**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**Washington,D. C. 20549**

 

**FORM 10-K**

 

**(Mark One)**

 

**ý****                                ****ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

**For thefiscal year ended December 31, 2005**

 

**OR**

 

**o****                                ****TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

**For thetransition period from                        to                        **

 

**Commission file number  0-9904**

 

**ARDENGROUP, INC.**

(Exact name of registrantas specified in its charter)

 

| **Delaware**                                        | ** ** | **95-3163136**                        |
|-----------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of                    |       | (I.R.S. Employer  Identification No.) |
| incorporation or  organization)                     |       |                                  |
|                                                |       |                                  |
| **2020  South Central Avenue, Compton, California** | ** ** | **90220**                             |
| (Address of principal  executive offices)           |       | (Zip Code)                            |

 

Registrant’s telephone number, including area code **(310)638-2842**

 

Securities registered pursuant to Section 12(b) of the Act:

 

| **Title of each class** | ** ** | **Name of each exchange on which registered** |
|----------------------------------------|------------|-----------------------------------------------------------------------------|
| None                                   |       | None                                                                        |

 

Securities registered pursuant to Section 12(g) of the Act:

 

**Class A Common Stock**

(Title of class)

 

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 of theSecurities Act.

Yes  o    No  ý

 

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 orSection 15(d) of the Exchange Act.

Yes  o    No  ý

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.                                                                         Yes  ý    No  o

 

Indicate by a check markif disclosure of delinquent filers pursuant to Item 405 of Regulation S-K isnot contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K.                                                                                                                         o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act.      Largeaccelerated filer  o  Acceleratedfiler  ý Non-acceleratedfiler   o

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).

Yes  o    No  ý

 

The aggregate marketvalue of the voting and non-voting common equity held by non-affiliates of theregistrant based on the price at which the Class A Common Stock last sold on July1, 2005, the last business day of the registrant’s most recently completedsecond fiscal quarter was $87,145,568.

 

The number of sharesoutstanding of the registrant’s class of common stock as of March 3, 2006 was: 

 

3,229,429 shares of ClassA Common Stock

 

 

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**TABLE OFCONTENTS**

 
| **PART I**     |                                                                                                                    |   |
|----------------|-------------------------------------------------------------------------------------------------------------------------|--------|
| Item 1.        | Business                                                                                                                |   |
| Item 1A.       | Risk Factors                                                                                                            |   |
| Item 1B.       | Unresolved Staff Comments                                                                                               |   |
| Item 2.        | Properties                                                                                                              |   |
| Item 3.        | Legal Proceedings                                                                                                       |   |
| Item 4.        | Submission of Matters to a  Vote of Security Holders                                                                    |   |
|           |                                                                                                                    |   |
| **PART II**    |                                                                                                                    |   |
| Item 5.        | Market for the Registrant’s  Common Equity, Related Stockholder Matters and Issuer Purchases of Equity  Securities |   |
| Item 6.        | Selected Financial Data                                                                                                 |   |
| Item 7.        | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                             |   |
| Item 7A.       | Quantitative  and Qualitative Disclosures about Market Risks                                                            |   |
| Item 8.        | Financial  Statements and Supplementary Data                                                                            |   |
| Item 9.        | Changes in  and Disagreements with Accountants on Accounting and Financial Disclosure                                   |   |
| Item 9A.       | Controls and  Procedures                                                                                                |   |
| Item 9B.       | Other Information                                                                                                       |   |
|           |                                                                                                                    |   |
| **PART III**   |                                                                                                                    |   |
| Item 10.       | Directors  and Executive Officers of the Registrant                                                                     |   |
| Item 11.       | Executive  Compensation                                                                                                 |   |
| Item 12.       | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                        |   |
| Item 13.       | Certain  Relationships and Related Transactions                                                                         |   |
|           |                                                                                                                    |   |
| **PART IV**    |                                                                                                                    |   |
| Item 14.       | Principal  Accountant Fees and Services                                                                                 |   |
| Item 15.       | Exhibits and Financial Statement  Schedules                                                                             |   |
|           |                                                                                                                    |   |
| **Signatures** |                                                                                                                    |   |

 

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**PART I**

** **

Item 1.    Business

 

**General**

 

The Registrant, ArdenGroup, Inc. (Company), is a holding company which conducts operations throughits wholly-owned subsidiary, Arden-Mayfair, Inc. (Arden-Mayfair) andArden-Mayfair’s wholly-owned subsidiary, Gelson’s Markets (Gelson’s) whichoperates supermarkets in Southern California. The Company also owns certainreal estate properties.

 

Arden Group, Inc. isheadquartered at 2020 South Central Avenue, Compton, California 90220 and itstelephone number is(310) 638-2842.

 

**Market Operations**

 

As of December 31, 2005,Gelson’s operated 18 full-service supermarkets in Southern California, whichcarry both perishable and grocery products, 17 under the name “Gelson’s” andone under the name “Mayfair.”  Gelson’s andMayfair are self-service cash-and-carry markets which offer a broad selectionof local and national brands as well as a limited number of private labelitems. Gelson’s targets the consumer who values superior customer service,merchandise, presentation and selection.

 

**Store Formats and BusinessStrategy**

 

Gelson’s businessstrategy is to offer a comfortable upscale shopping experience which issuperior to its competitors in terms of customer service and merchandiseselection and presentation. The goal of this strategy is to continue to developand maintain Gelson’s loyal base of customers and appeal to potential newcustomers. Central elements of this strategy are as follows:

 

Merchandise  The merchandise offerings in the markets aretailored in response to Gelson’s customer profile. Gelson’s stores, which rangein size from approximately 18,000 to 40,000 square feet, typically carry a widerange of items, including traditional grocery categories such as dry groceries,produce, meat, seafood, bakery, dairy, wine and liquor, floral, sushi,vitamins, health and natural food products, health and beauty aids and aselection of organic products. Gelson’s perishables are premium products, whichare rigorously maintained and culled as appropriate to assure quality andfreshness. Gelson’s merchandising emphasizes specialty items such as importedfoods and unusual delicatessen items, and items found in service departmentssuch as seafood, sit-down coffee areas, bakeries and service deli. The Mayfairstore offers a merchandise selection equal in quality to a Gelson’s butgenerally less broad.

 

Service  Gelson’s emphasizes customer service byoffering a variety of service departments including seafood, delicatessen,floral, sushi and bakery departments. All sushi and most bakery departments areoperated by third parties. Some Gelson’s stores include additional servicedepartments such as fresh pizza, coffee bars and carving carts offering cookedturkey and other meats. Additionally, selected stores offer banking and pharmacyservices through third parties. Stores are staffed so that, even at peak times,customer checkout time is minimized. In addition

 

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to checkers, there arepersonnel assigned to bagging and carrying out purchases. All employees areencouraged to know customers by name and assist them whenever possible. Allstores offer a Company credit card to qualified customers in addition to theoption of paying for their purchases with cash, checks or credit and debitcards. Stores are typically open 14 to 17 hours per day, with hours ofoperation determined by local code, lease provisions or as appropriate for thebusiness characteristics of each community.

 

Presentation  All stores are maintained in accordance withextremely high standards. Personnel continually fill and face shelves withproduct. Produce and other perishables are trimmed and culled to maintainquality and appearance.

 

Pricing  The pricing strategy at the stores is to becompetitive within their market niches, ranging from the more traditional tothe more exotic, specialty or high-end retailers.

 

Expansion and StoreDevelopment  Managementregularly evaluates the feasibility of opening new stores in and outside itsexisting trade area and remodeling existing stores in order to maximize theexisting stores’ appeal to consumers and their profit potential. In 2005,capital expenditures totaled $6,390,000, which included costs of approximately$2,400,000 related to the remodeling and expansion of the Century City store.

 

Advertising and Promotion  Gelson’s advertises in newspapers on alimited basis. Direct advertising is very limited (primarily newsletters anddirect mail) and is typically event rather than price oriented, emphasizing,for example, special holiday selections, specialty items and services, recipesand new products. In addition, Gelson’s maintains a website at www.gelsons.com which allows customersto learn more about the Company and to read about food related topics that maybe of interest to them. The website also provides an opportunity for customersto request a newsletter, offer feedback and to place catering and holiday mealorders online. The Company reevaluates its strategy regularly in an effort toidentify the most effective means of attracting and retaining customers.

 

**Competition**

 

The retail grocerybusiness is very competitive. Competition in the supermarket business is basedupon price, merchandise variety and quality, service and location. The numberof stores, market share and brand awareness are also important competitivefactors. Gelson’s is in direct competition with numerous local outlets ofregional and national supermarket chains (most of which have greater resourcesand a larger market share than Gelson’s), independent grocery stores,convenience stores, specialty and gourmet markets and food departments in massmerchandise and club stores. The stores of the national and regional chains aregenerally larger than Gelson’s stores which, in some cases, enables them tooffer more products. Competition also exists from other types of retailers withrespect to particular products. Gelson’s operates full-service supermarketscarrying both perishable and grocery products and competes primarily byoffering a combination of high-quality products and superior customer service.The Company also believes that Gelson’s prime store locations and long-standingreputation add to its competitive strength.

 

Certain competitors ofthe Company offer home delivery, in-store banks and pharmacies as an additionto their existing retail store operations. The Company continues to monitor andevaluate opportunities for home delivery, but has elected not to do so at thistime. A few of the

 

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Company’s stores offerin-store banks and pharmacies; most of the Company’s stores are not largeenough for such additional facilities.

 

**Seasonality**

 

Gelson’s business issomewhat seasonal with sales tending to increase during the last quarter of theyear due to the holiday season.

 

**Support and Other Services**

 

Each store has an on-sitestockroom, the size of which varies for each store. In addition, Gelson’soperates a 127,000 square foot warehouse and an adjacent 4,000 square foottruck service facility in the City of Commerce, California. The centralwarehouse distributes fresh produce, liquor, wine, floral and certain groceryitems to the stores. On a limited basis, the stores also receive meat,delicatessen, paper goods, health and beauty aids, hardware and supply itemsfrom the warehouse.

 

The bulk of allmerchandise purchasing takes place at Gelson’s office in Encino, California.Approximately 45% of the purchases for 2005 were distributed through thecentral warehouse; the remainder was delivered directly to the stores frommanufacturers, distributors or wholesalers. The central purchasing anddistribution operations are conducted based on electronic in-store orderingsystems. Stores can place and receive orders up to six days per week.Perishables are ordered more frequently than other goods.

 

The largest supplier for the stores is Unified Western Grocers, Inc.(Unified) (formerly Certified Grocers), a cooperative wholesaler which has beena supplier to the Company for approximately thirty-one years and which accountedfor approximately 18% of Gelson’s purchases in fiscal 2005. No other supplieraccounts for more than 3% of Gelson’s purchases. The Company believes thatthere would be a negative short-term impact if the Company were to lose Unifiedas a supplier for Gelson’s, but that such impact would likely be mitigated by acombination of events, which could include: (i) purchasing certain items for direct store delivery, thereby freeingwarehouse capacity to allow other items to be purchased through the warehouseand (ii) purchasing certain products through other wholesalers. However, such aloss could have an adverse effect on the performance of Gelson’s.

 

**Employees**

 

Gelson’s had approximately 1,292 full-time and 1,138 part-time store,warehouse and office employees at December 31, 2005. The total number ofemployees decreased from 2,518 at the end of the prior year as sales decreasedfollowing the end of a labor dispute involving other supermarkets in theCompany’s trade area. Most Gelson’s employees are covered by union collectivebargaining agreements that establish working conditions, benefits, hours, ratesof pay and procedures for the orderly settlement of disputes. In general, theseagreements have been negotiated on an area-wide and industry-wide basis.

 

OnOctober 5, 2003, the union contract covering most of Gelson’s employeesexpired. Prior to the contract expiration, the Company had agreed with theunion to continue operating under contract extensions and to be bound by allmodifications or by new contract, as applicable,

 

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regardingtrust funds and hourly wage rates as negotiated between the union and threemajor grocery retailers. On February 29, 2004, employees of the three majorretailers ratified a new union labor contract. The new contract provides for,among other things, a new two-tier employment structure, elimination of healthcare maintenance of benefits provided for under the prior agreement and bonuspayments in lieu of wage increases. In a vote held on March 24-25, 2004,employees of the Company who are members of the United Food and CommercialWorkers (UFCW) ratified a new labor contract on terms similar to those reachedby the three major grocery retailers. The new labor contract expires in March2007.

 

In addition to employees at Gelson’s, Arden-Mayfair had approximately73 full-time and 3 part-time employees at its executive and headquartersoffices at December 31, 2005, some of whom are covered by a collectivebargaining agreement.

 

**Governmental Regulation**

 

Gelson’s is subject toregulation by a variety of governmental agencies, including the U.S. Food andDrug Administration, the California Department of Alcoholic Beverage Control,and state and local health departments. The Company believes that Gelson’s andMayfair store operations comply with federal, state and local health,environmental and other laws and regulations. Although the Company cannotpredict the effect of future laws or regulations on its operations,expenditures for continued compliance with current laws are not expected tohave a material adverse effect on Gelson’s competitive position or theCompany’s consolidated financial position, results of operations or cash flows.

 

**Available Information**

 

The Company does not have an internet website to make its filings withthe Securities and Exchange Commission available. However, it will provide freeof charge upon written request to Assistant Secretary, Arden Group, Inc.,P.O.Box 512256, Los Angeles, California 90051-0256 paper copies of its annualreport on Form 10-K, quarterly reports on Form 10-Q, current reports on Form8-K and amendments to those reports filed or furnished pursuant to Section13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon asreasonably practicable after electronically filing such material with theSecurities and Exchange Commission. This information is also available atwww.sec.gov. The reference to this website address does not constituteincorporation by reference of the information contained on the website andshould not be considered part of this document.

 

Item 1A.         Risk Factors

 

The Private SecuritiesLitigation Reform Act of 1995 provides a safe harbor for forward-lookingstatements made by or on behalf of the Company. Certain statements contained inthis Item 1A, “Management’s Discussion and Analysis of Financial Condition andResults of Operations,” in other parts of this report and in other Companyfilings are forward-looking statements. These statements discuss, among other things,future sales growth, operating results and financial condition. Forward-lookingstatements reflect the Company’s current plans and expectations regardingimportant risk factors and are based on information currently known to theCompany.

 

The Company cautionsreaders that any forward-looking statements contained in this report or made bythe management of the Company involve risks and uncertainties, and are subjectto change based on various important factors. The Company does not undertakeany obligation to update forward-looking statements. The factors listed below,among others, could affect the Company’s financial results and could cause theCompany’s financial performance to differ materially from the expectationsexpressed in any forward-looking statement made by or on behalf of the Company:

 

*Changesin Economic, Political or Social Conditions*

 

Ourprofitability may be impacted by overall economic conditions, particularly inSouthern California. Changes in economic conditions such as inflation, employmentlevels, interest rates and tax rates may reduce consumer spending or influenceour customers to shift their spending to

 

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ourcompetitors. In addition, our business may be subject to interruption from actsof terrorism, national emergencies or natural disasters.

 

*Competitionin the Grocery Business*

 

Theretail grocery business is intensely competitive with respect to price, foodquality and selection, service and location. During the past several years,there has been a consolidation in the supermarket industry. We are in directcompetition with numerous local outlets of regional and national supermarketchains, independent grocery stores, convenience stores, specialty and gourmetmarkets and food departments in mass merchandise and club stores. There are anumber of well established competitors with substantially greater financial,marketing, personnel and other resources than ours, some of which are alsononunion. We frequently face the opening of a new or remodeled competitor’sstore. Competition also requires us to periodically remodel our existingstores, at ever-increasing costs, in order to maintain their appeal. Aninability to successfully compete with other grocery retailers in our markets couldprevent us from increasing or sustaining our revenues and profitability.

 

*Changesin Laws or Regulations or Failure to Comply*

 

Weare subject to various federal, state and local laws, regulations and licensingrequirements which regulate health and sanitation standards, food labeling andhandling, the sale of alcoholic beverages, employment, working conditions,citizenship requirements and public accommodations. Changes to such laws orregulations may adversely affect our profitability by increasing our costs oraffecting the sale of certain items. In addition, we must comply with state andlocal fire, zoning, land use and environmental regulations. Failure to complywith these regulations could adversely affect the operation of our existingstores or could delay or prevent the opening of a new store.

 

*Changesin Accounting Standards, Policies and Practices*

 

Theissuance of new pronouncements or changes to existing accounting policies andpractices could have a significant impact on our reported results or change theway we account for various transactions. New policies and changes to existingrules may adversely affect our reported financial results.

 

*Availabilityand Retention of Retail Space*

 

Wecurrently lease the majority of our store locations. Typically, our supermarketleases have initial 20-year lease terms and may include options for up to anadditional 20 years. The average term remaining on our supermarket leases,including renewal options, is approximately 22 years. Our revenues andprofitability would be negatively impacted if we are unable to renew theseleases at reasonable rates.

 

Ourcontinued growth depends to a significant degree on our ability to open oracquire new stores in existing and new markets and to operate these storessuccessfully. Our expansion strategy is dependent on finding suitablelocations, and we face intense competition from other retailers for such sites.We may not be able to find suitable locations that meet our demographicrequirements at a reasonable cost.

 

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*TheAbility of our Vendors to Supply Products and Services in a Timely Manner*

 

Ourbusiness is dependent on our ability to purchase products from a largewholesaler and numerous smaller vendors in a timely manner and at competitiveprices. The largest supplier for our stores is Unified, a cooperativewholesaler, who has provided product for our stores for thirty-one years. Wecurrently procure approximately 18% of our product from Unified. Any disruptionin the business of Unified or any of our other principal suppliers couldnegatively impact our sales and profitability. Even where we have access toalternative sources of supply, the failure of a supplier to meet our demandsmay temporarily disrupt store level merchandise selection.

 

*Abilityto Control  Insurance Coverage Costs andClaims Experience*

 

Weuse a combination of insurance and self-insurance plans to provide for coverageassociated with losses related to workers’ compensation, general and autoliability, property damage, director and officers liability, fiduciary,employment practices, business interruption, crime, earthquake and health care.The cost of insurance has risen significantly over the past few years and isexpected to continue to increase in the future. These increases could have anegative impact on our profitability if we are not able to offset the effect ofsuch increases with plan modifications, cost control measures, sales increasesor by improving our operating efficiency.

 

Weare self-insured for workers compensation and general and auto liability. Wehave stop-loss insurance coverage to limit our exposure on a per claim basisand are insured for covered costs in excess of per claim limits. The Companydevotes substantial time and effort to maintaining a safe environment in ourstores and offices. However, the cost of both insured and self-insured plans ishighly dependent upon legal and legislative trends, the inflation rate ofpremiums and our ability to manage claims.

 

*TheOutcome of Current and Future Legal Proceedings*

 

Fromtime to time we are the subject of complaints or litigation from customersalleging injury, food quality or operational concerns. We may be adverselyaffected by publicity resulting from such allegations, regardless of whethersuch allegations are valid or whether we are liable. We are also subject tocomplaints or allegations from former or current employees, claims concerninghazardous substances on our current or previously owned properties, classaction suits concerning warning labels and other claims. A lawsuit or claimcould result in a decision against us that could have an adverse effect on ourbusiness. Additionally, the cost of defending ourselves against lawsuits andclaims, regardless of merit, could have a negative impact on our profitability.

 

*Impactof Local Projects in the Vicinity of our Supermarkets*

 

Fromtime to time, local events or projects take place in the vicinity of our storesthat may have a negative impact on our sales and profitability. Major roadconstruction on Santa Monica Boulevard near our Century City store has beenunderway since March 2003. At times during the project, construction has, andwill continue to occur directly in front of, or very close to the shoppingcenter in which our store is located. This construction, together with a majorremodel

 

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ofthe shopping center, has resulted in a significant decline in sales andprofitability for the store. See “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” for further discussion.

 

*NewLabor Contracts and Labor Stoppages*

 

Themajority of our employees belong to a union with which we have signed a laboragreement which establishes rates of pay, benefits, working conditions andprocedures for the orderly settlement of disputes. In the past, the UFCW (whichthe majority of our store employees belong to) has first negotiated with themajor grocery retailers in our area. Subsequently, we have accepted terms thatare similar to those agreed to by the major grocery retailers. In order tocontinue to attract and retain quality personnel, we may be forced to acceptterms that increase our operating costs, which in turn, may negatively impactour profitability. In the future, the UFCW could choose to negotiate first withus and, if negotiations were unsuccessful, strike our stores. The currentagreement expires in March 2007.

 

*Retentionof Key Personnel*

 

Oursuccess will continue to be dependent on our key operating employees. We mustcontinue to attract, retain and motivate a sufficient number of qualifiedmanagement and operating personnel and be able to replace senior managementupon retirement. Individuals of this caliber are historically in short supplyand this shortage may limit our ability to hire and retain qualified personnel,and thus, may hinder our ability to operate effectively.

 

*StockPrice Volatility*

 

Themarket price of our Class A Common Stock (Class A) could be subject tosignificant fluctuation in response to various market factors and eventsincluding general economic and market conditions, variations in our earningsresults and publicity regarding us, our competitors and the grocery business ingeneral. The stock market in recent years has experienced extreme price andvolume fluctuations that often have been unrelated or disproportionate to theoperating performance of companies. Furthermore, there is not a significantvolume of trading in our Class A which subjects our stock price to a higherlevel of volatility and may adversely impact the liquidity of the stock.Fluctuations in our Class A price also impact compensation expense as itrelates to our outstanding stock appreciation rights (SARs). See “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” forfurther information.

 

Item 1B.                             Unresolved Staff Comments

 

None.

 

Item 2.                                     Properties

 

The Company currentlyowns two of its freestanding supermarket properties and a shopping center inwhich a Gelson’s Market is located. The shopping center owned by the Company,located in Calabasas, California, consists of approximately 58,000 leasablesquare feet, approximately 18,000 square feet of which is leased to multipletenants and approximately 40,000 square feet of which is leased to Gelson’s.Fifteen******supermarkets and thewarehouse and

 

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distribution facilities which service the markets are leased from thirdparties. Gelson’s corporate offices in Encino, California are also leased.Typically, supermarkets have initial 20-year lease terms and may includeoptions for up to an additional 20 years. These leases often require thepayment of percentage rent on sales in excess of certain levels in addition tominimum rent. The average term remaining on the supermarket leases, includingrenewal options, is approximately 22 years. The 18 markets range in size fromapproximately 18,000 to 40,000 square feet. Gelson’s warehouse, distributionand truck service facilities in the City of Commerce, California are leased andcontain approximately 131,000 square feet. The term of the lease, includingrenewal options, expires in January 2021. The Company had exercised its rightto terminate the lease for its Pasadena store in the Spring of 2005, but thelease was reinstated by mutual agreement on different terms in April 2005.

 

The Company owns its30,000 square foot corporate headquarters office building in Compton,California. The Company also owns or leases several parcels adjacent to, ornear, four of its stores which are used for additional parking. In addition,AMG Holdings, Inc. (AMG Holdings), a wholly-owned subsidiary of Arden-Mayfair,leases a 64,000 square foot building in Los Angeles consisting of office andwarehouse space, which is entirely subleased until the lease on the propertyexpires in 2012.

 

Item 3.                                     LegalProceedings

 

The Company and certainof its subsidiaries are involved in a number of pending legal and/oradministrative proceedings. Such proceedings are not expected individually orin the aggregate to have a material adverse impact upon either the Company’sconsolidated financial position, results of operations or cash flows. See thediscussion of “Commitments and Contingent Liabilities” in the Notes toConsolidated Financial Statements.

 

Item 4.                                     Submissionof Matters to a Vote of Security Holders

 

There was no matter submitted during the fourth quarter of fiscal year2005 to a vote of the security holders of the Registrant.

 

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**PART II**

** **

Item 5.                                     Marketfor the Registrant’s Common Equity, Related Stockholder Matters and IssuerPurchases of Equity Securities

 

(a)                                  TheCompany’s Class A is traded over-the-counter in the NASDAQ National MarketSystem under the symbol ARDNA. During the past two years, the range of high andlow sales prices (not including markups, markdowns or commissions) for eachquarterly period was, according to NASDAQ, the following:

 
| ** **  | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------|------------|----------|------------|----------|------------|
| ** **  | ** ** | **High** | ** ** | **Low**  | ** ** | **High** | ** ** | **Low** | ** ** |
|        |       |     |       |     |       |   |   |   |   |
| 1st Quarter |       | 102.62   |       | 66.29    |       | 79.80 |   | 70.20 |   |
| 2nd Quarter |       | 83.00    |       | 63.40    |       | 90.00 |   | 71.01 |   |
| 3rd Quarter |       | 93.45    |       | 72.05    |       | 90.45 |   | 76.07 |   |
| 4th Quarter |       | 92.45    |       | 72.20    |       | 114.86 |   | 77.67 |   |

 

The Company previouslyhad outstanding shares of Class B Common Stock (Class B) for which there was noestablished public trading market and which were subject to variousrestrictions on transfer. OnNovember 10, 2004, all the Class B shares were converted into Class A shares asprovided under the Company’s Restated Certificate of Incorporation. As a resultof the conversion, the Company has only Class A outstanding and allshareholders participate equally in the undistributed earnings of the Company.

 

(b)                                 Asof December 31, 2005, there were 1,027 holders of record of the Company’s ClassA, with aggregate holdings of 3,379,002 shares of Class A. This does notinclude 1,357,200******shares of the Company’sClass A owned by AMG Holdings, a wholly-owned second-tier subsidiary of theCompany.

 

(c)                                  InAugust 2003, the Company established a regular quarterly dividend of 25 centsper share of Class A and 22.5 cents per share of Class B. No dividends werepaid on either Class A or Class B during any period presented prior to August2003. Cash or property dividends on Class B were restricted to an amount equal to90% of any dividend paid on Class A. For the year ended December 31, 2005, theregular quarterly dividend was paid only to Class A, as all Class B had beenconverted as discussed above. The Company anticipates payment of comparableClass A quarterly dividends in future quarters*.*

 

On October 25, 2004, theBoard of Directors of the Company declared a special dividend in the amount of$20 per share on its outstanding Class A and $18 per share on its outstandingClass B payable on December 16, 2004 to shareholders of record on November 15,2004. As a result of the conversion on November 10, 2004 of Class B to Class A,the dividend was paid to Class A only. The aggregate amount of the specialdividend was approximately $67,665,000.

 

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Item 6.                                     Selected Financial Data 

 

**ARDENGROUP, INC. AND CONSOLIDATED SUBSIDIARIES**

 

(In Thousands, ExceptShare and Per Share Data)

 
| ** **                                                | ** ** | **2005**  | ** ** | **2004**  | ** ** | **2003**  | ** ** | **2002**  | ** ** | **2001**  | ** ** |
|-----------------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|-----------|------------|-----------|------------|
| Operations For  The Year:                                 |       |      |       |      |       |      |       |      |       |      |       |
| Sales                                                     |       | $         | 470,354    |      | $          | 502,898   |       | $         | 486,378    |      | $          | 398,231 |   | $ | 388,505 |   |
| Gross profit                                              |       | 214,365   |       | 225,413   |       | 215,720   |       | 176,725   |       | 167,636   |       |
| Operating income  (1)                                     |       | 31,816    |       | 34,579    |       | 25,458    |       | 21,644    |       | 19,377    |       |
| Other income  (expense), net                              |       | 1,606     |       | 3,591     |       | 2,446     |       | 1,644     |       | 1,926     |       |
| Income tax  provision                                     |       | 13,571    |       | 15,498    |       | 11,323    |       | 9,356     |       | 8,432     |       |
| Net income                                                |       | $         | 19,851     |      | $          | 22,672    |       | $         | 16,581     |      | $          | 13,932 |   | $ | 12,871 |   |
| Net income per  common share:                             |       |      |       |      |       |      |       |      |       |      |       |
| Basic – Class A                                      |       | $         | 5.87       |      | $          | 7.00      |       | $         | 5.11       |      | $          | 4.33 |   | $ | 3.96 |   |
| Basic – Class B                                      |       | N/A       |       | 6.13      |       | 4.60      |       | 3.90      |       | 3.56      |       |
| Diluted                                                   |       | 5.87      |       | 6.70      |       | 4.90      |       | 4.14      |       | 3.79      |       |
| Financial  Position At Year-End:                          |       |      |       |      |       |      |       |      |       |      |       |
| Total assets                                              |       | $         | 147,027    |      | $          | 122,135   |       | $         | 186,972    |      | $          | 138,971 |   | $ | 122,834 |   |
| Working capital                                           |       | 41,304    |       | 23,883    |       | 75,185    |       | 48,892    |       | 27,975    |       |
| Long-term debt                                            |       | 1,453     |       | 1,764     |       | 2,038     |       | 2,283     |       | 3,134     |       |
| Stockholders’  equity                                |       | 82,320    |       | 66,576    |       | 115,000   |       | 99,027    |       | 83,389    |       |
| Capital  expenditures                                     |       | 6,390     |       | 12,641    |       | 5,752     |       | 4,023     |       | 10,066    |       |
| Other Operating  and Financial Data:                      |       |      |       |      |       |      |       |      |       |      |       |
| Number of stores  at end of fiscal year                   |       | 18        |       | 18        |       | 18        |       | 18        |       | 18        |       |
| Sales increase  (decrease) (2):                           |       |      |       |      |       |      |       |      |       |      |       |
| Total stores                                              |       | (6.6      | )%         | 3.4       | %          | 22.3      | %          | 2.5       | %          | 8.9       | %          |
| Same stores                                               |       | (6.6      | )%         | 3.4       | %          | 22.3      | %          | 0.8       | %          | 2.2       | %          |
| Depreciation and  amortization                            |       | $         | 7,401      |      | $          | 6,990     |       | $         | 8,126      |      | $          | 8,139 |   | $ | 7,872 |   |
| Dividends  declared per common share:                     |       |      |       |      |       |      |       |      |       |      |       |
| Class A                                                   |       | $         | 1.00       |      | $          | 1.00      |       | $         | .50        |      |       |   |   |   |
| Class B                                                   |       | $         | N/A        |      | $          | .675      |       | $         | .45        |      |       |   |   |   |
| Special dividend  declared per Class A Common Stock share |       |      |       | $         | 20.00      |      |       |      |       |      |       |   |
| Weighted average  common shares outstanding:              |       |      |       |      |       |      |       |      |       |      |       |
| Basic – Class A                                      |       | 3,381,051 |       | 2,217,675 |       | 2,015,859 |       | 1,991,230 |       | 2,022,320 |       |
| Basic – Class B                                      |       | N/A       |       | 1,164,977 |       | 1,363,584 |       | 1,363,790 |       | 1,366,914 |       |
| Diluted                                                   |       | 3,381,051 |       | 3,382,652 |       | 3,380,524 |       | 3,365,961 |       | 3,398,671 |       |

 

*All years are 52 weeks except2003 which is 53 weeks.*

 

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(1)                Fiscal2003 operating income includes a $4,311 charge for impairment on long-livedassets related to leasehold improvements and equipment at the Pasadena store.See “Management’s Discussion and Analysis of Financial Condition and Results ofOperations” for additional information.

 

(2)                Samestore sales increases are calculated by comparing year-over-year sales forstores that were open in both years. If a store was not open for the entireyear in both years being compared, then the store is not included in the samestore analysis. No stores were closed during any of the periods presented.Fiscal 2003 was a 53-week year. No adjustment was made to remove the additionalweek for comparison purposes. Store sales used to calculate sales increases,above, do not include revenue from leases, subleases, licensing arrangementsand finance charges, and therefore, will not agree to total year-over-yearsales increases as disclosed in “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.”

 

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Item 7.                                     Management’sDiscussion and Analysis of Financial Condition and Results of Operations

 

The Private SecuritiesLitigation Reform Act of 1995 provides a safe harbor for forward-lookingstatements made by or on behalf of the Company. Certain statements contained in“Management’s Discussionand Analysis of Financial Condition and Results of Operations,” in otherparts of this report and in other Company filings are forward-lookingstatements. These statements discuss, among other things, future sales growth,operating results and financial condition. Forward-looking statements reflectthe Company’s current plans and expectations regarding important risk factorsand are based on information currently available to us. The Company cautionsreaders that any forward-looking statements contained in this report or made bythe management of the Company involve risks and uncertainties, and are subjectto change based on various important factors. The Company does not undertakeany obligation to update forward-looking statements.

 

**Results of Operations**

 

Theresults of operations for fiscal 2003 and 2004 reflect the pervasive impact ofa labor dispute in the Company’s trade area that commenced October 11, 2003 andconcluded February 29, 2004. The collective bargaining agreement covering themajority of the Company’s employees, as well as other participating employersin Southern California, expired on October 5, 2003. On October 11, 2003, theUFCW declared a strike against Vons and in turn, Albertsons and Ralphs lockedout their UFCW employees. On February 29, 2004, the UFCW announced thatemployees of these three major grocery retailers ratified a new contractthereby ending the labor dispute. Prior to the labor dispute, the Company hadagreed with the UFCW to continue operating under a contract extension and to bebound by all modifications regarding trust funds and hourly wage rates asnegotiated between the UFCW and the three major grocery retailers. In return,the UFCW agreed not to strike the Company and Gelson’s remained open. In a voteheld on March 24-25, 2004, employees of the Company who are members of theUFCW, ratified a new labor contract on terms similar to those reached by thethree major grocery retailers. The new labor contract expires in March 2007.

 

The labor disputeresulted in a temporary shift in consumer shopping patterns and a significantincrease in the Company’s sales and operating income during the fourth quarterof 2003 and the first quarter of 2004. Since the conclusion of the labordispute, customers have returned to their previous shopping patterns. However,the Company has successfully retained some of the incremental sales from newshoppers that experienced the Gelson’s format and service during the labordispute.

 

**2005 Compared to 2004**

 

Netincome in 2005 decreased 12.4% to $19,851,000 compared to $22,672,000 during2004. Operating income decreased 8.0% to $31,816,000 in 2005 compared to$34,579,000 in 2004.

 

Salesfrom the Company’s 18 supermarkets (all of which are located in SouthernCalifornia), including revenue from licensing arrangements, subleases, leasesand finance charges, were $470,354,000 in 2005. This represents an overalldecrease of 6.5% from 2004, when sales were

 

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$502,898,000and a same store sales decrease of 6.6%. The labor dispute in the Company’strade area contributed to the higher sales in the prior year. Sales werenegatively impacted for three weeks in the second half of 2004 as the CenturyCity store was closed due to construction at the Century City Shopping Centeras discussed below. The store, which was closed for a total of three weeks,reopened on October 18, 2004. Sales in both 2004 and 2005 were also negativelyimpacted as a result of ongoing construction near the Century City store. TheCompany does not believe that inflation contributed significantly to the changein sales.

 

TheCompany’s gross profit as a percent of sales was 45.6% in 2005 compared to44.8% in 2004 primarily due to a combination of cost reductions and productpricing decisions. The Company includes product costs, net of discounts andallowances, and inbound freight charges in cost of sales, thereby reducinggross profit by these amounts. Purchasing and receiving costs, inspectioncosts, internal transfer costs, warehousing costs and other costs of theCompany’s distribution network are recorded as Delivery, Selling, General andAdministrative (DSG&A) expense. Gross profit as a percent of sales for theCompany may not be comparable to those of other companies in the groceryindustry since other entities may record purchasing, warehousing anddistribution costs in cost of sales.

 

DSG&A expense as apercent of sales was 38.8% in 2005 compared to 37.9% in 2004. During the labordispute, the Company achieved significant economies of scale from incrementalsales. DSG&A expenseas a percent of sales has increased since the conclusion of the labor dispute;however, the Company has succeeded in retaining some of the economies of scaledue to the sales retained compared to pre-strike periods. Theseeconomies were partially offset by approximately $2,200,000 of bonus expenserecognized and paid in the first half of 2004 to the Company’s UFCW employeesand higher compensation expense in 2004 related to the Company’s SARs program. During 2005, the Company recognized $946,000of SARs compensation expense compared to $3,658,000 in 2004 due to a reductionin the Company’s Class A price at the end of fiscal 2005 compared to the end ofthe previous year.

 

The Company contributesto several multi-employer union pension and health care plans. Pension andhealth care payments are determined based on straight-time hours worked and therate per hour as stipulated in the Company’s various collective bargainingagreements. The**Company recognized union pensionexpense of $6,241,000 in 2005 compared to $6,064,000 in 2004. Higher pension costs in 2005 resulted from anincrease in the average hourly pension contribution rate. However, the increasewas partially offset by a reduction in the number of labor hours worked assales volumes declined in 2005 compared to 2004. In addition, pension costshave and will continue to decrease as the Company experiences turnover asemployees hired after the ratification of the new UFCW labor agreement mustmeet age and hours worked requirements prior to becoming eligible to enter theplan, and once in the plan, the Company’s contribution rate for these employeesis lower than the rate for employees hired prior to the ratification of the newlabor agreement. Union health care expense was $16,047,000 in 2005compared to $16,977,000 in 2004. Health care costs decreased due to thereduction in the number of labor hours worked as discussed above.

 

TheCompany reviews the carrying values of its property, plant and equipment on aquarterly basis to determine if any of those assets have become impaired.During the fourth quarter of 2003, the Company recorded a $4,311,000 impairmenton long-lived assets including leasehold improvements and equipment at itsPasadena store, which opened in September 2001 and has

 

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performedbelow management’s expectations. The Company had exercised its right toterminate its lease in the Spring of 2005, but the lease was reinstated bymutual agreement on different terms in April 2005. A termination of the leasein the future may result in an additional write-off of fixed assets and othercosts at that time. As of December 31, 2005, the remaining net book value offixed assets related to the Pasadena store was $376,000.

 

In June 2003, in an effortto control substantially increasing workers’ compensation rates, the Companyterminated its guaranteed cost workers’ compensation insurance coverage andpurchased a high deductible workers’ compensation policy. The Company hasstop-loss coverage to limit its exposure on a per claim basis and is insuredfor covered costs in excess of per claim limits. Self-insurance accruals forlosses up to the purchased stop-loss coverage are based on reported claims andan estimate of claims incurred but not reported. No assurance can be given thatthis change will ultimately result in a reduction in workers’ compensationexpense or limit future increases. The Company devotes substantial time andcommitment to maintaining a safe work environment. The ultimate cost of workers’compensation is highly dependent upon legal and legislative trends, theinflation 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, while it ispremature to predict the final outcome of claims incurred within recent policyyears, it appears that the legislative reform will have a positive effect inthe Company’s overall workers’ compensation costs.

 

TheCompany is also primarily self-insured for losses related to general and autoliability claims for up to $250,000 per claim. Accruals are based on reportedclaims and an estimate of claims incurred but not reported. While the ultimateamount of claims incurred is dependent on future developments, in management’sopinion, recorded reserves are adequate to cover the future payment of claims.

 

TheCompany carries property, business interruption, fiduciary, directors andofficers, crime, earthquake, special event and employee practices liabilityinsurance. Management believes, based on recent and past experience, thatcurrent insurance coverage meets the reasonable requirements of the Company.

 

Stock-based compensation,under the SARs program, is subject to variable accounting in accordance withFinancial Accounting Standards Board Interpretation No. (FIN) 28, “Accountingfor Stock Appreciation Rights and Other Variable Stock Option or Award Plans.” Forthe fiscal year ended December 31, 2005, SARs compensation expense was $946,000compared to $3,658,000 in fiscal 2004. The decrease in compensation expense wasdue to a decrease in the Company’s Class A price during 2005 partially offsetby the additional vesting of SARs. Effective beginning the first quarter of2006, the Company will account for the SARs program in accordance withStatement of Financial Accounting Standards No. (SFAS) 123R (revised 2004),“Share-Based Payment,” which will change the amount the Company records forSARs compensation expense. See the discussion under “Recent AccountingStandards” below.

 

During 2005, the Companyprocured approximately 18% of its product through Unified, a grocerycooperative. As a member-patron, the Company is required to provide Unifiedwith certain minimum deposits and credit in order to purchase product from thecooperative. As of December 31, 2005, the Company had approximately $2,150,000on deposit with Unified. The minimum deposit requirement is satisfied throughownership of equity shares in Unified. In

 

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2005 and 2004, theCompany recorded approximately $451,000 and $569,000, respectively, inpatronage dividend income received in the form of cash and Unified equityshares as a reduction of cost of sales.

 

Interest anddividend income was $1,722,000 in 2005 compared to $1,986,000 for 2004primarily due to lower cash levels in 2005 partially offset by higher interestrates. Cash available for investment was substantially lower in fiscal 2005 asa result of the special dividend of approximately $67,665,000 paid on December16, 2004.

 

Other income includesgains realized on investments of $36,000 and $1,787,000 in 2005 and 2004,respectively. During 2004, the Company sold an investment in a limited partnershipand recognized a gain of approximately $1,570,000.

 

 SFAS 115, “Accounting for Certain Investmentsin Debt and Equity Securities,” requires that unrealized holding gains andlosses from available-for-sale securities be included as a component of stockholders’equity. Unrealized losses on investments were $392,000 (net of income taxbenefit of $269,000) in 2005 compared to unrealized losses of $247,000 (net ofincome tax benefit of $169,000) in 2004. Management does not believe any ofthese losses are other-than-temporary.

 

A major road improvement project which has been underconstruction along Santa Monica Boulevard in West Los Angeles, California sinceMarch 2003, is presently estimated to be substantially completed in Summer2006. At times during the project, construction has, and will continue to occurdirectly in front of, or very close to, the Century City Shopping Center whereGelson’s has its Century City store. In addition, the Century City ShoppingCenter recently underwent a major construction project which began in March2004. The project involved the relocation of the movie theaters, food court andother tenants to newly constructed areas immediately adjacent to the Gelson’sstore, as well as the expansion of the Gelson’s store. The grand reopening ofthe Shopping Center, as renovated, occurred in December 2005. The Company wasalso in the process of remodeling the store beginning in September 2004. Thecurrent remodel plans are expected to be complete during 2006. Sales at theCentury City store have been negatively affected during the construction onSanta Monica Boulevard and at the Century City Shopping Center. The Company anticipates that sales willcontinue to be negatively impacted as construction on Santa Monica Boulevardcontinues. The Company also expects thatthe parking in the Century City Shopping Center for Gelson’s customers will beadversely affected by the relocation of the theaters, food court and othertenants to the immediate vicinity of the Gelson’s store. However, it alsoanticipates that the relocation will increase foot traffic in the vicinity ofthe store which, along with the expanded facilities and services within thestore, could increase customer count.

 

**2004 Compared to 2003**

 

Netincome in 2004 increased 36.7% to $22,672,000 compared to $16,581,000 during2003. Operating income increased 35.8% to $34,579,000 in 2004 compared to$25,458,000 in 2003.

 

Salesfrom the Company’s 18 supermarkets (all of which are located in SouthernCalifornia), including revenue from licensing arrangements, subleases, leasesand finance charges, were

 

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$502,898,000in 2004. This represents a comparable store sales increase, as well as anoverall increase of 3.4% over 2003, when sales were $486,378,000. Themajority of the sales increase from 2003 to 2004 resulted from the ability toretain some customers from the labor dispute. The Company does not believe thatinflation or changing prices contributed significantly to the sales increase. Saleswere negatively impacted during the second half of 2004 as the Century Citystore was closed for three weeks due to construction at the Century CityShopping Center. The store reopened on October 18, 2004.

 

TheCompany’s gross profit as a percent of sales was 44.8% in 2004 compared to44.4% in 2003. The Company includes product costs, net of discounts andallowances, and inbound freight charges in cost of sales, thereby reducinggross profit by these amounts. Purchasing and receiving costs, inspection costs,internal transfer costs, warehousing costs and other costs of the Company’sdistribution network are recorded as DSG&A expense. Gross profit as apercent of sales for the Company may not be comparable to those of othercompanies in the grocery industry since other entities may record purchasing,warehousing and distribution costs in cost of sales.

 

DSG&A expense as apercent of sales was 37.9% in 2004 compared to 39.1% in 2003. The higher costsin 2003 reflect a $5,797,000 charge to pay union health care claims and restoretrust fund reserves to the required levels, as well as a $4,311,000 impairmentcharge related to the Pasadena store as discussed above. The higher 2003expense was partially offset by higher average union health and welfare and pensionrates per hour in 2004 compared to the prior year, as well as the suspension ofUFCW pension plan contributions for two months during 2003. In addition, theCompany incurred fees of approximately $884,000 in 2004 in connection withSarbanes-Oxley Section 404 compliance.

 

The new collectivebargaining agreement ratified by employees of Vons, Ralphs and Albertsonseliminated the health care maintenance of benefits obligation included in theprior agreement. The same agreement was ratified by Gelson’s employees. Theexpired agreement provided that if health care maintenance of benefits iseliminated in a successor collective bargaining agreement, employers arerequired to contribute an amount sufficient to restore the total cash reservesto an amount equal to the unpaid health care claims liability. The labordispute resulted in a depletion of funds in the multi-employer health andwelfare trust fund. The Company was assessed $5,797,000 to pay union healthcare claims and restore trust fund reserves to the required levels. This$5,797,000 was reflected as a charge against earnings in 2003 as noted above. 

 

The Company contributesto several multi-employer union pension and health care plans. Pension andhealth care payments are determined based on straight-time hours worked and therate per hour as stipulated in the Company’s various collective bargainingagreements. Contributions to the multi-employer pension plan covering amajority of the Company’s employees have been periodically suspended andreinstated. The Company recognized union pension expense of $6,064,000 in 2004compared to $4,787,000 in 2003. The increase in union pension expense was theresult of pension plan contributions being suspended for two months in 2003, arate increase in the union contract and an increase in the hours worked onaccount of the increased sales volume in 2004. Union health care expense ran$16,977,000 in 2004 compared to $21,019,000 in 2003 which includes theadditional $5,797,000 union assessment discussed above.

 

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For a discussion ofworkers’ compensation, general and auto liability and other types of insurancecoverage, see “Management’sDiscussion and Analysis of Financial Condition and Results of Operations,” “2005Compared to 2004” presented above.

 

Stock-based compensation,under the SARs program, is subject to variable accounting in accordance withFIN 28, “Accounting for Stock Appreciation Rights and Other Variable StockOption or Award Plans.” For the fiscal year ended January 1, 2005, SARscompensation expense was $3,658,000 compared to $740,000 in fiscal 2003.

 

During 2004, the Companyprocured approximately 20% of its product through Unified, a grocerycooperative. As a member-patron, the Company is required to provide Unifiedwith certain minimum deposits and credit in order to purchase product from thecooperative. As of January 1, 2005, the Company had approximately $2,321,000 ondeposit with Unified. The minimum deposit requirement is satisfied through acombination of cash, credit and ownership of equity shares in Unified. In 2004,the Company recorded approximately $569,000 in patronage dividend incomereceived in the form of Unified equity shares as compared to $169,000 in 2003.

 

Interest anddividend income was $1,986,000 in 2004 compared to $1,768,000 for 2003primarily due to increased cash levels in 2004. Other income includes gainsrealized on investments of $1,787,000 and $950,000 in 2004 and 2003,respectively. Unrealized losses on investments were $247,000 (net of income taxbenefit of $169,000) in 2004 compared to unrealized gains of $114,000 (net ofincome tax expense of $78,000) in 2003.

 

**Liquidityand Capital Resources**

 

TheCompany’s current cash position, including investments and net cash provided byoperating activities, are the primary sources of funds available to meet theCompany’s capital expenditure and liquidity requirements. The Company’s cashposition, including investments, at December 31, 2005 was $56,988,000.Cash not required for the immediate needs of the Company is temporarilyinvested in commercial paper and marketable securities. Currently, alltemporary investments are highly liquid. The Company is continuallyinvestigating opportunities for the use of these funds including new locationsand the expansion and remodel of existing stores.

 

TheCompany also has two revolving lines of credit totaling $23,000,000 availablefor standby letters of credit, funding operations and expansion. There were nooutstanding borrowings against either of the revolving lines as of December 31,2005. The Company currently maintains five standby letters of creditaggregating $14,444,000 pursuant to the Company’s lease requirements andgeneral liability and workers’ compensation self-insurance programs. Thestandby letters of credit reduce the available borrowings under its revolvinglines.

 

The Company’s workingcapital was $41,304,000 at December 31, 2005 compared to $23,883,000 at January1, 2005. Net cash provided by operating activities of $33,079,000 contributedsignificantly to the increase in working capital during 2005. Cash flows fromoperating activities resulted primarily from net income plus non-cash expensesand changes in working capital.

 

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During 2005, the Company’s Consolidated Statement of Cash Flowsreflects an increase in accounts payable, trade and other current liabilitiesof approximately $1,734,000 compared to a decrease of $11,799,000 in the sameperiod of the prior year. Accounts payable decreased significantly after theconclusion of the labor dispute as customers returned to their previousshopping patterns and the Company’s product orders decreased. The labor disputealso resulted in a depletion of funds in the multi-employer health and welfaretrust fund maintained for the benefit of UFCW employees. As a result, theCompany was assessed approximately $5,797,000 to pay union health care claimsand restore trust fund reserves to the required levels. This assessment wasaccrued at the end of fiscal 2003 and paid during the first quarter of 2004. Inaddition, income taxes payable during 2005 increased approximately $3,511,000compared to a decrease of $11,434,000 during 2004. The Company recordedadditional income taxes payable at the end of fiscal 2003 as a result of theincrease in earnings that the Company achieved during the labor dispute. Thesetaxes were remitted to the appropriate taxing authorities during the firstquarter of 2004. Deferred rent payable increased approximately $924,000 in 2005primarily due to the extension of certain store leases by the Company.

 

Net cash used ininvesting activities was $1,472,000 in 2005. Investing activities includedprimarily the purchase and sale of investments which resulted in a net cash inflowof $4,866,000 offset by capital expenditures of $6,390,000. Net cash used infinancing activities was $3,932,000 in 2005. Financing activities included cashdividend payments of $3,382,000, payments to buy back shares of the Company’sClass A of $334,000 and principal payments of $216,000 on capital leaseobligations.

 

The Company’s currentratio was 1.87 at December 31, 2005 compared to 1.58 at January 1, 2005. TheCompany’s total liabilities to equity ratio decreased to .79 at December 31,2005 from .83 at January 1, 2005.

 

The followingtable sets forth the Company’s contractual cash obligations and commercialcommitments as of December 31, 2005:

 
| ** **                                                                | ** ** | **Contractual Cash Obligations (In Thousands)** | ** ** |
|---------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                                                | ** ** | ** **                                                          | ** ** | **Less Than** | ** ** | ** ** | ** ** | ** ** | ** ** | **After** | ** ** |
| ** **                                                                | ** ** | **Total**                                                           | ** ** | **1 Year** | ** ** | **1-3 Years** | ** ** | **4-5 Years** | ** ** | **5 Years** | ** ** |
|                                                                      |       |                                                                |       |   |   |   |   |   |   |   |   |
| 7% Subordinated  Income Debentures  Due September 2014 Including Interest |       | $                                                                   | 2,002      |   | $ | 86 |   | $ | 172 |   | $ | 172 |   | $ | 1,572 |   |
|                                                                      |       |                                                                |       |   |   |   |   |   |   |   |   |
| Capital Lease  Obligations Including Interest                             |       | 498                                                                 |       | 260 |   | 238 |   | 0 |   | 0 |   |
|                                                                      |       |                                                                |       |   |   |   |   |   |   |   |   |
| Operating Leases                                                          |       | 153,211                                                             |       | 9,074 |   | 19,118 |   | 18,216 |   | 106,803 |   |
|                                                                      |       |                                                                |       |   |   |   |   |   |   |   |   |
| Total  Contractual Cash Obligations (1)                                   |       | $                                                                   | 155,711    |   | $ | 9,420 |   | $ | 19,528 |   | $ | 18,388 |   | $ | 108,375 |   |

 
| ** **                     | ** ** | **Other Commercial Commitments (In Thousands)** | ** ** |
|--------------------------------|------------|-------------------------------------------------|------------|
| ** **                     | ** ** | ** **                                      | ** ** | **Less Than** | ** ** | ** ** | ** ** | ** ** | ** ** | **After** | ** ** |
| ** **                     | ** ** | **Total**                                       | ** ** | **1 Year** | ** ** | **1-3 Years** | ** ** | **4-5 Years** | ** ** | **5 Years** | ** ** |
|                           |       |                                            |       |   |   |   |   |   |   |   |   |
| Standby Letters  of Credit (2) |       | $                                               | 14,444     |   | $ | 14,444 |   | $ | 0 |   | $ | 0 |   | $ | 0 |   |
|                                |            |                                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)          Other Contractual Cash Obligations

 

TheCompany had the following other contractual cash obligations at December 31,2005. The Company is unable to include these liabilities in the tabulardisclosure of contractual cash obligations as the exact timing and amount ofpayments is unknown.

 

*Self-Insurance Reserves*

 

TheCompany is primarily self-insured for losses related to workers’ compensationand general and auto liability claims. The Company maintains stop-lossinsurance coverage to limit its loss exposure on a per claim basis. Liabilitiesassociated with the risks that are retained by the Company are estimated, inpart, by considering historical claims experience and regression analysis.Accruals are based on reported claims and an estimate of claims incurred butnot reported. While the ultimate amount of claims incurred is dependent onfuture developments, in management’s opinion recorded reserves are adequate tocover the future payment of claims. The Company’s liability reserve for unpaidand incurred but not reported claims at December 31, 2005 was approximately$9,523,000.

 

*Employment Agreement*

 

The Company has an employment agreement with a key executiveofficer that provides for annual retirement compensation equal to 25% of hisaverage base salary and bonus earned in the last three years prior to hisretirement. The Company had accrued $2,746,000 under the terms of theemployment agreement as of December 31, 2005.

 

*Property, Plant and Equipment Purchases*

 

As of December 31, 2005, management had authorizedexpenditures on incomplete projects for the purchase of property, plant andequipment which totaled approximately $1,910,000. The Company has an ongoingprogram to remodel existing supermarkets and to add new stores. During 2005,total capital expenditures were $6,390,000.

 

(2)          Standby Letters ofCredit

 

All of the Company’s lettersof credit renew automatically each year unless the issuer notifies the Companyotherwise. The amount of each letter of credit held pursuant to the Company’sworkers’ compensation and general liability insurance programs will be adjustedannually based upon the outstanding claim reserves as of the renewal date. Eachletter of credit obligation will cease when all claims for the particularpolicy year are closed or the Company negotiates a release.

 

InApril 2003, the Company announced a stock repurchase program, authorized by theBoard of Directors, to purchase from time to time up to 100,000 shares of itsClass A in the open market or in private transactions. The timing, volume andprice of purchases are at the discretion of the management of the Company.During 2003 and 2005, the Company purchased and retired 4,942 and 4,250 sharesof its Class A for an aggregate purchase price of approximately $296,000 and$334,000, respectively, in unsolicited private transactions with unrelatedparties. Subsequent to fiscal 2005 year end, the Company’s Board of Directorsauthorized the purchase of up to an

 

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additional150,000 shares of Class A. During January and February 2006, the Companypurchased 149,573 shares of Class A in unsolicited private transactionswith unrelated parties for an aggregate purchase price of approximately$12,481,000. The remaining number of shares authorized for purchase aftertaking into account the purchase of 149,573 shares is 91,235.

 

TheCompany paid quarterly dividends of 25 cents per share of Class A during 2005for a total of approximately $3,382,000. During 2004, the Company paidquarterly dividends of 25 cents per share of Class A and 22.5 cents per shareof Class B, aggregating approximately $3,280,000. On October 25, 2004, theCompany’s Board of Directors declared a special dividend of $20 per share onits Class A and $18 per share on its Class B. On November 10, 2004, all of theClass B shares were converted into Class A shares on a one-for-one basis asprovided under the Company’s Restated Certificate of Incorporation. As aresult, all owners of the Company’s Class B became owners of Class A prior tothe special dividend record date and were entitled to receive the dividend payableon Class A issued upon such conversion. The aggregate amount of the specialdividend was approximately $67,665,000 taking into account the conversion ofall Class B shares prior to the dividend record date.

 

**CriticalAccounting Policies**

 

The preparation offinancial statements in conformity with generally accepted accountingprinciples (GAAP) requires management to make estimates and assumptions aboutfuture events that may affect the reported amounts of assets, liabilities,revenues and expenses, as well as the disclosure of contingent assets andliabilities. Management has established accounting policies that they believeare appropriate in order to reflect the accurate reporting of the Company’soperating results, financial position and cash flows. The Company applies theseaccounting policies in a consistent manner. Management bases their estimates onhistorical experience, current and expected economic conditions and variousother factors that management believes to be reasonable under the circumstances.These estimates and assumptions form the basis for making judgments about thecarrying values of assets and liabilities that are not readily apparent fromother sources. The Company reevaluates these significant factors and makesadjustments where facts and circumstances dictate. Future events and theireffects cannot be determined with absolute certainty, and therefore actualresults may differ from estimates.

 

Management believes thatthe following accounting policies are the most critical in the preparation ofthe Company’s financial statements because they involve the most difficult,subjective or complex judgments about the effect of matters that are inherentlyuncertain.

 

*Investments*

 

Investmentsare accounted for under the provisions of SFAS 115, “Accounting for CertainInvestments in Debt and Equity Securities.” Management determines theappropriate classification of its investments in marketable securities at thetime of purchase and reevaluates such determination at each balance sheet date.Debt securities for which the Company does not have the intent or ability tohold to maturity and equity securities are classified as available-for-saleinvestments and any unrealized gains and losses are included as a separatecomponent of stockholders’ equity.

 

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The Company reviews itsinvestment portfolio on a quarterly basis to determine if market declines belowbook value may be other-than-temporary. Any decline that is determined to beother-than-temporary is recorded as a loss on the Consolidated Statements ofOperations and Comprehensive Income in accordance with Emerging Issues TaskForce (EITF) No. 03-1, “The Meaning of Other-Than-Temporary Impairment and itsApplication to Certain Issues.”

 

*Inventories*

 

Supermarket nonperishable inventories are recordedusing the retail method and are stated at the lower of cost or market, withcost determined using the last-in, first-out (LIFO) method. Perishableinventories are valued at the lower of cost on a first-in, first-out (FIFO)method or market.

 

Inventoryreserves are maintained for dry goods at historical run rates that are adjustedannually, and trued up at each physical count (three times per year) to ensureadequacy of the reserve. Inventories of perishable items are taken at the endof every month, and balances are adjusted accordingly and flowed through costof sales.

 

*Impairment of Long-Lived Assets*

 

The Company monitors thecarrying value of long-lived assets for potential impairment each quarter wheneverevents or changes in circumstances indicate the carrying value of an asset maynot be recoverable. Impairment is recognized when estimated future cash flows(undiscounted and before interest charges) are less than carrying value. Theestimation of expected future net cash flows is inherently uncertain and relieson assumptions regarding current and future economic and market conditions andthe availability of capital. If impairment analysis assumptions change, then anadjustment to the carrying value of the Company’s long-lived assets couldoccur. To the extent that an asset is impaired, the excess of the carryingamount of the asset over its estimated fair value is charged against earnings.

 

*Workers’Compensation and General and Auto Liability Insurance*

 

The Company is primarilyself-insured for losses related to workers’ compensation and general and autoliability claims. The Company purchases stop-loss insurance coverage to limitits loss exposure on a per claim basis. Accruals are based on reported claimsand an estimate of claims incurred but not reported. While the ultimate amountof claims incurred are dependent on future developments, in management’sopinion recorded reserves are adequate to cover the future payment of claims.

 

*Revenue Recognition*

 

The Company recognizes revenue at the time of sale.Discounts given to customers are recorded at the point of sale as a reductionof revenues. The Company maintains a bad debt allowance for receivables fromvendors and Gelson’s credit card sales. Valuation reserves are adjustedperiodically based on historical recovery rates. The Company

 

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records income from licensing arrangements, subleases,leases and finance charges as they are earned.

 

*Merchandise Costs*

 

Costof sales 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’sdistribution network are recorded as DSG&A expense. Warehousing andtransportation costs include labor, building rent, utilities, depreciation,repairs and maintenance and fuel for the Company’s distribution center anddistribution system.

 

*Vendor Allowances*

 

Promotionaland rebate allowances make up the majority of all allowances. With promotionalallowances, vendors pay the Company to promote their product. The promotion maybe a temporary price reduction, a feature in a print advertisement ornewsletter, or placement of the vendor’s product in a preferred location in astore. The promotions are typically two to three weeks long and are recognizedwhen the commitment has been fulfilled. Promotional and vendor rebateallowances are recorded as a reduction of cost of goods sold except advertisingreimbursements which are recorded as a reduction of advertising expense whichis included in DSG&A expense. The Company also receives other allowanceswhich are recognized as a reduction of cost of goods sold when they are earned.

 

Occasionally, the Company receives rebate allowances in theform of upfront lump-sum payments from vendors. Under the terms of theselong-term agreements, the Company earns the rebates as it purchases productfrom the vendor. The upfront payments are recorded as a liability when they arereceived and are recorded as a reduction of inventory cost as the product ispurchased. In the event that the Company does not purchase the minimum amountof product specified in the agreement, the upfront payments must be returned ona pro rata basis to the vendor. If the contract does not specify that therebate is earned as product is purchased, then the upfront payments arerecorded as a liability when received and recognized as a reduction of cost ofgoods sold on a pro rata basis as the product is sold.

 

*StockOptions and Stock Appreciation Rights*

 

The Company accounts forits Non-Officer and Non-Director Stock Option Plan (Stock Option Plan) usingthe Intrinsic Value Based method prescribed in Accounting Principles BoardOpinion No. (APB) 25, “Accounting for Stock Issued to Employees.” Under thismethod, compensation cost of $0, $0 and $90,000 was recognized in the Company’sConsolidated Statements of Operations and Comprehensive Income for fiscal years2005, 2004 and 2003, respectively. SFAS 123, “Accounting for Stock-BasedCompensation,” (as amended by SFAS 148, “Accounting for Stock-BasedCompensation-Transition and Disclosure”) encourages adoption of a Fair ValueBased method for valuing the cost of stock-based compensation. However, itallows companies to use the Intrinsic Value

 

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Based method prescribedby APB 25 and disclose pro forma net earnings and earnings per share inaccordance with SFAS 123.

 

Stock-based compensation under the SARs program issubject to variable accounting in accordance with FIN 28, “Accounting for StockAppreciation Rights and Other Variable Stock Option or Award Plans.” As aresult, changes in the market price of the Company’s Class A impactscompensation expense.

*** ***

Effective beginning the first quarter of 2006, theCompany will account for the Stock Option Plan and the SARs program inaccordance with SFAS 123R as discussed below.

*** ***

**Recent Accounting Standards**

 

InMarch 2004, the EITF amended and ratified previous consensus on EITF No. 03-1,“The Meaning of Other-Than-Temporary Impairment and its Application to CertainIssues.” EITF No. 03-1 establishes guidance to be used in determining when aninvestment is considered impaired, whether that impairment is other-than-temporaryand the measurement of an impairment loss. The effective date was originallythe Company’s third quarter of 2004. In September 2004, the FinancialAccounting Standards Board (FASB) issued EITF No. 03-1-1, “Effective Date ofParagraphs 10-20 of EITF 03-1,” to delay the effective date pending furtherdiscussions by the EITF. In November 2005, the FASB issued FASB Staff Position(FSP) Nos. FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-TemporaryImpairment and its Application to Certain Investments,” which addresses thedetermination as to when an investment is considered impaired, whether thatimpairment is other-than-temporary and the measurement of an impairment loss.This FSP also includes accounting considerations subsequent to the recognitionof an other-than-temporary impairment and requires certain disclosures aboutunrealized losses that have not been recognized as other-than-temporaryimpairments. This pronouncement is effective beginning with the Company’s firstquarter of 2006. The Company does not currently have any other-than-temporaryimpairment, and therefore, adoption of this standard on January 1, 2006will not have a significant impact on the Company’s consolidated financialstatements.

 

InNovember 2004, the FASB issued SFAS 151, “Inventory Costs - an amendment of ARBNo. 43, Chapter 4.” SFAS 151 clarifies that inventory costs that are “abnormal”are required to be charged to expense as incurred as opposed to beingcapitalized into inventory as a product cost. SFAS 151 provides examples of“abnormal” costs including costs of idle facilities, excess freight andhandling costs and spoilage. SFAS 151 is effective for the Company’s fiscalyear beginning January 1, 2006. Adoption of this standard will not have animpact on the Company’s consolidated financial statements.

 

InDecember 2004, the FASB issued SFAS 123R (revised 2004), “Share-Based Payment,”which will be effective in the first quarter of fiscal 2006. This statementwill eliminate the ability to account for share-based compensation transactionsusing APB 25, “Accounting for Stock Issued to Employees.” Under the provisionsof SFAS 123R, the Company’s SARs will be accounted for as a liability awardwith the fair value of SARs issued calculated using a Black Scholes model ateach reporting period. Compensation expense continues to be recorded over thevesting period of the award. The Company intends to adopt SFAS 123R using theModified Prospective Transition method which will require a cumulativeadjustment for the difference, if any, in the amount of accrued compensationexpense recorded as of December 31, 2005 and the amount required under theprovisions of SFAS 123R. The Company is still in the

 

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processof evaluating the impact that the adoption of SFAS 123R will have on itsconsolidated financial statements.

 

InMarch 2005, the FASB issued FIN 47, “Accounting for Conditional AssetRetirement Obligations,” an interpretation of SFAS 143. This statementclarified the term conditional asset retirement obligation and is effective forthe Company’s fourth quarter ending December 31, 2005. Adoption of FIN 47 didnot have an impact on the Company’s consolidated financial statements.

 

InSeptember 2005, the EITF amended and ratified previous consensus on EITF No.05-6, “Determining the Amortization Period for Leasehold Improvements Purchasedafter Lease Inception or Acquired in a Business Combination” which addressesthe amortization period for leasehold improvements in operating leases that areeither placed in service significantly after and not contemplated at or near thebeginning of the initial lease term or acquired in a business combination. Thisconsensus applies to leasehold improvements that are purchased or acquired inreporting periods beginning after ratification. Adoption of the provisions ofEITF No. 05-6 did not have an impact on the Company’s consolidated financialstatements.

 

InOctober 2005, the FASB issued FSP SFAS 13-1, “Accounting for Rental CostsIncurred during a Construction Period.” FSP SFAS 13-1 clarifies that rentalcosts associated with ground or building operating leases that are incurredduring a construction period should be recognized as rental expense. Thisstatement is effective with the Company’s first quarter of 2006. Adoption ofthis standard will not have an impact on the Company’s consolidated financialstatements.

 

Item 7A.                           Quantitativeand Qualitative Disclosures about Market Risks

 

The Company currently has no outstanding bank debt orfixture financing. If the Company should obtain financing or draw on itsexisting lines of credit, which bear interest at the bank’s reference rate orthe bank’s adjusted London Interbank Offer Rate (LIBOR) plus an index up to1.2%, the Company could then be exposed to market risk related to interestfluctuations.

 

A change in market prices exposes the Company tomarket risk related to its investments. As of December 31, 2005, allinvestments were classified as available-for-sale securities and totaled$20,650,000. A hypothetical 10% drop in the market value of these investmentswould result in a $2,065,000 unrealized loss and a corresponding decrease inthe fair value of these instruments. This hypothetical drop would not affectcash flow and would not have an impact on earnings until the Company sold theinvestments.

 

Item 8.                                     FinancialStatements and Supplementary Data

 

See Index toConsolidated Financial Statements.

 

Item 9.                                     Changes in and Disagreements with Accountantson Accounting and Financial Disclosure

 

None.

 

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Item 9A.                           Controls and Procedures

 

**Evaluation of Disclosure Controlsand Procedures**

 

Anevaluation was carried out by the Company’s Chief Executive Officer and theperson temporarily performing the functions of the Chief Financial Officer ofthe effectiveness of the Company’s disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of1934) as of December 31, 2005. Based upon that evaluation, the Chief ExecutiveOfficer and the person temporarily performing the functions of the Chief FinancialOfficer concluded that these disclosure controls and procedures were effective.

 

**Changesin Internal Control over Financial Reporting**

 

Management, with the participation of the ChiefExecutive Officer and the person temporarily performing the functions of theChief Financial Officer of the Company, has evaluated any changes in theCompany’s internal control over financial reporting that occurred during themost recent fiscal quarter. Based on that evaluation, management, the ChiefExecutive Officer and the person temporarily performing the functions of theChief Financial Officer of the Company have concluded that there has been nochange in the Company’s internal control over financial reporting during theCompany’s fiscal quarter ended December 31, 2005 that has materially affected,or is reasonably likely to materially affect, the Company’s internal controlover financial reporting.

 

Item 9B.                             Other Information

 

None.

 

25

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**PART III**

** **

Item 10.                               Directorsand Executive Officers of the Registrant

 

Identification andInformation Concerning Directors

 

Below is set forthcertain information about each of the Company’s directors as of February 25, 2006. Certain of thisinformation has been supplied by the persons shown.

 
| **Name**           | ** ** | **Age**    | ** ** | **Principal Occupation (1)  and Other Directorships**                                                                                                                                                                                                                                                                                                                           | ** ** | **Director  Since (2)** | ** ** | **Term  Expires** |
|--------------------|------------|------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-------------------|
| ** **         | ** ** | ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                          | ** ** | ** **                   | ** ** | ** **        |
| Bernard Briskin    |       | 81         |       | Chairman of the Board  of Directors, President and Chief Executive Officer of the Company and  Arden-Mayfair, a subsidiary of the Company, and Chairman of the Board,  President, Chief Executive Officer and Chief Operating Officer of AMG  Holdings and Chairman of the Board and Chief Executive Officer of Gelson’s,  both subsidiaries of Arden-Mayfair.                                 |       | 1970                         |       | 2007              |
|               |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                |       |                         |       |              |
| John G. Danhakl    |       | 49         |       | Partner, Leonard Green  & Partners, L.P. since March 1995. Managing Director of Donaldson Lufkin  Jenrette Securities Corporation from March 1990 to February 1995. Director of  Big 5 Sporting Goods Corporation, Leslie’s Poolmart, Inc., Horseshows in the  Sun, Inc. (HITS), The Neiman Marcus Group, Inc., Petco Animal Supplies, Inc.,  Rite Aid Corporation and The Tire Rack, Inc. |       | 1995                         |       | 2007              |
|               |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                |       |                         |       |              |
| Robert A. Davidow  |       | 63         |       | Private Investor.                                                                                                                                                                                                                                                                                                                                                                                   |       | 1993                         |       | 2008              |
|               |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                |       |                         |       |              |
| Kenneth A. Goldman |       | 63         |       | Attorney and Partner  with Reed Smith LLP since January 2003, Attorney and Director with Crosby,  Heafey, Roach & May, A Professional Corporation from September 2000 to  December 2002. For more than five years prior thereto, Attorney and Principal  of Sanders, Barnet, Goldman, Simons & Mosk, A Professional Corporation.                                                            |       | 2001                         |       | 2007              |
|               |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                |       |                         |       |              |
| Steven C. Gordon   |       | 58         |       | President, Chief  Executive Officer and a Director of Domino Realty, a privately held real  estate investment and development firm.                                                                                                                                                                                                                                                                 |       | 2005                         |       | 2006              |
|               |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                |       |                         |       |              |
| Steven Romick      |       | 42         |       | Investment Advisor,  Senior Vice President of First Pacific Advisors, Inc.                                                                                                                                                                                                                                                                                                                          |       | 2003                         |       | 2006              |

 

Ben Winters served as avalued director of the Company from 1978 until his passing February 2, 2005.Mr. Winters also served as Chairman of the Audit and Nominating Committees andwas a member of the Compensation and Investment Committees.

 

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(1)                                  Unlessotherwise indicated, principal occupation or occupations shown have been suchfor a period of at least five years in the aggregate.

 

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(2)                                  Dateshown for term of service indicates commencement of service as a director ofthe Company or Arden-Mayfair.

 

Identification ofExecutive Officers

 

Below is set forthcertain information about each of the executive officers of the Company as ofFebruary 25, 2006:

 
| **Name**        | ** ** | **Age** | ** ** | **Position(s)**                                                                                                                                                                                                                                                                                   |
|-----------------|------------|---------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |       |    |       |                                                                                                                                                                                                                                                                                              |
| Bernard Briskin |       | 81      |       | Chairman of the Board  of Directors, President and Chief Executive Officer of the Company and  Arden-Mayfair, and Chairman of the Board, President, Chief Executive Officer  and Chief Operating Officer of AMG Holdings and Chairman of the Board and  Chief Executive Officer of Gelson’s. |

 

Mr. Briskin served asChairman of the Executive Committee of the Board of Directors of Arden-Mayfairuntil August 1978, when he was elected President and Chief Executive Officer ofArden-Mayfair. In November 1978, Mr. Briskin was elected President and ChiefExecutive Officer of the Company, and in June 1994 he was elected Chairman ofthe Board of the Company. Mr. Briskin serves as Chairman of the Board,President and Chief Executive Officer of the Company and Arden-Mayfair, andChairman of the Board, President, Chief Executive Officer and Chief OperatingOfficer of AMG Holdings and Chairman of the Board and Chief Executive Officerof Gelson’s, pursuant to an employment agreement which expires onJanuary 1, 2008, although the term will be automatically extended forsuccessive one year periods unless certain termination notices are given byeither Mr. Briskin or the employers fifteen to eighteen months prior to thecurrent expiration date. See “Item 11. Executive Compensation.”

 

Except for Mr. Briskin,who has an employment agreement, all officers serve at the pleasure of theBoard of Directors.

 

Audit Committee and Financial Expert

 

The Board of Directorshas an Audit Committee comprised of three outside directors. During 2005, thefollowing individuals served as members of the Audit Committee:

 
|   |   |   |   | Steven Romick, Chairman  Robert A. Davidow  Steven C. Gordon (from June 22, 2005)  Ben Winters (deceased February 2, 2005) |
|--------|--------|--------|--------|----------------------------------------------------------------------------------------------------------------------------|

 

As a result of the deathof Ben Winters on February 2, 2005, a vacancy was created on the AuditCommittee. On June 22, 2005, the Board of Directors of the Company electedSteven C. Gordon as a director to fill the vacancy on the Board of Directorsand Mr. Gordon was also elected as a member of the Audit and CompensationCommittees.

 

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The Company’s Board ofDirectors has determined that at least one person serving on the AuditCommittee is an “audit committee financial expert” as defined under Item 401(h)of Regulation S-K. Ben Winters, formerly the Chairman of the Audit Committee,was independent as defined under applicable Securities and Exchange Commission(SEC) and NASDAQ rules and the Board of Directors determined he was an “auditcommittee financial expert.” The Board of Directors also determined that StevenRomick is an “audit committee financial expert” and he is independent asdefined under applicable SEC and NASDAQ rules.

 

Code of Ethics andBusiness Conduct

 

The Company has adopted aCode of Ethics and Business Conduct applicable to all officers, management andemployees. The Code of Ethics and Business Conduct includes a SupplementaryCode of Ethics for Financial Professionals which is applicable to the chiefexecutive officer, chief financial officer, principal accounting officer orcontroller and individuals performing similar functions. A copy of the Code ofEthics and Business Conduct may be obtained, without charge, upon writtenrequest to the Assistant Secretary, Arden Group, Inc., P.O. Box 512256, LosAngeles, California 90051-0256.

 

Section 16(a) BeneficialOwnership Reporting Compliance

 

Section 16(a) of theSecurities Exchange Act of 1934 requires that directors and executive officersof the Company, as well as persons holding more than ten percent (10%) of aregistered class of the Company’s equity securities, file with the SEC initialreports of the ownership and reports of changes of ownership of Class A andother equity securities of the Company. Based solely on review of copies ofsuch reports furnished to the Company and written representations that no otherreports were required to be filed during the fiscal year ended December 31,2005, except for an inadvertent late filing by Mr. Gordon with respect to thegrant of a SAR to him on his election as a director, all Section 16(a) filingrequirements applicable to the Company’s executive officers, directors andgreater than ten percent (10%) beneficial owners were complied with.

 

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Item 11.                               ExecutiveCompensation

 

General

 

The following table setsforth the total annual and long-term compensation paid or accrued by theCompany and its subsidiaries in connection with all businesses of the Companyand its subsidiaries to or for the account of the Chief Executive Officer ofthe Company and each other executive officer of the Company whose total annualsalary and bonus for the fiscal year ended December 31, 2005 exceeded $100,000in the aggregate.

 
| ** **            | ** ** | ** **                   | ** ** | ** **                | ** ** | ** **               | ** ** | **Long Term** | ** ** | ** **          | ** ** |
|-----------------------|------------|------------------------------|------------|---------------------------|------------|--------------------------|------------|--------------------|------------|---------------------|------------|
| ** **            | ** ** | ** **                   | ** ** | ** **                | ** ** | ** **               | ** ** | **Compensation**   | ** ** | ** **          | ** ** |
| ** **            | ** ** | **Annual Compensation** | ** ** | **Awards**                | ** ** | ** **               | ** ** |
| ** **            | ** ** | ** **                   | ** ** | ** **                | ** ** | ** **               | ** ** | **Securities**     | ** ** | ** **          | ** ** |
| ** **            | ** ** | ** **                   | ** ** | ** **                | ** ** | ** **               | ** ** | **Underlying**     | ** ** | **All Other**  | ** ** |
| **Name and**     | ** ** | ** **                   | ** ** | ** **                | ** ** | ** **               | ** ** | **Options/**       | ** ** | **Compen-**         | ** ** |
| **Principal**         | ** ** | ** **                   | ** ** | ** **                | ** ** | ** **               | ** ** | **SARs**           | ** ** | **sation**          | ** ** |
| **Position**          | ** ** | **Year**                     | ** ** | **Salary ($ )** | ** ** | **Bonus ($ )** | ** ** | **(#)(3)**         | ** ** | **($ )(4)(5)** | ** ** |
| Bernard Briskin,      |       | 2005                         |       | 611,382                   |       | 1,192,133                |       | 0                  |       | 16,800              |       |
| Chief Executive       |       | 2004                         |       | 588,716                   |       | 1,363,699                |       | 0                  |       | 16,400              |       |
| Officer               |       | 2003                         |       | 573,239                   |       | 991,334                  |       | 0                  |       | 16,000              |       |
|                  |       |                         |       |                      |       |                     |       |               |       |                |       |
| Debra L. Jensen  (1), |       | 2005                         |       | 95,966                    |       | 0                        |       | 0                  |       | 30,000              |       |
| Chief Financial       |       | 2004                         |       | 37,692                    |       | 0                        |       | 0                  |       | 0                   |       |
| Officer               |       |                         |       |                      |       |                     |       |               |       |                |       |
|                  |       |                         |       |                      |       |                     |       |               |       |                |       |
| David M. Oliver  (2), |       | 2004                         |       | 118,388                   |       | 0                        |       | 0                  |       | 0                   |       |
| Chief Financial       |       | 2003                         |       | 170,940                   |       | 25,000                   |       | 0                  |       | 16,000              |       |
| Officer               |       |                         |       |                      |       |                     |       |               |       |                |       |

 

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(1)                                  Ms. Jensen, Chief Financial Officer,joined the Company in September 2004 at an annual salary of $175,000. Ms.Jensen resigned as an officer of the Company in April 2005 and terminated heremployment in June 2005.

 

(2)                                  Mr. Oliver resigned as an officer of theCompany and terminated his employment in April 2004. Mr. Oliver’s salary of$118,388 in 2004 includes severance pay of $53,584.

 

(3)                                  The Company did not grant to Mr. Briskin,Mr. Oliver or Ms. Jensen any restricted stock, stock options or SARs and madeno payout to them on any long-term incentive plan in any of the fiscal yearspresented.

 

(4)                                  Exceptwith respect to Ms. Jensen, represents the Company’s contributions to the ArdenGroup, Inc. 401(k) Retirement Savings Plan. Ms. Jensen was not eligible toparticipate in the plan.

 

(5)                                  Perquisites and other personal benefitsdid not exceed the lesser of $50,000 or 10% of the compensation received by Ms.Jensen in 2004 or by Mr. Briskin or Mr. Oliver in any of the years for whichcompensation information is reported. In 2005, Ms. Jensen received a movingexpense reimbursement of $30,000.

 

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StockAppreciation Rights

 

TheCompany has granted SARs covering shares of the Company’s Class A tonon-employee directors and certain officers and employees of the Company. EachSAR entitles the holder to receive upon exercise thereof the excess of the fairmarket value of a share of Class A on the date of exercise over the fair marketvalue of such share on the date granted. The SARs vest 25% each year beginningat the end of the first year and expire five years from the date of grant. NoSARs were granted to or exercised by executive officers during the 2005 fiscalyear.

 

Employment Agreement

 

The compensation of Mr.Briskin, the Chief Executive Officer of the Company, is established under anEmployment Agreement, as amended (Employment Agreement) which currently expireson January 1, 2008. The Employment Agreement provides that, upon the expirationof the initial term on January 1, 2004, the term thereof is automaticallyextended for successive periods of one fiscal year unless either the employersor Mr. Briskin gives notice of termination not less than fifteen months and nomore than eighteen months prior to the date upon which the term of theEmployment Agreement will expire. Pursuant to the terms of the EmploymentAgreement, Mr. Briskin’s base salary increases on January 1 of each yearbased upon increases in the Consumer Price Index subject to a maximum annualincrease of 4%. His annual bonus is equal to 2-1/2% of the Company’s first$2,000,000 of pre-tax profits (as defined in the Employment Agreement) plus3-1/2% of pre-tax profits in excess of $2,000,000. The Employment Agreementprovides for an annual medical expense reimbursement up to $200,000 for Mr.Briskin and his immediate family, as well as annual retirement compensationequal to 25% of Mr. Briskin’s average base salary and bonus earned in the lastthree fiscal years prior to his retirement and continuation of health insurancebenefits and automobile allowance. The Employment Agreement provides that itsterms were subject to review during the 2003 fiscal year by the CompensationCommittee of the Board of Directors. Pursuant to this provision, discussionstook place between Mr. Briskin and the Committee concerning amendments tocertain provisions of the Employment Agreement, but no amendments have yet beeneffected.

 

Remuneration of Directors

 

Non-employee directorsare compensated for their services as directors at an annual rate of $24,000,plus $1,000 for each Board meeting attended and $1,000 for attendance at eachcommittee meeting. Non-employee directors who serve as committee chairmen areentitled to an additional $6,000 per year. Directors serving on the AuditCommittee receive an additional $12,000 per year and the Chairman of the AuditCommittee receives an additional $6,000 per year. Mr. Briskin is anemployee of the Company and does not receive the compensation otherwise payableto directors.

 

Each of the non-employeedirectors have been granted and presently hold SARs covering shares of Class A.On June 22, 2005, the Company issued SARs covering 10,000 shares of theCompany’s Class A to Mr. Gordon upon his election as a non-employee director.These SARs have a base price of $78.43 per share, representing the fair marketvalue on the date of grant. When the SARs are exercised, each unit entitles theholder to receive the excess of the fair market value of a share of Class A onthe date of exercise over the base price. Units vest 25% each year beginning atthe end of the first year and expire five years from the date of grant.

 

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CompensationCommittee Interlocks and Insider Participation

 

The Board of Directorshas a Compensation Committee. In 2005, the Compensation Committee was comprisedof the following directors, none of whom are or have been officers of theCompany:

 

John G. Danhakl, Chairman

Robert A. Davidow

Steven C. Gordon (from June 22, 2005)

Ben Winters (deceased February 2, 2005)

 

As a result of the deathof Ben Winters on February 2, 2005, a vacancy was created on the CompensationCommittee. On June 22, 2005, the Board of Directors of the Company electedSteven C. Gordon as a director to fill the vacancy on the Board of Directorsand Mr. Gordon was also elected as a member of the Audit and CompensationCommittees.

 

Item 12.                               SecurityOwnership of Certain Beneficial Owners and Management and Related StockholderMatters

 

Security Ownership ofCertain Beneficial Owners

 

The followingtable sets forth information as of February 25, 2006 relating to thestockholdings of persons known to the Company to be the beneficial owner ofmore than 5% of the Class A of the Company, its only outstanding class ofequity securities: 

 
| **Name and Address of   Beneficial Owner**                                                                         | ** ** | **Amount and********Nature of Beneficial  Ownership (1)** | ** ** | **Percent of Class** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|--------------------------------|------------|
|                                                                                                                                        |       |                                                                          |       |                           |       |
| Bernard  BriskinArden Group, Inc.9595 Wilshire Blvd., Suite 411  Beverly Hills, CA 90212                                                    |       | 1,911,945                                                                     | (2)(3)     | 59.2                           | %          |
|                                                                                                                                        |       |                                                                          |       |                           |       |
| Royce  & Associates, LLC1414 Avenue of the AmericasNew York, NY 10019                                                                   |       | 186,800                                                                       | (4)        | 5.8                            | %          |
|                                                                                                                                        |       |                                                                          |       |                           |       |
| City  National Bank, as Trustee of the Company’s  Stock Bonus Plan and Trust  1950 Avenue of the Stars, 2nd FloorLos Angeles, CA 90067 |       | 170,598                                                                       |       | 5.3                            | %          |

 

----

(1)                                  Unless otherwise indicated to thecontrary, all beneficial owners have sole investment and voting power. Forpurposes of this table, 1,357,200 treasury shares of Class A are not deemed tobe outstanding.

 

(2)                                  This amount includes the followingshares: (i) 186,096 shares held in trust (of which Mr. Briskin is the trustee)for the benefit of Mr. Briskin and his children and (ii) an aggregate of 103,012

 

31

----

 

shares held by Mr. Briskin’s spouse in her IndividualRetirement Accounts for her benefit. Mr. Briskin disclaims any beneficialownership of the shares set forth in clause (ii) hereof and has no voting orinvestment power with respect to these shares. Nothing herein should beconstrued as an admission that Mr. Briskin is in fact the beneficial owner ofthese shares.

 

(3)                                  This amount excludes 33,004 shares ofClass A held by The Judy and Bernard Briskin Foundation of which Mr. Briskinserves as a co-trustee. Mr. Briskin disclaims any beneficial ownership withrespect to these shares.

 

(4)                                  Based upon Schedule 13-G filed on January10, 2006 with the SEC.

 

Security Ownership of Management

 

The followingtable shows the beneficial ownership of the Company’s Class A, its onlyoutstanding class of equity securities, by each director, executive officer andby all directors and executive officers as a group as of February 25, 2006:

 
| **Name of Beneficial Owner**                                 | ** ** | **Amount and********Nature of Beneficial  Ownership (1)** | ** ** | **Percent of Class** | ** ** |
|--------------------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|--------------------------------|------------|
|                                                         |       |                                                                          |       |                           |       |
| Bernard  Briskin                                             |       | 1,911,945                                                                     | (2)        | 59.2                           | %          |
| John  G. Danhakl                                             |       | 0                                                                             |       |                           |       |
| Robert  A. Davidow                                           |       | 0                                                                             |       |                           |       |
| Kenneth  A. Goldman                                          |       | 125,200                                                                       | (3)        | 3.9                            | %          |
| Steven  C. Gordon                                            |       | 500                                                                           |       |                           | (4)        |
| Steven  Romick                                               |       | 0                                                                             |       |                           |       |
|                                                         |       |                                                                          |       |                           |       |
| All  directors and executive officers as a group (6 persons) |       | 2,037,645                                                                     | (2)        | 63.1                           | %          |

 

----

(1)                                  Unless otherwise indicated to thecontrary, all beneficial owners have sole investment and voting power. Thenumber of outstanding shares of Class A, on which the percentages shown in thistable are based, does not include 1,357,200 treasury shares of the Company’sClass A.

 

(2)                                  See notes (2) and (3) to the table under“Security Ownership of Certain Beneficial Owners” set forth above.

 

(3)                                  Of these shares, 37,200 are held in trustby Mr. Goldman, as trustee, for the grandchildren of Mr. and Mrs. Briskin and88,000 are held by limited partnerships, of which Mr. Goldman and Mr. Gordonare two of the general partners and the limited partners of which are membersof Mr. and Mrs. Briskin’s family.

 

(4)                                  Does not exceed 1%.

 

32

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EquityCompensation Plan Information

 

Thefollowing table provides information related to the Company’s equitycompensation plans as of December 31, 2005.

 
| ** **                                                      | ** ** | **(a)**                                                                                                                                  | ** ** | **(b)**                                                                                               | ** ** | **(c)**                                                                                                                                                                                          | ** ** |
|-----------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Plan category**                                          | ** ** | **Number of  securities to  be issued upon  exercise  of outstanding  options,  warrants and rights** | ** ** | **Weighted-  average  exercise price of  outstanding  options,  warrants and  rights** | ** ** | **Number of  securities  remaining available  for future issuance  under equity  compensation plans  (excluding  securities  reflected in column  (a))** | ** ** |
| Equity  compensation plans approved by security holders         |       | 0                                                                                                                                        |       | 0                                                                                                     |       | 0                                                                                                                                                                                                |       |
|                                                            |       |                                                                                                                                     |       |                                                                                                  |       |                                                                                                                                                                                             |       |
| Equity  compensation plans not approved by security holders (1) |       |                                                                                                                                     |       |                                                                                                  |       |                                                                                                                                                                                             |       |
| Non-Officer and  Non-Director Stock Option Plan                 |       | 0                                                                                                                                        |       | 0                                                                                                     |       | 28,500                                                                                                                                                                                           |       |

 

----

(1)                      Does not include SARs which provide for cash only compensation.

 

In 1998, the Companyadopted a Stock Option Plan which was not submitted to security holders forapproval and initially provided for the granting of stock options to keyemployees to purchase up to 35,000 shares of the Company’s Class A. The StockOption Plan was amended in fiscal 2000 to increase the number of sharesavailable thereunder to an aggregate of 70,000 shares. The objective of theStock Option Plan is to attract and retain quality personnel and to promote thesuccess of the Company by providing employees the opportunity to share in itsgrowth. These options vest at 25% per year beginning at the end of the firstyear and expire five years from the date of grant. The exercise price of stockoptions granted under the Stock Option Plan is equal to the fair market valueof the Company’s Class A on the date of grant. As of December 31, 2005, therewere no stock options issued and outstanding.

 

Item 13.                               CertainRelationships and Related Transactions

 

A director of the Company, Mr. Goldman, is a partner of a law firm whichperforms legal services for the Company.

 

33

----

 

**PART IV**

 

Item 14.                               PrincipalAccountant Fees and Services

 

Audit Fees

 

Auditfees include the aggregate fees billed for the audit of the Company’s annualconsolidated financial statements and the reviews of each of the quarterlyconsolidated financial statements included in the Company’s Forms 10-Q. Theaggregate audit fees billed to the Company by PricewaterhouseCoopers LLP (PwC)were approximately $499,000 for fiscal 2005 and $648,000 for fiscal 2004.

 

InNovember 2004, the Company responded to a comment letter from the SEC. As aresult, PwC billed the Company approximately $25,000 in fees related toresearching issues raised in the letter and reviewing the Company’s response.

 

Audit-Related Fees

 

Audit-relatedfees incurred in connection with the audit of the Company’s employee benefitplans totaled approximately $17,000 in 2004. The 2005 audit was performed by afirm other than PwC.

 

Tax Fees

 

Feesbilled by PwC for tax services in 2005 aggregated approximately $77,000,including $33,000 for tax return and compliance work, and $44,000 for otherprojects. Fees billed by PwC for tax services in 2004 aggregated approximately$102,000, including $32,000 for tax return and compliance work and $70,000 forother projects.

 

All Other Fees

 

Otherthan the fees for services described above, there were no additional feesbilled by PwC in 2005 or 2004.

 

Itis the policy of the Audit Committee to pre-approve all audit and non-auditservices provided by PwC. The Audit Committee reviewed the above-described feesfor non-audit services and considered whether the provision of those servicesis compatible with maintaining the independence of PwC and concluded that PwChas maintained its independence.

 

34

----

 
| Item 15. | Exhibits and Financial  Statement Schedules      |
|----------|--------------------------------------------------|
|     |                                             |
| (a)      | Exhibits and Financial  Statements and Schedules |
|     |                                             |
|     | (1)                                              | Financial Statements |
|     |                                             | See Index to  Consolidated Financial Statements |
|     |                                             |   |
|     | (2)                                              | Financial Statement  Schedules - None |
|     |                                             |   |
|     | (3)                                              | Exhibits |
|     |                                             | See Index to Exhibits |
|     |                                             |
| (b)      | Exhibits                                         |
|     | See  Index to Exhibits                           |
|     |                                             |
| (c)      | Other Financial  Schedules - None                |

 

35

----

 

**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
| ARDEN GROUP, INC. |
|-------------------|
|              |   |   |   |
| ** **        | ** ** | ** ** | **Date** |
|              |   |   |   |
| By                | /s/BERNARD BRISKIN |   | 3/9/06 |
|              | Bernard Briskin, Chairman of the Board, |   |   |
|              | President and Chief Executive Officer |   |   |

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed below by the following persons on behalf of theregistrant and in the capacities and on the date indicated.

 

 
| ** ** | ** **                                                        | ** ** | **Date** |
|------------|-------------------------------------------------------------------|------------|----------|
|       |                                                              |       |     |
|       | /s/BERNARD BRISKIN                                                |       | 3/9/06   |
|       | Bernard Briskin, Director, Chairman of the Board,  President      |       |     |
|       | and Chief Executive Officer                                       |       |     |
|       | (Principal Executive Officer)                                     |       |     |
|       |                                                              |       |     |
|       | /s/LAURA J. NEUMANN                                               |       | 3/9/06   |
|       | Laura J. Neumann,  Director of Financial Reporting and Compliance |       |     |
|       | (Principal Financial  and Principal Accounting Officer)           |       |     |
|       |                                                              |       |     |
|       | /s/JOHN G. DANHAKL                                                |       | 3/9/06   |
|       | John G. Danhakl,  Director                                        |       |     |
|       |                                                              |       |     |
|       | /s/ROBERT A. DAVIDOW                                              |       | 3/9/06   |
|       | Robert A. Davidow, Director                                       |       |     |
|       |                                                              |       |     |
|       | /s/KENNETH A. GOLDMAN                                             |       | 3/9/06   |
|       | Kenneth A. Goldman,  Director                                     |       |     |
|       |                                                              |       |     |
|       | /s/STEVEN C. GORDON                                               |       | 3/9/06   |
|       | Steven C. Gordon,  Director                                       |       |     |
|       |                                                              |       |     |
|       | /s/STEVEN ROMICK                                                  |       | 3/9/06   |
|       | Steven Romick, Director                                           |       |     |

 

36

----

 

**ARDENGROUP, INC. AND CONSOLIDATED SUBSIDIARIES**

 

**INDEX TOCONSOLIDATED FINANCIAL STATEMENTS**

 
| Management’s  Report on Internal Control over Financial Reporting                               |   |
|------------------------------------------------------------------------------------------------------|--------|
|                                                                                                 |   |
| Report  of Independent Registered Public Accounting Firm                                             |   |
|                                                                                                 |   |
| Financial Statements:                                                                                |   |
| Consolidated Balance Sheets,  December 31, 2005 and January 1, 2005                                  |   |
| Consolidated Statements of  Operations and Comprehensive Income for fiscal years 2005, 2004 and 2003 |   |
| Consolidated Statements of  Stockholders’ Equity for fiscal years 2005, 2004 and 2003           |   |
| Consolidated Statements of  Cash Flows for fiscal years 2005, 2004 and 2003                          |   |
| Notes to Consolidated  Financial Statements                                                          |   |

 

The financial statementsinclude the Company’s subsidiary (Arden-Mayfair, Inc.) and the subsidiaries ofArden-Mayfair, Inc.

 

Schedules are omittedbecause of the absence of the conditions under which they are required.

 

37

----

 

**Management’sReport on Internal Control over Financial Reporting**

 

Themanagement of the Company is responsible for establishing and maintainingadequate internal control over financial reporting. The Company’s internalcontrol over financial reporting is a process designed to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with generallyaccepted accounting principles. Because of its inherent limitations, internalcontrol over financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditionsor that the degree of compliance with the policies or procedures maydeteriorate.

 

TheCompany’s management assessed the effectiveness of the Company’s internalcontrol over financial reporting as of December 31, 2005. In making theassessment, it used the criteria set forth by the Committee of SponsoringOrganizations of the Treadway Commission in “Internal Control-IntegratedFramework.” Based on that assessment, management concluded that, as of December31, 2005, the Company’s internal control over financial reporting is effectivebased on those criteria.

 

Management’sassessment of the effectiveness of the Company’s internal control overfinancial reporting as of December 31, 2005 has been audited by PricewaterhouseCoopersLLP, an independent registered public accounting firm, as stated in theirreport which appears on page 39.

 

38

----

 

### **Reportof Independent Registered Public Accounting Firm**

 

To the Stockholders ofArden Group, Inc.:

 

Wehave completed integrated audits of Arden Group, Inc.’s December 31, 2005 andJanuary 1, 2005 consolidated financial statements and of its internalcontrol over financial reporting as of December 31, 2005, and an audit of itsJanuary 3, 2004 consolidated financial statements in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, arepresented below.

 

Consolidated financial statements

 

Inour opinion, the financial statementslisted in the index appearing under Item 15(a)(1) present fairly, in allmaterial respects, the financial position of Arden Group, Inc. and itssubsidiaries at December 31, 2005 and January 1, 2005, and the resultsof their operations and their cash flows for each of the three years in theperiod ended December 31, 2005 in conformity with accounting principlesgenerally accepted in the United States of America. These financial statementsare the responsibility of the Company’s management. Our responsibility is toexpress an opinion on these financial statements based on our audits. Weconducted our audits of these statements in accordance with the standards ofthe Public Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement. An audit offinancial statements includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements, assessing theaccounting principles used and significant estimates made by management, andevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

 

Internalcontrol over financial reporting

 

Also,in our opinion, management’s assessment, included in Management’s Report onInternal Control Over Financial Reporting appearing on page 38, that theCompany maintained effective internal control over financial reporting as ofDecember 31, 2005 based on criteria established in *InternalControl – Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO), is fairly stated, in allmaterial respects, based on those criteria. Furthermore, in our opinion, theCompany maintained, in all material respects, effective internal control overfinancial reporting as of December 31, 2005, based on criteria established in *Internal Control – Integrated Framework* issued by the COSO.The Company’s management is responsible for maintaining effective internalcontrol over financial reporting and for its assessment of the effectiveness ofinternal control over financial reporting. Our responsibility is to expressopinions on management’s assessment and on the effectiveness of theCompany’s internal control over financial reporting based on our audit. Weconducted our audit of internal control over financial 

 

39

----

 

reportingin accordance with the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether effective internal controlover financial reporting was maintained in all material respects. An audit ofinternal control over financial reporting includes obtaining an understandingof internal control over financial reporting, evaluating management’sassessment, testing and evaluating the design and operating effectiveness ofinternal control, and performing such other procedures as we consider necessaryin the circumstances. We believe that our audit provides a reasonable basis forour opinions.

 

Acompany’s internal control over financial reporting is a process designed toprovide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordancewith generally accepted accounting principles. A company’s internal controlover financial reporting includes those policies and procedures that(i) pertain to the maintenance of records that, in reasonable detail,accurately and fairly reflect the transactions and dispositions of the assetsof the company; (ii) provide reasonable assurance that transactions arerecorded as necessary to permit preparation of financial statements inaccordance with generally accepted accounting principles, and that receipts andexpenditures of the company are being made only in accordance withauthorizations of management and directors of the company; and(iii) provide reasonable assurance regarding prevention or timelydetection of unauthorized acquisition, use, or disposition of the company’sassets that could have a material effect on the financial statements.

 

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements. Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

 

 

PricewaterhouseCoopersLLP

Los Angeles, California

March 8, 2006

 

40

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**ARDENGROUP, INC. AND CONSOLIDATED SUBSIDIARIES**

 

**CONSOLIDATED BALANCE SHEETS**

 

(In Thousands, ExceptShare and Per Share Data)

 
| ** **                                                                                                                                                                                                                   | ** ** | **December 31, 2005** | ** ** | **January 1, 2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| **Assets**                                                                                                                                                                                                                   |       |                            |       |                          |       |
| Current assets:                                                                                                                                                                                                              |       |                            |       |                          |       |
| Cash and cash  equivalents                                                                                                                                                                                                   |       | $                               | 36,338     |                          | $          | 8,663 |   |
| Investments                                                                                                                                                                                                                  |       | 20,650                          |       | 26,078                        |       |
| Accounts  receivable, net of allowance for doubtful accounts of $195 and $181 as of  December 31, 2005 and January 1, 2005, respectively                                                                                     |       | 5,714                           |       | 6,033                         |       |
| Inventories, net                                                                                                                                                                                                             |       | 19,146                          |       | 18,765                        |       |
| Deferred income  taxes                                                                                                                                                                                                       |       | 4,348                           |       | 3,647                         |       |
| Other current  assets                                                                                                                                                                                                        |       | 2,568                           |       | 2,019                         |       |
| Total current  assets                                                                                                                                                                                                        |       | 88,764                          |       | 65,205                        |       |
| Property, plant  and equipment, net                                                                                                                                                                                          |       | 50,025                          |       | 51,262                        |       |
| Deferred income  taxes                                                                                                                                                                                                       |       | 4,850                           |       | 2,683                         |       |
| Other assets                                                                                                                                                                                                                 |       | 3,388                           |       | 2,985                         |       |
| Total assets                                                                                                                                                                                                                 |       | $                               | 147,027    |                          | $          | 122,135 |   |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                                                               |       |                            |       |                          |       |
| Current  liabilities:                                                                                                                                                                                                        |       |                            |       |                          |       |
| Accounts  payable, trade                                                                                                                                                                                                     |       | $                               | 19,662     |                          | $          | 17,560 |   |
| Federal and  state income taxes payable                                                                                                                                                                                      |       | 3,919                           |       | 408                           |       |
| Current portion  of long-term debt                                                                                                                                                                                           |       | 221                             |       | 273                           |       |
| Other current  liabilities                                                                                                                                                                                                   |       | 23,658                          |       | 23,081                        |       |
| Total current  liabilities                                                                                                                                                                                                   |       | 47,460                          |       | 41,322                        |       |
| Long-term debt                                                                                                                                                                                                               |       | 1,453                           |       | 1,764                         |       |
| Deferred rent                                                                                                                                                                                                                |       | 5,796                           |       | 4,872                         |       |
| Other  liabilities                                                                                                                                                                                                           |       | 9,998                           |       | 7,601                         |       |
| Total  liabilities                                                                                                                                                                                                           |       | 64,707                          |       | 55,559                        |       |
| Commitments and  contingent liabilities (Note 16)                                                                                                                                                                            |       |                            |       |                          |       |
| Stockholders’  equity:                                                                                                                                                                                                  |       |                            |       |                          |       |
| Common Stock,  Class A, $.25 par value; authorized 10,000,000 shares; 4,736,202 and  4,740,452 shares issued and outstanding as of December 31, 2005 and January  1, 2005, respectively, including 1,357,200 treasury shares |       | 1,184                           |       | 1,185                         |       |
| Common Stock,  Class B, $.25 par value; convertible participating; authorized 1,500,000  shares; 0 shares issued and outstanding as of December 31, 2005 and January  1, 2005 , respectively                                 |       | 0                               |       | 0                             |       |
| Capital surplus                                                                                                                                                                                                              |       | 5,638                           |       | 5,643                         |       |
| Unrealized gain  (loss) on investments                                                                                                                                                                                       |       | (293                            | )          | 99                            |       |
| Retained  earnings                                                                                                                                                                                                           |       | 79,544                          |       | 63,402                        |       |
|                                                                                                                                                                                                                         |       | 86,073                          |       | 70,329                        |       |
| Treasury stock,  1,357,200 shares at cost                                                                                                                                                                                    |       | (3,753                          | )          | (3,753                        | )          |
| Total  stockholders’ equity                                                                                                                                                                                             |       | 82,320                          |       | 66,576                        |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                             |       | $                               | 147,027    |                          | $          | 122,135 |   |

 

*The accompanying notes are anintegral part of these consolidated financial statements.*

 

41

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**ARDENGROUP, INC. AND CONSOLIDATED SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**AND COMPREHENSIVE INCOME**

 

(In Thousands, Except Shareand Per Share Data)

 
| ** **                                                                                                             | ** ** | **2005**  | ** ** | **2004**  | ** ** | **2003**  | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
| Sales                                                                                                                  |       | $         | 470,354    |      | $          | 502,898   |       | $ | 486,378 |   |
| Cost of sales                                                                                                          |       | 255,989   |       | 277,485   |       | 270,658   |       |
| Gross profit                                                                                                           |       | 214,365   |       | 225,413   |       | 215,720   |       |
| Delivery,  selling, general and administrative expense                                                                 |       | 182,549   |       | 190,834   |       | 190,262   |       |
| Operating income                                                                                                       |       | 31,816    |       | 34,579    |       | 25,458    |       |
| Interest and  dividend income                                                                                          |       | 1,722     |       | 1,986     |       | 1,768     |       |
| Other income  (expense), net                                                                                           |       | 36        |       | 1,787     |       | 950       |       |
| Interest expense                                                                                                       |       | (152      | )          | (182      | )          | (272      | )          |
| Income before  income taxes                                                                                            |       | 33,422    |       | 38,170    |       | 27,904    |       |
| Income tax  provision                                                                                                  |       | 13,571    |       | 15,498    |       | 11,323    |       |
| Net income                                                                                                             |       | $         | 19,851     |      | $          | 22,672    |       | $ | 16,581 |   |
| Other  comprehensive income (loss), net of tax:                                                                        |       |      |       |      |       |      |       |
| Unrealized gain  (loss) from available-for-sale securities:                                                            |       |      |       |      |       |      |       |
| Net unrealized  holding gain (loss) arising during the period                                                          |       | (381      | )          | (161      | )          | 568       |       |
| Reclassification  adjustment for realized gain included in net income                                                  |       | (11       | )          | (86       | )          | (454      | )          |
| Net unrealized  gain (loss), net of income tax expense (benefit) of ($269) for 2005, ($169)  for 2004 and $78 for 2003 |       | (392      | )          | (247      | )          | 114       |       |
| Comprehensive  income                                                                                                  |       | $         | 19,459     |      | $          | 22,425    |       | $ | 16,695 |   |
| Net income per  common share:                                                                                          |       |      |       |      |       |      |       |
| Basic – Class A  Common Stock                                                                                     |       | $         | 5.87       |      | $          | 7.00      |       | $ | 5.11 |   |
| Basic – Class B  Common Stock                                                                                     |       | N/A       |       | $         | 6.13       |      | $          | 4.60 |   |
| Diluted                                                                                                                |       | $         | 5.87       |      | $          | 6.70      |       | $ | 4.90 |   |
| Weighted average  common shares outstanding:                                                                           |       |      |       |      |       |      |       |
| Basic – Class A  Common Stock                                                                                     |       | 3,381,051 |       | 2,217,675 |       | 2,015,859 |       |
| Basic – Class B  Common Stock                                                                                     |       | 0         |       | 1,164,977 |       | 1,363,584 |       |
| Diluted                                                                                                                |       | 3,381,051 |       | 3,382,652 |       | 3,380,524 |       |

 

*The accompanying notes are anintegral part of these consolidated financial statements.*

 

42

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**ARDENGROUP, INC. AND CONSOLIDATED SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**

 

(In Thousands, ExceptShare Data)

 
| ** **                                                                                        | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                                                              |       |     |       |     |       |     |       |
| Common Stock,  Class A:                                                                           |       |     |       |     |       |     |       |
| Balance,  beginning of year                                                                       |       | $        | 1,185      |     | $          | 844      |       | $ | 839 |   |
| Purchase and  retirement of common stock (4,250 and 4,942 shares in 2005 and 2003,  respectively) |       | (1       | )          | 0        |       | (1       | )          |
| Shares issued  under Stock Option Plan (2,000 and 23,875 shares in 2004 and 2003,  respectively)  |       | 0        |       | 0        |       | 6        |       |
| Conversion of  Class B to Class A                                                                 |       | 0        |       | 341      |       | 0        |       |
| Balance, end of  year                                                                             |       | 1,184    |       | 1,185    |       | 844      |       |
| Common Stock,  Class B:                                                                           |       |     |       |     |       |     |       |
| Balance,  beginning of year                                                                       |       | 0        |       | 341      |       | 341      |       |
| Conversion of  Class B to Class A                                                                 |       | 0        |       | (341     | )          | 0        |       |
| Balance, end of  year                                                                             |       | 0        |       | 0        |       | 341      |       |
| Capital surplus:                                                                                  |       |     |       |     |       |     |       |
| Balance,  beginning of year                                                                       |       | 5,643    |       | 5,547    |       | 4,362    |       |
| Purchase and  retirement of common stock                                                          |       | (5       | )          | 0        |       | (5       | )          |
| Shares issued  under Stock Option Plan                                                            |       | 0        |       | 96       |       | 1,190    |       |
| Balance, end of  year                                                                             |       | 5,638    |       | 5,643    |       | 5,547    |       |
| Unrealized gain  (loss) on investments:                                                           |       |     |       |     |       |     |       |
| Balance,  beginning of year                                                                       |       | 99       |       | 346      |       | 232      |       |
| Net unrealized  gain (loss)                                                                       |       | (392     | )          | (247     | )          | 114      |       |
| Balance, end of  year                                                                             |       | (293     | )          | 99       |       | 346      |       |
| Retained  earnings:                                                                               |       |     |       |     |       |     |       |
| Balance,  beginning of year                                                                       |       | 63,402   |       | 111,675  |       | 97,006   |       |
| Net income                                                                                        |       | 19,851   |       | 22,672   |       | 16,581   |       |
| Dividends  declared to common stockholders                                                        |       | (3,381   | )          | (70,945  | )          | (1,622   | )          |
| Purchase and  retirement of common stock                                                          |       | (328     | )          |     |       | (290     | )          |
| Balance, end of  year                                                                             |       | 79,544   |       | 63,402   |       | 111,675  |       |
| Stockholders’  equity before treasury stock                                                  |       | 86,073   |       | 70,329   |       | 118,753  |       |
| Treasury stock,  at cost                                                                          |       | (3,753   | )          | (3,753   | )          | (3,753   | )          |
| Total  stockholders’ equity                                                                  |       | $        | 82,320     |     | $          | 66,576   |       | $ | 115,000 |   |

 

*The accompanying notes are anintegral part of these consolidated financial statements.*

 

43

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**ARDENGROUP, INC. AND CONSOLIDATED SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

 

(In Thousands)

 
| ** **                                               | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Cash flows from  operating activities:                   |       |     |       |     |       |     |       |
| Cash received  from customers                            |       | $        | 470,646    |     | $          | 503,553  |       | $ | 488,562 |   |
| Cash paid to  suppliers and employees                    |       | (426,372 | )          | (467,717 | )          | (430,982 | )          |
| Interest and  dividends received                         |       | 1,613    |       | 1,813    |       | 1,472    |       |
| Interest paid                                            |       | (155     | )          | (184     | )          | (258     | )          |
| Income taxes  paid                                       |       | (12,653  | )          | (26,046  | )          | (6,244   | )          |
| Net cash  provided by operating activities               |       | 33,079   |       | 11,419   |       | 52,550   |       |
| Cash flows from  investing activities:                   |       |     |       |     |       |     |       |
| Capital  expenditures                                    |       | (6,390   | )          | (12,641  | )          | (5,752   | )          |
| Purchases of  investments                                |       | (713     | )          | (15,737  | )          | (11,836  | )          |
| Sales of investments                                     |       | 5,579    |       | 25,070   |       | 6,828    |       |
| Proceeds from  the sale of property, plant and equipment |       | 52       |       | 54       |       | 99       |       |
| Net cash used in  investing activities                   |       | (1,472   | )          | (3,254   | )          | (10,661  | )          |
| Cash flows from  financing activities:                   |       |     |       |     |       |     |       |
| Purchase and  retirement of Company stock                |       | (334     | )          | 0        |       | (296     | )          |
| Principal  payments under capital lease obligations      |       | (216     | )          | (246     | )          | (220     | )          |
| Proceeds from  exercise of stock options                 |       | 0        |       | 58       |       | 874      |       |
| Cash dividends  paid                                     |       | (3,382   | )          | (70,911  | )          | (811     | )          |
| Net cash used in  financing activities                   |       | (3,932   | )          | (71,099  | )          | (453     | )          |
| Net increase  (decrease) in cash and cash equivalents    |       | 27,675   |       | (62,934  | )          | 41,436   |       |
| Cash and cash  equivalents at beginning of year          |       | 8,663    |       | 71,597   |       | 30,161   |       |
| Cash and cash  equivalents at end of year                |       | $        | 36,338     |     | $          | 8,663    |       | $ | 71,597 |   |

 

*The accompanying notes are anintegral part of these consolidated financial statements.*

 

44

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| ** **                                                                                          | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| **Reconciliation  of Net Income to Net Cash Provided by Operating Activities:**                     |       |     |       |     |       |     |       |
| ** **                                                                                          |       |     |       |     |       |     |       |
| Net income                                                                                          |       | $        | 19,851     |     | $          | 22,672   |       | $ | 16,581 |   |
|                                                                                                |       |     |       |     |       |     |       |
| Adjustments to  reconcile net income to net cash provided by operating activities:                  |       |     |       |     |       |     |       |
| Depreciation and  amortization                                                                      |       | 7,401    |       | 6,990    |       | 8,126    |       |
| Provision for  losses on accounts receivable                                                        |       | 49       |       | 15       |       | 0        |       |
| Deferred income  taxes                                                                              |       | (2,600   | )          | 849      |       | (5,022   | )          |
| Loss on  impairment of long-lived assets                                                            |       | 0        |       | 0        |       | 4,311    |       |
| Net loss from  the disposal of property, plant and equipment                                        |       | 27       |       | 23       |       | 33       |       |
| Realized gain on  investments, net                                                                  |       | (36      | )          | (1,787   | )          | (950     | )          |
| Amortization of  discount on investments                                                            |       | (62      | )          | (196     | )          | (128     | )          |
| Tax benefit of  stock option transactions                                                           |       | 0        |       | 38       |       | 232      |       |
| Stock  appreciation rights and stock options compensation expense                                   |       | 946      |       | 3,658    |       | 830      |       |
|                                                                                                |       |     |       |     |       |     |       |
| Changes in  assets and liabilities net of effects from noncash investing and financing  activities: |       |     |       |     |       |     |       |
|                                                                                                |       |     |       |     |       |     |       |
| (Increase)  decrease in assets:                                                                     |       |     |       |     |       |     |       |
| Accounts and  notes receivable                                                                      |       | 270      |       | 713      |       | (1,217   | )          |
| Inventories                                                                                         |       | (381     | )          | (1,768   | )          | (2,455   | )          |
| Other current  assets                                                                               |       | (549     | )          | (236     | )          | 690      |       |
| Other assets                                                                                        |       | (403     | )          | 307      |       | 822      |       |
|                                                                                                |       |     |       |     |       |     |       |
| Increase  (decrease) in liabilities:                                                                |       |     |       |     |       |     |       |
| Accounts  payable, trade and other current liabilities                                              |       | 1,734    |       | (11,799  | )          | 17,996   |       |
| Federal and  state income taxes payable                                                             |       | 3,511    |       | (11,434  | )          | 9,869    |       |
| Deferred rent                                                                                       |       | 924      |       | 399      |       | 691      |       |
| Other  liabilities                                                                                  |       | 2,397    |       | 2,975    |       | 2,141    |       |
|                                                                                                |       |     |       |     |       |     |       |
| Net cash  provided by operating activities                                                          |       | $        | 33,079     |     | $          | 11,419   |       | $ | 52,550 |   |

 

*The accompanying notes are anintegral part of these consolidated financial statements.*

 

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**ARDENGROUP, INC. AND CONSOLIDATED SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

** **

1.                    Summary ofSignificant Accounting Policies

 

Basis ofPresentation and Business Description

 

The consolidatedfinancial statements of Arden Group, Inc. (Company) include the accounts of theCompany and its direct and indirect subsidiaries. All intercompany accounts andtransactions are eliminated in consolidation. The Company operates 18supermarkets in Southern California.

 

Reclassifications

 

Certain amounts in fiscal2004 have been reclassified to conform to the current period financialstatement presentation, including the reclassification of $811,000 of cashdividends paid which were originally included under Cash Paid to Suppliers andEmployees on the Consolidated Statement of Cash Flows. The dividends have beenreclassified to Cash Flows from Financing Activities. The reclassification hadno effect on net cash flow.

 

Fiscal Year

 

The Company operates on afiscal year ending on the Saturday closest to December 31. Fiscal years for theconsolidated financial statements included herein ended on December 31,2005 (52 weeks), January 1, 2005 (52 weeks) and January 3, 2004 (53 weeks).

 

The following is asummary of significant accounting policies followed in the preparation of theseconsolidated financial statements.

 

Cash and CashEquivalents

 

The ConsolidatedStatements of Cash Flows classify changes in cash and cash equivalents(short-term, highly liquid investments readily convertible into cash with anoriginal maturity at date of purchase of three months or less) according tooperating, investing or financing activities. At times, cash balances held atfinancial institutions are in excess of federally insured limits. The Companyplaces its temporary cash investments with high credit, quality financialinstitutions and limits the amount of credit exposure to any one financialinstitution. The Company believes no significant concentration of credit riskexists with respect to these cash investments.

 

Investments

 

The Company invests inmarketable securities including mutual funds and debt and equity securities.Marketable securities are stated at market value as determined by the most

 

46

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recently traded price ofeach security at the balance sheet date. The Company reviews its investmentportfolio on a quarterly basis to determine if market declines below book valuemay be other-than-temporary. Any decline that is determined to beother-than-temporary is recorded as a loss on the Consolidated Statements ofOperations and Comprehensive Income in accordance with Emerging Issues TaskForce (EITF) No. 03-1, “The Meaning of Other-Than-Temporary Impairment and itsApplication to Certain Issues.” All marketable securities are defined asavailable-for-sale investments under the provisions of Statement of FinancialAccounting Standards No. (SFAS) 115, “Accounting for Certain Investments inDebt and Equity Securities.” The Company does not believe that any losses onits investments are other-than-temporary.

 

Management determines theappropriate classification of its investments in marketable securities at thetime of purchase and reevaluates such determination at each balance sheet date.Debt securities for which the Company does not have the intent or ability tohold to maturity and equity securities are classified as available-for-sale.Investments are carried at fair value, with the unrealized gains and losses,net of tax, reported as a separate component of stockholders’ equity. The costof investments sold is determined based on the Specific Identification method.

 

In January 2001, theCompany invested $2,500,000 in a limited partnership that invests primarily inpublicly traded, high yield bonds. This investment was sold in May 2004. Theholding represented less than a 3% interest and the Company did not have theability to exercise significant influence over the operating and financialpolicies of the partnership. Consequently, the investment was accounted forunder the cost method. A gain of approximately $1,570,000 was recognized in2004 equal to the difference between the sales price and the original cost ofthe investment and is included in Other Income (Expense) on the ConsolidatedStatements of Operations and Comprehensive Income.

 

Accounts Receivable

 

The Company monitorsvendor receivables and extensions of credit on an ongoing basis and has notexperienced significant losses related to its receivables. At December 31,2005, the Company did not have significant credit risk concentrations. No customeror vendor represented greater than 3% of total accounts receivable. Issuancecosts related to Gelson’s Markets (Gelson’s) charge cards are not significantand are expensed as incurred.

 

Inventories

 

Supermarket nonperishableinventories are recorded using the retail method and are stated at the lower ofcost or market, with cost determined using the last-in, first-out (LIFO)method. Perishable inventories are valued at the lower of cost on a first-in,first-out (FIFO) method or market.

 

Inventoryreserves are maintained for dry goods at historical run rates that are adjustedannually and at each physical count (three times per year) to ensure adequacyof the reserve. Inventories of perishable items are taken at the end of everymonth, and balances are adjusted accordingly and flowed through cost of sales.

 

47

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Property, Plantand Equipment

 

Property, plant andequipment is recorded at cost. Depreciation is provided on the straight-linemethod over the estimated useful lives of individual assets or classes ofassets as follows:

 
|   | Buildings and  improvements          |   | 5 to 15 years |   |
|--------|--------------------------------------|--------|---------------|--------|
|   | Store fixtures and  office equipment |   | 3 to 8 years  |   |
|   | Transportation  equipment            |   | 2 to 5 years  |   |
|   | Machinery and equipment              |   | 3 to 10 years |   |

 

Leasehold interests andimprovements to leased properties are amortized over their estimated usefullives or lease period, whichever is shorter.

 

Leased property meetingcertain capital lease criteria is capitalized and the present value of therelated lease payments is recorded as a liability. Amortization of capitalizedleased assets is computed on the straight-line method over the shorter of theestimated useful life or the initial lease term.

 

Normal repairs andmaintenance are expensed as incurred. Expenditures which materially increasevalues, change capacities or extend useful lives are capitalized. Replacementsare capitalized and the property, plant and equipment accounts are relieved ofthe items being replaced. The related costs and accumulated depreciation ofdisposed assets are eliminated and any gain or loss on disposition is includedin Delivery, Selling, General and Administrative (DSG&A) Expense on theConsolidated Statements of Operations and Comprehensive Income.

 

Impairment ofLong-Lived Assets

 

The Company monitors thecarrying value of long-lived assets for potential impairment whenever events orchanges in circumstances indicate the carrying value of an asset may not berecoverable. Impairment is recognized when estimated future cash flows(undiscounted and before interest charges) are less than carrying value. Theestimation of expected future net cash flows is inherently uncertain and relieson assumptions regarding current and future economic and market conditions andthe availability of capital. If impairment analysis assumptions change, then anadjustment to the carrying value of the Company’s long-lived assets couldoccur. To the extent that an asset is impaired, the excess of the carryingamount of the asset over its estimated fair value is charged against earnings.

 

Fair Value ofFinancial Instruments

 

The carrying values ofcash and cash equivalents, accounts receivable, accounts payable and accruedliabilities approximate fair values because of the short-term maturity of theseinstruments. The fair value of long-term debt closely approximates its carryingvalue. The Company uses quoted market prices, when available, or discountedcash flows to calculate these fair values.

 

48

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Workers’Compensation and General and Auto Liability Costs

 

In June 2003, the Companyterminated its guaranteed cost workers’ compensation policy and purchased ahigh deductible workers’ compensation policy. Accordingly, the Company isprimarily self-insured for losses related to workers’ compensation, as well asgeneral and auto liability claims. The Company maintains stop-loss coverage tolimit its loss exposure on a per claim basis and is insured for covered costsin excess of per claim limits. Accruals are based on reported claims and anestimate of claims incurred but not reported. The Company’s liability reservefor unpaid and incurred but not reported claims at December 31, 2005 andJanuary 1, 2005 was approximately $9,523,000 and $6,868,000, respectively.While the ultimate amount of claims incurred are dependent on futuredevelopments, the recorded reserves reflect management’s best estimate ofclaims to be incurred.

 

RevenueRecognition

 

The Company recognizesrevenue at the time of sale. Discounts given to customers are recorded at thepoint of sale as a reduction of revenues. The Company maintains a bad debtallowance for receivables from vendors and Gelson’s credit card sales.Valuation reserves are adjusted periodically based on historical recoveryrates. The Company records income from licensing arrangements, subleases,leases and finance charges as they are earned. Income from all licensingarrangements, rental income and finance charges represents less than 1% ofsales for all periods presented, and therefore is not disclosed separately onthe Consolidated Statements of Operations and Comprehensive Income.

 

Merchandise Costs

 

Costof sales 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’sdistribution network are recorded as DSG&A expense. These costs totaledapproximately $6,320,000, $6,203,000 and $6,211,000 for 2005, 2004 and 2003,respectively. Warehousing and transportation costs include labor, buildingrent, utilities, depreciation, repairs and maintenance and fuel for theCompany’s distribution center and distribution system.

 

Vendor Allowances

 

Promotionaland rebate allowances make up the majority of all allowances. With promotionalallowances, vendors pay the Company to promote their product. The promotion maybe a temporary price reduction, a feature in a print advertisement ornewsletter, or placement of the vendor’s product in a preferred location in astore. The promotions are typically two to three weeks long and are recognizedwhen the commitment has been fulfilled. Promotional and vendor rebateallowances are recorded as a reduction of Cost of Sales except advertisingreimbursements which are recorded as a reduction of advertising expense whichis included in DSG&A expense. The Company also receives other allowanceswhich are recognized as a reduction of Cost of Sales when they are earned.

 

Occasionally, the Companyreceives rebate allowances in the form of upfront lump-sum payments fromvendors. Under the terms of these long-term agreements, the Company earns

 

49

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the rebates as itpurchases product from the vendor. The upfront payments are recorded as aliability when they are received and are recorded as a reduction of inventorycost as the product is purchased. In the event that the Company does notpurchase the minimum amount of product specified in the agreement, the upfrontpayments must be returned on a pro rata basis to the vendor. If the contractdoes not specify that the rebate is earned as product is purchased, then theupfront payments are recorded as a liability when received and recognized as areduction of Cost of Sales on a pro rata basis as the product is sold.

 

Stock Options and Stock Appreciation Rights

 

As allowed by SFAS 123,“Accounting for Stock-Based Compensation” (as amended by SFAS 148, “Accountingfor Stock-Based Compensation Transition and Disclosure”), the Company followsthe disclosure requirements of SFAS 123, but continues to account for its Non-Officerand Non-Director Stock Option Plan (Stock Option Plan) in accordance withAccounting Principles Board Opinion No. (APB) 25, “Accounting for Stock Issuedto Employees,” which results in no charge to earnings when options are issuedat fair market value. The Company has not issued any options since fiscal 2000.There were no stock options outstanding during fiscal 2005.

 

The following table illustrates the effect on netincome and net income per share as if FAS 123 had been applied to alloutstanding stock option awards and stock appreciation rights (SARs) in each ofthe periods presented (1):

 
| **(In Thousands, Except Per Share Data)**                                                  | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net income as  reported                                                                                             |       | $        | 19,851     |     | $          | 22,672   |       | $ | 16,581 |   |
|                                                                                                                |       |     |       |     |       |     |       |
| Add:    Stock-based compensation expense determined  under APB 25, net of related tax effects        |       | 561      |       | 2,169    |       | 492      |       |
|                                                                                                                |       |     |       |     |       |     |       |
| Deduct:  Total stock-based employee compensation  expense determined under FAS 123, net of related tax effects |       | (561     | )          | (2,174   | )          | (460     | )          |
|                                                                                                                |       |     |       |     |       |     |       |
| Pro forma net  income                                                                                               |       | $        | 19,851     |     | $          | 22,667   |       | $ | 16,613 |   |
|                                                                                                                |       |     |       |     |       |     |       |
| Net income per  share:                                                                                              |       |     |       |     |       |     |       |
|                                                                                                                |       |     |       |     |       |     |       |
| Basic – Class A as  reported                                                                                   |       | $        | 5.87       |     | $          | 7.00     |       | $ | 5.11 |   |
| Basic – Class A pro  forma                                                                                     |       | 5.87     |       | 7.00     |       | 5.10     |       |
|                                                                                                                |       |     |       |     |       |     |       |
| Basic – Class B as  reported                                                                                   |       | N/A      |       | 6.13     |       | 4.60     |       |
| Basic – Class B pro  forma                                                                                     |       | N/A      |       | 6.13     |       | 4.60     |       |
|                                                                                                                |       |     |       |     |       |     |       |
| Diluted – as reported                                                                                          |       | 5.87     |       | 6.70     |       | 4.90     |       |
| Diluted – pro forma                                                                                            |       | 5.87     |       | 6.70     |       | 4.90     |       |

 

----

(1)                       2004 and 2003 stock based compensation amounts have been adjusted toinclude SARs compensation expense which was previously excluded from thepresentation above.

 

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The Company hasoutstanding SARs that have been granted to non-employee directors and certainemployees. Stock-based compensation under the SARs program is subject tovariable accounting in accordance with Financial Accounting Standards BoardInterpretation No. (FIN) 28, “Accounting for Stock Appreciation Rights andOther Variable Stock Option or Award Plans.” The Company records compensationexpense related to the vesting of SARs using the appropriate amortizationschedule as required by FIN 28. In addition, changes in the market price of theCompany’s Class A Common Stock (Class A) impact the charge related to SARs.

 

Effective beginning thefirst quarter of 2006, the Company will account for the SARs program inaccordance with SFAS 123R as discussed below under “Impact of Recently IssuedAccounting Standards.”

 

EnvironmentalCosts

 

Costs incurred toinvestigate and remediate contaminated sites are expensed as incurred.

 

Store OpeningCosts

 

Noncapital expendituresincurred in opening a new store are expensed as incurred.

 

Advertising andSales Promotion Costs

 

Advertising and salespromotion costs are expensed as incurred under DSG&A expense and totaled $2,845,000,$3,047,000 and $2,844,000 in 2005, 2004 and 2003, respectively.

 

Rental Expense

 

Rental payments onoperating leases are recorded over the lease term as they become payable orreceivable except for rental payments on leases with scheduled rent increaseswhich are recognized on a straight-line basis over the term of the lease.

 

Income Taxes

 

Deferred tax assets andliabilities are determined based on the difference between the financialstatement and tax bases of assets and liabilities, using enacted tax rates ineffect for the year in which the differences are expected to reverse.

 

Common Stock andNet Income Per Share

 

Effectivewith the second quarter of 2004, the Company adopted EITF No. 03-6,“Participating Securities and the Two-Class method under Financial AccountingStandards Board Statement No. 128,” which requires the use of the Two-Classmethod to calculate basic net income per share when a company has convertibleparticipating securities. Prior to November 10, 2004, the Company had two classesof Common Stock including Class B Common Stock (Class B) which was convertibleon a share–for-share basis into Class A. Class B stockholders were entitled toshare in 90% of the dividends (other than stock dividends) paid to Class Astockholders. Under the Two-Class method, the Company

 

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assumesthat 100% of undistributed earnings are distributed to Class A and Class Bstockholders according to the formula for allocation of dividends.Consequently, the Two-Class method results in a higher allocation of net incomeand net income per share to Class A versus Class B stockholders. Basic netincome per share is computed by dividing the net income attributable to Class Aand Class B stockholders, respectively, by the weighted average number ofcommon shares outstanding under each class during the period.

 

OnNovember 10, 2004, Bernard Briskin, Chairman of the Board and Chief ExecutiveOfficer of the Company, elected to convert Class B shares beneficially owned byhim, including shares beneficially owned with his spouse into Class A shares.The conversion of these shares triggered the automatic and simultaneousconversion of all remaining Class B shares as provided under the Company’sRestated Certificate of Incorporation. After the conversion, the Company hasonly Class A outstanding and all stockholders will participate equally in theundistributed earnings of the Company.

 

Dilutednet income per share is computed using the If Converted method in accordance withSFAS 128. Diluted net income per share is computed by dividing net incomeattributable to common stockholders by the weighted average number of commonand potential common shares outstanding during the period. Potential commonshares included in the diluted computation represent shares issuable uponassumed exercise of stock options using the Treasury Stock method. Diluted netincome 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 areconverted to Class A shares.

 

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**Net Income Per Share Reconciliation**

(InThousands Except Share and Per Share Data):

 
| ** **                         | ** ** | **2005**  | ** ** | **2004**  | ** ** | **2003**  | ** ** |
|------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
| Basic net income  per share:       |       |      |       |      |       |      |       |
|                               |       |      |       |      |       |      |       |
| Common Stock –  Class A       |       |      |       |      |       |      |       |
|                               |       |      |       |      |       |      |       |
| Dividends  declared (1)            |       | $         | 3,381      |      | $          | 2,360     |       | $ | 1,009 |   |
| Undistributed  earnings            |       | 16,470    |       | 13,167    |       | 9,298     |       |
| Allocated  earnings                |       | $         | 19,851     |      | $          | 15,527    |       | $ | 10,307 |   |
|                               |       |      |       |      |       |      |       |
| Weighted average  shares           |       | 3,381,051 |       | 2,217,675 |       | 2,015,859 |       |
|                               |       |      |       |      |       |      |       |
| Net income per  share              |       | $         | 5.87       |      | $          | 7.00      |       | $ | 5.11 |   |
|                               |       |      |       |      |       |      |       |
| Common Stock –  Class B       |       |      |       |      |       |      |       |
|                               |       |      |       |      |       |      |       |
| Dividends  declared (1)            |       |      |       | $         | 920        |      | $          | 613 |   |
| Undistributed  earnings            |       |      |       | 6,225     |       | 5,661     |       |
| Allocated  earnings                |       |      |       | $         | 7,145      |      | $          | 6,274 |   |
|                               |       |      |       |      |       |      |       |
| Weighted average  shares           |       |      |       | 1,164,977 |       | 1,363,584 |       |
|                               |       |      |       |      |       |      |       |
| Net income per  share              |       |      |       | $         | 6.13       |      | $          | 4.60 |   |
|                               |       |      |       |      |       |      |       |
| Diluted net  income per share:     |       |      |       |      |       |      |       |
|                               |       |      |       |      |       |      |       |
| Net income  allocated to Class A   |       | $         | 19,851     |      | $          | 15,527    |       | $ | 10,307 |   |
| Net income allocated  to Class B   |       |      |       | 7,145     |       | 6,274     |       |
| Total net income                   |       | $         | 19,851     |      | $          | 22,672    |       | $ | 16,581 |   |
|                               |       |      |       |      |       |      |       |
| Weighted average  shares:          |       |      |       |      |       |      |       |
|                               |       |      |       |      |       |      |       |
| Class A shares  outstanding        |       | 3,381,051 |       | 2,217,675 |       | 2,015,859 |       |
| Assumed  conversion of Class B     |       |      |       | 1,164,977 |       | 1,363,584 |       |
| Assumed exercise  of stock options |       | 0         |       | 0         |       | 1,081     |       |
| Total weighted  average shares     |       | 3,381,051 |       | 3,382,652 |       | 3,380,524 |       |
|                               |       |      |       |      |       |      |       |
| Net income per  share              |       | $         | 5.87       |      | $          | 6.70      |       | $ | 4.90 |   |

 

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(1)               Dividendsdeclared exclude the payment of a $67,665 special dividend in fiscal 2004 as itrelated to prior years’ undistributed earnings.

 

Use of Estimates

 

The preparation offinancial statements in conformity with generally accepted accountingprinciples (GAAP) requires management to make estimates and assumptions for thereporting period and as of the financial statement date. These estimates andassumptions affect the reported amounts of assets and liabilities, thedisclosure of contingent liabilities and the reported amounts of revenues andexpenses. Actual results could differ from these estimates.

 

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Impactof Recently Issued Accounting Standards

 

InMarch 2004, the EITF amended and ratified previous consensus on EITF No. 03-1,“The Meaning of Other-Than-Temporary Impairment and its Application to CertainIssues.” EITF No. 03-1 establishes guidance to be used in determining when aninvestment is considered impaired, whether that impairment is other-than-temporaryand the measurement of an impairment loss. The effective date was originallythe Company’s third quarter of 2004. In September 2004, the FinancialAccounting Standards Board (FASB) issued EITF No. 03-1-1, “Effective Date ofParagraphs 10-20 of EITF 03-1,” to delay the effective date pending furtherdiscussions by the EITF. In November 2005, the FASB issued FASB Staff Position(FSP) Nos. FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-TemporaryImpairment and its Application to Certain Investments,” which addresses thedetermination as to when an investment is considered impaired, whether thatimpairment is other-than-temporary and the measurement of an impairment loss.This FSP also includes accounting considerations subsequent to the recognitionof an other-than-temporary impairment and requires certain disclosures aboutunrealized losses that have not been recognized as other-than-temporaryimpairments. This pronouncement is effective beginning with the Company’s firstquarter of 2006. The Company does not currently have any other-than-temporaryimpairment, and therefore, adoption of this standard will not have asignificant impact on the Company’s consolidated financial statements.

 

InNovember 2004, the FASB issued SFAS 151, “Inventory Costs - an amendment of ARBNo. 43, Chapter 4.” SFAS 151 clarifies that inventory costs that are “abnormal”are required to be charged to expense as incurred as opposed to beingcapitalized into inventory as a product cost. SFAS 151 provides examples of“abnormal” costs including costs of idle facilities, excess freight andhandling costs and spoilage. SFAS 151 is effective for the Company’s fiscalyear beginning January 1, 2006. Adoption of this standard will not have animpact on the Company’s consolidated financial statements.

 

InDecember 2004, the FASB issued SFAS 123R (revised 2004), “Share-Based Payment.”This statement will eliminate the ability to account for share-basedcompensation transactions using APB 25, “Accounting for Stock Issued toEmployees.” Under the provisions of SFAS 123R, the Company’s SARs will beaccounted for as a liability award with the fair value of SARs issuedcalculated using a Black Scholes model at each reporting period. Compensationexpense continue to be recorded over the vesting period of the award. TheCompany intends to adopt SFAS 123R using the Modified Prospective Transitionmethod which will require a cumulative adjustment for the difference, if any,in the amount of accrued compensation expense recorded as of December 31, 2005and the amount required under the provisions of SFAS 123R. The Company is stillin the process of evaluating the impact that the adoption of SFAS 123R willhave on its consolidated financial statements.

 

InMarch 2005, the FASB issued FIN 47, “Accounting for Conditional AssetRetirement Obligations,” an interpretation of SFAS 143. This statementclarified the term conditional asset retirement obligation and is effective forthe Company’s fourth quarter ending December 31, 2005. Adoption of FIN 47 didnot have an impact on the Company’s consolidated financial statements.

 

54

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InSeptember 2005, the EITF amended and ratified previous consensus on EITF No.05-6, “Determining the Amortization Period for Leasehold Improvements Purchasedafter Lease Inception or Acquired in a Business Combination,” which addressesthe amortization period for leasehold improvements in operating leases that areeither placed in service significantly after and not contemplated at or nearthe beginning of the initial lease term or acquired in a business combination.This consensus applies to leasehold improvements that are purchased or acquiredin reporting periods beginning after ratification. Adoption of the provisionsof EITF No. 05-6 did not have an impact on the Company’s consolidated financialstatements.

 

InOctober 2005, the FSAB issued FSP SFAS 13-1, “Accounting for Rental CostsIncurred during a Construction Period.” FSP SFAS 13-1 clarifies that rentalcosts associated with ground or building operating leases that are incurredduring a construction period should be recognized as rental expense. Thisstatement is effective with the Company’s first quarter of 2006. Adoption ofthis standard will not have an impact on the Company’s consolidated financialstatements.

 

2.                    Investments

 

Marketable securities areshown on the accompanying Consolidated Balance Sheets at their fair value.

 
| ** **                           | ** ** | ** ** | ** ** | **Unrealized**       | ** ** | ** **          | ** ** |
|--------------------------------------|------------|------------|------------|----------------------|------------|---------------------|------------|
| **(In Thousands)**              | ** ** | **Cost**   | ** ** | **Gain (Loss)** | ** ** | **Fair Value** | ** ** |
| As of December  31, 2005:            |       |       |       |                 |       |                |       |
|                                 |       |       |       |                 |       |                |       |
| Investments:                         |       |       |       |                 |       |                |       |
| Mutual funds                         |       | $          | 18,399     |                 | $          | (509                | )          | $ | 17,890 |   |
| United States  government securities |       | 1,998      |       | (23                  | )          | 1,975               |       |
| Debt securities                      |       | 746        |       | 39                   |       | 785                 |       |
| Total                                |       | $          | 21,143     |                 | $          | (493                | )          | $ | 20,650 |   |
|                                 |       |       |       |                 |       |                |       |
| As of January 1,  2005:              |       |       |       |                 |       |                |       |
|                                 |       |       |       |                 |       |                |       |
| Investments:                         |       |       |       |                 |       |                |       |
| Mutual funds                         |       | $          | 21,729     |                 | $          | (13                 | )          | $ | 21,716 |   |
| United States  government securities |       | 1,997      |       | (16                  | )          | 1,981               |       |
| Debt securities                      |       | 2,185      |       | 196                  |       | 2,381               |       |
| Total                                |       | $          | 25,911     |                 | $          | 167                 |       | $ | 26,078 |   |

 

The investments in debtand United States government securities all have maturity dates of less thanone year.  Realized net gain from the saleof investments was $8,000, $1,739,000 and $843,000 in 2005, 2004 and 2003,respectively. In addition, the Company recognized capital gain income frommutual funds of $28,000, $48,000 and $107,000 in 2005, 2004 and 2003,respectively. Realized net gain (loss) from the sale of investments and capitalgain income are included in Other Income (Expense) on the ConsolidatedStatements of Operations and Comprehensive Income.

 

55

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3.                    AccountsReceivable, Net

 
| **(In Thousands)**                | ** ** | **December 31, 2005** | ** ** | **January 1, 2005** | ** ** |
|----------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
|                                   |       |                            |       |                          |       |   |   |
| Accounts  receivable, trade            |       | $                               | 3,220      |                          | $          | 3,388 |   |
| Other accounts  receivable             |       | 2,689                           |       | 2,826                         |       |
|                                   |       | 5,909                           |       | 6,214                         |       |
| Less: Allowance  for doubtful accounts |       | (195                            | )          | (181                          | )          |
|                                   |       | $                               | 5,714      |                          | $          | 6,033 |   |

 

The provision fordoubtful accounts in 2005, 2004 and 2003 was approximately $49,000, $15,000 and$0.

 

4.                    Inventories

 

Inventories valued by theLIFO method totaled $15,750,000 in 2005, $15,586,000 in 2004 and $13,880,000 in2003. Inventory balances would have been $4,155,000, $3,771,000 and $3,399,000higher at the end of 2005, 2004 and 2003, respectively, if they had been statedat the lower of FIFO cost or market. The LIFO effect on net income was adecrease of approximately $227,000, $221,000 and $126,000 in 2005, 2004 and2003, respectively.

 

5.                    SignificantSupplier

 

During 2005, the Companyprocured approximately 18% of its product through Unified Western Grocers, Inc.(Unified), a grocery cooperative. As a member-patron, the Company is requiredto provide Unified with certain minimum deposits and credit in order topurchase product from the cooperative. As of December 31, 2005, the Company hadapproximately $2,150,000 on deposit with Unified and recorded under OtherAssets on the Consolidated Balance Sheet. The minimum deposit requirement issatisfied through a combination of cash, credit and ownership of equity sharesin Unified.

 

6.                    Property,Plant and Equipment

 
| **(In Thousands)**                    | ** ** | **December 31, 2005** | ** ** | **January 1, 2005** | ** ** |
|--------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
|                                       |       |                            |       |                          |       |
| Land                                       |       | $                               | 8,584      |                          | $          | 8,584 |   |
| Buildings and  improvements                |       | 9,693                           |       | 9,693                         |       |
| Store fixtures  and office equipment       |       | 40,903                          |       | 40,049                        |       |
| Transportation  equipment                  |       | 2,789                           |       | 2,774                         |       |
| Machinery and  equipment                   |       | 1,752                           |       | 1,268                         |       |
| Leasehold  improvements                    |       | 47,513                          |       | 45,484                        |       |
| Leasehold  interests                       |       | 4,538                           |       | 4,538                         |       |
| Assets under  capital leases               |       | 2,200                           |       | 3,058                         |       |
| Property for  resale                       |       | 49                              |       | 51                            |       |
|                                       |       | 118,021                         |       | 115,499                       |       |
|                                       |       |                            |       |                          |       |
| Accumulated  depreciation and amortization |       | (70,481                         | )          | (64,998                       | )          |
|                                       |       | $                               | 47,540     |                          | $          | 50,501 |   |
|                                       |       |                            |       |                          |       |
| Assets under  construction                 |       | $                               | 2,485      |                          | $          | 761 |   |

 

56

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As of December 31, 2005,approximately $34,425,000 of property, plant and equipment (at cost) was fullydepreciated and is still being used in operations. As of December 31, 2005, theCompany has recorded $2,031,000 in accumulated amortization for assets undercapital lease.

 

In the fourth quarter of2003, the Company recorded a $4,311,000 pre-tax impairment on long-lived assetsrelated to leasehold improvements and equipment at its Pasadena store. Sales atPasadena have been below management’s expectations since the store’s initialopening in September 2001. During the fourth quarter of 2003, a labor disputein the Company’s trade area temporarily resulted in improved sales at thePasadena store. Sales have declined since the conclusion of the labor disputealthough they are still higher than prestrike levels. The Pasadena store iscurrently open and operating; however, sales still are not meeting management’soriginal expectations. The impaired assets are in use at the store at thistime. The impairment charge, a component of DSG&A expense, reflects thedifference between the carrying value of the Pasadena assets and the estimatedfair value, which is based on the discounted future cash flows using arisk-free interest rate. TheCompany had exercised its right to terminate the Pasadena lease in the Springof 2005, but the lease was reinstated by mutual agreement on different terms inApril 2005. A termination of the lease in the future may result in anadditional write-off of fixed assets and other costs at that time. As ofDecember 31, 2005, the remaining net book value of fixed assets related to thePasadena store was $376,000.

 

7.                    Other CurrentLiabilities

 
| **(In Thousands)**         | ** ** | **December 31, 2005** | ** ** | **January 1, 2005** | ** ** |
|---------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| Employee  compensated absences  |       | $                               | 5,211      |                          | $          | 5,267 |   |
| Stock  appreciation rights      |       | 3,275                           |       | 3,057                         |       |
| Employee  benefits              |       | 2,975                           |       | 2,834                         |       |
| Taxes (excluding  income taxes) |       | 2,462                           |       | 2,631                         |       |
| Payroll                         |       | 2,179                           |       | 1,968                         |       |
| Workers’  compensation     |       | 2,151                           |       | 1,739                         |       |
| Dividends  payable              |       | 845                             |       | 846                           |       |
| Rent                            |       | 789                             |       | 1,005                         |       |
| Other                           |       | 3,771                           |       | 3,734                         |       |
|                            |       | $                               | 23,658     |                          | $          | 23,081 |   |

 

8.                    Long-Term Debt

 
| ** **                                               | ** ** | **Current**          | ** ** | **Non-Current**     | ** ** |
|----------------------------------------------------------|------------|----------------------|------------|---------------------|------------|
| ** **                                               | ** ** | **Decembe 31,** | ** ** | **January 1,** | ** ** | **Decembe 31,** | ** ** | **January 1,** | ** ** |
| **(In Thousands)**                                  | ** ** | **2005**             | ** ** | **2005**            | ** ** | **2005** | ** ** | **2005** | ** ** |
|                                                     |       |                 |       |                |       |   |   |   |   |
| Obligations  under capital leases                        |       | $                    | 221        |                | $          | 273 |   | $ | 225 |   | $ | 536 |   |
| 7% Subordinated  income debentures due September 1, 2014 |       |                 |       |                |       | 1,228 |   | 1,228 |   |
|                                                     |       | $                    | 221        |                | $          | 273 |   | $ | 1,453 |   | $ | 1,764 |   |

 

57

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At December 31, 2005, theapproximate principal payments required on long-term debt for each fiscal yearare as follows:

 
| **(In Thousands)** | ** ** | ** ** | ** ** |
|-------------------------|------------|------------|------------|
|                    |       |       |       |   |
| 2007                    |       | $          | 225        |   |
| 2014                    |       | 1,228      |       |
|                    |       | $          | 1,453      |   |

 

The Company hasbank revolving lines of credit in the amount of $20,000,000 which expires inAugust 2006 and $3,000,000 which expires in October 2006. Borrowings bearinterest at the bank’s prime rate or the adjusted London Interbank Offer Rate(LIBOR) plus an index up to 1.2%. At the end of 2005 and 2004, there were noamounts borrowed against either of the revolving lines of credit. The Companycurrently maintains five standby letters of credit aggregating $14,444,000pursuant to the Company’s general liability and workers’ compensationself-insurance programs. The standby letters of credit reduce the availableborrowings under its revolving lines of credit.

 

Debentures: The indenturerelating to the 7% Subordinated Income Debentures (7% Debentures), dueSeptember 1, 2014, provides for interest payable semi-annually on March 1and September 1 to the extent that current annual net income is sufficienttherefor, or at the discretion of the Company, out of available retainedearnings. No accrued interest was in arrears as of December 31, 2005. The 7%Debentures are recorded at face value which approximates its fair value.

 

9.                    Capital Stock

 

Class A CommonStock: The Company is authorized to issue 10,000,000 shares of Class A, parvalue $.25 per share. At December 31, 2005 and January 1, 2005, the number ofshares issued were 4,736,202 and 4,740,452*,*respectively,including 1,357,200 treasury shares. During 2005 and 2003, the Companypurchased and retired 4,250 and 4,942 shares of its Class A for an aggregatepurchase price of approximately $334,000 and $296,000, respectively. The ClassA has one vote per share on all matters on which stockholders are entitled tovote or consent.

 

ClassB Common Stock: The Company was authorized to issue 1,500,000 shares ofconvertible participating Class B, par value $.25 per share. At December 31,2005 and January 1, 2005, there were no shares issued and outstanding. TheClass B had ten votes per share on virtually all matters on which stockholderswere entitled to vote or consent. Cash or property dividends on Class B wererestricted to an amount equal to 90% of any dividend paid on Class A. Transferof Class B was restricted to other Class B stockholders and certain otherclasses of transferees. Class B was convertible, at the option of the holder,into Class A on a share-for-share basis. As a result of the automaticconversion of all Class B shares as described below, under the Company’sRestated Certificate of Incorporation, future issuances of Class B areprohibited.

 

OnOctober 25, 2004, the Company’s Board of Directors declared a special dividendof $20 per share on its Class A and $18 per share on its Class B. The dividendtotaled approximately $67,665,000 and was paid on December 16, 2004 to holdersof record on November 15, 2004.

 

58

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As of the dividenddeclaration date, Bernard Briskin, Chairman of the Board and Chief ExecutiveOfficer of the Company, was the beneficial owner of 1,362,496 shares of theCompany’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. OnNovember 10, 2004, Mr. Briskin and his spouse elected to convert shares ofClass B owned by them into an equal number of the Company’s Class A shares. Theconversion of these shares triggered the automatic and simultaneous conversionof all remaining Class B shares as provided under the Company’s RestatedCertificate of Incorporation. As a result, all owners of the Company’s Class Bbecame owners of Class A prior to the dividend record date and were entitled toreceive the dividend payable on Class A issued upon such conversion.

 

The Board of Directors alsoapproved a $20 antidilution adjustment reducing the exercise price of alloutstanding SARs to account for the anticipated effect of the special dividendon the Company’s Class A share price.

 

OnJanuary 20, 2006, the Company paid a regular quarterly cash dividend of 25cents per share of Class A, aggregating approximately $845,000, to stockholdersof record on December 30, 2005. Subsequent to fiscal 2005 year end, theCompany’s Board of Directors authorized the purchase of up to an additional150,000 shares of Class A under the Company’s existing stock buyback program.During January and February 2006, the Company purchased 149,573 shares of ClassA in unsolicited private transactions with unrelated parties for an aggregatepurchase price of approximately $12,481,000.

 

10.              Stock Options andStock Appreciation Rights

 

In 1998, the Companyadopted the Stock Option Plan which initially provided for the granting ofstock options to key employees to purchase up to 35,000 shares of the Company’sClass A. The Stock Option Plan was amended in fiscal 2000 to increase thenumber of shares available thereunder to an aggregate of 70,000 shares. Theobjective of the Stock Option Plan is to attract and retain quality personneland to promote the success of the Company by providing employees theopportunity to share in its growth. These options vest at 25% per yearbeginning at the end of the first year and expire five years from the date ofgrant. The exercise price of stock options granted under the Stock Option Planis equal to the fair market value of the Company’s Class A on the date ofgrant. There were no stock options issued and outstanding as of December 31,2005.

 

The Company also has granted SARs covering shares ofthe Company’s Class A to non-employee directors and certain employees of theCompany. Each SAR entitles the holder to receive upon exercise thereof theexcess of the fair market value of a share of Class A on the date ofexercise over the fair market value of such share on the date granted. The SARsvest 25% each year beginning at the end of the first year and expire five yearsfrom the date of grant.

 

Stock options and SARs transactions during the pastthree years are summarized below. The weighted average exercise price of SARsoutstanding on October 25, 2004, was adjusted to reflect the declaration of aspecial dividend of $20 per share of the Company’s Class A on that date tostockholders of record on November 15, 2004.

 

59

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| ** **                          | ** ** | ** **                      | ** ** | ** **                       | ** ** | **SARs (1)**           | ** ** |
|-------------------------------------|------------|---------------------------------|------------|----------------------------------|------------|-----------------------------|------------|
| ** **                          | ** ** | **Stock Options (1)** | ** ** | **Officers and  Employees** | ** ** | **Non-Employee  Directors** | ** ** |
| ** **                          | ** ** | ** **                      | ** ** | **Weighted**                     | ** ** | ** **                  | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                          | ** ** | **Options**                     | ** ** | **Average Price**           | ** ** | **SARs**                    | ** ** | **Average Price** | ** ** | **SARs** | ** ** | **Average Price** | ** ** |
| Outstanding as  of 12/28/02         |       | 26,750                          |       | $                                | 15.81      |                        | 7,500      |   | $ | 10.89 |   | 32,500 |   | $ | 14.89 |   |
| Granted                             |       | 0                               |       | $                                | 0.00       |                        | 64,500     |   | $ | 51.88 |   | 10,000 |   | $ | 34.25 |   |
| Exercised                           |       | 23,875                          |       | $                                | 16.62      |                        | 3,125      |   | $ | 13.44 |   | 13,250 |   | $ | 9.06 |   |
| Forfeitures                         |       | 875                             |       | $                                | 9.06       |                        | 0          |   | $ | 0.00 |   | 0 |   | $ | 0.00 |   |
| Outstanding as  of 1/3/04           |       | 2,000                           |       | $                                | 9.06       |                        | 68,875     |   | $ | 49.16 |   | 29,250 |   | $ | 24.15 |   |
| Granted                             |       | 0                               |       | $                                | 0.00       |                        | 13,000     |   | $ | 57.00 |   | 50,000 |   | $ | 57.50 |   |
| Exercised                           |       | 2,000                           |       | $                                | 9.06       |                        | 9,450      |   | $ | 34.81 |   | 19,250 |   | $ | 19.71 |   |
| Outstanding as  of 1/1/05           |       | 0                               |       | $                                | 0.00       |                        | 72,425     |   | $ | 52.44 |   | 60,000 |   | $ | 53.36 |   |
| Granted                             |       | 0                               |       | $                                | 0.00       |                        | 5,000      |   | $ | 86.22 |   | 10,000 |   | $ | 78.43 |   |
| Exercised                           |       | 0                               |       | $                                | 0.00       |                        | 10,375     |   | $ | 41.10 |   | 10,000 |   | $ | 57.50 |   |
| Outstanding as  of 12/31/05         |       | 0                               |       | $                                | 0.00       |                        | 67,050     |   | $ | 56.72 |   | 60,000 |   | $ | 56.85 |   |
| Exercisable as  of 12/31/05         |       |                            |       |                             |       | 20,050                      |       |   |   | 15,000 |   |   |   |
| Available for  grant as of 12/31/05 |       | 28,500                          |       |                             |       | N/A                         |       |   |   | N/A |   |   |   |

 

The following table summarizes information about theCompany’s SARs outstanding at December 31, 2005:

 
| ** **                       | ** ** | **SARs Outstanding (1)** | ** ** | **SARs Exercisable (1)** | ** ** |
|----------------------------------|------------|------------------------------------|------------|------------------------------------|------------|
| ** **                       | ** ** | ** **                         | ** ** | **Weighted**                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                       | ** ** | ** **                         | ** ** | **Average**                        | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                       | ** ** | ** **                         | ** ** | **Remaining**                      | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| **Range of**                | ** ** | **Number**                         | ** ** | **Contractual**                    | ** ** | **Exercise** | ** ** | **Number** | ** ** | **Exercise** | ** ** |
| **Exercise Price (1)** | ** ** | **Outstanding**                    | ** ** | **Life**                           | ** ** | **Price** | ** ** | **Exercisable** | ** ** | **Price** | ** ** |
|                             |       |                               |       |                               |       |   |   |   |   |   |   |
| SARs - Officers  & Employees |       |                               |       |                               |       |   |   |   |   |   |   |
| $ 40.50                     |       |                               | 10,000     |                               | 2.6 years  |   | $ | 40.50 |   | 0 |   | $ | 40.50 |   |
| $ 57.00                     |       |                               | 39,050     |                               | 2.9 years  |   | $ | 57.00 |   | 16,800 |   | $ | 57.00 |   |
| $ 57.00                     |       |                               | 13,000     |                               | 3.5 years  |   | $ | 57.00 |   | 3,250 |   | $ | 57.00 |   |
| $ 86.22                     |       |                               | 5,000      |                               | 5.0 years  |   | $ | 86.22 |   | 0 |   | $ | 86.22 |   |
|                             |       | 67,050                             |       | 3.1 years                          |       | $ | 56.72 |   | 20,050 |   | $ | 57.00 |   |
|                             |       |                               |       |                               |       |   |   |   |   |   |   |
| SARs -  Non-Employee Directors   |       |                               |       |                               |       |   |   |   |   |   |   |
| $ 28.00                     |       |                               | 2,500      |                               | .5 years   |   | $ | 28.00 |   | 2,500 |   | $ | 28.00 |   |
| $ 34.25                     |       |                               | 7,500      |                               | 2.3 years  |   | $ | 34.25 |   | 2,500 |   | $ | 34.25 |   |
| $ 57.50                     |       |                               | 40,000     |                               | 3.1 years  |   | $ | 57.50 |   | 10,000 |   | $ | 57.50 |   |
| $ 78.43                     |       |                               | 10,000     |                               | 4.5 years  |   | $ | 78.43 |   | 0 |   | $ | 78.43 |   |
|                             |       | 60,000                             |       | 3.1 years                          |       | $ | 56.85 |   | 15,000 |   | $ | 48.71 |   |

 

----

(1) Exercise price reflects a $20 antidilution adjustment. See Note 9above.

 

For 2005, 2004 and 2003, the Company incurred compensation expenserelated to SARs of $946,000, $3,658,000 and $740,000, respectively.

 

60

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11.              Retirement Plans

 

The Company contributesto multi-employer union pension plans, administered by various trustees, whichmay be deemed to be defined benefit plans. Contributions to these plans arebased upon negotiated wage contracts. Information relating to accumulatedbenefits and fund assets as they may be allocable to the participants atDecember 31, 2005 is not available. The Company records pension expense forthese plans as contributions are made. The Company’s total union pensionexpense for all plans for 2005, 2004 and 2003 amounted to $6,241,000,$6,064,000 and $4,787,000, respectively. Contributions to the multi-employerunion pension plan covering the majority of the Company’s employees weresuspended for two months in 2003.

 

The Arden Group, Inc.401(k) Retirement Savings Plan (Company Savings Plan) covers all non-unionemployees of the Company and its subsidiaries who have attained the age of 18and have completed at least one year of service. The Company Savings Planprovides that, with certain limitations, a participating employee may elect tocontribute up to 100% of such employee’s annual compensation up to a maximum of$14,000 in 2005 to the Company Savings Plan on a tax-deferred basis. TheCompany made discretionary contributions to the Company Savings Plan of$801,000, $805,000 and $837,000 for the years 2005, 2004 and 2003,respectively.

 

The Company maintains anoncontributory, trusteed Stock Bonus Plan (Plan) which is qualified underSection 401(a) of the Internal Revenue Code of 1986, as amended. Under theThird Amendment to the Plan, effective January 1, 2002, no new participants orcontributions to the Plan are allowed. Existing contributions must be investedin the Company’s Class A with excess cash being invested in certaingovernment-backed securities.

 

An employment agreementwith a key executive officer provides for annual retirement compensation equalto 25% of his average base salary and bonus earned in the last three yearsprior to his retirement. The Company has accrued its obligation under the termsof the employment agreement. The Company expensed $344,000, $521,000 and$101,000 toward this benefit in 2005, 2004 and 2003, respectively. This accrualis recorded under Other Liabilities on the Consolidated Balance Sheets.

 

12.              Multi-Employer UnionHealth Care Plans

 

The Company contributesto multi-employer union health care plans, administered by various trustees, inaccordance with the provisions of various labor contracts. Contributions tothese plans are generally based on the number of straight-time hours worked.The Company’s expense for these plans totaled $16,047,000, $16,977,000 and$21,019,000 for 2005, 2004 and 2003, respectively. Health care expense in 2003reflects a $5,797,000 assessment by the trust fund covering the majority of theCompany’s employees to pay health care claims and restore trust fund reservesdepleted during the labor dispute. In addition, pension plan contributions forthe same group of employees were suspended for two months in 2003. There wereno other employer withdrawals, shortfall contributions, maintenance of benefitclauses or other material changes that affected the comparability of employerand multi-employer contributions from year to year.

 

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13.              Income Taxes

 

The composition of thefederal and state income tax provision (benefit) is as follows:

 
| **(In Thousands)**       | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                          |       |     |       |     |       |     |       |
| Current:                      |       |     |       |     |       |     |       |
| Federal                       |       | $        | 12,944     |     | $          | 11,433   |       | $ | 12,457 |   |
| State                         |       | 3,494    |       | 3,385    |       | 3,811    |       |
| Total current  tax provision  |       | 16,438   |       | 14,818   |       | 16,268   |       |
|                          |       |     |       |     |       |     |       |
| Deferred:                     |       |     |       |     |       |     |       |
| Federal                       |       | (2,317   | )          | 709      |       | (3,587   | )          |
| State                         |       | (550     | )          | (29      | )          | (1,358   | )          |
| Total deferred  tax provision |       | (2,867   | )          | 680      |       | (4,945   | )          |
| Total income tax  provision   |       | $        | 13,571     |     | $          | 15,498   |       | $ | 11,323 |   |

 

The Company’s deferred taxassets (liabilities) were attributable to the following:

 
| **(In Thousands)**              | ** ** | **December 31, 2005** | ** ** | **January 1, 2005** | ** ** |
|--------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
|                                 |       |                            |       |                          |       |
| Deferred tax  assets:                |       |                            |       |                          |       |
| Accrued expenses                     |       | $                               | 8,457      |                          | $          | 6,640 |   |
| Deferred rent                        |       | 2,361                           |       | 1,985                         |       |
| State income  taxes                  |       | 1,182                           |       | 1,170                         |       |
| Allowance for  doubtful accounts     |       | 79                              |       | 74                            |       |
| Capital lease  obligations           |       | 184                             |       | 333                           |       |
| Other                                |       | 339                             |       | 328                           |       |
| Deferred tax  assets                 |       | 12,602                          |       | 10,530                        |       |
|                                 |       |                            |       |                          |       |
| Deferred tax  liabilities:           |       |                            |       |                          |       |
| Deferred gain on  debenture exchange |       | (2,855                          | )          | (3,016                        | )          |
| Capital lease  assets                |       | (69                             | )          | (126                          | )          |
| Other                                |       | (480                            | )          | (1,058                        | )          |
| Deferred tax  liabilities            |       | (3,404                          | )          | (4,200                        | )          |
| Deferred income  taxes, net          |       | $                               | 9,198      |                          | $          | 6,330 |   |

 

Reconciliation of thestatutory federal rate and effective rate is as follows:

 
| **(In Thousands, Except**             | ** ** | **2005**   | ** ** | **2004** | ** ** | **2003**   | ** ** |
|-------------------------------------------------|------------|------------|------------|----------|------------|------------|------------|
| **Percentage Amounts)**                    | ** ** | **Amount** | ** ** | **Rate** | ** ** | **Amount** | ** ** | **Rate** | ** ** | **Amount** | ** ** | **Rate** | ** ** |
| Federal tax at  statutory rate                  |       | $          | 11,698     |     | 35.0       | %          | $          | 13,360 |   | 35.0 | % | $ | 9,767 |   | 35.0 | % |
| State income  taxes, net of federal tax benefit |       | 1,920      |       | 5.7      | %          | 2,193      |       | 5.7 | % | 1,603 |   | 5.7 | % |
| Other                                           |       | (47        | )          | (.1      | )%         | (55        | )          | (.1 | )% | (47 | ) | (.1 | )% |
|                                            |       | $          | 13,571     |     | 40.6       | %          | $          | 15,498 |   | 40.6 | % | $ | 11,323 |   | 40.6 | % |

 

14.              Leases

 

The principal kinds ofproperty leased by the Company and its subsidiaries are supermarket buildings.The most significant obligations assumed under the lease terms, other thanrental

 

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payments, are the upkeepof the facilities, insurance and property taxes. Most supermarket leasescontain contingent rental provisions based on sales volume and have renewaloptions. The Company’s decision to exercise renewal options is primarilydependent on the level of business conducted at the location and theprofitability thereof.

 

All leases and subleaseswith an initial term greater than one year are accounted for under SFAS 13,“Accounting for Leases.” These leases are classified as either capital leases,operating leases or subleases, as appropriate.

 

Assets Under CapitalLeases: Assets under capital leases are capitalized using interest ratesappropriate at the inception of each lease. Contingent rentals associated withcapital leases in 2005, 2004 and 2003 were $193,000, $464,000 and $428,000,respectively, and accordingly have been charged to expense as incurred.Following is an analysis of assets under capital leases:

 
| **(In Thousands)**   | ** ** | **December 31, 2005** | ** ** | **January 1, 2005** | ** ** |
|---------------------------|------------|---------------------------------|------------|-------------------------------|------------|
|                      |       |                            |       |                          |       |
| Buildings:                |       |                            |       |                          |       |
| Cost                      |       | $                               | 2,200      |                          | $          | 3,058 |   |
| Accumulated  amortization |       | (2,031                          | )          | (2,749                        | )          |
|                      |       | $                               | 169        |                          | $          | 309 |   |

 

Future minimum leasepayments for the assets under capital leases at December 31, 2005 are asfollows:

 
| **(In Thousands)**                   | ** ** | ** ** | ** ** |
|-------------------------------------------|------------|------------|------------|
|                                      |       |       |       |
| 2006                                      |       | $          | 260        |   |
| 2007                                      |       | 238        |       |
|                                      |       |       |       |
| Total minimum  obligations                |       | 498        |       |
|                                      |       |       |       |
| Interest                                  |       | (52        | )          |
|                                      |       |       |       |
| Present value of  net minimum obligations |       | 446        |       |
| Current portion                           |       | (221       | )          |
|                                      |       |       |       |
| Long-term  obligations                    |       | $          | 225        |   |

 

Operating Leases andSubleases: In addition to capital leases, the Company is obligated underoperating leases, primarily for buildings, which expire at various datesthrough 2027. Future minimum lease payments for all noncancelable operating leaseshaving a remaining term in excess of one year at December 31, 2005 are asfollows:

 
| ** **              | ** ** | ** **      | ** ** | **Deduct**   | ** ** | **Net**         | ** ** |
|-------------------------|------------|-----------------|------------|--------------|------------|-----------------|------------|
| ** **              | ** ** | ** **      | ** ** | **Sublease** | ** ** | **Rental**      | ** ** |
| **(In Thousands)** | ** ** | **Commitments** | ** ** | **Rentals**  | ** ** | **Commitments** | ** ** |
|                    |       |            |       |         |       |            |       |
| 2006                    |       | $               | 9,074      |         | $          | 617             |       | $ | 8,457 |   |
| 2007                    |       | 9,544           |       | 615          |       | 8,929           |       |
| 2008                    |       | 9,574           |       | 612          |       | 8,962           |       |
| 2009                    |       | 9,244           |       | 613          |       | 8,631           |       |
| 2010                    |       | 8,972           |       | 593          |       | 8,379           |       |
| Thereafter              |       | 106,803         |       | 1,107        |       | 105,696         |       |
|                    |       | $               | 153,211    |         | $          | 4,157           |       | $ | 149,054 |   |

 

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Rent expense underoperating leases was as follows:

 
| **(In Thousands)** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------|------------|----------|------------|----------|------------|----------|------------|
|                    |       |     |       |     |       |     |       |
| Minimum rent            |       | $        | 10,468     |     | $          | 8,870    |       | $ | 8,002 |   |
| Contingent rent         |       | 1,108    |       | 1,629    |       | 2,043    |       |
|                    |       | 11,576   |       | 10,499   |       | 10,045   |       |
| Sublease rentals        |       | (1,674   | )          | (1,636   | )          | (1,673   | )          |
|                    |       | $        | 9,902      |     | $          | 8,863    |       | $ | 8,372 |   |

 

15.              Related PartyTransactions

 

A director of the Company is a partner of a law firmwhich performs legal services for the Company.

 

16.              Commitments andContingent Liabilities

 

The Company has anemployment agreement with a key executive officer and shareholder whichcurrently expires on January 1, 2008. In addition to a base salary, theagreement provides for a bonus based on pre-tax earnings. No maximumcompensation limit exists. Total salary and bonus expensed in 2005, 2004 and2003 was approximately $1,804,000, $1,952,000 and $1,565,000, respectively. Theunpaid bonus at year end is recorded under Accounts Payable, Trade on theConsolidated Balance Sheets.

 

TheCompany is primarily self-insured for losses related to workers’ compensationand general and auto liability claims. The Company maintains stop-loss coverageto limit its loss exposure on a per claim basis. Liabilities associated withthe risks that are retained by the Company are estimated, in part, byconsidering historical claims experience and regression analysis. Accruals arebased on reported claims and an estimate of claims incurred but not reported.While the ultimate amount of claims incurred are dependent on futuredevelopments, the reserve represents the Company’s best estimate of futurepayments related to claims. The Company’s liability reserve for unpaid andincurred but not reported claims at December 31, 2005 and January 1, 2005 wasapproximately $9,523,000 and $6,868,000, respectively, and is recorded underOther Current Liabilities and Other Liabilities on the Consolidated BalanceSheets. The increase in the reserve is the result of the Company’s switch froma guaranteed cost workers’ compensation program to a high deductible workers’compensation policy in June 2003. The reserve as of January 1, 2005 coversapproximately nineteen months, whereas, the reserve as of December 31, 2005covers approximately thirty-one months.

 

As of December 31, 2005,management had authorized expenditures on incomplete projects for theconstruction and purchase of property, plant and equipment which totaledapproximately $1,910,000.

 

The Company and itssubsidiaries are subject to a myriad of environmental laws, regulations andlease covenants with its landlords regarding air, water and land use, productsfor sale, and the use, storage and disposal of hazardous materials. The Companybelieves it substantially complies, and has in the past substantially complied,with federal, state and local environmental laws and regulations and privatecovenants. The Company cannot, at

 

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this time, estimate theexpense it ultimately may incur in connection with any violations; however, itbelieves any such claims will not have a material adverse impact on either theCompany’s consolidated financial position, results of operations or cash flows.

 

The Company or itssubsidiaries are defendants in a number of cases currently in litigation, beingvigorously defended, in which the complainants seek monetary damages. As of thedate hereof, no estimate of potential liability, if any, is possible. Basedupon current information, management, after consultation with legal counseldefending the Company’s interests in the cases, believes the ultimatedisposition thereof will not have a material effect upon either the Company’sconsolidated financial position, results of operations or cash flows.

 

17.           Selected Quarterly Financial Data(Unaudited)

 

(In Thousands, Except Per Share Data)

 
| ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                   | ** ** | **Diluted**                 | ** ** |
|-------------|------------|------------|------------|------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **  | ** ** | ** ** | ** ** | **Gross**  | ** ** | ** **                   | ** ** | **Net Income**         | ** ** |
| **Quarter** | ** ** | **Sales**  | ** ** | **Profit** | ** ** | **Net Income (1)** | ** ** | **Per Share (2)** | ** ** |
| 2004        |       |       |       |       |       |                         |       |                        |       |
|        |       |       |       |       |       |                         |       |                        |       |
| First (3)   |       | $          | 147,394    |       | $          | 66,054                       |       | $                           | 8,555      |   | $ | 2.53 |   |
| Second      |       | 119,863    |       | 53,037     |       | 5,767                        |       | 1.70                        |       |
| Third       |       | 113,391    |       | 50,955     |       | 4,416                        |       | 1.31                        |       |
| Fourth      |       | 122,250    |       | 55,367     |       | 3,934                        |       | 1.16                        |       |
|        |       |       |       |       |       |                         |       |                        |       |
| 2005        |       |       |       |       |       |                         |       |                        |       |
|        |       |       |       |       |       |                         |       |                        |       |
| First       |       | $          | 115,976    |       | $          | 52,504                       |       | $                           | 5,483      |   | $ | 1.62 |   |
| Second      |       | 116,354    |       | 53,106     |       | 4,523                        |       | 1.34                        |       |
| Third       |       | 113,855    |       | 52,327     |       | 4,859                        |       | 1.44                        |       |
| Fourth      |       | 124,169    |       | 56,428     |       | 4,986                        |       | 1.48                        |       |

 

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(1)                The second quarterof 2004 includes a $1,570 gain from the sale of the Company’s investment in alimited partnership which was accounted for under the cost method.

 

(2)                Earnings per shareis calculated using the weighted average outstanding shares for the quarter.

 

(3)                Thefirst quarter 2004 results were favorably impacted by a labor dispute in theCompany’s trade area.

 

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**ARDENGROUP, INC. AND CONSOLIDATED SUBSIDIARIES**

 

**INDEX TOEXHIBITS**

 
| **Exhibit** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                          |
|-------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                                                                                                                                                                                                                                                |
| 3.1.1       |       | Restated Certificate of  Incorporation of Arden Group, Inc. dated November 7, 1988 filed as Exhibit  3.1 to the Annual Report on Form 10-K of Arden Group, Inc. for the fiscal  year ended December 31, 1988 and incorporated herein by reference.                                                                                                                  |
|        |       |                                                                                                                                                                                                                                                                                                                                                                |
| 3.1.2       |       | Certificate of  Amendment of Restated Certificate of Incorporation of Arden Group, Inc. dated  June 17, 1998 filed as Exhibit 3.1.2 to the Annual Report on Form 10-K of  Arden Group, Inc. for the fiscal year ended January 2, 1999 and incorporated  herein by reference.                                                                                        |
|        |       |                                                                                                                                                                                                                                                                                                                                                                |
| 3.2.1       |       | Amended and Restated  By-Laws of Arden Group, Inc. as amended as of November 6, 2001 filed as  Exhibit 3.2.2 to the Annual Report on Form 10-K of Arden Group, Inc. for the  fiscal year ended December 29, 2001 and incorporated herein by reference.                                                                                                              |
|        |       |                                                                                                                                                                                                                                                                                                                                                                |
| 4.1         |       | Indenture dated as of  September 1, 1964 between Arden Farms Co. and Security First National Bank,  as Trustee, pertaining to 6% Subordinated Income Debentures, due September 1,  2014, filed as Exhibit 4.2 to Registration Statement on Form S-1 of Arden  Group, Inc. and Arden-Mayfair, Inc., Registration No. 2-58687, and  incorporated herein by reference. |
|        |       |                                                                                                                                                                                                                                                                                                                                                                |
| 4.1.1       |       | First Supplemental  Indenture dated as of November 7, 1978, to Indenture which is Exhibit 4.1,  filed as Exhibit 7 to the Annual Report on Form 10-K of Arden Group, Inc. for  the fiscal year ended December 30, 1978 and incorporated herein by reference.                                                                                                        |
|        |       |                                                                                                                                                                                                                                                                                                                                                                |
| 4.1.2       |       | Second Supplemental  Indenture dated as of November 7, 1978, to Indenture which is Exhibit 4.1,  filed as Exhibit 8 to the Annual Report on Form 10-K of Arden Group, Inc. for  the fiscal year ended December 30, 1978 and incorporated herein by reference.                                                                                                       |
|        |       |                                                                                                                                                                                                                                                                                                                                                                |
| 4.1.3       |       | Third Supplemental  Indenture dated April 24, 1981, to Indenture which is Exhibit 4.1, filed as  Exhibit 4.2.3 to the Quarterly Report on Form 10-Q of Arden Group, Inc. for  the quarter ended April 4, 1981 and incorporated herein by reference.                                                                                                                 |
|        |       |                                                                                                                                                                                                                                                                                                                                                                |
| 10.1*       |       | Employment Agreement  dated May 13, 1988 by and among Arden Group, Inc., Arden-Mayfair, Inc.,  Telautograph Corporation and Gelson’s Markets and Bernard Briskin, filed as  Exhibit 10 to the Quarterly Report on Form 10-Q of Arden Group, Inc. for the  quarter ended July 2, 1988 and incorporated herein by reference.                                     |

 

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| **Exhibit** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                           |
|-------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                                                                                                                                                                                                                                                 |
| 10.2*       |       | Amendment to Employment  Agreement dated April 27, 1994 by and between Arden Group, Inc.,  Arden-Mayfair, Inc., AMG Holdings, Inc. and Gelson’s Markets and Bernard  Briskin, filed as Exhibit 10.7 to the Quarterly Report on Form 10-Q of Arden  Group, Inc. for the quarter ended April 2, 1994 and incorporated herein by  reference.                       |
|        |       |                                                                                                                                                                                                                                                                                                                                                                 |
| 10.3        |       | Form of Indemnification  Agreement between the Registrant and the Directors and certain officers,  filed as Exhibit 10.13 to the Annual Report on Form 10-K of Arden Group, Inc.  for the fiscal year ended December 29, 1990 and incorporated herein by  reference.                                                                                                 |
|        |       |                                                                                                                                                                                                                                                                                                                                                                 |
| 10.4*       |       | Second Amendment to  Employment Agreement as of January 1, 1997 by and between Arden Group, Inc.,  Arden-Mayfair, Inc., AMG Holdings, Inc. and Gelson’s Markets and Bernard  Briskin, filed as Exhibit 10.9 to the Annual Report on Form 10-K of Arden  Group, Inc. for the fiscal year ended January 3, 1998 and incorporated herein  by reference.            |
|        |       |                                                                                                                                                                                                                                                                                                                                                                 |
| 10.5*       |       | Phantom Stock Plan of  Arden Group, Inc., filed as Exhibit 10.11 to the Annual Report on Form 10-K  of Arden Group, Inc. for the fiscal year ended January 2, 1999 and  incorporated herein by reference.                                                                                                                                                            |
|        |       |                                                                                                                                                                                                                                                                                                                                                                 |
| 10.6*       |       | Form of Non-Employee  Director Phantom Stock Unit Agreement with Kenneth A. Goldman dated June 19,  2001 filed as Exhibit 10.13 to the Annual Report on Form 10-K of Arden Group,  Inc. for the fiscal year ended December 29, 2001 and incorporated herein by  reference.                                                                                           |
|        |       |                                                                                                                                                                                                                                                                                                                                                                 |
| 10.7*       |       | Form of Amendment to  Non-Employee Director Phantom Stock Unit Agreement with each John G. Danhakl,  Robert A. Davidow, Daniel Lembark, Ben Winters and Kenneth A. Goldman dated  December 9, 2002 filed as Exhibit 10.14 to the Annual Report on Form 10-K of  Arden Group, Inc. for the fiscal year ended December 28, 2002 and  incorporated herein by reference. |
|        |       |                                                                                                                                                                                                                                                                                                                                                                 |
| 10.8*       |       | Arden Group, Inc.,  Non-Officer and Non-Director Stock Option Plan filed as Exhibit 10.15 to the  Annual Report on Form 10-K of Arden Group, Inc. for the fiscal year ended  December 28, 2002 and incorporated herein by reference.                                                                                                                                 |
|        |       |                                                                                                                                                                                                                                                                                                                                                                 |
| 10.8.1*     |       | Form of Stock Option  Plan Agreement filed as Exhibit 10.15.1 to the Annual Report on Form 10-K of  Arden Group, Inc. for the fiscal year ended December 28, 2002 and  incorporated herein by reference.                                                                                                                                                             |

 

67

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| **Exhibit** | ** ** | ** **                                                                                                                                                                                                                                   |
|-------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                                                                                                                         |
| 10.9*       |       | Form of Non-Employee  Director Phantom Stock Unit Agreement with Steven Romick filed as Exhibit  10.1 to the Quarterly Report on Form 10-Q of Arden Group, Inc. for the  quarter ended June 28, 2003 and incorporated herein by reference.   |
|        |       |                                                                                                                                                                                                                                         |
| 10.10*      |       | Form of Non-Employee  Director Phantom Stock Unit Agreement with each of John G. Danhakl, Robert A.  Davidow, Ben Winters, Kenneth A. Goldman and Steven Romick dated January 20,  2004.                                                     |
|        |       |                                                                                                                                                                                                                                         |
| 10.11*      |       | Form of Non-Employee  Director Phantom Stock Unit Agreement with Steven C. Gordon filed as Exhibit  10.1 to the Quarterly Report on Form 10-Q of Arden Group, Inc. for the  quarter ended July 2, 2005 and incorporated herein by reference. |
|        |       |                                                                                                                                                                                                                                         |
| 21.         |       | Subsidiaries of  Registrant filed as Exhibit 21 to the Annual Report on Form 10-K of Arden  Group, Inc. for the fiscal year ended December 28, 2002 and incorporated  herein by reference.                                                   |
|        |       |                                                                                                                                                                                                                                         |
| 23.1        |       | Consent of Independent  Registered Public Accounting Firm.                                                                                                                                                                                   |
|        |       |                                                                                                                                                                                                                                         |
| 31.1        |       | Certification of Chief  Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                         |
|        |       |                                                                                                                                                                                                                                         |
| 31.2        |       | Certification of Chief  Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                         |
|        |       |                                                                                                                                                                                                                                         |
| 32.1        |       | Certification of Chief  Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                         |
|        |       |                                                                                                                                                                                                                                         |
| 32.2        |       | Certification of Chief  Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                         |

 

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*            Indicates management contracts orcompensatory plans or arrangements required to be filed as an exhibit to thisreport.

 

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