The last three fiscal years consist of the 53-week period ended January 3, 2009 ("fiscal 2008" or "2008"), the 52-week period ended December 29, 2007 ("fiscal 2007" or "2007") and the 52-week period ended December 30, 2006 ("fiscal 2006" or "2006").

Results of Operations

Economic Outlook The current economic environment has made consumers more cautious. This could lead to reduced consumer spending, to consumers trading down to a less expensive mix of products or to consumers trading down to discounters for grocery items, all of which could affect Safeway's sales growth. Additionally, in this uncertain economy, it is difficult to forecast whether we are entering a period of inflation or deflation. In 2008, Safeway experienced overall inflation, while early indications suggest that there may be deflation in certain product categories in 2009. Food deflation could reduce sales growth, while food inflation, combined with reduced consumer spending, could reduce gross profit margins.

However, in a slowing economy, some customers may trade down from dining out in restaurants to shopping more at grocery stores such as Safeway and from purchasing national brand products to purchasing less expensive Safeway private label brands. Additionally, when fuel prices are high, consumers may switch from shopping at more remote club and discount stores to Safeway's more convenient neighborhood locations.

Safeway reported net income of $965.3 million ($2.21 per diluted share) in 2008, $888.4 million ($1.99 per diluted share) in 2007 and $870.6 million ($1.94 per diluted share) in 2006. Results in fiscal 2006 were affected by a $62.6 million reduction of income tax expense which is described in this report under the caption "Income Taxes."

Sales Same-store sales increases for the past three fiscal years were as follows:

                                  Fiscal 2008 *                                Fiscal 2007                                 Fiscal 2006
                       Comparable-         Identical-store         Comparable-         Identical-store         Comparable-         Identical-store
                       store sales            sales **             store sales            sales **             store sales            sales **
Including fuel                 1.5 %                   1.4 %               4.4 %                   4.1 %               4.4 %                   4.1 %
Excluding fuel                 0.9 %                   0.8 %               3.6 %                   3.4 %               3.5 %                   3.3 %

* Based on the same 53-week period in both years.

** Excludes replacement stores.

Safeway's marketing strategies have evolved in recent years and are based on consumer research and competitive analysis. This helps us carry high quality perishables and the right products (such as organic products and our revitalized corporate brands) at the right prices (including our club card specials), increasingly merchandised in a warm and inviting shopping environment (our Lifestyle stores). We have communicated this message through our "Ingredients for life" advertising campaign. We believe all of these elements have contributed to our sales growth.

Through past experience, we have further improved our Lifestyle store execution by refining the layout and décor of the Lifestyle store and improving our store opening promotions. We believe this has contributed to our sales growth.

Sales increased 4.3% to $44.1 billion in 2008 from $42.3 billion in 2007 primarily because the additional week in 2008 contributed $777 million in sales, fuel sales increased $397 million and identical-store sales increased. At the end of 2008, Safeway had 1,276 Lifestyle stores compared to 1,024 at the end of 2007. Customer counts decreased, and average transaction size increased during fiscal 2008.

Sales increased 5.2% to $42.3 billion in 2007 from $40.2 billion in 2006 primarily because of Safeway's marketing strategy, Lifestyle store execution, an increase in fuel sales of $486 million and a favorable change in the Canadian

dollar exchange rate of $351 million (in U.S. dollars). At the end of 2007, Safeway had 1,024 Lifestyle stores compared to 751 at the end of 2006. Customer counts decreased, and average transaction size increased during fiscal 2007.

Total sales increased 4.6% to $40.2 billion in 2006 from $38.4 billion in 2005 primarily because of Safeway's marketing strategy, Lifestyle store execution and an increase in fuel sales of $385 million. At the end of 2006, Safeway had 751 Lifestyle stores compared to 458 at the end of 2005. Customer counts and average transaction size increased during fiscal 2006.

Gross Profit Gross profit represents the portion of sales revenue remaining after deducting the cost of goods sold during the period, including purchase and distribution costs. These costs include inbound freight charges, purchasing and receiving costs, warehouse inspection costs, warehousing costs and other costs associated with Safeway's distribution network. Advertising and promotional expenses are also a component of cost of goods sold. Additionally, all vendor allowances are classified as an element of cost of goods sold.

Gross profit margin was 28.38% of sales in 2008, 28.74% in 2007 and 28.82% in 2006.

The gross profit margin declined 36 basis points to 28.38% of sales in 2008 from 28.74% of sales in 2007. Excluding fuel, gross profit declined 25 basis points primarily because of investments in price and higher LIFO expense, partly offset by lower advertising expense and improved inventory shrink. LIFO expense was $34.9 million in 2008 compared to $13.9 million in 2007.

The decline in advertising expense was primarily the result of a more efficient mix of advertising media and may not necessarily continue in the future. Improved inventory shrink is the result of long-term efforts which we do expect to continue into the future.

Gross profit decreased eight basis points to 28.74% of sales in 2007 from 28.82% of sales in 2006. Higher fuel sales reduced gross profit by 20 basis points. Excluding fuel, gross profit increased 12 basis points primarily because of lower advertising expense, improved shrink and benefits from supply-chain initiatives, partly offset by investments in price and higher LIFO expense. LIFO expense was $13.9 million in 2007 compared to $1.2 million in 2006.

The decline in advertising expense was primarily the result of a different mix of advertising media. Improved inventory shrink and supply-chain initiatives are the result of long-term efforts. Supply-chain initiatives consist primarily of Company programs to reduce cost of goods, transportation and warehouse expenses.

Gross profit decreased 11 basis points to 28.82% of sales in 2006 from 28.93% of sales in 2005. Higher fuel sales reduced gross profit by 28 basis points. Excluding fuel, gross profit increased 17 basis points, primarily because of improved shrink, benefits from product-sourcing initiatives and improved product mix, partly offset by investments in price and increased advertising expense.

Vendor allowances totaled $2.6 billion in 2008 and $2.5 billion in both 2007 and 2006. Vendor allowances can be grouped into the following broad categories:
promotional allowances, slotting allowances and contract allowances. All vendor allowances are classified as an element of cost of goods sold.

Promotional allowances make up approximately three-quarters of all allowances. With promotional allowances, vendors pay Safeway to promote their product. The promotion may be any combination of a temporary price reduction, a feature in print ads, a feature in a Safeway circular or a preferred location in the store. The promotions are typically one to two weeks long.

Slotting allowances are a small portion of total allowances (typically less than 5% of all allowances). With slotting allowances, the vendor reimburses Safeway for the cost of placing new product on the shelf. Safeway has no obligation or commitment to keep the product on the shelf for a minimum period.

Contract allowances make up the remainder of all allowances. Under the typical contract allowance, a vendor pays

Safeway to keep product on the shelf for a minimum period of time or when volume thresholds are achieved.

Operating and Administrative Expense Operating and administrative expense consists primarily of store occupancy costs and backstage expenses, which, in turn, consist primarily of wages, employee benefits, rent, depreciation and utilities.

Operating and administrative expense was 24.17% of sales in 2008 compared to 24.55% in 2007 and 24.84% in 2006.

Operating and administrative expense improved 38 basis points to 24.17% of sales in 2008 from 24.55% of sales in 2007. Higher fuel sales in 2008 improved operating and administrative expense by 11 basis points. The remaining 27 basis point improvement is primarily due to reduced employee costs as a percentage of sales partly offset by higher energy costs, currency exchange losses and workers' compensation costs.

Operating and administrative expense decreased 29 basis points to 24.55% of sales in 2007 from 24.84% of sales in 2006. Higher fuel sales in 2007 reduced operating and administrative expense by 16 basis points. The remaining 13 basis point decline is primarily the result of reduced employee costs as a percentage of sales and higher gains on disposal of property, partly offset by higher depreciation expense.

Dominick's In February 2007, the Company announced a strategic plan to revitalize its operations at Dominick's. This plan included remodeling 20 stores to Lifestyle stores, new store development and closing 14 under-performing stores in 2007. In the second quarter of 2007, Safeway incurred a store-lease exit charge of $30.3 million ($0.04 per diluted share) as a result of these closures.

Operating and administrative expense decreased 93 basis points to 24.84% of sales in 2006 from 25.77% of sales in 2005. The store exit activities and employee buyouts in 2005 reduced operating and administrative expense by 44 basis points. Higher fuel sales in 2006 reduced operating and administrative expense by 13 basis points. The remaining decline is primarily the result of increased sales and reduced costs as a percentage of sales from store labor, workers' compensation and pension expense.

Gains on Property Retirements Operating and administrative expense included net gains on property retirements of $19.0 million in 2008, $42.3 million in 2007 and $17.8 million in 2006. In 2007 the Company sold a Bellevue, Washington distribution center at a gain of $46.6 million and a warehouse in Chicago, Illinois at a gain of $11.2 million. These gains were partly offset by net losses on other property retirements.

Interest Expense Interest expense was $358.7 million in 2008, compared to $388.9 million in 2007 and $396.1 million in 2006. Interest expense decreased in 2008 primarily due to a combination of lower average borrowings and a lower average interest rate. Interest expense decreased in 2007 and 2006 primarily due to lower average borrowings, partially offset by a higher average interest rate.

Other Income Other income consists of interest income, minority interest in a consolidated affiliate and equity in earnings from Safeway's unconsolidated affiliates. Interest income was $12.5 million in 2008, $11.8 million in 2007 and $11.1 million in 2006. Equity in (losses) earnings of unconsolidated affiliates was a loss of $2.5 million in 2008, income of $8.7 million in 2007 and income of $21.1 million in 2006.

Income Taxes The Company's effective tax rates for 2008, 2007 and 2006 were 35.8%, 36.7% and 29.8%, respectively. The effective tax rate for 2006 included a benefit of $62.6 million related to interest, net of income tax, on federal and state income tax refunds, and various other favorable items.

Critical Accounting Policies and Estimates

Critical accounting policies are those accounting policies that management believes are important to the portrayal of Safeway's financial condition and results of operations and require management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.

Workers' Compensation The Company is primarily self-insured for workers' compensation, automobile and general liability costs. It is the Company's policy to record its self-insurance liability as determined actuarially, based on claims filed and an estimate of claims incurred but not yet reported.

Self-insurance reserves are actuarially determined primarily by applying historical paid loss and incurred loss development trends to current cash and incurred expected losses in order to estimate total losses. We then discount total expected losses to their present value using a risk free rate of return.

Any actuarial projection of self-insured losses is subject to a high degree of variability. For example, self-insurance expense increased to $161.6 million in fiscal 2008 from $117.1 million in 2007 and $133.2 million in 2006. Litigation trends, legal interpretations, benefit level changes, claim settlement patterns and similar factors influenced historical development trends that were used to determine the current year expense and therefore contributed to the variability in annual expense. However, these factors are not direct inputs into the actuarial projection, and thus their individual impact cannot be quantified.

We believe that the discount rate is a significant factor that has led to variability in self-insured expenses. Since the discount rate is a direct input into the estimation process, we are able to quantify its impact. The discount rate, which is based on the United States Treasury Note rates for the estimated average claim life of five years, was 1.75% in 2008, 3.5% in 2007 and 4.5% in 2006. A 25-basis-point change in the discount rate affects the self-insured liability by approximately $5.3 million.

The majority of the Company's workers' compensation liability is from claims occurring in California. California workers' compensation has received intense scrutiny from the state's politicians, insurers, employers and providers, as well as the public in general. Recent years have seen escalation in the number of legislative reforms, judicial rulings and social phenomena affecting this business. Some of the many sources of uncertainty in the Company's reserve estimates include changes in benefit levels, medical fee schedules, medical utilization guidelines, vocation rehabilitation and apportionment.

Store Closures Safeway's policy is to recognize losses relating to the impairment of long-lived assets when expected net future cash flows are less than the assets' carrying values. When stores that are under long-term leases close, Safeway records a liability for the future minimum lease payments and related ancillary costs, net of estimated cost recoveries. In both cases, fair value is determined by estimating net future cash flows and discounting them using a risk-adjusted rate of interest. The Company estimates future cash flows based on its experience and knowledge of the market in which the closed store is located and, when necessary, uses real estate brokers. However, these estimates project future cash flows several years into the future and are affected by factors such as inflation, real estate markets and economic conditions.

At any one time, Safeway has a portfolio of closed stores which is widely dispersed over several markets. While individual closed store reserves are likely to be adjusted up or down in the future to reflect changes in assumptions, the change to the total closed store reserve has not been nor is expected to be material.

Employee Benefit Plans SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106, and 132(R)," requires an employer to recognize in its statement of financial position an asset for a plan's overfunded status or a liability for a plan's underfunded status, measure a plan's assets and its obligations that determine its funded status as of the end of the employer's fiscal year, and recognize changes in the funded status of a defined benefit postretirement plan in the year in which the changes occur. Additional disclosures are also required. Safeway adopted SFAS No. 158 as of December 30, 2006, as required.

The determination of Safeway's obligation and expense for pension benefits is dependent, in part, on the Company's selection of certain assumptions used by its actuaries in calculating these amounts. These assumptions are disclosed in Note I to the consolidated financial statements and include, among other things, the discount rate, the expected long-term rate of return on plan assets and the rate of compensation increases. Actual results in any given year will often

differ from actuarial assumptions because of economic and other factors. In accordance with GAAP, actual results that differ from the actuarial assumptions are accumulated and amortized over future periods and, therefore, affect recognized expense and recorded obligation in such future periods. While Safeway believes its assumptions are appropriate, significant differences in actual results or significant changes in the Company's assumptions may materially affect Safeway's pension and other postretirement obligations and its future expense.

Safeway bases the discount rate on current investment yields on high quality fixed-income investments. The discount rate assumption used to determine the year-end projected benefit obligation is increased or decreased to be consistent with the change in yield rates for high quality fixed-income investments for the expected period to maturity of the pension benefits. The discount rate used to determine 2008 pension expense was 5.9%. A lower discount rate increases the present value of benefit obligations and increases pension expense. Expected return on pension plan assets is based on historical experience of the Company's portfolio and the review of projected returns by asset class on broad, publicly traded equity and fixed-income indices, as well as target asset allocation. Safeway's target asset allocation mix is designed to meet the Company's long-term pension requirements. For 2008 the Company's assumed rate of return was 8.5% on U.S. pension assets and 7.0% on Canadian pension assets. Over the 10-year period ended January 3, 2009, the average rate of return was approximately 3% for U.S. and 4% for Canadian pension assets. At December 29, 2007, the 10-year average rate of return was approximately 9% for U.S. and 8% for Canadian pension assets. The deteriorating conditions in the global financial markets during 2008 led to a substantial reduction in the 10-year average rate of return on pension assets. We expect that the markets will eventually recover to our assumed long-term rate of return.

The following table summarizes actual allocations for Safeway's plans at year-end 2008 and year-end 2007:

                                                    Plan assets
                      Asset category   Target     2008      2007
                      Equity               65 %    60.8 %    67.8 %
                      Fixed income         35      38.0      31.8
                      Cash and other        -       1.2       0.4
                      Total               100 %   100.0 %   100.0 %

The investment policy also emphasizes the following key objectives: (1) maintain a diversified portfolio among asset classes and investment styles; (2) maintain an acceptable level of risk in pursuit of long-term economic benefit;
(3) maximize the opportunity for value-added returns from active investment management while establishing investment guidelines and monitoring procedures for each investment manager to ensure the characteristics of the portfolio are consistent with the original investment mandate; and (4) maintain adequate controls over administrative costs.

                         SAFEWAY INC. AND SUBSIDIARIES



Sensitivity to changes in the major assumptions for Safeway's pension plans are
as follows (dollars in millions):



                                              United States                                       Canada
                                          Projected benefit                          Projected benefit
                            Percentage       obligation           Expense               obligation          Expense
                              point           decrease            decrease               decrease           decrease
                              change         (increase)          (increase)             (increase)         (increase)
Expected return on assets    +/-1.0 pt             -           $  17.2/(17.2)                 -           $  3.3/(3.3)
Discount rate                +/-1.0 pt   $     185.6/(230.5)   $   8.6/(44.3)       $       38.4/(44.3)   $  5.7/(6.2)

Cash contributions, primarily in Canada, to the Company's pension plans are expected to total approximately $25.9 million in 2009 and totaled $33.8 million in 2008, $33.0 million in 2007 and $29.2 million in 2006.

Stock-Based Employee Compensation SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements as compensation cost based on the fair value on the date of grant. The Company determines fair value of such awards using the Black-Scholes option pricing model. The Black-Scholes option pricing model incorporates certain assumptions, such as a risk-free interest rate, expected volatility, expected dividend yield and expected life of options, in order to arrive at a fair value estimate.

Goodwill Goodwill represents the excess of cost of an acquired business over the fair value of the identifiable tangible and intangible assets acquired and liabilities assumed in a business combination. In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets," goodwill is not subject to amortization but must be evaluated for impairment.

We test goodwill for impairment annually (on the first day of the fourth quarter), or whenever events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount, by initially comparing the fair value of each of our reporting units to their related carrying values. If the fair value of the reporting unit is less than its carrying value, we perform an additional step to determine the implied fair value of goodwill associated with that reporting unit. If the carrying value of goodwill exceeds the implied fair value of goodwill, such excess represents the amount of goodwill impairment. Our goodwill impairment analysis also includes a comparison of the aggregate estimated fair value of all reporting units to our total market capitalization. Therefore, a significant and sustained decline in our stock price could result in goodwill impairment charges. During times of financial market volatility, significant judgment is given to determine the underlying cause of the decline and whether stock price declines are short-term in nature or indicative of an event or change in circumstances.

Determining the fair value of a reporting unit involves the use of significant estimates and assumptions. The estimate of fair value of each of our reporting units is based on our projection of sales, gross profit, operating profit and cash flows considering historical and estimated future results, general economic and market conditions as well as the impact of planned business and operational strategies. We base our fair value estimates on assumptions we believe to be reasonable at the time, but such assumptions are subject to inherent uncertainty. Actual results may differ from those estimates. The valuations employ present value techniques to measure fair value and consider market factors. Based upon the results of our September 7, 2008 analysis, no impairment of goodwill was indicated.

As of September 7, 2008, if forecasted cash flows had been 10% lower than estimated or if the discount rate applied in our analysis had been 10% higher than estimated, no goodwill impairment would have been indicated. However, changes in the judgments and estimates underlying our analysis of goodwill for possible impairment, including expected future cash flows and discount rate, could result in a significantly different estimate of the fair value of the reporting units in the future.

Income Tax Contingencies The Company is subject to periodic audits by the Internal Revenue Service and other foreign, state and local taxing authorities. These audits may challenge certain of the Company's tax positions such as the timing and amount of income and deductions and the allocation of taxable income to various tax jurisdictions. Income tax contingencies are accounted for in accordance with FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" ("FIN 48"), and may require significant management judgment in estimating final outcomes. Actual

results could materially differ from these estimates and could significantly affect the Company's effective tax rate and cash flows in future years. Note H to the consolidated financial statements set forth in Part II, Item 8 of this report provides additional information on income taxes.

Liquidity and Financial Resources

Net cash flow from operating activities was $2,250.9 million in 2008, $2,190.5 million in 2007 and $2,175.0 million in 2006 primarily due to the increasing amount of net income in such years.

Blackhawk receives a significant portion of the cash inflow from the sale of third-party gift cards late in the fourth quarter of the year and remits the majority of the cash, less commissions, to the card partners early in the first quarter of the following year. The growth of Blackhawk's net payables related to third-party gift cards declined to $23.9 million in 2008 from $84.1 million in 2007 as a result of the timing of payments due to the holidays, the 53rd week of fiscal 2008 and a change in the product mix.

Historically, cash contributions to the Company's retirement plans have been relatively small. For example, cash contributions were $33.8 million and $33.0 million in 2008 and 2007, respectively, and were limited primarily to our Canadian retirement plans. The decline in the financial markets during 2008 resulted in a substantial reduction in the fair value of the retirement plan assets. As a result, at the end of fiscal 2008, pension benefit obligations exceeded the fair value of plans assets for all of the Company's pension plans. In 2009, we expect pension expense to increase significantly, primarily as a result of the decline in the plan assets. The Company currently expects to . . .