Summary of SPARTAN STORES INC

Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations

Executive Overview

Spartan Stores is a leading regional grocery distributor and grocery retailer, operating principally in Michigan and Indiana.

We currently operate two reportable business segments: Distribution and Retail. Our Distribution segment provides a full line of grocery, general merchandise, health and beauty care, frozen and perishable items to approximately 350 independently owned grocery stores and our 99 corporate owned stores. Our Retail segment operates 99 retail supermarkets in Michigan under the banners Glen's Markets, Family Fare Supermarkets, D&W Fresh Markets, Felpausch Food Centers, and VG's Food and Pharmacy, and 19 fuel centers/convenience stores, included at our supermarket locations, under the banners Glen's Quick Stop, Family Fare Quick Stop, D&W Fresh Markets Quick Stop and Felpausch Quick Stop. Our retail supermarkets have a "neighborhood market" focus to distinguish them from supercenters and limited assortment stores.

Our sales and operating performance vary with seasonality. Our first and fourth quarters are typically our lowest sales quarters and therefore operating results are generally lower during these two quarters. Additionally, these two quarters can be affected by the timing of the Easter holiday, which results in a strong sales week. Many northern Michigan stores are dependent on tourism, and therefore, are most affected by seasons and weather patterns, including, but not limited to, the amount and timing of snowfall during the winter months and the range of temperature during the summer months. All quarters are 12 weeks, except for our third quarter, which is 16 weeks and includes the Thanksgiving and Christmas holidays. Fiscal 2007 contained 53 weeks; therefore, the fourth quarter of fiscal 2007 consisted of 13 weeks rather than 12 weeks.

On December 29, 2008, we acquired certain assets and assumed certain liabilities related to VG's Food Center, Inc. and VG's Pharmacy, Inc. (collectively, "VG's"). The results of operations of the VG's acquisition are included in the accompanying consolidated financial statements from the date of acquisition. VG's was a privately-held operator of 17 retail grocery stores based in Eastern Michigan. Prior to the acquisition, VG's was an independent customer of our Distribution segment. This transaction, following our acquisitions of D&W Food Centers and Felpausch Food Centers, represents another step in the component of our business strategy focused on growing our business through opportunistic acquisitions of other grocery operators that are adjacent to or in markets where we operate today. The VG's stores serve communities in key Eastern Michigan markets where we previously had no retail presence. The VG's transaction is expected to increase annual retail segment sales by approximately $300 million, but annual consolidated sales are expected to increase by approximately $150 million as VG's was an existing distribution customer.

We previously operated 14 deep-discount food and drug stores under the banner The Pharm. In fiscal 2009, we completed the closure and sale of prescription files of all The Pharm stores, allowing us to concentrate efforts and resources on business opportunities with the best long-term growth potential and focus more on core distribution and conventional supermarket operations. The financial results of The Pharm stores have been included in discontinued operations in the accompanying consolidated financial statements for all periods presented.

We have established four key management priorities that focus on the longer-term strategy of the Company, including establishing a well-differentiated market offering for our Distribution and Retail segments, and additional strategies designed to create value for our shareholders, retailers and customers. These priorities are:

• Retail sales growth: Continue with our capital plan focusing on remodels, replacement stores, adjacent acquisitions, expansions and new stores to fill in existing markets, leverage investments in fuel centers and pharmacy operations to drive related supermarket customer traffic and continue to focus on category management initiatives, specifically focusing on fresh offerings.
• Distribution sales growth: Focus on increasing penetration of existing customers, attracting new in-market customers and adjacent-state customers, continue to share "best retail practices" with customers, provide a superior value-added relationship and pursue acquisitions.

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• Margin enhancement: Continued focus on increasing penetration of private label programs, enhancing offerings in our fresh department, lowering the cost of merchandise through vendor partnerships and improving retail shrink.
• Selling, general and administrative expense cost containment: Continue to focus on improving efficiency and general cost containment in all areas to allow us to remain cost competitive in the long-term and help offset recessionary impacts on our business in the short-term.

During fiscal 2009, retail sales growth was fueled by the VG's acquisition completed in fiscal 2009 and the Felpausch acquisition completed in fiscal 2008 and capital expenditures that were made on major remodels at seven stores, one replacement store and three fuel centers. Late in fiscal 2009 we expanded our $4.00 generic prescription program to include additional stores. In fiscal 2010, we expect to continue to focus on capital investments in our retail segment by completing five store remodels, completing one store relocation into a newly constructed facility, adding one new store late in the year and adding six fuel centers. We will also continue to pursue opportunistic acquisitions.

During fiscal 2009, we continued focusing on product offerings that met or enhanced our individual customers' needs. During fiscal 2010, we will continue our successful model store program where we share the latest product offerings and merchandising programs with our customers.

We introduced over 200 new private label products during fiscal 2009. These products are typically less expensive and produce higher gross margins than national brands and tend to be more desired by consumers in challenging economic times. In fiscal 2010, we plan to expand our Spartan branded fresh product offerings and are targeting 75 SKU's.

During fiscal 2009 we completed a re-racking project in our grocery warehouse that will improve operational efficiency in fiscal 2010. Resetting the Grand Rapids grocery warehouse is the first step in the overall Supply Chain strategic plan to upgrade the efficiency and capacity of all our warehouses with a goal to complete all warehouses within the next three years. We also upgraded our dock scheduling and traffic management systems that enable the automation of manual processes for scheduling and routing of inbound deliveries to all warehouses.

We believe the weak economic cycle is likely to continue for the majority of fiscal 2010 and will influence consumer buying behavior towards a continued value orientation. Given this economic outlook, our near-term position is to be cautious, but opportunistic. We expect to continue making meaningful progress with our capital investment program and the acquisition integration, but we are also expecting additional competition from seven new supercenter openings in several markets where we own retail stores. We expect that these competitive openings will unfavorably impact fiscal 2010 retail comparable sales by approximately 1.7 percent. Moreover, the rate of product cost inflation tempered as we progressed through fiscal 2009, which will lower the inflation sensitive procurement and sales gains that we realized. These lower gains, however, should be partially mitigated by lower LIFO inventory valuation charges in the first three quarters of the fiscal year. Due to these events, retail comparable store sales could be slightly negative and core distribution sales, excluding the effect of the VG's sales reclassification, are expected to be comparable to fiscal 2009 levels. To proactively address these trends, we have taken a number of additional steps to reduce operating costs in fiscal 2010 such as, reducing the annual associate target bonus by twenty-five percent, suspending 401(k) matching contributions for all but our non-bonus eligible store associates and department managers, implementing a hiring freeze, and shifting the timing of annual merit pay increases.

We continuously evaluate our retail store base in the normal course of business to determine actions needed for store remodels, relocations and closings. We expect the retail sales reductions resulting from our store evaluations plus store carryover activity from fiscal 2009 to be approximately $20.0 million for fiscal 2010. The store opening, remodel, closing and other costs related to these activities will be approximately $5.2 million in fiscal 2010 compared with $4.2 million incurred in fiscal 2009.

As we look forward to what is likely to remain a challenging economic period, we will remain focused on a consumer-centric business strategy. Successfully navigating through this challenging period will require sound execution of the basics in grocery retailing and distribution. The basics include providing everyday good values to consumers, consistently delivering high quality products and services, working to help our distribution customers be more profitable and competitive, and being aware of, and adapting to, evolving conditions in our market place. We

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remain confident that we can be successful against this environment with our retail value proposition and value-added distribution services.

The matters discussed in this Item 7 include forward-looking statements. See "Forward-Looking Statements" at the beginning and "Risk Factors" in Item 1A of this Annual Report on Form 10-K.

Results of Operations

The following table sets forth items from our Consolidated Statements of Earnings as a percentage of net sales and the year-to-year percentage change in dollar amounts:

                                    Percentage of Net Sales          Percentage Change
                               ---------------------------------   ---------------------
                               March 28,   March 29,   March 31,   2009/2008   2008/2007
                                 2009        2008        2007      ---------   ---------
                               ---------   ---------   ---------
Net sales                          100.0       100.0       100.0         4.0        12.3
Gross margin                        20.8        20.0        19.6         8.3        14.7
Selling, general and                18.0        17.5        17.2         6.9        14.5
administrative
  expenses
Provision for asset                    -           -         0.2           -           *
impairments and exit           ---------   ---------   ---------   ---------   ---------
  costs
Operating earnings                   2.8         2.5         2.2        18.0        26.6
Other income and expenses            0.4         0.5         0.5        (1.7 )      (5.6 )
------------------------------ ---------   ---------   ---------   --------- - --------- -
Earnings before income taxes         2.4         2.0         1.7        22.3        36.6
and
  discontinued operations
Income taxes                         1.0         0.7         0.6        37.6        40.4
------------------------------ ---------   ---------   ---------   ---------   ---------
Earnings from continuing             1.4         1.3         1.1        13.7        34.5
operations
Earnings from discontinued           0.1         0.1         0.0         2.4        80.9
operations,                    ---------   ---------   ---------   ---------   ---------
  net of taxes
Net earnings                         1.5         1.4         1.1        13.1        36.4
------------------------------ ---------   ---------   ---------   ---------   ---------

* Percentage change is not meaningful

Results of Continuing Operations for the Fiscal Year Ended March 28, 2009 Compared to the Fiscal Year Ended March 29, 2008

Net Sales. Net sales increased $99.9 million, or 4.0%, from $2,476.8 million in fiscal 2008 to $2,576.7 million in fiscal 2009. The sales increase was primarily due to incremental sales from the Felpausch and VG's retail acquisitions, comparable store sales growth in our supermarkets, new distribution customer business and product cost inflation.

Net sales in our Distribution segment, after intercompany eliminations, decreased $35.7 million, or 2.8%, from $1,284.3 million to $1,248.6 million primarily due to the elimination of sales to VG's and Felpausch stores of $37.8 million and $20.6 million, respectively, (due to our acquisitions of the stores), lower sales in our marginally profitable pharmacy distribution program of $26.1 million, partially offset by incremental sales of $53.5 million to new distribution customers primarily obtained in fiscal 2008. As a result of the VG's acquisition, we expect reported annual Distribution sales to decline approximately $150.0 million compared to pre-acquisition annual sales due to the elimination of intercompany sales.

Net sales in our Retail segment increased $135.6 million, or 11.4%, from $1,192.5 million to $1,328.1 million. The sales increase was primarily due to incremental sales from the recently acquired VG's stores of $72.7 million and Felpausch retail stores of $43.2 million, supermarket comparable store sales growth of $23.3 million and increases in fuel center sales of $19.4 million, partially offset by lost sales of $23.4 million relating to three stores that were sold in fiscal 2008, one store that was closed early in fiscal 2009 and one store that was sold in the third quarter of fiscal 2009. Total retail comparable store sales increased 3.5 percent in fiscal 2009 principally due to our marketing programs, ongoing capital investment program, including store remodels, and product cost inflation. Excluding sales from fuel centers and Easter holiday sales in the prior year first and fourth quarters, comparable store sales increased 2.7 percent. We define a retail store as comparable when it is in operation for 14 accounting

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periods (a period equals four weeks), and we include remodeled, expanded and relocated stores in comparable stores.

Gross Margin. Gross margin represents net sales less cost of sales, which include purchase costs and promotional allowances. Vendor allowances that relate to our buying and merchandising activities consist primarily of promotional allowances, which are generally allowances on purchased quantities and, to a lesser extent, slotting allowances, which are billed to vendors for our merchandising costs, such as setting up warehouse infrastructure. Vendor allowances associated with product cost are recognized as a reduction in cost of sales when the product is sold. Lump sum payments received for multi-year contracts are amortized over the life of the contracts based on contractual terms.

Gross margin increased by $41.1 million, or 8.3%, from $495.0 million to $536.1 million. As a percent of net sales, gross margin increased from 20.0% to 20.8%. The gross margin rate improvement was due principally to an increase in the mix of higher margin retail sales as a percentage of consolidated sales and an improvement in distribution segment gross margin. We are anticipating higher overall gross profit margin rates in fiscal 2010 due to a higher mix of retail sales and improving gross profits in our retail segment. Higher private label penetration rates, the implementation of additional merchandising initiatives and improvements in our fuel procurement program will contribute to the expected gross profit margin improvement.

Selling, General and Administrative Expenses. Selling, general and administrative ("SG&A") expenses consist primarily of salaries and wages, employee benefits, warehousing costs, store occupancy costs, utilities, equipment rental, depreciation and other administrative costs.

SG&A expenses increased $30.0 million, or 6.9%, from $433.3 million to $463.4 million, and were 18.0% of net sales compared to 17.5% last year. The net increase in SG&A is due primarily to the following:

• Additional operating costs associated with the acquired VG's retail stores of $17.8 million, including approximately $0.3 million of training and other start-up related costs.
• Additional operating costs, excluding incremental grand re-opening costs for remodeled stores, associated with the acquired Felpausch retail stores of $7.5 million.
• Increases in compensation and benefits, excluding VG's, Felpausch and fuel centers, of $6.7 million.
• Incremental costs of $1.0 million related to grand re-opening costs for remodeled stores.
• Increased depreciation and amortization, excluding VG's, Felpausch and fuel centers, of $1.6 million.
• The cost of operating additional fuel centers of $1.4 million.
• Increased utilities costs, excluding VG's, Felpausch and fuel centers, of $1.2 million.
• Reduced operating costs related to the sale of four retail stores and closure of one store since the prior year of $6.0 million.
• Reclassification of operating expenses due to replacement of $1.5 million of the Michigan Single Business Tax (MSBT) with a new income tax for the State of Michigan. The MSBT was not considered an income tax and was included in operating expenses.

Given the challenging economic environment previously discussed, we have also taken a number of steps to reduce operating costs in fiscal 2010 such as completing the warehouse re-racking initiative, reducing the annual associate incentive bonus target by twenty-five percent, suspending 401(k) matching contributions for all but our non-bonus eligible store associates and department managers, implementing a hiring freeze, and shifting the timing of annual merit pay increases. Offsetting these cost savings, will be an increase in pension expense of $1.3 million resulting primarily from a decline in the fair value of pension plan assets. We also expect health care costs to trend higher.

Interest Expense. Interest expense decreased $0.1 million, or 1.2%, from $11.1 million to $11.0 million, and was 0.4% of net sales in both years. The decrease in interest expense is due to a decrease in interest rates, partially offset by an increase in average outstanding borrowings of $14.9 million.

On January 2, 2009, we entered into an interest rate swap agreement. The interest rate swap is considered to be a cash flow hedge of interest payments on $45.0 million of borrowings under our senior secured revolving credit facility by effectively converting a portion of the variable rate debt to a fixed rate basis. Under the terms of the agreement, we have agreed to pay the counterparty a fixed interest rate of 3.33% and the counterparty has agreed

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to pay Spartan Stores a floating interest rate based upon the 1-month LIBOR plus 1.25% (1.77% at March 28, 2009) on a notional amount of $45 million. The interest rate swap agreement expires concurrently with its senior secured revolving credit facility on December 24, 2012.

Our fiscal 2010 financial reporting will be modified to comply with FSP No. APB 14-1, "Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)" (FSP No. APB 14-1). In short, this requires that the Company recognize non-cash interest expense on its $110.0 million convertible senior notes. The amount of incremental expense anticipated for fiscal 2010 is approximately $3.4 million, pre-tax. FSP No. APB 14-1 must be applied on a retrospective basis, therefore, upon adoption on March 29, 2009, we expect to retroactively record additional non-cash interest expense of approximately $3.2 million and $2.7 million, pre-tax, for fiscal years 2009 and 2008, respectively.

Income Taxes. The effective tax rate is 40.5% and 36.0% for fiscal 2009 and fiscal 2008, respectively. The difference from the statutory rate is primarily due to State of Michigan income taxes. On January 1, 2008 a new income tax for the State of Michigan became effective which replaced the Michigan Single Business Tax ("MSBT"). The MSBT was not considered an income tax and was included in SG&A expenses. Total Michigan taxes, net of the Federal income tax benefit, were $3.3 million in fiscal 2009 compared to $1.3 million in fiscal 2008. The fiscal 2008 amount is comprised of MSBT expense of $0.8 million and $0.5 million for the new Michigan income tax, both net of the Federal tax benefit. We expect the effective tax rate for fiscal 2010 to increase to approximately 41.2% due to the affects of state income taxes.

Results of Continuing Operations for the Fiscal Year Ended March 29, 2008 Compared to the Fiscal Year Ended March 31, 2007

Net Sales. Net sales increased $270.6 million, or 12.3%, from $2,206.3 million in fiscal 2007 to $2,476.8 million in fiscal 2008. The sales increase was primarily due to incremental sales from the Felpausch acquisition, new distribution customer business, higher fuel center sales, comparable store sales growth in our supermarkets, increased sales to existing distribution customers and incremental sales from the acquired PrairieStone pharmacies. The sales increase was partially offset by the absence of an extra week of sales included in the prior year fourth quarter, lost sales associated with the ending of two customer relationships during the prior year, and lost sales from two corporate-owned stores closed near the end of the first quarter of fiscal 2007.

Net sales in our Distribution segment, after intercompany eliminations, increased $46.2 million, or 3.7%, from $1,238.1 million in fiscal 2007 to $1,284.3 million in fiscal 2008 primarily due to the addition of new distribution customers of $159.0 million and an increase in sales to existing customers of $19.5 million primarily as a result of a retail competitor exiting the eastern Michigan market, partially offset by the elimination of sales to Felpausch stores of $101.7 million (due to the acquisition), an extra week of sales in fiscal 2007 of $22.9 million and lost sales of $7.7 million as a result of terminated customer relationships in fiscal 2007.

Net sales in our Retail segment increased $224.3 million, or 23.2%, from $968.2 million in fiscal 2007 to $1,192.5 million in fiscal 2008. The sales increase was primarily due to incremental sales from the recently acquired Felpausch retail stores of $160.4 million, increases in fuel center sales of $40.4 million, supermarket comparable sales growth of $31.5 million, and incremental sales resulting from the acquisition of the PrairieStone pharmacies of $11.5 million, partially offset by lost sales relating to the previously disclosed closing of two retail stores near the end of the prior year first quarter of $3.1 million and an extra week of sales included in the prior year of $16.4 million. Total retail comparable store sales increased 6.1 percent in fiscal 2008 due to our ongoing capital investment program, including store remodels, the opening of additional fuel centers and the PrairieStone Pharmacy acquisition. Excluding sales from fuel centers, the PrairieStone Pharmacy acquisition and the impact of the extra week of sales in the prior year, comparable store sales increased 3.4 percent. We define a retail store as comparable when it is in operation for 14 accounting periods (a period equals four weeks), and we include remodeled, expanded and relocated stores in comparable stores.

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sold. Lump sum payments received for multi-year contracts are amortized over the life of the contracts based on contractual terms.

Gross margin increased by $63.5 million, or 14.7%, from $431.5 million in fiscal 2007 to $495.0 million in fiscal 2008. As a percent of net sales, gross margin increased from 19.6% to 20.0%. The gross margin rate improvement was primarily due to a larger concentration of higher margin retail sales as a percentage of consolidated sales and an improvement in distribution segment gross margin primarily due to the elimination of sales to our Felpausch stores, partially offset by an increase in LIFO expense of $2.3 million due to higher product costs, growth in lower margin fuel and pharmacy sales and additional promotional activity during grand re-openings of five remodeled stores and one replacement store which have resulted in increased sales and market share.

SG&A expenses increased $55.0 million, or 14.5%, from $378.3 million in fiscal 2007 to $433.3 million in fiscal 2008, and were 17.5% of net sales in fiscal 2008 compared to 17.2% in fiscal 2007. The net increase in SG&A is due primarily to the following:

• Incremental operating costs associated with the acquired retail stores of $42.0 million, including approximately $0.6 million of training and other start-up related costs, and also including $1.3 million of costs for grand re-openings of five remodeled stores and one relocated store.
• Increases in other compensation and benefits of $6.2 million due to increased sales volume and the absence of a $1.3 million insurance reserve adjustment recorded in fiscal 2007 due to reductions in workers' compensation and health care costs. The reduction in costs was due to improvement in workplace safety programs, implementation of procedures to settle claims quicker, and improvement in claims trends.
• Increased store labor of $2.9 million primarily due to increases in volume, including costs associated with grand re-openings of five remodeled stores and one replacement store.
• The cost of operating additional fuel centers of $2.5 million.
• Increased transportation fuel costs of $1.1 million.
• Increased depreciation and amortization of $0.9 million.

The increased SG&A expenses were partially offset by reduced operating costs due to the closure of two supermarkets near the end of the prior year first quarter of $1.1 million.

Interest Expense. Interest expense decreased $1.0 million, or 8.2%, from $12.1 million in fiscal 2007 to $11.1 million in fiscal 2008, and was 0.4% of net sales in fiscal 2008 compared to 0.5% in fiscal 2007. The decrease in interest expense is primarily due to the amendment of our existing revolving credit facility and the issuance of convertible senior notes, the proceeds of which were used to pay down amounts owed under our revolving credit facility, which has a higher interest rate. The effect of the lower rates was partially offset by an increase in outstanding debt due to the Felpausch acquisition. See the Liquidity and Capital Resources section for additional information on the issuance of convertible senior notes. Total average borrowings increased $36.0 million from $122.0 million in fiscal 2007 to $158.0 million in fiscal 2008.

In accordance with Emerging Issues Task Force ("EITF") Issue No. . . .