The following analysis should be read in conjunction with the Consolidated Financial Statements.

OVERVIEW

Second quarter 2009 total sales were $17.7 billion compared with $18.1 billion for the same period of 2008. This decrease in total sales is attributable to the year-over-year decline in retail fuel prices. The average retail price for a gallon of fuel sold at Kroger fuel stations was 37% lower in the second quarter of 2009 compared to the second quarter of 2008. In the second quarter of 2009, our identical supermarket sales increased 2.6% without fuel compared to the second quarter of 2008. We are pleased with this increase, considering changes in customer behavior, significant deflation in produce and dairy and an overall slightly negative product cost inflation estimate. This increase also reflects meaningful increases in estimated unit sales volumes of 8.5%, excluding fuel and pharmacy. These increases in identical supermarket sales and unit volume demonstrate our customer-focused strategy which delivers value in a number of ways through our people, products, prices and the overall shopping experience.

For the second quarter of 2009, net earnings for the Company totaled $255 million, or $0.39 per diluted share, a decrease of $.03 per diluted share over the second quarter of 2008. This decrease per diluted share was primarily due to lower gross margins partially offset by a lower LIFO charge compared to the second quarter of 2008. Our retail fuel operations accounted for approximately $.01 of this decrease due to lower retail fuel margins in the second quarter of 2009 compared to the second quarter of 2008. In addition, gross margin, without fuel, declined due to sudden deflation, changes in customer behavior, planned investments and heightened competitive activity.

Based on Kroger's second quarter sales results, we confirmed our fiscal year 2009 identical supermarket sales growth guidance of 3.0% to 4.0%, excluding fuel. This guidance assumes product costs for the remainder of fiscal 2009 are consistent with or slightly lower than they were in the second half of fiscal 2008. In addition, we have revised our 2009 earnings per share guidance to reflect continued changes in customer behavior and an uncertain operating environment. We anticipate full-year fiscal 2009 earnings of $1.90 to $2.00 per diluted share. This is a wider range than our previous guidance of $2.00 to $2.05 per diluted share because of the uncertain economic environment and the caution on the part of customers caused by this environment.

RESULTS OF OPERATIONS

Net Earnings

Net earnings totaled $255 million for the second quarter of 2009, a decrease of 7.9% from net earnings of $277 million for the second quarter of 2008. This decrease in our net earnings resulted from lower retail fuel margins and decreased operating profit, partially offset by a LIFO charge of $15 million pre-tax, compared to a LIFO charge of $46 million pre-tax in 2008. Net earnings totaled $690 million for the first two quarters of 2009, an increase of 4.1% from net earnings of $663 for the first two quarters of 2008. The increase in our net earnings for the first two quarters of 2009 resulted from an increase in operating profit, which benefited from a LIFO charge of $38 million pre-tax, compared to a LIFO charge of $86 million pre-tax in 2008.

Net earnings of $0.39 per diluted share for the second quarter of 2009 represented a decrease of 7.1% over net earnings of $0.42 per diluted share for the second quarter of 2008. Net earnings of $1.05 per diluted share for the first two quarters of 2009 represented an increase of 5.0% over net earnings of $1.00 for the first two quarters of 2008. The net earnings per share decline in the second quarter of 2009, compared to the second quarter of 2008, reflects the gross margin decline referred to above. Earnings per share growth for the first two quarters of 2009, compared to the first two quarters of 2008, resulted from increased net earnings.

Sales



                                  Total Sales

                                 (in millions)



                                 Second Quarter                                    Year-To-Date
                            Percentage               Percentage              Percentage               Percentage
                   2009      Increase       2008      Increase      2009      Increase       2008      Increase
Total
supermarket
sales without
fuel             $ 15,011          3.5 %  $ 14,499          5.6 % $ 34,990          3.7 %  $ 33,730          6.7 %
Total
supermarket
fuel sales       $  1,635        (26.6 )% $  2,228         63.8 % $  3,257        (29.9 )% $  4,645         57.7 %

Total
supermarket
sales            $ 16,646         (0.5 )% $ 16,727         10.9 % $ 38,247         (0.3 )% $ 38,375         11.1 %
Other sales(1)      1,089        (20.3 )%    1,367         26.2 %    2,287        (20.1 )%    2,863         20.6 %

Total sales      $ 17,735         (2.0 )% $ 18,094         11.9 % $ 40,534         (1.7 )% $ 41,238         11.7 %

This decrease in total sales and other sales for the second quarter and first two quarters of 2009 is attributable to the year-over-year decline in retail fuel prices. The change in our total supermarket sales without fuel for the second quarter and first two quarters of 2009 was primarily the result of increases in identical supermarket sales and retail square footage. Identical supermarket sales for the second quarter and first two quarters of 2009, excluding fuel, increased due to increased transaction count offset partially by a lower average sale per shopping trip.

We define a supermarket as identical when it has been in operation without expansion or relocation for five full quarters. Fuel center discounts received at our fuel centers and earned based on in-store purchases are included in all of the supermarket identical sales results calculations illustrated below. Differences between total supermarket sales and identical supermarket sales primarily relate to changes in supermarket square footage. Identical supermarket sales include all sales at identical Fred Meyer multi-department stores. Our identical supermarket sales results are summarized in the table below. We used the identical supermarket dollar figures presented to calculate second quarter 2009 percent changes.

                          Identical Supermarket Sales

                                ($ in millions)



                            Second Quarter
                           2009        2008
Including fuel centers   $ 15,867    $ 16,121
Excluding fuel centers   $ 14,341    $ 13,976

Including fuel centers       (1.6 )%      9.7 %
Excluding fuel centers        2.6 %       4.7 %

We define a supermarket as comparable when it has been in operation for five full quarters, including expansions and relocations. As is the case for identical supermarket sales, fuel center discounts received at our fuel centers and earned based on in-store purchases are included in all of the supermarket comparable sales results calculations illustrated below. Comparable supermarket sales include all sales at comparable Fred Meyer multi-department stores. Our comparable supermarket sales results are summarized in the table below. We used the comparable supermarket dollar figures presented to calculate second quarter 2009 percent changes.

                          Comparable Supermarket Sales

                                ($ in millions)



                            Second Quarter
                           2009        2008
Including fuel centers   $ 16,408    $ 16,617
Excluding fuel centers   $ 14,816    $ 14,391

Including fuel centers       (1.3 )%     10.1 %
Excluding fuel centers        3.0 %       4.9 %

FIFO Gross Margin

We calculate First-In, First-Out ("FIFO") Gross Margin as sales minus merchandise costs, including advertising, warehousing and transportation, but excluding the Last-In, First-Out ("LIFO") charge. Merchandise costs exclude depreciation and rent expense. FIFO gross margin is an important measure used by management to evaluate merchandising and operational effectiveness.

Our FIFO gross margin rate increased 59 basis points to 23.11% for the second quarter of 2009 from 22.52% for the second quarter of 2008. Retail fuel sales lower 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 rate decreased 60 basis points for the second quarter of 2009 compared to the second quarter of 2008. Our FIFO gross margin, excluding the effect of retail fuel operations, declined during the second quarter of 2009 due to planned investments into our Customer 1st strategy, sales mix changes, heightened competitive activity and produce and dairy deflation, slightly offset by improvements in shrink, advertising, warehousing and transportation expenses, as a percent of sales.

Our FIFO gross margin rate increased 99 basis points to 23.82% for the first two quarters of 2009 from 22.83% for the first two quarters of 2008. Excluding the effect of retail fuel operations, our FIFO gross margin rate decreased 23 basis points for the first two quarters of 2009 compared to the first two quarters of 2008, due to planned investments into our Customer 1st strategy, partially offset by improvements in shrink, advertising, warehousing and transportation expenses, as a percent of sales.

LIFO Charge

The LIFO charge in the second quarter of 2009 was $15 million compared to $46 million in the second quarter of 2008. The LIFO charge for the first two quarters of 2009 was $38 million compared to $86 million in the first two quarters of 2008. The LIFO charge decreased in both the second quarter and the first two quarters of 2009, compared to the same periods of 2008, primarily due to an expected decrease in annualized product cost inflation for those categories of inventory on the LIFO method of valuation for 2009 compared to 2008.

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, utilities and credit card fees. Rent expense, depreciation and amortization expense, and interest expense are not included in OG&A.

OG&A expenses, as a percent of sales, increased 81 basis points to 17.41% for the second quarter of 2009 from 16.60% for the second quarter of 2008. Retail fuel sales lower 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 7 basis points in the second quarter of 2009 compared to the second quarter of 2008. The decrease in our OG&A rate in the second quarter of 2009, excluding the effect of retail fuel sales, resulted primarily from increased supermarket identical sales growth, strong cost controls, and lower incentive compensation and utility costs. These benefits were partially offset by increases in health care, pension expenses and credit card fees.

OG&A expenses, as a percent of sales, increased 85 basis points to 17.57% for the first two quarters of 2009 from 16.72% for the first two quarters of 2008. OG&A expenses, as a percent of sales excluding fuel, decreased 3 basis points in the first two quarters of 2009 compared to the first two quarters of 2008. The decrease in our OG&A rate in 2009, excluding the effect of retail fuel operations, resulted primarily from increased identical supermarket sales growth, strong cost controls and lower utility costs. These benefits were partially offset by increases in health care costs, pension expenses and credit card fees.

Rent Expense

Rent expense was $150 million, or 0.85% of sales, for the second quarter of 2009, compared to $151 million, or 0.83% of sales, for the second quarter of 2008. For the year-to-date period, rent expense was $350 million, or 0.86% of total sales in 2009, compared to $358 million, or 0.87% of sales, in 2008. Rent expense, as a percent of sales excluding fuel, decreased 4 basis points in the second quarter of 2009 compared to the second quarter of 2008. Rent expense, as a percent of sales excluding fuel, decreased 6 basis points in the first two quarters of 2009 compared to the first two quarters of 2008. The decrease in rent expense in the second quarter of 2009 and the first two quarters of 2009, as a percent of sales excluding fuel, compared to the same periods in 2008, resulted from decreased rent expense and our continued strategy to own rather than lease whenever possible. The decrease in rent expense in the first two quarters of 2009, in total dollars, compared to the first two quarters of 2008, was primarily due to lower lease liabilities for closed stores.

Depreciation Expense

Depreciation expense was $348 million, or 1.96% of total sales, for the second quarter of 2009 compared to $327 million, or 1.81% of total sales, for the second quarter of 2008. Depreciation expense was $801 million, or 1.98% of total sales, for the first two quarters of 2009 compared to $760 million, or 1.84% of total sales, for the first two quarters of 2008. The increase in depreciation expense, in total dollars, was the result of higher capital expenditures over the last four quarters ending with the second quarter of 2009 compared to the comparable period ending in 2008.

Interest Expense

Net interest expense was $115 million, or 0.65% of total sales, in the second quarter of 2009 and $111 million, or 0.62% of total sales, in the second quarter of 2008. For the year-to-date period, interest expense was $278 million, or 0.69% of total sales, in 2009 and $263 million, or 0.64% of total sales, in 2008. The increase in net interest expense for both the quarter and year-to-date periods of 2009, when compared to the same periods of 2008, resulted primarily from a higher weighted average interest rate and a reduction in interest income.

Income Taxes

Our effective income tax rate was 34.6% for the second quarter of 2009 and 36.6% for the second quarter of 2008. For the year-to-date period, our effective income tax rate was 36.0% in 2009 and 36.7% in 2008. The 2009 and 2008 effective income tax rates differed from the federal statutory rate primarily due to the effect of state income taxes and the benefit from the favorable resolution of certain tax issues.

LIQUIDITY AND CAPITAL RESOURCES

Cash Flow Information

Net cash provided by operating activities

We generated $2.2 billion of cash from operating activities during the first two quarters of 2009, compared to $2.1 billion in the first two quarters of 2008. The cash provided by operating activities came from net earnings adjusted for non-cash expenses and changes in our operating assets and liabilities. We realized increases in cash from changes in operating assets and liabilities of $664 million in the first two quarters of 2009 and $427 million in the first two quarters of 2008. The increase in the change in operating assets and liabilities in the first two quarters of 2009, compared to the same period in 2008, resulted primarily from a decrease in income tax receivables and inventories and an increase in trade accounts payable, offset partially by decreased accrued expenses and prepaid expenses. Prepaid expenses decreased significantly since year-end, reflecting prepayments of certain employee benefits at year-end. In the first two quarters of 2009, we contributed $200 million to Kroger sponsored pension plans. During the first two quarters of 2008, we did not make a voluntary cash contribution to Kroger sponsored pension plans.

The amount of cash paid for income taxes decreased in the first two quarters of 2009 compared to the first two quarters of 2008 because we applied our fiscal 2008 overpayment of income taxes to current year taxes.

Net cash used by investing activities

We used $1.2 billion of cash for investing activities during the first two quarters of 2009 compared to $1.1 billion during the first two quarters of 2008. The amount of cash used for investing activities increased in the first two quarters of 2009 versus 2008 due to increased payments for capital expenditures, partially offset by decreased payments for acquisitions and proceeds from sale of assets. During the first two quarters of 2009, we paid $115 million for purchases of leased facilities related to several retail stores and one distribution center. These purchases of leased facilities have been classified as payments for capital expenditures.

Net cash used by financing activities

We used $838 million of cash for financing activities in the first two quarters of 2009 compared to $1.1 billion in the first two quarters of 2008. The decrease in the amount of cash used for financing activities in the first two quarters of 2009, compared to the same period of 2008, was primarily related to the decrease in the amount of treasury stock we purchased, payments on long-term debt and the credit facility offset by decreased proceeds from the issuance of long-term debt and capital stock. Proceeds from the issuance of common stock resulted from exercises of employee stock options. To preserve liquidity and financial flexibility, we reduced the amount of stock repurchased during the first two quarters of 2009 compared to the same period in 2008.

Debt Management

As of August 15, 2009, we maintained a committed $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 three uncommitted money market lines totaling $100 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 August 15, 2009, we did not have any borrowings under the credit facility, money market lines or outstanding commercial paper. The outstanding letters of credit that reduced the funds available under our credit agreement totaled $321 million as of August 15, 2009.

Our bank credit facility and the indentures underlying our publicly issued debt contain various restrictive covenants. As of August 15, 2009, we were in compliance with these financial covenants. Furthermore, management believes it is not reasonably likely that Kroger will fail to comply with these financial covenants in the foreseeable future.

Total debt, including both the current and long-term portions of capital leases and lease-financing obligations, decreased $87 million to $7.5 billion as of the end of the second quarter of 2009, from $7.6 billion as of the end of the second quarter of 2008. Total debt decreased $523 million as of the end of the second quarter of 2009 from $8.1 billion as of year-end 2008. The decrease as of the end of the second quarter of 2009, compared to the end of the second quarter of 2008, resulted from the issuance of $600 million of senior notes bearing an interest rate of 7.50% in the fourth quarter of 2008, offset by payment at maturity of our $350 million of senior notes bearing an interest rate of 7.25% in the second quarter of 2009, decreased outstanding commercial paper and payments on our money market lines. As of August 15, 2009, our cash and temporary cash investments were $369 million compared to $263 million as of January 31, 2009.

Common Stock Repurchase Program

During the second quarter of 2009, we invested $60 million to repurchase 2.8 million shares of Kroger stock at an average price of $21.58 per share. For the first two quarters of 2009, we invested $80 million to repurchase 3.7 million shares of Kroger stock at an average price of $21.39 per share. These shares were reacquired under two separate stock repurchase programs. The first is a $1 billion repurchase program that was authorized by Kroger's Board of Directors on January 18, 2008. The second is a program that uses the cash proceeds from the exercises of stock options by participants in Kroger's stock option and long-term incentive plans as well as the associated tax benefits. As of August 15, 2009, we had approximately $425 million remaining under the January 2008 repurchase program. In the second quarter of 2009, to preserve liquidity and financial flexibility, we reduced the amount of stock repurchased during the quarter, decreasing the uses of cash for treasury stock purchases during the quarter and in the first two quarters of 2009, compared to the same periods in 2008.

CAPITAL EXPENDITURES

Capital expenditures, excluding acquisitions and the purchase of leased facilities, totaled $518 million for the second quarter of 2009 compared to $461 million for the second quarter of 2008. Year-to-date, capital expenditures, excluding acquisitions and the purchase of leased facilities, totaled $1.1 billion in 2009 and 2008. During the second quarter of 2009, capital expenditures for the purchase of leased facilities totaled $84 million compared to $17 million for the second quarter of 2008. During the first two quarters of 2009, capital expenditures for purchases of leased facilities totaled $115 million compared to $17 million for the first two quarters of 2008. This increase was due to the Company purchasing several retail stores and one distribution center at very attractive rates during the first two quarters of 2009. During the second quarter of 2009, we opened, acquired, expanded or relocated 12 food stores and also completed 46 within-the-wall remodels. During the first two quarters of 2009, we opened, acquired, expanded or relocated 23 food stores and also completed 83 within-the-wall remodels. Total food store square footage increased 1.2% from the second quarter of 2008. Excluding acquisitions and operational closings, total food store square footage increased 1.8% over the second quarter of 2008.

CRITICAL ACCOUNTING POLICIES

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. Except as noted below, our critical accounting policies are summarized in our 2008 Annual Report on Form 10-K for the fiscal year ended January 31, 2009.

The preparation of financial statements in conformity with generally accepted accounting principles 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 vary from those estimates.

RECENTLY ADOPTED ACCOUNTING STANDARDS

In December 2007, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 160 (SFAS 160), which establishes accounting and reporting standards for a parent's noncontrolling interest in a subsidiary and the accounting for future ownership changes with respect to the subsidiary. This standard defines a noncontrolling interest, previously called a minority interest, as the portion of equity in a subsidiary that is not attributable, directly or indirectly, to a parent. SFAS 160 requires, among other things, that a noncontrolling interest be clearly identified, labeled and presented in the consolidated balance sheet as equity, but separate from the parent's equity; that the amount of consolidated net income attributable to the parent and to the noncontrolling interest be clearly identified and presented on the face of the consolidated statement of income; and that if a subsidiary is deconsolidated, the parent measure at fair value any noncontrolling equity investment that the parent retains in the former subsidiary and recognize a gain or loss in net income based on the fair value of the non-controlling equity investment. We adopted SFAS 160 effective February 1, 2009, and applied it retrospectively. As a result, we reclassified noncontrolling interests in amounts of $95 million from the mezzanine section to equity in the January 31, 2009 Consolidated Balance Sheet. Certain reclassifications to the Consolidated Statement of Operations have been made to prior period amounts to conform to the presentation of the current period under SFAS 160. Recorded amounts for prior periods previously presented as Net Earnings, which are now presented as Net Earnings Attributable to The Kroger Co., have not changed as a result of the adoption of SFAS 160.

Effective February 1, 2009, we adopted FASB Staff Position ("FSP") No. FAS 157-2, Effective Date of Statement No. 157(FSP 157-2). FSP 157-2 deferred the effective date of SFAS No. 157, Fair Value Measurements, for most non-financial assets and non-financial liabilities to fiscal years beginning after November 15, 2008. See Note 13 to the Consolidated Financial Statements for further discussion of the adoption of FSP 157-2.

Effective February 1, 2009, we adopted SFAS No. 141 (Revised 2007), Business Combinations (SFAS 141R), which replaces SFAS No. 141. SFAS 141R further expands the definitions of a business and the fair value measurement and reporting in a business combination. All business combinations completed after February 1, 2009, will be accounted for under SFAS 141R. We did not complete any business combinations during the first two quarters of fiscal 2009.

Effective February 1, 2009, we adopted SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities-an amendment of FASB Statement No. 133 (SFAS 161). SFAS 161 requires enhanced disclosures on an entity's derivative and hedging activities. The new disclosures required by this standard are included in Note 12 to the Consolidated Financial Statements.

Effective February 1, 2009, we adopted FSP No. EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities. This clarifies that share-based payment awards that entitle their holders to receive nonforfeitable dividends before vesting should be considered participating securities and included in the computation of EPS pursuant to the two-class method. See Note 7 to the Consolidated Financial Statements for further discussion of its adoption.

Effective May 24, 2009, we adopted SFAS No. 165, Subsequent Events(SFAS 165). SFAS 165 is intended to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. SFAS 165 requires the disclosure of the date through which an entity has evaluated . . .