KROGER CO — Annual Report 2008

Apr 1, 2008

10-K 1 a08-9380_110k.htm 10-K

*UNITED STATES*

*SECURITIES AND EXCHANGE COMMISSION*

*Washington, D.C. 20549*

*FORM 10-K*

*(Mark One)*

| x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 |
| --- | --- |
| | For the Fiscal year ended February 2, 2008. |
| | OR |
| o | 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 1-303 |

*THE KROGER CO.*

(Exact name of registrant as specified in its charter)

Ohio	31-0345740
(State or other jurisdiction of
incorporation or organization)	(I.R.S. Employer Identification No.)
1014 Vine Street, Cincinnati, OH	45202
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code (513) 762-4000

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

| Title
of each class | Name
of each exchange on which registered |
| --- | --- |
| Common Stock $1 par value | New York Stock Exchange |

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

*NONE*

(Title of class)

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

Yes x No o

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

Yes o No x

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 registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§299.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

| Large
accelerated filer | x | Accelerated
filer | o |
| --- | --- | --- | --- |
| Non-accelerated
filer (do not check if a smaller reporting company) | o | Smaller
reporting company | o |

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).

Yes o No x

The aggregate market value of the Common Stock of The Kroger Co. held by non-affiliates as of August 18, 2007: $18,043 million.

There were 661,600,170 shares of Common Stock ($1 par value) outstanding as of March 28, 2008.

*Documents Incorporated by Reference:*

Proxy statement to be filed pursuant to Regulation 14A of the Exchange Act on or before June 2, 2008, incorporated by reference into Part III of Form 10-K.

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*PART I*

ITEM 1. BUSINESS.

The Kroger Co. was founded in 1883 and incorporated in 1902. As of February 2, 2008, the Company was one of the largest retailers in the United States based on annual sales. The Company also manufactures and processes some of the food for sale in its supermarkets. The Company’s principal executive offices are located at 1014 Vine Street, Cincinnati, Ohio 45202, and its telephone number is (513) 762-4000. The Company maintains a web site (www.kroger.com) that includes additional information about the Company. The Company makes available through its web site, free of charge, its annual reports on Form 10-K, its quarterly reports on Form 10-Q and its current reports on Form 8-K, including amendments thereto. These forms are available as soon as reasonably practicable after the Company has filed or furnished them electronically with the SEC.

The Company’s revenues are earned and cash is generated as consumer products are sold to customers in its stores. The Company earns income predominantly by selling products at price levels that produce revenues in excess of its costs to make these products available to its customers. Such costs include procurement and distribution costs, facility occupancy and operational costs, and overhead expenses.

*E MPLOYEES*

The Company employs approximately 323,000 full and part-time employees. A majority of the Company’s employees are covered by collective bargaining agreements negotiated with local unions affiliated with one of several different international unions. There are approximately 330 such agreements, usually with terms of three to five years.

During fiscal 2008, the Company has major labor contracts covering its store employees expiring in Columbus, Indianapolis, Las Vegas, Louisville, Nashville, Phoenix and Portland. Negotiations in 2008 will be challenging as the Company must have competitive cost structures in each market while meeting our associates’ needs for good wages and affordable health care.

*S TORES*

As of February 2, 2008, the Company operated, either directly or through its subsidiaries, 2,486 supermarkets and multi-department stores, 696 of which had fuel centers. Approximately 43% of these supermarkets were operated in Company-owned facilities, including some Company-owned buildings on leased land. The Company’s current strategy emphasizes self-development and ownership of store real estate. The Company’s stores operate under several banners that have strong local ties and brand equity. Supermarkets are generally operated under one of the following formats: combination food and drug stores (“combo stores”); multi-department stores; marketplace stores; or price impact warehouses.

The combo stores are the primary food store format. They are typically able to earn a return above the Company’s cost of capital by drawing customers from a 2 – 2½ mile radius. The Company believes this format is successful because the stores are large enough to offer the specialty departments that customers desire for one-stop shopping, including natural food and organic sections, pharmacies, general merchandise, pet centers and high-quality perishables such as fresh seafood and organic produce. Many combo stores include a fuel center.

Multi-department stores are significantly larger in size than combo stores. In addition to the departments offered at a typical combo store, multi-department stores sell a wide selection of general merchandise items such as apparel, home fashion and furnishings, electronics, automotive products, toys and fine jewelry. Many multi-department stores include a fuel center.

Marketplace stores are smaller in size than multi-department stores. They offer full-service grocery and pharmacy departments as well as an expanded general merchandise area that includes outdoor living products, electronics, home goods and toys. Many marketplace stores include a fuel center.

Price impact warehouse stores offer a “no-frills, low cost” warehouse format and feature everyday low prices plus promotions for a wide selection of grocery and health and beauty care items. Quality meat, dairy, baked goods and fresh produce items provide a competitive advantage. The average size of a price impact warehouse store is similar to that of a combo store.

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In addition to supermarkets, the Company operates, either directly or through subsidiaries, 782 convenience stores and 394 fine jewelry stores. Substantially all of our fine jewelry stores are operated in leased locations. Subsidiaries operated 691of the convenience stores, while 91 were operated through franchise agreements. Approximately 50% of the convenience stores operated by subsidiaries were operated in Company-owned facilities. The convenience stores offer a limited assortment of staple food items and general merchandise and, in most cases, sell gasoline.

*S EGMENTS*

The Company operates retail food and drug stores, multi-department stores, jewelry stores, and convenience stores throughout the United States. The Company’s retail operations, which represent substantially all of the Company’s consolidated sales, earnings and total assets, are its only reportable segment. All of the Company’s operations are domestic. Revenues, profit and losses, and total assets are shown in the Company’s Consolidated Financial Statements set forth in Item 8 below.

*M ERCHANDISING AND M ANUFACTURING*

Corporate brand products play an important role in the Company’s merchandising strategy. Supermarket divisions typically stock approximately 14,400 private label items. The Company’s corporate brand products are produced and sold in three quality “tiers.” Private Selection is the premium quality brand designed to be a unique item in a category or to meet or beat the “gourmet” or “upscale” brands. The “banner brand” (Kroger, Ralphs, King Soopers, etc.), which represents the majority of the Company’s private label items, is designed to be equal to or better than the national brand and carries the “Try It, Like It, or Get the National Brand Free” guarantee. Kroger Value or local banner name is the value brand, designed to deliver good quality at a very affordable price.

Approximately 43% of the corporate brand units sold are produced in the Company’s manufacturing plants; the remaining corporate brand items are produced to the Company’s strict specifications by outside manufacturers. The Company performs a “make or buy” analysis on corporate brand products and decisions are based upon a comparison of market-based transfer prices versus open market purchases. As of February 2, 2008, the Company operated 42 manufacturing plants. These plants consisted of 18 dairies, 11 deli or bakery plants, five grocery product plants, three beverage plants, three meat plants and two cheese plants.

*E XECUTIVE O FFICERS OF THE R EGISTRANT*

The disclosure regarding executive officers is set forth in Item 10 of Part III of this Form 10-K under the heading “Executive Officers of the Company,” and is incorporated herein by reference.

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*ITEM 1A. RISK FACTORS.*

There are risks and uncertainties that can affect our business. The significant risk factors are discussed below. Please also see the “Outlook” section in Item 7 of this Form 10-K for forward-looking statements and factors that could cause us not to realize our goals or meet our expectations.

*C OMPETITIVE E NVIRONMENT*

The operating environment for the food retailing industry continues to be characterized by intense price competition, aggressive supercenter expansion, increasing fragmentation of retail formats, entry of non-traditional competitors and market consolidation. We have developed a strategic plan that we believe is a balanced approach that will enable Kroger to meet the wide-ranging needs and expectations of our customers in this challenging economic environment. However, the nature and extent to which our competitors implement various pricing and promotional activities in response to increasing competition - including our execution of our strategic plan - and our response to these competitive actions, can adversely affect our profitability. Our profitability and growth could also be adversely affected by changes in the overall economic environment that impact consumer spending, including discretionary spending.

*F OOD S AFETY*

Customers count on Kroger to provide them with wholesome food products. Concerns regarding the safety of food products sold by Kroger could cause shoppers to avoid purchasing certain products from us, or to seek alternative sources of supply for all of their food needs, even if the basis for the concern is outside of our control. Any lost confidence on the part of our customers would be difficult and costly to reestablish. As such, any issue regarding the safety of any food items sold by Kroger, regardless of the cause, could have a substantial and adverse effect on our operations.

*L ABOR R ELATIONS*

A significant majority of our employees are covered by collective bargaining agreements with unions, and our relationship with those unions, including any work stoppages, could have an adverse impact on our financial results.

We are a party to approximately 330 collective bargaining agreements. We have major contracts expiring in 2008 covering store employees in Columbus, Indianapolis, Las Vegas, Louisville, Nashville, Phoenix and Portland. In future negotiations with labor unions, we expect that rising health care, pension and employee benefit costs, among other issues, will continue to be important topics for negotiation. Upon the expiration of our collective bargaining agreements, work stoppages by the affected workers could occur if we are unable to negotiate acceptable contracts with labor unions. This could significantly disrupt our operations. Further, if we are unable to control health care, pension and wage costs, or gain operational flexibility under our collective bargaining agreements, we may experience increased operating costs and an adverse impact on future results of operations.

*S TRATEGY E XECUTION*

Our strategy focuses on improving our customers’ shopping experience through enhanced service, product selection and value. Successful execution of this strategy requires a balance between sales growth and earnings growth. Maintaining this strategy requires the ability to identify and execute plans to generate cost savings and productivity improvements that can be invested in the merchandising and pricing initiatives necessary to support our customer-focused programs, as well as recognizing and implementing organizational changes as required. If we are unable to execute our plans, or if our plans fail to meet our customers’ expectations, our sales and earnings growth expectations could be adversely affected.

*DATA AND TECHNOLOGY*

Our business is increasingly dependent on information technology systems that are complex and vital to continuing operations. If we were to experience difficulties maintaining existing systems or implementing new systems, we could incur significant losses due to disruptions in our operations. Additionally, these systems contain valuable proprietary data that, if breached, would have an adverse effect on Kroger.

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*I NDEBTEDNESS*

As of year-end 2007, Kroger’s outstanding indebtedness, including capital leases and financing obligations, totaled approximately $8.1 billion. This indebtedness could reduce our ability to obtain additional financing for working capital, acquisitions or other purposes and could make us more vulnerable to economic downturns and competitive pressures. If debt markets do not permit us to refinance certain maturing debt, we may be required to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness. Changes in our credit ratings, or in the interest rate environment, could have an adverse effect on our financing costs and structure.

*L EGAL P ROCEEDINGS*

From time to time, we are a party to legal proceedings, including matters involving personnel and employment issues, personal injury, antitrust claims and other proceedings. Some of these proceedings, including product liability cases, could result in a substantial loss to Kroger in the event that other potentially responsible parties are unable (for financial reasons or otherwise) to satisfy a judgment entered against them. Others purport to be brought as class actions on behalf of similarly situated parties. We estimate our exposure to these legal proceedings and establish accruals for the estimated liabilities. Assessing and predicting the outcome of these matters involves substantial uncertainties. While we currently do not expect any outstanding legal proceedings to have a material effect on the financial condition of Kroger, unexpected outcomes in these legal proceedings, or changes in our evaluations or predictions about the proceedings, could have a material adverse effect on our financial results. Please also refer to the “Legal Proceedings” section in Item 3 below.

*M ULTI -E MPLOYER P OST -R ETIREMENT O BLIGATIONS*

As discussed in more detail below in “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies- Post-Retirement Benefit Plans ,” Kroger contributes to several multi-employer pension plans based on obligations arising under collective bargaining agreements with unions representing employees covered by those agreements. In addition to future contribution obligations that Kroger may have under those plans, there is a risk that the agencies that rate Kroger’s outstanding debt instruments could view the underfunded nature of these plans unfavorably when determining their ratings on the Company’s debt securities. Any downgrading of Kroger’s debt ratings likely would increase Kroger’s cost of borrowing.

*I NSURANCE*

We use a combination of insurance and self-insurance to provide for potential liability for workers’ compensation, automobile and general liability, property, director and officers’ liability, and employee health care benefits. Any actuarial projection of losses is subject to a high degree of variability. Changes in legal trends and interpretations, variability in inflation rates, changes in the nature and method of claims settlement, benefit level changes due to changes in applicable laws, and changes in discount rates could all affect ultimate settlements of claims.

*ITEM 1B. UNRESOLVED STAFF COMMENTS.*

None.

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*ITEM 2. PROPERTIES.*

As of February 2, 2008, the Company operated more than 3,600 owned or leased supermarkets, convenience stores, fine jewelry stores, distribution warehouses and food processing facilities through divisions, subsidiaries or affiliates. These facilities are located throughout the United States. A majority of the properties used to conduct the Company’s business are leased.

The Company generally owns store equipment, fixtures and leasehold improvements, as well as processing and manufacturing equipment. The total cost of the Company’s owned assets and capitalized leases at February 2, 2008, was $22,436 million while the accumulated depreciation was $9,938 million.

Leased premises generally have base terms ranging from ten-to-twenty years with renewal options for additional periods. Some options provide the right to purchase the property after conclusion of the lease term. Store rentals are normally payable monthly at a stated amount or at a guaranteed minimum amount plus a percentage of sales over a stated dollar volume. Rentals for the distribution, manufacturing and miscellaneous facilities generally are payable monthly at stated amounts. For additional information on lease obligations, see Note 8 to the Consolidated Financial Statements.

*ITEM 3. LEGAL PROCEEDINGS.*

On October 6, 2006, the Company petitioned the Tax Court ( In Re: Ralphs Grocery Company and Subsidiaries, formerly known as Ralphs Supermarkets, Inc., Docket No. 20364-06 ) for a redetermination of deficiencies set by the Commissioner of Internal Revenue. The dispute at issue involves a 1992 transaction in which Ralphs Holding Company acquired the stock of Ralphs Grocery Company and made an election under Section 338(h)(10) of the Internal Revenue Code. The Commissioner has determined that the acquisition of the stock was not a purchase as defined by Section 338(h)(3) of the Internal Revenue Code and that the acquisition does not qualify as a purchase. The Company believes that it has strong arguments in favor of its position and believes it is more likely than not that its position will be sustained. However, due to the inherent uncertainty involved in the litigation process, there can be no assurances that the Tax Court will rule in favor of the Company. As of February 2, 2008, an adverse decision would require a cash payment of approximately $419 million including interest.

On February 2, 2004, the Attorney General for the State of California filed an action in Los Angeles federal court ( California, ex rel Lockyer v. Safeway, Inc. dba Vons, a Safeway Company; Albertson’s, Inc. and Ralphs Grocery Company, a division of The Kroger Co. , United States District Court Central District of California, Case No. CV04-0687) alleging that the Mutual Strike Assistance Agreement (the “Agreement”) between the Company, Albertson’s, Inc. and Safeway Inc. (collectively, the “Retailers”), which was designed to prevent the union from placing disproportionate pressure on one or more of the Retailers by picketing such Retailer(s) but not the other Retailer(s) during the labor dispute in southern California, violated Section 1 of the Sherman Act. The lawsuit seeks declarative and injunctive relief. On May 25, 2005, the Court denied a motion for a summary judgment filed by the defendants. Ralphs and the other defendants filed a notice of an interlocutory appeal to the United States Court of Appeals for the Ninth Circuit. On November 29, 2005, the appellate court dismissed the appeal. On December 7, 2006, the Court denied a motion for summary judgment filed by the State of California. The Company continues to believe it has strong defenses against this lawsuit and is vigorously defending it. Although this lawsuit is subject to uncertainties inherent to the litigation process, based on the information presently available to the Company, management does not expect that the ultimate resolution of this action will have a material adverse effect on the Company’s financial condition, results of operations or cash flows.

Various claims and lawsuits arising in the normal course of business, including suits charging violations of certain antitrust, wage and hour, or civil rights laws, are pending against the Company. Some of these suits purport or have been determined to be class actions and/or seek substantial damages. Any damages that may be awarded in antitrust cases will be automatically trebled. Although it is not possible at this time to evaluate the merits of all of these claims and lawsuits, nor their likelihood of success, the Company is of the belief that any resulting liability will not have a material adverse effect on the Company’s financial position.

The Company continually evaluates its exposure to loss contingencies arising from pending or threatened litigation and believes it has made adequate provisions therefor. Nonetheless, assessing and predicting the outcomes of these matters involve substantial uncertainties. It remains possible that despite management’s current belief, material differences in actual outcomes or changes in management’s evaluation or predictions could arise that could have a material adverse impact on the Company’s financial condition or results of operation.

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

None.

*PART II*

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

*(a)*

*C OMMON S TOCK P RICE R ANGE*

Quarter	2007 — High	Low	2006 — High	Low
1 st	$ 30.43	$ 24.74	$ 20.98	$ 18.05
2 nd	$ 31.94	$ 23.95	$ 23.23	$ 19.37
3 rd	$ 30.00	$ 25.30	$ 24.15	$ 21.49
4 th	$ 29.35	$ 24.23	$ 25.96	$ 21.12

Main trading market: New York Stock Exchange (Symbol KR)

| Number
of shareholders of record at year-end 2007: | 46,822 |
| --- | --- |
| Number
of shareholders of record at March 28, 2008: | 46,674 |

During fiscal 2006, the Company’s Board of Directors adopted a dividend policy and paid three quarterly dividends of $0.065 per share. During fiscal 2007, the Company paid one and three quarterly dividends of $0.065 and $0.075, respectively. On March 1, 2008, the Company paid its fourth quarterly dividend of $0.075 per share. On March 13, 2008, the Company announced that its Board of Directors had increased the quarterly dividend to $.09 per share, payable on June 1, 2008, to shareholders of record at the close of business on May 15, 2008.

*PERFORMANCE GRAPH*

Set forth below is a line graph comparing the five-year cumulative total shareholder return on Kroger’s common stock, based on the market price of the common stock and assuming reinvestment of dividends, with the cumulative total return of companies in the Standard & Poor’s 500 Stock Index and the Peer Group composed of food and drug companies.

Historically, our peer group has consisted of the major food store companies. In recent years there have been significant changes in the industry, including consolidation and increased competition from supercenters, drug chains, and discount stores. As a result, in 2003 we changed our peer group (the “Peer Group”) to include companies operating supermarkets, supercenters and warehouse clubs in the United States as well as the major drug chains with which Kroger competes.

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Company Name/Index	Base Period — 2002	INDEXED RETURNS Years Ending — 2003	2004	2005	2006	2007
The Kroger Co.	100	122.80	114.25	123.06	172.87	175.61
S&P 500
Index	100	134.57	141.76	158.24	181.97	178.69
Peer Group	100	116.66	124.90	122.44	134.83	139.96

Kroger’s fiscal year ends on the Saturday closest to January 31.

• Total assumes $100 invested on February 2, 2003, in The Kroger Co., S&P 500 Index and the Peer Group, with reinvestment of dividends.

** The Peer Group consists of Albertson’s, Inc., Costco Wholesale Corp., CVS Corp, Delhaize Group SA (ADR), Great Atlantic & Pacific Tea Company, Inc., Koninklijke Ahold NV (ADR), Marsh Supermarkets Inc. (Class A), Safeway, Inc., Supervalu Inc., Target Corp., Wal-Mart Stores Inc., Walgreen Co., Whole Foods Market Inc. and Winn-Dixie Stores, Inc. Albertson’s, Inc., was substantially acquired by Supervalu in July 2006, and is included through 2005. Marsh Supermarkets was acquired by Marsh Supermarkets Holding Corp. in September 2006, and is included through 2005. Winn-Dixie emerged from bankruptcy in 2006 as a new issue and returns for the old and new issue were calculated then weighted to determine the 2006 return.

Data supplied by Standard & Poor’s.

The foregoing Performance Graph will not be deemed incorporated by reference into any other filing, absent an express reference thereto.

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*(c)*

*ISSUER PURCHASES OF EQUITY SECURITIES*

Period (1)	Total Number of Shares Purchased	Average Price Paid Per Share	Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (2)	Maximum Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (3) (in millions)
First period -
four weeks
November 11,
2007 to December 8, 2007	2,774,327	$ 28.16	2,767,562	$ 124
Second period -
four weeks
December 9,
2007 to January 5, 2008	3,505,410	$ 26.39	3,498,334	$ 31
Third period –
four weeks
January 6,
2008 to February 2, 2008	3,836,391	$ 25.78	3,831,400	$ 941
Total	10,116,128	$ 26.64	10,097,296	$ 941

| (1) | The reported periods conform to the Company’s fiscal
calendar composed of thirteen 28-day periods. The fourth quarter of
2007 contained three 28-day periods. |
| --- | --- |
| (2) | Shares were repurchased under (i) a $1 billion
stock repurchase program, authorized by the Board of Directors on
June 26, 2007, (ii) a $1 billion stock repurchase program,
authorized by the Board of Directors on January 18, 2008, and
(iii) a program announced on December 6, 1999, to repurchase common
stock to reduce dilution resulting from our employee stock option plans which
program is limited to proceeds received from exercises of stock options and
the tax benefits associated therewith. The programs have no expiration date
but may be terminated by the Board of Directors at any time. During the
fourth quarter of fiscal 2007, the $1 billion stock-repurchase program
referred to in clause (ii) replaced the $1 billion stock repurchase
program referred to in clause (i). Accordingly, the Company does not intend
to make further purchases under the program referenced in clause (i). Total
shares purchased include shares that were surrendered to the Company by
participants under the Company’s long-term incentive plans to pay for taxes
on restricted stock awards. |
| (3) | The amounts shown in this column in the first and
second four-week periods reflect amounts remaining under the $1 billion stock
repurchase program referenced in clause (i) of Note 2 above. The amount
shown in this column in the third four-week period reflect amounts remaining
under the $1 billion stock repurchase program referenced in clause
(ii) of Note 2 above. Amounts to be invested under the program utilizing
option exercise proceeds are dependent upon option exercise activity. |

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*ITEM 6. SELECTED FINANCIAL DATA.*

	Fiscal Years Ended — February 2, 2008 (52 weeks)	February 3, 2007 (53 weeks)	January 28, 2006 (52 weeks)	January 29, 2005 (52 weeks)		January 31, 2004 (52 weeks)
	(In millions, except per share amounts)
Sales	$ 70,235	$ 66,111	$ 60,553	$ 56,434		$ 53,791
Net earnings
(loss)	1,181	1,115	958	(104	)	285
Diluted earnings
(loss) per share:
Net earnings
(loss)	1.69	1.54	1.31	(0.14	)	0.38
Total assets	22,299	21,215	20,482	20,491		20,767
Long-term
liabilities, including obligations under capital leases and financing
obligations	8,696	8,711	9,377	10,537		10,515
Shareowners’
equity	4,914	4,923	4,390	3,619		4,068
Cash dividends
per common share	0.29	0.195	—	—		—

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*ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.*

*O UR B USINESS*

The Kroger Co. was founded in 1883 and incorporated in 1902. It is one of the nation’s largest retailers, operating 2,486 supermarket and multi-department stores under two dozen banners including Kroger, Ralphs, Fred Meyer, Food 4 Less, King Soopers, Smith’s, Fry’s, Fry’s Marketplace, Dillons, QFC and City Market. Of these stores, 696 have fuel centers. We also operate 782 convenience stores and 394 fine jewelry stores.

Kroger operates 42 manufacturing plants, primarily bakeries and dairies, which supply approximately 43% of the corporate brand units sold in our retail outlets.

Our revenues are earned and cash is generated as consumer products are sold to customers in our stores. We earn income predominately by selling products at price levels that produce revenues in excess of our costs to make these products available to our customers. Such costs include procurement and distribution costs, facility occupancy and operational costs, and overhead expenses. Our operations are reported as a single reportable segment: the retail sale of merchandise to individual customers.

*O UR 2007 P ERFORMANCE*

2007 was a great year for Kroger. Once again, our actual results compare very favorably to our expectations for the year.

At the outset of fiscal 2007, we expected to grow identical sales, excluding fuel, by 3% to 5%. We achieved identical sales, excluding fuel, of 5.3% for fiscal year 2007, exceeding the upper end of our original guidance. We are particularly pleased with such strong identical sales growth in a challenging economic environment, and we believe this demonstrates the resiliency of our business model.

Kroger’s initial guidance for fiscal 2007 earnings was a range of $1.60 to $1.65 per diluted share. Our 2007 earnings were $1.69 per diluted share, also exceeding the upper end of our original guidance. This equates to 15% growth after adjusting for the extra week in fiscal 2006. This growth, plus Kroger’s dividend yield of slightly more than 1%, created strong value for shareholders.

Kroger’s business model is structured to produce sustainable earnings per share growth in a variety of economic and competitive conditions, primarily through strong identical sales growth. We recognize that continual investment in our customers’ shopping experience is necessary to drive strong, sustainable identical sales growth, and we have the operating cost structure that allows us to afford those pricing and service investments. We believe that Kroger’s dividend program and the sustainable earnings per share growth created by strong identical sales, slight operating margin improvement, and continued share repurchases is a solid approach to increasing shareholder value.

While the objective of our business model is to create shareholder value, the objective of Kroger’s Customer 1 st strategy is to serve customers. Our Customer 1 st strategy and business model work in tandem to build our successful business.

Kroger has several advantages that allow us to grow our business in a competitive industry. Our strong market share and geographic diversity are among the most important. Kroger serves customers in 44 major markets across 31 different states. We define a major market as one in which we operate nine or more stores. Our broad geographical diversity enables us to withstand competitive pressures in multiple markets and to manage unusual economic challenges. Economic conditions can affect our business, but our Customer 1 st strategy and business model allow us to provide a strong value proposition to customers whose spending may be pinched by economic pressures.

Market share is critical to us because it allows us to leverage the fixed costs in our business over a wider revenue base. We hold the number one or number two share position in 39 of our 44 major markets. Our fundamental operating philosophy is to maintain and increase market share.

During fiscal 2007, we grew our market share by roughly 65 basis points in our 44 major markets, based on our internal data and analysis. This was on top of very strong growth in 2005 and 2006. During the last three fiscal years combined, Kroger’s share has increased approximately 165 basis points across our major markets.

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*R ESULTS OF O PERATIONS*

The following discussion summarizes our operating results for 2007 compared to 2006 and for 2006 compared to 2005. Comparability is affected by certain income and expense items that fluctuated significantly between and among the periods.

Net Earnings

Net earnings totaled $1,181 million for 2007, compared to net earnings totaling $1,115 and $958 million in 2006 and 2005, respectively. The increase in our net earnings for 2007, compared to 2006 and 2005, resulted from spreading fixed costs over our increased identical sales. In addition, 2006 net earnings, compared to 2005, increased due to a 53 rd week in that year.

Earnings per diluted share totaled $1.69 in 2007, compared to $1.54 and $1.31 per share in 2006 and 2005, respectively. Earnings per diluted share increased 15% after adjusting for the extra week in fiscal 2006. Net earnings in 2006 benefited from a 53 rd week by an estimated $0.07 per share. Our earnings per share growth in 2007, 2006 and 2005 resulted from increased net earnings, strong identical sales growth and the repurchase of Kroger stock. During fiscal 2007, we repurchased 53 million shares of Kroger stock for a total investment of $1,421 million. During fiscal 2006, we repurchased 29 million shares of our stock for a total investment of $633 million. During fiscal 2005, we repurchased 15 million shares of Kroger stock for a total investment of $252 million.

Sales

*Total Sales*

(in millions)

	2007	Percentage Increase	2006	Percentage Increase	2005
Total food store
sales without fuel	$ 60,142	4.2 %	$ 57,712	7.9 %	$ 53,472
Total food store
fuel sales	5,741	28.9 %	4,455	26.3 %	3,526
Total food store
sales	$ 65,883	6.0 %	$ 62,167	9.1 %	$ 56,998
Other sales(1)	4,352	10.3 %	3,944	10.9 %	3,555
Total Sales	$ 70,235	6.2 %	$ 66,111	9.2 %	$ 60,553

(1) Other sales primarily relate to sales at convenience stores, including fuel, jewelry stores and sales by our manufacturing plants to outside firms.

The growth in our total sales was primarily the result of identical store sales increases and inflation in many core grocery and perishable categories. Increased transaction count and average transaction size were both responsible for our increases in identical supermarket sales, excluding retail fuel operations. After adjusting for the extra week in fiscal 2006, total sales increased 8.2% in 2007 over fiscal 2006.

We define a supermarket as identical when it has been in operation without expansion or relocation for five full quarters. Differences between total supermarket sales and identical supermarket sales primarily relate to changes in supermarket square footage. Annualized identical supermarket sales include all sales at the Fred Meyer multi-department stores. We calculate annualized identical supermarket sales based on a summation of four quarters of identical supermarket sales. Our identical supermarket sales results are summarized in the table below, based on the 52-week period of 2007, compared to the same 52-week period of the previous year. The identical store count in the table below represents the total number of identical supermarkets as of February 2, 2008 and February 3, 2007.

*Identical Supermarket Sales*

(in millions)

	2007	2006
Including
supermarket fuel centers	$ 62,440	$ 58,417
Excluding
supermarket fuel centers	$ 57,068	$ 54,198
Including
supermarket fuel centers	6.9 %	6.4 %
Excluding
supermarket fuel centers	5.3 %	5.6 %
Identical 4 th Quarter store count	2,280	2,288

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We define a supermarket as comparable when it has been in operation for five full quarters, including expansions and relocations. Annualized comparable supermarket sales include all Fred Meyer multi-departments. We calculate annualized comparable supermarket sales based on a summation of four quarters of comparable sales. Our annualized comparable supermarket sales results are summarized in the table below, based on the 52-week period of 2007, compared to the same 52-week period of the previous year. The comparable store count in the table below represents the total number of comparable supermarkets as of February 2, 2008 and February 3, 2007.

*Comparable Supermarket Sales*

(in millions)

	2007	2006
Including
supermarket fuel centers	$ 64,450	$ 60,128
Excluding
supermarket fuel centers	$ 58,838	$ 55,773
Including
supermarket fuel centers	7.2 %	6.7 %
Excluding
supermarket fuel centers	5.5 %	5.7 %
Comparable 4 th Quarter store count	2,352	2,362

FIFO Gross Margin

We calculate First-In, First-Out (“FIFO”) Gross Margin as follows: Sales minus merchandise costs plus Last-In, First-Out (“LIFO”) charge (credit). Merchandise costs include advertising, warehousing and transportation, but exclude depreciation expense and rent expense. FIFO gross margin is an important measure used by our management to evaluate merchandising and operational effectiveness.

Our FIFO gross margin rates were 23.65%, 24.27% and 24.80% in 2007, 2006 and 2005, respectively. Retail fuel sales lowered our FIFO gross margin rate due to the very low FIFO gross margin on retail fuel sales as compared to non-fuel sales. Excluding the effect of retail fuel operations, our FIFO gross margin rates decreased 20 basis points, 26 basis points and 4 basis points in 2007, 2006 and 2005, respectively. The decrease in our non-fuel FIFO gross margin rate reflects our continued reinvestment of operating cost savings into lower prices for our customers.

LIFO Charge

The LIFO charge in 2007, 2006, and 2005 was $154 million, $50 million and $27 million, respectively. Like many food retailers, we continue to experience product cost inflation at levels that have not occurred for several years. We estimate that product cost inflation was approximately 3% to 3.5% throughout 2007, as compared to estimated inflation rates that averaged approximately 1% over the previous two years. This increase in product cost inflation caused the increase in the LIFO charge in 2007.

Operating, General and Administrative Expenses

Operating, general and administrative (“OG&A”) expenses consist primarily of employee-related costs such as wages, health care benefit costs and retirement plan costs. Among other items, rent expense, depreciation and amortization expense, and interest expense are not included in OG&A.

OG&A expenses, as a percent of sales, were 17.31%, 17.91% and 18.21% in 2007, 2006 and 2005, respectively. The growth in our retail fuel sales lowers our OG&A rate due to the very low OG&A rate on retail fuel sales as compared to non-fuel sales. OG&A expenses, as a percent of sales excluding fuel, decreased 33 basis points, 9 basis points and 13 basis points in 2007, 2006 and 2005, respectively. Excluding the effect of retail fuel operations and expenses recorded for legal reserves, our OG&A rate declined 16 basis points in 2006. The decrease in our OG&A rate in 2007, excluding the effect of retail fuel operations, was primarily the result of strong identical sales growth, increased productivity, and progress we have made in controlling our utility, health care and pension costs. These improvements were partially offset by increases in credit card fees.

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Rent Expense

Rent expense was $644 million in 2007, as compared to $649 million and $661 million in 2006 and 2005, respectively. Rent expense, as a percent of sales, was 0.92% in 2007, as compared to 0.98% in 2006 and 1.09% in 2005. The decrease in rent expense, as a percent of sales, reflects our increasing sales and our continued emphasis on owning rather than leasing whenever possible.

Depreciation and Amortization Expense

Depreciation expense was $1,356 million, $1,272 million and $1,265 million for 2007, 2006 and 2005, respectively. The increases in depreciation and amortization expense were the result of capital expenditures totaling $2,060 million, $1,777 million and $1,306 million in 2007, 2006 and 2005, respectively. Depreciation and amortization expense, as a percent of sales, was 1.93%, 1.92% and 2.09% in 2007, 2006 and 2005, respectively. The increase in our depreciation and amortization expense compared to 2006, as a percent of sales, is due to an annual depreciation charge in both years with 2006 containing 53 weeks of sales due to the structure of our fiscal calendar. Excluding the effect of retail fuel operations, the decrease in our depreciation and amortization expense compared to 2005, as a percent of sales, is primarily the result of identical store sales increases.

Interest Expense

Net interest expense totaled $474 million, $488 million and $510 million for 2007, 2006 and 2005, respectively. The decrease in interest expense was the result of replacing borrowings with new borrowings at a lower interest rate. The average total debt balance in 2007 was comparable to both 2006 and 2005.

Income Taxes

Our effective income tax rate was 35.4%, 36.2% and 37.2% for 2007, 2006 and 2005, respectively. The effective tax rates for 2007 and 2006 differ from the expected federal statutory rate due to the resolution of certain tax issues and an adjustment of certain deferred tax balances, respectively. In addition, the effective income tax rates differ from the expected federal statutory rate in all years presented due to the effect of state taxes.

During the third quarter of 2007, we resolved favorably certain tax issues. This resulted in a 2007 tax benefit of approximately $40 million and reduced our effective rate by 1.9%.

In 2006, during the reconciliation of our deferred tax balances, and after the filing of our annual federal and state tax returns, we identified adjustments to be made in the previous years’ deferred tax reconciliation. We corrected these deferred tax balances in our Consolidated Financial Statements for the year ended February 3, 2007, which resulted in a reduction of our fiscal 2006 provision for income tax expense of approximately $21 million and reduced the rate by 1.2%. We do not believe these adjustments are material to our Consolidated Financial Statements for the year ended February 3, 2007, or to any prior years’ Consolidated Financial Statements. As a result, we have not restated any prior year amounts.

*C OMMON S TOCK R EPURCHASE P ROGRAM*

We maintain stock repurchase programs that comply with Securities Exchange Act Rule 10b5-1 and allow for the orderly repurchase of our common stock, from time to time. We made open market purchases totaling $1,151 million, $374 million and $239 million under these repurchase programs during fiscal 2007, 2006 and 2005, respectively. In addition to these repurchase programs, in December 1999 we began a program to repurchase common stock to reduce dilution resulting from our employee stock option plans. This program is solely funded by proceeds from stock option exercises, and the tax benefit from these exercises. We repurchased approximately $270 million, $259 million and $13 million under the stock option program during 2007, 2006 and 2005, respectively.

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*C APITAL E XPENDITURES*

Capital expenditures, including changes in construction-in-progress payables and excluding acquisitions, totaled $2,060 million in 2007 compared to $1,777 million in 2006 and $1,306 million in 2005. The increase in capital spending in 2007 compared to 2006 and 2005 was the result of increasing our focus on remodels, merchandising and productivity projects. The table below shows our supermarket storing activity and our total food store square footage:

*Supermarket Storing Activity*

| Beginning of
year | 2007 — 2,468 | | 2006 — 2,507 | | 2005 — 2,532 | |
| --- | --- | --- | --- | --- | --- | --- |
| Opened | 23 | | 20 | | 28 | |
| Opened
(relocation) | 9 | | 17 | | 12 | |
| Acquired | 38 | | 1 | | 1 | |
| Acquired
(relocation) | 1 | | — | | — | |
| Closed
(operational) | (43 | ) | (60 | ) | (54 | ) |
| Closed
(relocation) | (10 | ) | (17 | ) | (12 | ) |
| End of year | 2,486 | | 2,468 | | 2,507 | |
| Total food store
square footage (in millions) | 145 | | 142 | | 142 | |

*C RITICAL A CCOUNTING P OLICIES*

We have chosen accounting policies that we believe are appropriate to report accurately and fairly our operating results and financial position, and we apply those accounting policies in a consistent manner. Our significant accounting policies are summarized in Note 1 to the Consolidated Financial Statements.

The preparation of financial statements in conformity with generally accepted accounting principles (“GAAP”) requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses, and related disclosures of contingent assets and liabilities. We base our estimates on historical experience and other factors we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates.

We believe that the following accounting policies are the most critical in the preparation of our financial statements because they involve the most difficult, subjective or complex judgments about the effect of matters that are inherently uncertain.

Self-Insurance Costs

We primarily are self-insured for costs related to workers’ compensation and general liability claims. The liabilities represent our best estimate, using generally accepted actuarial reserving methods, of the ultimate obligations for reported claims plus those incurred but not reported for all claims incurred through February 2, 2008. We establish case reserves for reported claims using case-basis evaluation of the underlying claim data and we update as information becomes known.

For both workers’ compensation and general liability claims, we have purchased stop-loss coverage to limit our exposure to any significant exposure on a per claim basis. We are insured for covered costs in excess of these per claim limits. We account for the liabilities for workers’ compensation claims on a present value basis utilizing a risk-adjusted discount rate. A 25 basis point decrease in our discount rate would increase our liability by approximately $3 million. General liability claims are not discounted.

We are also similarly self-insured for property-related losses. We have purchased stop-loss coverage to limit our exposure to losses in excess of $25 million on a per claim basis, except in the case of an earthquake, for which stop-loss coverage is in excess of $50 million per claim, up to $200 million per claim in California and $300 million outside of California.

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The assumptions underlying the ultimate costs of existing claim losses are subject to a high degree of unpredictability, which can affect the liability recorded for such claims. For example, variability in inflation rates of health care costs inherent in these claims can affect the amounts realized. Similarly, changes in legal trends and interpretations, as well as a change in the nature and method of how claims are settled can affect ultimate costs. Our estimates of liabilities incurred do not anticipate significant changes in historical trends for these variables, and any changes could have a considerable effect on future claim costs and currently recorded liabilities.

Impairments of Long-Lived Assets

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets , we monitor the carrying value of long-lived assets for potential impairment each quarter based on whether certain trigger events have occurred. These events include current period losses combined with a history of losses or a projection of continuing losses or a significant decrease in the market value of an asset. When a trigger event occurs, we perform an impairment calculation, comparing projected undiscounted cash flows, utilizing current cash flow information and expected growth rates related to specific stores, to the carrying value for those stores. If we identify impairment for long-lived assets to be held and used, we compare discounted future cash flows to the asset’s current carrying value. We record impairment when the carrying value exceeds the discounted cash flows. With respect to owned property and equipment held for disposal, we adjust the value of the property and equipment to reflect recoverable values based on our previous efforts to dispose of similar assets and current economic conditions. We recognize impairment for the excess of the carrying value over the estimated fair market value, reduced by estimated direct costs of disposal. We recorded asset impairments in the normal course of business totaling $24 million, $61 million, and $48 million in 2007, 2006 and 2005, respectively. We record costs to reduce the carrying value of long-lived assets in the Consolidated Statements of Operations as “Operating, general and administrative” expense.

The factors that most significantly affect the impairment calculation are our estimates of future cash flows. Our cash flow projections look several years into the future and include assumptions on variables such as inflation, the economy and market competition. Application of alternative assumptions and definitions, such as reviewing long-lived assets for impairment at a different organizational level, could produce significantly different results.

Goodwill

We review goodwill for impairment during the fourth quarter of each year, and also upon the occurrence of trigger events. We perform reviews at the operating division level. Generally, fair value is determined using a multiple of earnings, or discounted projected future cash flows, and we compare fair value to the carrying value of a division for purposes of identifying potential impairment. We base projected future cash flows on management’s knowledge of the current operating environment and expectations for the future. If we identify potential for impairment, we measure the fair value of a division against the fair value of its underlying assets and liabilities, excluding goodwill, to estimate an implied fair value of the division’s goodwill. We recognize goodwill impairment for any excess of the carrying value of the division’s goodwill over the implied fair value. If actual results differ significantly from anticipated future results for certain reporting units, we would need to recognize an impairment loss for any excess of the carrying value of the division’s goodwill over the implied fair value. Results of the goodwill impairment reviews performed during 2007, 2006 and 2005 are summarized in Note 2 to the Consolidated Financial Statements.

The annual impairment review requires the extensive use of accounting judgment and financial estimates. Application of alternative assumptions and definitions, such as reviewing goodwill for impairment at a different organizational level, could produce significantly different results. Similar to our policy on impairment of long-lived assets, the cash flow projections embedded in our goodwill impairment reviews can be affected by several items such as inflation, the economy and market competition.

Intangible Assets

In addition to goodwill, we have recorded intangible assets totaling $32 million, $24 million and $34 million for leasehold equities, liquor licenses and pharmacy prescription file purchases, respectively, at February 2, 2008. Balances at February 3, 2007, were $26 million, $22 million and $28 million for lease equities, liquor licenses and pharmacy prescription files, respectively. We amortize leasehold equities over the remaining life of the lease. We do not amortize owned liquor licenses, however, we amortize liquor licenses that must be renewed over their useful lives. We amortize pharmacy prescription file purchases over seven years. We consider these assets annually during our testing for impairment.

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Store Closing Costs

We provide for closed store liabilities relating to the present value of the estimated remaining noncancellable lease payments after the closing date, net of estimated subtenant income. We estimate the net lease liabilities using a discount rate to calculate the present value of the remaining net rent payments on closed stores. We usually pay closed store lease liabilities over the lease terms associated with the closed stores, which generally have remaining terms ranging from one to 20 years. Adjustments to closed store liabilities primarily relate to changes in subtenant income and actual exit costs differing from original estimates. We make adjustments for changes in estimates in the period in which the change becomes known. We review store closing liabilities quarterly to ensure that any accrued amount that is not a sufficient estimate of future costs, or that no longer is needed for its originally intended purpose, is adjusted to earnings in the proper period.

We estimate subtenant income, future cash flows and asset recovery values based on our experience and knowledge of the market in which the closed store is located, our previous efforts to dispose of similar assets and current economic conditions. The ultimate cost of the disposition of the leases and the related assets is affected by current real estate markets, inflation rates and general economic conditions.

We reduce owned stores held for disposal to their estimated net realizable value. We account for costs to reduce the carrying values of property, equipment and leasehold improvements in accordance with our policy on impairment of long-lived assets. We classify inventory write-downs in connection with store closings, if any, in “Merchandise costs.” We expense costs to transfer inventory and equipment from closed stores as they are incurred.

Post-Retirement Benefit Plans

(a) Company-sponsored Pension Plans

We account for our pension plans using the recognition and disclosure provisions of SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans-an amendment of FASB Statements No. 87, 99, 106 and 132(R) , which require the recognition of the funded status of retirement plans on the Consolidated Balance Sheet. We record, as a component of Accumulated Other Comprehensive Income (“AOCI”), actuarial gains or losses, prior service costs or credits and transition obligations that have not yet been recognized. We currently use a December 31 measurement date. Effective for 2008, the statement also requires an employer to measure the funded status of a plan as of the date of its year-end statement of financial position. We will adopt the measurement date change in fiscal 2008.

The determination of our obligation and expense for Company-sponsored pension plans and other post-retirement benefits is dependent upon our selection of assumptions used by actuaries in calculating those amounts. Those assumptions are described in Note 14 to the Consolidated Financial Statements and include, among others, the discount rate, the expected long-term rate of return on plan assets, average life expectancy and the rate of increases in compensation and health care costs. Actual results that differ from our assumptions are accumulated and amortized over future periods and, therefore, generally affect our recognized expense and recorded obligation in future periods. While we believe that our assumptions are appropriate, significant differences in our actual experience or significant changes in our assumptions, including the discount rate used and the expected return on plan assets, may materially affect our pension and other post-retirement obligations and our future expense. Note 14 to the Consolidated Financial Statements discusses the effect of a 1% change in the assumed health care cost trend rate on other post-retirement benefit costs and the related liability.

The objective of our discount rate assumption is to reflect the rate at which the pension benefits could be effectively settled. In making this determination, we take into account the timing and amount of benefits that would be available under the plans. Our methodology for selecting the discount rate as of year-end 2007 was to match the plan’s cash flows to that of a yield curve that provides the equivalent yields on zero-coupon corporate bonds for each maturity. Benefit cash flows due in a particular year can be “settled” theoretically by “investing” them in the zero-coupon bond that matures in the same year. The discount rate is the single rate that produces the same present value of cash flows. The selection of the 6.50% discount rate as of year-end 2007 represents the equivalent single rate under a broad-market AA yield curve constructed by an outside consultant. We utilized a discount rate of 5.90% for year-end 2006. The 60 basis point increase in the discount rate decreased the projected pension benefit obligation as of February 2, 2008, by approximately $184 million.

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To determine the expected return on pension plan assets, we consider current and forecasted plan asset allocations as well as historical and forecasted returns on various asset categories. For 2007 and 2006, we assumed a pension plan investment return rate of 8.5%. Our pension plan’s average return was 8.5% for the 10 calendar years ended December 31, 2007, net of all investment management fees and expenses. Our actual return for the pension plan calendar year ending December 31, 2007, on that same basis, was 9.5%. We believe the pension return assumption is appropriate because we expect that future returns will achieve the same level of performance as the historical average annual return. We have been advised that during 2008, the trustees plan to increase the allocation of non-core assets, including high yield debt securities, commodities, hedge funds and real estate from 42% to 52%. The trustees have also indicated that they plan to increase hedge funds within these sectors from 17% to 22% to augment risk and return. Collectively, these changes should improve the diversification of pension plan assets. The trustees have advised us that they expect these changes will have little effect on the total return but will reduce the expected volatility of the return. See Note 14 to the Consolidated Financial Statements for more information on the asset allocations of pension plan assets.

Sensitivity to changes in the major assumptions used in the calculation of Kroger’s pension plan liabilities for the Qualified Plans is illustrated below (in millions).

Discount Rate	Percentage Point Change — +/- 1.0 %	Projected Benefit Obligation Decrease/(Increase) — $ 263/$(320	Expense Decrease/(Increase) — $ 27/$(27	)
Expected Return
on Assets	+/- 1.0 %	—	$ 19/$(19	)

We contributed $52 million and $150 million to our Company-sponsored pension plans in 2007 and 2006, respectively. Although we are not required to make cash contributions to our Company-sponsored pension plans during fiscal 2008, contributions may be made if required under the Pension Protection Act to avoid any benefit restrictions. We expect any elective contributions made during 2008 will decrease our required contributions in future years. Among other things, investment performance of plan assets, the interest rates required to be used to calculate the pension obligations, and future changes in legislation, will determine the amounts of any additional contributions.

Net periodic benefit cost decreased in 2007 compared to 2006 and 2005 due to participants in the Cash Balance formula of the Consolidated Retirement Benefit Plan being moved to a 401(k) retirement savings account plan effective January 1, 2007. Participants under that formula continue to earn interest on prior contributions but no additional pay credits will be earned. The 401(k) retirement savings plan provides to eligible employees both matching contributions and automatic contributions from Kroger based on participant contributions, plan compensation, and length of service. We contributed and expensed $90 million to employee 401(k) retirement savings accounts in 2007.

(b) Multi-Employer Plans

We also contribute to various multi-employer pension plans based on obligations arising from most of our collective bargaining agreements. These plans provide retirement benefits to participants based on their service to contributing employers. The benefits are paid from assets held in trust for that purpose. Trustees are appointed in equal number by employers and unions. The trustees typically are responsible for determining the level of benefits to be provided to participants as well as for such matters as the investment of the assets and the administration of the plans.

We recognize expense in connection with these plans as contributions are funded, in accordance with GAAP. We made contributions to these plans, and recognized expense, of $207 million in 2007, $204 million in 2006, and $196 million in 2005.

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Based on the most recent information available to us, we believe that the present value of actuarially accrued liabilities in most or all of these multi-employer plans substantially exceeds the value of the assets held in trust to pay benefits. We have attempted to estimate the amount by which these liabilities exceed the assets, (i.e., the amount of underfunding), as of December 31, 2007. Because Kroger is only one of a number of employers contributing to these plans, we also have attempted to estimate the ratio of Kroger’s contributions to the total of all contributions to these plans in a year as a way of assessing Kroger’s “share” of the underfunding. As of December 31, 2007, we estimate that Kroger’s share of the underfunding of multi-employer plans to which Kroger contributes was $500 million to $700 million, pre-tax, or $315 million to $440 million, after-tax. This represents a decrease in the amount of underfunding estimated as of December 31, 2006. This decrease is attributable to, among other things, the investment returns on assets held in trust for the plans during 2007. Our estimate is based on the best information available to us including actuarial evaluations and other data (that include the estimates of others), and such information may be outdated or otherwise unreliable. Our estimate is imprecise and not necessarily reliable.

We have made and disclosed this estimate not because this underfunding is a direct liability of Kroger. Rather, we believe the underfunding is likely to have important consequences. In 2007, our contributions to these plans increased approximately 1% over the prior year and have grown at a compound annual rate of approximately 5% since 2004. We expect our contributions to remain consistent subject to collective bargaining and capital market conditions. The projected contribution amounts in 2008 and beyond has been favorably affected by significant improvement in the values of assets held in trusts, by the labor agreements negotiated in recent years, and by related trustee actions. Although underfunding can result in the imposition of excise taxes on contributing employers, increased contributions or benefit reductions can reduce underfunding so that excise taxes are not triggered. Our estimate contemplates neither increased contributions or reduced benefits. Finally, underfunding means that, in the event we were to exit certain markets or otherwise cease making contributions to these funds, we could trigger a substantial withdrawal liability. Any adjustment for withdrawal liability will be recorded when it is probable that a liability exists and can be reasonably estimated, in accordance with SFAS No. 87, Employers’ Accounting for Pensions .

The amount of underfunding described above is an estimate and is disclosed for the purpose described. The amount could decline, and Kroger’s future expense would be favorably affected, if the values of net assets held in the trust significantly increase or if further changes occur through collective bargaining, trustee action or favorable legislation. On the other hand, Kroger’s share of the underfunding would increase and Kroger’s future expense could be adversely affected if net asset values decline, if employers currently contributing to these funds cease participation or if changes occur through collective bargaining, trustee action or adverse legislation.

Deferred Rent

We recognize rent holidays, including the time period during which we have access to the property for construction of buildings or improvements, as well as construction allowances and escalating rent provisions on a straight-line basis over the term of the lease. The deferred amount is included in Other Current Liabilities and Other Long-Term Liabilities on the Consolidated Balance Sheets.

Uncertain Tax Positions

Effective February 4, 2007, we adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109 (“FIN No. 48”), which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.

Various taxing authorities periodically audit our income tax returns. These audits include questions regarding our tax filing positions, including the timing and amount of deductions and the allocation of income to various tax jurisdictions. In evaluating the exposures connected with these various tax filing positions, including state and local taxes, we record allowances for probable exposures. A number of years may elapse before a particular matter, for which we have established an allowance, is audited and fully resolved. As of February 2, 2008, the Internal Revenue Service has concluded an examination for tax years 2002 through 2004.

The assessment of our uncertain tax positions relies on the judgment of management to estimate the exposures associated with our various filing positions. Although management believes those estimates and judgments are reasonable, actual results could differ, resulting in gains or losses that may be material to our Consolidated Statements of Operations.

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To the extent that we prevail in matters for which allowances have been established, or are required to pay amounts in excess of these allowances, our effective tax rate in any given financial statement period could be materially affected. An unfavorable tax settlement could require use of cash and result in an increase in our effective tax rate in the year of resolution. A favorable tax settlement would be recognized as a reduction in our effective tax rate in the year of resolution.

Share-Based Compensation Expense

We account for share-based compensation expense in accordance with the fair value recognition provisions of SFAS No. 123(R), Share-Based Payment. Under this method, we recognize compensation expense for all share-based payments granted on or after January 29, 2006, as well as all share-based payments granted prior to, but not yet vested as of, January 29, 2006, in accordance with SFAS No. 123(R). Under the fair value recognition provisions of SFAS No. 123(R), we recognize share-based compensation expense, net of an estimated forfeiture rate, over the requisite service period of the award. Prior to January 29, 2006, we applied APB No. 25, and related interpretations, in accounting for our stock option plans and provided the pro-forma disclosures required by SFAS No. 123. APB No. 25 provided for recognition of compensation expense for employee stock awards based on the intrinsic value of the award on the grant date.

Inventories

Inventories are stated at the lower of cost (principally on a LIFO basis) or market. In total, approximately 97% and 98% of inventories for 2007 and 2006, respectively, were valued using the LIFO method. Cost for the balance of the inventories was determined using the first-in, first-out (“FIFO”) method. Replacement cost was higher than the carrying amount by $604 million at February 2, 2008, and by $450 million at February 3, 2007. We follow the Link-Chain, Dollar-Value LIFO method for purposes of calculating our LIFO charge or credit.

We follow item-cost method of accounting to determine inventory cost before the LIFO adjustment for substantially all store inventories at our supermarket divisions. This method involves counting each item in inventory, assigning costs to each of these items based on the actual purchase costs (net of vendor allowances and cash discounts) of each item and recording the cost of items sold. The item-cost method of accounting allows for more accurate reporting of periodic inventory balances and enables management to more precisely manage inventory and purchasing levels when compared to the methodology followed under the retail method of accounting.

We evaluate inventory shortages throughout the year based on actual physical counts in our facilities. We record allowances for inventory shortages based on the results of recent physical counts to provide for estimated shortages from the last physical count to the financial statement date.

Vendor Allowances

We recognize all vendor allowances as a reduction in merchandise costs when the related product is sold. In most cases, vendor allowances are applied to the related product by item, and therefore reduce the carrying value of inventory by item. When it is not practicable to allocate vendor allowances to the product by item, we recognize vendor allowances as a reduction in merchandise costs based on inventory turns and as the product is sold. We recognized approximately $3.6 billion, $3.3 billion and $3.2 billion of vendor allowances as a reduction in merchandise costs in 2007, 2006 and 2005, respectively. We recognized more than 85% of all vendor allowances in the item cost with the remainder being based on inventory turns.

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*L IQUIDITY AND C APITAL R ESOURCES*

Cash Flow Information

Net cash provided by operating activities

We generated $2,581 million of cash from operations in 2007 compared to $2,351 million in 2006 and $2,192 million in 2005. The increase in cash generated from operating activities was primarily due to strong operating results adjusted for non-cash expenses. In addition, changes in our operating assets and liabilities also affect the amount of cash provided by our operating activities. We realized a $163 million, $129 million and $121 million decrease in cash from changes in operating assets and liabilities in 2007, 2006 and 2005, respectively. The decrease in 2007 is primarily attributable to an increase in forward inventory buying activity. These amounts are also net of cash contributions to our Company-sponsored pension plans totaling $52 million in 2007, $150 million in 2006 and $300 million in 2005.

The amount of cash paid for income taxes in 2007 was higher than the amounts paid in 2006 and 2005 due to higher net earnings.

Net cash used by investing activities

Cash used by investing activities was $2,218 million in 2007, compared to $1,587 million in 2006 and $1,279 million in 2005. The amount of cash used by investing activities increased in 2007 compared to 2006 and 2005 due primarily to higher capital spending and payments for two acquisitions. Capital expenditures, including changes in construction-in-progress payables and excluding acquisitions, were $2,060 million, $1,777 million and $1,306 million in 2007, 2006 and 2005, respectively. Refer to the Capital Expenditures section for an overview of our supermarket storing activity during the last three years.

Net cash used by financing activities

Financing activities used $310 million of cash in 2007 compared to $785 million in 2006 and $847 million in 2005. The decrease in the amount of cash used was primarily a result of proceeds received from the issuance of long term-debt, offset by greater stock repurchases and dividends paid. We repurchased $1,421 million of Kroger stock in 2007 compared to $633 million in 2006 and $252 million in 2005. We paid dividends totaling $202 million in 2007 compared to $140 million in 2006.

Debt Management

Total debt, including both the current and long-term portions of capital leases and financing obligations, increased $1,062 million to $8.1 billion as of year-end 2007 from $7.1 billion as of year-end 2006. Total debt decreased $173 million to $7.1 billion as of year-end 2006 from $7.2 billion as of year-end 2005. The increases in 2007, compared to 2006, resulted from the issuance of $600 million of senior notes bearing an interest rate of 6.4%, $750 million of senior notes bearing an interest rate of 6.15% and borrowings under the bank credit facility in 2007, offset by the repayment of $200 million of senior notes bearing an interest rate of 7.65% and $300 million of senior notes bearing an interest rate of 7.80% that came due in 2007. The decreases in 2006, compared to 2005, were primarily the result of using cash flow from operations to reduce outstanding debt.

Our total debt balances were also affected by our prefunding of employee benefit costs and by the mark-to-market adjustments necessary to record fair value interest rate hedges of our fixed rate debt, pursuant to SFAS No. 133 Accounting for Derivative Investments and Hedging Activities , as amended. We had prefunded employee benefit costs of $300 million at year-end 2007, 2006 and 2005. The mark-to-market adjustments increased the carrying value of our debt by $44 million and $18 million as of year-end 2007 and 2006.

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Factors Affecting Liquidity

We currently borrow on a daily basis approximately $250 million under our F2/P2/A3 rated commercial paper (“CP”) program. These borrowings are backed by our credit facility, and reduce the amount we can borrow under the credit facility. We have capacity available under our credit facility to backstop all CP amounts outstanding. If our credit rating declines below its current level of BBB/ Baa2/BBB-, the ability to borrow under our current CP program could be adversely affected for a period of time immediately following the reduction of our credit rating. This could require us to borrow additional funds under the credit facility, under which we believe we have sufficient capacity. However, in the event of a ratings decline, we do not anticipate that access to the CP markets currently available to us would be significantly limited for an extended period of time (i.e., in excess of 30 days). Although our ability to borrow under the credit facility is not affected by our credit rating, the interest cost on borrowings under the credit facility could be affected by a decrease in our credit rating or a decrease in our Applicable Percentage Ratio.

Our credit facility also requires the maintenance of a Leverage Ratio and a Fixed Charge Coverage Ratio (our “financial covenants”). A failure to maintain our financial covenants would impair our ability to borrow under the credit facility. These financial covenants and ratios are described below:

| · | Our
Applicable Percentage Ratio (the ratio of Consolidated EBITDA to Consolidated
Total Interest Expense, as defined in the credit facility) was 8.25 to 1 as
of February 2, 2008. Although our current borrowing rate is
determined based on our Applicable Percentage Ratio, under certain
circumstances that borrowing rate could be determined by reference to our
credit ratings. |
| --- | --- |
| · | Our
Leverage Ratio (the ratio of Net Debt to Consolidated EBITDA, as defined in
the credit facility) was 2.19 to 1 as of February 2, 2008. If this
ratio exceeded 3.50 to 1, we would be in default of our credit facility and
our ability to borrow under the facility would be impaired. |
| · | Our
Fixed Charge Coverage Ratio (the ratio of Consolidated EBITDA plus
Consolidated Rental Expense to Consolidated Cash Interest Expense plus
Consolidated Rental Expense, as defined in the credit facility) was 3.94 to 1
as of February 2, 2008. If this ratio fell below 1.70 to 1, we
would be in default of our credit facility and our ability to borrow under
the facility would be impaired. |

Consolidated EBITDA, as defined in our credit facility, includes an adjustment for unusual gains and losses. Our credit agreement is more fully described in Note 5 to the Consolidated Financial Statements. We were in compliance with our financial covenants at year-end 2007.

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The tables below illustrate our significant contractual obligations and other commercial commitments, based on year of maturity or settlement, as of February 2, 2008 (in millions of dollars):

	2008	2009	2010	2011	2012	Thereafter	Total
Contractual
Obligations (1) (2)
Long-term debt	$ 1,564	$ 402	$ 555	$ 527	$ 1,400	$ 3,191	$ 7,639
Interest on
long-term debt (3)	435	392	339	309	272	2,035	3,782
Capital lease
obligations	54	53	51	55	46	237	496
Operating lease
obligations	774	736	693	630	578	3,459	6,870
Low-income
housing obligations	8	—	—	—	—	—	8
Financed lease
obligations	13	13	13	13	13	177	242
Self-insurance
liability (4)	183	117	73	45	23	29	470
Construction
commitments	124	—	—	—	—	—	124
Purchase
obligations	361	79	49	30	19	22	560
Total	$ 3,516	$ 1,792	$ 1,773	$ 1,609	$ 2,351	$ 9,150	$ 20,191
Other
Commercial Commitments
Credit facility	$ 570	$ —	$ —	$ —	$ —	$ —	$ 570
Standby letters
of credit	366	—	—	—	—	—	366
Surety bonds	118	—	—	—	—	—	118
Guarantees	16	—	—	—	—	—	16
Total	$ 1,070	$ —	$ —	$ —	$ —	$ —	$ 1,070

(1) The contractual obligations table excludes funding of pension and other postretirement benefit obligations, which totaled approximately $76 million in 2007. This table also excludes contributions under various multi-employer pension plans, which totaled $207 million in 2007.

(2) We adopted FIN 48 on February 4, 2007. See Note 4 to our Consolidated Financial Statements for the adoption of FIN 48. The liability related to unrecognized tax benefits has been excluded from the contractual obligations table because a reasonable estimate of the timing of future tax settlements cannot be determined.

(3) Amounts include contractual interest payments using the interest rate as of February 2, 2008 applicable to our variable interest debt instruments, excluding commercial paper borrowings due to the short-term nature of these borrowings, and stated fixed and swapped interest rates for all other debt instruments.

(4) The amounts included in the contractual obligations table for self-insurance liability have been stated on a present value basis.

Our construction commitments include funds owed to third parties for projects currently under construction. These amounts are reflected in other current liabilities in our Consolidated Balance Sheets.

Our purchase obligations include commitments to be utilized in the normal course of business, such as several contracts to purchase raw materials utilized in our manufacturing plants and several contracts to purchase energy to be used in our stores and manufacturing facilities. Our obligations also include management fees for facilities operated by third parties. Any upfront vendor allowances or incentives associated with outstanding purchase commitments are recorded as either current or long-term liabilities in our Consolidated Balance Sheets.

As of February 2, 2008, we maintained a $2.5 billion, five-year revolving credit facility that, unless extended, terminates in 2011. Outstanding borrowings under the credit agreement and commercial paper borrowings, and some outstanding letters of credit, reduce funds available under the credit agreement. In addition to the credit agreement, we maintained four money market lines totaling $125 million in the aggregate. The money market lines allow us to borrow from banks at mutually agreed upon rates, usually at rates below the rates offered under the credit agreement. As of February 2, 2008, we had net outstanding commercial paper and borrowings under our credit agreement totaling $345 and $225 million, respectively, that reduced amounts available under our credit agreement and had no borrowings under the money market lines. The outstanding letters of credit that reduced the funds available under our credit agreement totaled $355 million as of February 2, 2008.

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In addition to the available credit mentioned above, as of February 2, 2008, we had available for issuance $1,250 million of securities under a shelf registration statement filed with the SEC and effective on December 20, 2007.

We also maintain surety bonds related primarily to our self-insured workers compensation claims. These bonds are required by most states in which we are self-insured for workers’ compensation and are placed with third-party insurance providers to insure payment of our obligations in the event we are unable to meet our claim payment obligations up to our self-insured retention levels. These bonds do not represent liabilities of Kroger, as we already have reserves on our books for the claims costs. Market changes may make the surety bonds more costly and, in some instances, availability of these bonds may become more limited, which could affect our costs of, or access to, such bonds. Although we do not believe increased costs or decreased availability would significantly affect our ability to access these surety bonds, if this does become an issue, we would issue letters of credit, in states where allowed, against our credit facility to meet the state bonding requirements. This could increase our cost and decrease the funds available under our credit facility.

Most of our outstanding public debt is jointly and severally, fully and unconditionally guaranteed by The Kroger Co. and some of our subsidiaries. See Note 17 to the Consolidated Financial Statements for a more detailed discussion of those arrangements. In addition, we have guaranteed half of the indebtedness of two real estate entities in which we have 50% membership interest. Our share of the responsibility for this indebtedness, should the entities be unable to meet their obligations, totals approximately $7 million. Based on the covenants underlying this indebtedness as of February 2, 2008, it is unlikely that we will be responsible for repayment of these obligations. We have also agreed to guarantee, up to $10 million, the indebtedness of an entity of which we have 25% membership interest. The guarantee is collateralized by inventory of the entity. Our share of the responsibility, as of February 2, 2008, should the entity be unable to meet its obligations, totals approximately $9 million and is collateralized by $8 million of inventory located in our stores.

We also are contingently liable for leases that have been assigned to various third parties in connection with facility closings and dispositions. We could be required to satisfy obligations under the leases if any of the assignees are unable to fulfill their lease obligations. Due to the wide distribution of our assignments among third parties, and various other remedies available to us, we believe the likelihood that we will be required to assume a material amount of these obligations is remote. We have agreed to indemnify certain third-party logistics operators for certain expenses, including pension trust fund withdrawal liabilities.

In addition to the above, we enter into various indemnification agreements and take on indemnification obligations in the ordinary course of business. Such arrangements include indemnities against third party claims arising out of agreements to provide services to Kroger; indemnities related to the sale of our securities; indemnities of directors, officers and employees in connection with the performance of their work; and indemnities of individuals serving as fiduciaries on benefit plans. While Kroger’s aggregate indemnification obligation could result in a material liability, we are not aware of any current matter that could result in a material liability.

*R ECENTLY A DOPTED A CCOUNTING S TANDARDS*

Effective February 4, 2007, we adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109 (“FIN No. 48”), which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.

The effect of adoption was to increase retained earnings by $4 million and to decrease our accrual for uncertain tax positions by a corresponding amount. Additionally, we decreased goodwill and accrual for uncertain tax positions by $72 million to reflect the measurement under the rules of FIN No. 48 of an uncertain tax position related to previous business combinations.

As of adoption, the total amount of unrecognized tax benefits for uncertain tax positions, including positions affecting only the timing of tax benefits, was $694 million. The amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate was $119 million.

To the extent interest and penalties would be assessed by taxing authorities on any underpayment of income tax, such amounts have been accrued and classified as a component of income tax expense in our Condensed Consolidated Statements of Operations. This accounting policy election is a continuation of our historical policy. As of February 4, 2007, the amount of accrued interest and penalties included on the Condensed Consolidated Balance Sheets was $118 million.

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The IRS concluded a field examination of our 2002 – 2004 U.S. tax returns during the third quarter of 2007. An examination of our 1999 – 2001 U.S. tax returns was completed in 2005. We contested two issues at the appellate level of the IRS. One of the issues was resolved in the third quarter of 2007 and we anticipate that the remaining issue may be resolved within the next 12 months. In the opinion of management, the ultimate disposition of the item noted above will not have a significant effect on our consolidated financial position, liquidity, or results of operations. Additionally, we have a case in the U.S. Tax Court. A decision on this case is not expected within the next 12 months. In connection with this case, we have extended the statute of limitations on our tax years after 1991.

As a result of settlements with taxing authorities during the third quarter, we reclassified unrecognized tax benefits of $168 million from other long-term liabilities to deferred income taxes and accrued taxes payable.

Effective February 3, 2007, we adopted the recognition and disclosure provisions of SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans-an amendment of FASB Statement No. 87, 99, 106 and 132(R), which requires the recognition of the funded status of its retirement plans on the Consolidated Balance Sheet. Actuarial gains or losses, prior service costs or credits and transition obligations that have not yet been recognized are required to be recorded as a component of Accumulated Other Comprehensive Income (“AOCI”). We currently use a December 31 measurement date. Effective for 2008, the statement also requires an employer to measure the funded status of a plan as of the date of its year-end statement of financial position. We will adopt the measurement date change in fiscal 2008.

Effective January 29, 2006, we adopted the provisions of SFAS No. 123(R), Share-Based Payment, using the modified-prospective method. Under this method, we recognize compensation expense for all share-based awards granted prior to, but not yet vested as of, January 29, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, Accounting for Stock-Based Compensation. For all share-based awards granted on or after January 29, 2006, we recognize compensation expense based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R).

*R ECENTLY I SSUED A CCOUNTING S TANDARDS*

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurement . SFAS No. 157 defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurement. SFAS No. 157 does not require any new fair value measurements. SFAS No. 157 will become effective for our fiscal year beginning February 3, 2008. We are evaluating the effect the implementation of SFAS No. 157 will have on our Consolidated Financial Statements.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115. SFAS No. 159 permits entities to make an irrevocable election to measure certain financial instruments and other assets and liabilities at fair value on an instrument-by-instrument basis. Unrealized gains and losses on items for which the fair value option has been elected should be recognized into net earnings at each subsequent reporting date. SFAS No. 159 will become effective for our fiscal year beginning February 3, 2008. We are currently evaluating the effect the adoption of SFAS No. 159 will have on our Consolidated Financial Statements.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements-an amendment of ARB No. 51. SFAS No. 160 will require the consolidation of noncontrolling interests as a component of equity. SFAS No. 160 will become effective for our fiscal year beginning February 1, 2009. We are currently evaluating the effect the adoption of SFAS No. 160 will have on our Consolidated Financial Statements.

In December 2007, the FASB issued SFAS No. 141 (Revised 2007), Business Combinations (SFAS No. 141R) , which replaces SFAS No. 141 . SFAS No. 141R further expands the definitions of a business and the fair value measurement and reporting in a business combination. SFAS No. 141R will become effective for our fiscal year beginning February 1, 2009. We are currently evaluating the effect the adoption of SFAS No. 141R will have on our Consolidated Financial Statements.

In March 2007, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities. SFAS No. 161 requires enhanced disclosures on an entity’s derivative and hedging activities. SFAS No. 161 will become effective for our fiscal year beginning February 1, 2009. We are currently evaluating the effect the adoption of SFAS No. 161 will have on our Consolidated Financial Statements.

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*O UTLOOK*

This discussion and analysis contains certain forward-looking statements about Kroger’s future performance. These statements are based on management’s assumptions and beliefs in light of the information currently available. Such statements relate to, among other things: projected change in net earnings; identical sales growth; expected pension plan contributions; our ability to generate operating cash flow; projected capital expenditures; square footage growth; opportunities to reduce costs; cash flow requirements; and our operating plan for the future; and are indicated by words such as “comfortable,” “committed,” “will,” “expect,” “goal,” “should,” “intend,” “target,” “believe,” “anticipate,” and similar words or phrases. These forward-looking statements are subject to uncertainties and other factors that could cause actual results to differ materially.

Statements elsewhere in this report and below regarding our expectations, projections, beliefs, intentions or strategies are forward-looking statements within the meaning of Section 21 E of the Securities Exchange Act of 1934. While we believe that the statements are accurate, uncertainties about the general economy, our labor relations, our ability to execute our plans on a timely basis and other uncertainties described below could cause actual results to differ materially.

| · | We
expect earnings per share in the range of $1.83-$1.90 for 2008. This
represents earnings per share growth of approximately 8%-12% in 2008. |
| --- | --- |
| · | We
anticipate earnings per share growth rates in the 1 st and 4 th quarters of 2008 will be higher than the annual growth rate, and the 3 rd quarter will be lower than the annual growth rate. |
| · | We
expect identical food store sales growth, excluding fuel sales, of 3%-5% in
2008. |
| · | In
2008, we will continue to focus on driving sales growth and balancing
investments in gross margin and improved customer service with operating cost
reductions to provide a better shopping experience for our customers.
We expect non-fuel operating margins to improve slightly in 2008. |
| · | In
2008, we expect the LIFO charge to be consistent with 2007. |
| · | We
plan to use free cash flow to repurchase stock and pay cash dividends. |
| · | We
expect to obtain sales growth from new square footage, as well as from
increased productivity from existing locations. |
| · | Capital
expenditures reflect our strategy of growth through expansion, as well as
focusing on productivity increase from our existing store base through
remodels. In addition, we will continue our emphasis on
self-development and ownership of real estate, logistics and technology
improvements. The continued capital spending in technology is focused
on improving store operations, logistics, manufacturing procurement, category
management, merchandising and buying practices, and should reduce merchandising
costs. We intend to continue using cash flow from operations to finance
capital expenditure requirements. We expect capital investment for 2008
to be in the range of $2.0-$2.2 billion, excluding acquisitions. Total
food store square footage is expected to grow approximately 2.0%-2.5% before
acquisitions and operational closings. |
| · | Based
on current operating trends, we believe that cash flow from operations and
other sources of liquidity, including borrowings under our commercial paper
program and bank credit facility, will be adequate to meet anticipated
requirements for working capital, capital expenditures, interest payments and
scheduled principal payments for the foreseeable future. We also believe we
have adequate coverage of our debt covenants to continue to respond
effectively to competitive conditions. |
| · | We
expect that our OG&A results will be affected by increased costs, such as
higher energy costs, pension costs and credit card fees, as well as any
potential future labor disputes, offset by improved productivity from process
changes, cost savings negotiated in recently completed labor agreements and
leverage gained through sales increases. |
| · | We
expect that our effective tax rate for 2008 will be approximately 38%. |

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| · | We
expect rent expense, as a percent of total sales and excluding closed-store
activity, will decrease due to the emphasis our current strategy places on
ownership of real estate. |
| --- | --- |
| · | We
believe that in 2008 there will be opportunities to reduce our operating
costs in such areas as administration, productivity improvements, shrink,
warehousing and transportation. These savings will be invested in our core
business to drive profitable sales growth and offer improved value and
shopping experiences for our customers. |
| · | Although
we are not required to make cash contributions to our Company-sponsored
pension plans during fiscal 2008, contributions may be made if our cash flows
from operations exceed our expectations or if required under the Pension
Protection Act to limit any benefit restrictions. We expect any
elective contributions made during 2008 will decrease our required
contributions in future years. Among other things, investment
performance of plan assets, the interest rates required to be used to
calculate the pension obligations, and future changes in legislation, will
determine the amounts of any additional contributions. In addition, we expect
to contribute and expense $100 million in 2008 to the 401(k) Retirement
Savings Account Plan. |
| · | We
expect our contributions to multi-employer pension plans to remain consistent
in 2008 subject to collective bargaining and capital market conditions. In
2007, we contributed $207 million to multi-employer pension plans. |
| · | In
2007, we recognized $6 million of expense from the credit extended to
customers through our company branded credit cards. This credit portfolio has
an above average credit score. We do not anticipate a material change to this
expense in 2008. |
| · | If actual results
differ significantly from anticipated future results for certain reporting
units, an impairment loss for any excess of the carrying value of the
division’s goodwill over the implied fair value would need to be recognized. |

Various uncertainties and other factors could cause us to fail to achieve our goals. These include:

| · | We
have various labor agreements expiring in 2008, covering associates in
Columbus, Indianapolis, Las Vegas, Louisville, Nashville, Phoenix and
Portland. In all of these store contracts, rising health care and
pension costs will continue to be an important issue in negotiations. A
prolonged work stoppage affecting a substantial number of locations
could have a material effect on our results. |
| --- | --- |
| · | Our
ability to achieve sales and earnings goals may be affected by: labor
disputes; 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 the
inflationary and deflationary trends in certain commodities; trends in
consumer spending; stock repurchases; and the success of our future growth
plans. |
| · | In
addition to the factors identified above, our identical store sales growth
could be affected by increases in Kroger private label sales, the effect of
our “sister stores” (new stores opened in close proximity to an existing
store) and reductions in retail pricing. |
| · | Our
operating margins, without fuel, could fail to improve as expected if we are
unsuccessful at containing our operating costs. |
| · | We
have estimated our exposure to the claims and litigation arising in the
normal course of business, as well as in material litigation facing Kroger,
and believe we have made adequate provisions for them where it is reasonably
possible to estimate and where we believe an adverse outcome is probable.
Unexpected outcomes in these matters, however, could result in an adverse
effect on our earnings. |
| · | Consolidation
in the food industry is likely to continue and the effects on our business,
either favorable or unfavorable, cannot be foreseen. |
| · | Rent
expense, which includes subtenant rental income, could be adversely affected
by the state of the economy, increased store closure activity and future
consolidation. |
| · | Depreciation
expense, which includes the amortization of assets recorded under capital
leases, is computed principally using the straight-line method over the
estimated useful lives of individual assets, or the remaining terms of
leases. Use of the straight-line method of depreciation creates a risk that
future asset write-offs or potential impairment charges related to store
closings would be larger than if an accelerated method of depreciation was
followed. |

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| · | Our
effective tax rate may differ from the expected rate due to changes in laws,
the status of pending items with various taxing authorities and the
deductibility of certain expenses. |
| --- | --- |
| · | The
actual amount of automatic and matching cash contributions to our
401(k) Retirement Savings Account Plan will depend on the savings rate,
plan compensation, and length of service of participants. |
| · | We
believe the multi-employer pension funds to which we contribute are
substantially underfunded. Should asset values in these funds deteriorate, or
if employers withdraw from these funds without providing for their share of
the liability, or should our estimates prove to be understated, our
contributions could increase more rapidly than we have anticipated. |
| · | The
grocery retail industry continues to experience fierce competition from other
traditional food retailers, supercenters, mass merchandisers, club or
warehouse stores, drug stores and restaurants. Our continued success is
dependent upon our ability to compete in this industry and to reduce
operating expenses, including managing health care and pension costs
contained in our collective bargaining agreements. The competitive
environment may cause us to reduce our prices in order to gain or maintain
share of sales, thus reducing margins. While we believe our opportunities for
sustained profitable growth are considerable, unanticipated actions of
competitors could adversely affect our sales. |
| · | Changes
in laws or regulations, including changes in accounting standards, taxation
requirements and environmental laws may have a material effect on our
financial statements. |
| · | Changes
in the general business and economic conditions in our operating regions,
including the rate of inflation, population growth and employment and job
growth in the markets in which we operate, may affect our ability to hire and
train qualified employees to operate our stores. This would negatively affect
earnings and sales growth. General economic changes may also affect the
shopping habits of our customers, which could affect sales and earnings. |
| · | Changes
in our product mix may negatively affect certain financial indicators. For
example, we continue to add supermarket fuel centers to our store base. Since
gasoline generates low profit margins, we expect to see our FIFO gross profit
margins decline as gasoline sales increase. Although this negatively affects
our FIFO gross margin, gasoline sales provide a positive effect on OG&A
expenses as a percent of sales. |
| · | Our
ability to integrate any companies we acquire or have acquired, and achieve operating
improvements at those companies, will affect our operations. |
| · | Our
capital expenditures, expected square footage growth, and number of store
projects completed during the year could differ from our estimate if we are
unsuccessful in acquiring suitable sites for new stores, if development costs
vary from those budgeted or if our logistics and technology projects are not
completed in the time frame expected or on budget. |
| · | Interest
expense could be adversely affected by the interest rate environment, changes
in the Company’s credit ratings, fluctuations in the amount of outstanding
debt, decisions to incur prepayment penalties on the early redemption of debt
and any factor that adversely affects our operations and results in an
increase in debt. |
| · | Adverse
weather conditions could increase the cost our suppliers charge for their
products, or may decrease the customer demand for certain products. Increases
in demand for certain commodities could also increase the cost our suppliers
charge for their products. Additionally, increases in the cost of inputs,
such as utility costs or raw material costs, could negatively affect
financial ratios and earnings. |
| · | Although
we presently operate only in the United States, civil unrest in foreign
countries in which our suppliers do business may affect the prices we are
charged for imported goods. If we are unable to pass on these increases to
our customers, our FIFO gross margin and net earnings will suffer. |

Other factors and assumptions not identified above could also cause actual results to differ materially from those set forth in the forward-looking information. Accordingly, actual events and results may vary significantly from those included in, contemplated or implied by forward-looking statements made by us or our representatives.

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*ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.*

Financial Risk Management

We use derivative financial instruments primarily to manage our exposure to fluctuations in interest rates and, to a lesser extent, adverse fluctuations in commodity prices and other market risks. We do not enter into derivative financial instruments for trading purposes. As a matter of policy, all of our derivative positions are intended to reduce risk by hedging an underlying economic exposure. Because of the high correlation between the hedging instrument and the underlying exposure, fluctuations in the value of the instruments generally are offset by reciprocal changes in the value of the underlying exposure. The interest rate derivatives we use are straightforward instruments with liquid markets.

We manage our exposure to interest rates and changes in the fair value of our debt instruments primarily through the strategic use of variable and fixed rate debt, and interest rate swaps. Our current program relative to interest rate protection contemplates hedging the exposure to changes in the fair value of fixed-rate debt attributable to changes in interest rates. To do this, we use the following guidelines: (i) use average daily outstanding borrowings to determine annual debt amounts subject to interest rate exposure, (ii) limit the average annual amount of debt subject to interest rate reset and the amount of floating rate debt to a combined total of $2.5 billion or less, (iii) include no leveraged products, and (iv) hedge without regard to profit motive or sensitivity to current mark-to-market status.

As of February 2, 2008, we maintained six interest rate swap agreements, with notional amounts totaling approximately $1,050 million, to manage our exposure to changes in the fair value of our fixed rate debt resulting from interest rate movements by effectively converting a portion of our debt from fixed to variable rates. These agreements mature at varying times between March 2008 and January 2015. The differential between fixed and variable rates to be paid or received is accrued as interest rates change in accordance with the agreements as an adjustment to interest expense. These interest rate swap agreements are being accounted for as fair value hedges. As of February 2, 2008, other long-term assets totaling $11 million were recorded to reflect the fair value of these agreements, offset by increases in the fair value of the underlying debt.

In addition to the interest rate swaps noted above, in 2005 the Company entered into three forward-starting interest rate swap agreements with a notional amount totaling $750 million. In 2007, the Company terminated two of these forward-starting interest rate swaps in a notional amount of $500 million. A forward-starting interest rate swap is an agreement that effectively hedges future benchmark interest rates on debt for an established period of time. The Company entered into the forward-starting interest rate swaps in order to lock into fixed interest rates on forecasted issuances of debt in 2007 and 2008. The unamortized payment and proceeds on the two terminated forward-starting interest rate swaps have been recorded net of tax in other comprehensive income and will be amortized to earnings as the payments of interest to which the hedges relate are made. The one remaining forward-starting interest rate swap as of February 2, 2008 has a ten-year term with a fixed interest rate of 5.11%. As of February 2, 2008, other long-term liabilities totaling $18 million were recorded to reflect the fair value of this agreement.

During 2003, we terminated six interest rate swap agreements that we accounted for as fair value hedges. We recorded approximately $114 million of proceeds received as a result of these terminations as adjustments to the carrying values of the underlying debt and they are being amortized over the remaining lives of the debt. As of February 2, 2008, the unamortized balances totaled approximately $33 million.

Annually, we review with the Financial Policy Committee of our Board of Directors compliance with the guidelines. The guidelines may change as our business needs dictate.

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The tables below provide information about our interest rate derivatives and underlying debt portfolio as of February 2, 2008. The amounts shown for each year represent the contractual maturities of long-term debt, excluding capital leases, and the average outstanding notional amounts of interest rate derivatives as of February 2, 2008. Interest rates reflect the weighted average rate for the outstanding instruments. The variable component of each interest rate derivative and the variable rate debt is based on U.S. dollar LIBOR using the forward yield curve as of February 2, 2008. The Fair-Value column includes the fair-value of our debt instruments and interest rate derivatives as of February 2, 2008. Refer to Notes 5, 6 and 7 to our Consolidated Financial Statements:

	Expected Year of Maturity
															Fair
	2008		2009		2010		2011		2012		Thereafter		Total		Value
	(In
millions)
Debt
Fixed rate	$ (994	)	$ (386	)	$ (547	)	$ (489	)	$ (1,360	)	$ (3,169	)	$ (6,945	)	$ (7,279	)
Average interest
rate	6.81	%	6.81	%	6.68	%	6.54	%	6.59	%	6.69	%
Variable rate	$ (570	)	$ (15	)	$ (7	)	$ (38	)	$ (41	)	$ (23	)	$ (694	)	$ (694	)
Average interest
rate	3.73	%	3.50	%	4.24	%	4.88	%	5.40	%	5.78	%

							February 2,	February 2,
	Average Notional Amounts Outstanding						2008	2008 Fair
	2008	2009	2010	2011	2012	Thereafter	Total	Value
				(In
millions)
Interest
Rate Derivatives
Fixed to
variable	$ 363	$ 300	$ 300	$ 300	$ 300	$ 300	$ 1,050	$ 11
Average pay rate	3.59 %	3.57 %	4.15 %	4.59 %	4.98 %	5.19 %
Average receive
rate	5.38 %	4.95 %	4.95 %	4.95 %	4.95 %	4.95 %

We expect the average pay rate for 2008 to decline from the table above by 40 to 50 basis points due to the recent Federal Reserve interest rate cuts in March 2008.

Commodity Price Protection

We enter into purchase commitments for various resources, including raw materials utilized in our manufacturing facilities and energy to be used in our stores, warehouses, manufacturing facilities and administrative offices. We enter into commitments expecting to take delivery of and to utilize those resources in the conduct of normal business. Those commitments for which we expect to utilize or take delivery in a reasonable amount of time in the normal course of business qualify as normal purchases.

Some of the product we purchase is shipped in corrugated cardboard packaging. We sell corrugated cardboard when it is economical to do so. As of February 2, 2008, we maintained three derivative instruments to manage exposure to changes in corrugated cardboard prices. These derivatives contain a three-year term. The instruments do not qualify for hedge accounting, in accordance with SFAS No. 133, Accounting for Derivative Investments and Hedging Activities , as amended. Accordingly, changes in the fair value of these instruments are marked-to-market in our Consolidated Statements of Operations in OG&A expenses. As of February 2, 2008, an accrued liability totaling $1 million had been recorded to reflect the fair value of these instruments.

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*ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.*

*Report of Independent Registered Public Accounting Firm*

To the Shareowners and Board of Directors of

The Kroger Co.:

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, cash flows and changes in shareowners’ equity present fairly, in all material respects, the financial position of The Kroger Co. and its subsidiaries at February 2, 2008 and February 3, 2007, and the results of their operations and their cash flows for each of the three years in the period ended February 2, 2008 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of February 2, 2008, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

As discussed in Note 15 to the consolidated financial statements, the Company adopted the provisions of Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes , as of February 4, 2007, the recognition and disclosure provisions of Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, as of February 3, 2007 and the provisions of Statement of Financial Accounting Standards No. 123(R), Share-Based Payment , as of January 29, 2006.

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

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ PricewaterhouseCoopers LLP

Cincinnati, Ohio

April 1, 2008

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*THE KROGER CO.*

*CONSOLIDATED BALANCE SHEETS*

(In millions)	February 2, — 2008		February 3, — 2007
ASSETS
Current assets
Cash and temporary
cash investments	$ 242		$ 189
Deposits
in-transit	676		614
Receivables	786		778
FIFO Inventory	5,459		5,059
LIFO credit	(604	)	(450	)
Prefunded
employee benefits	300		300
Prepaid and
other current assets	255		265
Total current
assets	7,114		6,755
Property, plant
and equipment, net	12,498		11,779
Goodwill	2,144		2,192
Other assets	543		489
Total Assets	$ 22,299		$ 21,215
LIABILITIES
Current
liabilities
Current portion
of long-term debt including obligations under capital leases and financing
obligations	$ 1,592		$ 906
Accounts payable	4,050		3,804
Accrued salaries
and wages	815		796
Deferred income
taxes	239		268
Other current
liabilities	1,993		1,807
Total current
liabilities	8,689		7,581
Long-term debt
including obligations under capital leases and financing obligations
Face value
long-term debt including obligations under capital leases and financing
obligations	6,485		6,136
Adjustment to
reflect fair value interest rate hedges	44		18
Long-term debt
including obligations under capital leases and financing obligations	6,529		6,154
Deferred income
taxes	367		722
Other long-term
liabilities	1,800		1,835
Total
Liabilities	17,385		16,292
Commitments and
Contingencies (See Note 11)
SHAREOWNERS’
EQUITY
Preferred stock,
$100 par, 5 shares authorized and unissued	—		—
Common stock, $1
par, 1,000 shares authorized: 947 shares issued in 2007 and 937 shares issued
in 2006	947		937
Additional
paid-in capital	3,031		2,755
Accumulated
other comprehensive loss	(122	)	(259	)
Accumulated
earnings	6,480		5,501
Common stock in
treasury, at cost, 284 shares in 2007 and 232 shares in 2006	(5,422	)	(4,011	)
Total
Shareowners’ Equity	4,914		4,923
Total
Liabilities and Shareowners’ Equity	$ 22,299		$ 21,215

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

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*THE KROGER CO.*

*CONSOLIDATED STATEMENTS OF OPERATIONS*

Years Ended February 2, 2008, February 3, 2007, and January 28, 2006

(In millions, except per share amounts)	2007 (52 weeks)	2006 (53 weeks)	2005 (52 weeks)
Sales	$ 70,235	$ 66,111	$ 60,553
Merchandise
costs, including advertising, warehousing, and transportation, excluding
items shown separately below	53,779	50,115	45,565
Operating,
general and administrative	12,155	11,839	11,027
Rent	644	649	661
Depreciation and
amortization	1,356	1,272	1,265
Operating Profit	2,301	2,236	2,035
Interest expense	474	488	510
Earnings before
income tax expense	1,827	1,748	1,525
Income tax
expense	646	633	567
Net earnings	$ 1,181	$ 1,115	$ 958
Net earnings per
basic common share	$ 1.71	$ 1.56	$ 1.32
Average number
of common shares used in basic calculation	690	715	724
Net earnings per
diluted common share	$ 1.69	$ 1.54	$ 1.31
Average number
of common shares used in diluted calculation	698	723	731

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

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*THE KROGER CO.*

*CONSOLIDATED STATEMENTS OF CASH FLOWS*

Years Ended February 2, 2008, February 3, 2007 and January 28, 2006

(In millions)	2007 (52 weeks)		2006 (53 weeks)		2005 (52 weeks)
Cash Flows From Operating Activities:
Net earnings	$ 1,181		$ 1,115		$ 958
Adjustments to
reconcile net earnings to net cash provided by operating activities:
Depreciation and
amortization	1,356		1,272		1,265
LIFO charge	154		50		27
Stock-based
employee compensation	87		72		7
Expense for
Company-sponsored pension plans	67		161		138
Deferred income
taxes	(86	)	(60	)	(63	)
Other	37		20		39
Changes in
operating assets and liabilities net of effects from acquisitions of
businesses:
Store deposits
in-transit	(62	)	(125	)	18
Inventories	(383	)	(173	)	(157	)
Receivables	(17	)	(90	)	(19	)
Prepaid expenses	3		(43	)	31
Accounts payable	185		256		(80	)
Accrued expenses	156		98		155
Income taxes
receivable (payable)	43		(4	)	200
Contribution to
Company-sponsored pension plans	(52	)	(150	)	(300	)
Other	(88	)	(48	)	(27	)
Net cash
provided by operating activities	2,581		2,351		2,192
Cash Flows From
Investing Activities:
Payments for
capital expenditures	(2,126	)	(1,683	)	(1,306	)
Proceeds from
sale of assets	49		143		69
Payments for
acquisitions	(90	)	—		—
Other	(51	)	(47	)	(42	)
Net cash used by
investing activities	(2,218	)	(1,587	)	(1,279	)
Cash Flows From
Financing Activities:
Proceeds from
issuance of long-term debt	1,372		10		14
Proceeds from
lease-financing transactions	8		15		76
Payments on
long-term debt	(560	)	(556	)	(103	)
Borrowings
(payments) on bank revolver	218		352		(694	)
Excess tax
benefits on stock-based awards	36		38		—
Proceeds from
issuance of capital stock	188		168		78
Treasury stock
purchases	(1,421	)	(633	)	(252	)
Dividends paid	(202	)	(140	)	—
Increase in book
overdrafts	61		1		35
Other	(10	)	(40	)	(1	)
Net cash used by
financing activities	(310	)	(785	)	(847	)
Net increase
(decrease) in cash and temporary cash investments	53		(21	)	66
Cash and
temporary cash investments:
Beginning of
year	189		210		144
End of year	$ 242		$ 189		$ 210
Reconciliation
of capital expenditures:
Payments for
capital expenditures	$ (2,126	)	$ (1,683	)	$ (1,306	)
Changes in
construction-in-progress payables	66		(94	)	—
Total capital
expenditures	$ (2,060	)	$ (1,777	)	$ (1,306	)
Disclosure of
cash flow information:
Cash paid during
the year for interest	$ 477		$ 514		$ 511
Cash paid during
the year for income taxes	$ 640		$ 615		$ 431

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

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*THE KROGER CO.*

*CONSOLIDATED STATEMENT OF CHANGES IN SHAREOWNERS’ EQUITY*

Years Ended February 2, 2008, February 3, 2007 and January 28, 2006

| (In
millions) | Common
Stock — Shares | Amount | Additional Paid-In — Capital | | Treasury
Stock — Shares | | Amount | | AccumulatedOther Comprehensive — Gain
(Loss) | | Accumulated — Earnings | | Total | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| Balances at January 29, 2005 | 918 | $ 918 | $ 2,432 | | 190 | | $ (3,149 | ) | $ (202 | ) | $ 3,620 | | $ 3,619 | |
| Issuance of common stock: | | | | | | | | | | | | | | |
| Stock options
and warrants exercised | 8 | 8 | 57 | | — | | — | | — | | — | | 65 | |
| Restricted stock
issued | 1 | 1 | 13 | | — | | — | | — | | — | | 14 | |
| Treasury stock
activity: | | | | | | | | | | | | | | |
| Treasury stock
purchases, at cost | — | — | — | | 14 | | (239 | ) | — | | — | | (239 | ) |
| Stock options
and restricted stock exchanged | — | — | — | | — | | (15 | ) | — | | — | | (15 | ) |
| Tax benefits
from exercise of stock options and warrants | — | — | 34 | | — | | — | | — | | — | | 34 | |
| Other
comprehensive loss, net of income tax of $26 | — | — | — | | — | | — | | (41 | ) | — | | (41 | ) |
| Other | — | — | — | | — | | — | | — | | (5 | ) | (5 | ) |
| Net earnings | — | — | — | | — | | — | | — | | 958 | | 958 | |
| Balances at
January 28, 2006 | 927 | 927 | 2,536 | | 204 | | (3,403 | ) | (243 | ) | 4,573 | | 4,390 | |
| Issuance of
common stock: | | | | | | | | | | | | | | |
| Stock options
and warrants exercised | 9 | 9 | 95 | | (1 | ) | 30 | | — | | — | | 134 | |
| Restricted stock
issued | 1 | 1 | 13 | | — | | (5 | ) | — | | — | | 9 | |
| Treasury stock
activity: | | | | | | | | | | | | | | |
| Treasury stock
purchases, at cost | — | — | — | | 18 | | (374 | ) | — | | — | | (374 | ) |
| Stock options
and restricted stock exchanged | — | — | — | | 11 | | (259 | ) | — | | — | | (259 | ) |
| Tax benefits
from exercise of stock options and warrants | — | — | 39 | | — | | — | | — | | — | | 39 | |
| Share-based
employee compensation | — | — | 72 | | — | | — | | — | | — | | 72 | |
| Other
comprehensive gain net of income tax of $(63) | — | — | — | | — | | — | | 102 | | — | | 102 | |
| SFAS
No. 158 adjustment net of income tax of $71 | — | — | — | | — | | — | | (120 | ) | — | | (120 | ) |
| Other | — | — | — | | — | | — | | 2 | | — | | 2 | |
| Cash dividends
declared ($0.26 per common share) | — | — | — | | — | | — | | — | | (187 | ) | (187 | ) |
| Net earnings | — | — | — | | — | | — | | — | | 1,115 | | 1,115 | |
| Balances at
February 3, 2007 | 937 | 937 | 2,755 | | 232 | | (4,011 | ) | (259 | ) | 5,501 | | 4,923 | |
| Issuance of
common stock: | | | | | | | | | | | | | | |
| Stock options and
warrants exercised | 10 | 10 | 175 | | — | | 3 | | — | | — | | 188 | |
| Restricted stock
issued | — | — | (25 | ) | (1 | ) | 11 | | — | | — | | (14 | ) |
| Treasury stock
activity: | | | | | | | | | | | | | | |
| Treasury stock
purchases, at cost | — | — | — | | 43 | | (1,151 | ) | — | | — | | (1,151 | ) |
| Stock options
and restricted stock exchanged | — | — | — | | 10 | | (270 | ) | — | | — | | (270 | ) |
| Tax benefits
from exercise of stock options | — | — | 35 | | — | | — | | — | | — | | 35 | |
| Share-based
employee compensation | — | — | 87 | | — | | — | | — | | — | | 87 | |
| Other
comprehensive gain net of income tax of $(82) | — | — | — | | — | | — | | 137 | | — | | 137 | |
| Other | — | — | 4 | | — | | (4 | ) | — | | 4 | | 4 | |
| Cash dividends
declared ($0.30 per common share) | — | — | — | | — | | — | | — | | (206 | ) | (206 | ) |
| Net earnings | — | — | — | | — | | — | | — | | 1,181 | | 1,181 | |
| Balances at
February 2, 2008 | 947 | $ 947 | $ 3,031 | | 284 | | $ (5,422 | ) | $ (122 | ) | $ 6,480 | | $ 4,914 | |

Comprehensive income:

Net earnings	2007 — $ 1,181		2006 — $ 1,115	2005 — $ 958
Realized loss on
hedging activities, net of income tax of $1	(2	)	—	—
Unrealized gain
(loss) on hedging activities, net of income tax of $12 in 2007, $(5) in
2006 and $(1) in 2005	(19	)	7	1
Additional
minimum pension liability adjustment, net of income tax of $(58) in 2006 and
$26 in 2005	—		95	(42	)
Change in
pensions and other postretirement defined benefit plans, net of income tax of
$(95)	158		—	—
Comprehensive
income	$ 1,318		$ 1,217	$ 917

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

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*NOTES TO CONSOLIDATED FINANCIAL STATEMENTS*

All dollar amounts are in millions except share and per share amounts.

Certain prior-year amounts have been reclassified to conform to current year presentation.

*1. A CCOUNTING P OLICIES*

The following is a summary of the significant accounting policies followed in preparing these financial statements.

Description of Business, Basis of Presentation and Principles of Consolidation

The Kroger Co. (the “Company”) was founded in 1883 and incorporated in 1902. As of February 2, 2008, the Company was one of the largest retailers in the United States based on annual sales. The Company also manufactures and processes food for sale by its supermarkets. The accompanying financial statements include the consolidated accounts of the Company and its subsidiaries. Significant intercompany transactions and balances have been eliminated.

Fiscal Year

The Company’s fiscal year ends on the Saturday nearest January 31. The last three fiscal years consist of the 52-week period ended February 2, 2008, the 53-week period ended February 3, 2007, and the 52-week period ended January 28, 2006.

Pervasiveness of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities. Disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amounts of consolidated revenues and expenses during the reporting period also is required. Actual results could differ from those estimates.

Cash and temporary cash investments

Cash and temporary cash investments represent store cash, escrow deposits and Euros held to settle Euro-denominated contracts. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 52, Foreign Currency Translation, the Company valued its carrying amount of Euros at the spot rate as of February 2, 2008.

Inventories

Inventories are stated at the lower of cost (principally on a last-in, first-out “LIFO” basis) or market. In total, approximately 97% and 98% of inventories for 2007 and 2006, respectively, were valued using the LIFO method. Cost for the balance of the inventories, including substantially all fuel inventories, was determined using the first-in, first-out (“FIFO”) method. Replacement cost was higher than the carrying amount by $604 at February 2, 2008 and $450 at February 3, 2007. The Company follows the Link-Chain, Dollar-Value LIFO method for purposes of calculating its LIFO charge or credit.

The item-cost method of accounting to determine inventory cost before the LIFO adjustment is followed for substantially all store inventories at the Company’s supermarket divisions. This method involves counting each item in inventory, assigning costs to each of these items based on the actual purchase costs (net of vendor allowances and cash discounts) of each item and recording the cost of items sold. The item-cost method of accounting allows for more accurate reporting of periodic inventory balances and enables management to more precisely manage inventory when compared to the retail method of accounting.

The Company evaluates inventory shortages throughout the year based on actual physical counts in its facilities. Allowances for inventory shortages are recorded based on the results of these counts to provide for estimated shortages as of the financial statement date.

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Property, Plant and Equipment

Property, plant and equipment are recorded at cost. Depreciation expense, which includes the amortization of assets recorded under capital leases, is computed principally using the straight-line method over the estimated useful lives of individual assets. Buildings and land improvements are depreciated based on lives varying from 10 to 40 years. All new purchases of store equipment are assigned lives varying from three to nine years. Some store equipment acquired as a result of the Fred Meyer merger was assigned a 15-year life. The life of this equipment was not changed. Leasehold improvements are amortized over the shorter of the lease term to which they relate, which varies from four to 25 years, or the useful life of the asset. Manufacturing plant and distribution center equipment is depreciated over lives varying from three to 15 years. Information technology assets are generally depreciated over five years. Depreciation and amortization expense was $1,356 in 2007, $1,272 in 2006 and $1,265 in 2005.

Interest costs on significant projects constructed for the Company’s own use are capitalized as part of the costs of the newly constructed facilities. Upon retirement or disposal of assets, the cost and related accumulated depreciation are removed from the balance sheet and any gain or loss is reflected in net earnings.

Deferred Rent

The Company recognizes rent holidays, including the time period during which the Company has access to the property for construction of buildings or improvements and escalating rent provisions on a straight-line basis over the term of the lease. The deferred amount is included in Other Current Liabilities and Other Long-Term Liabilities on the Company’s Consolidated Balance Sheets.

Goodwill

The Company reviews goodwill for impairment during the fourth quarter of each year, and also upon the occurrence of trigger events. The reviews are performed at the operating division level. Generally, fair value is determined using a multiple of earnings, or discounted projected future cash flows, and is compared to the carrying value of a division for purposes of identifying potential impairment. Projected future cash flows are based on management’s knowledge of the current operating environment and expectations for the future. If potential for impairment is identified, the fair value of a division is measured against the fair value of its underlying assets and liabilities, excluding goodwill, to estimate an implied fair value of the division’s goodwill. Goodwill impairment is recognized for any excess of the carrying value of the division’s goodwill over the implied fair value. Results of the goodwill impairment reviews performed during 2007, 2006 and 2005 are summarized in Note 2 to the Consolidated Financial Statements.

Intangible Assets

In addition to goodwill, the Company has recorded intangible assets totaling $32, $24 and $34 for leasehold equities, liquor licenses and pharmacy prescription file purchases, respectively at February 2, 2008. Balances at February 3, 2007 were $26, $22 and $28 for leasehold equities, liquor licenses and pharmacy prescription files, respectively. Leasehold equities are amortized over the remaining life of the lease. Owned liquor licenses are not amortized, while liquor licenses that must be renewed are amortized over their useful lives. Pharmacy prescription file purchases are amortized over seven years. These assets are considered annually during the Company’s testing for impairment.

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Impairment of Long-Lived Assets

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets , the Company monitors the carrying value of long-lived assets for potential impairment each quarter based on whether certain trigger events have occurred. These events include current period losses combined with a history of losses or a projection of continuing losses or a significant decrease in the market value of an asset. When a trigger event occurs, an impairment calculation is performed, comparing projected undiscounted future cash flows, utilizing current cash flow information and expected growth rates related to specific stores, to the carrying value for those stores. If impairment is identified for long-lived assets to be held and used, discounted future cash flows are compared to the asset’s current carrying value. Impairment is recorded when the carrying value exceeds the discounted cash flows. With respect to owned property and equipment held for sale, the value of the property and equipment is adjusted to reflect recoverable values based on previous efforts to dispose of similar assets and current economic conditions. Impairment is recognized for the excess of the carrying value over the estimated fair market value, reduced by estimated direct costs of disposal. The Company recorded asset impairments in the normal course of business totaling $24, $61 and $48 in 2007, 2006 and 2005, respectively. Costs to reduce the carrying value of long-lived assets for each of the years presented have been included in the Consolidated Statements of Operations as “Operating, general and administrative” expense.

Store Closing Costs

All closed store liabilities related to exit or disposal activities initiated after December 31, 2002, are accounted for in accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities . The Company provides for closed store liabilities relating to the present value of the estimated remaining noncancellable lease payments after the closing date, net of estimated subtenant income. The Company estimates the net lease liabilities using a discount rate to calculate the present value of the remaining net rent payments on closed stores. The closed store lease liabilities usually are paid over the lease terms associated with the closed stores, which generally have remaining terms ranging from one to 20 years. Adjustments to closed store liabilities primarily relate to changes in subtenant income and actual exit costs differing from original estimates. Adjustments are made for changes in estimates in the period in which the change becomes known. Store closing liabilities are reviewed quarterly to ensure that any accrued amount that is not a sufficient estimate of future costs, or that no longer is needed for its originally intended purpose, is adjusted to income in the proper period.

Owned stores held for disposal are reduced to their estimated net realizable value. Costs to reduce the carrying values of property, equipment and leasehold improvements are accounted for in accordance with the Company’s policy on impairment of long-lived assets. Inventory write-downs, if any, in connection with store closings, are classified in “Merchandise costs.” Costs to transfer inventory and equipment from closed stores are expensed as incurred.

The following table summarizes accrual activity for future lease obligations of stores closed that were closed in the normal course of business and locations closed in California prior to the Fred Meyer merger in 1999.

| Balance at
January 28, 2006 | Future Lease Obligations — $ 127 | |
| --- | --- | --- |
| Additions | 9 | |
| Payments | (20 | ) |
| Adjustments | (27 | ) |
| Balance at
February 3, 2007 | 89 | |
| Additions | 8 | |
| Payments | (16 | ) |
| Adjustments | (7 | ) |
| Balance at
February 2, 2008 | $ 74 | |

Interest Rate Risk Management

The Company uses derivative instruments primarily to manage its exposure to changes in interest rates. The Company’s current program relative to interest rate protection and the methods by which the Company accounts for its derivative instruments are described in Note 6.

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Commodity Price Protection

The Company enters into purchase commitments for various resources, including raw materials utilized in its manufacturing facilities and energy to be used in its stores, manufacturing facilities and administrative offices. The Company enters into commitments expecting to take delivery of and to utilize those resources in the conduct of the normal course of business. The Company’s current program relative to commodity price protection and the methods by which the Company accounts for its purchase commitments are described in Note 6.

Benefit Plans

Effective February 3, 2007, the Company adopted the recognition and disclosure provisions of SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans-an amendment of FASB Statements No. 87, 99, 106 and 132(R) , which required the recognition of the funded status of its retirement plans on the Consolidated Balance Sheet. Actuarial gains or losses, prior service costs or credits and transition obligations that have not yet been recognized are now required to be recorded as a component of Accumulated Other Comprehensive Income (“AOCI”). The Company currently uses a December 31 measurement date. Effective for 2008, the statement also requires an employer to measure the funded status of a plan as of the date of its year-end statement of financial position. The Company will adopt the measurement date change in fiscal 2008.

The determination of the obligation and expense for Company-sponsored pension plans and other post-retirement benefits is dependent on the selection of assumptions used by actuaries and the Company in calculating those amounts. Those assumptions are described in Note 14 and include, among others, the discount rate, the expected long-term rate of return on plan assets and the rates of increase in compensation and health care costs. Actual results that differ from the assumptions are accumulated and amortized over future periods and, therefore, generally affect the recognized expense and recorded obligation in future periods. While the Company believes that the assumptions are appropriate, significant differences in actual experience or significant changes in assumptions may materially affect the pension and other post-retirement obligations and future expense.

The Company also participates in various multi-employer plans for substantially all union employees. Pension expense for these plans is recognized as contributions are funded. Refer to Note 14 for additional information regarding the Company’s benefit plans.

Stock Option Plans

Effective January 29, 2006, the Company adopted the fair value recognition provisions of SFAS No. 123(R), Share-Based Payment, using the modified prospective transition method, and therefore, has not restated results for prior periods. Under this method, the Company recognizes compensation expense for all share-based payments granted after January 29, 2006, as well as all share-based payments granted prior to, but not yet vested as of, January 29, 2006, in accordance with SFAS No. 123(R). Under the fair value recognition provisions of SFAS No. 123(R), the Company recognizes share-based compensation expense, net of an estimated forfeiture rate, over the requisite service period of the award. Prior to the adoption of SFAS No. 123(R), the Company accounted for share-based payments under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, (“APB No. 25”) and the disclosure provisions of SFAS No. 123. The Company elected the alternative transition method for calculating windfall tax benefits available as of the adoption of SFAS No. 123(R). For further information regarding the adoption of SFAS No. 123(R), see Note 10 to the Consolidated Financial Statements.

Deferred Income Taxes

Deferred income taxes are recorded to reflect the tax consequences of differences between the tax basis of assets and liabilities and their financial reporting basis. Refer to Note 4 for the types of differences that give rise to significant portions of deferred income tax assets and liabilities. Deferred income taxes are classified as a net current or noncurrent asset or liability based on the classification of the related asset or liability for financial reporting purposes. A deferred tax asset or liability that is not related to an asset or liability for financial reporting is classified according to the expected reversal date.

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Uncertain Tax Positions

Effective February 4, 2007, the Company adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109 (“FIN No. 48”), which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.

Various taxing authorities periodically audit the Company’s income tax returns. These audits include questions regarding the Company’s tax filing positions, including the timing and amount of deductions and the allocation of income to various tax jurisdictions. In evaluating the exposures connected with these various tax filing positions, including state and local taxes, the Company records allowances for probable exposures. A number of years may elapse before a particular matter, for which an allowance has been established, is audited and fully resolved. As of February 2, 2008, the Internal Revenue Service has concluded an examination for tax years 2002 through 2004.

The assessment of the Company’s tax position relies on the judgment of management to estimate the exposures associated with the Company’s various filing positions.

Self-Insurance Costs

The Company primarily is self-insured for costs related to workers’ compensation and general liability claims. Liabilities are actuarially determined and are recognized based on claims filed and an estimate of claims incurred but not reported. The liabilities for workers’ compensation claims are accounted for on a present value basis. The Company has purchased stop-loss coverage to limit its exposure to any significant exposure on a per claim basis. The Company is insured for covered costs in excess of these per claim limits.

The following table summarizes the changes in the Company’s self-insurance liability through February 2, 2008.

| Beginning
balance | 2007 — $ 440 | | 2006 — $ 445 | | 2005 — $ 440 | |
| --- | --- | --- | --- | --- | --- | --- |
| Expense | 215 | | 196 | | 198 | |
| Claim payments | (185 | ) | (201 | ) | (193 | ) |
| Ending balance | 470 | | 440 | | 445 | |
| Less current
portion | (183 | ) | (165 | ) | (179 | ) |
| Long-term
portion | $ 287 | | $ 275 | | $ 266 | |

The current portion of the self-insured liability is included in “Other accrued liabilities”, and the long-term portion is included in “Other long-term liabilities” in the Consolidated Balance Sheets.

The Company is also similarly self-insured for property-related losses. The Company has purchased stop-loss coverage to limit its exposure to losses in excess of $25 on a per claim basis, except in the case of an earthquake, for which stop-loss coverage is in excess of $50 per claim, up to $200 per claim in California and $300 outside of California.

Revenue Recognition

Revenues from the sale of products are recognized at the point of sale of the Company’s products. Discounts provided to customers by the Company at the time of sale, including those provided in connection with loyalty cards, are recognized as a reduction in sales as the products are sold. Discounts provided by vendors, usually in the form of paper coupons, are not recognized as a reduction in sales provided the coupons are redeemable at any retailer that accepts coupons. Pharmacy sales are recorded when provided to the customer. Sales taxes are not recorded as a component of sales. The Company does not recognize a sale when it sells gift cards and gift certificates. Rather, a sale is recognized when the gift card or gift certificate is redeemed to purchase the Company’s products.

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Merchandise Costs

The “Merchandise costs” line item of the Consolidated Statements of Operations includes product costs, net of discounts and allowances; advertising costs (see separate discussion below); inbound freight charges; warehousing costs, including receiving and inspection costs; transportation costs; and manufacturing production and operational costs. Warehousing, transportation and manufacturing management salaries are also included in the “Merchandise costs” line item; however, purchasing management salaries and administration costs are included in the “Operating, general, and administrative” line item along with most of the Company’s other managerial and administrative costs. Rent expense and depreciation expense are shown separately in the Consolidated Statements of Operations.

Warehousing and transportation costs include distribution center direct wages, repairs and maintenance, utilities, inbound freight and, where applicable, third party warehouse management fees, as well as transportation direct wages and repairs and maintenance. These costs are recognized in the periods the related expenses are incurred.

The Company believes the classification of costs included in merchandise costs could vary widely throughout the industry. The Company’s approach is to include in the “Merchandise costs” line item the direct, net costs of acquiring products and making them available to customers in its stores. The Company believes this approach most accurately presents the actual costs of products sold.

The Company recognizes all vendor allowances as a reduction in merchandise costs when the related product is sold. When possible, vendor allowances are applied to the related product by item and, therefore, reduce the carrying value of inventory by item. When the items are sold, the vendor allowance is recognized. When it is not possible, due to systems constraints, to allocate vendor allowances to the product by item, vendor allowances are recognized as a reduction in merchandise costs based on inventory turns and, therefore, recognized as the product is sold.

Advertising Costs

The Company’s advertising costs are recognized in the periods the related expenses are incurred and are included in the “Merchandise costs” line item of the Consolidated Statements of Operations. The Company’s pre-tax advertising costs totaled $506 in 2007, $508 in 2006 and $498 in 2005. The Company does not record vendor allowances for co-operative advertising as a reduction of advertising expense.

Deposits In-Transit

Deposits in-transit generally represent funds deposited to the Company’s bank accounts at the end of the year related to sales, a majority of which were paid for with credit cards and checks, to which the Company does not have immediate access.

Consolidated Statements of Cash Flows

For purposes of the Consolidated Statements of Cash Flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be temporary cash investments. Book overdrafts, which are included in accounts payable, represent disbursements that are funded as the item is presented for payment. Book overdrafts totaled $661, $600 and $596 as of February 2, 2008, February 3, 2007, and January 28, 2006, respectively, and are reflected as a financing activity in the Consolidated Statements of Cash Flows.

Segments

The Company operates retail food and drug stores, multi-department stores, jewelry stores, and convenience stores throughout the United States. The Company’s retail operations, which represent substantially all of the Company’s consolidated sales, are its only reportable segment. All of the Company’s operations are domestic.

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*2. G OODWILL*

The annual evaluation of goodwill performed during the fourth quarter of 2007, 2006 and 2005 did not result in impairment.

The following table summarizes the changes in the Company’s net goodwill balance through February 2, 2008.

| Balance at
January 29, 2005 | Goodwill — $ 2,191 | |
| --- | --- | --- |
| Goodwill
recorded | — | |
| Purchase
accounting adjustments | 1 | |
| Balance at January 28,
2006 | 2,192 | |
| Goodwill
recorded | — | |
| Purchase
accounting adjustments | — | |
| Balance at
February 3, 2007 | 2,192 | |
| Goodwill
recorded | 23 | |
| Effect of FIN 48
adoption | (71 | ) |
| Balance at
February 2, 2008 | $ 2,144 | |

In the second quarter of 2007, the Company completed acquisitions of 18 Scott’s retail food stores in Northeast Indiana and 20 Farmer Jack retail food stores in Michigan for approximately $86. The transactions were recorded using the purchase method of accounting. Assets and liabilities were recorded based on fair values with the purchase prices being primarily allocated to inventory, property, plant and equipment and goodwill. The results of operations are included in the Company’s Consolidated Financial Statements since the date of acquisition.

The proforma effects of these acquisitions are not material to previously reported results.

*3. P ROPERTY, P LANT AND E QUIPMENT, N ET*

Property, plant and equipment, net consists of:

Land	2007 — $ 1,779		2006 — $ 1,690
Buildings and
land improvements	5,875		5,402
Equipment	8,620		8,255
Leasehold
improvements	4,626		4,221
Construction-in-progress	965		822
Leased property
under capital leases and financing obligations	571		592
Total property,
plant and equipment	22,436		20,982
Accumulated
depreciation and amortization	(9,938	)	(9,203	)
Property, plant
and equipment, net	$ 12,498		$ 11,779

Accumulated depreciation for leased property under capital leases was $286 at February 2, 2008, and $288 at February 3, 2007.

Approximately $540 and $566, original cost, of Property, Plant and Equipment collateralized certain mortgages at February 2, 2008, and February 3, 2007, respectively.

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*4. T AXES B ASED ON I NCOME*

The provision for taxes based on income consists of:

	2007		2006		2005
Federal
Current	$ 661		$ 652		$ 609
Deferred	(62	)	(52	)	(79	)
	599		600		530
State and local
Current	71		55		42
Deferred	(24	)	(22	)	(5	)
	47		33		37
Total	$ 646		$ 633		$ 567

A reconciliation of the statutory federal rate and the effective rate follows:

Statutory rate	2007 — 35.0	%	2006 — 35.0	%	2005 — 35.0 %
State income
taxes, net of federal tax benefit	1.7	%	1.9	%	1.6 %
Favorable
resolution of issues	(1.9	)%	—		—
Deferred tax
adjustment	—		(1.2	)%	—
Other changes,
net	0.6	%	0.5	%	0.6 %
	35.4	%	36.2	%	37.2 %

During the third quarter of 2007, the Company resolved favorably certain tax issues. This resulted in a 2007 tax benefit of approximately $40.

In 2006, during the reconciliation of the Company’s deferred tax balances, after the filing of annual federal and state tax returns, the Company identified adjustments to be made in the prior years’ deferred tax reconciliation. These deferred tax balances were corrected in the Company’s Consolidated Financial Statements for the year ended February 3, 2007, which resulted in a reduction of the Company’s 2006 provision for income tax expense of approximately $21. The Company does not believe these adjustments are material to its Consolidated Financial Statements for the year ended February 3, 2007, or to any prior years’ Consolidated Financial Statements. As a result, the Company has not restated any prior year amounts.

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The tax effects of significant temporary differences that comprise tax balances were as follows:

	2007		2006
Current deferred
tax assets:
Net operating
loss carryforwards	$ 16		$ 17
Compensation
related costs	53		32
Other	8		4
Total current
deferred tax assets	77		53
Current deferred
tax liabilities:
Insurance
related costs	(104	)	(109	)
Inventory
related costs	(212	)	(212	)
Total current
deferred tax liabilities	(316	)	(321	)
Current deferred
taxes	$ (239	)	$ (268	)
Long-term
deferred tax assets:
Compensation
related costs	$ 268		$ 332
Lease accounting	102		122
Closed store
reserves	68		68
Insurance
related costs	64		39
Net operating
loss carryforwards	35		29
Other	23		3
Long-term
deferred tax assets, net	560		593
Long-term
deferred tax liabilities:
Depreciation	(926	)	(1,114	)
Other	(1	)	(201	)
Total long-term
deferred tax liabilities	(927	)	(1,315	)
Long-term
deferred taxes	$ (367	)	$ (722	)

Long-term deferred taxes have decreased compared to 2006 due to the classification of temporary differences on a basis consistent with FIN No. 48. The result was a reclassification of approximately $500 as of the date of adoption.

At February 2, 2008, the Company had net operating loss carryforwards for federal income tax purposes of $22 that expire from 2010 through 2018. In addition, the Company had net operating loss carryforwards for state income tax purposes of $598 that expire from 2008 through 2028. The utilization of certain of the Company’s net operating loss carryforwards may be limited in a given year.

At February 2, 2008, the Company had state credits of $31 that expire from 2008 through 2021. The utilization of certain of the Company’s credits may be limited in a given year.

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The Company adopted the provisions of FIN No. 48, Accounting for Uncertainty in Income Taxes on February 4, 2007. As of adoption, the total amount of gross unrecognized tax benefits for uncertain tax positions, including positions impacting only the timing of tax benefits, was $694. A reconciliation of the beginning and ending amount of unrecognized tax benefits is a follows:

| Balance as of
February 4, 2007 | 2007 — $ 694 | |
| --- | --- | --- |
| Additions based
on tax positions related to the current year | 49 | |
| Reductions based
on tax positions related to the current year | (32 | ) |
| Additions for
tax positions of prior years | 11 | |
| Reductions for
tax positions of prior years | (162 | ) |
| Settlements | (90 | ) |
| Reductions due
to lapse of statute of limitations | (1 | ) |
| Balance as of
February 2, 2008 | $ 469 | |

The Company does not anticipate that changes in the amount of unrecognized tax benefits over the next twelve months will have a significant impact on its results of operations or financial position.

As February 2, 2008, the amount of unrecognized tax benefits that, if recognized, would impact the effective tax rate was $120.

To the extent interest and penalties would be assessed by taxing authorities on any underpayment of income tax, such amounts have been accrued and classified as a component of income tax expense. During the year ended February 2, 2008, the Company recognized approximately $(11) in interest and penalties. The Company had accrued approximately $101 and $118 for the payment of interest and penalties as of February 2, 2008 and February 3, 2007, respectively.

The IRS concluded a field examination of the Company’s 2002 – 2004 U.S. tax returns during the third quarter of 2007. An examination of the Company’s 1999 – 2001 U.S. tax returns was completed in 2005. The Company contested two issues at the appellate level of the IRS. One of the issues was resolved in the third quarter of 2007 and we anticipate that the remaining issue may be resolved within the next 12 months. In the opinion of management, the ultimate disposition of the item noted above will not have a significant effect on our consolidated financial position, liquidity, or results of operations. Additionally, the Company has a case in the U.S. Tax Court. A decision on this case is not expected within the next 12 months. In connection with this case, the Company has extended the statute of limitations on our tax years after 1991 and those years remain open to examination. States have a limited time frame to review and adjust federal audit changes reported. Assessments made and refunds allowed are generally limited to the federal audit changes reported.

*5. D EBT O BLIGATIONS*

Long-term debt consists of:

Credit facility	2007 — $ 570		2006 — $ 352
4.95% to 9.20%
Senior notes and debentures due through 2031	6,766		5,916
5.00% to 9.95%
mortgages due in varying amounts through 2034	166		169
Other	137		144
Total debt	7,639		6,581
Less current
portion	(1,564	)	(878	)
Total long-term
debt	$ 6,075		$ 5,703

In 2007, the Company issued $600 of senior notes bearing an interest rate of 6.4% due in 2017 and $750 of senior notes bearing an interest rate of 6.15% due in 2020.

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As of February 2, 2008, the Company had a $2,500 Five-Year Credit Agreement maturing in 2011, unless earlier terminated by the Company. Borrowings under the credit agreement bear interest at the option of the Company at a rate equal to either (i) the highest, from time to time of (A) the base rate of JP Morgan Chase Bank, N.A., (B) ½% over a moving average of secondary market morning offering rates for three-month certificates of deposit adjusted for reserve requirements, and (C) ½% over the federal funds rate or (ii) an adjusted Eurodollar rate based upon the London Interbank Offered Rate (“Eurodollar Rate”) plus an applicable margin. In addition, the Company pays a facility fee in connection with the credit agreement. Both the applicable margin and the facility fee vary based upon the Company’s achievement of a financial ratio or credit rating. At February 2, 2008, the applicable margin was 0.19%, and the facility fee was 0.06%. The credit facility contains covenants, which, among other things, require the maintenance of certain financial ratios, including fixed charge coverage and leverage ratios. The Company may prepay the credit agreement in whole or in part, at any time, without a prepayment penalty. As of February 2, 2008, the Company had $570 outstanding under the credit agreement including borrowings totaling $345 under its P2/F2/A3 rated commercial paper program. Any borrowings under this program are backed by the Company’s credit facility and reduce the amount available under the credit facility. The weighted average interest rate on the amounts outstanding under the credit agreement was 3.69% at February 2, 2008.

At February 2, 2008, the Company also maintains four money market lines totaling $125 in the aggregate. In addition to credit agreement borrowings, borrowings under the money market lines and some outstanding letters of credit reduce funds available under the Company’s credit agreement. The Company had no borrowings under the money market lines at February 2, 2008. The outstanding letters of credit that reduce funds available under the Company’s credit agreement totaled $355 as of February 2, 2008.

Most of the Company’s outstanding public debt is subject to early redemption at varying times and premiums, at the option of the Company. In addition, subject to certain conditions, some of the Company’s publicly issued debt will be subject to redemption, in whole or in part, at the option of the holder upon the occurrence of a redemption event, upon not less than five days’ notice prior to the date of redemption, at a redemption price equal to the default amount, plus a specified premium. “Redemption Event” is defined in the indentures as the occurrence of (i) any person or group, together with any affiliate thereof, beneficially owning 50% or more of the voting power of the Company, (ii) any one person or group, or affiliate thereof, succeeding in having a majority of its nominees elected to the Company’s Board of Directors, in each case, without the consent of a majority of the continuing directors of the Company or (iii) both a change of control and a below investment grade rating.

The aggregate annual maturities and scheduled payments of long-term debt, as of year-end 2007, and for the years subsequent to 2007 are:

2008	$
2009	402
2010	555
2011	527
2012	1,400
Thereafter	3,191
Total debt	$ 7,639

*6. F INANCIAL I NSTRUMENTS*

Interest Rate Risk Management

The Company historically has used derivatives to manage its exposure to changes in interest rates. The interest differential to be paid or received is accrued as interest expense. SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities , as amended, defines derivatives, requires that derivatives be carried at fair value on the balance sheet and provides for hedge accounting when certain conditions are met. In accordance with this standard, the Company’s derivative financial instruments are recognized on the balance sheet at fair value. Changes in the fair value of derivative instruments designated as “cash flow” hedges, to the extent the hedges are highly effective, are recorded in other comprehensive income, net of tax effects. Ineffective portions of cash flow hedges, if any, are recognized in current period earnings. Other comprehensive income or loss is reclassified into current period earnings when the hedged transaction affects earnings. Changes in the fair value of derivative instruments designated as “fair value” hedges, along with corresponding changes in the fair values of the hedged assets or liabilities, are recorded in current period earnings.

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The Company assesses, both at the inception of the hedge and on an ongoing basis, whether derivatives used as hedging instruments are highly effective in offsetting the changes in the fair value or cash flow of the hedged items. If it is determined that a derivative is not highly effective as a hedge or ceases to be highly effective, the Company discontinues hedge accounting prospectively.

The Company’s current program relative to interest rate protection contemplates hedging the exposure to changes in the fair value of fixed-rate debt attributable to changes in interest rates. To do this, the Company uses the following guidelines: (i) use average daily outstanding borrowings to determine annual debt amounts subject to interest rate exposure, (ii) limit the average annual amount subject to interest rate reset and the amount of floating rate debt to a combined total of $2,500 million or less, (iii) include no leverage products, and (iv) hedge without regard to profit motive or sensitivity to current mark-to-market status.

Annually, the Company reviews with the Financial Policy Committee of the Board of Directors compliance with the guidelines. These guidelines may change as the Company’s needs dictate.

The table below summarizes the outstanding interest rate swaps designated as fair value hedges as of February 2, 2008, and February 3, 2007.

	2007 — Pay	Pay	2006 — Pay	Pay
	Floating	Fixed	Floating	Fixed
Notional amount	$ 1,050	$ —	$ 1,050	$ —
Duration in
years	2.07	—	3.08	—
Average variable
rate	5.97 %	—	8.07 %	—
Average fixed
rate	6.74 %	—	6.74 %	—

In addition to the interest rate swaps noted above, in 2005 the Company entered into three forward-starting interest rate swap agreements with a notional amount totaling $750. A forward-starting interest rate swap is an agreement that effectively hedges future benchmark interest rates on debt for an established period of time. The Company entered into the forward-starting interest rate swaps in order to lock into fixed interest rates on forecasted issuances of debt in 2007 and 2008. In 2007, the Company terminated two of these forward-starting interest rate swaps with a notional amount of $500. The unamortized payment and proceeds on the two terminated forward-starting interest rate swaps have been recorded net of tax in other comprehensive income and will be amortized to earnings as the payments of interest to which the hedge relates are made. The one remaining forward-starting interest rate swap as of February 2, 2008 has a ten-year term with an interest rate of 5.11%.

Commodity Price Protection

The Company enters into purchase commitments for various resources, including raw materials utilized in its manufacturing facilities and energy to be used in its stores, warehouses, manufacturing facilities and administrative offices. The Company enters into commitments expecting to take delivery of and to utilize those resources in the conduct of normal business. Those commitments for which the Company expects to utilize or take delivery in a reasonable amount of time in the normal course of business qualify as normal purchases and normal sales.

Some of the product the Company purchases is shipped in corrugated cardboard packaging. The corrugated cardboard is sold when it is economical to do so. As of February 2, 2008, the Company maintained three derivative instruments to manage exposure to changes in corrugated cardboard prices. These derivatives have a three-year term. The instruments do not qualify for hedge accounting, in accordance with SFAS No. 133, Accounting for Derivative Investments and Hedging Activities, as amended. Accordingly, changes in the fair value of these instruments are marked-to-market in the Company’s Consolidated Statements of Operations as operating, general and administrative (“OG&A”) expenses. As of February 2, 2008, an accrued liability totaling $1 had been recorded to reflect the fair value of these instruments.

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*7. F AIR V ALUE OF F INANCIAL I NSTRUMENTS*

The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it was practicable to estimate that value:

Cash and Temporary Cash Investments, Store Deposits In-Transit, Receivables, Prepaid and Other Current Assets, Accounts Payable, Accrued Salaries and Wages and Other Current Liabilities

The carrying amounts of these items approximated fair value.

Long-term Investments

The fair values of these investments were estimated based on quoted market prices for those or similar investments, or estimated cash flows, if appropriate.

Long-term Debt

The fair value of the Company’s long-term debt, including the current portion thereof and excluding borrowings under the credit facility, was estimated based on the quoted market price for the same or similar issues adjusted for illiquidity based on available market evidence. If quoted market prices were not available, the fair value was based upon the net present value of the future cash flows using the forward interest rate yield curve in effect at the respective year-ends. The carrying values of long-term debt outstanding under the Company’s credit facility approximated fair value.

Interest Rate Protection Agreements

The fair value of these agreements was based on the net present value of the future cash flows using the forward interest rate yield curve in effect at the respective year-ends.

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The estimated fair values of the Company’s financial instruments are as follows:

	2007 — Carrying Value		Estimated Fair Value		2006 — Carrying Value		Estimated Fair Value
Cash and
temporary cash investments	$ 242		$ 242		$ 189		$ 189
Store deposits
in-transit	$ 676		$ 676		$ 614		$ 614
Long-term
investments for which it is
Practicable	$ 75		$ 75		$ 60		$ 60
Not Practicable	$ —		$ —		$ —		$ —
Debt for which
it is (1)
Practicable	$ (7,639	)	$ (7,973	)	$ (6,581	)	$ (6,859	)
Not Practicable	$ —		$ —		$ —		$ —
Interest Rate
Protection Agreements
Receive fixed
swaps asset/(liability) (2)	$ 11		$ 11		$ (28	)	$ (28	)
Forward-starting
swap asset/(liability) (3)	$ (18	)	$ (18	)	$ 12		$ 12
Corrugated
Cardboard Price Protection Agreements (4)	$ (1	)	$ (1	)	$ —		$ —

| (1) | Excludes
capital lease and lease-financing obligations. |
| --- | --- |
| (2) | As
of February 2, 2008 and February 3, 2007, the Company maintained
six interest rate swap agreements, with notional amounts totaling $1,050, to
manage its exposure to changes in the fair value of its fixed rate debt
resulting from interest rate movements by effectively converting a portion of
the Company’s debt from fixed to variable rates. These agreements
mature at varying times between March 2008 and January 2015.
The differential between fixed and variable rates to be paid or received is
accrued as interest rates change in accordance with the agreements as an
adjustment to interest expense. These interest rate swap agreements are
being accounted for as fair value hedges. As of February 2, 2008,
other long-term assets totaling $11 were recorded to reflect the fair value
of these agreements, offset by increases in the fair value of the underlying
debt. As of February 3, 2007, other long-term liabilities totaling $28
were recorded to reflect the fair value of these agreements, offset by
decreases in the fair value of the underlying debt. |
| (3) | As
of February 2, 2008 and February 3, 2007, the Company maintained
one and three forward-starting interest rate swap agreements, with a notional
amount of $250 and $750, respectively, to manage its exposure to changes in
future benchmark interest rates. A forward-starting interest rate swap
is an agreement that effectively hedges future benchmark interest rates on
debt for an established period of time. The Company entered into the
forward-starting interest rate swaps in order to lock in fixed interest rates
on the Company’s forecasted issuances of debt in 2007 and 2008. As of
February 2, 2008 and February 3, 2007, other long-term liabilities
and assets totaling $18 and $12, respectively, were recorded to reflect the
fair value of these agreements. |
| (4) | See
Note 6 for a description of the corrugated cardboard price protection
agreements. |

*8. L EASES AND L EASE-FINANCED T RANSACTIONS*

The Company operates primarily in leased facilities. Lease terms generally range from 10 to 20 years with options to renew for varying terms. Terms of certain leases include escalation clauses, percentage rent based on sales or payment of executory costs such as property taxes, utilities or insurance and maintenance. Rent expense for leases with escalation clauses or other lease concessions are accounted for on a straight-line basis beginning with the earlier of the lease commencement date or the date the Company takes possession. Portions of certain properties are subleased to others for periods generally ranging from one to 20 years.

Rent expense (under operating leases) consists of:

Minimum rentals	2007 — $ 747		2006 — $ 753		2005 — $ 760
Contingent
payments	11		10		8
Sublease income	(114	)	(114	)	(107	)
Total rent
expense	$ 644		$ 649		$ 661

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Minimum annual rentals and payments under capital leases and lease-financed transactions for the five years subsequent to 2007 and in the aggregate are:

2008	Capital Leases — $ 54	$ 774	Lease- Financed Transactions — $ 5
2009	53	736	5
2010	51	693	5
2011	55	630	6
2012	46	578	6
Thereafter	237	3,459	114
	496	$ 6,870	$ 141
Less estimated
executory costs included in capital leases	(1	)
Net minimum
lease payments under capital leases	495
Less amount
representing interest	(198	)
Present value of
net minimum lease payments under capital leases	$ 297

Total future minimum rentals under noncancellable subleases at February 2, 2008, were $553.

*9. E ARNINGS P ER C OMMON S HARE*

Basic earnings per common share equals net earnings divided by the weighted average number of common shares outstanding. Diluted earnings per common share equals net earnings divided by the weighted average number of common shares outstanding after giving effect to dilutive stock options and warrants.

The following table provides a reconciliation of earnings and shares used in calculating basic earnings per share to those used in calculating diluted earnings per share.

| (in millions, except per share amounts) | For
the year ended February 2, 2008 — Earnings (Numerator) | Shares (Denominator) | Per Share Amount | For
the year ended February 3, 2007 — Earnings (Numerator) | Shares (Denominator) | Per Share Amount | For
the year ended January 28, 2006 — Earnings (Numerator) | Shares (Denominator) | Per Share Amount |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| Basic EPS | $ 1,181 | 690 | $ 1.71 | $ 1,115 | 715 | $ 1.56 | $ 958 | 724 | $ 1.32 |
| Dilutive effect
of stock option awards and warrants | | 8 | | | 8 | | | 7 | |
| Diluted EPS | $ 1,181 | 698 | $ 1.69 | $ 1,115 | 723 | $ 1.54 | $ 958 | 731 | $ 1.31 |

For the years ended February 2, 2008, February 3, 2007 and January 28, 2006, there were options outstanding for approximately 2.0 million, 25.4 million and 24.6 million shares of common stock, respectively, that were excluded from the computation of diluted EPS. These shares were excluded because their inclusion would have had an anti-dilutive effect on EPS.

*10. S TOCK O PTION P LANS*

Prior to January 29, 2006, the Company applied APB No. 25, and related interpretations, in accounting for its stock option plans and provided the pro-forma disclosures required by SFAS No. 123. APB No. 25 provided for recognition of compensation expense for employee stock awards based on the intrinsic value of the award on the grant date.

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The Company grants options for common stock (“stock options”) to employees, as well as to its non-employee directors, under various plans at an option price equal to the fair market value of the stock at the date of grant. Equity awards may be made at one of four meetings of its Board of Directors occurring shortly after the Company’s release of quarterly earnings. The 2007 annual grant was made in conjunction with the June meeting of the Company’s Board of Directors.

Stock options typically expire 10 years from the date of grant. Stock options vest between one and five years from the date of grant, or for certain stock options, the earlier of the Company’s stock reaching certain pre-determined and appreciated market prices or nine years and six months from the date of grant. Under APB No. 25, the Company did not recognize compensation expense for these stock option grants. At February 2, 2008, approximately 11 million shares of common stock were available for future option grants under these plans.

In addition to the stock options described above, the Company awards restricted stock to employees under various plans. The restrictions on these awards generally lapse between one and five years from the date of the awards and expense is recognized over the lapsing cycle. Under APB No. 25, the Company generally recorded expense for restricted stock awards in an amount equal to the fair market value of the underlying stock on the date of award. As of February 2, 2008, approximately three million shares of common stock were available for future restricted stock awards under the 2005 Long-Term Incentive Plan (the “Plan”). The Company has the ability to convert shares available for stock options under the Plan to shares available for restricted stock awards. Four shares available for common stock option awards can be converted into one share available for restricted stock awards.

All awards become immediately exercisable upon certain changes of control of the Company.

Historically, stock option awards were granted to various employees throughout the organization. Restricted stock awards, however, were limited to approximately 150 associates, including members of the Board of Directors and certain members of senior management. Beginning in 2006, the Company began issuing a combination of stock option and restricted stock awards to those employees who previously received only stock option awards, in an effort to further align those employees’ interests with those of the Company’s non-employee shareholders. As a result, the number of stock option awards granted in 2007 and 2006 decreased and the number of restricted stock awards granted increased.

Stock Options

Changes in options outstanding under the stock option plans are summarized below:

| Outstanding,
year-end 2004 | Shares subject to option (in millions) — 61.5 | | Weighted- average exercise price — $ 18.20 |
| --- | --- | --- | --- |
| Granted | 6.8 | | $ 16.50 |
| Exercised | (7.7 | ) | $ 9.81 |
| Canceled or
Expired | (1.3 | ) | $ 20.92 |
| Outstanding,
year-end 2005 | 59.3 | | $ 19.03 |
| Granted | 3.2 | | $ 20.05 |
| Exercised | (9.5 | ) | $ 13.34 |
| Canceled or
Expired | (1.1 | ) | $ 21.01 |
| Outstanding,
year-end 2006 | 51.9 | | $ 20.09 |
| Granted | 3.4 | | $ 28.21 |
| Exercised | (10.1 | ) | $ 19.05 |
| Canceled or
Expired | (.4 | ) | $ 20.79 |
| Outstanding,
year-end 2007 | 44.8 | | $ 20.94 |

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A summary of options outstanding and exercisable at February 2, 2008 follows:

Range of Exercise Prices	Number outstanding	Weighted- average remaining contractual life	Weighted- average exercise price	Options exercisable	Weighted- average exercise price
	(in millions)	(in years)		(in millions)
$ 13.78 - $14.93	5.2	4.85	$ 14.91	5.2	$ 14.91
$ 14.94 - $16.39	5.3	7.13	$ 16.35	2.7	$ 16.33
$ 16.40 - $17.31	8.7	4.33	$ 16.97	6.7	$ 16.96
$ 17.32 - $22.99	11.4	4.09	$ 21.80	8.6	$ 22.10
$ 23.00 - $31.91	14.2	3.83	$ 26.57	9.1	$ 26.05
$ 13.78 - $31.91	44.8	4.50	$ 20.94	32.3	$ 20.51

The weighted-average remaining contractual life for options exercisable at February 2, 2008, was approximately 3.7 years.

Restricted stock

	Restricted shares outstanding — (in millions)		Weighted- average grant-date — fair value
Outstanding,
year-end 2005	.7		$ 17.85
Granted	2.2		$ 20.16
Lapsed	(0.4	)	$ 17.46
Canceled or
Expired	(0.1	)	$ 19.41
Outstanding,
year-end 2006	2.4		$ 20.02
Granted	2.5		$ 28.20
Lapsed	(1.4	)	$ 19.90
Canceled or
Expired	(0.1	)	$ 22.69
Outstanding,
year-end 2007	3.4		$ 25.89

Adoption of SFAS No. 123(R)

Effective January 29, 2006, the Company adopted the provisions of SFAS No. 123(R), Share-Based Payment, using the modified-prospective method. Under this method, the Company recognizes compensation expense for all share-based awards granted prior to, but not yet vested as of, January 29, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, Accounting for Stock-Based Compensation. For all share-based awards granted on or after January 29, 2006, the Company recognizes compensation expense based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R).

In accordance with the provisions of the modified-prospective transition method, results for prior periods have not been restated. Compensation expense for all share-based awards described above was recognized using the straight-line attribution method applied to the fair value of each option grant, over the requisite service period associated with each award. The requisite service period is typically consistent with the vesting period, except as noted below. Because awards typically vest evenly over the requisite service period, compensation cost recognized through February 2, 2008, is at least equal to the grant-date fair value of the vested portion of all outstanding awards. All of the Company stock-based incentive plans are considered equity plans under SFAS No. 123(R).

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The weighted-average fair value of stock options granted during 2007, 2006 and 2005 was $9.66, $6.90 and $7.70, respectively. The fair value of each stock option grant was estimated on the date of grant using the Black-Scholes option-pricing model, based on the assumptions shown in the table below. The Black-Scholes model utilizes extensive accounting judgment and financial estimates, including the term employees are expected to retain their stock options before exercising them, the volatility of the Company’s stock price over that expected term, the dividend yield over the term and the number of awards expected to be forfeited before they vest. Using alternative assumptions in the calculation of fair value would produce fair values for stock option grants that could be different than those used to record stock-based compensation expense in the Consolidated Statements of Operations.

The following table reflects the weighted-average assumptions used for grants awarded to option holders:

	2007	2006	2005
Weighted average
expected volatility (based on historical volatility)	29.23 %	27.60 %	30.83 %
Weighted average
risk-free interest rate	5.06 %	5.07 %	4.11 %
Expected
dividend yield	1.40 %	1.50 %	N/A
Expected term
(based on historical results)	6.9 years	7.5 years	8.7 years

The weighted-average risk-free interest rate was based on the yield of a treasury note as of the grant date, continuously compounded, which matures at a date that approximates the expected term of options. Prior to 2006, the Company did not pay a dividend, so an expected dividend rate was not included in the determination of fair value for options granted during those years. Using a dividend yield of 1.50% to value options issued in 2005 would have decreased the fair value of each option by approximately $1.60. Expected volatility was determined based upon historical stock volatilities; however, implied volatility was also considered. Expected term was determined based upon a combination of historical exercise and cancellation experience as well as estimates of expected future exercise and cancellation experience.

Under SFAS No. 123(R), the Company records expense for restricted stock awards in an amount equal to the fair market value of the underlying stock on the grant date of the award, over the period the awards lapse.

Total stock compensation recognized in 2007, 2006 and 2005 was $87, $72 and $7, respectively. Stock option compensation recognized in 2007 and 2006 was $51 and $50, respectively. Restricted shares compensation recognized in 2007, 2006 and 2005 was $36, $22 and $7 respectively.

If compensation cost for the Company’s stock option plans for the year ended January 28, 2006 had been determined based upon the fair value at the grant date for awards under these plans consistent with the methodology prescribed under SFAS No. 123, the net earnings and diluted earnings per common share would have been reduced to the pro forma amounts below:

| Net earnings, as
reported | 2005 — $ 958 | |
| --- | --- | --- |
| Stock-based
compensation expense included in net earnings, net of income tax benefits | 5 | |
| Total
stock-based compensation expense determined under fair value method for all
awards, net of income tax benefits | (34 | ) |
| Pro forma net
earnings | $ 929 | |
| Earnings per
basic common share, as reported | $ 1.32 | |
| Pro forma
earnings per basic common share | $ 1.28 | |
| Earnings per
diluted common share, as reported | $ 1.31 | |
| Pro forma
earnings per diluted common share | $ 1.27 | |

The total intrinsic value of options exercised was $33 and $79 in 2007 and 2006, respectively. The total amount of cash received from the exercise of options granted under share-based payment arrangements was $188. As of February 2, 2008, there was $110 of total unrecognized compensation expense related to non-vested share-based compensation arrangements granted under the Company’s equity award plans. This cost is expected to be recognized over a weighted-average period of approximately one year. The total fair value of options that vested was $53 and $44 in 2007 and 2006, respectively.

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Shares issued as a result of stock option exercises may be newly issued shares or reissued treasury shares. Proceeds received from the exercise of options, and the related tax benefit, are utilized to repurchase shares of the Company’s stock under a stock repurchase program adopted by the Company’s Board of Directors. During 2007, the Company repurchased approximately 10 million shares of stock in such a manner.

For share-based awards granted prior to the adoption of SFAS No. 123(R), the Company’s stock option grants generally contained retirement-eligibility provisions that caused the options to vest upon the earlier of the stated vesting date or retirement. Compensation expense was calculated over the stated vesting periods, regardless of whether certain employees became retirement-eligible during the respective vesting periods. Upon the adoption of SFAS No. 123(R), the Company continued this method of recognizing compensation expense for awards granted prior to the adoption of SFAS No. 123(R). For awards granted on or after January 29, 2006, options vest based on the stated vesting date, even if an employee retires prior to the vesting date. The requisite service period ends, however, on the employee’s retirement-eligible date. As a result, the Company recognizes expense for stock option grants containing such retirement-eligibility provisions over the shorter of the vesting period or the period until employees become retirement-eligible (the requisite service period). As a result of retirement eligibility provisions in stock option awards granted on or after January 29, 2006, approximately $13 of compensation expense was recognized in 2007 prior to the completion of stated vesting periods.

*11. C OMMITMENTS AND C ONTINGENCIES*

The Company continuously evaluates contingencies based upon the best available evidence.

The Company believes that allowances for loss have been provided to the extent necessary and that its assessment of contingencies is reasonable. To the extent that resolution of contingencies results in amounts that vary from the Company’s estimates, future earnings will be charged or credited.

The principal contingencies are described below:

Insurance — The Company’s workers’ compensation risks are self-insured in certain states. In addition, other workers’ compensation risks and certain levels of insured general liability risks are based on retrospective premium plans, deductible plans, and self-insured retention plans. The liability for workers’ compensation risks is accounted for on a present value basis. Actual claim settlements and expenses incident thereto may differ from the provisions for loss. Property risks have been underwritten by a subsidiary and are reinsured with unrelated insurance companies. Operating divisions and subsidiaries have paid premiums, and the insurance subsidiary has provided loss allowances, based upon actuarially determined estimates.

Litigation – On October 6, 2006, the Company petitioned the Tax Court ( In Re: Ralphs Grocery Company and Subsidiaries, formerly known as Ralphs Supermarkets, Inc., Docket No. 20364-06 ) for a redetermination of deficiencies set by the Commissioner of Internal Revenue. The dispute at issue involves a 1992 transaction in which Ralphs Holding Company acquired the stock of Ralphs Grocery Company and made an election under Section 338(h)(10) of the Internal Revenue Code. The Commissioner has determined that the acquisition of the stock was not a purchase as defined by Section 338(h)(3) of the Internal Revenue Code and that the acquisition does not qualify as a purchase. The Company believes that it has strong arguments in favor of its position and believes it is more likely than not that its position will be sustained. However, due to the inherent uncertainty involved in the litigation process, there can be no assurances that the Tax Court will rule in favor of the Company. As of February 2, 2008, an adverse decision would require a cash payment of approximately $419, including interest.

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On February 2, 2004, the Attorney General for the State of California filed an action in Los Angeles federal court ( California, ex rel Lockyer v. Safeway, Inc. dba Vons, a Safeway Company; Albertson’s, Inc. and Ralphs Grocery Company, a division of The Kroger Co. , United States District Court Central District of California, Case No. CV04-0687) alleging that the Mutual Strike Assistance Agreement (the “Agreement”) between the Company, Albertson’s, Inc. and Safeway Inc. (collectively, the “Retailers”), which was designed to prevent the union from placing disproportionate pressure on one or more of the Retailers by picketing such Retailer(s) but not the other Retailer(s) during the labor dispute in southern California, violated Section 1 of the Sherman Act. The lawsuit seeks declarative and injunctive relief. On May 25, 2005, the Court denied a motion for a summary judgment filed by the defendants. Ralphs and the other defendants filed a notice of an interlocutory appeal to the United States Court of Appeals for the Ninth Circuit. On November 29, 2005, the appellate court dismissed the appeal. On December 7, 2006, the Court denied a motion for summary judgment filed by the State of California. The Company continues to believe it has strong defenses against this lawsuit and is vigorously defending it. Although this lawsuit is subject to uncertainties inherent to the litigation process, based on the information presently available to the Company, management does not expect that the ultimate resolution of this action will have a material adverse effect on the Company’s financial condition, results of operations or cash flows.

Various claims and lawsuits arising in the normal course of business, including suits charging violations of certain antitrust, wage and hour, or civil rights laws, are pending against the Company. Some of these suits purport or have been determined to be class actions and/or seek substantial damages. Any damages that may be awarded in antitrust cases will be automatically trebled. Although it is not possible at this time to evaluate the merits of all of these claims and lawsuits, nor their likelihood of success, the Company is of the belief that any resulting liability will not have a material adverse effect on the Company’s financial position.

The Company continually evaluates its exposure to loss contingencies arising from pending or threatened litigation and believes it has made adequate provisions therefor. Nonetheless, assessing and predicting the outcomes of these matters involve substantial uncertainties. It remains possible that despite management’s current belief, material differences in actual outcomes or changes in management’s evaluation or predictions could arise that could have a material adverse impact on the Company’s financial condition or results of operation.

Guarantees – Most of the Company’s outstanding public debt is jointly and severally, fully and unconditionally guaranteed by The Kroger Co. and some of the Company’s subsidiaries. See Note 17 to the Consolidated Financial Statements for a more detailed discussion of those arrangements. In addition, the Company has guaranteed half of the indebtedness of two real estate entities in which Kroger has a 50% ownership interest. The Company’s share of the responsibility for this indebtedness, should the entities be unable to meet their obligations, totals approximately $7. Based on the covenants underlying this indebtedness as of February 2, 2008, it is unlikely that the Company will be responsible for repayment of these obligations. The Company also agreed to guarantee, up to $10, the indebtedness of an entity of which Kroger has a 25% ownership interest. The Company’s share of the responsibility, as of February 2, 2008, should the entity be unable to meet its obligations, totals approximately $9 and is collateralized by $8 of inventory located in the Company’s stores.

Assignments – The Company is contingently liable for leases that have been assigned to various third parties in connection with facility closings and dispositions. The Company could be required to satisfy the obligations under the leases if any of the assignees is unable to fulfill its lease obligations. Due to the wide distribution of the Company’s assignments among third parties, and various other remedies available, the Company believes the likelihood that it will be required to assume a material amount of these obligations is remote.

*12. S UBSEQUENT E VENTS*

On March 19, 2008, the Company announced the issuance of $400 of senior notes bearing an interest rate of 5.00% and $375 of senior notes bearing an interest rate of 6.90%, which will be due April, 2013 and April 2038, respectively.

*13. S TOCK*

Preferred Stock

The Company has authorized 5 million shares of voting cumulative preferred stock; 2 million were available for issuance at February 2, 2008. The stock has a par value of $100 per share and is issuable in series.

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Common Stock

The Company has authorized one billion shares of common stock, $1 par value per share. On May 20, 1999, the shareholders authorized an amendment to the Amended Articles of Incorporation to increase the authorized shares of common stock from 1 billion to 2 billion when the Board of Directors determines it to be in the best interest of the Company.

Common Stock Repurchase Program

The Company maintains stock repurchase programs that comply with Securities Exchange Act Rule 10b5-1 to allow for the orderly repurchase of Kroger stock, from time to time. The Company made open market purchases totaling $1,151, $374 and $239 under these repurchase programs in fiscal 2007, 2006 and 2005, respectively. In addition to these repurchase programs, in December 1999, the Company began a program to repurchase common stock to reduce dilution resulting from its employee stock option plans. This program is solely funded by proceeds from stock option exercises, and the tax benefit. The Company repurchased approximately $270, $259 and $13 under the stock option program during fiscal 2007, 2006 and 2005, respectively.

*14. BENEFIT PLANS*

The Company administers non-contributory defined benefit retirement plans for substantially all non-union employees and some union-represented employees as determined by the terms and conditions of collective bargaining agreements. These included several qualified pension plans (the “Qualified Plans”) and a non-qualified plan (the “Non-Qualified Plan”). The Non-Qualified Plan pays benefits to any employee that earns in excess of the maximum allowed for the Qualified Plans by Section 415 of the Internal Revenue Code. The Company only funds obligations under the Qualified Plans. Funding for the pension plans is based on a review of the specific requirements and on evaluation of the assets and liabilities of each plan.

In addition to providing pension benefits, the Company provides certain health care benefits for retired employees. The majority of the Company’s employees may become eligible for these benefits if they reach normal retirement age while employed by the Company. Funding of retiree health care benefits occurs as claims or premiums are paid.

Effective February 3, 2007, the Company adopted the recognition and disclosure provisions of SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans-an amendment of FASB Statement No. 87, 99, 106 and 132(R), which requires the recognition of the funded status of its retirement plans on the Consolidated Balance Sheet. Actuarial gains or losses, prior service costs or credits and transition obligations that have not yet been recognized are required to be recorded as a component of Accumulated Other Comprehensive Income (“AOCI”). The Company currently uses a December 31 measurement date. Effective for 2008, the statement also requires an employer to measure the funded status of a plan as of the date of its year-end statement of financial position. The Company will adopt the measurement date change in fiscal 2008.

Amounts recognized in AOCI as of February 2, 2008 consist of the following (pre-tax):

February 2, 2008	Pension Benefits	Other Benefits		Total
Unrecognized net
actuarial loss (gain)	$ 241	$ (38	)	$ 203
Unrecognized
prior service cost (credit)	6	(35	)	(29	)
Unrecognized
transition obligation	1	—		1
Total
liabilities	$ 248	$ (73	)	$ 175

Amounts in AOCI expected to be recognized as components of net periodic pension or postretirement benefit costs in 2008 are as follows (pre-tax):

February 2, 2008	Pension Benefits	Other Benefits		Total
Net actuarial
loss	$ 10	$ —		$ 10
Prior service
cost (credit)	2	(6	)	(4	)
Total
liabilities	$ 12	$ (6	)	$ 6

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Other changes recognized in other comprehensive income in 2007 are as follows (pre-tax):

| February 2, 2008 — Incurred prior
service cost | Pension Benefits — $ 2 | | Other Benefits — $ — | | Total — $ 2 | |
| --- | --- | --- | --- | --- | --- | --- |
| Incurred net
actuarial gain | (156 | ) | (65 | ) | (221 | ) |
| Amortization of
prior service cost | (3 | ) | 6 | | 3 | |
| Amortization of
net actuarial loss | (37 | ) | — | | (37 | ) |
| Total recognized
in other comprehensive income | (194 | ) | (59 | ) | (253 | ) |
| Total recognized
in net periodic benefit cost and other comprehensive income | $ (125 | ) | $ (36 | ) | $ (161 | ) |

Information with respect to change in benefit obligation, change in plan assets, the funded status of the plans recorded in the Consolidated Balance Sheets, net amounts recognized at end of fiscal years, weighted average assumptions and components of net periodic benefit cost follow:

	Pension Benefits
	Qualified Plans				Non-Qualified Plan				Other Benefits
	2007		2006		2007		2006		2007		2006
Change in
benefit obligation:
Benefit
obligation at beginning of fiscal year	$ 2,419		$ 2,284		$ 113		$ 105		$ 373		$ 356
Service cost	42		123		2		2		10		13
Interest cost	141		130		9		6		19		20
Plan
participants’ contributions	1		—		—		—		9		11
Amendments	2		—		—		—		—		—
Actuarial (gain)
loss	(143	)	(4	)	23		7		(65	)	4
Benefits paid	(120	)	(114	)	(8	)	(7	)	(26	)	(31	)
Benefit
obligation at end of fiscal year	$ 2,342		$ 2,419		$ 139		$ 113		$ 320		$ 373
Change in plan
assets:
Fair value of
plan assets at beginning of fiscal year	$ 2,098		$ 1,814		$ —		$ —		$ —		$ —
Actual return on
plan assets	200		248		—		—		—		—
Employer
contributions	51		150		8		7		17		20
Plan
participants’ contributions	1		—		—		—		9		11
Benefits paid	(120	)	(114	)	(8	)	(7	)	(26	)	(31	)
Fair value of
plan assets at end of fiscal year	$ 2,230		$ 2,098		$ —		$ —		$ —		$ —
Funded status at
end of fiscal year	$ (112	)	$ (321	)	$ (139	)	$ (113	)	$ (320	)	$ (373	)
Net asset
(liability) recognized at end of fiscal year	$ (112	)	$ (321	)	$ (139	)	$ (113	)	$ (320	)	$ (373	)

As of February 2, 2008 and February 3, 2007, pension plan assets included no shares of The Kroger Co. common stock.

Weighted average assumptions	Pension Benefits — 2007	2006	2005	Other Benefits — 2007	2006	2005
Discount rate –
Benefit obligation	6.50 %	5.90 %	5.70 %	6.50 %	5.90 %	5.70 %
Discount rate –
Net periodic benefit cost	5.90 %	5.70 %	5.75 %	5.90 %	5.70 %	5.75 %
Expected return
on plan assets	8.50 %	8.50 %	8.50 %
Rate of
compensation increase	3.56 %	3.50 %	3.50 %

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The Company’s discount rate assumption was intended to reflect the rate at which the pension benefits could be effectively settled. It takes into account the timing and amount of benefits that would be available under the plan. The Company’s methodology for selecting the discount rate as of year-end 2007 was to match the plan’s cash flows to that of a yield curve that provides the equivalent yields on zero-coupon corporate bonds for each maturity. Benefit cash flows due in a particular year can theoretically be “settled” by “investing” them in the zero-coupon bond that matures in the same year. The discount rate is the single rate that produces the same present value of cash flows. The selection of the 6.50% discount rate as of year-end 2007 represents the equivalent single rate under a broad-market AA yield curve constructed by an outside consultant. We utilized a discount rate of 5.90% for year-end 2006. The 60 basis point increase in the discount rate decreased the projected pension benefit obligation as of February 2, 2008, by approximately $184.

To determine the expected return on pension plan assets, the Company contemplates current and forecasted plan asset allocations as well as historical and forecasted returns on various asset categories. The average annual return on pension plan assets was 8.5% for the ten calendar years ended December 31, 2007, net of all fees and expenses. Our actual return for the pension plan calendar year ending December 31, 2007, on that same basis, was 9.5%. The Company utilized a pension return assumption of 8.5% in 2007, 2006 and 2005.

The Company uses the RP-2000 projected 2015 mortality table in calculating the pension obligation.

	Pension Benefits
	Qualified Plans						Non-Qualified Plan			Other Benefits
	2007		2006		2005		2007	2006	2005	2007		2006		2005
Components of
net periodic benefit cost:
Service cost	$ 42		$ 123		$ 118		$ 2	$ 2	$ 1	$ 10		$ 13		$ 12
Interest cost	141		130		113		9	6	6	19		20		19
Expected return
on plan assets	(165	)	(152	)	(130	)	—	—	—	—		—		—
Amortization of:
Transition asset	—		(1	)	(1	)	—	—	—	—		—		—
Prior service
cost	1		3		3		2	2	2	(6	)	(7	)	(7	)
Actuarial (gain)
loss	31		41		24		6	2	2	—		—		—
Curtailment
charge	—		5		—		—	—	—	—		—		—
Net periodic
benefit cost	$ 50		$ 149		$ 127		$ 19	$ 12	$ 11	$ 23		$ 26		$ 24

The following table provides the projected benefit obligation (“PBO”), accumulated benefit obligation (“ABO”) and the fair value of plan assets for all Company-sponsored pension plans.

	Qualified Plans — 2007	2006	Non-Qualified Plan — 2007	2006
PBO at end of
fiscal year	$ 2,342	$ 2,419	$ 139	$ 113
ABO at end of
fiscal year	$ 2,144	$ 2,232	$ 118	$ 103
Fair value of
plan assets at end of year	$ 2,230	$ 2,098	$ —	$ —

The following table provides information about the Company’s estimated future benefit payments.

	Pension Benefits	Other Benefits
2008	$ 139	$ 22
2009	$ 141	$ 24
2010	$ 145	$ 25
2011	$ 151	$ 26
2012	$ 159	$ 26
2013 - 2017	$ 932	$ 145

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The Company discontinued the accrual of additional benefits under the Company’s cash balance formula of the Consolidated Retirement Benefit Plan (the “Cash Balance Plan”) effective January 1, 2007. Participants in the Cash Balance Plan will continue to earn interest credits on their accrued benefit balance as of December 31, 2006, based on average Treasury rates, but will no longer accrue cash balance pay credits under the Cash Balance Plan after December 31, 2006. Projected pension benefit payments, as noted above, are lower than estimates in prior years as a result of the discontinuation of benefit accruals under the Cash Balance Plan. As a result of the decision to curtail benefits under the Cash Balance Plan, the Company recorded a charge totaling $5, pre-tax, in fiscal 2006, which represented the previously unrecognized prior service costs.

Net periodic benefit cost decreased in 2007 compared to 2006 and 2005 due to participants in the Cash Balance formula of the Consolidated Retirement Benefit Plan being moved to a 401(k) retirement savings account plan effective January 1, 2007. Participants under that formula continue to earn interest on prior contributions but no additional pay credits will be earned. The 401(k) retirement savings plan provides to eligible employees both matching contributions and automatic contributions from Kroger based on participant contributions, plan compensation, and length of service. The Company contributed and expensed $90 to employee 401(k) retirement savings accounts in 2007.

The following table provides information about the target and actual pension plan asset allocations. Allocation percentages are shown as of December 31 for each respective year. The pension plan measurement date is the December 31 st nearest the fiscal year-end.

	Target allocations — 2007	Actual allocations — 2007	2006
Pension plan asset
allocation, as of December 31:
Domestic equity
securities	17.5 %	15.2 %	21.1 %
International
equity securities	20.5	21.4	27.5
Investment grade
debt securities	21.8	21.6	23.3
High yield debt
securities	9.7	9.9	7.7
Private equity	5.0	5.9	4.9
Hedge funds	17.0	17.2	7.4
Real estate	1.4	1.7	1.4
Other	7.1	7.1	6.7
Total	100.0 %	100.0 %	100.0 %

Investment objectives, policies and strategies are set by the Pension Investment Committee (the “Committee”) appointed by the CEO. The primary objectives include holding, protecting and investing the assets and distributing benefits to participants and beneficiaries of the pension plans. Investment objectives have been established based on a comprehensive review of the capital markets and each underlying plan’s current and projected financial requirements. The time horizon of the investment objectives is long-term in nature and plan assets are managed on a going-concern basis.

Investment objectives and guidelines specifically applicable to each manager of assets are established and reviewed annually. Derivative instruments may be used for specified purposes. Any use of derivative instruments for a purpose or in a manner not specifically authorized is prohibited, unless approved in advance by the Committee.

The current target allocations shown represent 2007 targets that were established in 2006. To maintain actual asset allocations consistent with target allocations, assets are reallocated or rebalanced periodically. In addition, cash flow from employer contributions and participant benefit payments is used to fund underweight asset classes and divest overweight asset classes, as appropriate. The Company expects that cash flow will be sufficient to meet most rebalancing needs. Although the Company is not required to make cash contributions to its Company-sponsored pension plans during fiscal 2008, contributions may be made if required under the Pension Protection Act to avoid any benefit restrictions. The Company expects any voluntary contributions made during 2008 will reduce its minimum required contributions in future years.

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The measurement date for post-retirement benefit obligations is the December 31 st nearest the fiscal year-end. Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. The Company used a 8.50% initial health care cost trend rate and a 5.00% ultimate health care cost trend rate to determine its expense. A one-percentage-point change in the assumed health care cost trend rates would have the following effects:

| Effect on total
of service and interest cost components | 1% Point Increase — $ 4 | 1% Point Decrease — $ (3 | ) |
| --- | --- | --- | --- |
| Effect on
postretirement benefit obligation | $ 32 | $ (28 | ) |

On December 8, 2003, the President signed into law the Medicare Prescription Drug Improvement and Modernization Act of 2003. The law provides for a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit at least actuarially equivalent to the benefit established by the law. The Company has concluded that the plan is at least “actuarially equivalent” to the Medicare Part D plan for certain covered groups only and will be eligible for the subsidy for those groups. The effect of the subsidy reduced the Company’s postretirement benefit obligation as of February 2, 2008 and February 3, 2007 by $4 and $6, respectively, and did not have a material effect on the Company’s net periodic benefit cost in either of those years. The remaining groups’ benefits are not “actuarially equivalent” to the Medicare Part D plan, and the Company has made the decision to pay as secondary coverage to Medicare Part D for those groups.

The Company also contributes to various multi-employer pension plans based on obligations arising from most of its collective bargaining agreements. These plans provide retirement benefits to participants based on their service to contributing employers. The benefits are paid from assets held in trust for that purpose. Trustees are appointed in equal number by employers and unions. The trustees typically are responsible for determining the level of benefits to be provided to participants as well as for such matters as the investment of the assets and the administration of the plans.

The Company recognizes expense in connection with these plans as contributions are funded, in accordance with GAAP. The Company made contributions to these plans, and recognized expense, of $207 in 2007, $204 in 2006, and $196 in 2005.

Based on the most recent information available to it, the Company believes that the present value of actuarial accrued liabilities in most or all of these multi-employer plans substantially exceeds the value of the assets held in trust to pay benefits. Although underfunding can result in the imposition of excise taxes on contributing employers, factors such as increased contributions, increased asset values or future service benefit changes can reduce underfunding so that excise taxes are not triggered. Moreover, if the Company were to exit certain markets or otherwise cease making contributions to these funds, the Company could trigger a substantial withdrawal liability. Any adjustment for withdrawal liability will be recorded when it is probable that a liability exists and can be reasonably estimated, in accordance with GAAP.

The Company also administers other defined contribution plans for eligible union and non-union employees. The cost of these plans for 2007, 2006 and 2005 was $8.

*15. RECENTLY ADOPTED ACCOUNTING STANDARDS*

Effective February 4, 2007, the Company adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109 (“FIN No. 48”), which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.

The effect of adoption was to increase retained earnings by $4 and to decrease the Company’s accrual for uncertain tax positions by a corresponding amount. Additionally, the Company decreased goodwill and accrual for uncertain tax positions by $72 to reflect the measurement under the rules of FIN No. 48 of an uncertain tax position related to previous business combinations.

As of adoption, the total amount of unrecognized tax benefits for uncertain tax positions, including positions affecting only the timing of tax benefits, was $694. The amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate was $119.

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To the extent interest and penalties would be assessed by taxing authorities on any underpayment of income tax, such amounts have been accrued and classified as a component of income tax expense in the Company’s Condensed Consolidated Statements of Operations. This accounting policy election is a continuation of the Company’s historical policy. As of February 4, 2007, the amount of accrued interest and penalties included on the Condensed Consolidated Balance Sheets was $118.

The IRS concluded a field examination of the Company’s 2002 – 2004 U.S. tax returns during the third quarter of 2007. An examination of the Company’s 1999 – 2001 U.S. tax returns was completed in 2005. The Company contested two issues at the appellate level of the IRS. One of the issues was resolved in the third quarter of 2007 and the Company anticipates that the remaining issue may be resolved within the next 12 months. In the opinion of management, the ultimate disposition of the item noted above will not have a significant effect on the Company’s consolidated financial position, liquidity, or results of operations. Additionally, The Company has a case in the U.S. Tax Court. A decision on this case is not expected within the next 12 months. In connection with this case, the Company has extended the statute of limitations on its tax years after 1991.

As a result of settlements with taxing authorities during the third quarter, the Company reclassified unrecognized tax benefits of $168 from other long-term liabilities to deferred income taxes and accrued taxes payable. See Note 4 for further discussion of the adoption of FIN 48.

Effective February 3, 2007, the Company adopted the recognition and disclosure provisions of SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans-an amendment of FASB Statement No. 87, 99, 106 and 132(R), which requires the recognition of the funded status of its retirement plans on the Consolidated Balance Sheet. Actuarial gains or losses, prior service costs or credits and transition obligations that have not yet been recognized are required to be recorded as a component of Accumulated Other Comprehensive Income (“AOCI”). The Company currently uses a December 31 measurement date. Effective for 2008, the statement also requires an employer to measure the funded status of a plan as of the date of its year-end statement of financial position. The Company will adopt the measurement date change in fiscal 2008. See Note14 for further discussion of the adoption of SFAS 158.

Effective January 29, 2006, the Company adopted the provisions of SFAS No. 123(R), Share-Based Payment, using the modified-prospective method. Under this method, the Company recognizes compensation expense for all share-based awards granted prior to, but not yet vested as of, January 29, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, Accounting for Stock-Based Compensation. For all share-based awards granted on or after January 29, 2006, the Company recognizes compensation expense based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R). See Note10 for further discussion of the adoption of SFAS 123(R).

*16. R ECENTLY I SSUED A CCOUNTING S TANDARDS*

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurement . SFAS No. 157 defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurement. SFAS No. 157 does not require any new fair value measurements. SFAS No. 157 will become effective for the Company’s fiscal year beginning February 3, 2008. The Company is evaluating the effect the implementation of SFAS No. 157 will have on its Consolidated Financial Statements.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115. SFAS No. 159 permits entities to make an irrevocable election to measure certain financial instruments and other assets and liabilities at fair value on an instrument-by-instrument basis. Unrealized gains and losses on items for which the fair value option has been elected should be recognized into net earnings at each subsequent reporting date. SFAS No. 159 will be become effective for the Company’s fiscal year beginning February 3, 2008. The Company is currently evaluating the effect the adoption of SFAS No. 159 will have on its Consolidated Financial Statements.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements-an amendment of ARB No. 51. SFAS No. 160 will require the consolidation of noncontrolling interests as a component of equity. SFAS No. 160 will become effective for the Company’s fiscal year beginning February 1, 2009. The Company is currently evaluating the effect the adoption of SFAS No. 160 will have on its Consolidated Financial Statements.

In December 2007, the FASB issued SFAS No. 141 (Revised 2007), Business Combinations (SFAS No. 141R) , which replaces SFAS No. 141 . SFAS No. 141R further expands the definitions of a business and the fair value measurement and reporting in a business combination. SFAS No. 141R will become effective for the Company’s fiscal year beginning February 1, 2009. The Company is currently evaluating the effect the adoption of SFAS No. 141R will have on its Consolidated Financial Statements.

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In March 2007, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities. SFAS No. 161 requires enhanced disclosures on an entity’s derivative and hedging activities. SFAS No. 161 will become effective for the Company’s fiscal year beginning February 1, 2009. The Company is currently evaluating the effect the adoption of SFAS No. 161 will have on its Consolidated Financial Statements.

*17. G UARANTOR S UBSIDIARIES*

The Company’s outstanding public debt (the “Guaranteed Notes”) is jointly and severally, fully and unconditionally guaranteed by The Kroger Co. and some of its subsidiaries (the “Guarantor Subsidiaries”). At February 2, 2008, a total of approximately $6,766 of Guaranteed Notes was outstanding. The Guarantor Subsidiaries and non-guarantor subsidiaries are wholly-owned subsidiaries of The Kroger Co. Separate financial statements of The Kroger Co. and each of the Guarantor Subsidiaries are not presented because the guarantees are full and unconditional and the Guarantor Subsidiaries are jointly and severally liable. The Company believes that separate financial statements and other disclosures concerning the Guarantor Subsidiaries would not be material to investors.

The non-guaranteeing subsidiaries represent less than 3% on an individual and aggregate basis of consolidated assets, pre-tax earnings, cash flow, and equity. Therefore, the non-guarantor subsidiaries’ information is not separately presented in the tables below.

There are no current restrictions on the ability of the Guarantor Subsidiaries to make payments under the guarantees referred to above, except, however, the obligations of each guarantor under its guarantee are limited to the maximum amount as will result in obligations of such guarantor under its guarantee not constituting a fraudulent conveyance or fraudulent transfer for purposes of Bankruptcy Law, the Uniform Fraudulent Conveyance Act, the Uniform Fraudulent Transfer Act, or any similar Federal or state law (e.g., adequate capital to pay dividends under corporate laws).

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The following tables present summarized financial information as of February 2, 2008 and February 3, 2007 and for the three years ended February 2, 2008.

*Condensed Consolidating*

*Balance Sheets*

*As of February 2, 2008*

	The Kroger Co.	Guarantor Subsidiaries	Eliminations		Consolidated
Current assets
Cash and
temporary cash investments	$ 26	$ 216	$ —		$ 242
Deposits
in-transit	76	600	—		676
Receivables	152	2,515	(1,881	)	786
Net inventories	420	4,435	—		4,855
Prepaid and
other current assets	373	182	—		555
Total current
assets	1,047	7,948	(1,881	)	7,114
Property, plant
and equipment, net	1,684	10,814	—		12,498
Goodwill	56	2,088	—		2,144
Adjustment to
reflect fair value interest rate hedges	11	—	—		11
Other assets	1,412	657	(1,537	)	532
Investment in
and advances to subsidiaries	11,979	—	(11,979	)	—
Total Assets	$ 16,189	$ 21,507	$ (15,397	)	$ 22,299
Current
liabilities
Current portion
of long-term debt including obligations under capital leases and financing
obligations	$ 1,592	$ —	$ —		$ 1,592
Accounts payable	1,822	5,646	(3,418	)	4,050
Other current
liabilities	—	3,045	—		3,045
Total current
liabilities	3,414	8,691	(3,418	)	8,687
Long-term debt
including obligations under capital leases and financing obligations
Face value
long-term debt including obligations under capital leases and financing
obligations	6,485	—	—		6,485
Adjustment to
reflect fair value interest rate hedges	44	—	—		44
Long-term debt
including obligations under capital leases and financing obligations	6,529	—	—		6,529
Other long-term
liabilities	1,332	837	—		2,169
Total
Liabilities	11,275	9,528	(3,418	)	17,385
Shareowners’
Equity	4,914	11,979	(11,979	)	4,914
Total
Liabilities and Shareowners’ equity	$ 16,189	$ 21,507	$ (15,397	)	$ 22,299

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*Condensed Consolidating*

*Balance Sheets*

*As of February 3, 2007*

	The Kroger Co.	Guarantor Subsidiaries	Eliminations		Consolidated
Current assets
Cash and
temporary cash investments	$ 25	$ 164	$ —		$ 189
Deposits
in-transit	69	545	—		614
Receivables	168	1,982	(1,372	)	778
Net inventories	406	4,203	—		4,609
Prepaid and
other current assets	371	194	—		565
Total current
assets	1,039	7,088	(1,372	)	6,755
Property, plant
and equipment, net	1,429	10,350	—		11,779
Goodwill	56	2,136	—		2,192
Other assets	1,184	612	(1,307	)	489
Investment in
and advances to subsidiaries	11,510	—	(11,510	)	—
Total Assets	$ 15,218	$ 20,186	$ (14,189	)	$ 21,215
Current
liabilities
Current portion
of long-term debt including obligations under capital leases and financing
obligations	$ 906	$ —	$ —		$ 906
Accounts payable	1,614	4,869	(2,679	)	3,804
Other current
liabilities	—	2,871	—		2,871
Total current
liabilities	2,520	7,740	(2,679	)	7,581
Long-term debt
including obligations under capital leases and financing obligations
Face value
long-term debt including obligations under capital leases and financing
obligations	6,136	—	—		6,136
Adjustment to
reflect fair value interest rate hedges	18	—	—		18
Long-term debt
including obligations under capital leases and financing obligations	6,154	—	—		6,154
Other long-term
liabilities	1,621	936	—		2,557
Total
Liabilities	10,295	8,676	(2,679	)	16,292
Shareowners’
Equity	4,923	11,510	(11,510	)	4,923
Total
Liabilities and Shareowners’ equity	$ 15,218	$ 20,186	$ (14,189	)	$ 21,215

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*Condensed Consolidating*

*Statements of Operations*

*For the Year ended February 2, 2008*

	The Kroger Co.	Guarantor Subsidiaries	Eliminations		Consolidated
Sales	$ 9,022	$ 62,482	$ (1,269	)	$ 70,235
Merchandise
costs, including warehousing and transportation	6,877	48,171	(1,269	)	53,779
Operating,
general and administrative	1,666	10,489	—		12,155
Rent	125	519	—		644
Depreciation and
amortization	148	1,208	—		1,356
Operating profit	206	2,095	—		2,301
Interest expense	468	6	—		474
Equity in
earnings of subsidiaries	1,511	—	(1,511	)	—
Earnings (loss)
before tax expense	1,249	2,089	(1,511	)	1,827
Tax expense	68	578	—		646
Net earnings
(loss)	$ 1,181	$ 1,511	$ (1,511	)	$ 1,181

*Condensed Consolidating*

*Statements of Operations*

*For the Year ended February 3, 2007*

	The Kroger Co.	Guarantor Subsidiaries	Eliminations		Consolidated
Sales	$ 8,731	$ 58,383	$ (1,003	)	$ 66,111
Merchandise
costs, including warehousing and transportation	6,630	44,488	(1,003	)	50,115
Operating,
general and administrative	1,697	10,142	—		11,839
Rent	132	517	—		649
Depreciation and
amortization	136	1,136	—		1,272
Operating profit	136	2,100	—		2,236
Interest expense	480	8	—		488
Equity in
earnings of subsidiaries	1,843	—	(1,843	)	—
Earnings before
income tax expense	1,499	2,092	(1,843	)	1,748
Income tax
expense	384	249	—		633
Net earnings	$ 1,115	$ 1,843	$ (1,843	)	$ 1,115

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*Condensed Consolidating*

*Statements of Operations*

*For the Year ended January 28, 2006*

Sales	The Kroger Co. — $ 8,693		Guarantor Subsidiaries — $ 52,822	Eliminations — $ (962	)	Consolidated — $ 60,553
Merchandise
costs, including warehousing and transportation	6,502		40,021	(958	)	45,565
Operating,
general and administrative	1,657		9,368	2		11,027
Rent	165		502	(6	)	661
Depreciation and
amortization	139		1,126	—		1,265
Operating profit	230		1,805	—		2,035
Interest expense	498		12	—		510
Equity in
earnings of subsidiaries	1,164		—	(1,164	)	—
Earnings before
income tax expense	896		1,793	(1,164	)	1,525
Income tax
expense (benefit)	(62	)	629	—		567
Net earnings	$ 958		$ 1,164	$ (1,164	)	$ 958

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*Condensed Consolidating*

*Statements of Cash Flows*

*For the Year ended February 2, 2008*

| Net cash (used) provided
by operating activities | The Kroger Co. — $ (433 | ) | Guarantor Subsidiaries — $ 3,014 | | Consolidated — $ 2,581 | |
| --- | --- | --- | --- | --- | --- | --- |
| Cash flows from
investing activities: | | | | | | |
| Payments for
capital expenditures | (210 | ) | (1,916 | ) | (2,126 | ) |
| Other | (29 | ) | (63 | ) | (92 | ) |
| Net cash used by
investing activities | (239 | ) | (1,979 | ) | (2,218 | ) |
| Cash flows from
financing activities: | | | | | | |
| Proceeds from
issuance of long-term debt | 1,590 | | — | | 1,590 | |
| Payments on
long-term debt | (560 | ) | — | | (560 | ) |
| Proceeds from
issuance of capital stock | 224 | | — | | 224 | |
| Treasury stock
purchases | (1,421 | ) | — | | (1,421 | ) |
| Dividends paid | (202 | ) | — | | (202 | ) |
| Other | — | | 59 | | 59 | |
| Net change in
advances to subsidiaries | 1,042 | | (1,042 | ) | — | |
| Net cash (used) provided
by financing activities | 673 | | (983 | ) | (310 | ) |
| Net decrease in
cash and temporary cash investments | 1 | | 52 | | 53 | |
| Cash and
temporary cash investments: | | | | | | |
| Beginning of
year | 25 | | 164 | | 189 | |
| End of year | $ 26 | | $ 216 | | $ 242 | |

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*Condensed Consolidating*

*Statements of Cash Flows*

*For the Year ended February 3, 2007*

| Net cash
provided by operating activities | The Kroger Co. — $ 152 | | Guarantor Subsidiaries — $ 2,199 | | Consolidated — $ 2,351 | |
| --- | --- | --- | --- | --- | --- | --- |
| Cash flows from
investing activities: | | | | | | |
| Payments for
capital expenditures | (143 | ) | (1,540 | ) | (1,683 | ) |
| Other | 56 | | 40 | | 96 | |
| Net cash used by
investing activities | (87 | ) | (1,500 | ) | (1,587 | ) |
| Cash flows from
financing activities: | | | | | | |
| Proceeds from
issuance of long-term debt | 362 | | — | | 362 | |
| Payments on
long-term debt | (556 | ) | — | | (556 | ) |
| Proceeds from
issuance of capital stock | 168 | | — | | 168 | |
| Treasury stock
purchases | (633 | ) | — | | (633 | ) |
| Dividends paid | (140 | ) | — | | (140 | ) |
| Other | 18 | | (4 | ) | 14 | |
| Net change in
advances to subsidiaries | 702 | | (702 | ) | — | |
| Net cash used by
financing activities | (79 | ) | (706 | ) | (785 | ) |
| Net decrease in
cash and temporary cash investments | (14 | ) | (7 | ) | (21 | ) |
| Cash and
temporary cash investments: | | | | | | |
| Beginning of
year | 39 | | 171 | | 210 | |
| End of year | $ 25 | | $ 164 | | $ 189 | |

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*Condensed Consolidating*

*Statements of Cash Flows*

*For the Year ended January 28, 2006*

| Net cash
provided by operating activities | The Kroger Co. — $ 1,171 | | Guarantor Subsidiaries — $ 1,021 | | Consolidated — $ 2,192 | |
| --- | --- | --- | --- | --- | --- | --- |
| Cash flows from
investing activities: | | | | | | |
| Payments fro
capital expenditures | (188 | ) | (1,118 | ) | (1,306 | ) |
| Other | 11 | | 16 | | 27 | |
| Net cash used by
investing activities | (177 | ) | (1,102 | ) | (1,279 | ) |
| Cash flows from
financing activities: | | | | | | |
| Proceeds from
issuance of long-term debt | 14 | | — | | 14 | |
| Payments on
long-term debt | (764 | ) | (33 | ) | (797 | ) |
| Proceeds from
issuance of capital stock | 78 | | — | | 78 | |
| Treasury stock
purchases | (252 | ) | — | | (252 | ) |
| Other | 77 | | 33 | | (110 | ) |
| Net change in
advances to subsidiaries | (140 | ) | 140 | | — | |
| Net cash
provided (used) by financing activities | (987 | ) | 140 | | (847 | ) |
| Net increase in
cash and temporary cash investments | 7 | | 59 | | 66 | |
| Cash and
temporary cash investments: | | | | | | |
| Beginning of
year | 32 | | 112 | | 144 | |
| End of year | $ 39 | | $ 171 | | $ 210 | |

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*18. Q UARTERLY D ATA (U NAUDITED )*

2007	Quarter — First (16 Weeks)	Second (12 Weeks)	Third (12 Weeks)	Fourth (12 Weeks)	Total Year (52 Weeks)
Sales	$ 20,726	$ 16,139	$ 16,135	$ 17,235	$ 70,235
Net
earnings	$ 337	$ 267	$ 254	$ 323	$ 1,181
Net
earnings per basic common share	$ 0.48	$ 0.38	$ 0.37	$ 0.48	$ 1.71
Average
number of shares used in basic calculation	706	702	678	668	690
Net
earnings per diluted common share	$ 0.47	$ 0.38	$ 0.37	$ 0.48	$ 1.69
Average
number of shares used in diluted calculation	715	709	685	676	698

2006	Quarter — First (16 Weeks)	Second (12 Weeks)	Third (12 Weeks)	Fourth (13 Weeks)	Total Year (53 Weeks)
Sales	$ 19,415	$ 15,138	$ 14,699	$ 16,859	$ 66,111
Net earnings	$ 306	$ 209	$ 215	$ 385	$ 1,115
Net earnings per
basic common share	$ 0.42	$ 0.29	$ 0.30	$ 0.55	$ 1.56
Average number
of shares used in basic calculation	722	719	712	706	715
Net earnings per
diluted common share	$ 0.42	$ 0.29	$ 0.30	$ 0.54	$ 1.54
Average number
of shares used in diluted calculation	729	725	720	715	723

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

None.

ITEM 9A. CONTROLS AND PROCEDURES.

As of February 2, 2008, the Chief Executive Officer and the Chief Financial Officer, together with a disclosure review committee appointed by the Chief Executive Officer, evaluated Kroger’s disclosure controls and procedures. Based on that evaluation, Kroger’s Chief Executive Officer and Chief Financial Officer concluded that Kroger’s disclosure controls and procedures were effective as of February 2, 2008.

*C HANGES IN I NTERNAL C ONTROL O VER F INANCIAL R EPORTING*

There was no change in Kroger’s internal control over financial reporting during the fiscal quarter ended February 2, 2008, that has materially affected, or is reasonably likely to materially affect, Kroger’s internal control over financial reporting.

*M ANAGEMENT’S R EPORT ON I NTERNAL C ONTROL O VER F INANCIAL R EPORTING*

The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. With the participation of the Chief Executive Officer and the Chief Financial Officer, our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework and criteria established in Internal Control – Integrated Framework , issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that the Company’s internal control over financial reporting was effective as of February 2, 2008.

The effectiveness of the Company’s internal control over financial reporting as of February 2, 2008, has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report, which can be found in Item 8 of this Form 10-K.

ITEM 9B. OTHER INFORMATION.

None.

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*PART III*

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.

The information required by this Item not otherwise set forth below is set forth under the headings Election of Directors and Information Concerning the Board of Directors in the definitive proxy statement to be filed by the Company with the Securities and Exchange Commission and is hereby incorporated by reference into this Form 10-K.

SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Based solely on its review of the copies of all Section 16(a) forms received by the Company, or written representations from certain persons that no Forms 5 were required by those persons, the Company believes that during fiscal year 2007 all filing requirements applicable to its officers, directors and 10% beneficial owners were timely satisfied, with three exceptions. M. Elizabeth Van Oflen filed a Form 4 reporting a 2006 restricted stock award that was not reported on a prior Form 4, Don McGeorge filed a Form 5 reporting his wife’s sale of a fractional share from her Company 401(k) account that was not reported on a prior Form 4, and Susan Phillips filed a Form 5 reporting shares purchased through dividend reinvestment in 2007 that was not reported on a prior Form 4.

EXECUTIVE OFFICERS OF THE COMPANY

The following is a list of the names and ages of the executive officers and the positions held by each such person or those chosen to become executive officers as of March 28, 2008. Except as otherwise noted, each person has held office for at least five years. Each officer will hold office at the discretion of the Board for the ensuing year until removed or replaced.

Name	Age	Recent Employment History
Donald
E. Becker	59	Mr. Becker
was elected Executive Vice President on September 16, 2004 and Senior
Vice President on January 26, 2000. Prior to his election,
Mr. Becker was appointed President of the Company’s Central Marketing
Area in 1996. Before this, Mr. Becker served in a number of key
management positions in the Company’s Cincinnati/Dayton Marketing Area,
including Vice President of Operations and Vice President of Merchandising. He
joined the Company in 1969.
William
T. Boehm	60	Mr. Boehm
was elected Senior Vice President and President, Manufacturing on May 6,
2004. Prior to that he was elected Group Vice President, Logistics effective
April 29, 2001. Mr. Boehm joined the Company in 1981 as Director of
Economic Research. He was promoted to Vice President, Corporate Planning and
Research in 1986. He was named Vice President Grocery Procurement in 1989 and
Vice President of Logistics in 1994.
David
B. Dillon	57	Mr. Dillon
was elected Chairman of the Board on June 24, 2004 and Chief Executive
Officer effective June 26, 2003. Prior to this, he was elected President
and Chief Operating Officer effective January 26, 2000. Upon the merger
with Fred Meyer, Inc., he was named President of the combined Company.
Prior thereto, Mr. Dillon was elected President and Chief Operating
Officer of Kroger effective June 18, 1995. Prior to this he was elected
Executive Vice President on September 13, 1990, Chairman of the Board of
Dillon Companies, Inc. on September 8, 1992, and President of
Dillon Companies, Inc. on April 22, 1986.
Kevin
M. Dougherty	55	Mr. Dougherty
was elected Group Vice President, Logistics effective May 6, 2004.
Mr. Dougherty joined the Company as Vice President, Supply Chain
Operations in 2001. Before joining the Company, he maintained an independent
consulting practice focusing on logistics and operational performance.

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| Joseph A. Grieshaber, Jr. | 50 | Mr. Grieshaber
was elected Group Vice President, Perishables Merchandising and Procurement,
effective August 4, 2003. Prior to this, he held a variety of management
positions within the Company, most recently serving as Vice President of
Merchandising for the Company’s Great Lakes Marketing Area.
Mr. Grieshaber joined the Company in 1983. |
| --- | --- | --- |
| Paul
W. Heldman | 56 | Mr. Heldman
was elected Executive Vice President effective May 5, 2006, Senior Vice
President effective October 5, 1997, Secretary on May 21, 1992, and
Vice President and General Counsel effective June 18, 1989. Prior to his
election, he held various positions in the Company’s Law Department.
Mr. Heldman joined the Company in 1982. |
| Scott
M. Henderson | 52 | Mr. Henderson
was elected Vice President effective June 26, 2003 and Treasurer
effective January 6, 2002. Mr. Henderson joined the Company in 1981
as Manager of Financial Reporting. He held a variety of management positions
and was promoted to Vice President of Planning in February 2000. |
| Christopher
T. Hjelm | 46 | Mr. Hjelm
joined the Company on August 28, 2005 as Senior Vice President and Chief
Information Officer. From February 2005 to July 2005, he was Chief
Information Officer of Travel Distribution Services for Cendant Corporation.
From July 2003 to November 2004 Mr. Hjelm served as Chief
Technology Officer for Orbitz LLC, which was acquired by Cendant Corporation
in November 2004. Mr. Hjelm served as Senior Vice President for
Technology at eBay Inc. from March 2002 to June 2003, and served as
Executive Vice President for Broadband Network Services for At Home Company
from June 2001 to February 2002. From January 2000 to
June 2001, Mr. Hjelm served as Chairman, President and Chief
Executive Officer of ZOHO Corporation. Prior to that, he held various key
roles for 14 years with Federal Express Corporation, including that of Senior
Vice President and Chief Information Officer. |
| Carver
L. Johnson | 58 | Mr. Johnson
was elected Chief Diversity Officer effective June 22, 2006. Prior to
his election, Mr. Johnson served as Group Vice President of Management
Information Systems. Prior to joining the Company in December 1999, he
served as Vice President and Chief Information Officer of Gymboree. From 1993
to 1998, Mr. Johnson was Senior Systems Director of Corporate Services
for Sears, Roebuck & Co. He previously held management positions
with Jamesway Corp., Linens ‘n Things, and Pay ‘n Save Stores, Inc. |
| Lynn
Marmer | 55 | Ms. Marmer
was elected Group Vice President, Corporate Affairs effective
January 19, 1998. Prior to her election, Ms. Marmer was an attorney
in the Company’s Law Department. Ms. Marmer joined the Company in 1997.
Before joining the Company she was a partner in the law firm of
Dinsmore & Shohl. |
| Don
W. McGeorge | 53 | Mr. McGeorge
was elected President and Chief Operating Officer effective June 26,
2003. Prior to that, he was elected Executive Vice President effective
January 26, 2000 and Senior Vice President effective August 10,
1997. Before his election, Mr. McGeorge was President of the Company’s
Columbus Marketing Area effective December 29, 1996; and prior thereto
President of the Company’s Michigan Marketing Area effective June 20,
1993. Before this he served in a number of key management positions with the
Company, including Vice President of Merchandising of the Company’s Nashville
Marketing Area. Mr. McGeorge joined the Company in 1977. |

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| W. Rodney McMullen | 47 | Mr. McMullen
was elected Vice Chairman effective June 26, 2003. Prior to that he was
elected Executive Vice President, Strategy, Planning and Finance effective
January 26, 2000, Executive Vice President and Chief Financial Officer
effective May 20, 1999, Senior Vice President effective October 5,
1997, and Group Vice President and Chief Financial Officer effective
June 18, 1995. Before that he was appointed Vice President, Control and
Financial Services on March 4, 1993, and Vice President, Planning and
Capital Management effective December 31, 1989. Mr. McMullen joined
the Company in 1978 as a part-time stock clerk. |
| --- | --- | --- |
| M.
Marnette Perry | 56 | Ms. Perry
was elected Senior Vice President effective July 20, 2003. Prior to that
she was elected Group Vice President of Perishables Merchandising and
Procurement on March 3, 2003. Prior to this she held a variety of
significant positions with the Company, including President of the Company’s
Michigan Marketing Area, and President of the Company’s Columbus Marketing
Area. She joined the Company in 1972. |
| J.
Michael Schlotman | 50 | Mr. Schlotman
was elected Senior Vice President effective June 26, 2003, and Group
Vice President and Chief Financial Officer effective January 26, 2000.
Prior to that he was elected Vice President and Corporate Controller in 1995,
and served in various positions in corporate accounting since joining the
Company in 1985. |
| Paul
J. Scutt | 59 | Mr. Scutt
was elected Senior Vice President of Retail Operations on September 16,
2004 and he was elected Group Vice President of Retail Operations effective
May 21, 2002. He has held a number of significant positions with the
Company including Regional Vice President of the Company’s Hutchinson
operations, and most recently as President of the Company’s Central Marketing
Area. |
| M. Elizabeth Van Oflen | 50 | Ms. Van
Oflen was elected Vice President and Controller on April 11, 2003. Prior
to her election, she held various positions in the Company’s Finance and Tax
Departments. Ms. Van Oflen joined the Company in 1982. |
| Della
Wall | 56 | Ms. Wall
was elected Group Vice President, Human Resources effective April 9,
2004. Prior to her election, she held various key positions in the Company’s
human resources department, manufacturing group and drug store division, most
recently serving as Vice President of Human Resources. Ms. Wall joined
the Company in 1971. |
| R.
Pete Williams | 53 | Mr. Williams
was elected Senior Vice President on August 19, 2007. Prior to his
election, Mr. Williams held a variety of key management positions with
the Company, including President of the Company’s Mid-Atlantic Marketing
Area, Vice President of Operations, Vice President of Merchandising, and
Director of Labor Relations. He joined the Company in 1977. |

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ITEM 11. EXECUTIVE COMPENSATION.

The information required by this Item is set forth in the sections entitled Compensation Discussion and Analysis, Compensation Committee Report, and Executive Compensation in the definitive proxy statement to be filed by the Company with the Securities and Exchange Commission and is hereby incorporated by reference into this Form 10-K.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.

The following table provides information regarding shares outstanding and available for issuance under the Company’s existing equity compensation plans.

*Equity Compensation Plan Information*

	(a)	(b)	(c)
			Number of securities
			remaining for future
Plan Category	Number of securities to be issued upon exercise of outstanding options, warrants and rights	Weighted-average exercise price of outstanding options, warrants and rights	issuance under equity compensation plans excluding securities reflected in column (a)
Equity
compensation plans approved by security holders	44,781,032	$ 20.94	10,868,150
Equity
compensation plans not approved by security holders	—	$ —	—
Total	44,781,032	$ 20.94	10,868,150

The remainder of the information required by this Item is set forth in the Beneficial Ownership of Common Stock table in the definitive proxy statement to be filed by the Company with the Securities and Exchange Commission and is hereby incorporated by reference into this Form 10-K.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.

This information required by this Item is set forth in the sections entitled Related Person Transactions and Information Concerning the Board of Directors-Independence in the definitive proxy statement to be filed by the Company with the Securities and Exchange Commission and is hereby incorporated by reference into this Form 10-K.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.

The information required by this Item is set forth in the section entitled Selection of Auditors – Disclosure of Auditor Fees in the definitive proxy statement to be filed by the Company with the Securities and Exchange Commission and is hereby incorporated by reference into this Form 10-K.

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*PART IV*

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.

| (a)1. | Financial
Statements: |
| --- | --- |
| | Report
of Independent Registered Public Accounting Firm |
| | Consolidated
Balance Sheets as of February 2, 2008 and February 3, 2007 |
| | Consolidated
Statements of Operations for the years ended February 2, 2008,
February 3, 2007 and January 28, 2006 |
| | Consolidated
Statements of Cash Flows for the years ended February 2, 2008,
February 3, 2007 and January 28, 2006 |
| | Consolidated
Statement of Changes in Shareowners Equity |
| | Notes
to Consolidated Financial Statements |
| (a)2. | Financial
Statement Schedules: |
| | There
are no Financial Statement Schedules included with this filing for the reason
that they are not applicable or are not required or the information is
included in the financial statements or notes thereto. |
| (a)3.(b) | Exhibits |
| 3.1 | Amended
Articles of Incorporation are hereby incorporated by reference to
Exhibit 3.1 of the Company’s Quarterly Report on Form 10-Q for the
quarter ended May 26, 2007, filed with the SEC on July 3, 2007. |
| 3.2 | The
Company’s regulations are hereby incorporated by reference to
Exhibit 3.2 of the Company’s Quarterly Report on Form 10-Q for the
quarter ended May 20, 2006, filed with the SEC on June 29, 2006. |
| 4.1 | Instruments
defining the rights of holders of long-term debt of the Company and its
subsidiaries are not filed as Exhibits because the amount of debt under each
instrument is less than 10% of the consolidated assets of the Company.
The Company undertakes to file these instruments with the Commission upon
request. |
| 10.1 | Material
Contracts - Non-Employee Directors’ Deferred Compensation Plan. Incorporated
by reference to Appendix J to Exhibit 99.1 of Fred Meyer, Inc.’s
Current Report on Form 8-K dated September 9, 1997, SEC File
No. 1-133339. |
| 10.2 | The
Kroger Co. Deferred Compensation Plan for Independent Directors.
Incorporated by reference to Exhibit 10.3 to the Company’s
Form 10-K for fiscal year ended January 29, 2005. |
| 10.3 | The
Kroger Co. Executive Deferred Compensation Plan. Incorporated by
reference to Exhibit 10.4 to the Company’s Form 10-K for fiscal
year ended January 29, 2005. |
| 10.4 | The
Kroger Co. 401(k) Retirement Savings Account Restoration Plan.
Incorporated by reference to Exhibit 10.4 of The Kroger Co.’s
Form 10-K for the fiscal year ended February 3, 2007. |
| 10.5 | Dillon
Companies, Inc. Excess Benefit Pension Plan. Incorporated by reference
to Exhibit 10.5 of The Kroger Co.’s Form 10-K for the fiscal year
ended February 3, 2007. |
| 10.6 | The
Kroger Co. Supplemental Retirement Plans for Certain Benefit Plan
Participants. Incorporated by reference to Exhibit 10.6 of The Kroger
Co.’s Form 10-K for the fiscal year ended February 3, 2007. |
| 10.7 | 2006
Long-Term Bonus Plan. Incorporated by reference to Exhibit 99.1 of The
Kroger Co.’s Current Report on Form 8-K filed with the SEC on
December 14, 2005. |
| 10.8 | The
Kroger Co. 2005 Long-Term Incentive Plan. Incorporated by reference to
Exhibit 4.2 of The Kroger Co.’s Form S-8 filed with the SEC on
June 23, 2005. |
| 10.9* | Form of
Restricted Stock Grant Agreement under Long-Term Incentive Plans.
Incorporated by reference to Exhibit 10.9 of The Kroger Co.’s
Form 10-K for the fiscal year ended February 3, 2007. |

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| 10.10 | Form of
Non-Qualified Stock Option Grant Agreement under Long-Term Incentive Plans.
Incorporated by reference to Exhibit 10.10 of The Kroger Co.’s
Form 10-K for the fiscal year ended February 3, 2007. |
| --- | --- |
| 10.11 | Five
Year Credit Agreement dated as of November 15, 2006, incorporated by
reference to Exhibit 99.1 of The Kroger Co.’s Current Report on
Form 8-K filed with the SEC on November 20, 2006. |
| 10.12 | 4(2) Commercial
Paper Program Dealer Agreement between The Kroger Co., as Issuer and Banc of
America Securities, LLC, as Dealer dated as of December 3, 2003, as
amended on July 23, 2004, incorporated by reference to
Exhibit 10.15 of The Kroger Co.’s Annual Report on Form 10-K for
the fiscal year ended January 29, 2005. |
| 10.13 | 4(2) Commercial
Paper Program Dealer Agreement between The Kroger Co., as Issuer and
Citigroup Global Markets Inc., as Dealer dated as of December 3, 2003,
as amended on June 9, 2004, incorporated by reference to
Exhibit 10.16 of The Kroger Co.’s Annual Report on Form 10-K for
the fiscal year ended January 29, 2005. |
| 10.14 | Disclosure
of compensation of non-employee directors. Incorporated by reference to Item
2.02 of The Kroger Co.’s Form 8-K dated December 10, 2004. |
| 10.15 | The
Kroger Co. Employee Protection Plan dated December 13, 2007. |
| 10.16 | 2008
Long-Term Bonus Plan. |
| 12.1 | Statement
of Computation of Ratio of Earnings to Fixed Charges. |
| 21.1 | Subsidiaries
of the Registrant. |
| 23.1 | Consent
of Independent Registered Public Accounting Firm. |
| 24.1 | Powers
of Attorney. |
| 31.1 | Rule 13a-14(a)/15d-14(a) Certification. |
| 31.2 | Rule 13a-14(a)/15d-14(a) Certification. |
| 32.1 | Section 1350
Certifications |

• Management contract or compensatory plan or arrangement.

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*SIGNATURES*

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

| Dated:
April 1, 2008 | THE
KROGER CO. — By | (David
B. Dillon) |
| --- | --- | --- |
| | David
B. Dillon | |
| | Chief
Executive Officer | |
| | (principal
executive officer) | |
| Dated:
April 1, 2008 | By | (J.
Michael Schlotman) |
| | J.
Michael Schlotman | |
| | Chief
Financial Officer | |
| | (principal
financial officer) | |
| Dated:
April 1, 2008 | By | (*M.
Elizabeth Van Oflen) |
| | M.
Elizabeth Van Oflen | |
| | Vice
President & Controller | |
| | (principal
accounting officer) | |

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities indicated on the 1st of April 2008.

| (Reuben
V. Anderson) | Director |
| --- | --- |
| Reuben
V. Anderson | |
| (Robert
D. Beyer) | Director |
| Robert
D. Beyer | |
| (John
L. Clendenin) | Director |
| John
L Clendenin | |
| (David
B. Dillon) | Chairman,
Chief Executive Officer and Director |
| David
B. Dillon | |
| (Susan
J. Kropf) | Director |
| Susan
J. Kropf | |
| (John
T. LaMacchia) | Director |
| John
T. LaMacchia | |
| (David
B. Lewis) | Director |
| David
B. Lewis | |
| (Don
W. McGeorge) | President,
Chief Operating Officer, and Director |
| Don
W. McGeorge | |
| (W.
Rodney McMullen) | Vice
Chairman and Director |
| W.
Rodney McMullen | |
| (Jorge
P. Montoya) | Director |
| Jorge
P. Montoya | |
| (*Clyde
R. Moore) | Director |
| Clyde
R. Moore | |

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| (Katherine
D. Ortega) | Director |
| --- | --- |
| Katherine
D. Ortega | |
| (Susan
M. Phillips) | Director |
| Susan
M. Phillips | |
| (Steven
R. Rogel) | Director |
| Steven
R. Rogel | |
| (James
A. Runde) | Director |
| James
A. Runde | |
| (Ronald
L. Sargent) | Director |
| Ronald
L. Sargent | |
| (Bobby
S. Shackouls) | Director |
| Bobby
S. Shackouls | |

By:
Bruce
M. Gack
Attorney-in-fact

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*EXHIBIT INDEX*

Exhibit No.
3.1	Amended
Articles of Incorporation are hereby incorporated by reference to
Exhibit 3.1 of the Company’s Quarterly Report on Form 10-Q for the
quarter ended May 20, 2006, filed with the SEC on June 29, 2006.
3.2	The
Company’s regulations are hereby incorporated by reference to
Exhibit 3.2 of the Company’s Quarterly Report on Form 10-Q for the
quarter ended May 26, 2007, filed with the SEC on July 3, 2007.
4.1	Instruments
defining the rights of holders of long-term debt of the Company and its
subsidiaries are not filed as Exhibits because the amount of debt under each
instrument is less than 10% of the consolidated assets of the Company.
The Company undertakes to file these instruments with the Commission upon
request.
10.1*	Material
Contracts - Non-Employee Directors’ Deferred Compensation Plan. Incorporated
by reference to Appendix J to Exhibit 99.1 of Fred Meyer, Inc.’s
Current Report on Form 8-K dated September 9, 1997, SEC File
No. 1-133339.
10.2*	The
Kroger Co. Deferred Compensation Plan for Independent Directors.
Incorporated by reference to Exhibit 10.3 to the Company’s Form 10-K
for fiscal year ended January 29, 2005.
10.3*	The
Kroger Co. Executive Deferred Compensation Plan. Incorporated by
reference to Exhibit 10.4 to the Company’s Form 10-K for fiscal
year ended January 29, 2005.
10.4*	The
Kroger Co. 401(k) Retirement Savings Account Restoration Plan.
Incorporated by reference to Exhibit 10.4 of The Kroger Co.’s
Form 10-K for the fiscal year ended February 3, 2007.
10.5*	Dillon
Companies, Inc. Excess Benefit Pension Plan. Incorporated by reference
to Exhibit 10.5 of The Kroger Co.’s Form 10-K for the fiscal year
ended February 3, 2007.
10.6*	The
Kroger Co. Supplemental Retirement Plans for Certain Benefit Plan
Participants. Incorporated by reference to Exhibit 10.6 of The Kroger
Co.’s Form 10-K for the fiscal year ended February 3, 2007.
10.7*	2006
Long Term Bonus Plan. Incorporated by reference to Exhibit 99.1 of The
Kroger Co.’s Current Report on Form 8-K filed with the SEC on
December 14, 2005.
10.8*	The
Kroger Co. 2005 Long-Term Incentive Plan. Incorporated by reference to
Exhibit 4.2 of The Kroger Co.’s Form S-8 filed with the SEC on
June 23, 2005.
10.9*	Form of
Restricted Stock Grant Agreement under Long-Term Incentive Plans.
Incorporated by reference to Exhibit 10.9 of The Kroger Co.’s
Form 10-K for the fiscal year ended February 3, 2007.
10.10*	Form of
Non-Qualified Stock Option Grant Agreement under Long-Term Incentive Plans.
Incorporated by reference to Exhibit 10.10 of The Kroger Co.’s
Form 10-K for the fiscal year ended February 3, 2007.
10.11	Five
Year Credit Agreement dated as of November 15, 2006, incorporated by
reference to Exhibit 99.1 of The Kroger Co.’s Current Report on
Form 8-K filed with the SEC on November 20, 2006.
10.12	4(2) Commercial
Paper Program Dealer Agreement between The Kroger Co., as Issuer and Banc of
America Securities, LLC, as Dealer dated as of December 3, 2003, as
amended on July 23, 2004, incorporated by reference to
Exhibit 10.15 of The Kroger Co.’s Annual Report on Form 10-K for
the fiscal year ended January 29, 2005.
10.13	4(2) Commercial
Paper Program Dealer Agreement between The Kroger Co., as Issuer and
Citigroup Global Markets Inc., as Dealer dated as of December 3, 2003,
as amended on June 9, 2004, incorporated by reference to
Exhibit 10.16 of The Kroger Co.’s Annual Report on Form 10-K for
the fiscal year ended January 29, 2005.

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| 10.14 | Disclosure
of compensation of non-employee directors. Incorporated by reference to Item
2.02 of The Kroger Co.’s Form 8-K dated December 10, 2004. |
| --- | --- |
| 10.15 | The
Kroger Co. Employee Protection Plan. |
| 10.16* | 2008
Long-Term Bonus Plan. |
| 12.1 | Statement
of Computation of Ratio of Earnings to Fixed Charges. |
| 21.1 | Subsidiaries
of the Registrant. |
| 23.1 | Consent
of Independent Registered Public Accounting Firm. |
| 24.1 | Powers
of Attorney. |
| 31.1 | Rule 13a-14(a)/15d-14(a) Certification. |
| 31.2 | Rule 13a-14(a)/15d-14(a) Certification. |
| 32.1 | Section 1350
Certifications |

• Management contract or compensatory plan or arrangement.

80

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