form 8-K dated May 18, 2004

		Current Report on Form 8-K dated June 1, 2004

		Current Report on Form 8-K dated June 4, 2004

		Current Report on Form 8-K dated June 15, 2004

		Current Report on Form 8-K dated June 18, 2004


Date: August 11, 2004				/s/ Jack H. Brown Jack H. Brown Chairman of the Board, President, and Chief Executive Officer (Principal Executive Officer)

Date: August 11, 2004				/s/ Phillip J. Smith Phillip J. Smith Senior Vice President and Chief Financial Officer (Principal Financial Officer)


		Page





Part I	FINANCIAL INFORMATION (Unaudited)
Item 1.	Financial Statements




	Consolidated Balance Sheets as of September 28, 2003 and June 27, 2004 (Unaudited)		3




	Consolidated Balance Sheets of Income (Unaudited) for the 39 weeks ended June 29, 2003 and June 27, 2004		5




	Consolidated Statements of Operations (Unaudited) for the 13 weeks ended June 29, 2003 and June 27, 2004		6




	Consolidated Statements of Cash Flows (Unaudited) for the 39 weeks ended June 29, 2003 and June 27, 2004		7




	Notes to Consolidated Financial Statements (Unaudited)		8




Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		13




Item 3.	Quantitative and Qualitative Disclosure about Market Risk		27




Item 4.	Controls and Procedures		27





Part II	Other Information




Item 1.	Legal Proceedings		28




Item 2.	Changes in Securities and Use of Proceeds		28




Item 3.	Defaults Upon Senior Securities		28




Item 4.	Submission of Matters to a Vote of Security Holders		28




Item 5.	Other information		28




Item 6.	Exhibits and Reports on Form 8-K		29




Signatures			30

⁽²⁾		On June 29, 2004, the Company elected to redeem the remaining $41.0 million outstanding 10.75% Senior Notes due August 2006 on August 16, 2004. The outstanding notes will be redeemed at a price of $1,026.875 per $1,000 plus accrued interest. The redemption premium has been included with interest for purposes of this contractual cash obligations disclosure.

⁽³⁾		The Company leases the majority of its retail stores, offices, warehouses and distribution facilities. Certain leases provide for additional rents based on sales. Primary lease terms range from 3 to 55 years and substantially all leases provide for renewal options.

⁽⁴⁾		Standby letters of credit are committed as security for workers’ compensation obligations. Outstanding letters of credit expire between September 2004 and February 2005.