Edgar Filing: SAFEWAY INC

Quarterly Report on Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 9, 2006

¨	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: 1-00041

LOGO

SAFEWAY INC.

(Exact name of registrant as specified in its charter)


Delaware		94-3019135
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

5918 Stoneridge Mall Rd.
Pleasanton, California		94588-3229
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code (925) 467-3000

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

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 the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes ¨ No.

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


Large accelerated filer x		Accelerated filer ¨		Non-accelerated filer ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes x No.

As of October 11, 2006, there were issued and outstanding 443.3 million shares of the registrant’s common stock.

SAFEWAY INC. AND SUBSIDIARIES

Table of Contents


		Page
PART I–FINANCIAL INFORMATION (Unaudited)

Item 1.	Financial Statements

	Condensed Consolidated Balance Sheets as of September 9, 2006 and December 31, 2005	3

	Condensed Consolidated Statements of Income for the 12 and 36 weeks ended September 9, 2006 and September 10, 2005	5

	Condensed Consolidated Statements of Cash Flows for the 36 weeks ended September 9, 2006 and September 10, 2005	6

	Notes to Condensed Consolidated Financial Statements	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	19

Item 4.	Controls and Procedures	19

PART II–OTHER INFORMATION

Item 1.	Legal Proceedings	19

Item 1A.	Risk Factors	19

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	20

Item 6.	Exhibits	21

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

SAFEWAY INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In millions)

(Unaudited)


	September 9, 2006			December 31, 2005
ASSETS

Current assets:
Cash and equivalents	$	332.1		$	373.3
Receivables		365.9			350.6
Merchandise inventories		2,622.5			2,766.0
Prepaid expenses and other current assets		230.5			212.5

Total current assets		3,551.0			3,702.4

Property		17,139.7			16,128.8
Less accumulated depreciation and amortization		(7,654.6	)		(7,031.7	)

Property, net		9,485.1			9,097.1

Goodwill		2,403.7			2,402.4
Prepaid pension costs		144.2			179.4
Investment in unconsolidated affiliate		223.7			201.8
Other assets		171.5			173.8

Total assets	$	15,979.2		$	15,756.9

(Continued)

SAFEWAY INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (Continued)

(In millions, except per-share amounts)

(Unaudited)


	September 9, 2006			December 31, 2005
LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:
Current maturities of notes and debentures	$	544.5		$	714.2
Current obligations under capital leases		42.5			39.1
Accounts payable		2,127.9			2,151.5
Accrued salaries and wages		429.6			526.1
Other accrued liabilities		934.8			833.0

Total current liabilities		4,079.3			4,263.9

Long-term debt:
Notes and debentures		4,739.9			4,961.2
Obligations under capital leases		620.1			644.1

Total long-term debt		5,360.0			5,605.3
Deferred income taxes		222.8			223.1
Accrued claims and other liabilities		749.2			744.9

Total liabilities		10,411.3			10,837.2

Commitments and contingencies

Stockholders’ equity:
Common stock: par value $0.01 per share; 1,500 shares authorized; 581.7 and 580.1 shares outstanding		5.8			5.8
Additional paid-in capital		3,775.0			3,445.1
Accumulated other comprehensive income		207.7			172.8
Retained earnings		5,660.9			5,171.7

		9,649.4			8,795.4
Less: Treasury stock at cost; 138.7 and 130.7 shares		(4,081.5	)		(3,875.7	)

Total stockholders’ equity		5,567.9			4,919.7

Total liabilities and stockholders’ equity	$	15,979.2		$	15,756.9

See accompanying notes to condensed consolidated financial statements.

SAFEWAY INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In millions, except per-share amounts)

(Unaudited)


	12 Weeks Ended						36 Weeks Ended
	September 9, 2006			September 10, 2005			September 9, 2006			September 10, 2005
Sales and other revenue	$	9,419.8		$	8,945.5		$	27,681.5		$	26,369.9
Cost of goods sold		(6,753.7	)		(6,388.9	)		(19,742.6	)		(18,763.9	)

Gross profit		2,666.1			2,556.6			7,938.9			7,606.0

Operating and administrative expense		(2,312.0	)		(2,316.9	)		(6,884.9	)		(6,768.5	)

Operating profit		354.1			239.7			1,054.0			837.5

Interest expense		(90.0	)		(93.5	)		(274.6	)		(278.3	)

Other income, net		11.2			5.7			25.4			21.8

Income before income taxes		275.3			151.9			804.8			581.0

Income tax expense		(101.8	)		(29.4	)		(242.2	)		(193.3	)

Net income	$	173.5		$	122.5		$	562.6		$	387.7

Earnings per share:
Basic	$	0.39		$	0.27		$	1.26		$	0.87

Diluted	$	0.39		$	0.27		$	1.25		$	0.86

Weighted average shares outstanding:
Basic		443.8			448.1			446.8			447.5

Diluted		447.0			451.6			449.0			450.0

Dividends declared per common share	$	0.0575		$	0.050		$	0.165		$	0.100

See accompanying notes to condensed consolidated financial statements.

SAFEWAY INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In millions)

(Unaudited)


	36 Weeks Ended
	September 9, 2006			September 10, 2005
OPERATING ACTIVITIES:
Net income	$	562.6		$	387.7

Reconciliation to net cash flow from operating activities:
Property impairment charges		26.4			70.4
Stock option expense		34.7			42.9
Depreciation expense		673.6			636.5
Deferred income tax		—			(67.0	)
LIFO expense		6.9			6.9
Equity in earnings of unconsolidated affiliates, net		(14.0	)		(6.8	)
Net pension expense		55.1			80.3
Gain on property retirements and lease exit costs		(14.0	)		(13.1	)
Increase in accrued claims and other liabilities		49.4			32.3
Other		(10.0	)		0.6
Change in working capital items:
Receivables and prepaid expenses		(32.3	)		18.9
Inventories at FIFO cost		148.3			78.9
Income taxes		112.0			(127.4	)
Payables and accruals		(145.1	)		146.3

Net cash flow from operating activities		1,453.6			1,287.4

INVESTING ACTIVITIES:
Cash paid for property additions		(1,111.6	)		(855.5	)
Proceeds from sale of property		62.7			45.4
Other		(48.7	)		(25.6	)

Net cash flow used by investing activities		(1,097.6	)		(835.7	)

FINANCING ACTIVITIES:
Payments on short-term borrowings, net		—			(10.8	)
Additions to long-term borrowings		995.5			151.0
Payments on long-term borrowings		(1,423.8	)		(517.0	)
Net proceeds from exercise of stock options		31.7			14.2
Repurchase of common stock		(193.1	)		—
Dividends paid		(70.6	)		(22.4	)
Income tax refund related to prior years’ debt financing		259.2			—
Other		3.1			(1.9	)

Net cash flow used by financing activities		(398.0	)		(386.9	)

Effect of changes in exchange rates on cash		0.8			3.9

(Decrease) increase in cash and equivalents		(41.2	)		68.7

CASH AND EQUIVALENTS:
Beginning of period		373.3			266.8

End of period	$	332.1		$	335.5

See accompanying notes to condensed consolidated financial statements.

SAFEWAY INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE A–THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying condensed consolidated financial statements of Safeway Inc. and subsidiaries (“Safeway” or the “Company”) for the 12 and 36 weeks ended September 9, 2006 and September 10, 2005 are unaudited and, in the opinion of management, contain all adjustments that are of a normal and recurring nature necessary to present fairly the financial position and results of operations for such periods. These condensed consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States have been condensed or omitted, pursuant to SEC regulations. The condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes contained in the Company’s 2005 Annual Report on Form 10-K. The results of operations for the 12 and 36 weeks ended September 9, 2006 are not necessarily indicative of the results expected for the full year.

Reclassifications

Certain prior year amounts were reclassified to conform to the 2006 presentation.

Inventory

Net income reflects the application of the last-in, first-out (“LIFO”) method of valuing certain domestic inventories, based upon estimated annual inflation (“LIFO Indices”). Safeway recorded estimated LIFO expense of $6.9 million during the first 36 weeks of 2006 and 2005. Actual LIFO Indices are calculated during the fourth quarter of the year based upon a statistical sampling of inventories.

Vendor Allowances

Vendor allowances totaled $567.9 million for the third quarter of 2006 and $535.4 million for the third quarter of 2005. Vendor allowances totaled $1.7 billion for the first 36 weeks of 2006 and $1.6 billion for the first 36 weeks of 2005. 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 nearly 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.

Promotional and slotting allowances are accounted for as a reduction in the cost of purchased inventory and recognized when the related inventory is sold. Contract allowances are recognized as a reduction in the cost of goods sold as volume thresholds are achieved or through the passage of time.

Comprehensive Income

For the first 36 weeks of 2006, total comprehensive income was $597.6 million, which primarily consists of $562.6 million of net income and $35.2 million of foreign currency translation adjustments.

SAFEWAY INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

For the first 36 weeks of 2005, total comprehensive income was $409.7 million, which primarily consists of $387.7 million of net income offset by $21.2 million of foreign currency translation adjustments.

Income Taxes

The Company provides income tax expense or benefit in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes.” Deferred income taxes represent future net tax effects resulting from temporary differences between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Accrued interest on tax deficiencies and refunds is included in the income tax expense or benefit.

NOTE B–NEW ACCOUNTING STANDARDS

In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 158, “Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R).” SFAS No. 158 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. Those changes will be reported in comprehensive income and as a separate component of stockholders’ equity. Additional footnote disclosures will also be required. SFAS No. 158 is effective for Safeway in the fourth quarter of fiscal 2006. Safeway is evaluating the impact of SFAS No. 158 on its financial statements.

In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects of Prior Year Misstatements when Qualifying Misstatements in Current Year Financial Statements,” which provides interpretive guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment. SAB No. 108 is effective for companies with fiscal years ending after November 15, 2006 and is required to be adopted by the Company in its fiscal year ending December 30, 2006. The Company is currently assessing the impact, if any, of the adoption of SAB No. 108.

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 generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement does not require any new fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. Safeway is currently assessing the impact of SFAS No. 157 on its financial statements.

In July 2006, the FASB issued Staff Position (“FSP”) on FAS 13, FSP FAS 13-2, “Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction.” FSP FAS 13-2 addresses how a change or projected change in the timing of cash flows relating to income taxes generated by a leveraged lease transaction affects the accounting by a lessor for that lease and amends FAS 13, “Accounting for Leases.” FSP FAS 13-2 is effective for fiscal years beginning after December 15, 2006. Safeway is evaluating the impact, if any, of FSP FAS 13-2 on its financial statements.

In June 2006, the FASB issued Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109.” This Interpretation 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, and provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. This Interpretation is effective for fiscal years beginning after December 15, 2006. Safeway is continuing to assess the impact of the Interpretation on its financial statements.

SAFEWAY INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

In June 2006, the FASB ratified the consensus reached by the Emerging Issues Tax Force in Issue No. 06-3 (“EITF 06-3”), “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That is, Gross versus Net Presentation).” The scope of EITF 06-3 includes any tax assessed by a governmental authority that is directly imposed on a revenue-producing activity between a seller and a customer and may include, but is not limited to, sales, use, value added, and some excise taxes. EITF 06-3 also concluded that the presentation of taxes within its scope on either a gross (included in revenues and costs) or net (excluded from revenues) basis is an accounting policy decision subject to appropriate disclosure. EITF 06-3 is effective for periods beginning after December 15, 2006. Safeway currently presents these taxes on a net basis and has elected not to change its presentation method.

NOTE C–STOCK-BASED EMPLOYEE COMPENSATION

In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”). Safeway elected to early adopt SFAS No. 123R in the first quarter of 2005 using the modified prospective method. Under the modified prospective method, compensation expense is recorded for the unvested portion of previously issued awards outstanding at January 2, 2005, using the same estimate of the grant date fair value and the same attribution method used to determine the pro forma disclosure under SFAS No. 123. SFAS No. 123R requires that all share-based payments to employees, including grants of employee stock options after January 1, 2005, be recognized in the financial statements as compensation cost based on the fair value on the date of grant.

The Company recognized share-based compensation expense of $10.9 million ($0.02 per diluted share) and $14.6 million ($0.02 per diluted share) in the third quarter of 2006 and 2005, respectively, as a component of operating and administrative expense. The Company recognized share-based compensation expense of $34.7 million ($0.05 per diluted share) and $42.9 million ($0.06 per diluted share) for the first 36 weeks of 2006 and 2005, respectively, as a component of operating and administrative expense.

The Company determines fair value of such awards using the Black-Scholes option pricing model. The following weighted average assumptions were used to value Safeway’s grants through the first 36 weeks of 2006: 4.5 years expected life; expected stock volatility of 27.1% to 27.7%; risk-free interest rate of 4.57% to 4.78%; and expected dividend yield of 0.8% to 0.9% during the expected term. The following weighted average assumptions were used to value Safeway’s grants through the first 36 weeks of 2005: 4.5 years expected life; expected stock volatility of 28.9% to 30.8%; risk-free interest rate of 3.83% to 4.09%; and expected dividend yield of 0%-1% during the expected term.

An independent third party assisted the Company in determining the Black-Scholes weighted average assumptions utilized in the 2006 and 2005 valuations. The expected term of the awards was determined using the “simplified method” stated in SEC Staff Accounting Bulletin No. 107 that utilizes the following formula: ((vesting term + original contract term)/2). Expected stock volatility was determined based upon a combination of historical volatility for the 4.5-year-period preceding the measurement date and estimates of implied volatility based on open interests in traded option contracts on Safeway common stock. The risk-free interest rate was based on the yield curve in effect at the time the options were granted, using U.S. constant maturities over the expected life of the option. Expected dividend yield is based on Safeway’s dividend policy at the time the options were granted.

SAFEWAY INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE D–GOODWILL

A summary of changes in Safeway’s goodwill during the first 36 weeks of 2006 by geographic area is as follows (in millions):


	2006
	U.S.			Canada			Total
Balance–beginning of period	$	2,317.8		$	84.6		$	2,402.4
Adjustments		(1.1	)⁽¹⁾		2.4	⁽²⁾		1.3

Balance–end of period	$	2,316.7		$	87.0		$	2,403.7

(1)	Primarily represents revised estimate of pre-acquisition tax accrual.

(2)	Represents foreign currency translation adjustments in Canada.

NOTE E–FINANCING

Notes and debentures were composed of the following at September 9, 2006 and December 31, 2005 (in millions):


	Sept. 9, 2006			Dec. 31, 2005
Commercial paper	$	—		$	—
Bank credit agreement, unsecured, weighted average interest rate of 4.37% as of September 9, 2006		103.0			47.5
Other bank borrowings, unsecured		5.9			6.5
Mortgage notes payable, secured		21.0			22.4
9.30% Senior Secured Debentures due 2007		24.3			24.3
6.15% Senior Notes due 2006, unsecured		—			700.0
4.80% Senior Notes due 2007, unsecured		480.0			480.0
7.00% Senior Notes due 2007, unsecured		250.0			250.0
4.125% Senior Notes due 2008, unsecured		300.0			300.0
4.45% Senior Notes due 2008, unsecured		267.5			259.7
6.50% Senior Notes due 2008, unsecured		250.0			250.0
7.50% Senior Notes due 2009, unsecured		500.0			500.0
Floating Rate Notes due 2009, unsecured, interest rate of 5.83% as of September 9, 2006		250.0			—
4.95% Senior Notes due 2010, unsecured		500.0			500.0
6.50% Senior Notes due 2011, unsecured		500.0			500.0
5.80% Senior Notes due 2012, unsecured		800.0			800.0
5.625% Senior Notes due 2014, unsecured		250.0			250.0
7.45% Senior Debentures due 2027, unsecured		150.0			150.0
7.25% Senior Debentures due 2031, unsecured		600.0			600.0
9.875% Senior Subordinated Debentures due 2007, unsecured		24.2			24.2
Other notes payable, unsecured		8.5			10.8

		5,284.4			5,675.4
Less current maturities		(544.5	)		(714.2	)

Long-term portion	$	4,739.9		$	4,961.2

Pursuant to a shelf registration filed with the SEC on July 27, 2004 (as amended), Safeway issued $250 million of Floating Rate Notes (the “Notes”) on March 28, 2006. The Notes mature on March 27, 2009. Interest is equal to LIBOR plus 0.35% and will be reset quarterly. The Company pays interest on the Notes quarterly in arrears on each March 27, June 27, September 27 and December 27. The Company may redeem the Notes on any interest payment date that is on or after September 27, 2006, in whole or in part, at a price equal to 100% of the principal amount of the Notes being redeemed plus accrued and unpaid interest thereon. Safeway used the net proceeds from the Notes to repay borrowings under its U.S. commercial paper program.

SAFEWAY INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

On June 15, 2006, the Company amended its credit agreement dated June 1, 2005. The amendment extended the termination date for an additional year to June 1, 2011.

NOTE F–TAXES ON INCOME

As announced on April 10, 2006, Safeway settled a federal income tax refund claim of approximately $318 million. The settlement relates to Safeway’s claim for refunds in the years 1992 through 1999 for costs associated with debt financing. The refund, received in August 2006, consisted of a tax refund of $259.2 million and interest earned on that refund of approximately $97 million. The Company will pay approximately $38 million in income taxes related to the interest earned on the tax refund in the fourth quarter of 2006.

The tax refund of $259.2 million was recorded in the second quarter of 2006 as an increase to additional paid-in capital since the associated tax deductions exceeded the previously recognized book expense. The interest earned, net of tax, reduced income tax expense by $59 million in the second quarter of 2006.

NOTE G–PENSION PLAN

The following table provides the components of net pension expense for retirement plans (in millions):


	12 Weeks Ended Sept. 9, 2006			12 Weeks Ended Sept. 10, 2005			36 Weeks Ended Sept. 9, 2006			36 Weeks Ended Sept. 10, 2005
Estimated return on assets	$	(37.0	)	$	(35.7	)	$	(112.8	)	$	(106.9	)
Service cost		23.4			25.3			70.1			75.7
Interest cost		25.8			25.9			76.9			77.7
Amortization of prior service cost		5.3			3.9			16.0			11.6
Amortization of unrecognized losses		1.7			7.4			4.9			22.2

Net pension expense	$	19.2		$	26.8		$	55.1		$	80.3

Safeway made approximately $22.6 million of contributions to its defined benefit pension plan trusts, including the Retirement Restoration Plan, in the first 36 weeks of 2006. For the remainder of 2006, Safeway currently anticipates contributing approximately $11 million to these trusts.

NOTE H–CONTINGENCIES

Legal Matters

Note K to the Company’s consolidated financial statements, under the caption “Legal Matters” in the 2005 Annual Report on Form 10-K, provides information on certain litigation in which the Company is involved. There have been no material developments to these matters, except as noted in subsequent filings and except as described below.

With respect to the case entitled State of California, ex rel. Bill Lockyer v. Safeway Inc. dba Vons, et al., the hearing on the Attorney General’s motion seeking summary judgment on the grounds that the Mutual Strike Assistance Agreement constitutes a per se violation of the Sherman Act, which defendants have opposed, is now set for October 23, 2006. The court has set a trial date of August 21, 2007.

Guarantees

Note K to the Company’s consolidated financial statements, under the caption “Furrs and Homeland Lease Liabilities” in the 2005 Annual Report on Form 10-K, provides information on contingent liabilities for the Company’s former El Paso, Texas and Oklahoma City, Oklahoma divisions. Safeway is unable to determine the potential obligation with respect to other divested operations, should there be any similar defaults, because information about the total numbers of leases from these divestitures that are still outstanding is not available.

SAFEWAY INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Based on an internal assessment by the Company, performed by taking the original inventory of assigned leases at the time of the divestitures and accounting for the passage of time, Safeway expects that any potential losses beyond those recorded, should there be any similar defaults, would not be material to Safeway’s operating results, cash flow or financial position.

Note N to the Company’s consolidated financial statements, under the caption “Guarantees” in the 2005 Annual Report on Form 10-K, provides information on guarantees required under FIN No. 45.

NOTE I–STOCKHOLDERS’ EQUITY

Dividends on Common Stock

Safeway paid a quarterly dividend of $0.05 per common share on January 20, 2006 and April 21, 2006 to stockholders of record as of December 30, 2005 and March 31, 2006, respectively. In May 2006, the Company’s Board of Directors approved a 15% increase in the quarterly dividend from $0.05 to $0.0575 per common share. A cash dividend of $0.0575 per common share was paid on July 7, 2006 to stockholders of record as of June 16, 2006. The dividend payments totaled $70.6 million through the third quarter of fiscal 2006.

In August 2006, Safeway’s Board of Directors declared a quarterly cash dividend of $0.0575 per share, which was paid on October 5, 2006 to stockholders of record as of September 13, 2006. The dividend payment totaled $25.5 million.

Stock Repurchase Program

In July 2002, the Company announced that its Board of Directors had increased the authorized level of its stock repurchase program to $3.5 billion. Through the end of the third quarter of 2006, the aggregate cost of shares of common stock repurchased by the Company, including commissions, was approximately $3.1 billion, leaving an authorized amount for repurchases of approximately $354 million. During the third quarter of 2006, the Company repurchased approximately 2.4 million shares of its common stock under the repurchase program at an aggregate price, including commissions, of $71.8 million. The average price per share, excluding commissions, was approximately $29.36. Year-to-date through the third quarter of 2006, Safeway repurchased approximately 8.3 million shares of its common stock under the repurchase program at an aggregate price, including commissions, of $211.5 million. The average price per share, excluding commissions, was approximately $25.50. The repurchase program has no expiration date but may be terminated by the Board of Directors.

SAFEWAY INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Results of Operations

12-WEEKS ENDED SEPTEMBER 9, 2006 COMPARED WITH 12-WEEKS ENDED SEPTEMBER 10, 2005 Net income was $173.5 million ($0.39 per diluted share) for the third quarter ended September 9, 2006.

Net income was $122.5 million ($0.27 per diluted share) for the third quarter of 2005. Net income in the third quarter of 2005 was reduced by $0.08 per diluted share due to an impairment charge in Texas and $0.03 per diluted share due to an employee buyout charge in Northern California. Net income in the third quarter of 2005 was increased by $0.06 per diluted share due to the favorable resolution of various tax issues.

SALES AND OTHER REVENUE Total sales increased 5.3% to $9.4 billion in the third quarter of 2006 from $8.9 billion in the third quarter of 2005. Contributions from Lifestyle stores, strong perishable and non-perishable performance and increased fuel sales drove this increase. Identical-store sales increased 5.0% for the third quarter of 2006. Excluding fuel sales, identical-store sales increased 3.7%.

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 of 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 declined 28 basis points to 28.30% of sales in the third quarter of 2006 compared to 28.58% in the third quarter of 2005. Higher fuel sales (which have a lower gross margin) reduced gross profit margin by 19 basis points. The remaining 9 basis point decline is largely the result of investments in price and advertising, partly offset by improvement in shrink.

OPERATING AND ADMINISTRATIVE EXPENSE Operating and administrative expense declined to 24.54% of sales in the third quarter of 2006 from 25.90% in 2005.

Operating and administrative expense in 2005 included a $54.7 million pre-tax impairment charge in Texas and a $21.9 million pre-tax employee buyout charge. Excluding these items, operating and administrative expense in 2006 improved 50 basis points. This improvement is primarily due to increased sales and lower employee costs as a percentage of sales.

SAFEWAY INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

INTEREST EXPENSE Interest expense was $90.0 million in the third quarter of 2006, down slightly from $93.5 million in the third quarter of 2005. Indebtedness was lower in the third quarter of 2006 compared to 2005, while average interest rates were higher.

INCOME TAX EXPENSE Income tax expense was $101.8 million, or 37.0% of pre-tax income, in the third quarter of 2006 compared to 19.4% in the third quarter of 2005.

Safeway’s effective tax rate in 2005 was lower due to $17 million of tax benefits associated with the repatriation of earnings from Safeway’s Canadian subsidiary and to the favorable resolution of various tax issues totaling $10 million. The total benefit of these tax items was $0.06 per diluted share.

36-WEEKS ENDED SEPTEMBER 9, 2006 COMPARED WITH 36-WEEKS ENDED SEPTEMBER 10, 2005 Net income for the first 36 weeks of 2006 was $562.6 million ($1.25 per diluted share) compared to $387.7 million ($0.86 per diluted share) for the first 36 weeks of 2005. The gross profit margin was 28.68% in 2006 compared to 28.84% in 2005. Operating and administrative expense was 24.87% of sales in 2006 compared to 25.67% of sales in 2005.

Critical Accounting Policies

Critical accounting policies are those accounting policies that management believes are important to the portrayal of Safeway’s financial condition and results 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. The Company’s 2005 Annual Report on Form 10-K includes a description of certain critical accounting policies, including those with respect to workers’ compensation, store closures, employee benefit plans, stock-based employee compensation, goodwill and income tax contingencies.

New Accounting Standards

SAFEWAY INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

to income taxes generated by a leveraged lease transaction affects the accounting by a lessor for that lease and amends FAS 13, “Accounting for Leases.” FSP FAS 13-2 is effective for fiscal years beginning after December 15, 2006. Safeway is evaluating the impact, if any, of FSP FAS 13-2 on its financial statements.

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109.” This Interpretation 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, and provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. This Interpretation is effective for fiscal years beginning after December 15, 2006. Safeway is continuing to assess the impact of the Interpretation on its financial statements.

Liquidity and Financial Resources

Net cash flow from operating activities was $1,453.6 million in the first 36 weeks of 2006 compared to $1,287.4 million in the first 36 weeks of 2005, primarily because of higher net income.

Net cash flow used by investing activities, which consists principally of cash paid for property additions, was $1,097.6 million for the first 36 weeks of 2006 compared to $835.7 million in 2005. The Company incurred higher costs for purchases of land and buildings in the first quarter of 2006. In addition, a portion of the costs associated with the large number of Lifestyle projects completed late in the fourth quarter of 2005 was paid in the first quarter of 2006.

Financing activities used cash flow of $398.0 million in the first 36 weeks of 2006 compared to $386.9 million in 2005. The income tax refund related to prior years’ debt refinancing was offset by pay down of long-term borrowings, stock repurchases and dividends paid.

Based upon the current level of operations, Safeway believes that net cash flow from operating activities and other sources of liquidity, including potential borrowing under Safeway’s commercial paper program and its credit agreement, referred to below, will be adequate to meet anticipated requirements for working capital, capital expenditures, interest payments, dividend payments, stock repurchases, if any, and scheduled principal payments for the foreseeable future. There can be no assurance, however, that Safeway’s business will continue to generate cash flow at or above current levels or that the Company will maintain its ability to borrow under its commercial paper program and credit agreement.

CREDIT AGREEMENT On June 1, 2005, the Company entered into a $1,600.0 million credit agreement with a syndicate of banks. On June 15, 2006, the Company amended the credit agreement to extend the termination date for an additional year to June 1, 2011. The credit agreement, as amended (the “Credit Agreement”), provides (i) to Safeway a $1,350.0 million, five-year, revolving credit facility (the “Domestic Facility”), (ii) to Safeway and Canada Safeway Limited a Canadian facility of up to $250.0 million for U.S. Dollar and Canadian Dollar advances and (iii) to Safeway a $400.0 million sub-facility of the Domestic Facility for issuance of standby and commercial letters of credit. The Credit Agreement also provides for an increase in the credit facility commitments up to an additional $500.0 million, subject to the satisfaction of certain conditions. The restrictive covenants of the Credit Agreement limit Safeway with respect to, among other things, creating liens upon its assets and disposing of material amounts of assets other than in the ordinary course of business. Additionally, the Company is required to maintain a minimum Adjusted EBITDA,

SAFEWAY INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

as defined in the Credit Agreement, to interest expense ratio of 2.0 to 1 and not exceed an Adjusted Debt (total consolidated debt less cash and cash equivalents in excess of $75.0 million) to Adjusted EBITDA ratio of 3.5 to 1. As of September 9, 2006, the Company was in compliance with the covenant requirements. As of September 9, 2006, borrowings totaled $103.0 million and letters of credit totaled $48.3 million under the Credit Agreement. Total unused borrowing capacity under the Credit Agreement was $1,448.7 million as of September 9, 2006.

SHELF REGISTRATION In 2004, the Company filed a shelf registration statement covering the issuance from time to time of up to $2.3 billion of debt securities and/or common stock. Pursuant to this shelf registration, Safeway issued $250 million of Floating Rate Notes (the “Notes”) on March 28, 2006. The Notes mature on March 27, 2009. Interest is equal to LIBOR plus 0.35% and will be reset quarterly. The Company pays interest on the Notes quarterly in arrears on each March 27, June 27, September 27 and December 27, beginning on June 27, 2006. The Company may redeem the Notes on any interest payment date that is on or after September 27, 2006, in whole or in part, at a price equal to 100% of the principal amount of the Notes being redeemed plus accrued and unpaid interest thereon. Safeway used the net proceeds from the Notes to repay borrowings under its U.S. commercial paper program. As of September 9, 2006, $1.3 billion of securities were available for issuance under the shelf registration. The Company may issue debt or common stock in the future depending on market conditions, the need to refinance existing debt and capital expenditure plans or other investing activities.

DIVIDENDS ON COMMON STOCK Safeway paid a quarterly dividend of $0.05 per common share on January 20, 2006 and April 21, 2006 to stockholders of record as of December 30, 2005 and March 31, 2006, respectively. In May 2006, the Company’s Board of Directors approved a 15% increase in the quarterly dividend from $0.05 to $0.0575 per common share. A cash dividend of $0.0575 per common share was paid on July 7, 2006 to stockholders of record as of June 16, 2006. The dividend payments totaled $70.6 million through the third quarter of fiscal 2006.

STOCK REPURCHASE PROGRAM In July 2002, the Company announced that its Board of Directors had increased the authorized level of its stock repurchase program to $3.5 billion. Through the end of the third quarter of 2006, the aggregate cost of shares of common stock repurchased by the Company, including commissions, was approximately $3.1 billion, leaving an authorized amount for repurchases of approximately $354 million. During the third quarter of 2006, the Company repurchased approximately 2.4 million shares of its common stock under the repurchase program at an aggregate price, including commissions, of $71.8 million. The average price per share, excluding commissions, was approximately $29.36. Year-to-date through the third quarter of 2006, Safeway repurchased approximately 8.3 million shares of its common stock under the repurchase program at an aggregate price, including commissions, of $211.5 million. The average price per share, excluding commissions, was approximately $25.50. The repurchase program has no expiration date but may be terminated by the Board of Directors.

TAX SETTLEMENTS As announced on April 10, 2006, Safeway settled a federal income tax refund claim of approximately $318 million. The settlement relates to Safeway’s claim for refunds in the years 1992 through 1999 for costs associated with debt financing. The refund, received in August 2006, consisted of a tax refund of $259.2 million and interest earned on that refund of approximately $97 million. The Company will pay approximately $38 million in income taxes related to the interest earned on the tax refund in the fourth quarter of 2006.

Safeway has similar claims for refunds of income tax and interest in several states. As of September 9, 2006, the Company expects these state income tax refunds and interest will be approximately $30 million and $12 million, respectively, net of income tax. Collection of these funds may take several years.

SAFEWAY INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Capital Expenditure Program

Safeway invested $1.1 billion in capital expenditures in the first 36 weeks of 2006. The Company opened 9 new Lifestyle stores and completed 149 Lifestyle remodels. For the year, the Company expects to spend approximately $1.65 billion in capital expenditures and open approximately 20 new Lifestyle stores and complete approximately 275 Lifestyle remodels.

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements contain information about our future operating or financial performance. Forward-looking statements are based on our current expectations and involve risks and uncertainties, which may be beyond our control, as well as assumptions. If assumptions prove to be incorrect or if known or unknown risks and uncertainties materialize into actual events or circumstances, actual results could differ materially from those included in or contemplated or implied by these statements. Forward-looking statements do not strictly relate to historic or current facts. Forward-looking statements are indicated by words or phrases such as “will,” “may,” “continuing,” “on-going,” “expects,” “estimates,” “anticipates,” “believes,” “guidance” and similar words or phrases and the negative of such words or phrases.

This Quarterly Report on Form 10-Q includes forward-looking statements, including forward-looking statements relating to pension plan contributions; the amount and timing of the receipt of income tax refunds and interest thereon; defenses to legal proceedings; obligations arising out of divested operations; sufficiency of liquidity for the foreseeable future; repurchases of common stock; and Lifestyle stores. The following are among the principal factors that could cause actual results to differ materially from those included in or contemplated or implied by the forward-looking statements:

•

General business and economic conditions in our operating regions, including consumer spending levels, currency valuations, population, employment and job growth in our markets;

•

Pricing pressures and competitive factors, which could include pricing strategies, store openings, remodels or acquisitions by our competitors;

•

Results of our programs to control or reduce costs, improve buying practices and control shrink;

•

Results of our programs to increase sales;

•

Results of our efforts to revitalize corporate brands;

•

Results of our programs to improve our perishables departments;

•

Results of our promotional programs;

•

Results of our programs to improve capital management;

•

Results of any on-going litigation in which we are involved or any litigation in which we may become involved;

•

The ability to achieve satisfactory operating results in all geographic areas where we operate;

•

Changes in the financial performance of our equity investments;

•

Labor costs, including benefit plan costs and severance payments, or labor disputes that may arise from time to time and work stoppages that could occur in areas where certain collective bargaining agreements have expired or are on indefinite extensions or are scheduled to expire in the near future;

•

Legislative, regulatory, tax or judicial developments;

•

The cost and stability of fuel, energy and other power sources;

•

Unanticipated events or changes in real estate matters, including acquisitions, dispositions and impairments;

•

Adverse weather conditions;

•

Performance in new business ventures or other opportunities that we pursue;

•

The capital investment in and financial results from our Lifestyle stores;

•

The rate of return on our pension assets; and

•

The availability and terms of financing.

SAFEWAY INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

We undertake no obligation to update forward-looking statements to reflect new information, events or developments after the date hereof. Please refer to our most recent Annual Report on Form 10-K, subsequent Quarterly Reports on Form 10-Q and subsequent Current Reports on Form 8-K for more information regarding these risks and uncertainties. These reports are not intended to be a discussion of all potential risks or uncertainties, as it is not possible to predict or identify all risk factors.

SAFEWAY INC. AND SUBSIDIARIES

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes regarding the Company’s market risk position from the position reflected in the information provided under Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” of the Company’s 2005 Annual Report on Form 10-K.

Item 4. Controls and Procedures

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its President and Chief Executive Officer and its Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management necessarily applied its judgment in assessing the costs and benefits of such controls and procedures which, by their nature, can provide only reasonable assurance regarding management’s control objectives. Management, including the Company’s President and Chief Executive Officer along with the Company’s Chief Financial Officer, concluded that the Company’s disclosure controls and procedures are effective in reaching the level of reasonable assurance regarding management’s control objectives. The Company also has investments in certain unconsolidated entities, including Casa Ley. As the Company does not control or manage these entities, its disclosure controls and procedures with respect to such entities are necessarily more limited than those it maintains with respect to its consolidated subsidiaries.

The Company has carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s President and Chief Executive Officer along with the Company’s Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(b). Based upon the foregoing, as of September 9, 2006, the Company’s President and Chief Executive Officer along with the Company’s Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s Exchange Act reports. There has been no change during the Company’s fiscal quarter ended September 9, 2006 in the Company’s internal control over financial reporting that was identified in connection with the evaluation required by Exchange Act Rule 13a-15(d) which has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II—OTHER INFORMATION

Item 1. Legal Proceedings

Item 1A. Risk Factors

There have been no material changes in our risk factors from those disclosed in Part I, Item 1A, in the Company’s 2005 Annual Report on Form 10-K.

SAFEWAY INC. AND SUBSIDIARIES

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The following table contains information for shares repurchased during the third quarter of 2006.


Fiscal period	Total number of shares purchased	Average price paid per share¹		Total number of shares purchased as part of publicly announced plans or programs	Approximate dollar value of shares that may yet be purchased under the plans or programs (in millions)²
June 18, 2006 – July 15, 2006	—	$	N/A	—	$	425
July 16, 2006 – August 12, 2006	1,379,600		28.35	1,379,600		386
August 13, 2006 – September 9, 2006	1,063,700		30.68	1,063,700		354

TOTAL	2,443,300	$	29.36	2,443,300	$	354

¹	Average price per share excludes commissions.

In July 2002, the Company announced that its Board of Directors had increased the authorized level of its stock repurchase program to $3.5 billion from the previously announced level of $2.5 billion. From the initiation of the repurchase program in 1999 through the end of the third quarter of 2006, the aggregate cost of shares of common stock repurchased by the Company, including commissions, was approximately $3.1 billion, leaving an authorized amount for repurchases of approximately $354 million. The repurchase program has no expiration date but may be terminated by the Board of Directors.

SAFEWAY INC. AND SUBSIDIARIES

Item 6. Exhibits



Exhibit 11.1		Computation of Earnings Per Common Share.

Exhibit 31.1		Rule 13(a)-14(a)/15d-14(a) Certification.

Exhibit 31.2		Rule 13(a)-14(a)/15d-14(a) Certification.

Exhibit 32		Section 1350 Certifications.

SAFEWAY INC. AND SUBSIDIARIES

Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


		SAFEWAY INC.

Date: October 13, 2006		/s/ Steven A. Burd
		Steven A. Burd
		Chairman, President and Chief Executive Officer

Date: October 13, 2006		/s/ Robert L. Edwards
		Robert L. Edwards
		Executive Vice President and Chief Financial Officer

SAFEWAY INC. AND SUBSIDIARIES

Exhibit Index

LIST OF EXHIBITS FILED WITH FORM 10-Q FOR THE PERIOD

ENDED September 9, 2006



Exhibit 11.1		Computation of Earnings Per Common Share.

Exhibit 31.1		Rule 13(a)-14(a)/15d-14(a) Certification.

Exhibit 31.2		Rule 13(a)-14(a)/15d-14(a) Certification.

Exhibit 32		Section 1350 Certifications.