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Third Quarter 2007
Investor Conference Call Prepared Remarks
December 11, 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 third quarter press release and our prepared remarks from this conference call will be available on our website at

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

Comments by: Dave Dillon

Thank you Carin, and good morning everyone. We’re pleased you could join us to review Kroger’s third quarter 2007 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.

Let me begin by saying that we are very pleased with our results this quarter. Our business is robust and our strategy is working. Our performance this quarter is consistent with our Customer 1st approach and is yet another example of Kroger’s ability to continue to deliver financial results in the near-term while maintaining our focus on investing for the future. I’ll begin with a recap of the third quarter, year-to-date results and guidance. Rodney will then provide additional details on third quarter results. After that, we’ll be happy to take your questions.

Third Quarter Results

Kroger delivered another quarter of strong sales performance. Total sales for the third quarter increased 9.8% to $16.1 billion and identical supermarket sales increased 7.7% with fuel and 5.7% without fuel. This is the tenth consecutive quarter Kroger has reported identical supermarket sales increases, excluding fuel, in excess of 3%.

Our strong identical sales growth continues to be broad-based across the Company’s geographic regions and merchandise departments. All of our supermarket divisions and departments experienced positive identical sales growth. In addition, our convenience stores turned in another strong quarter of identical sales growth.

Net earnings in the third quarter totaled $253.8 million, or $0.37 per diluted share. These results include a benefit of approximately $40 million from the resolution of certain tax issues during the quarter. Most of this benefit was offset by lower margins from retail fuel operations and the Company’s decision to accelerate certain initiatives that are part of Kroger’s Customer 1st strategy.

Net earnings in the same period last year were $214.7 million, or $0.30 per diluted share.

Our earnings performance this quarter was solid. Our strategy continues to deliver earnings growth in a variety of economic and competitive conditions, which underscores the core strength of Kroger's business model. Kroger’s strong sales performance in the third quarter is the direct result of our associates’ efforts to focus on our customers. Our business model positions us well to serve the diverse needs of our customers.

While fuel margins in the third quarter were weaker when compared to the prior year, on a year-to-date basis they were more normalized. As we have said before, in the fuel business, it is not uncommon to see variations from quarter to quarter. It is important to consider a longer view when analyzing fuel margins to account for these fluctuations because, over time, return on assets in the fuel business is well above our cost to capital.

Year-to-date Results

Turning to year-to-date results, total sales increased 7.6% to $53.0 billion during the first three quarters of fiscal 2007. For the same period, identical supermarket sales, excluding fuel, increased 5.3%.

Net earnings for the first three quarters of fiscal 2007 were $857.6 million, or $1.22 per diluted share. Net earnings for the same period last year were
$730.1 million, or $1.01 per diluted share.

Fiscal 2007 Guidance

Based on year-to-date financial results and current trends, Kroger now expects identical supermarket sales growth of approximately 5% for the full year, excluding fuel sales. The Company expects earnings per share to slightly exceed the range previously given of $1.64 – $1.67 per diluted share. This earnings guidance includes the lower tax rate due to the resolution of certain tax issues this quarter, and a higher estimated LIFO charge of $130 million, which is $80 million more than the Company originally anticipated for fiscal 2007. In addition, Kroger’s dividend currently adds slightly over 1% to shareholder return.

As a reminder, the fourth quarter of fiscal 2006 included an extra week that we estimate benefited our results by $0.07 per diluted share.

Our year-to-date performance positions us to deliver a slightly expanding operating margin, low double-digit earnings per share growth and strong identical sales growth in fiscal 2007. Our associates' focus on building customer loyalty through service, product, and value initiatives remains key to Kroger's future earnings growth.

Looking beyond 2007, we expect identical supermarket sales growth in the
3 –5% range, with a slightly improving operating margin, excluding the effect of retail fuel operations.

Now I would like to turn the call over to Rodney for some additional details on our third quarter results.

Comments by Rodney McMullen:

Thank you, Dave, and good morning everyone.

As Dave mentioned, we are very pleased with Kroger’s results this quarter, and they are in line with our business plan. Our associates continue to do a great job of executing our Customer 1st strategy and we appreciate their efforts in helping us deliver another good quarter.

I’ll now discuss some of the income statement components that produced our earnings per share growth in the quarter.

Gross Margin

On a GAAP basis, Kroger's third quarter FIFO gross margin decreased 110 basis points to 23.38% of sales, primarily due to the lower margins associated with fuel sales. Fuel margins fluctuate from quarter to quarter and that is why we take a longer view.

In keeping with our strategy, we continue to focus on reducing operating expenses and reinvesting those savings back into customer service, product selection, and pricing. Investments in pricing are reflected in Kroger's supermarket selling gross margin on non-fuel sales, which declined 45 basis points during the quarter. Reductions in warehousing, advertising, and shrink expenses funded a portion of these pricing investments, as our FIFO gross margin on non-fuel sales declined 34 basis points from the prior year.

During recent quarters, we have discussed product cost inflation and the impact it has on our business. We estimate that our product cost inflation during the quarter was 3.0%. This figure excludes fuel and utilizes CPI to estimate inflation for products in our Pharmacy department. We continue to experience inflation across many core grocery and perishable categories at a level not seen in several years.
Product cost inflation has prompted questions in recent months regarding our position on passing inflation costs on to customers. Generally, we do pass along product cost inflation over the long term, but there can be shorter-term lags created by competitive situations when we may see opportunities to gain market share. During the quarter, we did pass along product cost increases. In our view, periods of modest inflation tend to improve sales, increase margin dollars and create greater leverage of fixed costs.


Inflation also creates the LIFO charge that we recognize quarterly. The current inflationary environment has caused us to increase the projected LIFO charge for the second quarter in a row. Kroger has historically elected to have 98% of our product inventory on the LIFO method of valuation.

When companies elect to use the LIFO method for taxes, they are required to use it for financial reporting as well. While a LIFO charge is a non-cash expense, it creates cash tax savings. Kroger's estimated fiscal 2007 LIFO charge will reduce our cash taxes by approximately $50 million.

Operating, General and Administrative (OG&A) Expenses

Turning now to OG&A, operating, general and administrative costs declined 78 basis points to 17.49% of sales. Excluding the effect of retail fuel operations, OG&A declined 49 basis points.

This decline was driven by strong identical sales leverage, increased productivity, and progress we have made in controlling our utility, health care and pension expenses. These improvements were reduced by higher credit card fees. Rent and depreciation expense, as a percent of sales, without fuel, were comparable to last year.

Operating Margin

Kroger’s operating margin on a year-to-date basis increased 3 basis points. It increased 7 basis points excluding fuel, charges for labor unrest in the first quarter of 2007, and certain legal expenses in 2006. As we have said before, we do not believe that a single quarter’s operating margin is the best gauge of the success of our business strategy. This is due to the timing of operating cost savings and investments in our business.

For the full year in fiscal 2007, we continue to anticipate a slight increase in Kroger’s non-fuel operating margin, which will enable us to deliver double-digit earnings per share growth.

Share Repurchase and Dividends

Kroger’s earnings per share growth this year is also driven by fewer shares outstanding. We continued our aggressive stock buyback program during the quarter, reflecting our judgment that Kroger shares represent a compelling investment. Kroger repurchased 16.5 million shares of stock in the third quarter at an average price of $26.77 for a total investment of $442.1 million. At the end of the quarter, $201.6 million remained under the $1 billion stock repurchase program we announced in June 2007.

Our share repurchase and dividend programs deliver substantial value to shareholders. Over the past four quarters, Kroger has returned $1.5 billion to shareholders in the form of share repurchases and dividends.


Moving now to debt, Kroger’s net total debt to EBITDA ratio was 1.97, compared with 2.03 during the same period last year. Net total debt was $7.5 billion, an increase of $502 million from a year ago. Total debt was $7.5 billion, an increase of $528 million from a year ago. Our strong EBITDA on a rolling, four-quarters basis, enabled us to improve our leverage ratio while investing $2.2 billion in capital projects and $1.3 billion to repurchase 47.0 million shares and pay $197 million in dividends. This is in line with our long-term financial strategy of maintaining a leverage ratio to support a solid investment grade rating.

Capital Investment

During the third quarter, Kroger invested $555.3 million in capital projects compared with $415 million a year ago. Total capital projects during the quarter included 13 new or expanded stores and 54 remodels. During the third quarter, we closed 7 locations. Five of these were operational closures.

Total supermarket square footage grew 1.8% year over year, excluding acquisitions and operational closures. We continue to anticipate supermarket square footage growth of 2.0% for fiscal 2007 and we still expect to invest $1.9 - $2.1 billion in capital projects this year. This estimate excludes spending on acquisitions. In terms of capital allocation, our emphasis remains on store remodels, and we are very satisfied with their performance. Our customers tell us they appreciate them as well. We have completed 155 remodels year-to-date through the end of the third quarter. That compares to 112 remodels during the same period last year.

Improving our return on assets is important to us. On a rolling four-quarters basis, our return on assets improved 74 basis points pre-tax, excluding the effect of the 53rd week in fiscal 2006. This is on the same basis that Kroger has consistently used to calculate return on assets.


Turning to labor relations, we reached agreements during the quarter with unions representing our associates in Cincinnati, West Virginia and in Southern California with Food4Less. We also reached an agreement with the union representing our associates who work in a warehouse in central Ohio. In Memphis, we have agreed to a contract extension with the union that represents our store associates as negotiations continue there.

In 2008, we will negotiate contracts covering store associates in Columbus, Indianapolis, Las Vegas, Louisville, Nashville, Phoenix and Portland.

Fair and balanced contract settlements continue to be our objective in all negotiations. We work to reach balanced agreements that meet our cost efficiency objectives and fulfill our commitment to providing our associates with solid wages and benefits. Maintaining this balance allows Kroger to invest in our business to provide new job opportunities for existing associates and create new jobs for more people.

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

Comments by Dave Dillon:

Thanks, Rodney. Our quarterly and year-to-date performance is a great example of the strategy we have been discussing with you for some time – a sustainable, sales-driven plan that allows us to invest cost savings into initiatives that are meaningful to our customers. We continue to execute our strategy well in every area of our business to create value for our shareholders, as evidenced by the results we shared with you today.

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 share some thoughts with our associates listening in today.

In our business, the holidays are obviously a very exciting time of year. Our stores look great and our plants, distribution centers and offices are running well as we all work together to create special experiences for our customers.

This season offers each of us a chance to reflect. Just before Thanksgiving, I had the opportunity to visit our store in Greensburg, Kansas. You may recall that this past summer, a tornado devastated that community and we lost both a small Dillons store and a Kwik Shop convenience store. As the town went about the difficult task of rebuilding, associates from Dillons worked together with a group of associates from our convenience stores to come up with a solution that works for Greensburg. Today, that community is served by a combination Dillons-Kwik Shop, which meets the daily grocery and household needs of Greensburg residents and provides the community with a much-needed fuel center and other conveniences Kwik Shop offers.

During my visit, I spoke with associates who are so proud of serving that community and I listened to customers who are very grateful to have a store that meets their needs. It was a clear reminder to count our blessings every day. I am thankful to count each of you, our associates, among mine. Thank you for all you do for our customers – and each other – every day. Have fun this holiday season and take time to celebrate with your friends and family.

Thank you all for joining us today. Happy Holidays.


These 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,” “expect,” 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 identical supermarket 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. 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 ability to increase identical supermarket sales also 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. Our anticipated capital expenditures may be affected by our ability to obtain suitable store, logistics, and other projects, and the timing of those projects. We assume no obligation to update the information contained herein. Our ability to increase our operating margins is dependent primarily on our ability to increase identical sales, pass along product cost increases, and our ability to reduce shrink, distribution costs, and advertising expenses as a rate of sales. Please refer to Kroger’s reports and filings with the Securities and Exchange Commission for a further discussion of these risks and uncertainties.