SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

(Mark One)

For the quarterly period ended October 2, 2004

OR

For the transition period from            to           

Commission file number 0-9904

ARDEN GROUP, INC.

No Change
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 the filing requirements for at least the past 90 days. Yes x No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes o No x

The number of shares outstanding of the registrant’s classes of common stock as of November 15, 2004 was:

3,383,252 of Class A Common Stock

Table of Contents

PART I. FINANCIAL INFORMATION

(In Thousands)

ARDEN GROUP, INC. AND CONSOLIDATED SUBSIDIARIES

(In Thousands, Except Share and Per Share Data)

ARDEN GROUP, INC. AND CONSOLIDATED SUBSIDIARIES

(In Thousands)

CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued

(In Thousands)

ARDEN GROUP, INC. AND CONSOLIDATED SUBSIDIARIES

1.		Summary of Significant Accounting Policies
		Basis of Presentation and Principles of Consolidation
		The consolidated financial statements of Arden Group, Inc. (the “Company”) include the accounts of the Company and its direct and indirect subsidiaries. All intercompany accounts and transactions are eliminated in consolidation. The Company operates 18 supermarkets in Southern California.
		The accompanying condensed consolidated financial statements for the thirteen and thirty-nine weeks ended October 2, 2004 and September 27, 2003 have been prepared in accordance with the instructions to Form 10-Q, Article 10 of Regulation S-X and generally accepted accounting principles (“GAAP”) for interim financial information. These financial statements have not been audited by an independent registered public accounting firm but include all adjustments which, in the opinion of management of the Company, are necessary for a fair statement of the financial position and the results of operations for the periods presented. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been omitted pursuant to Securities and Exchange Commission (“SEC”) regulations. Accordingly, the accompanying condensed consolidated financial statements should be read in conjunction with the Company’s fiscal 2003 Annual Report on Form 10-K. The results of operations for the nine months ended October 2, 2004 are not necessarily indicative of the results to be expected for the full year ending January 1, 2005.
		Revenue Recognition
		The Company recognizes revenue at the time of sale. Discounts given to customers are recorded at the point of sale as a reduction of revenues. The Company maintains a bad debt allowance for receivables from vendors and Gelson’s credit card sales. Valuation reserves are adjusted periodically based on historical recovery rates. The Company records income from licensing arrangements, subleases, leases and finance charges as they are earned.
		During the third quarter of 2004, the Company revised the way it classifies income from licensed operations within its supermarkets, subleases, leases and finance charges. The net rental, license or other income is now recorded as a component of sales on the consolidated statement of operations and comprehensive income. Previously, the revenue for these items had been classified as a reduction to delivery, selling, general and administrative (“DSG&A”) expense. Additionally, sales and cost of sales for one licensed department in the Company’s stores were recorded on the gross basis rather than reporting the net licensed revenue received. Income from all licensing arrangements, rental income and finance charges represents less than 1% of sales for all periods presented, and therefore is not disclosed separately on the income statement.
		The Company has revised amounts previously reported for the three and nine months ended September 27, 2003 to conform to the revised classification. None of the classification changes has an impact on operating income, net income, net cash flow or any element of the Company’s consolidated balance sheets for all periods presented. The Company does not consider the effect of these revisions in classification in 2004 or in prior periods, individually or in the aggregate, to be material.

		Merchandise Costs
		Cost of goods sold and inventory includes product costs, net of discounts and allowances, and inbound freight charges. Purchasing and receiving costs, inspection costs, internal transfer costs, warehousing costs and other costs of the Company’s distribution network are recorded as DSG&A expense. Warehousing and transportation costs include labor, building rent, utilities, depreciation, repairs and maintenance and fuel for the Company’s distribution center and distribution system. Costs related to the Company’s distribution network totaled approximately $1,604,000 and $1,395,000 for the third quarter of 2004 and 2003, respectively. On a year-to-date basis, distribution costs were approximately $4,462,000 and $3,945,000 for 2004 and 2003, respectively.
		Vendor Allowances
		Promotional and rebate allowances make up the majority of all allowances. With promotional allowances, vendors pay the Company to promote their product. The promotion may be a temporary price reduction, a feature in a print advertisement or newsletter, or placement of the vendor’s product in a preferred location in a store. The promotions are typically two to three weeks long and are recognized when the commitment has been fulfilled. Promotional and vendor rebate allowances are recorded as a reduction of cost of goods sold except advertising reimbursements which are recorded as a reduction of advertising expense which is included in DSG&A expense. The Company also receives other allowances which are recognized as they are earned as a reduction of cost of goods sold.

2.		Labor Dispute
		The collective bargaining agreement with the United Food and Commercial Workers (“UFCW”), which covers the majority of the Company’s employees expired on October 5, 2003. Three major grocery retailers in our trade area whose employees were covered under the expired agreement operated under strike or lockout from October 11, 2003 through February 29, 2004 when a contract settlement was reached. Prior to the contract expiration, the Company agreed to be bound by all modifications regarding trust funds and hourly wage rates as negotiated between the UFCW and the three major grocery retailers. The Company operated under contract extensions during the labor dispute. In return, the UFCW agreed not to strike the Company. Gelson’s remained open and its employees did not strike.
		In late February 2004, employees of the three major retailers ratified a new labor contract. The new contract provides for, among other things, a new two-tier employment structure, elimination of the requirement to maintain health care benefits at the same level as under the prior agreement and bonus payments in lieu of wage increases. In a vote held on March 24-25, 2004, employees of Gelson’s who are members of the UFCW ratified a new labor contract on terms similar to those reached by the three major grocery retailers. The new labor contract expires in March 2007.
		The labor dispute resulted in a temporary shift in consumer shopping patterns and a significant increase in the Company’s sales and operating income during the fourth quarter of 2003 and the first quarter of 2004. Since the February 2004 contract settlement, most former customers of the three major grocery retailers have returned to their previous shopping patterns; however, Gelson’s post-strike sales are greater than pre-strike periods as a result of the retention of some of the new shoppers that came to Gelson’s during the labor dispute.
3.		Extraordinary Dividend
		Subsequent to the end of the third quarter of 2004, the Company’s Board of Directors declared an extraordinary dividend of $20 per share on its Class A Common Stock (“Class A”) and $18 per share on its Class B Common Stock (“Class B”). The dividend will be paid on December 16, 2004 to holders of record on November 15, 2004.
		As of October 25, 2004, the dividend declaration date, Bernard Briskin, Chairman of the Board and Chief Executive Officer of the Company, was the beneficial owner of 1,362,496 shares of the Company’s Class B (a portion of which was beneficially owned with his spouse), representing over 99% of the then outstanding Class B of the Company. On November 10, 2004, Mr. Briskin and his spouse elected to convert shares of Class B owned by them into an equal number of the Company’s Class A shares. The conversion of these shares triggered the automatic and simultaneous conversion of all remaining Class B shares as provided under the Company’s Restated Certificate of Incorporation. As a result, all owners of the Company’s Class B became owners of Class A prior to the dividend record date and will be entitled to receive the dividend payable on Class A issued upon such conversion. The aggregate amount of the extraordinary dividend will be approximately $67,665,000 taking into account the conversion of all Class B shares prior to the dividend record date.
		The holders of Class B shares had ten votes for each share held, elected five of the authorized seven directors and were entitled to receive per share 90% of any dividend otherwise payable to the holders of Class A shares. As a result of the conversion of all Class B shares to Class A shares, the Company has only one class of outstanding common stock with all holders having the same rights.

		The Board of Directors also approved an antidilution adjustment to the exercise price of all outstanding stock appreciation rights (“SARs”) to account for the effect that the extraordinary dividend will have on the Company’s Class A share price.
4.		Multi-Employer Pension and Health Care Plans
		The Company contributes to several multi-employer union pension and health care plans, administered by various trustees, in accordance with the provisions of various labor contracts. Contributions to the multi-employer union pension plan, covering a majority of the Company’s employees, have been periodically suspended and reinstated in recent years. Most recently, contributions were suspended in November 2002 and reinstated in March 2003. Pension and health care costs are determined based on total hours worked and the rate per hour as stipulated in the Company’s various collective bargaining agreements. The Company’s contributions to all union pension and health care plans totaled approximately $5,649,000 and $4,898,000 in the third quarter of 2004 and 2003, respectively. Contributions were approximately $17,492,000 for the first nine months of 2004 compared to $13,893,000 in the same period of the prior year. The higher costs resulted primarily from additional labor hours which were required as sales levels increased in 2004 compared to the prior year, as well as the contribution suspension during January and February 2003.
		The Arden Group, Inc. 401(k) Retirement Savings Plan (the “Plan”) covers all nonunion employees of the Company and its subsidiaries who have attained the age of 18 and have completed at least one year of service. The Plan provides that, with certain limitations, a participating employee may elect to contribute up to 100% of such employee’s annual compensation to the Plan up to a maximum of $13,000 in 2004 on a tax-deferred basis. The Company makes discretionary contributions to the Plan and accrued approximately $155,000 and $177,000 towards this benefit for the third quarter of 2004 and 2003, respectively. The Company recognized $594,000 and $630,000 during the first nine months of 2004 and 2003, respectively.
5.		Stock Options and Stock Appreciation Rights
		As allowed by Statement of Financial Accounting Standards No. (“SFAS”) 123, “Accounting for Stock-Based Compensation” (as amended by SFAS 148, “Accounting for Stock-Based Compensation — Transition and Disclosure”) the Company follows the disclosure requirements of SFAS 123, but continues to account for its employee stock option plans in accordance with Accounting Principles Board Opinion No. (“APB”) 25, “Accounting for Stock Issued to Employees,” which results in no charge to earnings when options are issued at fair market value.

The following table illustrates the effect on net income and earnings per share as if the Fair Value Based method had been applied to all outstanding stock option awards in each period presented:

		The Company has outstanding SARs that have been granted to non-employee directors and certain employees. Stock-based compensation under the SARs program is subject to variable accounting in accordance with Financial Accounting Standards Board Interpretation No. (“FIN”) 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans.” The Company records compensation expense related to the vesting of SARs using the appropriate amortization schedule as required by FIN 28. In addition, changes in the market price of the Company’s Class A impact the charge related to SARs. During the third quarter, the Company recorded SARs expense of $1,000 and $75,000 for 2004 and 2003, respectively. The Company recognized $798,000 of SARs compensation expense in the first nine months of 2004 compared to $157,000 in the same period of the prior year.
6.		Common Stock and Net Income Per Common Share
		Effective with the second quarter of 2004, the Company adopted Emerging Issues Task Force (“EITF”) 03-6 “Participating Securities and the Two-Class method under Financial Accounting Standards Board Statement No. (“FAS”) 128” which requires the use of the Two-Class method to calculate basic earnings per share when a company has convertible participating securities. The Company’s Class B is convertible on a share by share basis into Class A. Class B shareholders are entitled to share in 90% of the dividends (other than stock dividends) paid to Class A shareholders. Under the Two-Class method, the Company assumes that 100% of undistributed earnings are distributed to Class A and Class B shareholders according to the formula for allocation of dividends. Consequently, the Two-Class method results in a higher allocation of net income and earnings per share to Class A versus Class B shareholders. Basic net income per share is computed by dividing the net income attributable to Class A and Class B shareholders, respectively, by the weighted average number of common shares outstanding under each class during the period. In accordance with EITF 03-6, prior periods have been restated using the Two-Class method.

Diluted net income per share is computed using the If Converted method in accordance with FAS 128. Diluted net income per share is computed by dividing net income attributable to common shareholders by the weighted average number of common and potential common shares outstanding during the period. Potential common shares included in the diluted computation represent shares issuable upon assumed exercise of stock options using the Treasury Stock method. Diluted net income per share is only shown for a single class of common shares because, under the If Converted method, it is assumed that all Class B shares are converted to Class A.

		On November 10, 2004, Bernard Briskin, Chairman of the Board and Chief Executive Officer of the Company, elected to convert Class B shares beneficially owned by him, including shares beneficially owned with his wife, into Class A shares. The conversion of these shares triggered the automatic and simultaneous conversion of all remaining Class B shares as provided under the Company’s Restated Certificate of Incorporation. After the conversion, the Company has only Class A outstanding, and all shareholders will participate equally in the undistributed earnings of the Company.
7.		Commitments and Contingent Liabilities
		The Company and its subsidiaries are subject to a myriad of environmental laws, regulations and lease covenants with its landlords regarding air, water and land use, products for sale, and the use, storage and disposal of hazardous materials. The Company believes it substantially complies, and has in the past substantially complied, with federal, state and local environmental laws and regulations and private covenants. The Company cannot, at this time, estimate the expense it ultimately may incur in connection with any current or future violations; however, it believes any such claims will not have a material adverse impact on either the Company’s consolidated financial position, results of operations or cash flows.
		The Company or its subsidiaries are defendants in a number of cases currently in litigation, being vigorously defended, in which the complainants seek monetary damages. As of the date hereof, no estimate of potential liability, if any, is possible. Based upon current information, management, after consultation with legal counsel defending the Company’s interests in the cases, believes the ultimate disposition thereof will have no material effect upon either the Company’s consolidated financial position, results of operations or cash flows.
8.		Recent Accounting Standards
		In November 2003, the EITF reached a consensus on EITF 03-10, “Application of EITF 02-16 by Resellers to Sales Incentives Offered to Consumers by Manufacturers.” EITF 03-10 addresses the accounting for manufacturer sales incentives offered directly to consumers, including manufacturer coupons. EITF 03-10 is effective for the first interim period beginning after November 25, 2003. Adoption of the provisions of EITF 03-10 did not have an impact on the Company’s consolidated financial statements.
		In March 2004, the EITF amended and ratified previous consensus on EITF 03-1, “The Meaning of Other Than Temporary Impairment and its Application to Certain Issues.” EITF 03-1 establishes guidance to be used in determining when an investment is considered impaired, whether that impairment is other than temporary and the measurement of an impairment loss. The effective date was originally the Company’s third quarter of 2004. In September 2004, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position No. EITF 03-1-1, “Effective Date of Paragraphs 10-20 of EITF 03-1” to delay the effective date pending further discussions by the EITF. During the period of delay, the Company will continue to apply applicable pronouncements to determine any other than temporary impairments of its investments.

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

RESULTS OF OPERATIONS

The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements made by or on behalf of the Company. Certain statements contained in Management’s Discussion and Analysis, in other parts of this report and in other Company filings are forward-looking statements. These statements discuss, among other things, future sales growth, operating results and financial condition. Forward-looking statements reflect the Company’s current plans and expectations regarding important risk factors and are based on information currently known to the Company.

The Company cautions readers that any forward-looking statements contained in this report or made by the management of the Company involve risks and uncertainties, and are subject to change based on various important factors. The following factors, among others, could affect the Company’s financial results and could cause the Company’s financial performance to differ materially from the expectations expressed in any forward-looking statement made by or on behalf of the Company:

	•		the strength of the U.S. economy and, in particular, the economic conditions in Southern California;
	•		the effects of and changes in fiscal policies and laws, as well as, changes in accounting policies and practices;
	•		inflation or deflation;
	•		potential business disruptions from acts of terrorism, national emergencies or natural disasters;
	•		the impact of fluctuations in the Company’s stock price on compensation expense;
	•		the ability of vendors, including Unified Western Grocers, Inc., to continue providing products and services in a timely manner;
	•		consolidations in the supermarket industry and competition from other supermarkets and food retailers, some of which are nonunion;
	•		the ability to renew current leases at favorable rates;
	•		the ability of the Company to materially increase sales at its Pasadena store;
	•		the impact on the Century City store of major construction on Santa Monica Boulevard in West Los Angeles, California and at the Century City Shopping Center;
	•		the amount of future premium increases incurred by the Company in order to maintain current levels of insurance coverage;
	•		the financial impact of the Company’s termination of its guaranteed cost workers’ compensation policy and the resulting change to self-insurance with stop-loss coverage for workers’ compensation claims;
	•		the impact of the Company’s workers’ compensation safety records and claims experience and any changes to the insurance industry’s rating process and premium schedules on workers’ compensation stop-loss coverage;
	•		the impact of new worker’s compensation legislation;
	•		the adequacy of self-insurance reserves for reported claims and incurred but not reported claims;
	•		the impact of uninsured losses;
	•		the effects of the Company’s new contracts with its unions;
	•		the impact of any violation of environmental laws, regulations or lease provisions;
	•		the retirement of existing senior management;
	•		the term of any future suspension and subsequent reinstatement of multi-employer union pension contributions, the number of hours worked by the applicable union employees, the required rate of contribution and the future rate of return received by the union pension plans on their investments;

	•		changes in the Company’s health care costs;
	•		any changes in assumptions or market conditions that could affect management’s estimate of future cash flows when evaluating assets for impairment.

Third Quarter Analysis

The results of operations for the third quarter of 2004 compared to the third quarter of 2003 reflects incremental sales achieved as a result of a labor dispute in the Company’s trade area that commenced October 11, 2003 and concluded February 29, 2004. The collective bargaining agreement covering the majority of the Company’s employees, as well as other participating employers in Southern California, expired on October 5, 2003. While three major grocery retailers covered under the agreement operated under strike or lockout from October 11, 2003 through February 29, 2004, the Company operated under contract extensions and Gelson’s remained open. Its employees did not strike and the UFCW agreed not to strike the Company.

The labor dispute resulted in a temporary shift in consumer shopping patterns and a significant increase in the Company’s sales and operating income during the fourth quarter of 2003 and the first quarter of 2004. Since the labor dispute, customers have returned to their previous shopping patterns. However, the Company has successfully retained some of the incremental sales from new shoppers that experienced the Gelson’s format and service.

Net income in the third quarter of 2004 increased 47.9% to $4,416,000 compared to $2,985,000 during the third quarter of 2003. Operating income increased 49.2% to $6,968,000 in the third quarter of 2004 compared to $4,671,000 in the prior year.

Comparable store sales from the Company’s 18 supermarkets (all of which are located in Southern California) were $113,391,000 in the third quarter of 2004 representing an increase of 12.2% compared to sales of $101,060,000 in the third quarter of 2003. The majority of the sales increase resulted from the ability to retain some customers from the labor dispute in the Company’s trade area earlier in the year. The Company does not believe that inflation or changing prices contributed significantly to the sales increase. Sales were negatively impacted during the last week of the third quarter of 2004 as the Century City store was closed due to construction at the Century City Shopping Center as discussed below. The store, which was closed for a total of three weeks, reopened on October 18, 2004.

The Company’s gross profit as a percent of sales was 44.9% in the third quarter of 2004 compared to 45.0% in the same period of 2003. The Company includes product costs, net of discounts and allowances, and inbound freight charges in cost of goods sold, thereby reducing gross profit by these amounts. Purchasing and receiving costs, inspection costs, internal transfer costs, warehousing costs and other costs of the Company’s distribution network are recorded as DSG&A expense. Gross profit as a percent of sales for the Company may not be comparable to those of other companies in the grocery industry since other entities may record purchasing, warehousing and distribution costs in costs of goods sold.

DSG&A expense as a percent of sales was 38.8% in the third quarter of 2004 compared to 40.3% in the third quarter of 2003. During the labor dispute, the Company achieved significant economies of scale from incremental sales. The Company has continued to realize some of these savings during the third quarter of 2004 as a result of the higher sales volume.

The Company contributes to several multi-employer union pension and health care plans. Contributions to the multi-employer union pension plan, covering a majority of the Company’s employees, have been

periodically suspended and reinstated in recent years. Most recently, contributions were suspended in November 2002 and reinstated in March 2003. Pension and health care costs are determined based on total hours worked and the rate per hour as stipulated in the Company’s various collective bargaining agreements. The Company’s contributions to all union pension and health care plans increased approximately 15.3% to $5,649,000 in the third quarter of 2004 compared to $4,898,000 in the third quarter of 2003. The higher costs resulted primarily from additional labor hours which were required as sales levels increased in 2004 compared to the prior year.

In June 2003, in an effort to control the substantially increasing workers’ compensation rates, the Company terminated its guaranteed cost workers’ compensation insurance coverage and purchased a high deductible workers’ compensation policy. The Company has stop-loss coverage to limit its exposure on a per claim basis and is insured for covered costs in excess of per claim limits. Self-insurance accruals for losses up to the purchased stop-loss coverage are based on reported claims and an estimate of claims incurred but not reported. No assurance can be given that this change will ultimately result in a reduction in workers’ compensation expense or limit future increases. The Company devotes substantial time and commitment to maintaining a safe work environment. The ultimate cost of workers’ compensation is highly dependent upon legal and legislative trends, the inflation rate of health care costs and the Company’s ability to manage claims. In April 2004, California passed legislation aimed at reforming the workers’ compensation insurance system in the state. At this point in time, the Company is unable to predict how this legislation will impact overall costs.

The Company has outstanding SARs that have been granted to non-employee directors and certain employees. For the fiscal year ended January 3, 2004, SARs compensation expense was $740,000. Assuming the Company’s stock price remains at the October 2, 2004 closing price of $85.21 (before adjustment for the extraordinary dividend), the Company anticipates fiscal 2004 SARs compensation expense of approximately $963,000 related to the additional vesting of SARs. As of October 2, 2004, $798,000 of this estimate has been accrued. The estimate assumes that no additional SARs are granted and no existing SARs are terminated or exercised. Changes in the Company’s stock price, exercise or termination of outstanding SARs or additional grants could cause this estimate to vary.

Interest and dividend income was $530,000 in the third quarter of 2004 compared to $419,000 for the same period in 2003 primarily due to increased cash levels and higher interest rates in 2004. As a result of the extraordinary dividend payable on December 16, 2004, the Company expects that future interest and dividend income will be substantially lower.

SFAS 115, “Accounting for Certain Investments in Debt and Equity Securities,” requires that unrealized holding gains and losses from available-for-sale securities be included as a component of stockholders’ equity. Unrealized gains on available-for-sale securities were $29,000 (net of income tax expense of $20,000) in the third quarter of 2004. There were no unrealized gains (losses) in the third quarter of 2003.

In September 2001, the Company opened a Gelson’s Market in a mixed use shopping center/apartment project in Pasadena, California, which is performing below management’s expectations. During the fourth quarter of 2003, the Company recorded a $4,311,000 impairment on long-lived assets including leasehold improvements and equipment at its Pasadena store. The Company has the right, under certain circumstances, to terminate its lease in the Spring of 2005 which may result in an additional write-off of fixed assets and other costs. At October 2, 2004, the remaining net book value of fixed assets related to the Pasadena store was $416,000.

A major road improvement project is under construction along Santa Monica Boulevard in West Los Angeles, California, which is presently estimated to be completed in March 2006. At times during the

project, construction has, and will continue to occur directly in front of, or very close to, the Century City Shopping Center where Gelson’s has its Century City store. It can be expected that the sales of the Century City store will be negatively impacted during the period when the construction is at or near the Century City Shopping Center, but that access to the shopping center is expected to improve once the roadway project has been completed. In addition, the landlord of the Century City Shopping Center has commenced a major construction project which will result in the relocation of the movie theaters, food court and other tenants to newly constructed areas immediately adjacent to the Gelson’s store. Those plans also include the expansion of the Gelson’s store. Construction began in March 2004. The Company does not know how long this project will take. Sales at the Century City store have been, and the Company expects will continue to be, negatively affected during this construction. The store was closed for a three week period beginning September 27, 2004 as construction took place immediately above the store. Since the store reopened on October 18, 2004, sales have returned to levels consistent with those immediately preceding the closure; however, they continue to be negatively impacted by the construction at the Center and on Santa Monica Boulevard. It is not presently anticipated that any future store closures will be required. The Company also expects that the parking for Gelson’s customers will be adversely affected by the relocation of the theaters, food court and other tenants to the immediate vicinity of the Gelson’s store. However, it also anticipates that the relocation will increase foot traffic in the vicinity of the store which, along with the expanded facilities and services within the store, could increase customer count.

Year-To-Date Analysis

Net income in the first nine months of 2004 increased 107.2% to $18,738,000 compared to $9,045,000 during the first nine months of 2003. Operating income increased 113.9% to $28,725,000 for the first nine months of 2004 compared to $13,429,000 in the same period of the prior year.

Comparable store sales from the Company’s 18 supermarkets (all of which are located in Southern California) were $380,648,000 in the first nine months of 2004. This represents an increase of 26.4% over the first nine months of 2003 when sales were $301,230,000. The majority of the sales increase resulted from the labor dispute in the Company’s trade area. The Company does not believe that inflation or changing prices contributed significantly to the sales increase. Sales were negatively impacted during the last week of the third quarter of 2004 as the Century City store was closed due to construction at the Century City Shopping Center as discussed above. The store, which was closed for a total of three weeks, reopened on October 18, 2004. During the first quarter of 2003, the Silverlake/Los Feliz Mayfair store was converted to the Gelson’s name and format as part of a major remodel. Sales at the store were adversely impacted by a ten-day closure and reduced customer traffic during the construction phase of the remodel which was completed in late March 2003.

The Company’s gross profit as a percent of sales was 44.7% in the first nine months of both 2004 and 2003. The Company includes product costs, net of discounts and allowances, and inbound freight charges in cost of goods sold, thereby reducing gross profit by these amounts. Purchasing and receiving costs, inspection costs, internal transfer costs, warehousing costs and other costs of the Company’s distribution network are recorded as DSG&A expense. Gross profit as a percent of sales for the Company may not be comparable to those of other companies in the grocery industry since other entities may record purchasing, warehousing and distribution costs in costs of goods sold.

DSG&A expense as a percent of sales was 37.1% in the first nine months of 2004 compared to 40.3% in the same period of 2003. During the labor dispute, the Company achieved significant economies of scale from incremental sales. These economies were partially offset by approximately $2,200,000 in bonus payments for the majority of the Company’s union employees and approximately $17,492,000 in union

pension and health care contributions compared to $13,893,000 in 2003. The higher pension and healthcare costs resulted primarily from additional labor hours which were required as sales levels increased in 2004 compared to the prior year. The Company also recognized $798,000 of compensation expense in the first nine months of 2004 related to SARs compared to $157,000 in the same period of the prior year.

Interest and dividend income was $1,466,000 in the first nine months of 2004 compared to $1,185,000 for the same period in 2003 primarily due to increased cash levels. As a result of the extraordinary dividend payable on December 16, 2004, the Company expects that future interest and dividend income will be substantially lower.

Other income includes net gains realized on investments of $1,571,000 and $843,000 in the first nine months of 2004 and 2003, respectively.

SFAS 115, “Accounting for Certain Investments in Debt and Equity Securities,” requires that unrealized holding gains and losses from available-for-sale securities be included as a component of stockholders’ equity. Unrealized losses on available-for-sale securities were $107,000 (net of income tax benefit of $72,000) in the first nine months of 2004 compared to unrealized gains of $202,000 (net of income tax expense of $140,000) in the same period of 2003.

CAPITAL EXPENDITURES/LIQUIDITY

The Company’s current cash position, including investments, and net cash provided by operating activities are the primary sources of funds available to meet the Company’s capital expenditure and liquidity requirements. The Company’s cash position, including investments, at the end of the third quarter 2004 was $101,123,000. During the thirty-nine weeks ended October 2, 2004, the Company generated approximately $3,783,000 of cash from operating activities. Cash not required for the immediate needs of the Company have been temporarily invested in commercial paper and marketable securities. All temporary investments are highly liquid. The Company is continually investigating opportunities for the use of these funds including new locations and the expansion and remodel of existing stores. Capital expenditures of approximately $7,919,000 were incurred during the thirty-nine weeks ended October 2, 2004. Subsequent to the end of the third quarter of 2004, the Company declared an extraordinary dividend totaling approximately $67,665,000.

The Company also has two revolving lines of credit totaling $15,000,000 available for standby letters of credit, funding operations and expansion. There were no outstanding borrowings against either of the revolving lines as of October 2, 2004. The Company currently maintains four standby letters of credit aggregating $10,844,000 pursuant to the Company’s general liability and workers’ compensation self-insurance programs. The standby letters of credit reduce the available borrowings under its revolving lines. On July 23, 2004, the Company established a separate investment account with initial funds totaling $11,000,000 which serves as collateral for the outstanding standby letters of credit.

Current liabilities decreased $22,925,000 during the nine months ended October 2, 2004 primarily due to a reduction in income taxes payable, accounts payable and accrued union health care costs. The Company recorded additional income taxes payable at the end of fiscal 2003 as a result of the increase in earnings that the Company achieved during the labor dispute. These taxes were remitted to the appropriate taxing authorities during the first quarter of 2004. Accounts payable decreased significantly after the conclusion of the labor dispute as customers returned to their previous shopping patterns and the Company’s product orders decreased. The labor dispute also resulted in a depletion of funds in the multi-employer health and welfare trust fund maintained for the benefit of UFCW employees. As a result, the Company was

assessed approximately $5,797,000 to pay union health care claims and restore trust fund reserves to the required levels. This assessment was accrued at the end of fiscal 2003 and paid during the first quarter of 2004.

The following table sets forth the Company’s contractual cash obligations and commercial commitments as of October 2, 2004:

In April 2003, the Company announced a stock repurchase program, authorized by the Board of Directors, to purchase from time to time up to 100,000 shares of its Class A in the open market or in

private transactions. The timing, volume and price of purchases are at the discretion of the management of the Company. No shares were repurchased during the thirty-nine weeks ended October 2, 2004.

On October 20, 2004, the Company paid a regular quarterly cash dividend of 25 cents per share of Class A and 22.5 cents per share of Class B, aggregating approximately $812,000, to stockholders of record on September 30, 2004. On October 25, 2004, the Company’s Board of Directors declared an extraordinary dividend of $20 per share on Class A and $18 per share on Class B. The dividend will be paid on December 16, 2004 to holders of record on November 15, 2004. See Note 3 of Notes to Consolidated Financial Statements for further details.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company currently has no bank debt or fixture financing. If the Company should obtain financing or draw on its existing lines of credit, which bear interest at the bank’s reference rate or the bank’s adjusted LIBOR rate plus an index up to 1.2%, the Company could then be exposed to market risk related to interest fluctuations.

A change in market prices exposes the Company to market risk related to its investments. As of October 2, 2004, all investments were classified as available-for-sale securities and totaled $46,877,000. A hypothetical 10% drop in the market value of these investments would result in a $4,688,000 unrealized loss and a corresponding decrease in the fair value of these instruments. This hypothetical drop would not affect cash flow and would not have an impact on earnings until the Company sold the investments.

ITEM 4. CONTROLS AND PROCEDURES

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in its reports filed pursuant to Rule 13a-15(e) or 15d-15(e) of the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management, with the participation of the Chief Executive Officer and Chief Financial Officer of the Company, has performed an evaluation of the design and operation of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer of the Company concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report.

Management, with the participation of the Chief Executive Officer and Chief Financial Officer of the Company, has evaluated any changes in the Company’s internal control over financial reporting that occurred during the most recent fiscal quarter. Based on that evaluation, management, the Chief Executive Officer and the Chief Financial Officer of the Company have concluded that there has been no change in the Company’s internal control over financial reporting during the Company’s fiscal quarter ended October 2, 2004 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 6. EXHIBITS

SIGNATURES

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

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