Unified Grocers 10-Q 2006 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

FOR THE QUARTERLY PERIOD ENDED JULY 1, 2006

OR

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

FOR THE TRANSITION PERIOD FROM             TO             

Commission file number: 0-10815

UNIFIED WESTERN GROCERS, INC.

(Exact name of registrant as specified in its charter)

California	95-0615250
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

5200 Sheila Street, Commerce, CA 90040

(Address of principal executive offices) (Zip Code)

(323) 264-5200

(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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  [    ] Accelerated filer  [    ] Non-accelerated filer  [X]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes [    ]    No [X]

The number of shares outstanding of each of the registrant’s classes of common stock, as of July 29, 2006, were as follows:

Class A:128,750 shares;Class B: 483,390 shares;Class C: 15 shares;Class E: 154,603 shares

Table of Contents

Item		Page
PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	Consolidated Condensed Balance Sheets	3
	Consolidated Condensed Statements of Earnings and Comprehensive Earnings	4
	Consolidated Condensed Statements of Cash Flows	5
	Notes to Consolidated Condensed Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	33
Item 4.	Controls and Procedures	34
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	34
Item 1A.	Risk Factors	35
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	35
Item 3.	Defaults Upon Senior Securities	35
Item 4.	Submission of Matters to a Vote of Security Holders	35
Item 5.	Other Information	35
Item 6.	Exhibits	35
Signatures		36

2

PART I.    FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS (UNAUDITED)

Unified Western Grocers, Inc. and Subsidiaries

Consolidated Condensed Balance Sheets – Unaudited

(dollars in thousands)

	July 1, 2006			October 1, 2005
Assets
Current assets:
Cash and cash equivalents	$	15,987		$	17,437
Accounts and notes receivable, net of allowances of $2,452 and $2,538 at July 1, 2006 and October 1, 2005, respectively		146,730			145,279
Inventories		176,750			193,157
Prepaid expenses		8,138			6,948
Deferred income taxes		12,408			12,408
Total current assets		360,013			375,229
Properties, net		174,968			177,946
Investments		71,036			78,604
Notes receivable, net of allowances of $631 and $921 at July 1, 2006 and October 1, 2005, respectively		9,908			9,584
Goodwill		27,982			27,982
Other assets, net		39,670			38,704
Total Assets	$	683,577		$	708,049
Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable	$	147,336		$	156,754
Accrued liabilities		106,742			118,835
Current portion of notes payable		8,863			10,826
Members’ excess deposits and estimated patronage dividends		22,262			13,432
Total current liabilities		285,203			299,847
Notes payable, less current portion		131,119			156,640
Long-term liabilities, other		103,815			98,233
Members’ deposits and certificates:
Members’ required deposits		10,938			10,367
Subordinated patronage dividend certificates		3,141			3,141
Commitments and contingencies
Shareholders’ equity:
Class A Shares: 500,000 shares authorized, 128,000 and 132,800 shares outstanding at July 1, 2006 and October 1, 2005, respectively		20,339			21,023
Class B Shares: 2,000,000 shares authorized, 483,390 and 505,757 shares outstanding at July 1, 2006 and October 1, 2005, respectively		78,397			81,913
Class E Shares: 2,000,000 shares authorized, 154,603 and 155,711 shares outstanding at July 1, 2006 and October 1, 2005, respectively		15,460			15,571
Retained earnings after elimination of accumulated deficit of $26,976 effective September 28, 2002		36,864			22,514
Receivable from sale of Class A Shares to members		(431	)		(726	)
Accumulated other comprehensive loss		(1,268	)		(474	)
Total shareholders’ equity		149,361			139,821
Total Liabilities and Shareholders’ Equity	$	683,577		$	708,049

The accompanying notes are an integral part of these statements.

3

Unified Western Grocers, Inc. and Subsidiaries

Consolidated Condensed Statements of Earnings

and Comprehensive Earnings – Unaudited

(dollars in thousands)

	Thirteen Weeks Ended						Thirty-Nine Weeks Ended
	July 1, 2006			July 2, 2005			July 1, 2006			July 2, 2005
Net sales	$	726,446		$	715,417		$	2,187,288		$	2,141,583
Cost of sales		651,480			643,870			1,962,816			1,919,369
Distribution, selling and administrative expenses		55,735			57,992			174,308			179,905
Operating income		19,231			13,555			50,164			42,309
Interest expense		(3,413	)		(3,780	)		(10,911	)		(11,353	)
Earnings before estimated patronage dividends and income taxes		15,818			9,775			39,253			30,956
Estimated patronage dividends		(7,860	)		(5,517	)		(17,223	)		(17,226	)
Earnings before income taxes		7,958			4,258			22,030			13,730
Income taxes		(2,821	)		(1,740	)		(7,097	)		(5,183	)
Net earnings		5,137			2,518			14,933			8,547
Other comprehensive earnings, net of income taxes:
Unrealized holding (loss) gain on investments		(430	)		837			(794	)		475
Comprehensive earnings	$	4,707		$	3,355		$	14,139		$	9,022

The accompanying notes are an integral part of these statements.

4

Unified Western Grocers, Inc. and Subsidiaries

Consolidated Condensed Statements of Cash Flows – Unaudited

(dollars in thousands)

	Thirty-Nine Weeks Ended
	July 1, 2006			July 2, 2005
Cash flows from operating activities:
Net earnings	$	14,933		$	8,547
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and amortization		14,979			18,341
(Decrease) increase in provision for doubtful accounts		(427	)		795
(Gain) loss on sale of properties		(97	)		85
Deferred income taxes		—			271
Purchases of trading securities		(4,241	)		(5,915	)
Proceeds from maturities or sales of trading securities		3,743			243
(Increase) decrease in assets:
Accounts receivable		(1,221	)		338
Inventories		16,407			18,502
Prepaid expenses		(1,190	)		(969	)
Pension plan assets		(1,041	)		(918	)
Increase (decrease) in liabilities:
Accounts payable		(9,418	)		(9,612	)
Accrued liabilities		(12,093	)		(4,720	)
Long-term liabilities, other		6,623			5,303
Net cash provided by operating activities		26,957			30,291
Cash flows from investing activities:
Purchases of properties		(8,394	)		(6,859	)
Purchases of securities and other investments		(24,001	)		(21,695	)
Proceeds from maturities or sales of securities and other investments		30,843			14,813
Increase (decrease) in notes receivable		(127	)		3,207
Proceeds from sales of properties		718			44
Increase in other assets		(4,446	)		(4,596	)
Net cash utilized by investing activities		(5,407	)		(15,086	)
Cash flows from financing activities:
Reduction of long-term notes payable		(18,725	)		(26,079	)
Reduction of short-term notes payable		(9,002	)		(7,850	)
Payment of deferred financing fees		(75	)		(20	)
Members’ excess deposits and estimated patronage dividends		8,830			8,513
Increase in members’ required deposits		571			2,460
Decrease in receivable from sale of Class A Shares to members		295			325
Repurchase of shares from members		(5,571	)		(7,380	)
Issuance of shares to members		677			558
Net cash utilized by financing activities		(23,000	)		(29,473	)
Net decrease in cash and cash equivalents		(1,450	)		(14,268	)
Cash and cash equivalents at beginning of period		17,437			43,443
Cash and cash equivalents at end of period	$	15,987		$	29,175

The accompanying notes are an integral part of these statements.

5

Unified Western Grocers, Inc. and Subsidiaries

Consolidated Condensed Statements of Cash Flows – Unaudited – Continued

(dollars in thousands)

	Thirty-Nine Weeks Ended
	July 1, 2006		July 2, 2005
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest	$	9,535	$	10,377
Income taxes	$	11,947	$	6,347
Supplemental disclosure of non-cash items:
Retirement of Class B Shares	$	—	$	1,234
Reduction in purchase accounting reserve against goodwill	$	—	$	300
Reduction in pre quasi-reorganization deferred tax valuation allowance credited to Class A and Class B Shares	$	—	$	2,000
Increase to pre quasi-reorganization discontinued operations and lease reserves, net of deferred taxes of $33 as of July 2, 2005	$	—	$	52

The accompanying notes are an integral part of these statements.

6

Unified Western Grocers, Inc. and Subsidiaries

Notes to Consolidated Condensed Financial Statements (Unaudited)

1.    BASIS OF PRESENTATION

The consolidated condensed financial statements include the accounts of Unified Western Grocers, Inc. and all its subsidiaries (the “Company” or “Unified”). Inter-company transactions and accounts with subsidiaries have been eliminated. The interim financial statements included herein have been prepared by the Company without audit, pursuant to the rules and regulations promulgated by the Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in the financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted pursuant to SEC rules and regulations; nevertheless, management believes that the disclosures are adequate to make the information presented not misleading. These consolidated condensed financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s latest Annual Report on Form 10-K filed with the SEC. The results of operations for the interim periods are not necessarily indicative of the results for the full year.

The accompanying consolidated condensed financial statements reflect all adjustments that, in the opinion of management, are both of a normal and recurring nature and necessary for the fair presentation of the results for the interim periods presented. The preparation of the consolidated condensed financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the consolidated condensed financial statements and accompanying notes. As a result, actual results could differ from those estimates.

The Company’s banking arrangements allow the Company to fund outstanding checks when presented to the financial institution for payment. This cash management practice frequently results in total issued checks exceeding the available cash balance at a single financial institution. The Company’s policy is to record its cash disbursement accounts with a cash book overdraft in accounts payable. At July 1, 2006 and October 1, 2005, the Company had book overdrafts of $30.6 million and $47.7 million, respectively, classified in accounts payable.

Certain other amounts in the prior periods’ consolidated condensed financial statements have been reclassified to conform to the current period’s presentation.

2.    VARIABLE INTEREST ENTITY

In fiscal 2004, the Company signed a purchase and sale agreement with an unrelated business property developer to transfer and assign the leasehold and sub-leasehold interests and certain assets relating to eleven closed store locations.

At July 1, 2006, the Company remains contingently liable for the lease payments on eight of these store locations until such time as the leases expire or the Company is released from all liabilities and obligations under the respective leases. The net present value of the Company’s currently estimated obligation for the remaining leasehold and sub-leasehold interests for the eight stores totals approximately $5.7 million at July 1, 2006, with the last lease expiring in 2019. The Company’s maximum loss exposure related to these leases is $20.1 million.

The Financial Accounting Standards Board (“FASB”) issued in January 2003 and revised in December 2003 FASB Interpretation No. 46R (“FIN 46R”),“Consolidation of Variable Interest Entities – an Interpretation of Accounting Research Bulletin (“ARB”) No. 51, Consolidated Financial Statements.”Although the Company has no ownership interest in the unrelated third party that assumed the leasehold and sub-leasehold interests from the Company, that third party is considered a variable interest entity pursuant to FIN 46R. Because the primary investor in the variable interest entity currently does not have sufficient equity at risk, the Company is considered the primary beneficiary. Accordingly, the Company is required to consolidate the assets, liabilities and non-controlling interests of the variable interest entity, as well as the results of operations.

At July 1, 2006 and October 1, 2005, the Company consolidated the variable interest entity’s accounts, including total assets of $0.7 million and $1.5 million, respectively, comprised primarily of $0.1 million and $0.4 million in properties, respectively, and $0.6 million and $1.1 million in other assets, respectively, to be used in the development of the properties and for payment of lease obligations, with lease reserves of approximately $5.7 million and $3.0 million, respectively.

7

Unified Western Grocers, Inc. and Subsidiaries

Notes to Consolidated Condensed Financial Statements (Unaudited)—(Continued)

3.    SEGMENT INFORMATION

Unified is a retailer-owned, grocery wholesale cooperative serving independent and chain supermarket operators located primarily in the western United States and in the South Pacific. Unified sells a wide variety of grocery-related and general merchandise products to its customers. The Company’s customers include its owners (“Members”) and non-owners (“non-members”). Unified also provides support services to its customers, including financing and insurance. The availability of specific products and services may vary by geographic region.

Management identifies segments based on the information monitored by the Company’s chief operating decision-makers to manage the business and, accordingly, has the following two reportable segments:

• Wholesale Distribution includes the results of operations from the sale of food and general merchandise products to both Members and non-members. As of July 1, 2006, the Wholesale Distribution segment represents approximately 99% of the Company’s total sales and approximately 85% of total assets.

• The Insurance segment includes the results of operations for the Company’s three insurance subsidiaries (Grocers and Merchants Insurance Service, Inc., Springfield Insurance Company and Springfield Insurance Company, Ltd.). These subsidiaries provide insurance and insurance-related services, including workers’ compensation and liability insurance policies, to both the Company and its Members primarily located in California. As of July 1, 2006, the Company’s Insurance segment accounts for approximately 1% of the Company’s total sales and approximately 12% of total assets.

The “All Other” category includes the results of operations for the Company’s other support businesses, including its finance subsidiary, whose services are provided to a common customer base, none of which individually meets the quantitative thresholds of a reportable segment. As of July 1, 2006, the “All Other” category collectively accounts for less than 1% of the Company’s total sales and approximately 3% of total assets.

8

Unified Western Grocers, Inc. and Subsidiaries

Notes to Consolidated Condensed Financial Statements (Unaudited)—(Continued)

Information about the Company’s operating segments is summarized below.

(dollars in thousands)
	Thirteen Weeks Ended						Thirty-Nine Weeks Ended
	July 1, 2006			July 2, 2005			July 1, 2006			July 2, 2005
Net sales
Wholesale distribution	$	722,649		$	709,725		$	2,175,462		$	2,123,121
Insurance		5,146			7,077			16,631			22,951
All other		856			757			1,693			1,443
Inter-segment eliminations		(2,205	)		(2,142	)		(6,498	)		(5,932	)
Total net sales	$	726,446		$	715,417		$	2,187,288		$	2,141,583
Operating income
Wholesale distribution	$	16,815		$	12,131		$	43,513		$	39,259
Insurance		3,313			1,192			7,832			3,339
All other		(897	)		232			(1,181	)		(289	)
Total operating income		19,231			13,555			50,164			42,309
Interest expense		(3,413	)		(3,780	)		(10,911	)		(11,353	)
Estimated patronage dividends		(7,860	)		(5,517	)		(17,223	)		(17,226	)
Income taxes		(2,821	)		(1,740	)		(7,097	)		(5,183	)
Net earnings	$	5,137		$	2,518		$	14,933		$	8,547
Depreciation and amortization
Wholesale distribution	$	4,667		$	5,678		$	14,812		$	18,128
Insurance		50			66			159			207
All other		6			2			8			6
Total depreciation and amortization	$	4,723		$	5,746		$	14,979		$	18,341
Capital expenditures
Wholesale distribution	$	1,759		$	3,246		$	8,330		$	6,770
Insurance		36			27			56			89
All other		—			—			8			—
Total capital expenditures	$	1,795		$	3,273		$	8,394		$	6,859
Identifiable assets
Wholesale distribution	$	579,759		$	584,551		$	579,759		$	584,551
Insurance		85,554			89,795			85,554			89,795
All other		18,264			17,585			18,264			17,585
Total identifiable assets	$	683,577		$	691,931		$	683,577		$	691,931

4.    SHAREHOLDERS’ EQUITY

During the 39-week period ended July 1, 2006, the Company issued 3,000 Class A Shares with an issuance value of $0.59 million and redeemed 7,800 Class A Shares with a redemption value of $1.48 million. In addition, the Company issued 1,088 Class B Shares with an issuance value of $0.2 million and also redeemed 23,455 Class B Shares with a redemption value of $4.09 million. The Company also voided 1,108 Class E Shares in the amount of $0.1 million.

5.    CONTINGENCIES

During the thirteen weeks ending July 1, 2006, Unified received payment on a judgment in favor of the Company from a successful litigation against a firm for professional negligence by such firm. The judgment was entered in 2004; however, the defendants in the litigation appealed. All appeals have now been resolved in the Company’s

9

Unified Western Grocers, Inc. and Subsidiaries

Notes to Consolidated Condensed Financial Statements (Unaudited)—(Continued)

favor. The Company’s net proceeds were $3.0 million after payment of contingent attorneys’ fees, and were recorded as a reduction of distribution, selling and administrative expenses for the thirty-nine weeks ended July 1, 2006.

The Company is a party to various litigation, claims and disputes, some of which are for substantial amounts, arising in the ordinary course of business. While the ultimate effect of such actions cannot be predicted with certainty, the Company believes the outcome of these matters will not result in a material adverse effect on its financial condition or results of operations.

6.    NOTES PAYABLE

On January 6, 2006 (the “effective date”), the Company entered into an agreement (the “Amendment”) with John Hancock Life Insurance Company (“Hancock”) to amend and restate its Senior Note Agreement ($92.5 million at October 1, 2005) to $96.8 million as of the effective date of the Amendment. The Amendment extends the maturity date to January 1, 2016 from April 1, 2008 and October 1, 2009 on $86.0 million of the notes. The Amendment also decreases interest rates that ranged from 7.72% to 8.71% on $86.0 million of notes to a range of 6.421% to 7.157%. The Amendment calls for interest only payments for the first five years of the term, and then starting on the 61^st payment, principal plus interest on the $86.0 million of notes. At the maturity date, a balloon payment of $66.8 million is due. In addition, $10.8 million of notes will mature on April 1, 2008 (monthly payments of principal plus interest at 7.72%) and October 1, 2009 (monthly payments of interest only at 8.71%), with balloon payments of $4.4 million and $4.5 million, respectively. The amount outstanding under the amended Senior Note Agreement was $96.7 million at July 1, 2006.

The notes continue to be secured by certain of the Company’s personal and real property and contain customary covenants, default provisions (including acceleration of the debt in the event of an uncured default), and prepayment penalties similar to those included in the original note purchase agreement.

7.    PENSION AND OTHER POSTRETIREMENT BENEFITS

The Company sponsors a cash balance plan (“Cash Balance Plan”). The Cash Balance Plan is a noncontributory defined benefit pension plan covering substantially all employees of the Company who are not subject to a collective bargaining agreement. Benefits under the Cash Balance Plan are provided through a trust and also through annuity contracts.

The Company also sponsors an executive salary protection plan (“ESPP II”) that provides supplemental post-termination retirement income based on each participant’s final salary and years of service as an officer of the Company. Funds are held in a rabbi trust for the ESPP II consisting primarily of life insurance policies reported at cash surrender value. The cash surrender value of such life insurance policies aggregated $14.3 million and $13.6 million at July 1, 2006 and October 1, 2005, respectively, and are included in other assets in the Company’s consolidated condensed balance sheets. The related accrued benefit cost (representing the Company’s benefit obligation to participants) of $13.9 million and $12.7 million at July 1, 2006 and October 1, 2005, respectively, is recorded in other long-term liabilities in the Company’s consolidated condensed balance sheets. The ESPP II accrued benefit cost is included in the pension table below. However, the trust assets are excluded from ESPP II plan assets as they do not qualify as plan assets under Statement of Financial Accounting Standards (“SFAS”) No. 87,“Employers’ Accounting for Pensions” (“SFAS 87”). The assets held in the rabbi trust are not available for general corporate purposes. The rabbi trust is subject to creditor claims in the event of insolvency.

The Company sponsors postretirement benefit plans that cover both non-union and union employees. The plans are not funded.

10

Unified Western Grocers, Inc. and Subsidiaries

Notes to Consolidated Condensed Financial Statements (Unaudited)—(Continued)

The components of net periodic cost for pension (Cash Balance Plan and ESPP II) and other postretirement benefits for the thirty-nine weeks ended July 1, 2006 and July 2, 2005 consist of the following:

	Pension Benefits						Other Postretirement Benefits
	July 1, 2006			July 2, 2005			July 1, 2006		July 2, 2005
Service cost	$	3,662		$	3,567		$	1,237	$	1,012
Interest cost		5,030			4,772			2,555		2,590
Expected return on plan assets		(4,917	)		(4,273	)		—		—
Amortization of prior service cost		181			181			—		—
Recognized actuarial loss		104			25			558		324
Net periodic cost	$	4,060		$	4,272		$	4,350	$	3,926

The Company’s net periodic benefit cost for its combined pension and other postretirement benefits was approximately $8.4 million for the thirty-nine week period ended July 1, 2006 compared to $8.2 million for the thirty-nine week period ended July 2, 2005.

The Company funding policy is to make contributions to the Cash Balance Plan in amounts that are at least sufficient to meet the minimum funding requirements of applicable laws and regulations, but no more than amounts deductible for federal income tax purposes. The Company contributed $1.04 million to the Cash Balance Plan during the thirty-nine weeks ended July 1, 2006. Commencing with quarterly contributions of $1.04 million made on April 14, 2006 and July 14, 2006, the Company expects to make contributions of $1.04 million per quarter for the remainder of the 2006 plan year. Subsequent to July 14, 2006, additional contributions will be due October 15, 2006 and January 15, 2007. At its discretion, the Company may contribute in excess of these amounts. Additional contributions for the 2005 plan year, if any, will be due by September 15, 2006, while contributions for the 2006 plan year will be due by September 15, 2007. The Company contributed $0.7 million to the ESPP II during the thirty-nine weeks ended July 1, 2006 to fund projected benefit payments to participants for the 2006 plan year.

At July 1, 2006, the fair value of the Cash Balance Plan assets increased to $84.8 million from $73.2 million at October 1, 2005.

8.    RELATED PARTY TRANSACTIONS

Prior to fiscal year 2004, the Company purchased 80,000 shares of preferred stock (the “Series A-1 Preferred Shares”) from C&K Market, Inc. (“C&K”) for $8.0 million. Douglas A. Nidiffer, a director of the Company, is a shareholder, director and an officer of C&K. In connection with a capital restructuring of C&K during fiscal year 2004 (approved by the Company and an unrelated third party lender), the Company exchanged its 80,000 Series A-1 Preferred Shares and $1.5 million of deferred dividends for 95,000 shares of Series A-2 Preferred Shares (the “Series A-2 Preferred Shares”). The original value of the Series A-2 Preferred Shares was $8.0 million and was to accrete to the redemption value of $9.5 million over 10 years.

On February 9, 2006, C&K repurchased the 95,000 shares of Series A-2 Preferred Shares held by Unified for $9.8 million. The payment included $9.5 million for the redemption value of the Series A-2 Preferred Shares and $0.3 million for accrued dividends. The investment was carried at $8.4 million, which represented the original value of the Series A-2 Preferred Shares plus cumulative accretion through the date of repurchase. As a result of the share repurchase, the Company recognized a gain on the difference between the carrying value of the investment and the redemption value of approximately $1.1 million.

11

Unified Western Grocers, Inc. and Subsidiaries

Notes to Consolidated Condensed Financial Statements (Unaudited)—(Continued)

9.    NEW ACCOUNTING PRONOUNCEMENTS

In July 2006, the FASB issued Interpretation No. 48 (“FIN 48”),“Accounting for Uncertainty in Income Taxes,” which clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with FASB Statement No. 109,“Accounting for Income Taxes.” FIN 48 provides guidance on the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently assessing the financial impact of FIN 48 on its consolidated condensed financial statements.

In November 2005, the FASB issued FASB Staff Position (“FSP”) No. FSP FAS 115-1 and FAS 124-1,“The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“FSP 115-1 and 124-1”). FSP 115-1 and 124-1 addresses determining when an investment is considered impaired and whether that impairment is other-than-temporary, and measuring impairment loss as well as addressing the accounting after an entity recognized an other-than-temporary impairment. Certain disclosures about unrealized losses that the entity did not recognize as other-than-temporary impairments are also addressed. FSP 115-1 and 124-1 is effective for periods beginning after December 15, 2005. The Company adopted this pronouncement beginning with its second fiscal quarter of 2006. The adoption of this accounting pronouncement did not have a significant impact on the Company’s financial condition and results of operations.

In October 2005, the FASB issued FSP FAS No. 13-1,“Accounting for Rental Costs Incurred During a Construction Period” (“FSP No. 13-1”), which requires rental costs associated with ground or building operating leases that are incurred during a construction period to be recognized as rental expense. FSP No. 13-1 is effective for periods beginning after December 15, 2005. The Company adopted this pronouncement beginning with its second fiscal quarter of 2006. The adoption of this accounting pronouncement did not have an impact on the Company’s financial condition and results of operations.

In May 2005, the FASB issued SFAS No. 154,“Accounting Changes and Error Corrections” (“SFAS No. 154”). SFAS No. 154 requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle and that a change in method of depreciation, amortization, or depletion for long-lived, non-financial assets be accounted for as a change in accounting estimate that is effected by a change in accounting principle. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005 (period ending September 29, 2007 for the Company). The Company does not currently believe that the adoption of SFAS No. 154 will have a significant impact on its financial condition and results of operations.

In March 2005, the FASB issued FASB Interpretation No. 47 (“FIN 47”),“Accounting for Conditional Asset Retirement Obligations – an Interpretation of FASB Statement No. 143, Accounting for Asset Retirement Obligations.”FIN 47 clarifies that the termconditional asset retirement obligation (“CARO”) as used in FASB Statement No. 143,“Accounting for Asset Retirement Obligations” (“SFAS No. 143”),refers to a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and (or) method of settlement. Therefore, an entity is required to recognize a liability for the fair value of a CARO when that obligation is incurred (generally upon acquisition, construction, or development and (or) through the normal operation of the asset), if the liability’s fair value can be reasonably estimated. Any uncertainty surrounding the timing and method of settlement that is conditional on the occurrence of a future event should be factored into the measurement of the liability, not the timing of its recognition. If sufficient information is not available at the time the liability is incurred, paragraph 3 of SFAS No. 143 requires a liability to be recognized initially in the period in which sufficient information becomes available to estimate its fair value. The provisions of FIN 47 are effective no later than fiscal years ending after December 15, 2005 (period ending September 30, 2006 for the Company). Retrospective application of interim financial information is permitted but is not required. The Company is currently assessing the impact of FIN 47 on its results of operations and financial condition.

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Unified Western Grocers, Inc. and Subsidiaries

Notes to Consolidated Condensed Financial Statements (Unaudited)—(Continued)

In December 2004, the FASB issued FASB Staff Position No. FAS 109-1,“Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004” (“FSP No. 109-1”). FSP No. 109-1 clarifies the guidance in FASB SFAS No. 109,“Accounting for Income Taxes” (“SFAS No. 109”), that applies to the new deduction for qualified domestic production activities under the American Jobs Creation Act of 2004 (the “AJCA”). FSP No. 109-1 clarifies that the deduction should be accounted for as a special deduction under SFAS No. 109, not as a tax-rate reduction, because the deduction is contingent on performing activities identified in the AJCA. As a result, companies qualifying for the special deduction will not have a one-time adjustment of deferred tax assets and liabilities in the period the AJCA is enacted. FSP No. 109-1 requires that tax benefits resulting from the qualified domestic production activities should be recognized no earlier than the year in which they are reported in the entity’s tax return. FSP No. 109-1 is effective upon issuance (December 21, 2004). Since the tax benefits would not be recognized any earlier than the tax year ended September 30, 2006, the impact, if any, of FSP 109-1 would be reported in the Company’s financial statements no earlier than fiscal year ended September 30, 2006. The Company is currently assessing the financial impact of FSP No. 109-1 on its consolidated condensed financial statements.

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

FORWARD-LOOKING INFORMATION

This report contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to expectations concerning matters that (a) are not historical facts, (b) predict or forecast future events or results, or (c) embody assumptions that may prove to have been inaccurate. These forward-looking statements involve risks, uncertainties and assumptions. When the Company uses words such as “believes,” “expects,” “anticipates” or similar expressions, the Company is making forward-looking statements. Although Unified believes that the expectations reflected in such forward-looking statements are reasonable, the Company cannot give readers any assurance that such expectations will prove correct. The actual results may differ materially from those anticipated in the forward-looking statements as a result of numerous factors, many of which are beyond the Company’s control. Important factors that could cause actual results to differ materially from the Company’s expectations include, but are not limited to, the factors discussed in the sections entitled “Risk Factors” and “Critical Accounting Policies and Estimates” within “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” All forward-looking statements attributable to Unified are expressly qualified in their entirety by the factors that may cause actual results to differ materially from anticipated results. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s opinion only as of the date hereof. The Company undertakes no duty or obligation to revise or publicly release the results of any revision to these forward-looking statements. Readers should carefully review the risk factors described in this document as well as in other documents the Company files from time to time with the Securities and Exchange Commission.

COMPANY OVERVIEW

Unified Western Grocers, Inc. (referred to in this Form 10-Q as “Unified,” “Company,” “our” or “we”) is a retailer-owned, grocery wholesale cooperative serving supermarket operators located primarily in the western United States and the South Pacific. The Company’s customers range in size from single store operators to regional supermarket chains. The Company operates its business in two reportable business segments: (1) Wholesale Distribution and (2) Insurance. All remaining business activities are grouped into “All Other” (see Note 3 of Notes to Consolidated Condensed Financial Statements).

We sell a wide variety of products typically found in supermarkets. We report all product sales in our Wholesale Distribution segment, which represents approximately 99% of our total sales. Our customers include our owners (“Members”) and non-owners (“non-members”). We also provide support services to our customers, including insurance and financing. Insurance activities account for approximately 1% of total sales and are reported in our Insurance segment, while finance activities are grouped with our All Other business activities. The availability of specific products and services may vary by geographic region. We have three separate geographical and marketing regions. The regions are Southern California, Northern California and the Pacific Northwest.

A California corporation organized in 1922 and incorporated in 1925, Unified does business primarily with those customers that have been accepted as Members. Members are required to meet specific member capitalization requirements, which include capital stock ownership and may include required cash deposits. In addition, each Member must meet minimum purchase requirements. The membership requirements, including capitalization requirements, may be modified at the discretion of the Company’s Board of Directors (the “Board”).

We distribute the earnings from activities conducted with our Members, excluding subsidiaries (collectively “patronage business”), in the form of patronage dividends. Our patronage earnings are based on the combined results of the Company’s three patronage earnings divisions: the Southern California Dairy Division, the Pacific Northwest Dairy Division and the Cooperative Division. The Company does business on a non-patronage basis in the Wholesale Distribution segment through its specialty food subsidiary (Market Centre, formerly known as Grocers Specialty Company) and its international sales subsidiary (Unified International, Inc). These businesses sell products to both Members and non-members. An entity that does not meet Member purchase requirements or does not desire to become a Member may conduct business with Unified as a non-member customer on a non-patronage basis. The Company does business through its subsidiaries on a non-patronage basis. Earnings from the Company’s subsidiaries and from business conducted with non-members on a non-patronage basis (collectively “non-patronage business”) are retained by the Company.

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The Company operates various warehouse and office facilities that are located in Commerce, Santa Fe Springs, Stockton, Hayward, Livermore and Fresno, California and Milwaukie, Oregon. The Company also operates a bakery manufacturing facility and a milk processing plant in Los Angeles, which primarily serve the Southern California region.

Sales Activities and Recent Developments

We experienced an overall sales increase of $45.7 million, or 2.1%, for the thirty-nine weeks ended July 1, 2006 (the “2006 Period”) as compared to the thirty-nine week period ended July 2, 2005 (the “2005 Period”). This increase was due primarily to a $91.5 million, or 4.3%, sales increase in our continuing customer business driven primarily by new store openings, growth in the Company’s perishables divisions, and growth in our specialty grocery subsidiary. Sales related to customers who discontinued their business with us and began purchasing from competitors resulted in a $45.8 million decline in sales in the 2006 Period versus the 2005 Period.

The marketplace in which we operate continues to evolve and present challenges both to our customers and us. The continued expansion of large box store formats into our marketplace will present challenges for some of the retail grocery stores owned by our customers. In addition, self-distributing alternative formats such as warehouse, supercenters, discount, drug, natural and organic, and convenience stores continue to expand their offering of products that are a core part of the conventional grocery store offering, thereby creating additional competition for our customers. Demographic changes have created more ethnic diversity in our marketplace. To effectively compete, our successful customers have focused on, among other things, differentiation strategies in specialty products and items on the perimeter of the store such as produce, service deli, service bakery and meat categories.

To further enhance our strategy to help our customers differentiate themselves from the competition, during the second quarter of fiscal 2006, we changed the name of our specialty grocery subsidiary to Market Centre to better reflect the company’s broad range of product offerings and unique services that are offered to our retail customers. The new focus on Market Centre will help us improve this important tool to help our retailers with their individual differentiation strategies. Through our Market Centre subsidiary, we offer specialty grocery products in four categories: gourmet specialties, ethnic foods, natural/organic products and confections. In addition to supplying these products, Market Centre will continue to offer a wide range of retail support services, including category development and management, merchandising services, marketing programs and promotional strategies.

We also support growth by offering promotions on fast-moving products and by supporting and sponsoring major events that help promote sales at the retail level.

Economic Factors

In recent periods, we have experienced significant volatility in certain costs. For example, costs associated with our workers’ compensation coverage in California have significantly improved after several years of cost increases while, on the other hand external factors continue to drive increases in costs associated with fuel and employment benefits. Management continually focuses attention on initiatives aimed at improving business processes and managing costs. These initiatives have resulted in significant improvements, most notably in improved warehouse and transportation efficiencies. Labor efficiencies, such as the number of cases moved in the warehouse per hour of work, have increased 6.1% in the first thirty-nine weeks of fiscal 2006 compared to the same period of fiscal 2004.

Technology

Technology improvements have been an important part of Unified’s strategy to improve service to its customers and lower costs. Over the past two years we have been upgrading our warehouse systems to improve efficiencies and order fulfillment accuracy. We are also in the process of implementing a new Enterprise Resource Planning (“ERP”) system that will operate in our dairy processing and bakery plants. The new system will automate our record keeping process, allow for more efficient procurement and production planning and provide greater visibility of manufacturing variances, thus allowing us to analyze and improve the manufacturing process. Additionally, we have made improvements to better support our interactions with vendors and customers, including our new item introductions, promotions management and payment support activities that have also helped improve efficiencies and lower costs. These efforts include improvements that complete the supply chain cycle by improving speed-to-shelf for new items and enhancing retail promotion planning.

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RESULTS OF OPERATIONS

The following discussion of the Company’s financial condition and results of operations should be read in conjunction with the consolidated condensed financial statements and notes to the consolidated condensed financial statements, specifically Note 3 to Notes to Consolidated Condensed Financial Statements, “Segment Information,” included elsewhere in this report. Certain statements in the following discussion are not historical in nature and should be considered to be forward-looking statements that are inherently uncertain.

The following table sets forth the percentage of selected consolidated financial data of Unified expressed as a percentage of net sales for the periods indicated and the percentage increase or decrease in such items over the prior period.

	Thirteen Weeks Ended				% Change		Thirty-Nine Weeks Ended				% Change
Fiscal Period Ended	July 1, 2006		July 2, 2005		Thirteen Weeks		July 1, 2006		July 2, 2005		Thirty-Nine Weeks
Net sales	100.0	%	100.0	%	1.5	%	100.0	%	100.0	%	2.1	%
Cost of sales	89.7		90.0		1.2		89.7		89.6		2.2
Distribution, selling and administrative expenses	7.7		8.1		(3.9	)	8.0		8.4		(3.1	)
Operating income	2.6		1.9		41.9		2.3		2.0		18.6
Interest expense	(0.4	)	(0.5	)	(9.7	)	(0.5	)	(0.5	)	(3.9	)
Estimated patronage dividends	(1.1	)	(0.8	)	42.5		(0.8	)	(0.8	)	0.0
Income taxes	(0.4	)	(0.2	)	62.1		(0.3	)	(0.3	)	36.9
Net earnings	0.7	%	0.4	%	104.0	%	0.7	%	0.4	%	74.7	%

THIRTEEN WEEK PERIOD ENDED JULY 1, 2006 (“2006 PERIOD”) COMPARED TO THE THIRTEEN WEEK PERIOD ENDED JULY 2, 2005 (“2005 PERIOD”)

Overview of the 2006 Period.    The Company’s consolidated operating income was $19.2 million in the 2006 Period compared to $13.6 million in the 2005 Period. Operating income improved in both of the Company’s operating segments, but was offset in part by a decline in the All Other category.

• Wholesale Distribution Segment:    The Wholesale Distribution segment’s operating income was $16.8 million in the 2006 Period compared to $12.1 million in the 2005 Period. The results of a net $3.0 million judgment in favor of the Company contributed to the increase in operating income (see Note 5 of Notes to Consolidated Condensed Financial Statements). We continue to realize cost reductions in workers’ compensation expense due to the positive impact of recent legislative changes and management’s ongoing emphasis on safety programs and use of higher deductible policies to reduce premiums. See additional discussion under “Net sales – Wholesale Distribution Segment” below.

• Insurance Segment:    Operating income improved $2.1 million in the Company’s Insurance segment to $3.3 million in the 2006 Period compared to $1.2 million in the 2005 Period. Our workers’ compensation claims development continued to improve during the 2006 Period. The improvement is attributable to several factors, including the positive impact on claims development resulting from legislative reforms passed by California’s legislature. These reforms have helped to reduce the cost of claims, particularly with respect to medical costs. Continued participation of our customers in higher deductible policies has also contributed to the improvement. These policies can be less costly for customers and reduce Unified’s portion of its claims loss exposure.

• All Other:    All Other business activities primarily consist of our finance subsidiary and the consolidation of a variable interest entity as discussed in Note 2 of the Notes to the Consolidated Condensed Financial Statements in Item 1. Operating income decreased $1.1 million to a loss of $0.9 million for the 2006 Period compared to income of $0.2 million in the 2005 Period, and consisted of $0.7 million in operating income from our finance subsidiary offset by $1.6 million in operating expenses incurred due to increasing lease loss reserves on properties associated with our variable interest entity.

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The following tables summarize the performance of each business segment for the 2006 and 2005 Periods.

Wholesale Distribution Segment (dollars in thousands)
		Thirteen Weeks Ended July 1, 2006					Thirteen Weeks Ended July 2, 2005
		Amounts in 000’s		Percent to Net Sales			Amounts in 000’s		Percent to Net Sales		Difference
Gross sales	$	722,649		—		$	709,725		—	$	12,924
Inter-segment eliminations		—		—			—		—		—
Net sales		722,649		100.0			709,725		100.0		12,924
Cost of sales		653,768		90.5			641,690		90.4		12,078
Distribution, selling and administrative expenses		52,066		7.2			55,904		7.9		(3,838	)
Operating income	$	16,815		2.3		$	12,131		1.7	$	4,684
Insurance Segment (dollars in thousands)
		Thirteen Weeks Ended July 1, 2006					Thirteen Weeks Ended July 2, 2005
		Amounts in 000’s		Percent to Net Sales			Amounts in 000’s		Percent to Net Sales		Difference
Gross sales—premiums earned	$	5,146		—		$	7,077		—	$	(1,931	)
Inter-segment eliminations		(2,023	)	—			(2,037	)	—		14
Net sales—premiums earned		3,123		100.0			5,040		100.0		(1,917	)
Cost of sales—underwriting expenses		(2,288	)	(73.3	)		2,180		43.3		(4,468	)
Selling and administrative expenses		2,098		67.2			1,668		33.1		430
Operating income	$	3,313		106.1		$	1,192		23.6	$	2,121
All Other (dollars in thousands)
		Thirteen Weeks Ended July 1, 2006					Thirteen Weeks Ended July 2, 2005
		Amounts in 000’s		Percent to Net Sales			Amounts in 000’s		Percent to Net Sales		Difference
Gross sales	$	856		—		$	757		—	$	99
Inter-segment eliminations		(182	)	—			(105	)	—		(77	)
Net sales		674		100.0			652		100.0		22
Distribution, selling and administrative expenses		1,571		233.1			420		64.4		1,151
Operating income (loss)	$	(897	)	(133.1	)	$	232		35.6	$	(1,129	)

Net sales.    Consolidated net sales increased $11.0 million to $726.4 million in the 2006 Period compared to $715.4 million for the 2005 Period.

• Wholesale Distribution Segment:    Net Wholesale Distribution sales increased $12.9 million to $722.6 million in the 2006 Period compared to $709.7 million for the 2005 Period. We continued to experience sales growth through new store openings and growth in sales of products that help our customers differentiate their stores from the competition. We also continued to experience a decline in sales of center store dry grocery products as a result of continued competitive pressures from alternate format food stores (warehouse, supercenters, discount, drug, natural and organic, and convenience) that are influencing shoppers’ buying practices, as well as certain customers buying more product directly from manufacturers.

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Continuing Customer Sales Growth

• Sales increased by approximately $25.6 million due primarily to the distribution volume of existing customers’ expansion to new store locations, growth in our perishables product offerings such as meat, produce, service deli and service bakery, and growth in our specialty foods subsidiary that have helped our customers differentiate themselves from their competition. As a result of these efforts, sales of perishables products grew $13.9 million while our Market Centre sales grew $5.1 million over the 2005 Period.

Customer Changes

• Sales to customers in the 2005 Period that discontinued business with us and began purchasing their products from competitors were $12.7 million.

• Insurance Segment:    Net sales, consisting principally of premium revenues, decreased $1.9 million to $3.1 million in the 2006 Period compared to $5.0 million for the 2005 Period due primarily to decreased premium rates charged to California customers for workers’ compensation insurance. Our Insurance segment primarily sells workers’ compensation coverage in California. The California legislature passed legislation in 2003 and 2004 to allow greater controls over medical costs related to workers’ compensation. These cost reductions have led to lower policy premiums in the 2006 Period compared to the 2005 Period.

• All Other:    Net revenues were consistent at $0.7 million for both the 2006 and 2005 Periods.

Cost of sales.    Consolidated cost of sales were $651.5 million for the 2006 Period and $643.9 million for the 2005 Period and comprised 89.7% and 90.0% of consolidated net sales for the 2006 and 2005 Periods, respectively.

• Wholesale Distribution Segment:    Cost of sales increased by $12.1 million to $653.8 million in the 2006 Period compared to $641.7 million in the 2005 Period. As a percentage of net wholesale sales, cost of sales was 90.5% and 90.4% for the 2006 and 2005 Periods, respectively.

• A change in product and Member sales mix contributed to a 0.2% increase in cost of sales as a percent of net wholesale sales. Our growth was primarily in products that carry a higher cost of sales as a percent of net sales compared to the 2005 Period product mix average. In addition, our larger customers have driven the sales growth in new store openings. These customers typically pick up their orders from our facilities and their larger order sizes allow for higher operational efficiencies. As a result, the margin on these customers is lower than average and increases the cost of sales as a percent of total sales.

• A change in vendor promotional support contributed to a 0.1% decrease in cost of sales as a percent of net wholesale sales. Our vendors and brokers are continually evaluating their go-to-market strategies to effectively promote their products. Changes in their strategies could have a favorable or unfavorable impact on our financial performance. See “Critical Accounting Policies and Estimates – Vendor Funds” discussed in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the year ended October 1, 2005 for additional information.

• Insurance Segment:    Cost of sales decreased $4.5 million from $2.2 million in the 2005 Period to a $2.3 million credit in the 2006 Period. The main components in cost of sales that contributed to this decrease were reductions in (1) claims loss expense and loss reserve expenses (consisting of payments to health care providers and injured workers, along with estimates of claims not yet completed), and (2) loss adjustment expenses (consisting of adjudication expenses and legal expenses associated with defending claims). Cost of sales also includes underwriting expenses (consisting of commissions, premium taxes and regulatory fees); however, these expenses remained stable in the 2006 Period relative to the 2005 Period. During 2003 and 2004, California legislative reforms were passed aimed at reducing the rising cost of workers’ compensation expenses, primarily in the cost of providing health care. We began experiencing the benefits of the California legislative reforms in the latter half of our 2005 fiscal year. These benefits have continued in the 2006 Period. The decline in cost of sales in the 2006 Period resulted from lowering loss reserves at July 1, 2006 based on improving loss experience for earlier periods. The reduction in reserves at July 1, 2006 for losses and loss adjustment expenses was greater than the accrual of new reserves plus paid losses and loss adjustment expenses for the 2006 Period. The cost of insurance and the sufficiency of loss reserves are also impacted by actuarial estimates based on

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a detailed analysis of health care cost trends, mortality rates, claims history, demographics and industry trends. As a result, the amount of loss reserves and future expenses is significantly affected by these variables and may significantly change, depending on the cost of providing benefits and the results of further legislative action.

Distribution, selling and administrative expenses.    Consolidated distribution, selling and administrative expenses were $55.7 million in the 2006 Period compared to $58.0 million in the 2005 Period, and comprised 7.7% and 8.1% of net sales for the 2006 and 2005 Periods, respectively.

• Wholesale Distribution Segment:    Distribution, selling and administrative expenses were $52.1 million in the 2006 Period compared to $55.9 million in the 2005 Period, and comprised 7.2% and 7.9% of net wholesale sales for the 2006 and 2005 Periods, respectively. As discussed in further detail below, the net proceeds of a judgment, combined with decreases in workers’ compensation expense and depreciation and amortization expense, reduced costs $6.1 million, or 0.9% of net wholesale sales, which were partially offset by increased costs for benefits, professional services, transportation and general expenses of $2.3 million, or 0.2% of net wholesale sales.

During the thirteen weeks ending July 1, 2006, Unified received payment of a judgment in favor of the Company whose net proceeds, after payment of contingent attorneys’ fees, reduced costs $3.0 million, or 0.4% as a percent of net wholesale sales (see Note 5 of Notes to Consolidated Condensed Financial Statements). Additional factors contributing to the decrease in expenses as a percent of net wholesale sales are as follows:

• Workers’ Compensation Expense:    The Company’s Wholesale Distribution segment is self-insured up to $300,000 per incident with stop loss coverage provided by our Insurance segment up to $1,000,000 and third party coverage over that amount. Loss accruals up to the stop loss coverage are made based on actuarially developed loss estimates. Our workers’ compensation expenses declined by $1.9 million, or 0.3% as a percent of net wholesale sales, primarily due to the positive impact of the California legislative reforms discussed above. Workers’ compensation expenses have also been reduced due to management’s ongoing emphasis on safety programs and use of higher deductible policies to reduce premiums. Since Unified utilizes higher deductible policies and participates directly in losses, it realizes the benefits of lower losses directly and more dramatically than if it had used fully insured policies. Future expenses may significantly change depending on the cost of providing health care and the results of any further legislative action.

• Depreciation and Amortization Expense:    Expenses related to depreciation and amortization declined $1.2 million, or 0.2% as a percent of net wholesale sales. In September 1999, we completed a merger (the “Merger”) with United Grocers, Inc. (“United”), a grocery cooperative headquartered in Milwaukie, Oregon. Following the Merger, our capital and information technology requirements temporarily increased. Over the past three years, our need for new capital and information technology declined from the post-Merger level. The reduction in expense is related to many of those Merger-related activities becoming fully depreciated and amortized. We expect this reduction to continue only through the remainder of this fiscal year.

The following expenses increased in the 2006 Period compared to the 2005 Period, partially offsetting the decreases in distribution, selling and administrative expenses that were discussed above:

• Other Expense Changes:    General expenses increased $1.0 million, but resulted in no change as a percent of net wholesale sales.

• Benefits and Professional Services:    During the period, we incurred cost increases of $0.8 million, or 0.1% as a percent of net wholesale sales.

• Transportation Cost Increases:    During the period, costs related to fuel and common carrier activities increased $0.5 million, or 0.1% as a percent of net wholesale sales. The fuel cost increases were recovered through fuel surcharges reported as a reduction in cost of sales.

• Insurance Segment:    Distribution, selling and administrative expenses for the Insurance segment were comparable at $2.1 million for the 2006 Period compared to $1.7 million for the 2005 Period.

• All Other:    Distribution, selling and administrative expenses for our All Other business activities for the 2006 Period were $1.5 million compared to $0.4 million for the 2005 Period. During the 2006 Period, we incurred higher lease reserves on properties associated with our variable interest entity.

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Interest.    Interest expense was $3.4 million in the 2006 Period compared to $3.8 million in the 2005 Period, or 0.4% and 0.5% as a percent of consolidated net sales for the 2006 Period and the 2005 Period, respectively. Factors contributing to the decrease in interest expense are as follows:

· Interest expense on our primary debt instruments was $2.7 million and $3.1 million for the 2006 and 2005 Periods, respectively.

• Weighted Average Borrowings:    Interest expense declined $0.5 million over the 2005 Period due to a reduction in our weighted average borrowings. Weighted average borrowings were reduced by $24.2 million due to improved cash flow from operations and our Equity Enhancement Program (see “Equity Enhancement Plan”).

• Interest Rates:    Interest expense increased $0.1 million over the 2005 Period due to an increase in our effective borrowing rate. Our effective borrowing rate for the combined primary debt, made up of the revolving line of credit and senior secured notes, was 7.8% and 7.5% for the 2006 and 2005 Periods, respectively. Several offsetting factors contributed to the increase in interest rates. First, we signed an agreement on January 6, 2006 to amend and restate our Senior Note Agreement (see “Outstanding Debt and Other Financing Arrangements”) reducing our effective interest rate. Second, we realized a reduction in our interest rate margin over the base borrowing rate on the revolving line of credit due to achieving certain financial results. Third, with the overall market interest rate change, the base borrowing rate on the revolver increased over the 2005 Period, more than offsetting the reduction in margin on the revolver and the improved rate on the Senior Notes.

Borrowings on our revolving credit agreement are subject to market rate fluctuations. A 25 basis point change in the market rate of interest over the period would have resulted in a $30,000 increase or decrease in corresponding interest expense.

· Interest expense on our secondary debt instruments was $0.7 million for both the 2006 and 2005 Periods.

Estimated patronage dividends.    Estimated patronage dividends for the 2006 Period were $7.9 million, compared to $5.5 million in the 2005 Period, an increase of 42.5%. Patronage dividends for the 2006 and 2005 Periods consisted of the patronage earnings from the Company’s three patronage earnings divisions: the Southern California Dairy Division, the Pacific Northwest Dairy Division and the Cooperative Division. For the 2006 and 2005 Periods, respectively, the Company had patronage earnings of $2.3 million and $2.6 million in the Southern California Dairy Division, $0.1 million and $0.1 million in the Pacific Northwest Dairy Division and $5.5 million and $2.8 million in the Cooperative Division. Patronage dividends for the Dairy Divisions are declared and paid after the end of each quarter. Patronage dividends for the Cooperative Division are declared and paid annually, after our fiscal year end.

Income taxes.    The Company’s effective income tax rate was 35.4% for the 2006 Period compared to 40.9% for the 2005 Period. The Company estimates that its effective tax rate will be 34% for the remainder of fiscal 2006. The lower rate for the 2006 Period is due to provision-to-return differences and fluctuations in permanent items.

THIRTY-NINE WEEK PERIOD ENDED JULY 1, 2006 (“2006 PERIOD”) COMPARED TO THE THIRTY-NINE WEEK PERIOD ENDED JULY 2, 2005 (“2005 PERIOD”)

Overview of the 2006 Period.    The Company’s consolidated operating income improved by $7.8 million to $50.1 million in the 2006 Period compared to $42.3 million in the 2005 Period. Operating income improved in both of the Company’s operating segments, but was offset in part by a decline in the All Other category.

• Wholesale Distribution Segment:    The Wholesale Distribution segment realized an overall net increase in operating income of $4.2 million to $43.5 million in the 2006 Period compared to $39.3 million in the 2005 Period. The results of a net $3.0 million judgment in favor of the Company contributed to the increase in operating income (see Note 5 of Notes to Consolidated Condensed Financial Statements). We have also benefited from cost reductions in workers’ compensation expense due to management actions (implementing safety programs and reducing corporate risk exposure via the use of higher deductible policies) and recent legislative changes. See additional discussion under “Net sales – Wholesale Distribution Segment” below.

• Insurance Segment:    Operating income improved $4.5 million in the Company’s Insurance segment to $7.8 million in the 2006 Period compared to $3.3 million in the 2005 Period. Our workers’ compensation

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claims development continued to improve during the 2006 Period. The improvement is attributable to several factors, including the positive impact on claims development resulting from legislative reforms passed by California’s legislature. These reforms have helped to reduce the cost of claims, particularly with respect to medical costs. Continued participation of our customers in higher deductible policies, which can be less costly for them and reduce Unified’s portion of its claims loss exposure, has also contributed to the improvement.

• All Other:    All Other business activities primarily consist of the Company’s finance subsidiary and the consolidation of a variable interest entity as discussed in Note 2 of the Notes to Consolidated Condensed Financial Statements in Item 1. Operating income declined $0.9 million to a loss of $1.2 million in the 2006 Period compared to a loss of $0.3 million in the 2005 Period. The loss of $1.2 million for the 2006 period was due to lease expenses associated with the Company’s variable interest entity of $2.2 million partially offset by income of $1.0 million in the Company’s finance subsidiary.

The following tables summarize the performance of each business segment for the 2006 and 2005 Periods.

Wholesale Distribution Segment (dollars in thousands)
		Thirty-Nine Weeks Ended July 1, 2006					Thirty-Nine Weeks Ended July 2, 2005
		Amounts in 000’s		Percent to Net Sales			Amounts in 000’s		Percent to Net Sales			Difference
Gross sales	$	2,175,462		—		$	2,123,121		—		$	52,341
Inter-segment eliminations		—		—			—		—			—
Net sales		2,175,462		100.0			2,123,121		100.0			52,341
Cost of sales		1,965,261		90.3			1,910,613		90.0			54,648
Distribution, selling and administrative expenses		166,688		7.7			173,249		8.2			(6,561	)
Operating income	$	43,513		2.0		$	39,259		1.8		$	4,254
Insurance Segment (dollars in thousands)
		Thirty-Nine Weeks Ended July 1, 2006					Thirty-Nine Weeks Ended July 2, 2005
		Amounts in 000’s		Percent to Net Sales			Amounts in 000’s		Percent to Net Sales			Difference
Gross sales—premiums earned	$	16,631		—		$	22,951		—		$	(6,320	)
Inter-segment eliminations		(6,024	)	—			(5,652	)	—			(372	)
Net sales—premiums earned		10,607		100.0			17,299		100.0			(6,692	)
Cost of sales—underwriting expenses		(2,445	)	(23.1	)		8,756		50.6			(11,201	)
Selling and administrative expenses		5,220		49.3			5,204		30.1			16
Operating income	$	7,832		73.8		$	3,339		19.3		$	4,493
All Other (dollars in thousands)
		Thirty-Nine Weeks Ended July 1, 2006					Thirty-Nine Weeks Ended July 2, 2005
		Amounts in 000’s		Percent to Net Sales			Amounts in 000’s		Percent to Net Sales			Difference
Gross sales	$	1,693		—		$	1,443		—		$	250
Inter-segment eliminations		(474	)	—			(280	)	—			(194	)
Net sales		1,219		100.0			1,163		100.0			56
Distribution, selling and administrative expenses		2,400		196.9			1,452		124.8			948
Operating (loss) income	$	(1,181	)	(96.9	)	$	(289	)	(24.8	)	$	(892	)

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Net sales.    Consolidated net sales increased $45.7 million to $2.187 billion in the 2006 Period compared to $2.141 billion in the 2005 Period.

• Wholesale Distribution Segment:    Net Wholesale Distribution sales increased $52.3 million to $2.17 billion in the 2006 Period compared to $2.12 billion for the 2005 Period. We continued to experience sales growth through new store openings and growth in sales of products that help our customers differentiate their stores from the competition. We also continued to experience a decline in sales of center store dry grocery products as a result of continued competitive pressures from alternate format food stores (warehouse, supercenters, discount, drug, natural and organic, and convenience) that are influencing shoppers’ buying practices, as well as certain customers buying more product directly from manufacturers.

Continuing Customer Sales Growth

• Sales increased by approximately $98.1 million due primarily to the distribution volume of existing customers’ expansion to new store locations, growth in our perishables product offerings such as meat, produce, service deli and service bakery, and growth in our specialty foods subsidiary that have helped our customers differentiate themselves from their competition. As a result of these efforts, sales of perishables products grew $47.3 million while our Market Centre sales grew $17.5 million over the 2005 Period.

Customer Changes

• Sales to customers in the 2005 Period that discontinued business with us and began purchasing their products from competitors were $45.8 million.

• Insurance Segment:    Net sales, consisting principally of premium revenues, decreased $6.7 million to $10.6 million in the 2006 Period compared to $17.3 million for the 2005 Period. Our Insurance segment primarily sells workers’ compensation coverage in California. The drivers of the decline are as follows:

Policy Renewals

• Net policy renewals declined 3.5% in the 2006 Period, representing a $4.4 million reduction in premium revenues. The decline in policy renewals resulted from increased competitive pressures as new carriers entered the marketplace.

Rate Decline

• A decline in policy rates caused a $2.3 million reduction in premium revenues. The California legislature passed legislation in 2003 and 2004 to allow greater controls over medical costs related to workers’ compensation. These cost reductions have led to lower policy premiums in the 2006 Period compared to the 2005 Period.

• All Other:    Net sales were $1.2 million for both the 2006 and 2005 Periods.

Cost of sales.    Consolidated cost of sales increased $43.4 million to $1.96 billion for the 2006 Period compared to $1.92 billion for the 2005 Period and comprised 89.7% and 89.6% of consolidated net sales for the 2006 and 2005 Periods, respectively.

• Wholesale Distribution Segment:    Cost of sales increased by $54.6 million to $1.96 billion in the 2006 Period compared to $1.91 billion in the 2005 Period. As a percentage of net wholesale sales, cost of sales was 90.3% and 90.0% for the 2006 and 2005 Periods, respectively. Several factors contributed to the 0.3% increase in cost of sales as a percentage of net wholesale sales.

• A change in product and Member sales mix contributed to a 0.2% increase in cost of sales as a percent of net wholesale sales. Our growth was primarily in products that carry a higher cost of sales as a percent of net sales compared to the 2005 Period product mix average. In addition, our larger customers have driven the sales growth through new store openings. These customers typically pick up their orders from our facilities and their larger order sizes allow for higher operational efficiencies. As a result, the margin on these customers is lower than average and increases the cost of sales as a percent of total sales.

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• A change in vendor promotional support contributed to a 0.1% increase in cost of sales as a percent of net wholesale sales. Our vendors and brokers are continually evaluating their go-to-market strategies to effectively promote their products. Changes in their strategies could have a favorable or unfavorable impact on our financial performance. See “Critical Accounting Policies and Estimates – Vendor Funds” discussed in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the year ended October 1, 2005 for additional information.

• Insurance Segment:    Cost of sales decreased $11.2 million from $8.8 million in the 2005 Period to a $2.4 million credit in the 2006 Period. The main components in cost of sales that contributed to this decrease were reductions in (1) claims loss expense and loss reserve expenses (consisting of payments to health care providers and injured workers, along with estimates of claims not yet completed), and (2) loss adjustment expenses (consisting of adjudication expenses and legal expenses associated with defending claims). Cost of sales also includes underwriting expenses (consisting of commissions, premium taxes and regulatory fees); however, these expenses remained stable in the 2006 Period relative to the 2005 Period. During 2003 and 2004, California legislative reforms were passed aimed at reducing the rising cost of workers’ compensation expenses, primarily in the cost of providing health care. We began experiencing the benefits of the California legislative reforms in the latter half of our 2005 fiscal year. These benefits have continued in the 2006 Period. The decline in cost of sales in the 2006 Period resulted from lowering loss reserves at July 1, 2006 based on improving loss experience for earlier periods. The reduction in reserves at July 1, 2006 for losses and loss adjustment expenses was greater than the accrual of new reserves plus paid losses and loss adjustment expenses for the 2006 Period. The cost of insurance and the sufficiency of loss reserves are also impacted by actuarial estimates based on a detailed analysis of health care cost trends, mortality rates, claims history, demographics and industry trends. As a result, the amount of loss reserves and future expenses is significantly affected by these variables and may significantly change, depending on the cost of providing benefits and the results of further legislative action.

Distribution, selling and administrative expenses.    Consolidated distribution, selling and administrative expenses were $174.3 million in the 2006 Period compared to $179.9 million in the 2005 Period, and comprised 8.0% and 8.4% of net sales for the 2006 Period and the 2005 Period, respectively.

• Wholesale Distribution Segment:    Distribution, selling and administrative expenses were $166.7 million in the 2006 Period compared to $173.3 million in the 2005 Period, and comprised 7.7% and 8.2% of net Wholesale Distribution sales for the 2006 Period and the 2005 Period, respectively. As discussed in further detail below, the net proceeds of a judgment, combined with decreases in workers’ compensation expense and depreciation and amortization expense, reduced costs $13.4 million, or 0.7% of net wholesale sales, which were partially offset by increased costs for benefits, professional services, and transportation expenses of $6.8 million, or 0.2% of net wholesale sales.

During the thirteen weeks ending July 1, 2006, Unified received payment of a judgment in favor of the Company whose net proceeds, after payment of contingent attorneys’ fees, reduced costs $3.0 million, or 0.1% as a percent of net wholesale sales (see Note 5 of Notes to Consolidated Condensed Financial Statements). Additional factors contributing to the decrease in cost as a percent of net wholesale sales are as follows:

• Workers�� Compensation Expense:    The Company’s Wholesale Distribution segment is self-insured up to $300,000 per incident with stop loss coverage provided by our Insurance segment up to $1,000,000 and third party coverage over that amount. Loss accruals up to the stop loss coverage are made based on actuarially developed loss estimates. Our workers’ compensation expenses declined by $4.7 million, or 0.3% as a percent of net wholesale sales, primarily due to the positive impact of the California legislative reforms discussed above. Workers’ compensation expenses have also been reduced due to management’s ongoing emphasis on safety programs and use of higher deductible policies to reduce premiums. Since Unified utilizes higher deductible policies and participates directly in losses, it realizes the benefits of lower losses directly and more dramatically than if it had used fully insured policies. Future expenses may significantly change depending on the cost of providing health care and the results of any further legislative action.

• Depreciation and Amortization Expense:    Expenses related to depreciation and amortization declined $3.6 million, or 0.2% as a percent of net wholesale sales. In September 1999, we completed the Merger with United, a grocery cooperative headquartered in Milwaukie, Oregon. Following the Merger,

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our capital and information technology requirements temporarily increased. Over the past three years, our need for new capital and information technology declined from the post-Merger level. The reduction in expense is related to many of those Merger-related activities becoming fully depreciated and amortized. We expect this reduction to continue only through the remainder of this fiscal year.

• Other Expense Changes:    General expenses decreased $2.1 million, or 0.1% as a percent of net wholesale sales.

The following expenses increased in the 2006 Period compared to the 2005 Period, partially offsetting the decreases in distribution, selling and administrative expenses that were discussed above:

• Benefits and Professional Services:    During the period, we incurred cost increases of $3.7 million, or 0.1% as a percent of net wholesale sales.

• Transportation Cost Increases:    During the period, costs related to fuel and common carrier activities increased $3.1 million, or 0.1% as a percent of net wholesale sales. The fuel cost increases were recovered through fuel surcharges reported as a reduction in cost of sales.

• Insurance Segment:    Distribution, selling and administrative expenses for the Insurance segment were $5.2 million for both the 2006 and 2005 Periods.

• All Other:    Distribution, selling and administrative expenses for the Company’s All Other business activities for the 2006 Period were $2.4 million compared to $1.4 million for the 2005 Period. During the 2006 Period, we incurred higher lease reserves on properties associated with our variable interest entity.

Interest.    Interest expense was $10.9 million in the 2006 Period compared to $11.4 million in the 2005 Period and comprised 0.5% of consolidated net sales for both the 2006 and the 2005 Periods.

· Interest expense on the Company’s primary debt instruments was $8.8 million and $9.1 million for the 2006 and the 2005 Periods, respectively. A reduction in weighted average borrowings and a reduction in the interest rates on the senior secured notes were partially offset by an increase in rates on the revolving credit facility.

• Weighted Average Borrowings:    Interest expense declined $0.9 million over the 2005 Period due to a reduction in our weighted average borrowings. Weighted average borrowings were reduced by $22.3 million due to improved cash flow from operations, our Equity Enhancement Program (see “Equity Enhancement Plan”) and C&K’s repurchase on February 9, 2006 of 95,000 shares of Series A-2 Preferred Shares held by Unified for $9.8 million (see Note 8 of Notes to Consolidated Condensed Financial Statements).

• Interest Rates:    Interest expense increased $0.6 million over the 2005 Period due to an increase in our effective borrowing rate. Our effective borrowing rate for the combined primary debt, made up of the revolving line of credit and senior secured notes, was 7.6% and 6.9% for the 2006 and 2005 Periods, respectively. Several offsetting factors contributed to the increase in interest rates. First, we signed an agreement on January 6, 2006 to amend and restate our Senior Note Agreement (see “Outstanding Debt and Other Financing Arrangements”), reducing our effective interest rate. Second, we realized a reduction in our interest rate margin over the base borrowing rate on the revolving line of credit due to achieving certain financial results. Third, consistent with the overall market interest rate change, the base borrowing rate on the revolver increased over the 2005 Period, offsetting the reduction in margin on the revolver and the improved rate on the Senior Notes.

Borrowings on our revolving credit agreement are subject to market rate fluctuations. A 25 basis point change in the market rate of interest over the period would have resulted in a $0.1 million increase or decrease in corresponding interest expense.

· Changes in secondary debt instruments resulted in a $0.2 million decrease in expense to $2.1 million in the 2006 Period compared to $2.3 million in the 2005 Period.

Estimated patronage dividends.    Estimated patronage dividends were $17.2 million for both the 2006 and 2005 Periods. Patronage dividends for the 2006 Period consisted of the patronage earnings from the Company’s three patronage earnings divisions: the Southern California Dairy Division, the Pacific Northwest Dairy Division and the Cooperative Division. For the 2006 and 2005 Periods, respectively, the Company had patronage earnings of $7.3 million and $7.8 million in the Southern California Dairy Division, $0.4 million and $0.3 million in the Pacific

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Northwest Dairy Division and $9.5 million and $9.1 million in the Cooperative Division. Patronage dividends for the Dairy Divisions are declared and paid after the end of each quarter. Patronage dividends for the Cooperative Division are declared and paid annually, after our fiscal year end.

Income taxes.    The Company’s effective income tax rate was 32.2% for the 2006 Period compared to 37.7% for the 2005 Period. The Company estimates that its effective tax rate will be 34% for the remainder of fiscal 2006. The lower rate for the 2006 Period is due to provision-to-return differences and fluctuations in permanent items.

LIQUIDITY AND CAPITAL RESOURCES

The Company finances its capital needs through a combination of internal and external sources. These sources include cash from operations, Member investments, bank borrowings, various types of long-term debt and lease financing. The Company believes that the combination of cash flows from operations, current cash balances, its Equity Enhancement Plan described below, and available lines of credit, will be sufficient to service its debt and to meet its anticipated needs for working capital and capital expenditures through at least fiscal 2006.

CASH FLOW

The Company continued to generate positive cash flow from operations, which was used for investing and financing activities during the thirty-nine week 2006 Period to reduce long-term debt, provide financing to Members, invest in the Company’s infrastructure, reinvest proceeds from maturing investments and redeem Members’ capital shares.

Net cash, consisting of cash and cash equivalents, decreased by $1.4 million to $16.0 million as a result of this activity for the thirty-nine week 2006 Period compared to $17.4 million as of the fiscal year ended October 1, 2005.

The following table summarizes the impact of operating, investing and financing activities on the Company’s cash flows for the thirty-nine week 2006 and 2005 Periods:

(dollars in thousands)
Summary of Net Increase (Decrease) in Total Cash Flows	2006			2005			Difference
Cash provided by operating activities	$	26,957		$	30,291		$	(3,334	)
Cash utilized by investing activities		(5,407	)		(15,086	)		9,679
Cash utilized by financing activities		(23,000	)		(29,473	)		6,473
Total (decrease) increase in cash flows	$	(1,450	)	$	(14,268	)	$	12,818

Net cash used by operating, investing and financing activities decreased $12.8 million to $1.5 million for the 2006 Period compared to $14.3 million for the 2005 Period. The improvement in net cash for the 2006 Period occurred primarily as a result of reduced cash used by investing activities of $9.7 million due primarily to the sale of investments (seeInvesting Activities below) and reduced cash used by financing activities of $6.5 million due to lower payments on long term debt as the Company continued to optimize its borrowing levels. This improvement was partially offset by decreased cash from operating activities of $3.3 million due primarily to increased accounts receivable and lower relative declines in inventory between the periods. Working capital was $74.8 million and $75.4 million, respectively, and the current ratio was 1.3 at July 1, 2006 and October 1, 2005.

Operating Activities:    Net cash provided by operating activities decreased by $3.3 million to $27.0 million for the 2006 Period compared to $30.3 million for the 2005 Period. Two key activities were responsible for the decline in cash provided by operating activities compared to the 2005 Period. First, we experienced increased accounts receivable resulting from higher sales, and second, management initiatives designed to improve our working capital were achieved. In fiscal 2003, management implemented initiatives designed to improve our working capital. These initiatives provided an overall improvement in net operating cash. As we achieved our initiatives, the year-to-year benefits declined. We captured the majority of the benefits through the 2005 Period and have reached our desired initiative levels in the 2006 Period. Net changes in accounts receivable, inventory, prepaid expenses and accounts payable provided $4.6 million and $8.3 million in cash for the 2006 and 2005 Periods, respectively, resulting in a $3.7 million reduction in cash provided by operating activities between the periods.

Investing Activities:    Net cash used in investing activities decreased by $9.7 million to $5.4 million for the 2006 Period compared to $15.1 million utilized in the 2005 Period. The decrease in cash used for investing activities

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during the 2006 Period as compared to the 2005 Period was due to decreases in net investments of $13.7 million, consisting of the purchase and sale of securities to replace maturing investments in the portfolios of the Company’s insurance subsidiaries and C&K’s repurchase of Series A-2 Preferred Shares held by Unified (see Note 8 of Notes to Consolidated Condensed Financial Statements). The decrease in cash used for net investment activity was partially offset by increased notes receivable funding of $3.3 million, reflecting normal fluctuations in loan activity to Members for their inventory and equipment financing, and increased capital expenditures of $1.5 million for a building renovation project and purchases of warehouse and computer equipment. Spending on investing activities is expected to be funded by existing cash balances, cash generated from operations or additional borrowings.

Financing Activities:    Net cash utilized by financing activities was approximately $23.0 million for the 2006 Period compared to $29.5 million for the 2005 Period. The net decrease of $6.5 million in cash used by financing activities for the 2006 Period as compared to the 2005 Period was due primarily to a reduction in debt repayment resulting from lower borrowings that decreased cash use by $6.2 million as the Company continued to optimize its borrowing levels. In addition, cash used to repurchase Member shares was reduced by $1.8 million. These decreases in cash used were offset by a decrease in cash provided by Member deposits (both excess and required) and estimated patronage dividends of $1.6 million between the periods, consisting of increased excess deposits and patronage earnings of $0.3 million and reduced required deposits of $1.9 million for Members that participate in the Reduced Class B Investment Requirement program, which was effective March 31, 2005 (see “Member Investments and Patronage Dividends” discussed in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the year ended October 1, 2005 for additional information). Cash used by financing activities is expected to be funded by the Company’s continuing operating cash flow and the positive impact of the Equity Enhancement Plan to meet operating and capital spending requirements.

Equity Enhancement Plan

In fiscal 2002, the Company initiated an equity enhancement plan designed to build equity in the Company for future investment in the business and other infrastructure improvements. See “Equity Enhancement Plan” discussed in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the year ended October 1, 2005 for additional information.

Credit Facilities

The Company has a $225.0 million revolving credit agreement that expires on December 5, 2007. See “Contractual Obligations and Commercial Commitments” discussed in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the year ended October 1, 2005 for additional information. The Company has begun the planning process to refinance its revolving credit agreement. The Company borrowed only $34.9 million under the facility as of July 1, 2006, with access to a significant amount of capital under this facility still available to the Company. In addition, on January 6, 2006, the Company amended and restated its Senior Note Agreement with John Hancock Life Insurance Company (see “Outstanding Debt and Other Financing Arrangements”). This amended and restated Senior Note Agreement provided an additional $6.2 million in funds to the Company and extended the maturity date to January 1, 2016 from April 1, 2008 and October 1, 2009 on $86.0 million of the notes.

Off-Balance Sheet Arrangements

As of the date of this report, with the exception of the transaction disclosed in Note 2 of Notes to Consolidated Condensed Financial Statements, the Company does not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS

Other than as discussed in “Outstanding Debt and Other Financing Arrangements” below, there have been no material changes in the Company’s contractual obligations and commercial commitments outside the ordinary course of the Company’s business during the thirty-nine week period ending July 1, 2006. See “Contractual Obligations and Commercial Commitments” discussed in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the year ended October 1, 2005 for additional information.

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OUTSTANDING DEBT AND OTHER FINANCING ARRANGEMENTS

Other than as discussed below, there have been no material changes in the Company’s outstanding debt and other financing arrangements outside the ordinary course of the Company’s business during the interim period ending July 1, 2006. See “Outstanding Debt and Other Financing Arrangements” discussed in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the year ended October 1, 2005 for additional information.

The Company had a total of $92.5 million outstanding in senior secured notes to certain insurance companies and pension funds (referred to collectively as John Hancock Life Insurance Company, or “Hancock”) under a note purchase agreement dated September 29, 1999 (as amended, the “Senior Note Agreement”) at October 1, 2005, and $96.7 million outstanding at July 1, 2006 under the Senior Note Agreement as amended and restated effective January 6, 2006.

On January 6, 2006 (the “effective date”), the Company entered into an agreement (the “Amendment”) with Hancock which amended and restated its Senior Note Agreement ($92.5 million at October 1, 2005) to $96.8 million as of the effective date of the Amendment. The Amendment extended the maturity date to January 1, 2016 from April 1, 2008 and October 1, 2009 on $86.0 million of the notes. The Amendment also decreased interest rates that ranged from 7.72% to 8.71% on $86.0 million of notes to a range of 6.421% to 7.157%.

The Amendment calls for interest only payments for the first five years of the term, and then starting on the 61st payment, principal plus interest on the $86.0 million of notes. At the maturity date, a balloon payment of $66.8 million is due. In addition, $10.8 million of notes will mature on April 1, 2008 (monthly payments of principal plus interest at 7.72%) and October 1, 2009 (monthly payments of interest only at 8.71%), with balloon payments of $4.4 million and $4.5 million, respectively.

The notes continue to be secured by certain of the Company’s personal and real property and contain customary covenants, default provisions (including acceleration of the debt in the event of an uncured default), and prepayment penalties similar to those included in the original note purchase agreement.

MEMBER INVESTMENTS AND PATRONAGE DIVIDENDS

Members are required to meet specific Member capitalization requirements, which include capital stock ownership and may include required cash deposits (“Required Deposits”). Members may also maintain deposits with Unified in excess of such Required Deposit amounts (“Excess Deposits”). See “Member Investments and Patronage Dividends” discussed in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the year ended October 1, 2005 for additional information.

Members’ Required Deposits are contractually subordinated and subject to the prior payment in full of certain senior indebtedness of the Company. Unified’s obligation to repay Members’ Required Deposit accounts on termination of Member status (once the Member’s obligations to Unified have been satisfied) is reported as a long-term liability on Unified’s consolidated condensed balance sheets. Excess Deposits are not subordinated to Unified’s other obligations and are reported as short-term liabilities on Unified’s consolidated condensed balance sheets. At July 1, 2006 and October 1, 2005, Unified had $10.9 and $10.4 million, respectively, in “Members’ required deposits” and $22.3 and $13.4 million, respectively, in “Members’ excess deposits and estimated patronage dividends” (of which $11.7 and $10.0 million, respectively, represented Excess Deposits).

REDEMPTION OF CAPITAL STOCK

On October 19, 2005, the Board authorized the repurchase on October 25, 2005 of 1,950 shares of the Company’s Class A Shares that had been tendered and were pending redemption. The Company paid approximately $0.34 million to redeem the shares. On October 5, 2005 and October 21, 2005, the Company repurchased 129 and 196 shares, respectively, of the Company’s Class B Shares that had been tendered and were pending redemption. The Company paid approximately $0.06 million to redeem the shares. On December 14, 2005, the Board authorized the repurchase on December 30, 2005 of 1,600 shares of the Company’s Class A Shares and 23,130 shares of the Company’s Class B Shares that had been tendered and were pending redemption. The Company paid approximately $0.31 million and $4.0 million, respectively, to redeem the shares.

On February 10, 2006, the Company authorized that 1,108 shares of the Company’s Class E Shares (in the amount of $0.1 million) be voided on March 10, 2006. Concurrently, 566 shares of the Company’s Class B Shares were issued in the amount of $0.1 million.

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On April 19, 2006, the Board authorized the repurchase on April 21, 2006 of 2,000 shares of the Company’s Class A Shares that had been tendered and were pending redemption. The Company paid approximately $0.39 million to redeem the shares. On June 6, 2006, the Board authorized the repurchase on June 29, 2006 of 2,250 shares of the Company’s Class A Shares that had been tendered and were pending redemption. The Company paid approximately $0.44 million to redeem the shares.

See “Redemption of Capital Stock” discussed in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the year ended October 1, 2005 for additional information.

PENSION AND POSTRETIREMENT BENEFIT PLANS

The Company sponsors a cash balance plan (“Cash Balance Plan”). The Company’s funding policy is to make contributions to the Cash Balance Plan in amounts that are at least sufficient to meet the minimum funding requirements of applicable laws and regulations, but no more than amounts deductible for federal income tax purposes. The Company also sponsors an executive salary protection plan (“ESPP II”) that provides supplemental post-termination retirement income based on each participant’s final salary and years of service as an officer of the Company. Funds are held in a rabbi trust for the ESPP II consisting primarily of life insurance policies reported at cash surrender value.

The Company sponsors postretirement benefit plans that cover both non-union and union employees. These plans are not funded.

The Company’s net periodic benefit cost for its combined pension and other postretirement benefits was approximately $8.4 million for the thirty-nine week period ended July 1, 2006 compared to $8.2 million for the thirty-nine week period ended July 2, 2005.

The Company contributed $1.04 million to the Cash Balance Plan during the thirty-nine weeks ended July 1, 2006. Commencing with its quarterly contributions of $1.04 million made on April 14, 2006 and July 14, 2006, the Company expects to make contributions of $1.04 million per quarter for the remainder of the 2006 plan year. Additional contributions will be due October 15, 2006 and January 15, 2007. At its discretion, the Company may contribute in excess of these amounts. Additional contributions for the 2005 plan year, if any, will be due by September 15, 2006, while contributions for the 2006 plan year will be due by September 15, 2007. The Company contributed $0.7 million to the ESPP II during the thirty-nine weeks ended July 1, 2006 to fund projected benefit payments to participants for the 2006 plan year.

At July 1, 2006, the fair value of the Cash Balance Plan assets increased to $84.8 million from $73.2 million at October 1, 2005.

RISK FACTORS

The risks and uncertainties described below are not the only ones the Company faces. Additional risks and uncertainties not presently known to the Company or that the Company currently deems immaterial also may impair the Company’s business operations. If any of the following risks occur, the Company’s business, prospects, financial condition, operating results and cash flows could be adversely affected in amounts that could be material.

Unified’s management deals with many risks and uncertainties in the normal course of business. Readers should be aware that the occurrence of the risks, uncertainties and events described in the risk factors below and elsewhere in this Form 10-Q could have an adverse effect on the Company’s business, results of operations and financial position.

The markets in which we operate are highly competitive.    The wholesale food distribution and retail grocery industries are highly competitive and characterized by high volume and low profit margins. The shifting of market share among competitors is typical of the wholesale food business as competitors attempt to increase sales in various markets. A significant portion of the Company’s sales are made at prices based on the cost of products it sells plus a markup. As a result, the Company’s profit levels may be negatively impacted if it is forced to respond to competitive pressure by reducing prices.

The increased competition has caused the industry to undergo changes as participants seek to lower costs, further increasing pressure on the industry’s already low profit margins. In addition to price competition, food wholesalers

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also compete with regard to quality, variety and availability of products offered, strength of private label brands offered, schedules and reliability of deliveries and the range and quality of services provided.

Continued consolidation in the industry, consolidation among the Company’s suppliers, new entrants and trends toward vertical integration could create additional competitive pressures that reduce margins and adversely affect the Company’s business, financial condition and results of operations.

The Company may experience reduced sales if Members lose market share.    The Company’s customers face increasing competition at the retail distribution level with several large fully integrated chain store organizations, as well as alternative format food stores including warehouse stores and supercenters. These supercenters have benefited from concentrated buying power and low-cost distribution technology, and have increasingly gained market share at the expense of traditional supermarket operators, including some independent operators, many of whom are the Company’s customers. The market share of such alternative format stores is expected to grow in the future, potentially resulting in a loss of sales volume for the Company. A loss of sales volume could potentially cause patronage dividends to be reduced and/or the book value of the Company’s shares to decrease, thereby reducing the value of the Members’ Class B Shares.

We will continue to be subject to risk of loss of member volume.    The Company’s operating results are highly dependent upon either maintaining or growing its distribution volume to its customers. The Company’s top ten Member and non-member customers constituted approximately 41.3% of total sales for the thirty-nine week period ended July 1, 2006. A significant loss in membership or volume could adversely affect the Company’s operating results. We will continue to be subject to the risks associated with consolidation within the grocery industry. When independent retailers are acquired by large chains with self-distribution capacity, are driven from business by larger grocery chains, or become large enough to develop their own self-distribution system, we will lose distribution volume. Members may also select other wholesale providers. Reduced volume is normally injurious to profitable operations since fixed costs must be spread over a lower sales volume.

The Company may experience reduced sales if Members purchase directly from suppliers.    Increased industry competitive pressure is causing some of the Company’s Members that can qualify to purchase directly from suppliers to increase their level of direct purchases from suppliers and expand their self-distribution activities. The Company’s operating results could be adversely affected if a significant reduction in distribution volume occurred in the future.

We are vulnerable to changes in general economic conditions.    The Company is affected by certain economic factors that are beyond its control including inflation. An inflationary economic period could impact the Company’s operating expenses in a variety of areas, including, but not limited to, employee wages, benefits and workers’ compensation insurance, as well as energy and fuel costs. A significant portion of the Company’s debt is at floating interest rates and an inflationary economic cycle typically results in higher interest costs. The Company operates in an industry characterized by low margins within a highly competitive marketplace; therefore, passing on such cost increases to customers could be difficult. To the extent the Company is unable to mitigate increasing costs, patronage dividends may be reduced and/or the book value of the Company’s shares may decrease, thereby reducing the value of the Members’ Class A and Class B Shares.

Changes in the economic environment could adversely affect Unified’s customer’s ability to meet certain obligations to the Company or leave the Company exposed for obligations the Company has guaranteed. Loans to Members, trade receivables and lease guarantees could be at risk in a sustained inflationary environment. In response to this potential risk, the Company establishes reserves for notes receivable, trade receivables, and lease commitments for which the Company may be at risk for default. Under certain circumstances, the Company would be required to foreclose on assets provided as collateral or assume payments for leased locations for which the Company has guaranteed payment. Although the Company believes its reserves to be adequate, the Company’s operating results could be adversely affected in the event that actual losses exceed available reserves.

The Company may on occasion hold investments in the common and preferred stock of Members (see Note 8 of Notes to Consolidated Condensed Financial Statements). These investments are generally held at cost or accounted for under the equity method and are periodically evaluated for impairment. As a result, changes in the economic environment that adversely affect the business of these Members could result in the write-down of these investments. This risk is unique to a cooperative form of business in that investments are made to support

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Members’ businesses, and those economic conditions that adversely affect the Members can also reduce the value of the Company’s investment, and hence the book value of the underlying capital shares.

Litigation could lead to unexpected losses.    During the normal course of carrying out its business, the Company may become involved in litigation. In the event that management determines that the probability of an adverse judgment in a pending litigation is likely and that the exposure can be reasonably estimated, appropriate reserves are recorded at that time pursuant to Statement of Financial Accounting Standards (“SFAS”) No. 5“Accounting for Contingencies.” Although the Company believes its reserves to be adequate, the final outcome of any litigation could adversely affect operating results if the actual settlement amount exceeds established reserves and insurance coverage.

We are subject to environmental laws and regulations.    The Company owns and operates various facilities for the manufacture, warehousing and distribution of products to its customers. Accordingly, the Company is subject to increasingly stringent federal, state and local laws, regulations and ordinances that (i) govern activities or operations that may have adverse environmental effects, such as discharges to air and water, as well as handling and disposal practices for solid and hazardous wastes and (ii) impose liability for the costs of cleaning up, and certain damages resulting from, sites of past spills, disposals or other releases of hazardous materials. In particular, under applicable environmental laws, the Company may be responsible for remediation of environmental conditions and may be subject to associated liabilities (including liabilities resulting from lawsuits brought by private litigants) relating to its facilities and the land on which the Company facilities are situated, regardless of whether the Company leases or owns the facilities or land in question and regardless of whether such environmental conditions were created by it or by a prior owner or tenant. The Company believes it is in compliance with all such laws and regulations and has established reserves for known and anticipated costs of remediation.

We are exposed to potential product liability claims.    The packaging, marketing and distribution of food products purchased from others involve an inherent risk of product liability, product recall and adverse publicity. Such products may contain contaminants that may be inadvertently redistributed by the Company. These contaminants may result in illness, injury or death if such contaminants are not eliminated. Accordingly, the Company maintains stringent quality standards on the products it purchases from suppliers, as well as products manufactured by the Company itself. The Company generally seeks contractual indemnification and insurance coverage from parties supplying its products and rigorously tests its private brands and manufactured products to ensure the Company’s quality standards are met. In addition, the Company is insured for product liability claims and believes its coverage to be adequate. However, product liability claims in excess of available reserves and insurance coverage, as well as the negative publicity surrounding any assertion that the Company’s products caused illness or injury could have a material adverse effect on its reputation and on the Company’s business, financial condition and results of operations.

Our insurance reserves may be inadequate if unexpected losses occur.    The Company’s insurance subsidiaries are regulated by the State of California and are subject to the rules and regulations promulgated by the appropriate regulatory agencies. In addition, the Company is self insured for workers’ compensation up to $1,000,000 per incident and maintains appropriate reserves to cover anticipated payments. Insurance reserves are recorded based on estimates made by management and validated by third party actuaries to ensure such estimates are within acceptable ranges. Actuarial estimates are based on detailed analyses of health care cost trends, mortality rates, claims history, demographics, industry trends and federal and state law. As a result, the amount of reserve and related expense is significantly affected by the outcome of these studies. Although the Company believes its reserves to be adequate, significant and adverse changes in the experience of claims settlement, legislative changes and other underlying assumptions could negatively impact operating results.

We may not have adequate resources to fund our operations.    The Company relies primarily upon cash flow from its operations and Member investments to fund its operating activities. In the event that these sources of cash are not sufficient to meet the Company’s requirements, additional sources of cash are expected to be obtained from the Company’s credit facilities to fund its daily operating activities. Our Revolving Credit Agreement, which expires on December 5, 2007, requires compliance with certain financial covenants, including minimum tangible net worth, fixed charge coverage ratio and total funded debt to earnings before interest, taxes, depreciation, amortization and patronage dividends (“EBITDAP”). While the Company is currently in compliance with all required covenants and expects to remain in compliance, this does not guarantee the Company will remain in compliance in future periods.

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The Company’s Revolving Credit Agreement permits advances of up to 85% of eligible accounts receivable and up to 65% of eligible inventory up to a maximum of $225 million. As of July 1, 2006, the Company believes it has sufficient cash flow from operations and availability under the Revolving Credit Agreement to meet operating needs and capital spending requirements through fiscal 2006. However, if access to operating cash or to the Revolving Credit Agreement becomes restricted, the Company may be compelled to seek alternate sources of cash. The Company cannot assure that alternate sources will provide cash on terms favorable to the Company. Consequently, the inability to access alternate sources of cash on terms similar to its existing agreement could adversely affect the Company’s operations.

The value of our benefit plan assets and liabilities is based on estimates and assumptions, which may prove inaccurate.    The Company’s employees participate in Company sponsored defined pension and postretirement benefit plans. Officers of the Company also participate in a Company sponsored ESPP II, which provides additional post-termination retirement income based on each participant’s final salary and years of service as an officer of the Company. The postretirement plans provide medical benefits for retired non-union employees, life insurance benefits for retired non-union employees for which active non-union employees are no longer eligible, and lump-sum payouts for unused sick days covering certain eligible union and non-union employees. Liabilities for the postretirement plans are not funded. The Company accounts for these benefit plans in accordance with SFAS No. 87,“Employers’ Accounting for Pensions,” SFAS No. 106“Employers’ Accounting for Postretirement Benefits Other Than Pensions” and SFAS No. 112“Employers’ Accounting for Postemployment Benefits,” which require the Company to make actuarial assumptions that are used to calculate the carrying value of the related assets, where applicable, and liabilities and the amount of expenses to be recorded in the Company’s consolidated financial statements. Assumptions include the expected return on plan assets, discount rates, health care cost trend rate, projected life expectancies of plan participants and anticipated salary increases. While we believe the underlying assumptions are appropriate, the carrying value of the related assets and liabilities and the amount of expenses recorded in the consolidated financial statements could differ if other assumptions are used.

A system failure or breach of system or network security could delay or interrupt services to our customers or subject us to significant liability.    Despite system redundancy, the implementation of security measures and the existence of a Disaster Recovery Plan for the Company’s internal information systems, these systems are vulnerable to damage from computer viruses, unauthorized access, energy blackouts, natural disasters, terrorism, war and telecommunication failures. It is possible that a system failure, accident or security breach could result in a material disruption to the Company’s business. In addition, substantial costs may be incurred to remedy the damages caused by these disruptions or security breaches. From time to time, the Company installs new or upgraded business management systems. To the extent that a critical system fails or is not properly implemented and the failure cannot be corrected in a timely manner, the Company may experience disruptions to the business that could have a material adverse effect on the Company’s results of operations.

Our success depends on our retention of our executive officers, senior management and our ability to hire and retain additional key personnel.    The Company’s success depends on the skills, experience and performance of its executive officers, senior management and other key personnel. The loss of service of one or more of its executive officers, senior management or other key employees could have a material adverse effect on the Company’s business, prospects, financial condition, operation results and cash flows. The Company’s future success also depends on its continuing ability to attract and retain highly qualified technical, sales and managerial personnel. Competition for these personnel is intense, and there can be no assurance that the Company can retain our key employees or that it can attract, assimilate or retain other highly qualified technical, sales and managerial personnel in the future.

The successful operation of our business depends upon the supply and marketing relationships from other companies.    The Company depends upon third parties for supply of products and raw materials. Any disruption in the services provided by any of these suppliers, or any failure by them to handle current or higher volumes of activity, could have a material adverse effect on the Company’s business, prospects, financial condition, operating results and cash flows.

The Company participates in various marketing and promotional programs to increase sales volume and reduce merchandise costs. Failure to continue these relationships on terms that are acceptable to Unified, or to obtain adequate marketing relationships could have a material adverse effect on the Company’s business, prospects, financial condition, operating results and cash flows.

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Increased energy, diesel fuel and gasoline costs could reduce our profitability.    The Company’s operations require and are dependent upon the continued availability of substantial amounts of electricity, diesel fuel and gasoline to manufacture, store and transport products. The Company’s trucking operations are extensive and diesel fuel storage capacity represents approximately two weeks average usage. The prices of electricity, diesel fuel and gasoline fluctuate significantly over time. Given the competitive nature of the grocery industry, we may not be able to pass on increased costs of production, storage and transportation to our customers. As a result, either a shortage or significant increase in the cost of electricity, diesel fuel or gasoline could disrupt distribution activities and negatively impact our business and results of operations.

Strike or work stoppage by our union employees could disrupt our business.    Approximately 60% of our employees are covered by collective bargaining agreements, some of which are due to expire in fiscal 2010. The inability to negotiate acceptable contracts with the unions could result in a strike or work stoppage and increased operating costs resulting from higher wages or benefits paid to union members or replacement workers. Such outcome could have a material negative impact on the Company’s operations and financial results.

If we fail to maintain an effective system of internal controls, we may not be able to detect fraud or report our financial results accurately, which could harm our business and we could be subject to regulatory scrutiny.    Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”), Unified will be required, beginning in its fiscal year 2007, to perform an evaluation of the Company’s internal controls over financial reporting and have the Company’s independent registered public accounting firm test and evaluate the design and operating effectiveness of such internal controls and publicly attest to such evaluation. The Company has prepared an internal plan of action for compliance with the requirements of Section 404, which includes a timeline and scheduled activities, although as of the date of this filing the Company has not yet completed its effectiveness evaluation. Although the Company believes its internal controls are operating effectively, the Company cannot guarantee that it will not have any material weaknesses. Compliance with the requirements of Section 404 is expected to be expensive and time-consuming. If the Company fails to complete this evaluation in a timely manner, or if the Company’s independent registered public accounting firm cannot timely attest to the Company’s evaluation, the Company could be subject to regulatory scrutiny and a loss of public confidence in our internal controls. In addition, any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm the Company’s operating results or cause the Company to fail to meet its reporting obligations.

Members will be required to report as income any patronage dividends that we distribute in the form of qualified written notices of allocation.    Members are required to consent to include in their gross income, in the year received, all cash as well as the stated dollar amount of all qualified written notices of allocation, including subordinated patronage dividend certificates (“Patronage Certificates”) and the book value of Class B Shares distributed to them as part of the qualified written notices of allocation. Patronage Certificates and Class B Shares distributed as part of the qualified written notices of allocation are also subject to state income and corporate franchise taxes in California and may be subject to these taxes in other states. The Member does not include a nonqualified written notice of allocation, whether in Class B Shares, Class E Shares or Patronage Certificates, as income in the year of receipt and the Company is not entitled to an income tax deduction in the year of issuance. The Member will have ordinary taxable income and the Company will have an income tax deduction when the stock is redeemed or the Patronage Certificate is paid in cash or property. The Company’s Board will determine whether patronage dividends will be paid in the form of qualified written notices of allocation or nonqualified written notices of allocation. For the fiscal years ended 2003, 2004 and 2005, the Company’s Board determined that patronage dividends would be paid in the form of nonqualified written notices of allocation for the Cooperative Division. Patronage dividends paid in the Dairy Divisions were paid in the form of qualified written notices of allocation.

Members are urged to consult their tax advisors with respect to the applicability of U.S. federal income, state or local tax rules on the ownership and disposition of Class A, Class B and Class E Shares and the receipt of Patronage Certificates with respect to their own tax status.

A loss of our cooperative tax status could increase tax liability.    Subchapter T of the Internal Revenue Code sets forth rules for the tax treatment of cooperatives. As a cooperative, the Company distributes deductible patronage dividends, which offset its entire patronage income. However, we are taxed as a corporation on the remainder of our earnings from our Member business (those earnings which we have not deemed to be patronage income) and on earnings from nonmember business. If the Company were not entitled to be taxed as a cooperative under Subchapter T, its revenues would be taxed when earned by the Company and the Members would be taxed when

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dividends were distributed. The Internal Revenue Service can challenge the tax status of cooperatives. The Internal Revenue Service has not challenged the Company’s tax status and the Company would vigorously defend any such challenge. If we were not entitled to be taxed as a cooperative, taxation at both the Company and the Member level would have a material, adverse impact on the Company.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of the Company’s consolidated condensed financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company to make estimates, assumptions and judgments that affect the amount of assets and liabilities reported in the consolidated condensed financial statements, the disclosure of contingent assets and liabilities as of the date of the consolidated condensed financial statements and reported amounts of revenues and expenses during the year. The Company believes its estimates and assumptions are reasonable; however, future results could differ from those estimates under different assumptions or conditions.

The Company’s discussion and analysis of its financial condition and results of operations is based upon its consolidated condensed financial statements. On an ongoing basis, we evaluate our estimates, including those related to allowances for doubtful accounts, lease loss reserves, inventories, investments, goodwill and intangible assets, long-lived assets, income taxes, insurance reserves, pension and postretirement benefits and contingencies and litigation. We base our estimates on historical experience and on various other assumptions and factors that we believe to be reasonable under the circumstances. Based on our ongoing review, we make adjustments we consider appropriate under the facts and circumstances. We have discussed the development, selection and disclosure of these estimates with the Audit Committee. The accompanying consolidated condensed financial statements are prepared using the same critical accounting policies and estimates discussed in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the fiscal year ended October 1, 2005.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

Refer to Note 9 to Notes to Consolidated Condensed Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for management’s discussion of recently issued accounting pronouncements and their expected impact, if any, on the Company’s consolidated condensed financial statements.

AVAILABILITY OF SEC FILINGS

Unified makes available, free of charge, through its website (www.uwgrocers.com) its Forms 10-K, 10-Q and 8-K, as well as its registration and proxy statements, as soon as reasonably practicable after those reports are electronically filed with the Securities and Exchange Commission (the “SEC”). A copy of any of the reports filed with the SEC can be obtained from the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. A copy may also be obtained by calling the SEC at 1-800-SEC-0330. All reports filed electronically with the SEC are available on the SEC’s web site at http://www.sec.gov.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The following discussion of the market risks the Company faces contains forward-looking statements. Forward-looking statements are subject to risks and uncertainties. Actual results could differ materially from those discussed in the forward-looking statements.

Unified is subject to interest rate changes on its notes payable under the Company’s credit agreements that may affect the fair value of the notes payable, as well as cash flow and earnings. Based on the notes payable outstanding at July 1, 2006 and the current market condition, a one percent increase in the applicable interest rates would decrease the Company’s annual cash flow and pretax earnings by approximately $0.4 million. Conversely, a one percent decrease in the applicable interest rates would increase annual cash flow and pretax earnings by approximately $0.4 million.

The Company’s investments in convertible bonds are classified as trading securities. As such, the Company is subject to market risk associated with fluctuations in interest rates and the market value of the embedded conversion feature.

The Company is exposed to credit risk on accounts receivable through the ordinary course of business and the Company performs ongoing credit evaluations. Concentration of credit risk with respect to accounts receivables are limited due to the nature of our customer base (i.e., primarily Members). The Company currently believes its allowance for doubtful accounts is sufficient to cover customer credit risks.

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ITEM 4. CONTROLS AND PROCEDURES

Disclosure controls and procedures.    Disclosure controls are controls and procedures designed to reasonably assure that information required to be disclosed in our reports filed under the Exchange Act, such as this Quarterly Report, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls are also designed to reasonably assure that such information is accumulated and communicated to our management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. Disclosure controls and procedures, no matter how well designed and implemented, can provide only reasonable assurance of achieving an entity’s disclosure objectives. The likelihood of achieving such objectives is affected by limitations inherent in disclosure controls and procedures. These include the fact that human judgment in decision-making can be faulty and that breakdowns in internal control can occur because of human failures such as simple errors, mistakes or intentional circumvention of the established processes.

At the end of the period covered by this report, Unified’s management, with the participation of our Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934). Our Chief Executive Officer and Chief Financial Officer concluded that these disclosure controls and procedures were not effective at the reasonable assurance level described above as of the end of the period covered in this report. See below for additional discussion.

Changes in internal controls over financial reporting.    Management, with the participation of the Chief Executive Officer and Chief Financial Officer of the Company, has evaluated any changes in the Company’s internal control over financial reporting that occurred during the most recent fiscal quarter. Based on that evaluation, management, the Chief Executive Officer and the Chief Financial Officer of the Company have concluded that no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) occurred during the quarter ended July 1, 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

In the fourth quarter of fiscal 2005, the Company became aware of a material weakness relating to the Company’s internal control over financial reporting with respect to its promotions tracking system. In June 2005, the Company made a modification to the promotions tracking system that was previously installed during 2004. This system will enable the Company to better monitor the cash flows relating to promotions and evaluate the factors influencing the effectiveness of promotional activities. Subsequent to the implementation of this modification, the Company discovered a limitation in the reporting capabilities of the system that could lead to a material misstatement in our financial statements. Upon discovering this limitation, the Company performed extensive alternative analysis and we are satisfied that this has not resulted in a material misstatement of the information presented in our current or previously issued financial statements. During the first quarter of fiscal 2006, the Company implemented, among other things, an enhanced reconciliation process to ensure that the impact of promotional activities is fairly stated in our financial statements. This process was further refined during the second and third quarters of fiscal 2006. We will continue to evaluate the effectiveness of such enhancements to be reasonably assured that we have appropriately remedied the deficiency in our internal controls.

The Company is a non-accelerated filer and is required to comply with the internal control reporting and disclosure requirements of Section 404 of the Sarbanes-Oxley Act for fiscal years ending on or after July 15, 2007. The Company is currently in the documentation phase of its Section 404 compliance and will be required to comply with these disclosure requirements for its fiscal year ending September 29, 2007.

PART II.    OTHER INFORMATION

ITEM 1.    LEGAL PROCEEDINGS

During the thirteen weeks ending July 1, 2006, Unified received payment on a judgment in favor of the Company from a successful litigation against a firm for professional negligence by such firm. The judgment was entered in 2004; however, the defendants in the litigation appealed. All appeals have now been resolved in the Company’s favor. The Company’s net proceeds were $3.0 million after payment of contingent attorneys’ fees, and were recorded as a reduction of distribution, selling and administrative expenses for the thirty-nine weeks ended July 1, 2006.

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The Company is a party to various litigation, claims and disputes, some of which are for substantial amounts, arising in the ordinary course of business. While the ultimate effect of such actions cannot be predicted with certainty, the Company believes the outcome of these matters will not result in a material adverse effect on its financial condition or results of operations.

ITEM 1A.    RISK FACTORS

There are no material changes from risk factors as previously disclosed in our Annual Report on Form 10-K for the fiscal year ended October 1, 2005, filed on December 21, 2005 (File No. 000-10815). Refer to “Risk Factors” in Part I, Item 2 of this Quarterly Report on Form 10-Q for a summary of the Company’s risk factors.

ITEM 2.    UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

COMPANY PURCHASES OF EQUITY SECURITIES

Period	Total Number of Shares Purchased	Average Price Paid Per Share
April 2, 2006 – April 29, 2006	2,000 Class A Shares	$	195.72
April 30, 2006 – May 27, 2006	— Class A Shares		—
May 28, 2006 – July 1, 2006	2,250 Class A Shares	$	195.72
Total	4,250 Class A Shares	$	195.72

Refer to “Redemption of Capital Stock” in Part I, Item 2 of this Quarterly Report on Form 10-Q for discussion of the Company’s share redemptions.

ITEM 3.    DEFAULTS UPON SENIOR SECURITIES

None.

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

None.

ITEM 5.    OTHER INFORMATION

None.

ITEM 6.    EXHIBITS

(a)	Exhibits
3.1	Amended and Restated Articles of Incorporation of the Registrant, as amended (incorporated by reference to Exhibit 3.1 to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 29, 2003).
3.2	Bylaws of the Registrant, as amended (incorporated by reference to Exhibit 3.2 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended September 27, 2003, filed on December 16, 2003).
31.1	Chief Executive Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Chief Financial Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Chief Executive Officer Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Chief Financial Officer Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

UNIFIED WESTERN GROCERS, INC.
By	/s/    ALFRED A. PLAMANN
	Alfred A. Plamann President and Chief Executive Officer (Principal Executive Officer)
By	/s/    RICHARD J. MARTIN
	Richard J. Martin Executive Vice President, Finance & Administration and Chief Financial Officer (Principal Financial and Accounting Officer)
By	/s/    RANDALL G. SCOVILLE
	Randall G. Scoville Vice President, Accounting and Chief Accounting Officer

Dated: August 15, 2006

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