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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549





FORM 10-Q



|(X) | QUARTERLY REPORT PURSUANT TO SECTION 13 OR
    SECTION 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JULY
    2, 2005.            
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                 
|    | OR                                                                                                                                                              
|    |                                                                                                                                                                 
|( ) | TRANSITION REPORT PURSUANT TO SECTION 13 OR
    SECTION 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM
    __________ TO __________







Commission file number 0-21577





WILD OATS MARKETS, INC.

(Exact name of registrant as specified in its charter)



Delaware
    84-1100630(State or other
    jurisdiction of
    (I.R.S. Employer
    Identification Number)Incorporation or
    organization)












3375 Mitchell Lane

Boulder, Colorado 80301

(Address of principal executive offices, including zip code)







(303) 440-5220

(Registrants telephone number, including area code)







Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing requirements for the past 90
days.

Yes       ( X )       No      (
)



Indicate by check mark whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2).

Yes       ( X )       No      (
)



As of August 1, 2005, there were 28,760,651 shares outstanding of the registrant's
common stock (par value $.001 per share).





---







TABLE OF CONTENTS

|PART I.                |  | FINANCIAL
    INFORMATION                                                                                                                  | Page
|---------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------ | ----
|                       |  |                                                                                                                                            |     
|Item 1.                |  | Financial Statements:                                                                                                                      |     
|                       |  |                                                                                                                                            |     
|                       |  | Consolidated Balance Sheets, July
      2, 2005 (unaudited) 
      and January 1, 2005                                                     | 3   
|                       |  |                                                                                                                                            |     
|                       |  | Consolidated Statements
      of Operations (unaudited), 
      Three and Six Months Ended July 2, 2005 and June 26, 2004                  | 4   
|                       |  |                                                                                                                                            |     
|                       |  | Consolidated
      Statements of Comprehensive (Loss) Income (unaudited), 
      Three and Six Months Ended July 2, 2005 and June 26, 2004 | 5   
|                       |  |                                                                                                                                            |     
|                       |  | Consolidated Statements
      of Cash Flows (unaudited), 
      Six Months Ended July 2, 2005 and June 26, 2004                            | 6   
|                       |  |                                                                                                                                            |     
|                       |  | Notes to
      Consolidated Financial Statements (unaudited)                                                                               | 7   
|                       |  |                                                                                                                                            |     
|Item 2.                |  | Managements Discussion and Analysis of Financial Condition and Results of
      Operations                                                | 16  
|                       |  |                                                                                                                                            |     
|Item 3.                |  | Quantitative
      and Qualitative Disclosures About Market Risk                                                                           | 26  
|                       |  |                                                                                                                                            |     
|Item 4.                |  | Controls and Procedures                                                                                                                    | 26  
|                       |  |                                                                                                                                            |     
|PART II.               |  | OTHER INFORMATION                                                                                                                          |     
|                       |  |                                                                                                                                            |     
|Item 1.                |  | Legal Proceedings                                                                                                                          | 29  
|                       |  |                                                                                                                                            |     
|Item 2.                |  | Unregistered
      Sales of Equity Securities and Use of Proceeds                                                                          | 29  
|                       |  |                                                                                                                                            |     
|Item 3.                |  | Defaults
      Upon Senior Securities                                                                                                      | 29  
|                       |  |                                                                                                                                            |     
|Item 4.                |  | Submission
      of Matters to a Vote of Security Holders                                                                                  | 30  
|                       |  |                                                                                                                                            |     
|Item 5.                |  | Other Information                                                                                                                          | 30  
|                       |  |                                                                                                                                            |     
|Item 6.                |  | Exhibits                                                                                                                                   | 30  
|                       |  |                                                                                                                                            |     
|SIGNATURE AND EXHIBITS | 
|                       |  |                                                                                                                                            |     
|                       |  | Signatures                                                                                                                                 | 31  
|                       |  |                                                                                                                                            |     



---

PART I.  FINANCIAL INFORMATION





Item 1.  Financial Statements



WILD OATS MARKETS, INC.

Consolidated Balance Sheets

(in thousands, except share data)

|                                         |                                                              |                                                                                                                                                                    |                            |          | July 2, 2005 |          | January 1, 2005
|---------------------------------------- | ------------------------------------------------------------ | ------------------------------------------------------------------------------------------------------------------------------------------------------------------ | -------------------------- | -------- | ------------ | -------- | ---------------
|                                         |                                                              |                                                                                                                                                                    |                            |          | (unaudited)  |          |                
|                                         |                                                              |                                                                                                                                                                    |                            |          |              |          |                
|ASSETS                                   |                                                              |                                                                                                                                                                    |                            |         
|                                         |                                                              |                                                                                                                                                                    |                            |         
|                                         | Current assets:                                              |                                                                                                                                                                    |                            |          |             
|                                         |                                                              | Cash and cash equivalents                                                                                                                                          |                            | $ 43,418 |              | $ 30,671
|                                         |                                                              | Short-term investments                                                                                                                                             |                            | -        |              | 11,144  
|                                         |                                                              | Inventories (net of reserves of
    $889 and $815, respectively)                                                                                                   |                            | 58,475   |              | 54,960  
|                                         |                                                              | Accounts receivable (net of
    allowance for doubtful accounts of $116 and $153, respectively)                                                                    |                            | 3,211    |              | 3,860   
|                                         |                                                              | Prepaid expenses and other current
    assets                                                                                                                      |                            | 5,454    |              | 5,741   
|                                         |                                                              |                                                                                                                                                                    |                            |          |              |         
|                                         |                                                              |                                                                                                                                                                    | Total current assets       |          | 110,558      |          | 106,376        
|                                         |                                                              |                                                                                                                                                                    |                            |          |              |          |                
|                                         | Property and equipment, net                                  |                                                                                                                                                                    | 176,068                    |          | 177,830     
|                                         | Goodwill, net                                                |                                                                                                                                                                    | 105,124                    |          | 106,084     
|                                         | Other intangible assets, net                                 |                                                                                                                                                                    | 6,271                      |          | 6,491       
|                                         | Deposits and other assets                                    |                                                                                                                                                                    | 8,109                      |          | 8,361       
|                                         | Deferred tax asset, net                                      |                                                                                                                                                                    | 674                        |          | 418         
|                                         |                                                              |                                                                                                                                                                    |                            |          |              |         
|                                         |                                                              |                                                                                                                                                                    |                            |          | $ 406,804    |          | $ 405,560      
|                                         |                                                              |                                                                                                                                                                    |                            |          |              |          |                
|LIABILITIES AND
    STOCKHOLDERS EQUITY |                                                              |                                                                                                                                                                    |                            |         
|                                         |                                                              |                                                                                                                                                                    |                            |         
|                                         | Current liabilities:                                         |                                                                                                                                                                    |                            |          |             
|                                         |                                                              | Accounts payable                                                                                                                                                   |                            | $ 57,816 |              | $ 54,428
|                                         |                                                              | Book overdraft                                                                                                                                                     |                            | 20,974   |              | 23,325  
|                                         |                                                              | Accrued liabilities                                                                                                                                                |                            | 52,161   |              | 53,154  
|                                         |                                                              | Current portion of debt, capital
    leases and financing obligations                                                                                              |                            | 706      |              | 405     
|                                         |                                                              | Deferred tax liabilities                                                                                                                                           |                            | 345      |              | -       
|                                         |                                                              |                                                                                                                                                                    |                            |          |              |         
|                                         |                                                              |                                                                                                                                                                    | Total current liabilities  |          | 132,002      |          | 131,312        
|                                         |                                                              |                                                                                                                                                                    |                            |          |              |          |                
|                                         | Long-term debt, capital leases and
    financing obligations |                                                                                                                                                                    | 148,453                    |          | 148,675     
|                                         | Other long-term obligations                                  |                                                                                                                                                                    | 24,282                     |          | 24,472      
|                                         |                                                              |                                                                                                                                                                    |                            |          |              |         
|                                         |                                                              |                                                                                                                                                                    | 304,737                    |          | 304,459     
|                                         |                                                              |                                                                                                                                                                    |                            |          |              |         
|                                         | Commitments and contingencies                                |                                                                                                                                                                    |                            |          |             
|                                         |                                                              |                                                                                                                                                                    |                            |          |              |          |                
|                                         | Stockholders equity:                                        |                                                                                                                                                                    |                            |          |             
|                                         |                                                              | Preferred stock, $0.001 par value;
    5,000,000 shares authorized, no shares issued and outstanding                                                               |                            |          |              | -       
|                                         |                                                              | Common stock, $0.001 par value;
    60,000,000 shares authorized, 30,645,967 and 30,466,701 shares issued; 28,668,167 and
    28,488,901 outstanding, respectively |                            | 31       |              | 30      
|                                         |                                                              | Treasury stock, at cost: 1,977,800
    shares as of July 2, 2005 and January 1, 2005                                                                               |                            | (24,999) |              | (24,999)
|                                         |                                                              | Additional paid-in capital                                                                                                                                         |                            | 222,820  |              | 221,029 
|                                         |                                                              | Note receivable, related party                                                                                                                                     |                            | (11,730) |              | (11,416)
|                                         |                                                              | Accumulated deficit                                                                                                                                                |                            | (84,738) |              | (84,509)
|                                         |                                                              | Accumulated other comprehensive
    income                                                                                                                         |                            | 683      |              | 966     
|                                         |                                                              |                                                                                                                                                                    |                            |          |              |         
|                                         |                                                              |                                                                                                                                                                    | Total stockholders equity |          | 102,067      |          | 101,101        
|                                         |                                                              |                                                                                                                                                                    |                            |          |              |         
|                                         |                                                              |                                                                                                                                                                    |                            |          | $ 406,804    |          | $ 405,560      
|                                         |                                                              |                                                                                                                                                                    |                            |          |              |         
|                                         |                                                              |                                                                                                                                                                    |                            |          |              |          |                





The accompanying notes are an integral part of these consolidated
financial statements.



---



WILD OATS MARKETS, INC.

Consolidated Statements
of Operations

(in thousands, except per-share data) (unaudited)

|                                                                     |                                                                 | THREE MONTHS 
    ENDED           |         | SIX MONTHS
    
    ENDED
|-------------------------------------------------------------------- | --------------------------------------------------------------- | --------------------------------- | ------- | -------------------------
|                                                                     |                                                                 |                                   |         |                          
|                                                                     |                                                                 | July 2,                           |         | June 26,                 
|                                                                     |                                                                 | 2005                              |         | 2004                     
|                                                                     |                                                                 |                                   |         |                          
|                                                                     |                                                                 |                                   |         |                          
|Sales                                                                |                                                                 | $ 284,608                         |         | $ 251,697                
|Cost of goods sold and occupancy
    costs                           |                                                                 | 202,049                           |         | 178,263                  
|                                                                     |                                                                 |                                   |         |                          
|Gross profit                                                         |                                                                 | 82,559                            |         | 73,434                   
|Operating expenses:                                                  |                                                                 |                                   |         |                          
|                                                                     | Direct store expenses                                           |                                   | 60,724  |                          
|                                                                     | Selling, general and
    administrative    expenses             |                                   | 17,201  |                          
|                                                                     | Loss (gain) on disposal of assets                               |                                   | 53      |                          
|                                                                     | Pre-opening expenses                                            |                                   | 780     |                          
|                                                                     | Restructuring and asset impairment
       charges (income), net |                                   | 909     |                          
|                                                                     |                                                                 |                                   |         |                          
|                                                                     |                                                                 | Income from operations            |         | 2,892                    
|                                                                     |                                                                 |                                   |         |                          
|                                                                     | Loss on early extinguishment of
    debt                        |                                   | -       |                          
|                                                                     | Interest income                                                 |                                   | 361     |                          
|                                                                     | Interest expense                                                |                                   | (2,144) |                          
|                                                                     |                                                                 |                                   |         |                          
|                                                                     |                                                                 | Income (loss) before income taxes |         | 1,109                    
|                                                                     | Income tax expense                                              |                                   | 187     |                          
|                                                                     |                                                                 |                                   |         |                          
|Net income (loss)                                                    |                                                                 | $ 922                             |         | $ (331)                  
|                                                                     |                                                                 |                                   |         |                          
|                                                                     |                                                                 |                                   |         |                          
|Net income (loss) per common
    share:                              |                                                                 |                                   |         |                          
|                                                                     | Basic                                                           |                                   | $ 0.03  |                          
|                                                                     | Diluted                                                         |                                   | $ 0.03  |                          
|                                                                     |                                                                 |                                   |         |                          
|Weighted average common shares
       outstanding, basic             |                                                                 | 28,667                            |         | 29,788                   
|Dilutive effect of stock options
    and    restricted stock units   |                                                                 | 518                               |         | -                        
|                                                                     |                                                                 |                                   |         |                          
|                                                                     |                                                                 |                                   |         |                          
|Weighted average common shares
       outstanding, assuming dilution |                                                                 | 29,185                            |         | 29,788                   
|                                                                     |                                                                 |                                   |         |                          
|                                                                     |                                                                 |                                   |         |                          



The accompanying notes are an integral part of these consolidated
financial statements.



---









WILD OATS MARKETS, INC.

Consolidated
Statements of Comprehensive Income (Loss)

(in thousands) (unaudited)



|                            |                                                                |       |       |         | THREE MONTHS
    ENDED |         | SIX MONTHS
    ENDED
|--------------------------- | -------------------------------------------------------------- | ----- | ----- | ------- | ---------------------- | ------- | --------------------
|                            |                                                                |       |       |         |                        |         |                     
|                            |                                                                |       |       |         | July 2,                |         | June 26,            
|                            |                                                                |       |       |         | 2005                   |         | 2004                
|                            |                                                                |       |       |         |                        |         |                     
|Net income (loss)           |                                                                | $ 922 |       | $ (331) |                        | $ (229) |                     
|Other comprehensive loss:   |                                                                |       |       |         |                        |         |                     
|                            | Foreign currency translation
    adjustments                   |       | (198) |         | (125)                  |         | (255)               
|                            | Unrealized gain (loss) on
    available-for-sale    securities |       | 2     |         | -                      |         | (28)                
|                            |                                                                |       |       |         |                        |         |                     
|Other comprehensive loss    |                                                                | (196) |       | (125)   |                        | (283)   |                     
|                            |                                                                |       |       |         |                        |         |                     
|                            |                                                                |       |       |         |                        |         |                     
|Comprehensive income (loss) |                                                                | $ 726 |       | $ (456) |                        | $ (512) |                     
|                            |                                                                |       |       |         |                        |         |                     
|                            |                                                                |       |       |         |                        |         |                     





The accompanying notes are an integral part of these consolidated
financial statements.



---

WILD OATS MARKETS, INC.

Consolidated Statements
of Cash Flows

(in thousands) (unaudited)



|                                                                           |                                                                                              |                                                       |                                                         |          | SIX MONTHS
    ENDED
|-------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------- | ----------------------------------------------------- | ------------------------------------------------------- | -------- | --------------------
|                                                                           |                                                                                              |                                                       |                                                         |          |                     
|                                                                           |                                                                                              |                                                       |                                                         |          | July 2,             
|                                                                           |                                                                                              |                                                       |                                                         |          | 2005                
|                                                                           |                                                                                              |                                                       |                                                         |          |                     
|                                                                           |                                                                                              |                                                       |                                                         |          |                     
|CASH FLOWS FROM OPERATING
    ACTIVITIES:                                  |                                                                                              |                                                       |                                                         |         
|                                                                           | Net (loss) income                                                                            |                                                       | $ (229)                                                 |          | $ 1,738             
|                                                                           | Adjustments to reconcile net
    (loss) income to net cash provided by operating activities: |                                                       |                                                         |          |                     
|                                                                           |                                                                                              | Depreciation and amortization                         |                                                         | 13,117   |                     
|                                                                           |                                                                                              | Loss (gain) on disposal of
    property and equipment |                                                         | 44       |                     
|                                                                           |                                                                                              | Deferred tax expense                                  |                                                         | 134      |                     
|                                                                           |                                                                                              | Restructuring and asset impairment
    expense, net   |                                                         | 2,460    |                     
|                                                                           |                                                                                              | Interest on related party
    receivable              |                                                         | (314)    |                     
|                                                                           |                                                                                              | Stock based compensation                              |                                                         | 244      |                     
|                                                                           |                                                                                              | Income tax benefit from stock
    based compensation  |                                                         | -        |                     
|                                                                           |                                                                                              | Accretion of debt issuance costs                      |                                                         | 259      |                     
|                                                                           |                                                                                              | Loss on early extinguishment of
    debt              |                                                         | 559      |                     
|                                                                           | Change in assets and liabilities:                                                            |                                                       |                                                         |          |                     
|                                                                           |                                                                                              | Inventories, net                                      |                                                         | (3,565)  |                     
|                                                                           |                                                                                              | Receivables, net, and other assets                    |                                                         | 345      |                     
|                                                                           |                                                                                              | Accounts payable                                      |                                                         | 3,411    |                     
|                                                                           |                                                                                              | Accrued liabilities and other
    liabilities         |                                                         | (1,728)  |                     
|                                                                           |                                                                                              |                                                       |                                                         |          |                     
|                                                                           |                                                                                              |                                                       | Net cash provided by operating
    activities           |          | 14,737              
|                                                                           |                                                                                              |                                                       |                                                         |          |                     
|                                                                           |                                                                                              |                                                       |                                                         |          |                     
|CASH FLOWS FROM INVESTING
    ACTIVITIES:                                  |                                                                                              |                                                       |                                                         |         
|                                                                           | Capital expenditures                                                                         |                                                       | (11,978)                                                |          | (27,374)            
|                                                                           | Proceeds from sale of short-term
    investments                                             |                                                       | 11,116                                                  |          | -                   
|                                                                           | Proceeds from sale of property and
    equipment                                             |                                                       | 26                                                      |          | 964                 
|                                                                           |                                                                                              |                                                       |                                                         |          |                     
|                                                                           |                                                                                              |                                                       | Net cash used in investing
    activities               |          | (836)               
|                                                                           |                                                                                              |                                                       |                                                         |          |                     
|                                                                           |                                                                                              |                                                       |                                                         |          |                     
|CASH FLOWS FROM FINANCING
    ACTIVITIES:                                  |                                                                                              |                                                       |                                                         |         
|                                                                           | Net repayments under
    line-of-credit agreement                                            |                                                       | -                                                       |          | (30,179)            
|                                                                           | Net decrease in book overdraft                                                               |                                                       | (2,351)                                                 |          | (5,492)             
|                                                                           | Proceeds from long-term debt                                                                 |                                                       | -                                                       |          | 115,150             
|                                                                           | Purchase of treasury stock                                                                   |                                                       | -                                                       |          | (24,999)            
|                                                                           | Payment of debt issuance costs                                                               |                                                       | -                                                       |          | (3,636)             
|                                                                           | Repayments on notes payable,
    long-term debt and capital leases                           |                                                       | (183)                                                   |          | (64)                
|                                                                           | Proceeds from issuance of common
    stock, net                                              |                                                       | 1,548                                                   |          | 2,551               
|                                                                           |                                                                                              |                                                       |                                                         |          |                     
|                                                                           |                                                                                              |                                                       | Net cash (used in) provided by
    financing activities |          | (986)               
|                                                                           |                                                                                              |                                                       |                                                         |          |                     
|                                                                           |                                                                                              |                                                       |                                                         |          |                     
|Effect of exchange rate changes
    on cash                                |                                                                                              | (168)                                                 |                                                         | (85)    
|                                                                           |                                                                                              |                                                       |                                                         |          |                     
|Net increase in cash and cash
    equivalents                              |                                                                                              | 12,747                                                |                                                         | 48,371  
|Cash and cash equivalents at
    beginning of period                       |                                                                                              | 30,671                                                |                                                         | 17,400  
|                                                                           |                                                                                              |                                                       |                                                         |          |                     
|Cash and cash equivalents at
    end of period                             |                                                                                              | $ 43,418                                              |                                                         | $ 65,771
|                                                                           |                                                                                              |                                                       |                                                         |          |                     
|                                                                           |                                                                                              |                                                       |                                                         |          |                     
|SUPPLEMENTAL DISCLOSURE OF NONCASH
    INVESTING AND FINANCING ACTIVITIES:
|                                                                           | Equipment acquired through capital
    lease                                                 |                                                       | $ 262                                                   |          | $ 105               
|                                                                           |                                                                                              |                                                       |                                                         |          |                     
|                                                                           |                                                                                              |                                                       |                                                         |          |                     



The accompanying notes are an integral part of these consolidated
financial statements.



---

WILD OATS MARKETS, INC.

Notes to
Consolidated Financial Statements

(unaudited)



|1. | Nature of Operations and
    Basis of Presentation
|-- | --------------------------------------------------



Wild Oats Markets, Inc. ("Wild Oats" or the
"Company"), headquartered in Boulder, Colorado, owns and operates natural and
organic foods supermarkets in the United States and Canada. The Company also operates
bakeries, commissary kitchens and a distribution center that supply the stores. The
Companys operations are concentrated in one market segment, grocery stores, and are
geographically concentrated in the western and central parts of the United States.



The Consolidated Balance Sheet as of July 2, 2005, the Consolidated
Statements of Operations and Consolidated Statements of Comprehensive Income (Loss) for
the three and six months ended July 2, 2005 and June 26, 2004, as well as the Consolidated
Statements of Cash Flows for the six months ended July 2, 2005 and June 26, 2004 have been
prepared without an audit. In the opinion of management, all adjustments, consisting only
of normal, recurring adjustments necessary for a fair statement thereof, have been made.



The financial statements have been prepared by the Company in
accordance with the rules and regulations of the Securities and Exchange Commission
("SEC"). Certain information and footnote disclosures normally included in
financial statements prepared in accordance with accounting principles generally accepted
in the United States have been condensed or omitted pursuant to SEC regulations,
therefore, these consolidated financial statements should be read in conjunction with
financial statements and notes thereto included in the Company's 2004 Annual Report on
Form 10-K, as amended. The preparation of financial statements requires management to make
estimates and assumptions that affect the reported amounts of assets, liabilities,
revenue, expenses and related disclosures of contingent assets and liabilities. Examples
include accounting for self-insurance reserves, restructuring charges and store closing
costs, asset impairment charges, goodwill, inventory valuation, and contingencies. Actual
results may differ from these estimates. The results of operations for interim periods
presented are not necessarily indicative of the operating results for the full year.
Certain prior period information has been reclassified to conform to the current year
presentation.



The unaudited information included in the consolidated financial
statements for the three months and six months ended July 2, 2005 and June 26, 2004
include the results of operations of the Company for the 13 and 26 weeks then ended.





|2. | Short-Term Investments
|-- | ----------------------



The amortized cost of debt securities in this category is adjusted for
amortization of premiums and accretion of discounts to maturity computed under the
effective interest method. Such amortization and accretion is included in interest income.
Realized gains and losses and declines in value judged to be other-than-temporary on
available-for-sale securities are included in interest income. The cost of securities sold
is based on the specific identification method. Income and dividends on securities
classified as available-for-sale are included in interest income. Investments classified
as available-for-sale are marked to market each reporting period with the unrealized gain
or loss reflected as a component of other comprehensive income (loss).





|3. | Stock-Based Compensation
|-- | ------------------------



At July 2, 2005, the Company had six stock-based employee compensation
plans, which are described more fully in Note 9  Stock Plans and Options in
our fiscal 2004 Annual Report filed on Form 10-K, as amended, for the period ended January
1, 2005. These plans allow for awards of both stock options and restricted stock units
("RSUs"). The Company accounts for those plans in accordance with the intrinsic
value based method in Accounting Principles Board ("APB") Opinion No. 25, Accounting
for Stock Issued to Employees, and related interpretations. Some stock-based
compensation expense is reflected in net income for options issued at a discount and for
RSUs issued as Board of Directors compensation. All other options granted under the
plans had an exercise price equal to the market value of the underlying common stock on
the date of grant; therefore, no stock-based compensation expense is reflected in net
income for these grants. Reflected in results of operations for the first six months of
fiscal 2005 and 2004 is compensation expense of $244,000 and $537,000, respectively.



As required by Financial Accounting Standards Board ("FASB")
Statement of Financial Accounting Standards ("SFAS") Nos. 123, Accounting for
Stock-Based Compensation,and 148, Accounting for Stock-Based
Compensation-Transition and Disclosure, the following table illustrates the effect on
net income and earnings per share if stock-based compensation costs were to be calculated
based on the fair value of the options granted and recognized ratably over the vesting
period as prescribed in SFAS No. 123 (in thousands):



|                               |                                                                                                                        |                             |       |         | THREE MONTHS
    ENDED |          | SIX MONTHS
    ENDED
|------------------------------ | ---------------------------------------------------------------------------------------------------------------------- | --------------------------- | ----- | ------- | ---------------------- | -------- | --------------------
|                               |                                                                                                                        |                             |       |         |                        |          |                     
|                               |                                                                                                                        |                             |       |         | July 2,                |          | June 26,            
|                               |                                                                                                                        |                             |       |         | 2005                   |          | 2004                
|                               |                                                                                                                        |                             |       |         |                        |          |                     
|                               |                                                                                                                        |                             |       |         |                        |          |                     
|Net income (loss), as reported |                                                                                                                        | $ 922                       |       | $ (331) |                        | $ (229)  |                     
|                               | Add: Stock-based compensation
    expense included in reported net income, net of tax*                                 |                             | 70    |         | 60                     |          | 146                 
|                               | Deduct: Total stock-based
    compensation expense determined under fair value based method for all awards, net of tax |                             | (145) |         | (687)                  |          | (1,110)             
|                               |                                                                                                                        |                             |       |         |                        |          |                     
|                               |                                                                                                                        | Pro forma net income (loss) |       | $ 847   |                        | $ (958)  |                     
|                               |                                                                                                                        |                             |       |         |                        |          |                     
|                               |                                                                                                                        |                             |       |         |                        |          |                     
|                               | Net income (loss) per share:                                                                                           |                             |       |         |                        |          |                     
|                               |                                                                                                                        | Basic  as reported         |       | $ 0.03  |                        | $ (0.01) |                     
|                               |                                                                                                                        |                             |       |         |                        |          |                     
|                               |                                                                                                                        | Basic  pro forma           |       | $ 0.03  |                        | $ (0.03) |                     
|                               |                                                                                                                        |                             |       |         |                        |          |                     
|                               |                                                                                                                        |                             |       |         |                        |          |                     
|                               |                                                                                                                        | Diluted  as reported       |       | $ 0.03  |                        | $ (0.01) |                     
|                               |                                                                                                                        |                             |       |         |                        |          |                     
|                               |                                                                                                                        | Diluted - pro forma         |       | $ 0.03  |                        | $ (0.03) |                     
|                               |                                                                                                                        |                             |       |         |                        |          |                     
|                               |                                                                                                                        |                             |       |         |                        |          |                     



* Amounts are net of a pro-forma tax rate which is not necessarily
indicative of our effective tax rate for the respective periods.





In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based
Payment ("SFAS No. 123R"). SFAS No. 123R is a revision of SFAS No. 123, and
supersedes APB Opinion No. 25. The new standard establishes accounting standards for
transactions in which an entity exchanges its equity instruments for goods or services,
including stock option and restricted stock grants. The provisions of SFAS No. 123R will
be effective for the Companys first quarter of fiscal year 2006 beginning January 1,
2006. The Company is currently evaluating the impact on its results from adopting SFAS No.
123R, but expects it to be comparable to the pro forma effects of applying the original
SFAS No. 123. Accordingly, the adoption of SFAS No. 123R is expected to have a material
effect on the Companys results of operations.



In February 2005, the Company approved the acceleration of all
non-director, non-officer options that were unvested with an exercise price of $9.00 or
higher, resulting in the accelerated vesting of an aggregate of 219,190 options. The
effect of the accelerated vesting of these options is included in the SFAS No. 123
calculation above. The purpose of this acceleration was driven by the Companys
efforts to reduce non-cash compensation expense that will be required beginning with the
first quarter of 2006 in accordance with SFAS No. 123R.





|4. | Property and Equipment
|-- | ----------------------



Property, plant and equipment are recorded at cost and consist of the
following (in thousands):

|                                         |  |           |  |           | July 2, 2005 |  | January 1, 2005 | 
|---------------------------------------- |  | --------- |  | --------- | ------------ |  | --------------- | 
|                                         |  |           |  |           |              |  |                 | 
|                                         |  |           |  |           |              |  |                 | 
|Machinery and equipment                  |  | $ 137,842 |  | $ 131,133 |             
|Buildings and leasehold
    improvements |  | 160,185   |  | 156,829   |             
|Construction in progress                 |  | 8,754     |  | 14,283    |             
|                                         |  |           |  |           |              |  |                 | 
|                                         |  | 306,781   |  | 302,245   |             
|Less: accumulated depreciation           |  | (130,713) |  | (124,415) |             
|                                         |  |           |  |           |              |  |                 | 
|                                         |  | $ 176,068 |  | $ 177,830 |             
|                                         |  |           |  |           |              |  |                 | 
|                                         |  |           |  |           |             



Depreciation expense was $6.3 million and $6.6 million for the three months ended July
2, 2005 and June 26, 2004, respectively, and $12.9 million and $13.9 million for the six
months ended July 2, 2005 and June 26, 2004, respectively.



|5. | Debt
|-- | ----



Contingent convertible senior debentures. In June 2004, the Company
issued $115 million aggregate principal amount of its 3.25% Convertible Senior Debentures
due May 15, 2034 in a private placement. The debentures bear regular interest at the
annual rate of 3.25%, payable semiannually on May 15 and November 15 of each year until
May 15, 2011, after which date, no regular interest will be due. Commencing May 20, 2011
and ending November 14, 2011, and for any six-month period thereafter, contingent interest
will be due and payable in the amount of 0.25% of the average trading price of the
debentures during a specified period, if the average trading price of the debentures
equals or exceeds 125% of the principal amount of the debentures.



The debentures are callable and convertible into the Company's common
stock prior to maturity at the option of the holders under the following circumstances:
(1) during any calendar quarter commencing after June 30, 2004 and before March 31, 2029,
if the last reported sale price of the Companys common stock is greater than or
equal to 130% of the conversion price of $17.70 per share; (2) at any time on or after
April 1, 2029 if the last reported sale price of the Companys common stock on any
date on or after March 31, 2029 is greater than or equal to 130% of the conversion price;
(3) subject to certain limitations, during the five business-day period after any five
consecutive trading-day period in which the trading price per debenture for each day of
that period was less than 98% of the product of the conversion rate and the last reported
sale price of the Company's common stock; (4) if the Company calls the debentures for
redemption; (5) upon the occurrence of certain corporate transactions; or (6) if the
Company obtains credit ratings for the debentures, at any time when the credit ratings
assigned to the debentures are below specified levels. The debentures are initially
convertible into 56.5099 shares of the Company's common stock per $1,000 principal amount,
which is equivalent to approximately $17.70 per share, for total initial underlying shares
of 6,498,639. The conversion rate will be subject to adjustment upon the occurrence of
specified events. During the second quarter of 2005, the Company made an irrevocable
election to pay the principal amount of debentures in cash upon conversion, however, the
Company retains the ability to satisfy the remainder of any conversion payment, in cash or
any combination of cash and common stock. Pursuant to the underwriting agreement and
within 90 days of issuance, the Company filed a shelf registration statement covering
resales of the debentures and the common stock issuable upon conversion thereof.



On or after May 20, 2011, the Company may redeem for cash some or all
of the debentures at any time and from time to time, for a price equal to 100% of the
principal amount of the debentures plus accrued and unpaid contingent interest, if any.
Holders have the right to require the Company to repurchase any or all debentures for
cash, at a repurchase price equal to 100% of the principal amount of the debentures, plus
accrued and unpaid interest on: (1) May 15, 2011, May 15, 2014, and May 15, 2024; and (2)
upon the occurrence of a fundamental change (as defined in the debenture indenture). In
the case of a fundamental change in which all of the consideration for the common stock in
the transaction or transactions constituting the fundamental change consists of cash, the
Company also will pay to the holders a make-whole premium (as defined in the debenture
indenture), the amount of which could be significant but would not be determinable unless
and until there were to be a public announcement of such a fundamental change. Any
make-whole premium would be payable to all holders regardless of whether the holder elects
to require the Company to repurchase the debentures or elects to surrender the debentures
for conversion.



The debentures are unsecured and unsubordinated obligations, and rank
equal in priority with all of the Company's existing and future unsecured and
unsubordinated indebtedness and senior in right of payment to all of its subordinated
indebtedness. The debentures will effectively rank junior to any of the Company's secured
indebtedness and any of its indebtedness that is guaranteed by its subsidiaries. Payment
of principal and interest on the debentures will be structurally subordinated to the
liabilities of the Company's subsidiaries.



There are no financial covenants within the debenture indenture,
however, the Company paid penalty interest of 0.25% for the first 90 days of 2005 and paid
or will be paying 0.50% thereafter until the debentures are publicly registered. As of
July 2, 2005, the Company has accrued $79,095 and paid $138,160 in additional interest to
debenture holders due to not having an effective registration statement within the
specified timeframe.



In 2004, total proceeds from the issuance of the debentures were $115.2
million. The Company used $25.0 million of the net proceeds to repurchase 1,977,800
outstanding shares of its common stock, $31.2 million to pay the outstanding balance on
its credit facility, and approximately $3.7 million to pay related debt issuance costs.



Credit facility. On March 31, 2005, the Company entered into a
five-year revolving secured credit facility with Bank of America, N.A. (the "B of A
Facility"). Concurrent with the execution of the B of A Facility, the Company
terminated its existing $95 million credit facility (the "Wells Facility") with
Wells Fargo Bank N.A. as administrative agent. The B of A Facility allows borrowings and
letters of credit up to a maximum of $40 million, with an option to increase borrowings up
to $100 million, subject to a borrowing base determined by the value of certain inventory,
credit card receivables, invested cash and, at the Companys discretion, mortgaged
leaseholds. The B of A Facility is secured by certain assets including, but not limited
to, cash, inventory and fixed assets. Borrowings under the B of A Facility bear interest,
at the Companys election, at the prime rate or at LIBOR plus a margin ranging from
1.00% to 1.50%, depending on the excess borrowing availability over amounts borrowed.
Interest rates are determined quarterly. The Company is charged a commitment fee on the
unused portion of the B of A Facility. There are no financial covenants, other than the
obligation to maintain a certain percentage of minimum excess availability (as defined in
the agreement) at all times. The B of A Facility requires compliance on a monthly basis
with certain non-financial covenants, including limitations on incurring additional
indebtedness and making investments, the use and disposition of collateral, changes of
control, as well as cash management provisions. In conjunction with the debt refinancing,
the Company incurred a non-cash charge of approximately $559,000 to write off the
remaining unamortized debt issuance cost from its prior credit facility and capitalized
debt issuance costs of approximately $239,000 through July 2, 2005, to be amortized over
the life of the agreement using the effective interest method.



The Companys prior credit facility was entered into in February
of 2003, with Wells Fargo Bank N.A. acting as lead bank and administrative agent (the
"Wells Facility"). The Wells Facility had a $95 million limit and a three-year
term with a one-year renewal option.



As part of the Wells Facility, the Company gave its lenders collateral
in the form of cash, equipment and fixtures, inventory and other assets. The Company also
granted leasehold mortgages in certain leasehold interests. The Wells Facility required
compliance as of the last day of each fiscal quarter, with certain financial covenants,
including the following: an adjusted leverage ratio (as described below); a fixed charge
coverage ratio, which is the ratio of EBITDAR, as defined, for the last four fiscal
quarters minus certain maintenance capital expenditures and taxes to fixed charges for the
four fiscal quarters; a minimum stockholders equity of $125 million plus a portion
of cumulative net income, adjusted for stock issuances and repurchases; a limitation on
new leases per fiscal year, and a cap on capital expenditures per fiscal year. The Company
was also obligated, on a continuous basis, to maintain a minimum cash balance. In
connection with the debenture offering in June 2004, the Wells Facility was amended to,
among other things, (1) increase the maximum allowable leverage ratio, (2) permit the
repurchase of our common stock, within specified limits, (3) increase the annual limits on
capital expenditures and new leases, (4) raise the limit on the value of acquisitions and
divestitures the Company can make without the consent of the lending group, and (5)
increase the maximum percentage rate to either prime plus 0.1% or one month LIBOR plus
2.5%. The Wells Facility was subsequently amended in August and November 2004. As amended,
the interest rate on the Wells Facility was either prime plus 1.25% or one-month LIBOR
plus 2.75%, at the Companys election, and the rates modified depending on an
adjusted leverage ratio equal to the ratio of average total funded debt, as defined under
the credit facility, plus six times rent expense, to EBITDAR for the four fiscal quarter
periods then ended, as calculated on the Companys quarterly compliance certificate.
The Company was charged a commitment fee on the unused portion of the line based on
defined performance objectives. The outstanding balance on the Wells Facility was repaid
in June 2004 from the proceeds of the debenture issuance. As of January 1, 2005, and as of
the date of termination of the Wells Facility, there were no outstanding borrowings under
the Wells Facility, and letters of credit outstanding totaled $9.1 million.





|6. | Derivatives and Hedging
    Activities
|-- | --------------------------------------



The Company does not have any derivative financial instruments as of
July 2, 2005 that meet the criteria of SFAS No. 133,Accounting for Derivative
Instruments and Hedging Activities.





|7. | Earnings Per Share
|-- | ------------------



Earnings per share are calculated in accordance with the provisions of
SFAS No. 128, Earnings Per Share("SFAS No. 128"). SFAS No. 128 requires
the Company to report both basic earnings per share, which is based on the
weighted-average number of common shares outstanding, and diluted earnings per share,
which is based on the weighted-average number of common shares outstanding and all
dilutive potential common shares outstanding, except where the effect of their inclusion
would be anti-dilutive. Anti-dilutive stock options of 994,948 and 351,081 for the three
months ended July 2, 2005 and June 26, 2004, respectively, and 1,728,802 and 351,081 for
the six months ended July 2, 2005 and June 26, 2004, respectively, were not included in
the diluted earnings per share calculations.



The Emerging Issues Task Force ("the Task Force") of the FASB
concluded in Issue No. 04-8, The Effect of Contingently Convertible Debt on Diluted
Earnings per Share that contingently convertible debt should be included in diluted
earnings per share computations using the if-converted method regardless of whether any of
the conversion contingencies have been met. During the second quarter of 2005, the Company
irrevocably elected to satisfy 100% of the principal amount of the debentures in cash to
be converted on or after July 1, 2005. The Company maintains the right to satisfy the
remainder of the conversion obligation to the extent it exceeds the principal amount in
cash or common stock or any combination of cash and common stock. In calculating diluted
earnings per share for the six months ending July 2, 2005, no shares related to the
debentures conversion have been included as the effect would have been anti-dilutive.





|8. | Goodwill and Intangible
    Assets
|-- | ----------------------------------



During the second quarter of fiscal 2005, no goodwill was recorded as a
result of acquisitions, the Company concluded goodwill was not impaired and no other
changes in the carrying amount of goodwill occurred. During the first quarter of fiscal
2005, $960,000 goodwill, net of accumulated amortization, was written off resulting in an
ending net balance of $105,124. See Note 9  Restructuring and Asset Impairment
Chargesfor further details.



Other intangible assets consist of the following (in thousands):



| |  |                                        |  |         | July 2, 2005 |         | January 1, 2005
| |  | -------------------------------------- |  | ------- | ------------ | ------- | ---------------
| |  |                                        |  |         |              |         |                
| |  |                                        |  |        
| |  | Leasehold interests                    |  | $ 8,373 |              | $ 8,388
| |  | Less accumulated amortization          |  | (2,396) |              | (2,200)
| |  |                                        |  |         |              |         |                
| |  | Leasehold interests, net               |  | 5,977   |              | 6,188  
| |  | Liquor licenses (indefinite
    lived) |  | 294     |              | 303    
| |  |                                        |  |         |              |         |                
| |  |                                        |  | $ 6,271 |              | $ 6,491
| |  |                                        |  |         |              |         |                
| |  |                                        |  |         |              |        



Amortization expense related to finite lived intangible assets was
$93,000 and $75,000 for the three months ended July 2, 2005 and June 26, 2004,
respectively, and $196,000 and $141,000 for the six months ended July 2, 2005 and June 26,
2004, respectively. The estimated amortization of finite lived intangible assets for each
of the five fiscal years ending in fiscal 2009 is as follows (in thousands):



| | FISCAL 
    YEAR |  | AMORTIZATION EXPENSE | 
| | ---------------- |  | -------------------- | 
| |                  |  |                      | 
| |                  |  |                      | 
| | 2005             |  | $ 179                | 
| | 2006             |  | 358                  | 
| | 2007             |  | 358                  | 
| | 2008             |  | 358                  | 
| | 2009             |  | 358                  | 





|9. | Restructuring and Asset
    Impairment Charges
|-- | ----------------------------------------------



During the second quarter of fiscal 2005, the Company recorded net
restructuring and asset impairment charges of $909,000 consisting of the following
components (in thousands):



| | Change in estimate related to
    lease-related liabilities for sites previously identified for closure or sale |                                                      | $ (287) | 
| | --------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------- | ------- | 
| | Lease-related liability for
    sites closed and relocated during the quarter                                   |                                                      | 304     | 
| | Severance for employees
    terminated during the second quarter of fiscal 2005 and earlier                     |                                                      | (104)   | 
| | Accretion expense on lease
    related liabilities                                                              |                                                      | 112     | 
| | Asset impairment charges                                                                                        |                                                      | 884     | 
| |                                                                                                                 |                                                      |         | 
| |                                                                                                                 | Total restructuring and asset
    impairment expense | $ 909   | 
| |                                                                                                                 |                                                      |         | 





Details of the significant components are as follows:



- Changes in estimate related to lease-related liabilities for sites previously identified
    for closure or sale. ($287,000 of restructuring income)



- Lease-related liability for sites closed and relocated during the second quarter.
    ($304,000 of restructuring expense)



- Severance for employees notified of termination in the second quarter of fiscal 2005.
    ($104,000 of restructuring income) -



- Accretion expense on lease-related liabilties. ($112,000 of restructuring expense)



- Asset impairment charges.



For the six months ended July 2, 2005 the Company recorded net
restructuring and asset impairment charges of $2,460,000 consisting of the following
components (in thousands):



| | Change in
    estimate related to lease-related liabilities for    sites previously
    identified for closure or sale |                                                      | $ (147) | 
| | ---------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------- | ------- | 
| | Lease-related
    liabilities for sites closed during the year                                                         |                                                      | 424     | 
| | Severance for
    employees terminated during the six months    ended 2005                                             |                                                      | 113     | 
| | Accretion
    expense on lease related liabilities                                                                     |                                                      | 226     | 
| | Write off of
    goodwill                                                                                              |                                                      | 960     | 
| | Asset
    impairment charges                                                                                           |                                                      | 884     | 
| |                                                                                                                        |                                                      |         | 
| |                                                                                                                        | Total
    restructuring and asset impairment expense | $ 2,460 | 
| |                                                                                                                        |                                                      |         | 





Details of the significant components are as follows:



- Changes in estimate related to lease-related liabilities for sites previously
    identified for closure or sale. ($147,000 of restructuring income)  For the six
    months ended July 2, 2005, the Company accrued additional amounts for a Tennessee location
    prior to finding a subtenant, and subsequently accrued the minimum estimated lease
    payments net of expected subtenant income for two Tennessee locations. In addition, the
    Company reached an agreement to receive a fee for early termination of an existing lease
    agreement in Scottsdale, Arizona.



- Lease-related liabilities for sites closed year to date through July 2, 2005. ($424,000
    of restructuring expense)



- Severance for employees notified of termination. ($113,000 of restructuring expense)



- Accretion expense on lease-related liabilities. ($226,000 of restructuring expense)



- Write off of goodwill. ($960,000 of restructuring expense)



- Asset impairment charges.



During the three and six month periods ended July 2, 2005, and the
three and six month periods ended June 26, 2004, respectively, the Company incurred
$55,000, $448,000, $864,000 and $2.6 million of charges for accelerated depreciation
related to planned store closures. These costs are included in the "Cost of goods
sold and occupancy costs" line of the Consolidated Statements of Operations.



The following table summarizes accruals related to the Companys
restructuring charges (in thousands):



|                          |  | 2001 and |  |       |  |         |  |         |  | 1st Qtr |  | 2nd Qtr |  |        
|------------------------- |  | -------- |  | ----- |  | ------- |  | ------- |  | ------- |  | ------- |  | -------
|EXIT PLANS                |  | Prior    |  | 2002  |  | 2003    |  | 2004    |  | 2005    |  | 2005    |  | Total  
|                         
|Balance at                |  |          |  |       |  |         |  |         |  |         |  |         |  |        
|December 27, 2003:        |  | $ 8,615  |  | $ 421 |  | $ 224   |  | $
    - |  | $
    - |  | $
    - |  | $ 9,260
|                          |  |          |  |       |  |         |  |         |  |         |  |         |  |        
|Severance expense         |  | -        |  | -     |  | -       |  | 754     |  | -       |  | -       |  | 754    
|Lease-related expenses    |  | (310)    |  | 344   |  | 70      |  | 566     |  | -       |  | -       |  | 670    
|                          |  |          |  |       |  |         |  |         |  |         |  |         |  |        
|Cash paid:                |  |          |  |       |  |         |  |         |  |         |  |         |  |        
|Severance expense         |  | -        |  | (7)   |  | (54)    |  | (495)   |  | -       |  | -       |  | (556)  
|Lease-related liabilities |  | (1,429)  |  | (757) |  | (235)   |  | (48)    |  | -       |  | -       |  | (2,469)
|                          |  |          |  |       |  |         |  |         |  |         |  |         |  |        
|Provision adjustments     |  | (212)    |  | -     |  | (5)     |  | (15)    |  |         |  |         |  | (232)  
|                          |  |          |  |       |  |         |  |         |  |         |  |         |  |        
|                          |  |          |  |       |  |         |  |         |  |         |  |         |  |        
|Balance at                |  |          |  |       |  |         |  |         |  |         |  |         |  |        
|January 1, 2005:          |  | $ 6,664  |  | $ 1   |  | $
    - |  | $ 762   |  | $
    - |  | $
    - |  | $ 7,427
|                          |  |          |  |       |  |         |  |         |  |         |  |         |  |        
|Severance expense         |  | -        |  | -     |  | -       |  | -       |  | 217     |  | -       |  | 217    
|Lease-related expenses    |  | 114      |  | -     |  | 140     |  | -       |  | 120     |  | -       |  | 374    
|                          |  |          |  |       |  |         |  |         |  |         |  |         |  |        
|Cash paid:                |  |          |  |       |  |         |  |         |  |         |  |         |  |        
|Severance expense         |  | -        |  | -     |  | -       |  | (88)    |  | (99)    |  | -       |  | (187)  
|Lease-related liabilities |  | (429)    |  | -     |  | (35)    |  | (99)    |  | 21      |  | -       |  | (542)  
|                          |  |          |  |       |  |         |  |         |  |         |  |         |  |        
|Provision adjustments     |  | -        |  | -     |  | -       |  | -       |  | (7)     |  | -       |  | (7)    
|                          |  |          |  |       |  |         |  |         |  |         |  |         |  |        
|                          |  |          |  |       |  |         |  |         |  |         |  |         |  |        
|Balance at                |  |          |  |       |  |         |  |         |  |         |  |         |  |        
|April 2, 2005:            |  | $ 6,349  |  | $ 1   |  | $ 105   |  | $ 575   |  | $ 252   |  | $
    - |  | $ 7,282
|                          |  |          |  |       |  |         |  |         |  |         |  |         |  |        
|Severance expense         |  | -        |  | -     |  | -       |  | -       |  | -       |  | (104)   |  | (104)  
|Lease-related expenses    |  | (465)    |  | -     |  | 377     |  | (87)    |  | -       |  | 304     |  | 129    
|                          |  |          |  |       |  |         |  |         |  |         |  |         |  |        
|Cash paid:                |  |          |  |       |  |         |  |         |  |         |  |         |  |        
|Severance                 |  | -        |  | -     |  | -       |  | (79)    |  | (14)    |  | (25)    |  | (118)  
|Lease-related liabilities |  | (408)    |  | -     |  | (35)    |  | (135)   |  | -       |  | (154)   |  | (732)  
|                          |  |          |  |       |  |         |  |         |  |         |  |         |  |        
|Provision adjustments     |  | 656      |  | -     |  | -       |  | 92      |  | (104)   |  | 684     |  | 1,328  
|                          |  |          |  |       |  |         |  |         |  |         |  |         |  |        
|                          |  |          |  |       |  |         |  |         |  |         |  |         |  |        
|Balance at                |  |          |  |       |  |         |  |         |  |         |  |         |  |        
|July 2, 2005:             |  | $ 6,1321 |  | $ 11  |  | $ 4471  |  | $ 3662  |  | $ 1341  |  | $ 7051  |  | $ 7,785
|                          |  |          |  |       |  |         |  |         |  |         |  |         |  |        
|                          |  |          |  |       |  |         |  |         |  |         |  |         |  |        



|Notes: | 1. The restructuring accrual balance
    consists of lease-related liabilities.                                    
|------ | -------------------------------------------------------------------------------------------------------------------
|       | 2. The restructuring accrual balance
    consists of lease-related liabilities and $6,000 for employee termination.



As of July 2, 2005, the Companys restructuring balances consist of $3.1 million
in accrued liabilities and other long-term obligations of $4.7 million.



|10. | Income Taxes
|--- | ------------



For the six months ended July 2, 2005, the Company recorded $322,000 of
income tax expense, as a result of income before income taxes of $ 93,000 during the
period. The tax expense relates to income generated by the Companys Canadian
operations. The Company has a $674,000 net deferred tax asset, primarily as a result of
timing differences related to its Canadian operations. The Company performs assessments of
the realization of its net deferred tax assets according to SFAS No. 109, Accounting
for Income Taxes. As a result of these assessments, the Company concluded at December
31, 2004, that it should place a full valuation allowance against its US net deferred tax
asset. The Company has adjusted its valuation allowance during the current quarter to
continue to record a full valuation allowance against its US net deferred tax asset. Due
to income from US operations generated in the current quarter, the Company recorded tax
expense related to US operations during the second quarter of 2005.





|11. | Related Party
    Transactions
|--- | ------------------------------



Perry D. Odak. In May 2002, the Companys Board of Directors
amended the employment agreement of Perry D. Odak, the Companys CEO and President,
to extend through December 2002 the period during which the issuance by the Company of
additional securities as part of an equity financing would entitle Mr. Odak to receive up
to 300,000 stock options exercisable for the Companys common stock. In March 2002,
Mr. Odak was issued options to purchase 5,856 shares of common stock under a provision of
his employment agreement that provided for the maintenance of his 5% equity position in
the event of a capital-raising transaction, based upon the issuance of 111,269 shares of
common stock, the resale of which was registered on Form S-3, filed in April 2002. In
August 2002, the Companys Board of Directors approved a third amendment to Mr.
Odaks employment agreement, pursuant to which up to 70,000 of the stock options to
which Mr. Odak would be entitled under his employment agreement as a result of the closing
of a capital-raising transaction could be granted to other employees of the Company
designated by Mr. Odak. The options would only be granted upon the closing of the
capital-raising transaction, have a 10-year term, vest over four years and have an
exercise price equal to the closing price of the Companys stock on the date the
capital-raising transaction was concluded. An equal number of options would be granted
simultaneously to Mr. Odak, provided that the options granted to Mr. Odak would only be
exercisable as the options granted to other employees terminated (as opposed to expired)
without exercise.



As a result of the completion of an equity offering of 4.45 million
shares of the Companys common stock in September 2002, the Company issued options
exercisable for 164,211 shares of the Companys stock to Mr. Odak pursuant to the
terms of his employment agreement. An additional 70,000 options, to which Mr. Odak would
have been entitled under his employment agreement, were issued to executives of the
Company designated by Mr. Odak. The Company also issued an additional 70,000 options to
Mr. Odak, provided that the options granted to Mr. Odak are only exercisable as the
options granted to the designated executives under the third amendment to Mr. Odaks
employment agreement terminate (as opposed to expire) without exercise. The Company also
made a matching grant of 70,000 additional options from the Companys 1996 Equity
Incentive Plan to the same executives. The Company may incur quarterly compensation
expense, based on any increase in the then-current stock price over the exercise price, as
a result of the issuance of the initial 70,000 options (as opposed to the Companys
matching grant of 70,000 additional options) to the designated executives and Mr. Odak.



In 2004, the Compensation Committee of the Board of Directors
recommended to the Company's Board, which approved, in concept, a modification to Mr.
Odak's employment agreement to provide for the payment of the existing $9.2 million
supplemental bonus in the event of Mr. Odak's death or disability while employed by the
Company. The Board also approved the modification of the definition of
"disability" to extend the period during which Mr. Odak is unable to work from
90 to 365 consecutive days. Subsequently, the Compensation Committee recommended, and the
Board approved, in concept, a modification to the employment agreement to provide for a
payment of a bonus of approximately $1.6 million: (i) in the event Mr. Odak terminates his
employment for Good Reason, as defined in his employment agreement; (ii) in the event Mr.
Odak is terminated without Cause, as defined in the agreement; or (iii) in the event his
employment agreement is not renewed at the end of its initial term in March, 2006. The
Company has acquired an insurance policy for the benefit of the Company to cover payment
in the event of Mr. Odak's death or disability in the approximate amount of the
supplemental bonus. On May 10, 2005, the Company and Mr. Odak entered into a Fourth
Amendment to Employment Agreement, documenting the foregoing.



Other. Mark A. Retzloff is a current member of the Companys
Board of Directors, and sits on its Real Estate Committee. Mr. Retzloff is Chief Organic
Officer of Aurora Organic Dairy, which derives 8% of its total revenues from sales of
organic milk to the Company under the Companys private label brand. Mr. Retzloff
sits on the boards of directors of several other natural or organic companies that derive
5% of their revenues from sales of products to the Company. Stacey J. Bell, a current
member of the Companys Board of Directors, is an employee of Ideasphere, Inc., which
manufactures certain of the Companys private label vitamins and supplements. Total
purchases from these vendors for the three and six months ended July 2, 2005 and June 26,
2004 were $1.2 million and $2.2 million, and $833,000 and $1.4 million, respectively.
Purchases of grocery products are made primarily through the Companys primary
distributor, UNFI and therefore are indirect in nature. As of the fiscal quarters ending
July 2, 2005 and June 26, 2004, amounts owed for these vendors were $70,000 and $81,000,
respectively.





|12. | Contingencies
|--- | -------------



Wild Oats Markets Canada, Inc., as successor to Alfalfa's Canada, Inc.,
a Canadian subsidiary of the Company, was a defendant in Helen Fakhri and Ady Aylon, as
Representative Plaintiffs v. Alfalfa's Canada, Inc., a class action suit for monetary
damages brought in the Supreme Court of British Columbia, Canada by the representative
plaintiffs on behalf of two groups of claimants - those who claim to have contracted
Hepatitis A allegedly through the consumption of food purchased at a Capers Community
Market in the spring of 2002, and those who were inoculated against Hepatitis A in March
and April, 2002, after handling and/or consuming food products from Capers that were or
might have been contaminated with Hepatitis A. In July 2005, the Court approved a
settlement agreement pursuant to which plaintiffs submitting proof of claim receive either
cash or a gift card, redeemable at the Companys Canadian stores, of certain amounts
determined by classification of the claimant within one of three separate categories. The
Company's insurers have acknowledged coverage for defense and administrative costs and
settlement liability, and the Company has exhausted its deductible.



Tim Auchterlonie, individually and on behalf of all others similarly
situated and the general public, and Roes 1 to 1000 vs. Wild Oats Markets, Inc. and Does 1
through 100, is a purported class action suit brought in August 2004 in the Superior
Court, County of Los Angeles, for payment of overtime and damages relating to alleged
violations of the California Business and Professions Code by a former managerial
employee, on behalf of himself and all other similarly situated California employees,
claiming that store directors at the Companys California stores should have been
classified as non-exempt employees and paid on an hourly basis. Plaintiff also alleges
that the Companys incentive bonus program is illegal based upon deductions for items
outside of the employees control. The Company believes that the employee, a former
store director, was properly classified as an exempt employee based upon his job duties,
and intends to vigorously defend the suit. At this time, the Company does not have
sufficient facts to estimate any potential damages. The case has been designated
non-complex and trial has been scheduled for October 2005.



In June 2002, an administrative law judge ("ALJ") found
against the Company in Wild Oats Markets, Inc. and Local 371, United Food &
Commercial Workers, in certain unfair labor practice charges brought in connection
with the opening of the Companys store in Westport, Connecticut. The Company
appealed the ALJs decision to the National Labor Relations Board. In May 2005, the
National Labor Relations Board denied the appeal and issued a Decision and Order, setting
forth certain equitable, injunctive and monetary remedies to be undertaken by the Company,
including payment of backpay less interim earnings, and offers of employment to certain
former employees of a store previously sold by the Company in 2000 (the "Sold
Store"). The Company is currently evaluating whether to appeal all or part of the
Decision. The Company is not presently able to estimate its potential liability to former
employees of the Sold Store because the process of identification and establishment of
such claims has not commenced.



The Company also is named as defendant in various actions and
proceedings arising in the normal course of business. In all of these cases, the Company
is denying the allegations and is vigorously defending against them and, in some cases,
has filed counterclaims. Although the eventual outcome of the various lawsuits cannot be
predicted, it is managements opinion that these lawsuits will not result in
liabilities that would materially affect the Companys consolidated results of
operations, financial position, or cash flows.





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

This report on Form 10-Q contains certain forward-looking statements
regarding our future results of operations and performance. Important factors that could
cause differences in results of operations include, but are not limited to, the timing,
execution and performance of new store openings, relocations and remodels; the timing and
liability resulting from sales and closures; amount of time before new stores become
profitable; the timing and impact of merchandising programs and promotional and
advertising campaigns; the impact of competition; changes in product supply or suppliers;
changes in management information needs; changes in customer needs and expectations;
governmental and regulatory actions; general industry or business trends or events;
changes in economic or business conditions in general or affecting the natural foods
industry in particular; and competition for and the availability of sites for new stores
and potential acquisition candidates. See Management's Discussion and Analysis of
Financial Condition and Results of Operations - Cautionary Statement Regarding
Forward-Looking Statements.



Executive Summary



This Executive Summary section of Managements Discussion and
Analysis of Financial Condition and Results of Operationsprovides a broad summary of
the more specific and detailed information disclosed in other sections of this report. The
context that it provides should be viewed as a supplement to, and read in conjunction
with, the details contained elsewhere in this report.



Wild Oats Markets, Inc. is one of the largest natural foods supermarket
chains in North America. As of the date of this report, we operated 111 natural foods
stores in 24 states and British Columbia, Canada. We operate in the retail grocery
industry with two store formats: the natural foods supermarket format, under the Wild Oats
Natural Marketplace(R) name nationwide and the Capers Community Market(R)
name in Canada; and the farmers market format, under the Henrys Farmers Market(R)
name in southern California and Phoenix, Arizona, and the Sun Harvest name in Texas.
Both formats emphasize natural and organic products with a wide selection of products in a
full-service environment. The formats share a core demographic customer profile. We manage
support services provided to the stores centrally from our Boulder, Colorado headquarters.
All of our stores, regardless of format, purchase from the same primary distributor based
on centralized negotiations, merchandising and marketing strategies. Our distribution
facility, opened in February 2004, supplies produce and other perishables for
approximately 70 stores in the western United States.



In 2005, we are refining our product mix and marketing strategies to
maximize the potential of all of our stores with an expanded product offering that we
believe will better appeal to our customer demographics of our existing store sites. We
intend to broaden our product offerings to include a limited number of convenience items.
In early 2005, we began to introduce more gourmet and epicurean items to reach the
specialty foods customer, and in anticipation of the 2005 release of the new U.S.
Department of Agriculture "food pyramid" dietary guidelines, we launched our
Superfoods program in all of our stores. Store signage helped identify 20 nutrient-dense
foods, and brochures and recipes emphasizing the benefits of incorporation of Superfoods
into our customers daily diet were offered by trained staff at all stores. We
continue to expand our private label line of products, including the Wild Oats(R)
and the Henrys Marketplace(R) branded products and plan to introduce
additional private label products during 2005 and beyond. We continue to focus on growth
through new store development. To date in 2005, we have added six new stores to our base
and plan to open three additional stores in areas where we already have a market presence.



As of July 2, 2005, we had 111 stores located in 24 states and Canada,
as compared to 105 stores as of June 26, 2004.



| |                                    |  | TOTAL
    STORE COUNT
| | ---------------------------------- |  | ---------------------
| |                                    |  | SIX MONTHS
    ENDED 
| |                                    |  |                      
| |                                    |  | July 2,
    2005     
| |                                    |  |                      
| | Store count at beginning of period |  | 108                  
| | Stores opened                      |  | 6                    
| | Stores closed                      |  | (3)                  
| | Stores sold                        |  | -                    
| |                                    |  |                      
| | Store count at end of period       |  | 111                  
| |                                    |  |                      
| |                                    |  |                      



In the second quarter of fiscal 2005, we opened one new Henrys
Farmers Market store in Temecula, California, and we relocated one Wild Oats Natural
Marketplace store in Suburban Portland, Oregon.





Results of Operations



Our net income for the second quarter of fiscal 2005 was $922,000, or
$0.03 per diluted share, compared with net loss of $331,000, or $(0.01) per diluted share,
in the same period in fiscal 2004. The following table sets forth, for the periods
indicated, certain selected income statement data expressed as a percentage of sales and
in dollars (in thousands - percentages may not add due to rounding):



| |                                                              | THREE MONTHS
    ENDED
| | ------------------------------------------------------------ | ----------------------
| |                                                              |                       
| |                                                              | July 2, 2005          
| |                                                              |                       
| |                                                              |                       
| | Sales                                                        | $ 284,608             
| | Cost of goods sold and occupancy costs                       | 202,049               
| |                                                              |                       
| | Gross profit                                                 | 82,559                
| | Direct store expenses                                        | 60,724                
| | Selling, general and administrative expenses                 | 17,201                
| | Loss on disposal of assets                                   | 53                    
| | Pre-opening expenses                                         | 780                   
| | Restructuring and asset impairment charges
    (income), net | 909                   
| |                                                              |                       
| | Income from operations                                       | 2,892                 
| |                                                              |                       
| | Interest income                                              | 361                   
| | Interest expense                                             | (2,144)               
| |                                                              |                       
| | Income (loss) before income taxes                            | 1,109                 
| | Income tax expense                                           | 187                   
| |                                                              |                       
| | Net income (loss)                                            | $ 922                 
| |                                                              |                       
| |                                                              |                       



| |                                                     |           | SIX MONTHS
    ENDED
| | --------------------------------------------------- | --------- | --------------------
| |                                                     |           |                     
| |                                                     |           | July 2, 2005        
| |                                                     |           |                     
| |                                                     |           |                     
| | Sales                                               | $ 562,687 |                     
| | Cost of goods sold and occupancy
    costs          | 399,872   |                     
| |                                                     |           |                     
| | Gross profit                                        | 162,815   |                     
| | Direct store expenses                               | 121,095   |                     
| | Selling, general and
    administrative expenses    | 32,241    |                     
| | Loss (gain) on disposal of assets                   | 44        |                     
| | Pre-opening expenses                                | 2,697     |                     
| | Restructuring and asset impairment
    charges, net | 2,460     |                     
| |                                                     |           |                     
| | Income from operations                              | 4,278     |                     
| |                                                     |           |                     
| | Loss on early extinguishment of
    debt            | (559)     |                     
| | Interest income                                     | 685       |                     
| | Interest expense                                    | (4,311)   |                     
| |                                                     |           |                     
| | Income before income taxes                          | 93        |                     
| | Income tax expense                                  | 322       |                     
| |                                                     |           |                     
| | Net (loss)
    income                               | $ (229)   |                     
| |                                                     |           |                     
| |                                                     |           |                     





Income Statement Analysis  Second Quarter of 2005 vs. Second
Quarter of 2004



Sales. Sales for the three months ended July 2, 2005 increased
13.1% as compared to the same period in fiscal 2004. This increase was primarily driven by
our six new stores opened since the end of the second quarter of 2004, and an increase in
comparable store sales over 2004. Total square feet of open stores increased 8.6% over the
second quarter of 2004, as the second fiscal quarter 2005 ended with 2.53 million total
square feet as compared to 2.33 million total square feet in the second fiscal quarter of
2004. Comparable store sales increased 5.4% for the quarter as compared to a 1.5% increase
in the same period last year. Comparable store basket size grew 5.0% for the fiscal
quarter ended July 2, 2005 as compared to 4.5% in the same period last year, while
customer traffic increased 0.3% as compared to a decline of 3.0% for the second quarters
2005 and 2004, respectively. During the second quarter, the Company lapped the final
quarter of difficult comparisons when it benefited from the California strike against
conventional grocery retailers. Excluding the strike affected stores, comparable sales
were 7.9% relative to 0.1% during the second quarter of 2005 and 2004, respectively.



Gross profit. Gross profit consists of sales less cost of goods
sold and store occupancy costs. Occupancy costs include store related depreciation, rent
and utilities. As a percentage of sales, gross profit decreased to 29.0% in the second
quarter of fiscal 2005 from 29.2% in the same period in fiscal 2004, due primarily to the
impact of the lower gross profit at new stores, which is approximately 40 basis points
relative to prior year. Offsetting this decrease was margin improvement in our existing
store base of approximately 20 basis points, due primarily to department mix changes. New
stores historically carry lower margins after opening due to higher shrink and heavy
promotional activity.



Direct store expenses. Direct store expenses include the following:
payroll, payroll taxes and benefits, store supplies and maintenance, in-store community
marketing and other store-specific contract costs. As a percentage of sales, direct store
expenses decreased to 21.3% in the fiscal quarter ended July 2, 2005, from 22.4% in the
same period last year. The improvement is due to leveraging payroll and the related taxes
along with improved loss history in our self-insured employee benefits. There has also
been a minor shift in marketing strategy which has seen the in-store community marketing
costs remain constant over last year, while incremental marketing spending is noted in
selling, general and administrative expenses.



Selling, general and administrative expenses. Selling, general and
administrative expenses include corporate and regional administrative support services,
purchasing, marketing and travel. Selling, general and administrative expenses for the
quarter ended July 2, 2005 increased 0.3% as compared to the same period in fiscal 2004.
Selling, general and administrative expenses in the second quarter of 2005 exceeded the
same period in 2004 due to an increased level of marketing and advertising expenses spent
to maintain sales momentum in addition to accrued corporate and regional level bonuses.



Pre-opening expenses. Pre-opening expenses include labor, rent,
advertising, utilities, supplies and certain other costs incurred prior to a stores
opening. Pre-opening expenses for the second quarter of fiscal 2005 decreased to $780,000
compared to $2.0 million during the same period in fiscal 2004, due to the opening of two
new stores in the second quarter of fiscal 2005 compared to five new stores during the
second quarter of last year.



Restructuring and asset impairment charges, net. During the second
quarter of fiscal 2005, we recorded net restructuring and asset impairment expense of
$909,000. Details of the significant components are as follows:



- Changes in estimate related to lease-related liabilities for sites previously identified
    for closure or sale. ($287,000 of restructuring income)



- Lease-related liability for sites closed and relocated during the second quarter.
    ($304,000 of restructuring expense)



- Severance for employees notified of termination in the second quarter of fiscal 2005.
    ($104,000 of restructuring income) -



- Accretion expense on lease-related liabilties. ($112,000 of restructuring expense)



In addition to the net restructuring expense described above,
management also identified during the second quarter of 2005, net asset impairment charges
of $884,000 in accordance with the provisions of SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assetsfor two stores held for use. In
determining whether an impairment exists, the Company estimates the stores future
cash flows on an undiscounted basis, and if the cash flows are not sufficient to recover
the carrying value, then the Company uses a discounted cash flow based on a risk-adjusted
discount rate, to adjust its carrying value of the assets, and records a provision for
impairment as appropriate. The Company continually re-evaluates its stores
performance to monitor the carrying value of its long-lived assets in comparison to
projected cash flows.



Interest income. Interest income was $361,000 for the second
quarter ended July 2, 2005 compared to $222,000 for the fiscal quarter ended June 26,
2004. This is due to the increase in average cash and short-term investment balances over
prior year.



Interest expense. Interest expense for the fiscal quarter ended
July 2, 2005 increased to $2.1 million from $1.3 million in the same period in fiscal
2004, as a result of the increase of average borrowings due to the $115.0 million
debentures.



Income tax expense. For the quarter ended July 2, 2005, we recorded
$187,000 of income tax expense, as a result of taxable foreign income during the period.
In addition, we concluded that the valuation allowance recorded during the first quarter
of 2005 could be partially reversed to reflect the benefit of a decrease in the
year-to-date domestic loss.





Income Statement Analysis  First Six Months of 2005 vs. First Six
Months of 2004.



Sales. Sales for the six months ended July 2, 2005 increased 9.2%
as compared to the same period in fiscal 2004. This increase was primarily driven by our
new stores and an increase in average basket size. Comparable store sales increased 2.5%
for the first half of 2005 which was less than the 4.9% increase for the same period in
2004 due to the California conventional grocery strike.



Gross profit. Gross profit consists of sales less cost of goods
sold and store occupancy costs. Occupancy costs include store related depreciation, rent
and utilities. As a percentage of sales, gross profit decreased to 28.9% in the first six
months of fiscal 2005 from 29.3% in the same period in fiscal 2004, due primarily to the
impact of the lower gross profit at new stores, which is approximately 30 basis points
relative to prior year, and the impact of the southern California conventional grocery
strike during the first quarter of 2004.



Direct store expenses. Direct store expenses include the following:
payroll, payroll taxes and benefits, store supplies and maintenance, in-store community
marketing and other store-specific contract costs. As a percentage of sales, direct store
expenses decreased to 21.5% in the year to date period ended July 2, 2005, from 22.0% in
the same period last year. The improvement is due to leveraging payroll and the related
taxes along with improved loss history in our self-insured employee benefits.



Selling, general and administrative expenses. Selling, general and
administrative expenses include: corporate and regional administrative support services,
purchasing, marketing and travel. Selling, general and administrative expenses for the six
months ended July 2, 2005 decreased 0.1% as compared to the same period in fiscal 2004.
Selling, general and administrative expenses during the first six months of 2005 decreased
over prior year due to the Companys third quarter 2004 reorganization and ability to
achieve greater operating efficiency through information technology investments. These
efficiencies were offset by additional marketing expenses and accrued corporate and
regional level bonuses.



Loss on disposal of assets. We recorded a $44,000 loss on disposal
of assets for the six months ended July 2, 2005 compared to a $69,000 gain in the same
period in fiscal 2004.



Pre-opening expenses. Pre-opening expenses include labor, rent,
advertising, utilities, supplies and certain other costs incurred prior to a stores
opening. Pre-opening expenses for year to date fiscal 2005 were consistent with prior
year, due to the opening of six new stores in each of the six months ended 2005 and 2004.



Restructuring and asset impairment charges, net. For the six months
ended July 2, 2005, we recorded net restructuring and asset impairment expense of
$2,460,000 consisting of the following components (in thousands):



- Changes in estimate related to lease-related liabilities for sites previously identified
    for closure or sale. ($147,000 of restructuring income)  For the six months
    ended July 2, 2005, the Company accrued additional amounts for a Tennessee location prior
    to finding a subtenant, and subsequently accrued the minimum estimated lease payments net
    of expected subtenant income for two Tennessee locations. In addition, the Company reached
    an agreement to receive a fee for early termination of an existing lease agreement in
    Scottsdale, Arizona.



- Lease-related liabilities for sites closed year to date through July 2, 2005. ($424,000
    of restructuring expense)



- Severance for employees notified of termination. ($113,000 of restructuring expense)



- Accretion expense on lease-related liabilities. ($226,000 of restructuring expense)



- Write off of goodwill. ($960,000 of restructuring expense)



- Asset impairment charges.



Loss on early extinguishment of debt. During the year to date
period ended 2005, we had a loss on the early extinguishment of debt of $559,000 due to
the write off of remaining unamortized debt issuance costs relating to the termination of
the Wells Facility (see Managements Discussion and Analysis of Financial
Condition and Results of Operations  Liquidity and Capital Resources below).
There was no such activity during the six months of fiscal 2004.



Interest income. Interest income was $685,000 for the six months
ended July 2, 2005 compared to $408,000 for the same period ended June 26, 2004. This is
due to the increase in average invested cash and short-term investment balances over prior
year.



Interest expense. Interest expense for the fiscal year to date
period ended July 2, 2005 increased to $4.3 million from $2.3 million in the same period
in fiscal 2004, as a result of the increase of average borrowings due to the $115.0
million debentures.



Income tax expense. For the year to date period ended July 2, 2005,
we recorded $322,000 of income tax expense, as a result of taxable foreign income during
the period. The tax valuation allowance established at fiscal 2004 year end was partially
reversed as a result of the decrease in domestic loss year to date through the second
quarter.



Earnings before interest, taxes, depreciation and amortization, loss on
early extinguishment of debt, loss (gain) on asset disposals, net, and restructuring and
asset impairment charges (income), net, as adjusted ("EBITDA, as adjusted").EBITDA, as adjusted, was $19.9 million for the six months ended 2005 as compared to
$19.0 million in the first six months of 2004. We believe that the reconciliation of
earnings before interest, taxes, depreciation and amortization ("EBITDA") and
EBITDA, as adjusted, provides meaningful non GAAP financial measures to help management
and investors understand and compare business trends among different reporting periods on
a consistent basis, independently of regularly reported non-cash charges and infrequent or
unusual events as determined by management. Readers are cautioned not to view EBITDA or
EBITDA, as adjusted, as an alternative to GAAP results or as being comparable to results
reported or forecasted by other companies, and should refer to the reconciliation of GAAP
net income (loss) results to EBITDA and EBITDA, as adjusted, for the second quarters and
first halves of 2005 and 2004, respectively. For an explanation of EBITDA, and EBITDA, as
adjusted, see Non GAAP Financial Information.



Remainder of 2005. Comparable store sales for full fiscal 2005 are
expected to be in the range of 3.0% to 4.0%.





Liquidity and Capital Resources

Our primary sources of capital have been cash flow from operations
(which includes trade payables), bank indebtedness, and the sale of equity securities. In
addition to these, we have also raised an additional $112.3 million, net of sales
commissions, in capital through the issuance of contingent convertible senior debentures
in a private placement in June 2004, as discussed below. Primary uses of cash have been
the financing of new store development, new store openings, relocations, remodels and
acquisitions, repurchase of common stock and repayment of debt.



Net cash generated by operating activities decreased to $14.7 million
during the first six months of fiscal 2005, as compared to $21.5 million during the same
period in fiscal 2004. This decrease is due to lower net earnings, higher restructuring
charges and working capital changes as compared to second quarter 2004.



Net cash used in investing activities was $836,000 during the first six
months of fiscal 2005 as compared to a $26.4 million use of cash during the same period in
fiscal 2004, due to a decrease in capital expenditures and proceeds from the sale of the
short term investments in 2005.



Net cash used in financing activities of $1.0 million during the first
six months of 2005 was $54.3 million less than the $53.3 million reported during the same
period in fiscal 2004. The decrease in cash flows from financing activities is the direct
result of a $115 million private debenture offering completed in June 2004 as discussed
below.



EBITDA. EBITDA was $16.8 million for the six month period ended
July 2, 2005, as compared to $19.0 million for the six months ended June 26, 2004. EBITDA
was negatively impacted in 2005 due to $2.3 million of restructuring and asset impairment
charges in addition to $559,000 in losses on the extinguishment of debt. For an
explanation and reconciliation of EBITDA, see Non GAAP Financial Information.



Contingent convertible senior debentures. In June 2004, we issued
$115 million aggregate principal amount of its 3.25% Convertible Senior Debentures due May
15, 2034 in a private placement. The debentures bear regular interest at the annual rate
of 3.25%, payable semiannually on May 15 and November 15 of each year until May 15, 2011,
after which date, no regular interest will be due. Commencing May 20, 2011 and ending
November 14, 2011, and for any six-month period thereafter, contingent interest will be
due and payable in the amount of 0.25% of the average trading price of the debentures
during a specified period, if the average trading price of the debentures equals or
exceeds 125% of the principal amount of the debentures.



The debentures are callable and convertible into our common stock prior
to maturity at the option of the holders under the following circumstances: (1) during any
calendar quarter commencing after June 30, 2004 and before March 31, 2029, if the last
reported sale price of our common stock is greater than or equal to 130% of the conversion
price of $17.70 per share; (2) at any time on or after April 1, 2029 if the last reported
sale price of our common stock on any date on or after March 31, 2029 is greater than or
equal to 130% of the conversion price; (3) subject to certain limitations, during the five
business-day period after any five consecutive trading-day period in which the trading
price per debenture for each day of that period was less than 98% of the product of the
conversion rate and the last reported sale price of our common stock; (4) if we call the
debentures for redemption; (5) upon the occurrence of certain corporate transactions; or
(6) if we obtain credit ratings for the debentures, at any time when the credit ratings
assigned to the debentures are below specified levels. The debentures are initially
convertible into 56.5099 shares of our common stock per $1,000 principal amount, which is
equivalent to approximately $17.70 per share, for total initial underlying shares of
6,498,639. The conversion rate will be subject to adjustment upon the occurrence of
specified events. During the second quarter of 2005, we made an irrevocable election to
pay the principal amount of debentures in cash upon conversion; however, the Company
retains the ability to satisfy the remainder of any conversion payment, in cash or any
combination of cash and common stock. Pursuant to the underwriting agreement and within 90
days of issuance, we filed a shelf registration statement covering resales of the
debentures and the common stock issuable upon conversion thereof.



On or after May 20, 2011, we may redeem for cash some or all of the
debentures at any time and from time to time, for a price equal to 100% of the principal
amount of the debentures plus accrued and unpaid contingent interest, if any. Holders have
the right to require us to repurchase any or all debentures for cash, at a repurchase
price equal to 100% of the principal amount of the debentures, plus accrued and unpaid
interest on: (1) May 15, 2011, May 15, 2014, and May 15, 2024; and (2) upon the occurrence
of a fundamental change (as defined in the debenture indenture). In the case of a
fundamental change in which all of the consideration for the common stock in the
transaction or transactions constituting the fundamental change consists of cash, we also
will pay to the holders a make-whole premium (as defined in the debenture indenture), the
amount of which could be significant but would not be determinable unless and until there
were to be a public announcement of such a fundamental change. Any make-whole premium
would be payable to all holders regardless of whether the holder elects to require us to
repurchase the debentures or elects to surrender the debentures for conversion.



The debentures are unsecured and unsubordinated obligations, and rank
equal in priority with all of our existing and future unsecured and unsubordinated
indebtedness and senior in right of payment to all of our subordinated indebtedness. The
debentures will effectively rank junior to any of our secured indebtedness and any of its
indebtedness that is guaranteed by our subsidiaries. Payment of principal and interest on
the debentures will be structurally subordinated to the liabilities of our subsidiaries.



There are no financial covenants within the debenture indenture,
however, we paid penalty interest of 0.25% for the first 90 days of 2005 and paid or will
be paying 0.50% thereafter until the debentures are publicly registered. As of July 2,
2005, the Company has accrued $79,095 and paid $138,160 in additional interest to
debenture holders due to not having an effective registration statement within the
specified timeframe.



In 2004, total proceeds from the issuance of the debentures were $115.2
million. We used $25.0 million of the net proceeds to repurchase 1,977,800 outstanding
shares of its common stock, $31.2 million to pay the outstanding balance on its credit
facility, and approximately $3.7 million to pay related debt issuance costs.



Credit facility. On March 31, 2005, we entered into a five-year
revolving secured credit facility with the Bank of America, N.A. ("B of A
Facility"). Concurrent with the execution of the B of A Facility, we terminated our
existing $95 million credit facility with Wells Fargo Bank N.A. as administrative agent.
The B of A Facility allows borrowings and letters of credit up to a maximum of $40
million, with an option to increase borrowings up to $100 million, subject to a borrowing
base determined by the value of certain inventory, credit card receivables, invested cash
and, at our discretion, mortgaged leaseholds. The B of A Facility is secured by certain of
our assets including, but not limited to, cash, inventory and fixed assets. Borrowings
under the B of A Facility bear interest, at our election, at the prime rate or at LIBOR
plus a margin ranging from 1.00% to 1.50%, depending on the excess borrowing availability
over amounts borrowed. Interest rates are determined quarterly. We are charged a
commitment fee on the unused portion of the B of A Facility. There are no financial
covenants, other than the obligation to maintain a certain percentage of minimum excess
availability (as defined in the agreement) at all times. The B of A Facility requires
compliance on a monthly basis with certain non-financial covenants, including limitations
on incurring additional indebtedness and making investments, the use and disposition of
collateral, changes of control, as well as cash management provisions. We expect that we
will be in compliance with all covenants. We further expect that our cash requirements
through the third quarter of fiscal 2005 will be primarily satisfied from the proceeds of
the 2004 debenture issuance as well as cash generated from operations, and thereafter from
cash generated from operations and borrowings under the new credit facility.



Our prior credit facility was entered into in February of 2003, with
Wells Fargo Bank N.A. acting as lead bank and administrative agent (the "Wells
Facility"). The Wells Facility had a $95.0 million limit and a three-year term with a
one-year renewal option.



As part of the Wells Facility, we gave our lenders collateral in the
form of cash, equipment and fixtures, inventory and other assets. We also granted
leasehold mortgages in certain leasehold interests. The Wells Facility required compliance
as of the last day of each fiscal quarter, with certain financial covenants, including the
following: an adjusted leverage ratio (as described below); a fixed charge coverage ratio,
which is the ratio of EBITDAR, as defined, for the last four fiscal quarters minus certain
maintenance capital expenditures and taxes to fixed charges for the four fiscal quarters;
a minimum stockholders equity of $125 million plus a portion of cumulative net
income, adjusted for stock issuances and repurchases; a limitation on new leases per
fiscal year, and a cap on capital expenditures per fiscal year. We were also obligated, on
a continuous basis, to maintain a minimum cash balance. As of January 1, 2005 and as of
the date of our termination of the Wells Facility, there were no outstanding borrowings
and letters of credit outstanding totaled $9.1 million.



As of July 2, 2005, we had no off-balance sheet arrangements,
unconsolidated subsidiaries, commitments or guarantees, except as disclosed in the notes
to the consolidated financial statements. As of July 2, 2005, we had a working capital
deficit of $(21.4) million, or an improvement of $3.5 million over fiscal 2004 year-end.



Capital expenditures. We spent approximately $5.8 million during
the second fiscal quarter of fiscal 2005 for new store construction, remodels and other
capital expenditures. Our average capital expenditures to open a store, including
leasehold improvements, equipment and fixtures, has ranged from approximately $2.0 million
to $5.0 million historically, excluding inventory costs and initial operating losses. We
anticipate that the average capital expenditures to open a natural foods supermarket
format store will be $2.0 million to $4.0 million in the future, on a turnkey lease basis.
Turnkey leases are properties that are ready for a tenant to begin business by having the
tenant furnish only furniture and inventory. Our average capital expenditures to open a
farmers market format store are estimated at $1.6 million to $3.0 million in the
future. Delays in opening new stores may result in increased pre-opening costs for the
site, as well as lower than planned sales for the Company.



Based upon the current level of operations, we believe that cash flows
from operations and other sources available such as cash from our debentures and available
line of credit will be adequate to meet anticipated requirements for working capital,
capital expenditures, interest payments and future debenture payments in the foreseeable
future. However, there can be no assurance that the business will continue to generate
cash flows from operations at current levels or that we will be able to maintain our
ability to borrow under the line of credit.





Critical Accounting Policies and Estimates



Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been prepared
in accordance with accounting principles generally accepted in the United States of
America. The preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and expenses,
and related disclosures of contingent assets and liabilities. We base our estimates on
historical experience and on various other assumptions that are believed to be reasonable
under the circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates.



On an ongoing basis, we evaluate the continued appropriateness of our
accounting policies and resulting estimates, including those related to:



- Goodwill valuation,
- Asset impairment charges,
- Restructuring charges and store closing costs,
- Inventory valuation and reserves,
- Self-insurance reserves, and
- Tax valuation allowances



We believe the following critical accounting policies affect our most
significant judgments and estimates used in the preparation of our consolidated financial
statements. There have been no changes in 2005 in the application of these policies:





Goodwill. Goodwill consists of the excess cost of acquired
companies over the sum of the fair market value of their underlying assets acquired and
liabilities assumed. In accordance with SFAS No. 142, "Goodwill and Other Intangible
Assets", goodwill is reviewed for impairment annually at the end of the second
quarter at a reporting unit level, or more frequently, if certain indicators of impairment
exist. We have one reporting unit at the enterprise level to which goodwill is allocated.
We estimate fair value utilizing a combination of three different methods, consisting of
market capitalization, discounted future cash flows, and earnings before interest, taxes,
depreciation, amortization ("EBITDA") multiples, and compare it to the carrying
value of the enterprise for purposes of identifying potential impairment.



The annual review for impairment relies heavily on our ability to
accurately project future cash flows, which in itself, requires the extensive use of
accounting judgment and financial assumptions and estimates. These projections can be
affected by many items that are interdependent on one another and are outside of our
control and ability to predict except at the time of evaluation, such as changes in the
economy, trends affecting the natural and organic food industry, and changing competitive
pressures.



Two of the most significant assumptions underlying the determination of
the fair value of goodwill and other intangible assets are the EBITDA multiples and the
growth rate on our free cash flow projections. In connection with our annual goodwill
impairment measurement, we determined that a 33% reduction in our EBITDA multiple would
have decreased the valuation model by $71.9 million and a 25% reduction in our free cash
flow projection percentage would have resulted in a decrease of $100.7 million. Despite
these calculated decreases, our lowest valuation still exceeds book value, and therefore,
no impairment would be recognized.



Impairment of long-lived assets. We monitor the carrying value of
our long-lived assets, including finite-lived intangible assets, for potential impairment
whenever changes in circumstance indicate a potential for impairment may exist. The
triggering events for evaluations of finite lived intangible assets include a significant
decrease in the market value of an asset, acquisition and construction costs in excess of
budget, or current store operating losses combined with a history of losses or a
projection of continuing losses. If impairment is identified, based on undiscounted future
cash flows, management compares the assets future cash flows, discounted to present
value using a risk-adjusted discount rate, to its current carrying value and records a
provision for impairment as appropriate. With respect to equipment and leasehold
improvements associated with closed stores, the value of these assets is adjusted to
reflect recoverable values estimated based on our previous efforts to dispose of similar
assets, with consideration for current economic conditions.



Our review for impairment relies heavily on our ability to accurately
project future cash flows related to our stores and support facilities. Our cash flow
projections look several years into the future and include assumptions about sales growth
and cost trends that could be significantly impacted by changes in the local and national
economy, trends in the natural and organic food industry, local competitive pressures, as
well as the effectiveness of various operational initiatives underway in our stores.



A 2% increase in our sales growth assumption utilized in the cash flow
projection would have resulted in no change to the number of stores or related dollar
amount of impaired assets. A 2% decrease in our sales growth assumption would have
resulted in the impairment of an additional two stores held for use and approximately $2.2
million of additional asset impairment charges.



Restructuring and store closure costs. We reserve for the present
value of lease-related costs associated with store and support facility closures,
relocations, and sales when the store or facility is closed. The calculation of the lease
related liabilities involves applying a discount rate to the estimation of our remaining
lease obligations, taxes and common area maintenance, net of future estimated subtenant
income. The lease liabilities usually are paid over the lease terms associated with the
closed stores, which have had remaining terms ranging from one month to 25 years. Store
closing liabilities are reviewed each reporting period to ensure that the amounts recorded
reasonably reflect our future obligations associated with closed stores and facilities
based on the most current information available. Adjustments to existing lease related
liabilities are primarily a result of changes in the expected timing or amount of
subtenant income, and are made in the period in which the change in facts and
circumstances, as well as their related impacts, become known and estimable. Lease related
closure costs and associated severance costs are made in accordance with SFAS No. 146
"Accounting for Costs Associated with Exit of Disposal Activities." Severance
costs incurred in connection with store closings are recorded when the employees have been
identified and notified of the termination benefits to be made to the employees.



In evaluating the reserves for lease related liabilities, management
considers a number of variables that would affect the marketability of the space such as
recent demand for similar space in the market area, the number of potential subtenants
expressing interest, specific characteristics of the property, any limitations in the use
of the space imposed by the landlord, as well as the creditworthiness of actual
subtenants. The above factors are continuously reevaluated and have a significant impact
on managements assumptions used in estimating the timing and amount of any subtenant
income, and thus the amount of required reserves.



In calculating the lease related liabilities, we apply a discount rate
to the estimation of our remaining lease obligations. By decreasing the discount rate by
22%, we determined that our second quarter lease related restructuring expense would have
increased by approximately $39,000. An increase of 22% in the discount rate would have
decreased the second quarter lease related restructuring expense by $35,000.



Inventory. Our inventory is stated at the lower of cost or market
on a first-in, first-out basis using the retail method of accounting to determine cost of
sales and inventory for approximately 80% of inventories and using the item cost method
for highly perishable products representing approximately 20% of inventories in our
stores. Under the retail inventory method, the valuation of inventories at cost and the
resulting gross margins are determined by applying a cost-to-retail ratio for various
categories of similar items to the retail value of inventories. Inherent in the retail
inventory method calculations are certain management judgments and estimates, including
shrinkage, which could significantly impact the ending inventory valuation at cost as well
as the resulting gross margins. Physical inventory counts are taken at each location to
ensure that the amounts reflected in the consolidated financial statements are properly
stated as of the end of each reporting period.



We maintain allowances for excess or unsaleable inventory as a
percentage of its gross inventory balance based on historical experience and assumptions
about market conditions. If actual market conditions are less favorable than those
projected by management, or if we expand our forward buying of inventory, which will
increase our inventory levels, then additional inventory write-downs may be required.



Relative to the above, a hypothetical increase of 1% to our
cost-to-retail ratio would result in a decrease of approximately $700,000 to our inventory
valuation. Conversely, a hypothetical decrease of 1% would result in an increase of
approximately $700,000 to our inventory balance as of the end of second quarter, 2005.
With regards to our allowance for inventory, an increase or decrease of 1% would cause our
allowance to fluctuate by about $590,000.



Self-insurance. We use a combination of stop-loss insurance and are
self-insured for losses relating to workers compensation claims, general liability
and employee medical and dental benefits. We have purchased stop-loss coverage in order to
limit exposure to any significant claim or levels of claims that would be catastrophic to
our Company. Self-insured losses are accrued based upon estimates of the aggregate
uninsured claims incurred using certain actuarial assumptions followed in the insurance
industry which are based on our industrys experience as well as our historical
claims experience. While we believe that the assumptions and methodology used are
appropriate, the estimated accruals for these liabilities could be significantly affected
if actual loss development and payment patterns vary significantly from the assumptions
and historical trends utilized.



Tax valuation allowances. We utilize the concepts and guidance of
SFAS No. 109, "Accounting for Income Taxes" in assessing the ability to realize
our deferred tax assets. The Company establishes valuation allowances based on historical
taxable income, projected future income, the expected timing of the reversals of existing
temporary differences and the implementation of tax planning strategies. Based on our
analysis in 2004, we established a full valuation allowance against our net deferred tax
assets as it was not more likely than not that the assets would be realized under SFAS No.
109 Accounting for Income Taxes.



When we are able to show a profitable trend (generally 6 to 8 quarters), we will
re-evaluate the need for a valuation allowance using all factors available to us at that
time.





Cautionary Statement Regarding Forward-Looking Statements



This Report on Form 10-K contains "forward-looking
statements," within the meaning of the Private Securities Litigation Reform Act of
1995, which involve known and unknown risks. Such forward-looking statements include
statements as to the number of stores we plan to open or relocate in future periods and
the anticipated performance of such stores; the impact of competition; the sufficiency of
funds to satisfy our cash requirements through the remainder of fiscal 2005; the impact of
changes resulting from our merchandising and marketing programs; our ability to benefit
from past supply chain modifications; expected pre-opening expenses and capital
expenditures; and other statements containing words such as "believes,"
"anticipates," "estimates," "expects," "may,"
"intends" and words of similar import or statements of management's opinion.
These forward-looking statements and assumptions involve known and unknown risks,
uncertainties and other factors that may cause our actual results, market performance or
achievements to differ materially from any future results, performance or achievements
expressed or implied by such forward-looking statements. Important factors that could
cause differences in results of operations include, but are not limited to, the timing and
execution of new store openings, relocations, remodels and closures; new competitive
impacts; changes in product supply or suppliers and supplier performance levels; changes
in management information needs; changes in customer needs and expectations; changes in
government regulations applicable to our business; changes in economic or business
conditions in general or affecting the natural foods industry in particular; and
competition for and the availability of sites for new stores. We undertake no obligation
to update any forward-looking statements in order to reflect events or circumstances that
may arise after the date of this Report.





Non GAAP Financial Information



The following is a reconciliation of EBITDA and EBITDA, as adjusted, to
net income (in thousands):



| |                                                                 |  | THREE MONTHS
    ENDED
| | --------------------------------------------------------------- |  | ----------------------
| |                                                                 |  |                       
| |                                                                 |  | July 2, 2005          
| |                                                                 |  |                       
| |                                                                 |  |                       
| | Net income (loss)                                               |  | $ 922                 
| | Interest expense, net of
    interest income                    |  | 1,783                 
| | Income tax expense                                              |  | 187                   
| | Depreciation and
    amortization                               |  | 6,382                 
| |                                                                 |  |                       
| | EBITDA                                                          |  | 9,274                 
| | Loss on asset disposals,
    net                                |  | 53                    
| | Restructuring and asset
    impairment charges    (income), net |  | 909                   
| |                                                                 |  |                       
| | EBITDA, as adjusted                                             |  | $ 10,236              
| |                                                                 |  |                       
| |                                                                 |  |                       



| |                                                     |  | SIX MONTHS
    ENDED
| | --------------------------------------------------- |  | --------------------
| |                                                     |  |                     
| |                                                     |  | July 2, 2005        
| |                                                     |  |                     
| |                                                     |  |                     
| | Net (loss) income                                   |  | $ (229)             
| | Interest expense, net of
    interest income        |  | 3,626               
| | Income tax expense                                  |  | 322                 
| | Depreciation and
    amortization                   |  | 13,117              
| |                                                     |  |                     
| | EBITDA                                              |  | 16,836              
| | Loss on early
    extinguishment of debt            |  | 559                 
| | Loss (gain) on asset
    disposals, net             |  | 44                  
| | Restructuring and asset
    impairment charges, net |  | 2,460               
| |                                                     |  |                     
| | EBITDA, as adjusted                                 |  | $ 19,899            
| |                                                     |  |                     
| |                                                     |  |                     



EBITDA and EBITDA, as adjusted, are measures used by management to
measure operating performance.  EBITDA is defined as net income plus interest, taxes,
depreciation, and amortization.  EBITDA, as adjusted, excludes certain non-cash
charges and other items that management does not utilize in assessing operating
performance or for purposes of corporate and regional level bonuses.  The items
included in the reconciliation from EBITDA to EBITDA, as adjusted, are either (a) non-cash
items (e.g. asset impairments) or (b) items that management does not consider to be
relevant to assessing operating performance (e.g. restructuring, gain/loss on sale of
assets, net).  Regarding the non-cash items, management believes that investors can
better assess operating performance if the measures are presented without such items.
  In the case of the items that management does not consider relevant to assessing
operating performance, management believes that investors can better assess ongoing
operating performance if the measures are presented without these items because their
financial impact has no continuing relevance to our ongoing business.  The above
table reconciles net income to EBITDA and EBITDA, as adjusted.   Management
believes that EBITDA and EBITDA, as adjusted, are useful to investors because securities
analysts, lenders and other interested parties frequently utilize them to evaluate our
peer companies and us. Neither EBITDA nor EBITDA, as adjusted, are recognized terms under
GAAP and do not purport to be an alternative to net income as an indicator of operating
performance or any other GAAP measure.  Not all companies utilize identical
calculations, therefore, the presentation of EBITDA and EBITDA, as adjusted, may not be
comparable to other identically titled measures of other companies.  In addition,
EBITDA and EBITDA, as adjusted, are not intended to be measures of free cash flow for
managements discretionary use since they do not consider certain cash requirements,
such as interest payments, tax payments and capital expenditures.



Comparable stores sales. We deem sales of a new, relocated or
acquired stores comparable commencing in the thirteenth full month of operations.





Item
3.  Quantitative and Qualitative Disclosures about Market Risk



In the normal course of business, the Company is exposed to
fluctuations in interest rates and the value of foreign currency. The Company employs
various financial instruments to manage certain exposures when practical.



The Company is exposed to foreign currency exchange risk. The Company
owns and operates three natural foods supermarkets and a commissary kitchen in British
Columbia, Canada. The commissary supports the three Canadian stores and does not
independently generate sales revenue. Sales made from the Canadian stores are made in
exchange for Canadian dollars. To the extent that those revenues are repatriated to the
United States, the amounts repatriated are subject to the exchange rate fluctuations
between the two currencies. The Company does not hedge against this risk because of the
small amounts of funds at risk.



Should we begin drawing on the B of A Facility for additional capital,
our exposure to interest rate changes would be primarily related to our variable rate debt
issued under the B of A Facility. The total commitment available is $40.0 million under a
revolving line of credit, with a five-year term expiring March 31, 2010. The interest rate
on the credit facility is prime or LIBOR plus 1.25%, at our election, and the rates modify
depending on the excess borrowings availability over amounts borrowed. Because the
interest rate on the facility is variable, based upon the prime rate or LIBOR, the
Company's interest expense and net income would be affected by interest rate fluctuations.





Item 4. Controls and
Procedures



Disclosure Controls and Procedures. The Company's management, with
the participation of the Company's Chief Executive Officer and Chief Financial Officer,
has evaluated the effectiveness of the Company's disclosure controls and procedures (as
such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of
1934, as amended (the "Exchange Act")) as of July 2, 2005. Based on such
evaluation, the Company's Chief Executive Officer and Chief Financial Officer have
concluded that, as of July 2, 2005, the Company's disclosure controls and procedures are
effective in recording, processing, summarizing and reporting, on a timely basis,
information required to be disclosed by the Company in the reports that it files or
submits under the Exchange Act and are effective in ensuring that information required to
be disclosed by the Company in the reports that it files or submits under the Exchange Act
is accumulated and communicated to the Company's management, including the Company's Chief
Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions
regarding required disclosure.



Internal Control Over Financial Reporting. There have not been any
changes in the Company's internal control over financial reporting (as such term is
defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter
ended July 2, 2005 that have materially affected, or are reasonably likely to materially
affect, the Companys internal control over financial reporting.





Part II.  OTHER
INFORMATION



Item 1.  Legal Proceedings



Wild Oats Markets Canada, Inc., as successor to Alfalfa's Canada, Inc.,
a Canadian subsidiary of the Company, was a defendant in Helen Fakhri and Ady Aylon, as
Representative Plaintiffs v. Alfalfa's Canada, Inc., a class action suit for monetary
damages brought in the Supreme Court of British Columbia, Canada by the representative
plaintiffs on behalf of two groups of claimants - those who claim to have contracted
Hepatitis A allegedly through the consumption of food purchased at a Capers Community
Market in the spring of 2002, and those who were inoculated against Hepatitis A in March
and April, 2002, after handling and/or consuming food products from Capers that were or
might have been contaminated with Hepatitis A. In July 2005, the Court approved a
settlement agreement pursuant to which plaintiffs submitting proof of claim receive either
cash or a gift card, redeemable at our Canadian stores, of certain amounts determined by
classification of the claimant within one of three separate categories. Our insurers have
acknowledged coverage for defense and administrative costs and settlement liability, and
we have exhausted our deductible.



Tim Auchterlonie, individually and on behalf of all others similarly
situated and the general public, and Roes 1 to 1000 vs. Wild Oats Markets, Inc. and Does 1
through 100, is a purported class action suit brought in August 2004 in the Superior
Court, County of Los Angeles, for payment of overtime and damages relating to alleged
violations of the California Business and Professions Code by a former managerial
employee, on behalf of himself and all other similarly situated California employees,
claiming that store directors at our California stores should have been classified as
non-exempt employees and paid on an hourly basis. Plaintiff also alleges that our bonus
program is illegal based upon deductions for items outside of the employees control.
We believe that the employee, a former store director, was properly classified as an
exempt employee based upon his job duties, and intend to vigorously defend the suit. At
this time, we do not have sufficient facts to estimate any potential damages. The case has
been designated non-complex and trial has been scheduled for October 2005.



In June 2002 an administrative law judge ("ALJ") found
against us in Wild Oats Markets, Inc. and Local 371, United Food & Commercial
Workers, in certain unfair labor practice charges brought in connection with the
opening of our store in Westport, Connecticut. We appealed the ALJs decision to the
National Labor Relations Board. In May 2005, the National Labor Relations Board denied the
appeal and issued a Decision and Order, setting forth certain equitable, injunctive and
monetary remedies to be undertaken by us, including payment of backpay less interim
earnings, and offers of employment to certain former employees of a store that we
previously sold in 2000 (the "Sold Store"). We are currently evaluating whether
to appeal all or part of the Decision. We are not presently able to estimate our potential
liability to former employees of the Sold Store because the process of identification and
establishment of such claims has not commenced.



The Company also is named as defendant in various actions and
proceedings arising in the normal course of business. In all of these cases, we are
denying the allegations and are vigorously defending against them and, in some cases, have
filed counterclaims. Although the eventual outcome of the various lawsuits cannot be
predicted, it is managements opinion that these lawsuits will not result in
liabilities that would materially affect our consolidated results of operations, financial
position, or cash flows.





Item
2.  Unregistered Sales of Equity Securities and Use of Proceeds.



None.





Item
3.  Defaults Upon Senior Securities



None.





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



At the Companys Annual Meeting of Stockholders held on May 17,
2005, the Companys stockholders elected the following director to the Companys
Board of Directors for a three-year term:David Gallitano. The following number of
votes were cast for and against the election of the director:



|Director        | For        | Withheld
|--------------- | ---------- | --------
|David Gallitano | 24,057,316 | 324,207 



The remaining directors whose terms continue after the meeting date are
Stacey Bell, David Chamberlain, Brian Devine, Robert Miller, Perry Odak, Mark Retzloff and
John Shields.



The Companys stockholders ratified the selection of Ernst &
Young, LLP as independent accountants for the Company for its fiscal year ended December
31, 2005. The shareholders voted for the ratification by the following number of votes:



|For        | Against | Abstain | Broker Non-Votes
|---------- | ------- | ------- | ----------------
|24,282,005 | 64,014  | 35,504  | 0               





Item 5.  Other Information



None.





Item 6.  Exhibits



|                                                                                                                       | Exhibit Number | Description                                                                                                                                                                                                                                      
|---------------------------------------------------------------------------------------------------------------------- | -------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                       |                |                                                                                                                                                                                                                                                  
|                                                                                                                       | 10.1#**        | Employment
    Agreement dated April 26, 2005 between Robert B. Dimond and the Registrant. (1)                                                                                                                                                   
|                                                                                                                       | 10.2#**        | Robert
    B. Dimond Equity Incentive Plan. (1)                                                                                                                                                                                                  
|                                                                                                                       | 10.3#**        | Severance
    Agreement dated May 9, 2005 between Robert B. Dimond and Registrant. (1)                                                                                                                                                           
|                                                                                                                       | 10.4#**        | Fourth
    Amendment to Employment Agreement, dated May 10, 2005, between Perry D. Odak and the
    Registrant. (1)                                                                                                                              
|                                                                                                                       | 10.5**         | First
    Amendment dated June 20, 2005, to Loan and Security Agreement Loan and Security Agreement,
    dated March 31, 2005, by and among Wild Oats Markets, Inc., Bank of America, N.A., as
    agent, and the lenders identified therein. (2)
|                                                                                                                       | 10.6#+         | Employment Agreement dated July 19, 2005 between Dan Bolstad and the
    Registrant.                                                                                                                                                             
|                                                                                                                       | 10.7#+         | Dan Bolstad Equity Incentive Plan.                                                                                                                                                                                                               
|                                                                                                                       | 10.8#+         | Severance Agreement dated July 27, 2005 between Dan Bolstad and
    Registrant.                                                                                                                                                                  
|                                                                                                                       | 31.1+          | CEO
    Certification under Section 302 of Sarbanes-Oxley Act of 2002                                                                                                                                                                            
|                                                                                                                       | 31.2+          | CFO
    Certification under Section 302 of Sarbanes-Oxley Act of 2002                                                                                                                                                                            
|                                                                                                                       | 32.1+          | CEO
    Certification under Section 906 of Sarbanes-Oxley Act of 2002                                                                                                                                                                            
|                                                                                                                       | 32.2+          | CFO
    Certification under Section 906 of Sarbanes-Oxley Act of 2002                                                                                                                                                                            
|                                                                                                                       |                |                                                                                                                                                                                                                                                  
|#    Management
    Compensation Plan.                                                                                
|**   Previously
    filed.                                                                                            
|+    Included
    herewith.                                                                                           
|(1) Incorporated by
    reference from the Registrants 10-Q
    for the period ended April 2, 2005 (File No. 0-21577)
|(2) Incorporated by
    reference from the Registrants Form
    8-K filed on July 6, 2005 (File No. 0-21577).        



---

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of Boulder, County of Boulder, State of Colorado,
on the 11th day of August 2005.



| | Wild Oats Markets, Inc.                      
| | ---------------------------------------------
| | (Registrant)                                 
| |                                              
| |                                              
| | By:/s/ Robert B. Dimond                      
| | Robert B. Dimond                             
| | Executive Officer and Chief Financial Officer
| | (Principal Financial and Accounting Officer) 
| |