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Fourth Quarter 2006
Investor Conference Call Prepared Remarks
March 13, 2007


Carin Fike, Director of Investor Relations:

Good morning and thank you for joining us. Before we begin, I want to remind you that today’s discussion will include forward-looking statements. We want to caution you that such statements are predictions, and actual events or results can differ materially. A detailed discussion of the many factors that we believe may have a material effect on our business on an ongoing basis is contained in our SEC filings, but Kroger assumes no obligation to update that information.

Both our fourth quarter press release and our prepared remarks from this conference call will be available on our website at www.kroger.com.

Now I would like to introduce Mr. David Dillon, Chairman and Chief Executive Officer of Kroger.

Comments by: Dave Dillon
Thanks Carin and good morning everyone. We’re pleased you could join us to review Kroger’s fourth quarter and fiscal year 2006 financial results. With me today are Rodney McMullen, Kroger’s Vice Chairman; Don McGeorge, Kroger’s President and Chief Operating Officer; and Mike Schlotman, Senior Vice President and Chief Financial Officer.

I will begin with a recap of Kroger’s fourth quarter sales results. Then I will provide market share information along with sales and earnings guidance for 2007. Rodney will discuss Kroger’s fourth quarter and fiscal year 2006 results and share additional detail on guidance. Then we’ll be happy to take your questions.

Sales
Total sales for the fourth quarter increased 14.5% to $16.9 billion. After adjusting for the extra week in the fourth quarter of 2006, total sales increased 5.7% over the fourth quarter of fiscal 2005. Identical supermarket sales increased 5.6% with fuel and 5.3% without fuel, based on a 13-week period in both years. This is on top of very strong growth during the same period last year.

Our associates helped sustain the sales momentum we enjoyed leading into the holiday season by executing our plans well. Growth this quarter was broad-based across all geographic regions and all departments. The strongest departments were Grocery, Drug/GM, Produce, Nutrition, Deli/Bakery, and Pharmacy.

In addition, our convenience stores turned in another strong quarter of sales growth – both in fuel gallons and non-fuel merchandise.

Our strong fourth quarter results indicate once again that our associates understand the importance of offering customers improved service, product quality and selection, and value. Our Company delivered yet another quarter of impressive identical sales growth – the key driver of our objective to increase earnings and create value for shareholders. Excluding fuel, this marks the fourteenth consecutive quarter Kroger has reported positive identical supermarket sales, and the seventh consecutive quarter Kroger has reported identical supermarket sales in excess of 3%.

Market Share
Our strong identical sales results throughout fiscal 2006 translated into a second consecutive year of impressive market share gains.

It is our practice at this time of year to describe our market share statistics to you. The market share figures we report are based on internal estimates. We determine the potential for sales in each market from all retail outlets that sell merchandise comparable to our own – including supercenters and other non-traditional retail formats such as dollar stores, drug stores, and warehouse clubs. Many third-party market share data providers only include some of these non-traditional formats.

Now for the detail on Kroger’s 2006 market share statistics. We define a “major market” as one in which we operate nine or more stores. By this definition, Kroger serves customers in 44 major markets. For 2006, Kroger held the #1 or #2 share position in 38 of our 44 major markets. Kroger’s overall market share in these 44 markets rose approximately 65 basis points during 2006, on a volume-weighted basis. Our share increased in 36 of those 44 major markets, declined in seven, and remained unchanged in one.

Kroger competes against a total of 1,262 supercenters – an increase of 133 over last year. There are 34 major markets in which supercenters have achieved at least a #3 market share position. Kroger’s overall market share in these 34 markets rose over 70 basis points during 2006, on a volume-weighted basis. Our share increased in 27 of those 34 major markets, declined in six, and remained unchanged in one.

Of the 1,262 supercenters that I mentioned, 1,000 are operated by Wal-Mart. This is an increase of 125 over last year. Wal-Mart supercenters have achieved at least a #3 share position in 32 of the major markets where Kroger faces significant supercenter competition. Kroger’s overall market share in these 32 markets rose nearly 75 basis points during 2006, on a volume-weighted basis. Our share increased in 26 of these major markets, declined in five, and remained unchanged in one.

While these market share gains are dramatic on their own, we think they are even more impressive when you consider that they follow our strong market share gains in the previous year. In 2005, Kroger’s overall market share in our 44 major markets increased more than 35 basis points. When you look at the two years combined, our major market share increased approximately 100 basis points. Needless to say, this is huge.

Furthermore, our 2006 data indicate that Kroger continued to achieve significant growth in market share even in the face of aggressive expansion by supercenters and other non-traditional formats. The pace of their expansion shows no signs of slowing down, and the industry is not getting any less competitive.

Our business plan and Customer 1st strategy are built around this reality so that we can continue to grow despite evolving and increasing competition. We challenged our associates to help us improve our connection with customers. They accepted the challenge and raised the bar, as these market share gains clearly show.

Still, there is plenty of room for further growth. Even with Kroger’s strong share in our 44 major markets, approximately 47% of the share in those markets continues to be held by competitors without our economies of scale. We estimate that their share has declined by about 3% over the last three years.

Fiscal 2007 Guidance
Now I will turn to our expectations for fiscal 2007. We are expecting another great year!

Based on the momentum of our fiscal 2006 performance, Kroger anticipates earnings of $1.60 - $1.65 per diluted share in fiscal 2007. This equates to 9 – 12% growth from an adjusted fiscal 2006 earnings base of $1.47 per diluted share, as detailed in Table 5 of our earnings release.

As in 2006, strong identical sales, slightly improving operating margins, and fewer shares outstanding will drive Kroger’s earnings per share growth in fiscal 2007. This growth rate assumes a stable labor environment. We expect identical supermarket sales growth of 3 – 5%, excluding fuel sales, for fiscal 2007.

Kroger’s quarterly cash dividend is an important component of shareholder return. We expect the combination of the Company’s dividend and earnings per share target to deliver a double-digit return for Kroger shareholders in 2007.

Later, Rodney will share some additional details on our guidance for fiscal 2007. First, he will discuss Kroger’s fourth quarter and fiscal 2006 results. Rodney?

Comments by Rodney McMullen:
Thank you, Dave, and good morning everyone.

Net Earnings
Net earnings in the fourth quarter totaled $384.8 million, or $0.54 per diluted share. The current quarter benefited by $0.03 per diluted share from the adjustments of certain deferred tax balances. This was not contemplated in the Company’s prior guidance.

Net earnings in the same period last year were $282.1 million, or $0.39 per diluted share.

Kroger’s fourth quarter results illustrate the successful execution of our strategy. That is, we are utilizing operating cost savings to fund improvements in value and service for our customers in order to drive strong identical sales growth that results in earnings growth for shareholders. Our gross margin and OG&A results reflect this strategy.

Gross Margin
During the quarter, FIFO gross margin declined 37 basis points to 24.48% of sales. Excluding the effect of retail fuel operations, FIFO gross margin declined 29 basis points from the prior year.

Our fourth quarter supermarket selling gross margin on non-fuel sales declined 21 basis points, reflecting continued investment in lower prices for our customers. “Selling gross margin” is a term we use internally to describe the Company’s gross margin before incurring expenses directly related to distributing and merchandising products on our stores shelves.

Operating, general and administrative (OG&A)
Operating, general and administrative costs, or OG&A, declined 32 basis points to 17.65% of sales. Excluding the effect of retail fuel operations and stock option expense, OG&A declined 34 basis points versus last year.

This decline was driven by strong identical sales leverage, increased productivity, and progress we have made in controlling our energy and health care expenses. These gains were partially offset by higher incentive pay, based on Kroger’s strong 2006 results.

Credit card fees also increased as a percentage of sales during the quarter.

Tax Rate
Our tax rate in the fourth quarter was 33.4% compared to 37.6% during the same period last year. Excluding adjustments to certain deferred tax balances, our fourth quarter 2006 tax rate was 37.4%.

Use of Free Cash Flow
During the fourth quarter, Kroger repurchased 4.6 million shares of stock at an average price of $23.13 for a total investment of $105.8 million. At the end of the fourth quarter, $233.0 million remained under the $500 million stock buyback announced in May 2006.

Since January 2000, Kroger has invested $5.6 billion to repurchase shares and to reduce total debt. Of this total, $3.6 billion was used to repurchase 184.7 million shares at an average price of $19.56 per share. Total debt was reduced by $2.0 billion.

We ended fiscal 2006 with a total debt balance of $7.1 billion, a reduction of $172.9 million from a year ago.

Our investment grade rating continues to be very important to us. Our debt to EBITDA ratio in the fourth quarter was 1.89, an improvement of 17 basis points from the same period last year.

Fiscal Year 2006
Turning now to Kroger’s fiscal 2006 performance, total sales increased 9.2% to $66.1 billion for the full fiscal year. After adjusting for the extra week in fiscal 2006, total sales increased 7.0% over fiscal 2005.

Net earnings for fiscal 2006 were $1.11 billion, or $1.54 per diluted share. Fiscal 2006 included a 53rd week that benefited the year by an estimated $0.07 per diluted share. You might recall that our 2006 guidance contemplated a favorable impact of $0.05 per diluted share from the 53rd week. As it turned out, that particular week was an exceptionally strong one for our business, and we surpassed our original sales and profit expectations by a meaningful amount, largely due to weather conditions in certain parts of the country.

Fiscal 2006 earnings also included $0.03 of expense per diluted share for legal reserves recorded in the first quarter. This item was contemplated in our December guidance of 8 – 10% growth in earnings per diluted share. Additionally, fiscal 2006 benefited by $0.03 per diluted share from the adjustments of certain deferred tax balances that were not contemplated in the Company’s guidance.

In fiscal 2005, net earnings were $958.0 million, or $1.31 per diluted share.

During the year, FIFO gross margin declined 53 basis points to 24.27% of sales. Excluding the effect of retail fuel operations, FIFO gross margin declined 27 basis points from the prior year. Our fiscal 2006 supermarket selling gross margin on non-fuel sales declined 34 basis points, reflecting Kroger’s strategy of delivering value to our customers.

Full-year OG&A costs, which do not include rent and depreciation expense, declined 30 basis points to 17.91% of sales. Excluding the effect of retail fuel operations, stock option expense, and the increase in the legal reserve, OG&A declined 28 basis points. Strong identical sales leverage and operating cost reductions allowed us to fund investments in additional service and value for our customers.

Our fiscal 2006 operating margin rose 2 basis points over the prior year. Excluding the effect of retail fuel sales, stock option expense, and the increase in the legal reserve, Kroger’s operating margin increased 23 basis points over the prior year. In 2006, Kroger was able to balance cost savings and productivity improvements to improve our customers’ shopping experience. Sales leverage over rent and depreciation expense provided most of the operating margin expansion.

Fiscal 2006 Scorecard
Before sharing some additional guidance for 2007, I would like to compare the 2006 objectives we set out for investors a year ago to Kroger’s actual fiscal 2006 results. Thanks to the efforts of our associates, Kroger delivered another year of consistently strong results during the fiscal year, and exceeded our original guidance for both identical supermarket sales and earnings per share growth.

Our original target for fiscal 2006 identical supermarket sales growth, excluding fuel sales, was to exceed of 3.5%. Each quarter we raised that target to reflect our sales momentum throughout the year. Today, we reported full-year identical supermarket sales growth, excluding fuel sales, of 5.6% – well in excess of our original goal.

We originally expected to deliver earnings per share growth in 2006 of 6 – 8%. In December, we raised that range to 8 – 10%. Today we reported earnings per share growth of 15%, on a basis consistent with this guidance. Our quarterly cash dividend added further value of a little over 1% to this growth.

Our earnings per share growth was driven primarily by three factors: strong identical sales, slightly improving operating margins, and fewer shares outstanding.

We had planned to invest approximately $1.7 - $1.9 billion in capital projects during the year. Our actual capital expenditures for 2006 came in at $1.8 billion. We opened, expanded, relocated or acquired 53 supermarkets. We completed 158 remodels. Our total supermarket square footage grew 1.5%, excluding acquisitions and operational closings. Our return on assets improved almost 104 basis points on a pre-tax basis, using the method Kroger has consistently used to calculate return on assets.

When you look at everything together, we had a terrific year! Kroger's strategic plan served customers, associates and shareholders well in fiscal 2006. We believe it will continue to enable the Company to achieve its objectives in 2007.

Additional Guidance for 2007
Dave outlined our sales and earnings guidance for 2007 earlier. While we do not give specific quarterly guidance, I do want to remind you of the timing of certain items in 2006 that will affect our quarterly earnings per share growth during 2007.

I would like to note that we anticipate earnings per share growth rates in the first and fourth quarters of 2007 will be less than the annual growth rate. That, in turn, means the second and third quarters will be higher. This is important to remember when calculating your 2007 quarterly estimates because the first and fourth quarters in 2006 were very strong.

Additionally, the first quarter of 2006 was reduced by $0.03 per share due to the legal reserve and the fourth quarter of 2006 was $0.10 per share higher due to the extra week and adjustments to deferred tax balances.

I would like to point out that our guidance assumes the same intensely competitive environment we operate in today.

Here are some other expectations that are incorporated into our guidance for the year:

  • We plan to invest $1.9 to $2.1 billion in capital projects, excluding acquisitions. This capital budget includes approximately 60 major projects covering new stores, expansions and relocations, and 200 remodels, and other investments to support our Customer 1st business strategy;
  • We anticipate total supermarket square footage growth of 2.0% – before acquisitions and operational closings – with an emphasis on large, fast-growing markets;
  • We expect to make a cash contribution of approximately $125 million to the Company-sponsored retirement plans, a reduction of about $25 million from 2006;
  • We forecast that our tax rate for fiscal 2007 will be approximately 38%, excluding any effect from the implementation of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes.
  • And, we have labor negotiations this year covering store associates in Southern California, Cincinnati, Detroit, Houston, Memphis, Toledo, Seattle and West Virginia. Negotiations this year will be challenging as we must have competitive cost structures in each market while meeting our associates’ needs for good wages and affordable health care.

Now I will turn it back to Dave for some closing remarks.

Comments by Dave Dillon:
Thanks, Rodney. We are very pleased with our results for the fourth quarter and fiscal 2006. As Rodney discussed, our fiscal 2006 results compared favorably to each of the objectives we outlined for you at the beginning of 2006.

We made significant strides in several key areas. We grew our average market share by 65 basis points despite intense competition. We showed even stronger growth in markets where we compete directly with supercenters. These gains clearly show our plan is working. We continue to balance operating cost reductions with investments aimed at improving our customers’ overall shopping experience in all aspects including service, product quality and selection and pricing.

Keeping our efforts focused on each and every customer is so important as we continue to face competitive challenges on all fronts. We believe we have the right approach to uniquely meet the diverse needs of today’s shoppers. And we have the talented people to do so in 2007 and beyond.

Now, we would like to take a few moments to answer your questions.

Closing comments after Q&A:
Thank you. Before we sign off, I would like to offer some additional comments to our associates listening in today.

On behalf of our customers and shareholders, I want to congratulate and thank our 300,000-plus associates across all of our banners and operations for a successful year. The market share gains we outlined earlier underscore the efforts you make on a daily basis. You are the reason behind our success and we appreciate your hard work and dedication.

There is another important area where Kroger excels that we should all be proud of – leading the fight to end hunger in America. Last year, our family of stores contributed more than 30 million pounds of food and other products to more than 85 food banks serving the local communities where we operate. Thanks to the generous contributions of our customers, associates and vendors, those donations provided more than 22 million meals to families and individuals across the country through food banks, soup kitchens and emergency pantries.

Kroger has been supporting the fight to end hunger in America for more than 25 years. Last year, we were again selected “Retailer of the Year” by America’s Second Harvest, the largest hunger-relief organization in the U.S. It is the fourth time in six years our Company has received this award. This honor is particularly noteworthy because food banks across the country select the recipient. Kroger was selected – again – because of the relationships our associates have directly with local food banks. We are proud of the long-standing relationships you have all helped to build in our communities.

Helping to combat hunger is one of Kroger’s core priorities. We appreciate the role our associates, customers and vendors play in helping us make a difference – in every community we serve.

In closing, because of you, we had a terrific year. Thank you.

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The remarks contain certain forward-looking statements about the future performance of the Company. These statements are based on management’s assumptions and beliefs in light of the information currently available to it. Such statements are indicated by words or phrases such as “will,” “plan,” “expects,” and “anticipate.” These forward-looking statements are subject to uncertainties and other factors that could cause actual results to differ materially. Our ability to achieve sales and earnings growth and earnings per share goals may be affected by: labor disputes, particularly as the Company seeks to manage health care and pension costs; industry consolidation; pricing and promotional activities of existing and new competitors, including non-traditional competitors; our response to these actions; the state of the economy, including interest rates and the inflationary and deflationary trends in certain commodities; weather conditions; stock repurchases; the success of our future growth plans; goodwill impairment; and our ability to generate sales at desirable margins, as well as the success of our programs designed to increase our identical sales without fuel. Operating margins could fail to improve if our operations do not continue to improve as expected or if we are unsuccessful in containing our operating costs. In addition any delays in opening new stores, or changes in the economic climate could cause us to fall short of our sales and earnings targets. Our capital expenditures could vary from our expectations if we are unsuccessful in acquiring suitable sites for new stores; development costs exceed those budgeted; or our logistics and technology or store projects are not completed on budget or in the time frame expected. Our ability to increase identical supermarket sales could be adversely affected by increased competition and sales shifts to other stores that we operate, as well as increases in sales of our corporate brand products. Square footage growth during the year is dependent upon our ability to acquire desirable sites for construction of new facilities, as well as the timing of completion of projects. Any change in tax laws, the regulations related thereto, the applicable accounting rules or standards, or the interpretation thereof by federal, state or local authorities could affect our expected tax rate. The amount of our contribution to Company-sponsored retirement plans will depend primarily on the success of our strategic plan and the extent to which we are able to generate free cash flow. We assume no obligation to update the information contained herein. Please refer to Kroger’s reports and filings with the Securities and Exchange Commission for a further discussion of these risks and uncertainties.

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