-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, IX+SRssz3XSdyY4AHjVG+7Ch7xF4derduVbLjoq7IGMkFhCyglHaXECMSUNgjidE tx49w9la7g+8NBtL5XU7TQ== 0000037912-99-000021.txt : 19990818 0000037912-99-000021.hdr.sgml : 19990818 ACCESSION NUMBER: 0000037912-99-000021 CONFORMED SUBMISSION TYPE: 10-K405/A PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19990102 FILED AS OF DATE: 19990817 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FOOD LION INC CENTRAL INDEX KEY: 0000037912 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-GROCERY STORES [5411] IRS NUMBER: 560660192 STATE OF INCORPORATION: NC FISCAL YEAR END: 0102 FILING VALUES: FORM TYPE: 10-K405/A SEC ACT: SEC FILE NUMBER: 000-06080 FILM NUMBER: 99694601 BUSINESS ADDRESS: STREET 1: P O BOX 1330 STREET 2: 2110 EXECUTIVE DR CITY: SALISBURY STATE: NC ZIP: 28145 BUSINESS PHONE: 7046338250 MAIL ADDRESS: STREET 1: P O BOX 1330 STREET 2: 2110 EXECUTIVE DR CITY: SALISBURY STATE: NC ZIP: 28145 FORMER COMPANY: FORMER CONFORMED NAME: FOOD TOWN STORES INC DATE OF NAME CHANGE: 19830510 10-K405/A 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K/A ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended January 2, 1999. Commission File No. 0-6080 F O O D L I O N, INC. (Exact name of registrant as specified in its charter) Incorporated in North Carolina 56-0660192 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) P.O. Box 1330, 2110 Executive Drive Salisbury, North Carolina 28145-1330 (Address of principal executive office) (Zip Code) Registrant's telephone number, including area code-- (704) 633-8250 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Class A Common Stock, par value $.50 per share Class B Common Stock, par value $.50 per share (Title of Class) 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. Yes X No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K ( 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.[x] The aggregate market value of the voting and non-voting stock held by non- affiliates of the Registrant based on the price of such stock at the close of business on March 26, 1999, was $1,033,294,366 and $1,457,690,498, respectively. For purposes of this report and as used herein, the term "non-affiliate" includes all shareholders of the Registrant other than Directors, executive officers, and other senior management of the Registrant and persons holding more than five per cent of the outstanding voting stock of the Registrant. Outstanding shares of common stock of the Registrant as of March 26, 1999. Class A Common Stock - 247,914,301 Class B Common Stock - 230,830,364 Exhibit index is located on sequential page 16 hereof. DOCUMENTS INCORPORATED BY REFERENCE Portions of the following documents are incorporated by reference in this Form 10-K: 1. Annual Report to Shareholders for the fiscal year ended January 2, 1999, or is incorporated by reference in Part II hereof. 2. Proxy Statement for the 1999 Annual Meeting of Shareholders of the Company to be held on May 6, 1999, or is incorporated by reference in Part III hereof. PART I Item 1. Business. Food Lion, Inc. (the "Company") engages in one line of business, the operation of retail food supermarkets in the southeastern and Mid-Atlantic regions of the United States. The Company was incorporated in North Carolina in 1957 and maintains its corporate headquarters in Salisbury, North Carolina. The Company's stores, which are operated under the names of "Food Lion" and "Kash n' Karry," sell a wide variety of groceries, produce, meats, dairy products, seafood, frozen food, deli/bakery and non-food items such as health and beauty care, prescriptions, and other household and personal products. The Company offers nationally and regionally advertised brand name merchandise as well as products manufactured and packaged for the Company under the private labels of "Food Lion" and "Kash n' Karry." The Company offers over 30,000 Stock Keeping Units (SKU's) in its Food Lion locations and over 35,000 in its Kash n' Karry locations. The Company's current Food Lion store prototype is a 38,000 square foot model. The current Kash n' Karry store prototype is a 46,000 square foot model. The products sold by the Company are purchased through a centralized buying department at the Company's headquarters. The centralization of the buying function allows the management of the Company to establish long-term relationships with many vendors providing various alternatives for sources of product supply. The business in which the Company is engaged is highly competitive and characterized by low profit margins. The Company competes with national, regional and local supermarket chains, supercenters, discount food stores, single unit stores, convenience stores, warehouse clubs and drug stores. The Company will continue to develop and evaluate new retailing strategies that will respond to its customers' needs. Seasonal changes have no material effect on the operation of the Company's supermarkets. As of January 2, 1999, 1,207 supermarkets were in operation as follows: Delaware 12 North Carolina 409 Florida 186 Pennsylvania 7 Georgia 56 South Carolina 112 Kentucky 12 Tennessee 81 Maryland 49 Virginia 266 West Virginia 17 -2- As of March 26, 1999, the Company had opened 21 supermarkets since January 2, 1999, closed one supermarket, relocated four supermarkets and had signed leases for 16 supermarkets which are expected to open in either 1999 or 2000. Warehousing and distribution facilities, including its transportation fleet, are owned and operated by the Company and are located in Green Cove Springs and Plant City, Florida; Salisbury and Dunn, North Carolina; Greencastle, Pennsylvania; Elloree, South Carolina; Clinton, Tennessee; and Disputanta, Virginia. As of January 2, 1999, the Company employed 32,991 full-time and 59,134 part-time employees. The following table shows the number of stores opened, closed and relocated, and the number of stores open at the end of each year, for the past three years. # Stores # Stores #Stores # Stores Opened Opened Closed Relocated Year-end 1998 79 (12) (17) 1,207 1997 164 (a) (94) (b) (25) 1,157 1996 64 ( 3) (22) 1,112 (a) Includes 100 stores acquired from Kash n' Karry (b) Includes 61 Southwest store closings Item 2. Properties. Supermarkets operated by the Company in the southeastern and Mid-Atlantic states average 32,218 square feet in size. The Company's current Food Lion store prototype retail format is a 38,000 square foot model with a deli/bakery department. The current Kash n' Karry store prototype is a 46,000 square foot model. All of the Company's supermarkets are self-service stores which have off- street parking facilities. With the exception of operating 66 owned supermarkets, the Company occupies its various supermarket premises under lease agreements providing for initial terms of up to 30 years, with options generally ranging from five to twenty years. At the end of 1998 the Company had $21.0 million (net book value) in property held for sale. The following table identifies the location and square footage of distribution centers and office space operated by the Company as of January 2, 1999. Location of Property Square Footage Distribution Center #1 Salisbury, NC 1,630,233 Distribution Center #2 Disputanta, VA 1,123,718 Distribution Center #3 Elloree, SC 1,098,612 Distribution Center #4 Dunn, NC 1,224,652 Distribution Center #5 Green Cove Springs, FL 832,109 Distribution Center #6 Clinton, TN 833,042 Distribution Center #7 Greencastle, PA 1,236,124 Distribution Center #8 Plant City, FL 759,546 Corporate Headquarters Salisbury, NC 271,592 9,009,628 -3- Item 3. Legal Proceedings. The Company has had no significant developments related to legal matters since the Item 1 disclosure included in the Company's Form 10-Q for the quarter ended September 12, 1998. Item 4. Submission of Matters to a Vote of Security Holders. This item is not applicable. Executive Officers of the Registrant The names and ages of the current executive officers of the Company and their positions as of March 26, 1999, are set forth below. The footnotes following the table below include the business experience during the past five years for each executive officer who has been employed by the Company for fewer than five years. Unless otherwise indicated by footnote, each of the executive officers served in various managerial capacities with the Company over the past five years. None of the executive officers named below is related to any other executive officer or director by blood, marriage or adoption. Officers serve at the discretion of the Board of Directors. Name and all Positions with Age Year First Year First the Company Held at March Elected Elected to 26, 1999 Officer Present Office Tom E. Smith 57 1974 1981 President and Chief Executive Officer Joseph C. Hall, Jr. 49 1988 1995 Senior Vice President and Chief Operating Officer R. William McCanless 41 1993 1995 Senior Vice President, Chief Administrative Officer and Secretary Pamela K. Kohn 34 1995 1997 Senior Vice President of Merchandising A. Edward Benner, Jr. 57 1980 1996 Vice President and Chief Information Officer -4- Robert J. Brunory 44 1994 1994 Vice President Procurement/Category Management Michael D. Byars 40 1997 1997 Vice President of Operations, Food Lion, Kash n' Karry Division Robert E. Crosslin (1) 44 1997 1997 Vice President of Distribution W. Bruce Dawson 46 1995 1995 Vice President of Operations/ Northern Division Keith M. Gehl 40 1997 1997 Vice President of Real Estate and Store Development Carol M. Herndon 36 1991 1994 Corporate Controller and Director of Accounting Richard A. James 39 1997 1997 Director of Finance and Treasurer L. Darrell Johnson 46 1997 1997 Vice President of Human Resources Laura C. Kendall (2) 47 1997 1997 Vice President of Finance and Chief Financial Officer C. Dave Morgan 48 1997 1997 Vice President of Operations/ Southern Division Elwyn G. Murray, III 32 1998 1998 Vice President of Marketing Lester C. Nail (3) 39 1995 1995 Vice President Legal Affairs and Assistant Secretary Thomas J. Robinson 38 1997 1997 Vice President of Operations/ Central Division Natalie M. Taylor 39 1997 1997 Vice President of Diversity -5- (1) Mr.Crosslin joined Food Lion in October 1996 and served as Corporate Transportation Manager until his promotion to Vice President in May 1998. Prior to joining Food Lion in 1996, Mr. Crosslin served as Director of Fleet Services to Ralphs Grocery Company. (2) Ms. Kendall served as the Chief Financial Officer for F&M Distributors prior to joining Food Lion. From 1995 until March of 1997, she was the presiding officer overseeing the liquidation process for F&M Distributors. (3) Prior to joining Food Lion in 1995, Mr. Nail served as Corporate Counsel to Wal-Mart Stores, Inc. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. The information pertaining to the Class A and Class B Common Stock price range, dividends and record holders discussed beneath the headings "Market Price of Common Stock" and "Dividends Declared Per Share of Common Stock" in the Annual Report to Shareholders for the fiscal year ended January 2, 1999, is hereby incorporated by reference. Item 6. Selected Financial Data. The information set forth beneath the heading "Ten Year Summary of Operations" in the Annual Report to Shareholders for the fiscal year ended January 2, 1999, is hereby incorporated by reference. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. The information set forth beneath the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Annual Report to Shareholders for the fiscal year ended January 2, 1999, is hereby incorporated by reference. Item 8. Financial Statements and Supplementary Data. The financial statements, including the accompanying notes and results by quarter, set forth beneath the headings "Consolidated Statements of Income", "Consolidated Balance Sheets", "Consolidated Statements of Cash Flows", "Consolidated Statements of Shareholders' Equity", "Notes to Consolidated Financial Statements" and "Results by Quarter" in the Annual Report to Shareholders for the fiscal year ended January 2, 1999, are hereby incorporated by reference. -6- Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure. This item is not applicable. PART III Item 10. Directors and Executive Officers of the Registrant. The information pertaining to nominees for election as directors set forth beneath the heading "Election of Directors" in the Proxy Statement for the 1999 Annual Meeting of Shareholders to be held May 6, 1999 is incorporated by reference. Information concerning the Company's executive officers is contained under the heading "Executive Officers of the Registrant" in Part I of this report. Item 11. Executive Compensation. The information pertaining to executive compensation set forth beneath the headings "Executive Compensation" and "Report of the Senior Management Compensation Committee, Stock Option Committee and Board of Directors" in the Proxy Statement for the 1999 Annual Meeting of Shareholders to be held on May 6, 1999, is hereby incorporated by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management. The information pertaining to security ownership of certain beneficial owners and management set forth beneath the heading "Security Ownership of Certain Beneficial Owners and Management" in the Proxy Statement for the 1999 Annual Meeting of Shareholders to be held on May 6, 1999, is hereby incorporated by reference. Item 13. Certain Relationships and Related Transactions. The information relating to certain relationships and related transactions set forth beneath the headings "Employment Plans and Agreements - Low Interest Loan Plan", "Compensation Committee Interlocks and Insider Participation" and "Certain Transactions" in the Proxy Statement for the 1999 Annual Meeting of Shareholders to be held May 6, 1999, is hereby incorporated by reference. -7- PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. (a) The following documents are filed as part of this report: 1. Financial Statements: The following financial statements are incorporated by reference in Item 8 hereof from the Annual Report to Shareholders for the fiscal year ended January 2, 1999: ANNUAL REPORT PAGE NO. Consolidated Statements of Income for the fiscal years ended January 2, 1999, January 3, 1998 and December 28, 1996 20 Consolidated Balance Sheets, as of January 2, 1999 and January 3, 1998 21 Consolidated Statements of Cash Flows for the fiscal years ended January 2, 1999, January 3, 1998 and December 28, 1996 22 Consolidated Statements of Shareholders' Equity for the fiscal years ended January 2, 1999, January 3, 1998 and December 28, 1996 23 Notes to Consolidated Financial Statements 24-29 Results by Quarter (unaudited) 31 10-K PAGE NO. 2. Other: Report of Independent Accountants 15 All other schedules are omitted since the required information is not applicable or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the financial statements and notes thereto. -8- With the exception of the financial statements listed in the above index, the information referred to in Items 5, 6, 7 and the supplementary quarterly financial information referred to in Item 8, all of which is included in the portions of the Annual Report to Shareholders for the fiscal year ended January 2, 1999 and incorporated by reference into this Form 10-K Annual Report, the Annual Report to Shareholders for the fiscal year ended January 2, 1999 is not to be deemed "filed" as part of this report. 3. Exhibits: Exhibit No. 3(a) Articles of Incorporation, together with all amendments thereto (through May 5, 1988) (incorporated by reference to Exhibit 3(a) of the Company's Annual Report on Form 10-K dated March 24, 1992) 3(b) Bylaws of the Company effective July 3, 1997 4(a) Indenture dated as of August 15, 1991, between the Company and the Bank of New York, Trustee, providing for the issuance of an unlimited amount of Debt Securities in one or more series (incorpo- rated by reference to Exhibit 4(a) of the Company's Annual Report on Form 10-K dated March 24, 1992) 4(b) Form of Food Lion, Inc. Medium Term Note (Global Fixed Rate) (incorporated by reference to Exhibit 4(b) of the Company's Annual Report on Form 10-K dated March 24, 1992) 10(a) Low Interest Loan Plan (incorporated by reference to Exhibit 19(a) of the Company's Report on Form 8-K dated October 27, 1986) 10(b) Form of Deferred Compensation Agreement (incorporated by reference to Exhibit 19(b) of the Company's Report on Form 8-K dated October 27, 1986) 10(c) Form of Salary Continuation Agreement (incorporated by reference to Exhibit 19(c) of the Company's report on Form 8-K dated October 27, 1986) 10(d) 1994 Shareholders' Agreement dated as of the 15th day of September 1994 among Etablissements Delhaize Freres et Cie "Le Lion" S.A., Delhaize The Lion America, Inc., and the Company (incorporated by reference to Exhibit 10 of the Company's Report on Form 8-K dated October 7, 1994) -9- 10(e) Proxy Agreement dated January 4, 1991, between Etablissements Delhaize Freres et Cie "Le Lion" S.A. and Delhaize The Lion, America, Inc. (incorporated by reference to Exhibit 10(e) of the Company's Annual Report on Form 10-K dated March 25, 1991) 10(f) Employment Agreement dated August 1, 1991, between the Company and Tom E. Smith (incorporated by reference to Exhibit 10(h) of the Company's Annual Report on Form 10-K dated March 24, 1992) 10(g) Stock Purchase Agreement dated June 30, 1981, between the Company and Ralph W. Ketner (incorporated by reference to Exhibit 10(j) of the Company's Annual Report on Form 10-K dated April 1, 1987) 10(h) Amended and Restated Food Lion, Inc. 1983 Employee Stock Option Plan (incorporated by reference to Exhibit 10(k) of the Company's Annual Report on Form 10-K dated March 24, 1992) 10(i) 1991 Employee Stock Option Plan of Food Lion, Inc. (incorporated by reference to Exhibit 10(l) of the Company's Annual Report on Form 10-K dated March 24, 1992) 10(j) Split Dollar Life Insurance Agreement between the Company and Tom E. Smith (incorporated by reference to Exhibit 10(o) of the Company's Annual Report on Form 10-K dated April 1, 1987) 10(k) Split Dollar Life Insurance Agreement between the Company and Tom E. Smith issued May 25, 1988 (incorporated by reference to Exhibit 10(w) of the Company's Annual Report on Form 10-K dated March 20, 1989) 10(l) Letter Agreement dated May 10, 1990, between the Company and Ralph W. Ketner (incorporated by reference to Exhibit 10(q) of the Company's Annual Report on Form 10-K dated March 25, 1991) 10(m) U.S. Distribution Agreement dated August 20, 1991, between the Company and Goldman, Sachs & Co. and Merrill Lynch & Co. relating to the sale of up to $300,000,000 in principal amount of the Company's Medium-Term Notes (incorporated by reference to Exhibit 10(p) of the Company's Annual Report on Form 10-K dated March 24, 1992) 10(n) License Agreement between the Company and Etablissements Delhaize Freres Et Cie "Le Lion" S.A. dated January 1, 1983 (incorporated by reference to Exhibit 10(t) of the Company's Annual Report on Form 10-K dated March 31, 1994) -10- 10(o) 1996 Employee Stock Incentive Plan of Food Lion, Inc. (incorporated by reference to Exhibit 10(a) of the Company's Quarterly Report on Form 10-Q dated July 30, 1996) 10(p) Key Executive Annual Incentive Bonus Plan (incorporated by reference to Exhibit 10(b) of the Company's Quarterly Report on Form 10-Q dated July 30, 1996) 10(q) Profit Sharing Restoration Plan effective as of May 4, 1995 (incorporated by reference to Exhibit 10(c) of the Company's 10-Q A dated August 13, 1996) 10(r) Supplemental Executive Retirement Plan effective as of May 4, 1995 (incorporated by reference to Exhibit 10(d) of the Company's 10-Q A dated August 13, 1996) 10(s) Employee Severance Agreement dated September 5, 1996, between the Company and Dan A. Boone (incorporated by reference to Exhibit 10 of the Company's Quarterly Report on Form 10-Q dated October 16, 1996) 10(t) Employment Agreement dated as of February 27, 1997, between Joseph C. Hall, Jr. and the Company (incorporated by reference to Exhibit 10(w) of the Company's Annual Report on Form 10-K dated March 27, 1997) 10(u) Employment Agreement dated as of February 27, 1997, between R. William McCanless and the Company (incorporated by reference to Exhibit 10(x) of the Company's Annual Report on Form 10-K dated March 27, 1997) 10(v) Agreement and Plan of Merger dated as of October 31, 1996, among the Company, KK Acquisition Corp. and Kash n' Karry Food Stores, Inc. (incorporated by reference to Exhibit 2 of the Company's Report on Form 8-K dated October 31, 1996) 10(w) Stockholders' Agreement, dated as of October 31, 1996, among the Company, KK Acquisition Corp., Kash n' Karry Food Stores, Inc. and the stockholders of Kash n' Karry Food Stores, Inc. signatory thereto (incorporated by reference to Exhibit 10 of the Company's Report on Form 8-K dated October 31, 1996) 10(x) License Agreement, dated as of June 19, 1997, among the Company, Kash n' Karry Food Stores, Inc., and Etablissements Delhaize Freres Et Cie "Le Lion" S.A. (incorporated by reference to Exhibit 10(a) of the Company's Quarterly Report on Form 10-Q dated July 25, 1997) -11- 10(y) Food Lion Inc. and The Bank of New York, Trustee, First Supplement Indenture dated as of April 21, 1997 (incorporated by reference to Exhibit 10(a) of the Company's Quarterly Report on Form 10-Q dated May 2, 1997) 10(z) Underwriting Agreement dated as of April 16, 1997, between Food Lion, Inc. and Salomon Brothers, Inc. for itself and as representative for NationsBanc Capital Markets Inc. (incorporated by reference to Exhibit 10(b) of the Company's Quarterly Report on Form 10-Q dated May 2, 1997) 10(aa) Deferral Agreement and Election, dated as of December 18, 1997, by and between Tom E. Smith and the Company (incorporated by reference to 10(ac) of the Company's Annual Report on Form 10-K dated April 8, 1998) 10(ab) Employment Agreement, dated as of October 1, 1997, between Pamela K. Kohn and the Company (incorporated by reference to 10(ad) of the Company's Annual Report on Form 10-K dated April 8, 1998) 10(ac) Employment Agreement, dated as of October 1, 1997, between A. Edward Benner and the Company (incorporated by reference to 10(ae) of the Company's Annual Report on Form 10-K dated April 8, 1998) 10(ad) Agreement, dated as of January 4, 1998, between Etablissements Delhaize Freres et Cie "Le Lion" S.A. and the Company (incorporated by reference to 10(af) of the Company's Annual Report on Form 10-K dated April 8, 1998) 10(ae) Credit Agreement dated as of December 15, 1998, among the Company, the lenders party thereto, and The Chase Manhattan Bank, N.A., as Documentation Agent 13 Portions of the Annual Report to Shareholders for the fiscal year ended January 2, 1999 21 Subsidiaries of Registrant 23 Consent of Independent Accountants 27 Financial Data Schedules 99 Undertaking of the Company to file exhibits pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K (b) Reports on Form 8-K: The Company did not file a report on Form 8-K during the fiscal year ended January 2, 1999. -12- Pursuant to the requirements of Section 13 or 15(d) 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. Food Lion, Inc. Date: By Tom E. Smith President, Chief Executive Officer, Principal Executive Officer and Director Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated. Date: By Tom E. Smith President, Chief Executive Officer, Principal Executive Officer and Director Date: By Pierre-Olivier Beckers Director Date: By Dr. Jacqueline K. Collamore Director Date: By Jean-Claude Coppieters t' Wallant Director Date: By William G. Ferguson Director Date: By Dr. Bernard Franklin Director Date: By Joseph C. Hall Senior Vice President of Operations Director Date: By Margaret H. Kluttz Director Date: By Dominque Raquez Director Date: By Gui de Vaucleroy Director -13- Date: By R. William McCanless Chief Administrative Officer and Secretary Date: 8/17/99 By /s/ Laura Kendall Laura Kendall Vice President of Finance Chief Financial Officer Principal Accounting Officer -14- REPORT OF INDEPENDENT ACCOUNTANTS To the Shareholders of Food Lion, Inc.: In our opinion, the consolidated financial statements of Food Lion, Inc. and subsidiaries, which financial statements are included on pages 20 through 29 of the 1998 Annual Report to Shareholders of Food Lion, Inc. incorporated by reference herein, present fairly, in all material respects, the financial position of Food Lion, Inc. and subsidiaries at January 2, 1999 and January 3, 1998, and the results of its operations and its cash flows for each of the three years in the period ended January 2, 1999, in conformity with generally accepted accounting principles . These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. Charlotte, North Carolina February 10, 1999 PRICEWATERHOUSECOOPERS LLP -15- EXHIBIT INDEX to ANNUAL REPORT ON FORM 10-K of Food Lion, Inc. For the fiscal Year Ended January 2, 1999 Sequential Exhibit No. Description Page No. 3(a) Articles of Incorporation, together with all amendments thereto (through May 5, 1988) (incorporated by reference to Exhibit 3(a) of the Company's Annual Report on Form 10-K dated March 24, 1992) 3(b) Bylaws of the Company effective July 3, 1997 20-33 4(a) Indenture dated as of August 15, 1991, between the Company and the Bank of New York, Trustee, providing for the issuance of an unlimited amount of Debt Securities in one or more series (incorporated by reference to Exhibit 4(a) of the Company's Annual Report on Form 10-K dated March 24, 1992) 4(b) Form of Food Lion, Inc. Medium Term Note (Global Fixed Rate) (incorporated by reference to Exhibit 4(b) of the Company's Annual Report on Form 10-K dated March 24, 1992) 10(a) Low Interest Loan Plan (incorporated by reference to Exhibit 19(a) of the Company's Report on Form 8-K dated October 27, 1986) 10(b) Form of Deferred Compensation Agreement (incorporated by reference to Exhibit 19(b) of the Company's Report on Form 8-K dated October 27, 1986) 10(c) Form of Salary Continuation Agreement (incorporated by reference to Exhibit 19(c) of the Company's Report on Form 8-K dated October 27, 1986) 10(d) 1994 Shareholders' Agreement dated as of the 15th day of September 1994 among Etablissements Delhaize Freres et Cie "Le Lion" S.A., Delhaize The Lion America, Inc., and the Company (incorporated by reference to Exhibit 10 of the Company's Report on Form 8-K dated October 7, 1994) 10(e) Proxy Agreement dated January 4, 1991, between Etablissements Delhaize Freres et Cie "Le Lion" S.A. and Delhaize The Lion America, Inc. (incorporated by reference to Exhibit 10(e) of the Company's Annual Report on form 10-K dated March 25, 1991) -1- 10(f) Employment Agreement dated August 1, 1991, between the Company and Tom E. Smith (incorporated by reference to Exhibit 10(h) of the Company's Annual Report on Form 10-K dated March 24, 1992) 10(g) Stock Purchase Agreement dated June 30, 1981, between the Company and Ralph W. Ketner (incorporated by reference to Exhibit 10(j) of the Company's Annual Report on Form 10-K dated April 1, 1987) 10(h) Amended and Restated Food Lion, Inc. 1983 Employment Stock Option Plan (incorporated by reference to Exhibit 10(k) of the Company's Annual Report on Form 10-K dated March 24, 1992) 10(i) 1991 Employee Stock Option Plan of Food Lion, Inc. (incorporated by reference to Exhibit 10(l) of the Company's Annual Report on Form 10-K dated March 24, 1992) 10(j) Split Dollar Life Insurance Agreement between the Company and Tom E. Smith (incorporated by reference to Exhibit 10(o) of the Company's Annual Report on Form 10-K dated April 1, 1987) 10(k) Split Dollar Life Insurance Agreement between the Company and Tom E. Smith issued May 25, 1988 (incorporated by reference to Exhibit 10(w) of the Company's Annual report on Form 10-K dated March 20, 1989) 10(l) Letter Agreement dated May 10, 1990. between the Company and Ralph W. Ketner (incorporated by reference to Exhibit 10(q) of the Company's Annual Report on Form 10-K dated March 25, 1991) 10(m) U.S. Distribution Agreement dated August 20, 1991, between the Company and Goldman, Sachs & Co and Merrill Lynch & Co. relating to the sale of up to $300,000,000 in principal amount to the Company's Medium-Term Notes (incorporated by reference to Exhibit 10(p) of the Company's Annual Report on Form 10-K dated March 24, 1992) 10(n) License Agreement between the Company and Etablissements Delhaize Freres Et Cie "Le Lion" S.A. dated January 1, 1983 (incorporated by reference to Exhibit 10(t) of the Company's Annual Report on Form 10-K dated March 31, 1994) 10(o) 1996 Employee Stock Incentive Plan of Food Lion, Inc. (incorporated by reference to Exhibit 10(a) of the Company's Quarterly Report on Form 10-Q dated July 30, 1996) 10(p) Key Executive Annual Incentive Bonus Plan (incorporated by reference to Exhibit 10(b) of the Company's Quarterly Report on Form 10-Q dated July 30, 1996) -2- 10(q) Profit Sharing Restoration Plan effective as of May 4, 1995 (incorporated by reference to Exhibit 10(c) of the Company's 10-Q A dated August 13, 1996) 10(r) Supplemental Executive Retirement Plan effective as of May 4, 1995 (incorporated by reference to Exhibit 10(d) of the Company's 10-Q A dated August 13, 1996) 10(s) Employee Severance Agreement dated September 5, 1996, between the Company and Dan A. Boone (incorporated by reference to Exhibit 10 of the Company's Quarterly Report on Form 10-Q dated October 16, 1996) 10(t) Employment Agreement dated as of February 27, 1997, between Joseph C. Hall, Jr. and the Company (incorporated by reference to Exhibit 10(w) of the Company's Annual Report on Form 10-K dated March 27, 1997) 10(u) Employment Agreement dated as of February 27, 1997, between R. William McCanless and the Company (incorporated by reference to Exhibit 10(x) of the Company's Annual Report on Form 10-K dated March 27, 1997) 10(v) Agreement and Plan of Merger dated as of October 31, 1996, among the Company, KK Acquisition Corp. and Kash n' Karry Food Stores, Inc. (incorporated by reference to Exhibit 2 of the Company's Report on Form 8-K dated October 31, 1996) 10(w) Stockholders' Agreement, dated as of October 31, 1996, among the Company, KK Acquisition Corp., Kash n' Karry Food Stores, Inc. and the stockholders of Kash n' Karry Food Stores, Inc. signatory thereto (incorporated by reference to Exhibit 10 of the Company's Report on Form 8-K dated October 31, 1996) 10(x) License agreement, dated as of June 19, 1997, among the Company, Kash n' Karry Food Stores, Inc., and Etablissements Delhaize Freres Et Cie "Le Lion" S.A. (incorporated by reference to Exhibit 10(a) of the Company's Quarterly Report on Form 10-Q dated July 25, 1997) 10(y) Food Lion Inc. and The Bank of New York, Trustee, First Supplement Indenture dated as of April 21, 1997 (incorporated by reference to Exhibit 10(a) of the Company's Quarterly Report on Form 10-Q dated May 2, 1997) 10(z) Underwriting Agreement dated as of April 16, 1997, between Food Lion, Inc. and Salomon Brothers, Inc. for itself and as representative for NationsBanc Capital Markets Inc. (incorporated by reference to Exhibit 10(b) of the Company's Quarterly Report on Form 10-Q dated May 2, 1997) -3- 10(aa) Deferral Agreement and Election, dated as of December 18, 1997, by and between Tom E. Smith and the Company (incorporated by reference to Exhibit 10 (ac) of the Company's Annual Report on Form 10-K dated April 8, 1998) 10(ab) Employment Agreement, dated as of October 1,1997, between Pamela K. Kohn and the Company. (incorporated by reference to Exhibit 10 (ad) of the Company's Annual Report on Form 10-K dated April 8, 1998) 10(ac) Employment Agreement, dated as of October 1, 1997, between A. Edward Benner and the Company (incorporated by reference to Exhibit 10 (ae) of the Company's Annual Report on Form 10-K dated April 8, 1998) 10(ad) Agreement, dated as of January 4, 1998, between Etablissements Delhaize Freres et Cie "Le Lion" S.A. and the Company. (incorporated by reference to Exhibit 10 (af) of the Company's Annual Report on Form 10-K dated April 8, 1998) 10(ae) Credit Agreement dated as of December 15, 1998, among the Company, the lenders party thereto, and The Chase Manhattan Bank, as Administrative Agent, and Wachovia Bank, N.A., as Documentation Agent. 34-145 13 Portions of the Annual Report to Shareholders for the fiscal year ended January 2, 1999 147-179 21 Subsidiaries of Registrant 180 23 Consent of Independent Accountants 181 27 Financial Data Schedules 182-183 99 Undertaking of the Company to file exhibits pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K 184 (b) Reports on Form 8-K: The Company did not file a report on Form 8-K during the fiscal year ended January 2, 1999. -4- EX-13 2 Exhibit 13 Portions of the Annual Report to Shareholders for the fiscal year ended January 2, 1999 Ten Year Summary of Operations (Dollars in thousands 1998 1997 1996 except per share amounts) (52 weeks) (53 weeks) (52 weeks) Financial Data: 1. Net sales $ 10,219,474 10,194,385 9,005,932 2. Same store sales percent change % 2.57 0.22 5.70 3. Cost of goods sold $ 7,925,844 7,975,659 7,087,177 4. Selling and administrative expenses $ 1,770,314 1,736,559 1,490,878 5. Asset impairment reserve $ 0 0 22,187 6. Store closing charge/(income) $ 0 84,402 (27,600) 7. Operating income $ 523,316 397,765 433,290 8. Depreciation and amortization $ 236,021 219,833 165,286 9. Interest expense $ 95,334 115,389 80,520 10. Income before income taxes $ 427,982 282,376 352,770 11. Net income $ 272,585 172,250 215,220 12. Current assets $ 1,512,277 1,328,511 1,539,039 13. Non-current assets $ 2,163,684 2,167,625 2,052,496 14. Total assets $ 3,675,961 3,496,136 3,591,535 15. Current liabilities $ 1,040,417 960,788 1,248,028 16. Long-term debt $ 429,763 586,355 495,111 17. Capital lease obligations, deferred taxes and other liabilities $ 606,859 615,808 623,308 18. Shareholders' equity $ 1,598,922 1,333,185 1,225,088 19. Cash dividends Class A $ 36,832 31,825 26,436 Class B $ 34,439 30,923 25,874 20. Weighted average shares outstanding (000) 478,084 468,916 470,216 21. Earnings per share (a) $ .57 .37 .46 22. Dividends per share (a) $ .149 .134 .111 23. Book value per share (a) $ 3.34 2.84 2.61 24. Asset turnover x 2.85 2.88 2.89 25. Return on sales % 2.67 1.69 2.39 26. Return on assets % 7.60 4.86 6.90 27. Return on equity % 18.59 13.47 18.49 28. Equity ratio % 43.50 38.13 34.11 29. Return on investment % 18.64 15.81 18.61 30. Current ratio x 1.45 1.38 1.23 Other Data: 31. Store count 1,207 1,157 1,112 32. Stores opened/acquired 79 164 64 33. Stores relocated (17) (25) (22) 34. Stores closed (12) (94) (3) 35. Total stores square footage (000) 38,887 36,107 32,615 36. Capital expenditures $ 356,058 346,134 283,564 37. Number of employees 92,125 83,871 73,170 38. Number of Deli/Bakery departments 1,099 1,008 888 39. Recapitalization and stock splits -18- (Dollars in thousands 1995 1994 except per share amounts) (52 weeks) (52 weeks) Financial Data: 1. Net sales $ 8,210,884 7,932,592 2. Same store sales percent change % 2.33 3.34 3. Cost of goods sold $ 6,516,637 6,323,693 4. Selling and administrative expenses $ 1,337,702 1,269,637 5. Asset impairment reserve $ 0 0 6. Store closing charge/(income) $ 0 0 7. Operating income $ 356,545 339,262 8. Depreciation and amortization $ 146,170 139,834 9. Interest expense $ 73,484 86,564 10. Income before income taxes $ 283,061 252,698 11. Net income $ 172,361 152,898 12. Current assets $ 1,149,235 1,125,471 13. Non-current assets $ 1,496,030 1,356,470 14. Total assets $ 2,645,265 2,481,941 15. Current liabilities $ 698,695 690,062 16. Long-term debt $ 355,300 355,300 17. Capital lease obligations, deferred taxes and other liabilities $ 488,760 409,226 18. Shareholders' equity $ 1,102,510 1,027,353 19. Cash dividends Class A $ 23,621 22,021 Class B $ 22,672 21,131 20. Weighted average shares outstanding (000) 481,154 483,708 21. Earnings per share (a) $ .36 .32 22. Dividends per share (a) $ .096 .089 23. Book value per share (a) $ 2.29 2.12 24. Asset turnover x 3.20 3.18 25. Return on sales % 2.10 1.93 26. Return on assets % 6.72 6.13 27. Return on equity % 16.18 15.72 28. Equity ratio % 41.68 41.39 29. Return on investment % 17.31 16.69 30. Current ratio x 1.64 1.63 Other Data: 31. Store count 1,073 1,039 32. Stores opened/acquired 47 30 33. Stores relocated (12) (3) 34. Stores closed (1) (84) 35. Total stores square footage (000) 30,056 27,335 36. Capital expenditures $ 219,905 117,312 37. Number of employees 69,345 64,840 38. Number of Deli/Bakery departments 733 575 39. Recapitalization and stock splits -18- Ten Year Summary of Operations (Dollars in thousands 1993 1992 1991 except per share amounts) (52 weeks) (53 weeks) (52 weeks) Financial Data: 1. Net sales $7,609,817 7,195,923 6,438,507 2. Same store sales percent change % (2.58) (0.42) 2.68 3. Cost of goods sold $6,121,274 5,759,534 5,102,977 4. Selling and administrative expenses $1,239,348 1,096,727 960,423 5. Asset impairment reserve $ 0 0 0 6. Store closing charge/(income) $ 170,500 0 0 7. Operating income $ 78,695 339,662 375,107 8. Depreciation and amortization $ 143,042 121,616 104,614 9. Interest expense $ 72,343 49,057 34,436 10. Income before income taxes $ 6,352 290,605 340,671 11. Net income $ 3,852 178,005 205,171 12. Current assets $1,135,200 1,147,849 982,112 13. Non-current assets $1,368,483 1,373,643 1,037,180 14. Total assets $2,503,683 2,521,492 2,019,292 15. Current liabilities $ 619,271 986,274 676,768 16. Long-term debt $ 569,350 240,537 240,810 17. Capital lease obligations, deferred taxes and other liabilities $ 397,508 338,962 270,659 18. Shareholders' equity $ 917,554 955,719 831,055 19. Cash dividends Class A $ 21,483 27,355 24,393 Class B $ 20,603 26,457 23,638 20. Weighted average shares outstanding (000) 483,701 483,663 483,516 21. Earnings per share (a) $ .01 .37 .42 22. Dividends per share (a) $ .087 .111 .099 23. Book value per share (a) $ 1.90 1.98 1.72 24. Asset turnover x 3.03 3.17 3.58 25. Return on sales % .05 2.47 3.19 26. Return on assets % .15 7.84 11.40 27. Return on equity % .41 19.92 27.28 28. Equity ratio % 36.65 37.90 41.16 29. Return on investment % 5.68 20.02 26.09 30. Current ratio x 1.83 1.16 1.45 Other Data: 31. Store count 1,096 1,012 881 32. Stores opened/acquired 100 140 111 33. Stores relocated (4) (4) (6) 34. Stores closed (12) (5) (2) 35. Total stores square footage (000) 28,950 26,428 22,480 36. Capital expenditures $ 159,857 402,327 305,879 37. Number of employees 65,494 59,721 53,583 38. Number of Deli/Bakery departments 553 446 279 39. Recapitalization and stock splits 3 for 2 -19- (Dollars in thousands 1990 1989 except per share amounts) (52 weeks) (52 weeks) Financial Data: 1. Net sales $5,584,410 4,717,066 2. Same store sales percent change % 4.50 8.60 3. Cost of goods sold $4,447,177 3,772,473 4. Selling and administrative expenses $ 820,175 684,938 5. Asset impairment reserve $ 0 0 6. Store closing charge/(income) $ 0 0 7. Operating income $ 317,058 259,655 8. Depreciation and amortization $ 81,432 65,042 9. Interest expense $ 32,587 29,180 10. Income before income taxes $ 284,471 230,475 11. Net income $ 172,571 139,775 12. Current assets $ 787,869 671,207 13. Non-current assets $ 791,996 610,470 14. Total assets $1,579,865 1,281,677 15. Current liabilities $ 597,392 510,838 16. Long-term debt $ 91,721 95,774 17. Capital lease obligations, deferred taxes and other liabilities $ 217,694 136,611 18. Shareholders' equity $ 673,058 538,454 19. Cash dividends Class A $ 21,926 16,549 Class B $ 21,082 15,971 20. Weighted average shares outstanding (000) 483,210 482,964 21. Earnings per share (a) $ .36 .29 22. Dividends per share (a) $ .089 .067 23. Book value per share (a) $ 1.39 1.11 24. Asset turnover x 3.90 3.98 25. Return on sales % 3.09 2.96 26. Return on assets % 12.06 11.79 27. Return on equity % 28.49 28.84 28. Equity ratio % 42.60 42.01 29. Return on investment % 29.33 28.85 30. Current ratio x 1.32 1.31 Other Data: 31. Store count 778 663 32. Stores opened/acquired 121 105 33. Stores relocated (5) (8) 34. Stores closed (1) (1) 35. Total stores square footage (000) 19,424 16,326 36. Capital expenditures $ 206,391 147,810 37. Number of employees 47,276 40,736 38. Number of Deli/Bakery departments 183 149 39. Recapitalization and stock splits -19- Notes to Ten Year Summary of Operations (a) Amounts are based upon the weighted average number of the Class A and Class B common shares outstanding. DEFINITIONS Line 20. Weighted average shares outstanding: Weighted average shares outstanding have been restated to reflect the stock split in 1992. 21. Earnings per share: Net income per common share (line 11/line 20). 22. Dividends per share: Cash dividends per common share (line 19/line 20). 23. Book value per share: Book value of shareholders' equity per common share (line 18/line 20). 24. Asset turnover: The ratio of sales per dollar of assets employed during the year. It is calculated by dividing sales by the average total assets (line 1/line 14). 25. Return on sales: The percentage of net income earned on each dollar of sales (line 11/line 1). 26. Return on assets: The percentage of net income earned on average total assets (line 11/line 14). 27. Return on equity: The percentage of net income earned on average shareholders' equity (line 11/line 18). 28. Equity ratio: Shows the share of total assets of the business owned by the shareholders as opposed to outside sources. It is calculated by dividing year-end shareholders' equity by year-end total assets (line 18/line 14). 29. Return on investment: The percentage of net income, excluding interest expense, to invested capital ([line 11 + line 9] / [average line 16 + average line 18]). 30. Current ratio: The ratio of current assets to current liabilities (line 12/ line 15). 31. Store count: Number of stores operating at year-end. 37. Number of employees: Number of full-time and part-time employees at year-end. 38. Number of Deli/Bakery departments: Number of stores with Deli/Bakery departments at year end. -19- Consolidated Statements of Income Year Ended Year Ended Year Ended January 2, January 3, December 28, (Dollars in thousands 1999 1998 1996 except per share amounts) Net sales $10,219,474 $10,194,385 $9,005,932 Cost of goods sold 7,925,844 7,975,659 7,087,177 Selling and administrative expenses 1,770,314 1,736,559 1,490,878 Asset impairment reserve - - 22,187 Store closing charge/(income) - 84,402 (27,600) Operating income 523,316 397,765 433,290 Interest expense 95,334 115,389 80,520 Income before income taxes 427,982 282,376 352,770 Provision for income taxes 155,397 110,126 137,550 Net income $ 272,585 $ 172,250 $ 215,220 Earnings per share: Basic $.57 $.37 $.46 Diluted $.57 $.36 $.45 (Results as a percentage of net sales) Net sales 100.00% 100.00% 100.00% Cost of goods sold 77.56 78.24 78.69 Selling and administrative expenses 17.32 17.04 16.56 Asset impairment reserve - - .25 Store closing charge/(income) - .82 (.31) Operating income 5.12 3.90 4.81 Interest expense .93 1.13 .89 Income before income taxes 4.19 2.77 3.92 Provision for income taxes 1.52 1.08 1.53 Net income 2.67% 1.69% 2.39% The accompanying notes are an integral part of the consolidated financial statements. -20- Consolidated Balance Sheets January 2, January 3, (Dollars in thousands 1999 1998 except per share amounts) Assets Current assets: Cash and cash equivalents $ 123,592 $ 93,340 Receivables 199,101 166,790 Inventories 1,103,635 982,744 Prepaid expenses 20,552 22,514 Deferred tax asset 65,397 63,123 Total current assets 1,512,277 1,328,511 Property, at cost, less accumulated depreciation 1,897,080 1,842,269 Deferred tax asset 4,707 51,980 Intangible assets less accumulated amortization 258,402 267,656 Other assets 3,495 5,720 Total assets $3,675,961 $3,496,136 Liabilities and Shareholders' Equity Current liabilities: Short-term borrowings $ 61,000 $ 80,000 Accounts payable, trade 545,015 497,907 Accrued expenses 360,105 351,173 Capital lease obligations - current 21,940 20,427 Long term debt - current 42,518 2,525 Other liabilities - current 9,839 8,756 Total current liabilities 1,040,417 960,788 Long-term debt 429,763 586,355 Capital lease obligations 492,660 489,928 Other liabilities 114,199 125,880 Total liabilities 2,077,039 2,162,951 Shareholders' equity: Class A non-voting common stock, $.50 par value; authorized 1,500,000,000 shares; issued and outstanding 247,893,000 shares at January 2, 1999 and 236,224,000 shares at January 3, 1998 123,946 118,112 Class B voting common stock, $.50 par value; authorized 1,500,000,000 shares; issued and outstanding 230,830,000 shares at January 2, 1999 and 232,727,000 shares at January 3, 1998 115,415 116,364 Additional capital 60,332 794 Retained earnings 1,299,229 1,097,915 Total shareholders' equity 1,598,922 1,333,185 Total liabilities and shareholders' equity $3,675,961 $3,496,136 The accompanying notes are an integral part of the consolidated financial statements. -21- Consolidated Statements of Cash Flows January 2, January 3, 1999 1998 (Dollars in thousands) Cash flows from operating activities Net income $272,585 $172,250 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 236,021 219,833 (Gain)loss on disposals of property (8,953) 964 Store closing charge - 84,402 Asset impairment reserve - - Deferred income taxes 44,999 (36,527) Changes in operating assets and liabilities net of effect of acquisition of subsidiary: Receivables (32,311) (15,627) Inventories (120,891) 82,999 Prepaid expenses 1,962 8,377 Other assets 2,225 (2,951) Accounts payable and accrued expenses 56,040 (116,816) Income taxes payable - (5,578) Other liabilities (10,598) (36,416) Total adjustments 168,494 182,660 Net cash provided by operating activities 441,079 354,910 Cash flows from investing activities Capital expenditures (356,058) (346,134) Proceeds from sale of property 109,850 32,572 Investment in subsidiary, net of cash received - - Net cash used in investing activities (246,208) (313,562) Cash flows from financing activities Net (payments) proceeds under short-term borrowings (19,000) (170,010) Principal payments on long-term debt (6,154) (212,027) Proceeds from issuance of long-term debt - 304,823 Principal payments under capital lease obligations (22,172) (22,076) Dividends paid (71,271) (62,748) Repurchase of common stock (50,192) (2,960) Proceeds from issuance of common stock 4,170 1,555 Net cash (used in) provided by financing activities (164,619) (163,443) Net increase (decrease) in cash and cash equivalents 30,252 (122,095) Cash and cash equivalents at beginning of year 93,340 215,435 Cash and cash equivalents at end of year $123,592 $ 93,340 The accompanying notes are an integral part of the consolidated financial statements -22- Consolidated Statements of Cash Flows December 28, 1996 (Dollars in thousands) Cash flows from operating activities Net income $215,220 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 165,286 Loss on disposals of property 466 Store closing (income) (27,600) Asset impairment reserve 22,187 Deferred income taxes (23,450) Changes in operating assets and liabilities: Receivables (50,845) Inventories (90,484) Prepaid expenses (6,940) Other assets 409 Accounts payable and accrued expenses 184,415 Income taxes payable 5,578 Other liabilities 34,099 Total adjustments 213,121 Net cash provided by operating activities 428,341 Cash flows from investing activities Capital expenditures (283,564) Proceeds from sale of property 27,464 Investment in subsidiary, net of cash received (99,852) Net cash used in investing activities (355,952) Cash flows from financing activities Net proceeds under short-term borrowings 250,000 Principal payments on long-term debt (65,656) Proceeds from issuance of long-term debt - Principal payments under capital lease obligations (17,764) Dividends paid (52,310) Repurchase of common stock (44,345) Proceeds from issuance of common stock 3,086 Net cash provided by financing activities 73,011 Net increase in cash and cash equivalents 145,400 Cash and cash equivalents at beginning of year 70,035 Cash and cash equivalents at end of year $215,435 The accompanying notes are an integral part of the consolidated financial statements -22- Consolidated Statements of Shareholders' Equity Class A Class B (Dollars and shares in thousands Common Stock Common Stock except per share amounts) Shares Amount Shares Amount Balances December 30, 1995 238,509 $119,255 236,625 $118,313 Cash dividends declared: Class A - $.1120 per share Class B - $.1104 per share Sale of stock 587 293 - - Repurchase of common stock (3,047) (1,524) (3,723) (1,862) Converted debt 117 59 Net income Balances December 28, 1996 236,166 118,083 232,902 116,451 Cash dividends declared: Class A - $.1348 per share Class B - $.1328 per share Sale of stock 293 147 - - Repurchase of common stock (235) (118) (175) (87) Net income Balances January 3, 1998 236,224 118,112 232,727 116,364 Cash dividends declared: Class A - $.1500 per share Class B - $.1480 per share Sale of stock 746 373 - - Repurchase of common stock (3,086) (1,543) (1,897) (949) Restricted shares 29 14 Converted debt 13,980 6,990 Net income Balances January 2, 1999 247,893 $123,946 230,830 $115,415 The accompanying notes are an integral part of the consolidated financial statements -23- Additional Retained Capital Earnings Total Balances December 30, 1995 - $864,942 $1,102,510 Cash dividends declared: Class A - $.1120 per share (26,436) (26,436) Class B - $.1104 per share (25,874) (25,874) Sale of stock 2,793 - 3,086 Repurchase of common stock (1,953) (39,006) (44,345) Converted debt 868 927 Net income 215,220 215,220 Balances December 28, 1996 1,708 988,846 1,225,088 Cash dividends declared: Class A - $.1348 per share (31,825) (31,825) Class B - $.1328 per share (30,923) (30,923) Sale of stock 1,408 1,555 Repurchase of common stock (2,322) (433) (2,960) Net income 172,250 172,250 Balances January 3, 1998 794 1,097,915 1,333,185 Cash dividends declared: Class A - $.1500 per share (36,832) (36,832) Class B - $.1480 per share (34,439) (34,439) Sale of stock 3,585 3,958 Repurchase of common stock (47,700) - (50,192) Restricted shares 198 212 Converted debt 103,455 110,445 Net income 272,585 272,585 Balances January 2, 1999 $60,332 $1,299,229 $1,598,922 -23- Notes to Consolidated Financial Statements 1. Summary of Significant Accounting Policies Nature of Operations As of January 2, 1999, the Company operated 1,207 retail food supermarkets and eight distribution centers in 11 states in the Southeast and Mid-Atlantic United States. The Company's stores, which are operated under the names of "Food Lion" and "Kash n' Karry," sell a wide variety of groceries, produce, meats, dairy products, seafood, frozen foods, deli/bakery and non-food items, such as health and beauty care, prescriptions, and other household and personal products. Principles of Consolidation The consolidated financial statements include the accounts of Food Lion, Inc. and its wholly-owned subsidiaries. All significant intercompany accounts and transactions are eliminated in consolidation. Operating Segment The Company engages in one line of business, the operation of general food supermarkets. Fiscal Year The Company's fiscal year ends on the Saturday nearest to December 31. The years ended January 2, 1999 and December 28, 1996 each included 52 weeks. The year ended January 3, 1998 included 53 weeks. The 1998 disclosed amounts represent the year ended January 2, 1999. Use of Estimates in Financial Statements The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash and Cash Equivalents The Company considers all highly liquid investment instruments purchased with an original maturity of three months or less to be cash equivalents. Inventories Inventories are stated at the lower of cost or market. Inventories valued using the last-in, first out (LIFO) method comprised approximately 87% and 86% of inventories, in 1998 and 1997, respectively. Meat, produce and deli inventories are valued on the first-in, first-out (FIFO) method. If the FIFO method were used entirely, inventories would have been $139.1 million and $114.4 million greater in 1998 and 1997, respectively. Application of the LIFO method resulted in increases in the cost of goods sold of $24.7, $10.0 and $10.2 million for 1998, 1997 and 1996, respectively. -24- Statements of Cash Flows Selected cash payments and non-cash activities were as follows: (Dollars in thousands) 1998 1997 1996 Cash payments for income taxes $127,352 $158,543 $154,791 Cash payments for interest, net of amounts capitalized 103,820 108,743 76,631 Non-cash investing and financing activities: Capitalized lease obligations incurred for store properties 62,608 80,207 130,899 Capitalized lease obligations terminated for store properties 30,026 31,633 25,710 Capitalized lease obligations terminated for store equipment 6,165 7,148 - Conversion of long term debt to stock 110,445 - 927 Property Property is stated at historical cost and depreciated on a straight-line basis over the estimated service lives of assets, generally as follows: Buildings 40 years Furniture, fixtures and equipment 3 - 10 years Leasehold improvements 8 years Vehicles 7 years Property under capital leases Lease term Annually, the value of all long-lived assets is reviewed by store, in conjunction with the Company's compliance with Financial Accounting Standards Board Statement No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" (FASB No.121). Intangible Assets Intangible assets primarily include goodwill, tradenames and favorable leasehold interests, all of which have been acquired in conjunction with purchase business combinations. Intangible assets are amortized on a straight-line basis over the estimated useful lives. The Company evaluates the period of amortization for intangible assets, on an ongoing basis, to determine whether current circumstances warrant revised estimates of useful lives. In addition, the Company evaluates, on an ongoing basis, the carrying value of intangible assets based on projections of undiscounted cash flows. If impairment is identified, the Company compares the asset's future discounted cash flows to its current carrying value and records specific provisions as appropriate. Deferred Income Taxes Deferred tax liabilities or assets are established for temporary differences between financial and tax reporting bases and are subsequently adjusted to reflect changes in tax rates expected to be in effect when the temporary differences reverse. Revenue Recognition Revenues from the sale of products are recognized at the point of sale to the Company's customers. Cost of Goods Sold Purchases are recorded net of cash discounts. Advertising Costs Advertising costs are expensed as incurred. -24- Capitalized Interest The Company capitalizes interest costs incurred to bring certain assets to their intended use. Store Opening Costs Costs associated with the opening of new stores are expensed as incurred. Store Closing Costs When a decision is made to close a store, the Company records a charge to cover the estimated costs of the planned store closing including (1) the unrecoverable portion of the present value of the remaining lease payments on leased stores (recorded in Other Liabilities on the Company's Consolidated Balance Sheet), (2) the write down of store assets (building, equipment, etc.) to reflect estimated realizable values (recorded as a reduction of the recorded asset cost on the Company's Consolidated Balance Sheet), and (3) other costs associated with the store closing (recorded in Accrued Expenses on the Company's Consolidated Balance Sheet). The Company intends to close stores within a year after the decision to close is made. Recoverable and realizable values are determined based on historical disposition of similar assets and current economic conditions, and are reviewed as new information becomes available or economic conditions change. The Company makes adjustments to the valuation reserves as needed. At the store closing date, the Company discontinues depreciation on all assets related to closed store properties. Disposition efforts on these assets begin immediately following the store closing. Significant cash outflows associated with store closings relate to ongoing rent payments on leased stores. The principal portion of the rent payments is charged against the lease liability established for closed stores (discussed above), while the interest portion of the rent payments is recorded against current year earnings in Interest Expense. Self Insurance The Company is self-insured for workers' compensation, general liability and vehicle accident claims. The self-insurance liability is determined actuarially, based on claims filed and an estimate of claims incurred but not yet reported. Maximum per occurrence is $500,000 for workers' compensation, $600,000 for general liability and $750,000 for vehicle liability. The Company is insured for covered costs in excess of these limits. Self insurance expense related to the above totaled $34.2 million in 1998, $32.9 million in 1997, and $30.4 million in 1996. Total claim payments were $31.2 million in 1998, $30.3 million in 1997, and $25.8 million in 1996. Earnings Per Share Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding (478,084,000 shares in 1998, 468,916,000 shares in 1997 and 470,216,000 shares in 1996). Diluted earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding and the weighted average number of potential common shares outstanding. The common stock equivalents that were added to the weighted average shares outstanding for purposes of diluted EPS were 1,037,000, 737,000 and 573,000 for outstanding stock options in 1998, 1997 and 1996, respectively. Additionally, common stock equivalents in 1997 and 1996 included 14,440,000 shares issuable upon conversion of 5% convertible subordinated debentures due 2003. During the second quarter of 1998, the Company's convertible subordinated debentures were redeemed. -24- Reclassification Certain financial statement items have been reclassified to conform to the current year's format. 2. Acquisitions On December 18, 1996, the Company acquired all of the outstanding shares of Kash n' Karry Food Stores, Inc. ("Kash n' Karry"), a Florida-based supermarket retailer which operated 100 stores, for $121.6 million. The Company began reporting consolidated results of operations, including Kash n' Karry, in the first quarter of 1997. The Kash n' Karry acquisition was accounted for using the purchase method of accounting, and, accordingly, the purchase price was allocated to the assets acquired and the liabilities assumed based upon their respective fair values at the date of acquisition (see Note 15 regarding store closing reserves established at the date of acquisition). In accordance with Accounting Principles Board Opinion No. 17, the Company determined that the balance of the purchase price (goodwill, including tradenames) had an unlimited useful life, and as a result, established a 40-year straight-line amortization period for these intangible assets. The net purchase price was initially allocated as follows: (Dollars in thousands) Property, plant and equipment $103,078 Other assets 49,229 Intangible assets 269,348 Long-term debt (230,836) Other liabilities, net ( 90,967) Purchase price less cash received $ 99,852 The following unaudited pro forma summary combines the consolidated results of operations of the Company and Kash n' Karry as if the acquisition had occurred as of the beginning of fiscal 1996. The pro forma results include revised depreciation expense based on the fair market value of the property and equipment acquired, the amortization of intangibles arising from the transaction, and the adjustments to interest expense resulting from the refinancing of Kash n' Karry's long term debt. This pro forma financial information is presented for informational purposes only and may not be indicative of what the actual consolidated results of operations would have been if the acquisition had been effective at the beginning of fiscal 1996. Year ended (Dollars in thousands) December 28,1996 Sales $9,945,888 Net income 204,722 Earnings per share $.44 -25- 3. Property Property consists of the following: (Dollars in thousands) 1998 1997 Land and improvements $ 103,820 $ 160,543 Buildings 377,736 397,496 Furniture, fixtures and equipment 1,343,514 1,265,085 Vehicles 100,370 98,529 Leasehold improvements 478,848 361,278 Construction in progress (estimated costs to complete and equip at January 2, 1999 are $80.0 million) 44,895 41,488 2,449,183 2,324,419 Less accumulated depreciation 1,012,193 941,298 1,436,990 1,383,121 Property under capital leases 584,931 569,855 Less accumulated depreciation 124,841 110,707 460,090 459,148 $1,897,080 $1,842,269 At January 2, 1999 and January 3, 1998, the Company had $21.0 million and $99.4 million (net book value), respectively, in property held for sale. 4. Intangible Assets Intangible assets is comprised of the following: (Dollars in thousands) 1998 1997 Goodwill $203,286 $205,809 Tradenames 58,000 58,000 Leasehold interests 18,438 15,312 279,724 279,121 Accumulated amortization 21,322 11,465 $258,402 $267,656 During 1998, changes in Goodwill arose primarily from adjustments to reduce store closing reserves for Kash n' Karry, originally established at the acquisition date, to reflect updated recoverable values and costs related to the Company's current plans to close stores as part of the acquisition strategy. 5. Accrued Expenses Accrued expenses consist of the following: (Dollars in thousands) 1998 1997 Employee benefit plan $100,647 $100,634 Self insurance 76,207 75,735 Payroll 66,887 37,410 Reserves for store closings 1,126 7,436 Other 115,238 129,958 $360,105 $351,173 -25- 6. Employee Benefit Plan The Company has a non-contributory retirement plan covering all Food Lion employees with one or more years of service. Employees' benefits under the plan become vested after five years of consecutive service. Forfeitures of the plan are treated as contributions and are allocated to the remaining participants at year end. The plan provides benefits to participants upon death, retirement or termination of employment with the Company. Contributions to the retirement plan are determined by the Company's Board of Directors. Expense related to the plan totaled $94.9 million in 1998, $97.8 million in 1997 and $94.9 million in 1996. 7. Long-Term Debt Long-term debt consists of the following: (Dollars in thousands) 1998 1997 Medium-term notes, due from 1999 to 2006. Interest ranges from 8.32% to 8.73%. $150,300 $150,300 Debt Securities, due 2007. Interest is at 7.55%. 150,000 150,000 Debt Securities, due 2027. Interest is at 8.05%. 150,000 150,000 Convertible subordinated debentures converted May 1998. - 114,073 Mortgage payables due from 1999 through 2003. Interest ranges from 7.50% to 10.35%. 19,029 20,043 Other 2,952 4,464 472,281 588,880 Less current portion 42,518 2,525 $429,763 $586,355 -25- During the second quarter of 1998, the Company redeemed its outstanding convertible subordinated debentures totaling $113.8 million through either (1) payment to the bond holders at 101% of the principal together with accrued interest or (2) conversion of the debentures into shares of the Company's Class A Stock. Most bond holders elected conversion resulting in the issuance of 13.9 million shares of Class A Common Stock. The Company paid $3.8 million in principal, premium and accrued interest to remaining bond holders. At January 2, 1999, $23.2 million (net book value) in property was pledged as collateral for mortgage payables. At January 2, 1999 and January 3, 1998, the Company estimated that the fair value of its long-term debt was approximately $522.0 million and $641.3 million, respectively. The fair value of the Company's long-term debt is estimated based on the current rates offered to the Company for debt of the same remaining maturities. Approximate maturities of long-term debt in the years 1999 through 2003 are $42.5, $2.8, $106.3, $1.6 and $11.0 million, respectively. 8. Credit Arrangements The Company maintains a revolving credit facility with a syndicate of commercial banks providing $625.0 million in committed lines of credit, which will expire on December 13, 1999. These lines replaced the previous $700.0 million revolving credit facility. There were no borrowings outstanding under each of the facilities for the years ended January 2, 1999 and January 3, 1998. Additionally, the Company had other committed short-term lines of credit with banks totaling $20.0 million, of which $20.0 million was outstanding at January 2, 1999. There were no borrowings outstanding at January 3, 1998. During 1998, the Company had average borrowings of $100,000 at a daily weighted average interest rate of 5.37% with a maximum amount outstanding of $20.0 million. The Company has a $250.0 million commercial paper program. No borrowings were outstanding during the years ended January 2, 1999 and January 3, 1998. In addition, the Company has periodic short-term borrowings under other informal arrangements. Outstanding borrowings under these arrangements were $41.0 million at January 2, 1999 at an average interest rate of 5.64% and $80.0 million at January 3, 1998 at an average interest rate of 6.09%. 9. Leases The Company's stores operate principally in leased premises. Lease terms for open stores generally range from 10 to 20 years with renewal options ranging from five to 20 years. The average remaining lease term for closed stores is nine years. The following schedule shows, as of January 2, 1999, the future minimum lease payments under capital leases, together with the present value of net minimum lease payments, and operating leases that have initial or remaining non-cancelable lease terms in excess of one year. -26- Capital Operating Leases (Dollars in thousands) Leases Open Stores Closed Stores 1999 $ 83,463 $ 149,181 $ 19,920 2000 83,208 148,371 19,535 2001 82,627 147,330 19,145 2002 82,599 145,408 18,724 2003 82,354 142,018 17,964 Thereafter 845,502 1,234,793 128,053 Total minimum payments 1,259,753 $1,967,101 $223,341 Less estimated executory costs 59,864 Net minimum lease payments 1,199,889 Less amount representing interest 685,289 Present value of net minimum lease payments $ 514,600 Minimum payments have not been reduced by minimum sublease income of $22.8 million due in the future over the term of non-cancelable subleases. Total rent payments for operating leases, excluding those with terms of one year or less, is as follows: (Dollars in thousands) 1998 1997 1996 Minimum rents $172,481 $133,786 $137,157 Contingent rents, based on sales 255 371 680 $172,736 $134,157 $137,837 In addition, the Company has signed lease agreements for additional store facilities, the construction of which were not complete at January 2, 1999. The leases expire on various dates extending to 2023 with renewal options generally ranging from 10 to 20 years. Total future minimum rents under these agreements are approximately $673 million. -26- 10. Income Taxes Provisions for income taxes for 1998, 1997 and 1996 consist of the following: (Dollars in thousands) Current Deferred Total 1998 Federal $ 95,839 $40,199 $136,038 State 14,559 4,800 19,359 $110,398 $44,999 $155,397 1997 Federal $119,553 $(30,327) $ 89,226 State 27,100 ( 6,200) 20,900 $146,653 $(36,527) $110,126 1996 Federal $134,000 $(19,550) $114,450 State 27,000 ( 3,900) 23,100 $161,000 $(23,450) $137,550 The Company's effective tax rate varied from the federal statutory rate as follows: 1998 1997 1996 Federal statutory rate 35.0% 35.0% 35.0% State income taxes, net of federal tax benefit 2.9 4.8 4.3 Federal refund (1.7) 0.0 0.0 Other 0.1 (0.8) (0.3) 36.3% 39.0% 39.0% Deferred income tax expense relates to the following: (Dollars in thousands) 1998 1997 1996 Excess tax depreciation $21,868 $ 8,892 $ 2,774 Provision for store closings 11,745 (43,041) 7,793 Excess interest and depreciation over rent paid on capital leases (2,743) (4,604) (3,003) Excess tax loss/(gain) 14,964 (4,372) (9,277) Accrued expenses 6,342 (2,258) (3,251) Tax loss carryforwards - (1,959) - Asset impairment reserve 184 4,892 (8,713) Other (7,361) 5,923 (9,773) $44,999 $(36,527) $(23,450) The components of deferred income tax assets and liabilities at January 2, 1999 and January 3, 1998 are as follows: (Dollars in thousands) 1998 1997 Current assets: Inventories $ 14,818 $ 10,436 Accrued expenses 50,579 52,692 Provision for store closings 0 (5) Total current assets 65,397 63,123 Non-current assets/(liability): Depreciation (142,389) (105,483) Leases 43,560 50,937 Provision for store closings 73,777 76,970 Tax loss carryforwards 22,737 22,737 Other deferred charges 7,022 6,819 Total non-current assets 4,707 51,980 Net deferred taxes $ 70,104 $ 115,103 -26- As of January 2, 1999, the Company had net operating loss carryforwards for tax purposes of approximately $56 million related to Kash n' Karry. Due to certain change of ownership requirements of Section 382 of the Internal Revenue Code, utilization of the Kash n' Karry net operating losses is expected to be limited to approximately $3.6 million or $6.9 million per year, depending upon the year in which the loss was generated. If the full amount of the limitation is not used in any year, the amount not used increases the allowable limit in the subsequent year. Loss carryovers will expire during the years 2006 through 2011. 11. Other Liabilities Other liabilities consist of the following: (Dollars in thousands) 1998 1997 Remaining lease liability - closed stores $113,161 $123,105 Other 10,877 11,531 124,038 134,636 Less current portion 9,839 8,756 $114,199 $125,880 The Company uses an 8% discount rate to calculate the present value of the remaining rent payments on closed stores. 12. Stock Options and Restricted Stock Plans The Company has a stock option plan under which options to purchase up to 10 million shares of Class A common stock may be granted to officers and key employees at prices equal to fair market value on the date of the grant. Options become exercisable as determined by the Stock Option Committee of the Board of Directors of the Company on the date of grant, provided that no option may be exercised more than ten years after the date of grant. In addition, the Company established a restricted stock plan in 1996 for executive employees pursuant to the 1996 Stock Incentive Plan. Under this stock plan, the Company issued 161,545 shares in 1998 (26,760 shares forfeited), 196,003 shares in 1997 (10,524 shares forfeited), and 133,393 shares in 1996 (1,803 shares forfeited). Currently, the Company has 423,034 shares of restricted Class A Common Stock outstanding under the plan. These shares of stock will vest over five years from grant date. The weighted average grant date fair value for these shares is $8.14, $7.03 and $7.43 for 1998, 1997 and 1996, respectively. At January 2, 1999, 28,820 of these restricted shares had been issued. Changes in the shares reserved for outstanding options and restricted stock as of January 2, 1999, and related weighted average exercise price are presented below: -27- Weighted Average Shares Exercise Price 1998 Outstanding at beginning of year 3,322,792 $6.63 Granted 1,180,589 8.73 Exercised (771,135) 5.10 Forfeited/expired (490,060) 6.43 Outstanding at end of year 3,242,186 7.14 Options exercisable at end of year 136,604 8.77 1997 Outstanding at beginning of year 2,553,835 $6.08 Granted 1,401,509 8.13 Exercised (289,833) 5.27 Forfeited/expired (342,719) 11.35 Outstanding at end of year 3,322,792 6.63 Options exercisable at end of year 958,595 5.71 1996 Outstanding at beginning of year 2,658,069 $5.97 Granted 931,715 7.38 Exercised (587,795) 6.19 Forfeited/expired (448,154) 11.35 Outstanding at end of year 2,553,835 6.08 Options exercisable at end of year 1,367,820 5.75 As of January 2, 1999, there were 5,111,257 shares of Class A common stock available for future grants. The following table summarizes options outstanding and options exercisable as of January 2, 1999, and the related weighted average remaining contractual life (years) and weighted average exercise price (excluding restricted stock). Options Outstanding Range of Weighted exercise Number Weighted Average prices Outstanding Average Exercise Remaining Price Contractual Life $ 5.12 - $7.70 1,674,269 7.4 $ 6.86 $ 7.71 - $11.55 1,069,883 8.6 10.03 $11.56 - $12.42 75,000 2.8 12.42 $ 5.12 - $12.42 2,819,152 7.7 $ 8.21 Options Exercisable Range of exercise Weighted prices Number Average Exercise Exercisable Price $ 5.12 - $ 7.70 76,571 $ 5.92 $ 7.71 - $11.55 33 8.56 $11.56 - $12.42 60,000 12.42 $ 5.12 - $12.42 136,604 $ 8.77 -27- The weighted average fair value at date of grant for options granted during 1998, 1997, and 1996 was $2.62, $2.14, and $2.35 per option, respectively. The fair value of options at date of grant was estimated using the Black-Scholes model with the following weighted average assumptions: 1998 1997 1996 Expected dividend yield (%) 1.50 1.50 1.50 Expected volatility (%) 30.00 25.00 25.00 Risk-free interest rate (%) 5.60 6.50 6.60 Expected term (years) 5.0 5.5 5.5 The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation." Accordingly, no compensation cost has been recognized for the stock options granted in 1998, 1997 or 1996. Had compensation cost been determined based on the fair value at the grant date consistent with the provisions of this statement, the Company's pro forma net earnings and earnings per share would have been as follows: (Dollars in thousands, except per share data) 1998 1997 1996 Net earnings - as reported $272,585 $172,250 $215,220 Net earnings - pro forma 272,144 171,656 214,986 Basic earnings per share - as reported 0.57 0.37 0.46 Basic earnings per share - pro forma 0.57 0.37 0.46 -28- 13. Common Stock On January 2, 1999, approximately 23.2% and 14.4% of the issued and outstanding Class A non-voting common stock and 24.7% and 27.5% of the issued and outstanding Class B voting common stock was held, respectively, by Etablissements Delhaize Freres et Cie "Le Lion" S.A. (Delhaize) and Delhaize The Lion America, Inc., a wholly owned subsidiary of Delhaize (Detla). In the aggregate, Delhaize and Detla owned approximately 52.2% of the Class B voting common stock and 37.6% of the Class A non-voting common stock. Holders of Class B common stock are entitled to one vote for each share of Class B common stock held, while holders of Class A common stock are not entitled to vote except as required by law. The Board of Directors of the Company may declare dividends with respect to Class A common stock without declaring and paying any dividends with respect to the Class B common stock. When dividends are declared with respect to the Class B common stock, the Board of Directors of the Company must declare a greater per share dividend to the holders of Class A common stock. 14. Interest Expense Interest expense consists of the following: (Dollars in thousands) 1998 1997 1996 Interest on capital leases $58,774 $ 56,809 $46,767 Other interest(net of $2.4, $2.0 and $1.5 million capitalized in 1998, 1997 and 1996, respectively) 36,560 58,580 33,753 $95,334 $115,389 $80,520 15. Reserves for Closed Stores (Dollars in millions) Reduction Lease Accrued of Asset Liabilities Expenses Total Values Balance at December 30,1995 $ 58.2 $ 67.0 $ 20.5 $145.7 Additions 20.2 92.3 1.4 113.9 Reductions (31.2) (9.2) (1.8) (42.2) Recognition of unused reserves (8.5) 0.0 (19.1) (27.6) Balance at December 28,1996 38.7 150.1 1.0 189.8 Additions 98.8 22.6 13.7 135.1 Reductions (12.9) (20.0) (3.6) (36.5) Recognition of unused reserves (20.8) (29.6) (3.7) (54.1) Balance at January 3,1998 103.8 123.1 7.4 234.3 Additions 2.7 19.2 9.4 31.3 Reductions (90.7) (21.9) (15.7) (128.3) Recognition of unused reserves 0.0 (7.2) 0.0 (7.2) Balance at January 2, 1999 $ 15.8 $113.2 $ 1.1 $130.1 1998 Activity: During the year, the Company recorded $15.2 million in store closing costs (included in Selling and Administrative Expenses on the Company's Consolidated Statement of Income), related to 26 stores which the Company plans to close in the normal course of business generally over the next 12 months. These costs are included in the "Additions" line in the table above. -28- Significant additions also include gains ($11.1 million) related to the disposal of various properties ($5.1 million) and the sale of the Company's distribution center in the Southwest market ($6 million). Significant reductions in the reserves for closed stores in 1998 include $89.9 million for the disposition of 51 owned stores and the distribution center facility in the Southwest market, which the Company closed in 1997 (see discussion under 1997 Activity). Other significant reductions include (1) ongoing rent payments of $7.3 million made on remaining lease obligations, (2) fees of $17.5 million for lease terminations, and (3) incremental direct costs to dispose of closed store properties and expenses arising from contractual obligations totaling $13.2 million. The Kash n' Karry acquisition strategy included plans to close 23 stores in conjunction with the Company's store relocation program, and as a result of identifying underperforming units that did not meet operating expectations. The purchase price allocation included $52.3 million in reserves related to these stores. Through the end of 1998 the Company had closed 13 of these store locations. The Company made a decision in 1998 not to close three of the original 23 stores due to improved performance. The original estimated store closing costs related to these three stores totals $7.2 million and comprises the unused reserves recognized as a reduction to Goodwill in fiscal 1998. The Company plans to close seven additional stores (six are intended to close by the end of 1999, while one is intended to close by the end of the year 2000). It has taken the Company longer than anticipated to execute this store closing plan due to a strategic repositioning of the Kash n' Karry stores and a thorough review of the impact of such store closings on plans for neighboring Food Lion store locations. During 1998, the Company closed 29 stores in the normal course of business, including 17 relocation closings and 12 closings due to poor performance. The revenues and operating results of these stores were not significant to the Company's total revenues and operating results. During 1998, the Company completed disposition efforts related to 74 closed stores. At the end of 1998, the Company had $130.1 million in store closing costs related to 157 stores and one closed distribution center. Of the 157 stores, 131 stores are closed, while 26 stores are scheduled to close over the next 12 months. -28- 1997 Activity: During 1997, the Company recorded a pre-tax charge of $116.5 million related to the divestiture of its Southwest market. This charge included the write-down of store and distribution center assets to reflect estimated realizable values ($92.1 million), the present value (calculated by applying an 8% discount rate) of remaining rent payments on leased stores ($17.1 million) included in Other Liabilities above, and other costs associated with the store closings. These other costs include legal fees, commissions, severance costs, and certain other costs to sell the related assets and/or expenses arising from contractual obligations ($7.3 million) included in Accrued Expenses above. The Southwest market had negatively impacted the Company's operating results by approximately $0.01 per share annually. During 1997, the Company reduced store closing costs by $54.1 million in unused reserves which arose primarily from changes in estimated liabilities on remaining lease obligations and in estimated recoverable values of owned properties. Of this amount, $14.4 million related to stores closed in previous years, and $17.7 million related to the 1997 store closings in the Southwest market. These unused reserves were recorded into income. The remaining $22.0 million related to Kash n' Karry store closings and was reflected as an adjustment to Goodwill. The remaining 1997 activity represents store closing costs incurred, the disposition of properties held for sale, and payments made on remaining lease obligations, related to store closings in the normal course of business. During 1997, the Company closed 58 stores in the normal course of business including 25 relocation closings and 33 closings due to poor performance. The revenues and operating results of these stores were not significant to the Company's total revenues and operating results. During 1997, the Company completed disposition efforts related to 33 closed stores. 1996 Activity: Significant additions to the reserve represent store closing reserves for Kash n' Karry established at the date of acquisition. During 1996, the Company recognized $27.6 million in unused reserves related to a $170.5 million pre-tax store closing charge against 1993 earnings. The remaining 1996 activity relates to store closings in the normal course of business and represents store closing costs incurred, the disposition of properties held for sale, and payments made on remaining lease obligations. During 1996, the Company closed 25 stores in the normal course of business including 22 relocation closings and three closings due to poor performance. The revenues and operating results of these stores were not significant to the Company's total revenues and operating results. During 1996, the Company completed disposition efforts related to 39 closed stores. -29- 16. Commitments and Contingencies The Company is involved in various claims and lawsuits arising out of the normal conduct of its business. Although the ultimate outcome of these legal proceedings cannot be predicted with certainty, the management of the Company believes that the resulting liability, if any, will not have a material effect upon the Company's consolidated financial statements or liquidity. -29- Report of Independent Accountants To the Shareholders of Food Lion, Inc.: In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, shareholders' equity, and cash flows present fairly, in all material respects, the financial position of Food Lion, Inc. and subsidiaries (the "Company") at January 2, 1999 and January 3, 1998, and the results of their operations and their cash flows for each of the three years in the period ended January 2, 1999, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PricewaterhouseCoopers LLP Charlotte, North Carolina February 10, 1999 -30- Results by Quarter (unaudited) (Dollars in thousands except per share amounts) 1998 First Second Third Fourth Quarter Quarter Quarter Quarter (12 Weeks) (12 Weeks) (12 Weeks) (16 Weeks) Net sales $2,305,473 $2,353,260 $2,378,922 $3,181,819 Cost of goods sold 1,800,115 1,826,657 1,843,988 2,455,084 Selling and administrative 388,713 406,621 411,820 563,160 expenses Operating income 116,645 119,982 123,114 163,575 Net income $ 55,234 $ 60,033 $ 72,769 $ 84,549 Basic and diluted earnings per common share $0.12 $0.13 $0.15 $0.18 (Dollars in thousands except per share amounts) 1997 First Second Third Fourth Quarter Quarter Quarter Quarter (12 Weeks) (12 Weeks) (12 Weeks) (17 Weeks)* Net sales $2,276,746 $2,324,719 $2,366,905 $3,226,015 Cost of goods sold 1,783,063 1,821,049 1,853,473 2,518,074 Selling and administrative 395,538 397,563 398,212 545,246 expenses Store closing charge/(income) 0 0 96,414 (12,012) Operating income 98,145 106,107 18,806 174,707 Net income(loss) $ 43,591 $ 47,791 $ ( 6,382) $ 87,250 Basic and diluted earnings per common share $0.09 $0.10 $(0.01) $0.19 *Note: The 1998 fourth quarter comprised 16 weeks; the 1997 fourth quarter comprised 17 weeks. -31- Market Price of Common Stock Year Ended January 2, 1999 Year Ended January 3, 1998 Class A Class B Class A Class B Quarter High Low High Low High Low High Low First 11.25 8.47 11.38 8.13 9.78 7.63 10.13 8.00 Second 10.88 9.25 11.06 9.13 8.25 6.47 8.38 6.56 Third 11.44 8.81 11.06 9.00 7.50 6.94 7.56 6.91 Fourth 11.06 8.38 10.81 7.88 8.75 7.44 8.53 7.44 The Company's Class A and Class B common stock trade on the Nasdaq stock market under the symbols: FDLNA and FDLNB, respectively. Price quotations are reported on the Nasdaq national market system. The closing market prices per share for both Class A and Class B common stock at January 2, 1999 were $10.63 and $10.06, respectively compared with $8.50 and $8.31, respectively for both Class A and Class B common stock at January 3, 1998. The over-the-counter quotations reflect inter-dealer prices without retail mark-up, mark-down or commission and may not necessarily represent actual transactions. On March 19, 1999, there were 24,319 holders of record of Class A common stock and 16,676 holders of record of Class B common stock. The closing market prices per share for the Class A and the Class B common stock at March 19, 1999 were $9.47 and $9.31, respectively. Dividends Declared Per Share of Common Stock Year Ended January 2, 1999 Year Ended January 3, 1998 Quarter Class A Class B Class A Class B First $.0375 $.0370 $.0337 $.0332 Second .0375 .0370 .0337 .0332 Third .0375 .0370 .0337 .0332 Fourth .0375 .0370 .0337 .0332 Total $.1500 $.1480 $.1348 $.1328 -31- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of Operations The Company posted a record level of sales and earnings during 1998. Sales totaled $10.2 billion as earnings reached $272.6 million. The Company was able to achieve these strong operating results despite highly competitive conditions. In addition, the Company was able to accomplish these results while preserving its continued commitment to delivering low price leadership to its customers in all markets. During 1998, the Company complimented its guarantee of low price leadership with increased variety and selection, which not only addressed the demands of its customers but also helped to boost operating profits. Finally, the Company's continued focus on gaining operating efficiencies and increased productivity through its low cost structure rounded out the completion of Food Lion's most successful year. During 1998, the Company opened 79 new stores and closed 29 existing stores (including 17 relocations). As a result, at the end of 1998, the Company operated 1,207 stores compared with 1,157 stores in operation at the end of 1997. The Company renovated 141 existing stores in 1998. Sales Sales were $10.2 billion for the 52 weeks of fiscal 1998 compared with $10.2 billion during the 53 week period of fiscal 1997, and $9.0 billion for the 52 week period in 1996, resulting in annual increases of 0.2%, 13.2% and 9.7%, respectively. The Company's 1998 total sales are not comparable to 1997 total sales due to (1) the extra week included in fiscal 1997, (2) $249.1 million in prior year sales from stores in the Southwest market which closed during the fourth quarter of 1997 and (3) a change in the method of collecting sales tax on products discounted through the MVP customer ("MVP") and Preferred customer ("PCC") loyalty card programs. On a comparable basis, total sales increased 6.1% for fiscal 1998. In 1998, same store sales increased 2.6% as compared with increases of 0.2% for 1997 and 5.7% for 1996. Beginning in May 1998, after receiving permission from all state departments of revenue, the Company began collecting sales tax on the net sales price, after considering the MVP/PCC discount granted, rather than the full retail price of the MVP/PCC items. The related impact to fiscal 1998 was to reduce reported sales by approximately $127.1 million. This change does not impact the same store sales calculation or the Company's net income, as gross profit and expense dollars are the same under either method. The only difference is that under the new method the discount granted is reflected in sales as opposed to in cost of goods sold under the original method. The following table illustrates the impact of the change. Fiscal 1998 1998 1998 Dollars % % Dollars Comparable Comparable As to 1996 - As to 1996 - Reported 1997 Reported 1997 (Dollars and shares (New (Original (New (Original in thousands) Method) Method) Method) Method) Net sales $10,219,474 $10,346,538 100.00% 100.00% Cost of goods sold 7,925,844 8,052,908 77.56 77.83 Selling and 1,770,314 1,770,314 17.32 17.11 administrative expenses Operating income 523,316 523,316 5.12 5.06 Interest expense 95,334 95,334 .93 .92 Income before income 427,982 427,982 4.19 4.14 taxes Provision for income 155,397 155,397 1.52 1.51 taxes Net income $272,585 $272,585 2.67% 2.63% Basic and diluted earnings per share $.57 $.57 Weighted average number of shares 478,084 478,084 outstanding During 1998, the sales increase of 6.1% (on a comparable basis) resulted from the Company's new store additions and renovations of existing stores, as well as category management and marketing initiatives. The Company opened 79 new stores in 1998 and closed 29 existing stores (including 17 relocations), a net increase of 50 stores. Store renovations also increased sales, as 141 existing stores were renovated to update equipment and properties, and in many locations, to add square footage and deli/bakery departments. The Company's stores currently have an average age of only five years, compared with an industry average of seven years, as a result of its continued aggressive new store construction and renovation program. The Company continued to enhance the Food Lion MVP Customer card program and implemented the Kash n' Karry Preferred Customer Club card (PCC) program in 1998. These programs, which are primarily vendor supported, reward customers with additional discounts on the Company's everyday low prices on a selection of featured items. Up to 1,500 items are highlighted on the programs each week. In 1998, the Company created special promotions for customer card users, including the MVP Million Dollar Giveaway and direct mail offers, which have resulted in increased card usage and higher sales. During 1999, the Company plans increased usage of the expansive MVP and PCC customer databases to support targeted marketing efforts. The 1999 business plan currently includes opening 80 new stores (approximately 20 of these will replace older stores) and renovating approximately 140 existing stores. The Company is committed to a growth strategy, which includes plans to open new stores and strengthen existing stores through renovations in order to maintain a competitive edge in its current markets. In addition, the Company will continue to evaluate its store base and may close stores to take advantage of relocation opportunities or to eliminate operating losses in underperforming stores. The Company's growth strategy is flexible, and the Company will listen to its consumers and revise its strategy accordingly in an effort to meet current and future customer needs. Gross Profit In fiscal 1998, gross profit was 22.44% (22.17% adjusted to the original method of reporting sales tax) of sales compared with 21.76% and 21.31% in 1997 and 1996, respectively. The gross profit increase of 0.68% (0.41% increase on a comparable basis) of sales in 1998 is attributable to a continued focus on category management initiatives (merchandising stores for maximum performance). Product analysis, selection and strategic pricing all contributed to gross profit increases in the grocery, perishable and meat departments in 1998. In addition, gross profits were positively impacted by the Company's private label sales, which currently represent 16.0% of consolidated total sales. The LIFO charge, as a percentage of sales, decreased gross profit by 0.24% in 1998, 0.10% in 1997 and 0.11% in 1996. Current year inflation totaled 2.3% due primarily to the increase in the cost of cigarettes imposed by tobacco manufacturers during 1998. Cigarette costs increased $6.35 per carton, or 49% during 1998. Excluding cigarettes, all other merchandise categories experienced little or no inflation. The 1998 inflation rate excluding the cigarette cost increase was 0.7%. Selling and Administrative Expenses Selling and administrative expenses as a percentage of sales were 17.32% in 1998 (17.11% adjusted to the original method of reporting sales tax) and 17.04% and 16.56% in 1997 and 1996, respectively. The comparable decrease is attributable to decreases in 1) administrative costs, due to having Kash n' Karry fully integrated for the entire year of 1998 compared with only five months in 1997, and 2) a decrease in advertising costs as the Company increased the number of vendor- supported marketing programs. These decreases were partially offset by an increase in store utilities and an increase in store rent expense related primarily to 72 new leased stores and expansions of existing stores. The Company believes it is important to maintain flexibility with regard to expense levels and will take advantage of additional opportunities to grow sales profitably through new marketing and customer service programs. The Company expects to continue to perform at an expense ratio in the range of 15.0% - 15.5%. Food Lion's 1998 business plan reflected the Company's commitment to maintaining its existing store base as 141 store renovations were completed in 1998 compared with 99 in 1997 and 124 in 1996. The Company anticipates completing approximately 140 renovations to existing stores in 1999. Store renovations result in an average sales increase of 10% - 20% in the year following the renovation. The Company plans to continue an aggressive renovation program to maintain a modern and convenient shopping environment for customers in all stores. Store Closings With over 1,200 retail outlets, the Company must constantly evaluate its store base, and make decisions about store openings and closings that are in the best interest of shareholders. These store closings consist of both relocations, where a new store is opened to replace an older location in the same neighborhood, and the closing of stores due to poor performance. During 1998, 29 stores were closed in the normal course of business as discussed above. The average cost to close a store as part of the Company's normal business strategy is approximately $500,000 to $1,000,000. During 1998, the Company recorded $15.2 million in store closing costs (included in Selling and administrative expenses on the Company's Consolidated Statement of Income), related to planned store closings (see Note 15 to the consolidated financial statements). In 1997, the Company recorded a pre-tax charge of $116.5 million related to the divestiture of its Southwest market. This charge included the write-down of store and distribution center assets to reflect estimated realizable values ($92.1 million), the present value (calculated by applying an 8% discount rate) of remaining rent payments on leased stores ($17.1 million), and other costs associated with the store closings such as legal fees, commissions, severance costs, and certain other costs to sell the related assets and/or expenses arising from contractual obligations ($7.3 million). The Southwest market had negatively impacted the Company's operating results by approximately $0.01 per share annually. Significant cash outflows associated with store closings relate to on going rent payments on leased stores. These rent payments are funded by income from operations. The projected rental payments on closed stores are included in Note 9 to the consolidated financial statements. At the end of each year, the value of all owned assets related to store properties remaining to be disposed is reviewed in conjunction with the Company's compliance with Financial Accounting Standards Board Statement no. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" ("FASB no. 121"). No adjustments were recorded during 1998. Interest Expense Interest expense as a percent of sales was 0.93% in 1998 and 1.13% and 0.89% in 1997 and 1996, respectively. During 1998, the Company reached an agreement with the U.S. Internal Revenue Service ("IRS") regarding its examination of tax years 1991-1994. As a result of this agreement, the Company received a refund related to tax paid in previous years. The refund included $7.2 million in tax (recorded during the year as a reduction to the Provision for Income Taxes) and related interest income of $7.6 million (recorded during the year as a reduction to Interest expense). In addition, Interest expense was impacted by (1) the conversion of the Company's convertible subordinated debentures in 1998, and (2) the pre-payment of $50 million in note purchase agreements in late 1997. LIFO The LIFO reserve increased $24.7 million in 1998 as compared with increases of $10.0 million in 1997 and $10.3 million in 1996. The 1998 increase was primarily due to a significant increase in cigarette costs (see discussion above). In 1997, increased coffee, paper and cigarette costs were the primary contributors to the LIFO increase, while in 1996, the increased costs of grocery, frozen food and dairy items supported the LIFO increase. Income Taxes The provision for income taxes was $155.4 million in 1998, $110.1 million in 1997 and $137.6 million in 1996. The Company's effective tax rate was 36.3% in 1998 and 39.0% in 1997 and 1996. The effective tax rate for 1998 was reduced by a $7.2 million tax refund received from the IRS (see discussion above under Interest Expense). The Company expects its continuing effective tax rate to be 38%. Liquidity and Capital Resources Cash provided by operating activities was $441.1 million in 1998 compared with $354.9 million in 1997 and $428.3 million in 1996. The increase in 1998 was due to improved earnings, an increase in inventory levels, net of trade payables, an increase in accrued expenses, and a reduction in deferred taxes. The increase in 1997 over the prior years was due primarily to a decrease in inventory levels resulting from continued inventory management efforts, the consolidation of the Kash n' Karry warehouse operation into Food Lion's Plant City, Florida distribution center, and closing the Southwest distribution center. The decrease in 1996 from 1995 was primarily due to increased inventory levels, net of trade payables, resulting from the Kash n' Karry acquisition and increased receivables. Cash flows used in investing activities decreased to $246.2 million in 1998 compared with $313.6 million in 1997 and $356.0 million in 1996. The decrease in investing activities in 1998 compared to 1997 is the result of an increase in the proceeds received from the disposition of the assets related to stores in the Southwest market. The decrease in investing activities in 1997 compared to 1996 reflects the investment in Kash n' Karry during 1996, partially offset by an increase in capital expenditures in 1997. In December of 1996, Food Lion purchased the stock of Kash n' Karry for $121.6 million. Capital expenditures increased to $356.1 million in 1998, compared with $346.1 million in 1997 and $283.6 million in 1996. During 1998, the Company equipped a total of 79 new stores and renovated 141 existing stores (including expanding square footage and adding deli/bakeries in many of these stores). During 1997, the Company equipped a total of 64 new stores and renovated 99 existing stores (including expanding square footage and adding deli/bakeries in most of these stores). During 1996, the Company equipped a total of 55 new stores and renovated 124 existing stores (including expansions in the majority of these stores) and implemented debit/credit and on-line communication technology in its Food Lion stores. Total store square footage increased 7.7% from 36.1 million in 1997 to 38.9 million in 1998. The total distribution space operated by the Company was 8.7 million square feet at the end of both 1998 and 1997, compared with 10.7 million at the end of 1996. The decrease in distribution space from 1996 to 1997 was the result of closing the distribution center in the Company's Southwest market, and the consolidation of the Kash n' Karry warehouse operation into Food Lion's Plant City, Florida distribution center. In 1999, the Company plans to continue its three-fold growth plan, which focuses on a combination of new store openings and renovations, as well as growth through acquisitions, as appropriate. The Company anticipates opening 80 new stores (20 of these will replace older stores) and renovating approximately 140 stores in 1999. The Company anticipates that the majority of the new stores will be opened under conventional leasing arrangements and, as a result, the impact on liquidity of owning stores will be insignificant in 1999. Capital expenditures for 1999 are expected to total $390 million, which includes approximately $160 million for store expansion and new store construction and $160 million to equip new and renovated stores. The Company plans to finance capital expenditures for 1999 through funds generated from operations and existing bank and credit lines. The Company will consider the possibility of sale-leaseback transactions on certain free-standing Company-owned stores in the future if advantageous opportunities are presented by potential lessors. Cash flows used in financing activities increased to $164.6 million in 1998, compared with $163.4 million in 1997 and cash provided from financing of $73.0 in 1996. The increase in 1998 was primarily the result of shares purchased under the Company's share repurchase plan as described below, partially offset by a decrease in net payments on debt. The increase in cash used in 1997 compared to 1996 was related primarily to principal payments on debt. Under the Company's current share repurchase program, which expires in May 1999, the Company may repurchase up to $100.0 million in outstanding securities. The share repurchase program allows the Company the flexibility to repurchase securities as it deems appropriate in the best interests of its shareholders and in consideration of all other possible uses of funds generated by operations. During 1998, the Company expended $50.2 million (including commissions) for the purchase of Class A and Class B shares, as part of its repurchase program compared to $3.0 million in 1997, and $44.3 million in 1996. See table below. Class A Class B 1998 Shares purchased 3,085,700 1,897,000 Average purchase $10.37 $ 9.60 price Total purchased $31,998,709 $18,211,200 1997 Shares purchased 235,000 175,000 Average purchase $ 7.34 $ 7.06 price Total purchased $1,724,900 $1,235,000 1996 Shares purchased 3,047,000 3,722,250 Average purchase $ 5.89 $ 7.09 price Total purchased $17,946,830 $26,390,753 Additional purchases may be made in the open market under the current program as deemed in the best interest of shareholders. Debt In 1998, the Company redeemed its outstanding convertible subordinated debentures totaling $113.8 million through either (1) payment to the bond holders at 101% of the principal together with accrued interest or (2) conversion of the debentures into shares of the Company's Class A Stock at $7.90 per share. Most bond holders elected conversion resulting in the issuance of 13.9 million shares of Class A Common Stock with $3.8 million in principal, premium and accrued interest paid to the remaining bond holders. The conversion election had no impact on the Company's basic or diluted earnings per share. The Company currently has outstanding medium-term notes of $150.3 million due from 1999 to 2006 at interest rates of 8.32% to 8.73%. Additionally, the Company has long-term debt securities of $300.0 million of which $150.0 million is due 2007 at 7.55% and $150.0 million matures in 2027 at an interest rate of 8.05%. In December 1998, the Company replaced its $700.0 million revolving credit facility. The current credit facility with a syndicate of commercial banks provides for $625.0 million in committed lines of credit, which will expire on December 13, 1999. As of January 2, 1999, the Company had no outstanding borrowings related to this credit facility. The Company also maintains additional committed lines of credit totaling $20.0 million, which are available when needed. The Company is not required to maintain compensating balances related to these lines of credit, and borrowings may occur periodically. As of January 2, 1999, the Company had outstanding borrowings of $20.0 million. During 1998, the Company had average borrowings of $100,000 at a daily weighted average interest rate of 5.37% with a maximum amount outstanding of $20.0 million. The Company has a $250.0 million commercial paper program, of which no borrowings were outstanding at January 2, 1999, January 3, 1998, and December 28, 1996, nor used during these years. Finally, the Company has periodic short-term borrowings under informal credit arrangements which are available to the Company at the discretion of the lender (see table below): Informal Credit Arrangements (Dollars in millions) 1998 1997 1996 Outstanding borrowings at year end $41.0 $80.0 $0.0 Average borrowings 12.2 8.2 3.0 Maximum amount outstanding 100.0 80.0 55.0 Daily weighted average interest rate 5.47% 5.76% 5.48% Self Insurance The Company is self-insured for its workers' compensation, general liability and vehicle accident claims. The Company establishes reserves based on an independent actuary's valuation of open claims reported and an estimate of claims incurred but not yet reported. It is possible that the final resolution of some of these claims may require significant expenditures by the Company in excess of its existing reserves, over an extended period of time, and in a range of amounts that cannot be reasonably estimated. Impact of Inflation During 1998, the inflation rate on merchandise purchases was 2.3%. Inventory and labor, the Company's primary costs, increase with inflation and, where possible, will be recovered through operating efficiencies and gross profits. Year 2000 In 1996, the Company began evaluating both its information technology systems, and other systems and equipment in order to identify and adjust date sensitive systems for Year 2000 compliance. As part of this undertaking, the Company created a Year 2000 Project Team to address the issues related to Year 2000 compliance. The Year 2000 Team is led by representatives from the Company's Information Technology department and includes key representatives from other areas of the Company. The Year 2000 Team has developed a three-phase plan to identify and remediate all existing systems to ensure the Company's readiness for the century change. These phases consist of assessment, system remediation and integration testing. Project Phase One primarily focused on assessing the business impact of the century change on the Company's operating environment. This assessment included information technology systems, non- information technology systems and supply chain readiness. The assessment was conducted based on an analysis of the Company's individual business processes and the potential material risks associated with the Company's operations. Project Phase Two primarily focused on code and system conversion (remediation) of date impacted applications and systems. Remediation or replacement was conducted for all information technology and embedded systems impacted by Year 2000 issues. Project Phase Three involves the execution of various testing protocol, analysis of test results and the development of contingency plans for each of the impacted systems. The Company has completed Project Phase One for all systems and Project Phase Two for all systems not scheduled for replacement. The Company expects to complete installation of certain replacement systems impacted by Year 2000 issues by mid-1999 and has included the cost of these systems in its estimates for the Year 2000 Project. The Company has commenced Project Phase Three, which includes testing and validation of impacted systems, and anticipates this phase will be substantially complete by mid-1999. However, the Company anticipates testing and validation procedures, as well as development of contingency plans, will continue throughout 1999. Except for the cost of replacement systems, the Company will expense the cost of the Year 2000 Project as incurred. The Company is funding the costs associated with the Year 2000 Project through operating cash flows and has not deferred any Information Technology projects in order to complete the Year 2000 Project. The Company estimates the total incremental cost of the Year 2000 Project is approximately $17.0 million which includes equipment and software replacements, reprogramming, systems testing, and outside consulting services. Approximately $4.0 million of the total cost for the Year 2000 Project is related to reprogramming or remediation of existing software and new systems, while the remaining cost of approximately $13.0 million is related to the implementation of certain replacement systems. At the end of fiscal year 1998, the Company had incurred approximately $8.9 million of the total cost of the Year 2000 project of which $2.8 million had been expensed as incurred and $6.1 million had been capitalized for replacement systems. The Company has not materially increased the number of its employees in order to complete the Year 2000 Project. Although the Company has utilized external contractors in various phases of the Year 2000 Project, the Company does not consider any of these contracts or relationships material for the completion of the Year 2000 Project. The Company has assigned certain employees from its Information Technology department to the Year 2000 Project (averaging approximately 20 employees during Phase One and 22 employees during Phase Two of the project and less than 15 employees from its user departments). As discussed above, the Company has created a Year 2000 Project Team composed of representatives from all areas of the Company. Members of the Year 2000 Project Team have completed the tasks associated with the Year 2000 Project as part of their normal duties. Although the Company has discussed its Year 2000 Project with certain of its consultants third parties were not retained to perform independent verification and validation processes regarding the risks and cost estimates of the Year 2000 Project. As part of the Year 2000 Project, the Company has identified relationships with third parties, including vendors, suppliers, and service providers, which the Company believes are critical to its business operations. Although the Company considered several factors in identifying these critical relationships, the Company has concentrated its communication efforts as discussed below with suppliers and vendors from whom the company makes annual purchases in excess of $10 million. The Company is in the process of communicating with these third parties through questionnaires, letters and interviews in an effort to determine the extent to which they are addressing their Year 2000 compliance issues. Based on the responses received to date from these efforts, the Company understands that all critical suppliers have indicated they anticipate being Year 2000 compliant. A small percentage of these critical suppliers have indicated they are Year 2000 compliant, however, a majority have indicated they are still addressing Year 2000 issues. Where appropriate, the Company has developed strategies to work with its suppliers to verify Year 2000 readiness and create contingency plans as discussed below. The Company has identified its operational and supply chain activities as its most critical functions potentially impacted by Year 2000 issues. The Company will conduct testing within a parallel operating environment created to simulate business processes and integrated systems functionality, including front-end operations and supply chain activities. Validation of integrated systems functionality will be performed by comparing test results to actual processes and data. The Company cannot assure that there will not be an adverse impact on the Company if third parties do not appropriately address their Year 2000 issues in a timely manner. Such other possible consequences include, but are not limited to, loss of communications with stores, loss of electric power, and an inability to process customer transactions or otherwise engage in similar normal business activities. As discussed below, the Company has developed contingency plans with its critical suppliers in order to arrange for the timely delivery of inventory. The Company will continue to communicate with, assess and monitor the progress of these third parties in resolving Year 2000 issues. Although the Company does not believe the actual impact of any system failures related to the century change will be material, the Company has developed various contingency plans with its critical suppliers and certain other vendors in order to assure the timely delivery of inventory and prepare for normal business activities following the century change. In the event the Company or a key supplier is adversely impacted by the century change, the Company will implement its contingency plan for such situation. These plans include alternate means of communication with suppliers, such as facsimile, telephone and hand delivery, manual operation of certain systems, as well as the implementation of certain established ordering procedures. Under the terms of these established ordering procedures, the Company's critical suppliers will provide inventory to the Company based on historical ordering patterns. These suppliers will also substitute products and adjust inventory levels of substitute items based on the availability of certain products. The Company will continue to develop and finalize the implementation of its contingency plans with third parties throughout 1999. The projections and project completion dates are based on management's best estimates and may be updated from time to time as additional information becomes available. This section discussing Year 2000 issues contains forward-looking statements (refer to "Other" below which addresses forward-looking statements made by the Company). Other: Information provided by the Company, including written or oral statements made by its representatives, may contain forward-looking information as defined in the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical facts, which address activities, events or developments that the Company expects or anticipates will or may occur in the future, including such things as expansion and growth of the Company's business, future capital expenditures and the Company's business strategy, are forward- looking statements. In reviewing such information, it should be kept in mind that actual results may differ materially from those projected or suggested in such forward-looking statements. This forward-looking information is based on various factors and was derived utilizing numerous assumptions. Many of these factors have previously been identified in filings or statements made by or on behalf of the Company, including filings with the Securities and Exchange Commission of Forms 10-Q, 10-K and 8-K. Important assumptions and other important factors that could cause actual results to differ materially from those set forth in the forward-looking statements include: changes in the general economy or in the Company's primary markets, changes in consumer spending, competitive factors, the nature and extent of continued consolidation in the industry, changes in the rate of inflation, changes in state or federal legislation or regulation, adverse determinations with respect to litigation or other claims, inability to develop new stores or complete remodels as rapidly as planned, stability of product costs -- supply or quality control problems with the Company's vendors, and issues and uncertainties related to Year 2000 detailed from time-to- time in the Company's filings with the Securities and Exchange Commission. EX-23 3 EXHIBIT 23 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the registration statements of Food Lion, Inc. on Form S-8 (File Nos. 33-18796,33-18797 and 33-03669) and Form S-3 (File Nos. 33-40457,33-50037 and 33-49620) of our report dated February 10, 1999, on our audits of the consolidated financial statements of Food Lion, Inc. and subsidiaries as of January 2, 1999, and January 3, 1998, and for the fiscal years ended January 2, 1999, January 3, 1998, and December 28, 1996, which report is included in this Annual Report on Form 10-K/A. PRICEWATERHOUSECOOPERS, LLP Charlotte, North Carolina August 17, 1999 -----END PRIVACY-ENHANCED MESSAGE-----