10-K 1 k10-00.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) Annual report pursuant to Section 13 or 15(d) of the Securities X Exchange Act of 1934 [No Fee Required] For the fiscal year ended December 30, 2000 OR Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 [No Fee Required] For the transition period from to . Commission file number 33-48862 HOMELAND HOLDING CORPORATION (Exact name of registrant as specified in its charter) Delaware 73-1311075 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 2601 N. W. Expressway Oil Center - East, Suite 1100E Oklahoma City, Oklahoma 73112 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (405) 879-6600 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $ .01 per share. 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 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. [ ] Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15 (d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes X No State the aggregate market value of the voting stock held by non- affiliates of the registrant as of April 23, 2001: $985,174, based on a closing price of $0.20 of the registrant's common stock on the NASDAQ/NMS. Indicate the number of shares outstanding of each of the registrant's classes of common stock as of April 23, 2001: Homeland Holding Corporation Common Stock: 4,925,871 shares Documents incorporated by reference: Portions of the definitive Proxy Statement for the 2001 Annual Stockholders Meeting are incorporated into Part III of this Form 10-K by reference. HOMELAND HOLDING CORPORATION FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 30, 2000 TABLE OF CONTENTS Page PART I ITEM 1. BUSINESS 1 General 1 Background 1 AWG Transaction 1 Restructuring 2 Business Strategy 2 Homeland Supermarkets 2 Merchandising Strategy and Pricing 3 Customer Services 4 Advertising and Promotion 4 Products 4 Supply Arrangements 5 Employees and Labor Relations 5 Computer and Management Information Systems 5 Competition 6 Trademarks and Service Marks 6 Regulatory Matters 6 ITEM 2. PROPERTIES 7 ITEM 3. LEGAL PROCEEDINGS 7 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 7 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS 8 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA 8 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 11 Results of Operations 11 Liquidity and Capital Resources 14 Inflation/Deflation 18 Recent Accounting Pronouncements 18 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 18 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 18 i Page PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 19 ITEM 11. EXECUTIVE COMPENSATION 19 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 19 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 19 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K 20 SIGNATURES II-1 INDEX TO FINANCIAL STATEMENTS AND EXHIBITS F-1 EXHIBIT INDEX E-1 ii HOMELAND HOLDING CORPORATION FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 30, 2000 ITEM 1. BUSINESS General Homeland Holding Corporation ("Holding"), through its wholly-owned subsidiary, Homeland Stores, Inc. ("Homeland") and Homeland's wholly-owned subsidiary, JCH Beverage, Inc. ("JCH"), and JCH's wholly-owned subsidiary, SLB Marketing, Inc. (collectively referred to herein as the "Company"), is a leading supermarket chain in the Oklahoma, southern Kansas and Texas Panhandle region. The Company operates in four distinct market places: Oklahoma City, Oklahoma; Tulsa, Oklahoma; Amarillo, Texas; and certain rural areas of Oklahoma, Kansas and Texas. As of December 30, 2000, the Company operates 85 stores throughout these markets. The Company's executive offices are located at 2601 N.W. Expressway, Oklahoma City, Oklahoma 73112, and its telephone number is (405) 879-6600. Background Holding and Homeland were organized as Delaware corporations in 1987 by a group of investors led by Clayton, Dubilier & Rice, Inc. ("CD&R"), a private investment firm specializing in leveraged acquisitions with the participation of management, for the purpose of acquiring substantially all of the assets and assuming specified liabilities of the Oklahoma division of Safeway Inc. ("Safeway"). The stores changed their name to "Homeland" in order to highlight the Company's regional identity. AWG Transaction On April 21, 1995, the Company sold 29 of its stores and its warehouse and distribution center to Associated Wholesale Grocers, Inc. ("AWG") pursuant to an Asset Purchase Agreement dated as of February 6, 1995 (the "AWG Purchase Agreement"), for a cash purchase price of approximately $72.9 million, including inventory, and the assumption of certain liabilities by AWG. At the closing, the Company and AWG also entered into a seven-year supply agreement, whereby the Company became a retail member of the AWG cooperative and AWG became the Company's primary supplier. The Company has purchased 15 shares of AWG Class A Common Stock, representing an equity position of 0.3%, in order to be a member of AWG. The transactions between the Company and AWG are referred to herein as the "AWG Transaction." AWG is a buying cooperative which sells groceries on a wholesale basis to its retail member stores. AWG serves more than 800 member stores located in a ten state region with approximately $3.3 billion in revenues in 2000. The AWG Transaction enabled the Company: (a) to reduce the Company's borrowed money indebtedness by approximately $37.2 million in the aggregate; (b) to have AWG assume, or provide certain undertakings with respect to, certain contracts and leases and certain pension liabilities of the Company; (c) to sell the Company's warehouse and distribution center, which eliminated the high fixed overhead costs associated with the operation of the warehouse and distribution center and thereby permitted the Company to close marginal and unprofitable stores; and (d) to obtain the benefits of becoming a member of the AWG cooperative, including increased purchases of private label products, special product purchases, dedicated support programs and access to AWG's store systems and participation in the membership rebate and patronage programs. 1 Restructuring On May 13, 1996, Holding and Homeland filed voluntary petitions under Chapter 11 of the United States Bankruptcy Code with the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court"). Simultaneously with such filings, the Company submitted a "pre-arranged" plan of reorganization which set forth the terms of the restructuring of the Company (the "Restructuring"). The purpose of the Restructuring was to substantially reduce the Company's debt service obligations and labor costs and to create a capital and cost structure that would allow the Company to maintain and enhance the competitive position of its business and operations. The Restructuring was negotiated with, and supported by, the lenders under the Company's then existing revolving credit facility, an ad hoc committee (the "Noteholders Committee") representing approximately 80% of the Company's outstanding Old Notes and the Company's labor unions. The Bankruptcy Court confirmed the Company's First Amended Joint Plan of Reorganization, as modified (the "Plan of Reorganization") on July 19, 1996, and the Plan of Reorganization became effective on August 2, 1996 (the "Effective Date"). Business Strategy The Company's general business strategy is to improve the sales and profitability of its core business through a consumer marketing strategy which positions the Company as a faster, fresher, better alternative to other food outlets. Usage of the Homeland Savings Card as a relationship marketing tool, as well as strong weekly promotions communicated through extensive use of print, television and radio are intended to help the Company achieve this business strategy. The Company is committed to high quality perishable departments and quick and friendly checkout. Having been in its market for more than 68 years (through its predecessor Safeway), the Company enjoys a high recognition with its customers. The Company continues to build this rapport with its customers by participating in local community events and offering the "Apples for Students" program, whereby schools can obtain computers and other educational products by collecting Homeland receipts. The Company is also a major sponsor of the Easter Seals program in its markets. The Company's plan also involves reviewing marginal and unprofitable stores for closing and reviewing new sites, independent stores or new markets for growth in its market share. In 1997, the Company acquired four stores, two in Oklahoma City, Oklahoma, one in Shawnee, Oklahoma and one in Lawton, Oklahoma. The Company closed one store in Amarillo, Texas in 1998. During 1999, the Company completed the acquisition of nine stores located in eastern Oklahoma, one of which was subsequently closed, completed the acquisition of four stores in Muskogee, Oklahoma, and closed 1 store in Yukon, Oklahoma. During the first quarter of 2000, the Company completed the acquisition of three stores located in Oklahoma City, Oklahoma, one of which was subsequently closed as planned. In the second quarter of 2000, the Company completed the acquisition of four stores, three of which are in Oklahoma City, and one in Lawton, Oklahoma. In the second quarter 2000, one of the acquired stores in Oklahoma City was actually under construction at the time and ultimately opened in September 2000. This store was a replacement store for an existing Homeland store that was closed upon its opening. In the first quarter of 2001, the Company closed seven stores due to poor financial performance of the stores and the high costs of potential renovation. For additional information, see also "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." Homeland Supermarkets The Company's current network of stores features three basic store formats. The Company's conventional stores are primarily in the 21,000 total 2 square feet range and carry the traditional mix of grocery, meat, produce and general merchandise products. These stores contain more than 20,000 stock keeping units, including food and general merchandise. Sales volumes of conventional stores range from $53,000 to $115,000 per week. The Company's superstores are in the 36,000 total square feet range and offer, in addition to the traditional departments, two or more specialty departments. Sales volumes of superstores range from $76,000 to $297,000 per week. The Company's combo store format includes stores of approximately 58,000 total square feet and larger and was designed to enable the Company to expand shelf space devoted to general merchandise. Sales volumes of combo stores range from $115,000 to $342,000 per week. The Company's new stores and certain remodeled locations have incorporated the Company's new, larger superstore and combo formats. Of the 85 stores operated by the Company as of December 30, 2000, 18 are conventional stores, 48 are superstores and 19 are combo stores. The chart below summarizes Homeland's store development over the last three fiscal years: Fiscal Year Ended 12/30/00 1/1/00 1/2/99 Average sales per store (1) (in millions) $ 7.1 $ 7.8 $ 7.6 Average total square feet per store 37,765 35,786 37,473 Average sales per square foot (1) $197 $206 $206 Number of stores: Stores at start of period 80 69 70 Stores remodeled 0 5 8 New stores opened 7 13 0 Stores sold or closed 2 2 1 Stores at end of period 85 80 69 Size of stores: Less than 25,000 sq. ft. 13 13 7 25,000 to 35,000 sq. ft. 28 28 25 35,000 sq. ft. or greater 44 39 37 Store formats: Conventional 18 18 10 SuperStore 48 49 47 Combo 19 13 12 (1) For those stores open entire fiscal year. The Company's network of stores is managed by district managers on a geographical basis through five districts. Store managers are responsible for determining staffing levels, managing store inventories (within the confines of certain parameters set by the Company's corporate headquarters) and purchasing products. Store managers have significant flexibility with respect to the quantities of items carried while the Company's corporate headquarters is directly responsible for merchandising, advertising, pricing and capital expenditure decisions. Merchandising Strategy and Pricing The Company's merchandising strategy emphasizes a competitive pricing structure, as well as leadership in quality products and service, selection, convenient store locations, specialty departments and perishable products (i.e., meat, produce, bakery and seafood). The Company's strategy is 3 to price competitively with targeted supermarket operators in each market area. The Company also offers double coupons, with some limitations, in all areas in which it operates. The in-store merchandising strategy combines a strong presentation of fresh products along with meaningful values throughout the store on a wide variety of fresh and shelf stable products each week. The Company's main vehicle of value delivery is its "Homeland Savings Card" which allows customers with the card, the opportunity to purchase over 2,000 items at a reduced cost each week. In addition, information gathered through card usage allows the Company to target product and service offerings in order to increase loyalty among targeted customers. Customer Services The Company's stores provide a variety of customer services including, among other things, carry-out services, facsimile services, automated teller machines, pharmacies, check cashing, utility payments, money transfers and money orders. The Company believes it is able to attract new customers and retain its existing customers because of its level of customer service and convenience. Advertising and Promotion All advertising and promotion decisions are made by the Company's corporate merchandising and advertising staff. The Company's advertising strategy is designed to enhance its value-oriented merchandising concept and emphasize its reputation for variety and quality. Accordingly, the Company is focused on presenting itself as a competitively-priced, promotions-oriented operator that offers value to its customers and an extensive selection of high quality merchandise in clean, attractive stores. This strategy allows the Company to accomplish its marketing goals of attracting new customers and building loyalty with existing customers. In addition, signage in the stores calls attention to various in-store specials thereby creating a friendlier and more stimulating shopping experience. The Company currently utilizes a broad range of print and broadcast advertising in the markets it serves, including newspaper advertisements, advertising inserts and circulars, television and radio commercials and promotional campaigns that cover substantially all of the Company's markets. The Company receives cooperative and performance advertising reimbursements from vendors which reduce its advertising costs. Products The Company provides a wide selection of name-brand and private label products to its customers. All stores carry a full line of meat, dairy, produce, frozen food, health and beauty care and selected general merchandise. As of the close of fiscal year 2000, approximately 82% of the Company's stores had service delicatessens and/or bakeries and approximately 61% had in-store pharmacies. In addition, some stores provide additional specialty departments that offer ethnic food, fresh and frozen seafood, floral services and salad bars. As a result of the Company's supply relationship with AWG, the Company's stores also offer AWG private label goods, including Best Choicer and Always Saver. Private label products generally represent quality and value to customers and typically contribute to a higher gross profit margin than national brands. The promotion of private label products is an integral part of the Company's merchandising philosophy of building customer loyalty as well as improving the Company's "pricing image." The Company intends to use the Best Choicer line of products as the main vehicle to accomplish these goals. 4 Supply Arrangements The Company is a party to the supply agreement with AWG (the "Supply Agreement"), pursuant to which the Company became a member of the AWG cooperative and AWG became the Company's primary supplier. AWG currently supplies approximately 70% of the goods sold in the Company's stores. See "Business -- AWG Transaction." Pursuant to the Supply Agreement, AWG is required to supply products to the Company at the lowest prices and on the best terms available to AWG's retail members. In addition, the Company is: (a) eligible to participate in certain cost-savings programs available to AWG's other retail members; (b) is entitled to receive certain member rebates and refunds based on the dollar amount of the Company's purchases from AWG's distribution center; and (c) is to receive periodic cash payments from AWG, up to a maximum of $1.2 million per fiscal quarter, based on the dollar amount of the Company's purchases from AWG's distribution centers during such fiscal quarter. The Company purchases goods from AWG on an open account basis. AWG requires that each member's account be secured by a letter of credit or certain other collateral in an amount based on such member's estimated weekly purchases through the AWG distribution center. The Company's open account with AWG no longer requires a letter of credit, however, the open account is secured by a first lien on all "AWG Equity" owned from time to time by the Company, which includes, among other things, AWG membership stock, the Company's right to receive monthly payments and certain other rebates, refunds and other credits owed to the Company by AWG (including patronage refund certificates, direct patronage or year-end patronage and concentrated purchase allowances). In the event that the Company's open account with AWG exceeds the amount of the required collateral for the Company's open account, AWG is not required to accept orders from, or deliver goods to, the Company until a letter of credit has been established for any such deficiency. The Supply Agreement with AWG contains certain "Volume Protection Rights," including: (a) the right of first offer (the "First Offer Rights") with respect to any proposed sales of stores supplied under the Supply Agreement (the "Supplied Stores") and a sale of more than 50% of the outstanding stock of Holding or Homeland to an entity primarily engaged in the retail or wholesale grocery business; (b) the Company's agreement not to compete with AWG as a wholesaler of grocery products during the term of the Supply Agreement; and (c) the Company's agreement to dedicate the Supplied Stores to the exclusive use of a retail grocery facility owned by a retail member of AWG (the "Use Restrictions"). The Company's agreement not to compete and the Use Restrictions contained in the Supply Agreement are terminable with respect to a Supplied Store upon the occurrence of certain events, including the Company's compliance with AWG's First Offer Rights with respect to any proposed sale of such store. In addition, the Supply Agreement provides AWG with certain purchase rights in the event the Company closes 90% or more of the Supplied Stores. Employees and Labor Relations At December 30, 2000, the Company had a total of 4,381 employees, of whom 2,864, or approximately 65%, were employed on a part-time basis. The Company employs 4,281 in its supermarket operations. The remaining employees are corporate and administrative personnel. The Company is the only unionized grocery chain in its market areas. Approximately 92% of the Company's employees are union members, represented primarily by the United Food and Commercial Workers of North America ("UFCWNA"). 5 Computer and Management Information Systems The Company utilizes client/server systems in order to enhance its information management capabilities and improve its competitive position. The systems include the following features: time and attendance, human resource, accounting and budget tracking, and scan support and merchandising systems. In 1997, the Company installed a direct store delivery system and a check verification and credit card system. The Company installed a centralized scale and pricing system for its meat, deli and bakery departments in 1998. The Company has scanning checkout systems in all of its 85 stores. As a result of store acquisitions, the Company currently utilizes three separate scanning systems. The Company will continue to evaluate a common system for all stores and to evaluate the need to invest and upgrade its scanning and point-of- sale systems to improve efficiency. The Company also collects information on the purchases made by its "Homeland Savings Card" holders with the intent to target its promotional activities on this market segment. See "Business -- Advertising and Promotion." Competition The supermarket business in the Company's market area is highly competitive, but very fragmented, and includes numerous independent operators. The Company estimates that these operators represent a substantial percentage of its markets. The Company also competes with larger store chains such as Albertson's and Wal-Mart, which operate 28 stores and 31 stores, respectively, in the Company's market areas, "price impact" stores such as Crest, large independent store groups such as IGA, regional chains such as United and discount warehouse stores. The Company is a leading supermarket chain in Oklahoma, southern Kansas and the Texas Panhandle region. The Company attributes its market position to advantages it has over certain of its competitors including its high quality perishable departments, effective advertising, excellent long- standing store locations and a strong reputation within the communities in which the Company operates. The Company's business has been adversely affected in recent years by the entry of new competition into the Company's key markets, which has resulted in a decline in the Company's comparable store sales in 1997 and 1998. In 1997, there were 8 competitive openings in the Company's market area, including 3 new Wal-Mart Supercenters and 2 new Albertson's. In 1998, there were 7 additional competitive openings, including 4 new Wal-Mart Supercenters and 3 new independent stores. In 1999, the Company's comparable sales increased despite 8 competitive openings, including 4 new Albertson's, 3 new Wal-Mart Supercenters and one new independent store. In 2000, the Company once again experienced a decline in comparable store sales. During the year ended December 30, 2000, there were 13 competitive openings including 4 new Wal-Mart Supercenters, 7 new Wal-Mart Neighborhood Markets and two new independent stores. Based on information publicly available, the Company expects that, during 2001, Wal-Mart will open 2 new Supercenters and 4 new Neighborhood Markets, Albertsons will open 1 new store and independents will open 3 new stores in the Company's markets. Trademarks and Service Marks During the transition from "Safeway" to "Homeland," the Company was able to generate a substantial amount of familiarity with the "Homeland" name. The Company continues to build and enhance this name recognition through promotional advertising campaigns. The "Homeland" name is considered material to the Company's business and is registered for use as a service mark and trademark. The Company has received federal and certain state registrations of the "Homeland" mark as a service mark and a trademark for use on certain products. The Company also received a federal registration of the service mark "A Good Deal Better." 6 Regulatory Matters Homeland is subject to regulation by a variety of local, state and federal governmental agencies, including the United States Department of Agriculture, state and federal pharmacy regulatory agencies and state and local alcoholic beverage and health regulatory agencies. By virtue of this regulation, Homeland is obligated to observe certain rules and regulations, the violation of which could result in suspension or revocation of various licenses or permits held by Homeland. ITEM 2. PROPERTIES Of the 85 supermarkets operated by the Company as of December 30, 2000, 15 are owned by Homeland and the balance are held under leases which expire at various times between 2001 and 2030. Most of the leases are subject to up to six (6) five-year renewal options. Out of 70 leased stores, only 6 have terms (including option periods) of fewer than 10 years remaining. Most of the leases require the payment of taxes, insurance and maintenance costs and many of the leases provide for additional contingent rentals based on sales in excess of certain stipulated amounts. No individual store operated by Homeland is by itself material to the financial performance or condition of Homeland as a whole. Substantially all of the Company's properties are subject to mortgages and security agreements securing the borrowings under the Loan Agreement (as defined hereinafter) and a number of the stores acquired from AWG and its retail members are subject to mortgages and security agreements in favor of AWG. See "Management's Discussion and Analysis of Financial Conditions and Results of Operations -- Liquidity and Capital Resources." ITEM 3. LEGAL PROCEEDINGS The Company is a party to ordinary routine litigation incidental to its business. Homeland and Holding were debtors in cases styled In re Homeland Holding Corporation, Debtor, Case No. 96-748 (PJW), and In re Homeland Stores, Inc., Debtor, Case No. 96-747 (PJW), initiated with the Bankruptcy Court on May 13, 1996. While the Plan of Reorganization was confirmed on July 19, 1996, and became effective on August 2, 1996, the Company is still involved in the resolution of claims filed in these proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted by Holding to a vote of Holding's security holders during the quarter ended December 30, 2000. 7 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS The Common Stock of Holding commenced public trading on the Nasdaq National Market System ("Nasdaq/NMS") on April 14, 1997. High and low sales prices of the Common Stock as reported by Nasdaq/NMS for each fiscal quarter of 1999 and 2000 are listed below: High Low March 27, 1999 $4.000 $3.000 June 19, 1999 $3.625 $2.875 September 11, 1999 $4.125 $3.000 January 1, 2000 $3.938 $3.281 March 25, 2000 $4.531 $3.375 June 17, 2000 $4.500 $3.438 September 9, 2000 $4.375 $3.125 December 30, 2000 $3.375 $0.313 On April 23, 2001, there were 843 stockholders of record. As additional claims are resolved pursuant to the Plan of Reorganization, the Company expects that the number of stockholders will increase, assuming that there is no change in the number of current stockholders. The Company received notification on March 8, 2001 from NASDAQ of a staff determination to delist the Company's Common Stock for failing to maintain the required minimum market value of public float and received notification on March 29, 2001, from NASDAQ of a staff determination to delist the Company's Common Stock for failing to meet the minimum share price. The Company has requested a review of the staff determination with NASDAQ's Listing Qualifications Panel, which it expects to occur by the end of April 2001. If there is no change in the staff determination, the Company expects that trading in its Common Stock would move to the OTC Bulletin Board. No cash dividends were declared or paid since the Effective Date of the Plan of Reorganization. Holding is restricted from paying dividends by the Loan Agreement and Indenture. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The following table sets forth selected consolidated financial data of the Company which has been derived from financial statements of the Company for the 52 weeks ended December 30, 2000, the 52 weeks ended January 1, 2000, the 52 weeks ended January 2, 1999, the 53 weeks ended January 3, 1998, and the 20 weeks ended December 28, 1996 (Successor Company), and the 32 weeks ended August 10, 1996 (Predecessor Company), respectively. See "Notes to Selected Consolidated Financial Data" for additional information. As discussed in "Business -- Restructuring," the Company emerged from Chapter 11 proceedings effective August 2, 1996. For financial reporting purposes, the Company accounted for the consummation of the Restructuring effective as of August 10, 1996. The Company has adopted "fresh-start" reporting pursuant to SOP No. 90-7. The periods prior to the Restructuring have been designated "Predecessor Company" and the periods subsequent to the Restructuring have been designated "Successor Company." Because of the adjustments associated with the adoption of "fresh-start" reporting, historical financial data of the Predecessor Company and Successor Company is not necessarily comparable. The selected consolidated financial data should be read in conjunction with the respective consolidated financial statements and notes thereto which are contained elsewhere herein. 8 (In thousands, except per share amounts) Successor Company 52 weeks 52weeks 52 weeks ended ended ended 12/30/00 1/1/00 1/2/99 Summary of Operating Data: Sales, net $ 600,835 $ 559,554 $ 529,576 Cost of sales 460,735 425,394 402,261 Gross profit 140,100 134,160 127,315 Selling and administrative expenses 133,244 120,594 114,335 Store closing charge (1) 2,823 - - Amortization of excess reorganization value (2) - 6,890 13,672 Asset impairment - 925 - Operating profit (loss) 4,033 5,751 (692) Gain (loss) on disposal of assets (61) (15) 34 Interest income 751 569 426 Interest expense (10,612) (9,011) (8,484) Income (loss) before reorganization items, income taxes and extraordinary items (5,889) (2,706) (8,716) Reorganization items (3) - - - Income tax provision - (1,588) (1,875) Loss before extraordinary items (5,889) (4,294) (10,591) Extraordinary items (4) - - - Net income (loss) $ (5,889) $ (4,294) $ (10,591) Basic and diluted net income (loss) per common share $ (1.20) $ (0.87) $ (2.18) Consolidated Balance Sheet Data: 12/30/00 1/1/00 1/2/99 Total assets $ 179,758 $ 175,630 $ 165,084 Long-term obligations, including current portion of long-term obligations $ 114,247 $ 100,785 $ 89,979 Redeemable common stock (5) $ - $ - $ - Stockholders' equity (deficit) $ 21,097 $ 27,654 $ 31,868 continued Successor Company Predecessor Company 53 weeks 20 weeks 32 weeks ended ended ended 1/3/98 12/28/96 8/10/96 Summary of Operating Data: continued Sales, net $ 527,993 $ 204,026 $ 323,747 Cost of sales 401,691 154,099 244,423 Gross profit 126,302 49,927 79,324 Selling and administrative expenses 112,590 43,995 73,183 Store closing charge (1) - - - Amortization of excess reorganization value (2) 14,527 5,819 - Asset impairment - - - Operating profit (loss) (815) 113 6,141 Gain (loss) on disposal of assets (117) (90) 114 Interest income 385 56 69 Interest expense (8,408) (3,199) (5,639) Income (loss) before reorganization items, income taxes and extraordinary items (8,955) (3,120) 685 Reorganization items (3) - - (25,996) Income tax provision (1,689) - - Loss before extraordinary items (10,644) (3,120) (25,311) Extraordinary items (4) - - 63,118 Net income (loss) $ (10,644) $ (3,120) $ 37,807 Basic and diluted net income (loss) per common share $ (2.23) $ (0.66) $ 1.16 1/3/98 12/28/96 8/10/96 Consolidated Balance Sheet Data: Total assets $ 172,768 $ 176,123 $ 139,217 Long-term obligations, including current portion of long-term obligations $ 86,002 $ 80,568 $ 124,411 Redeemable common stock (5) $ - $ - $ 17 Stockholders' equity (deficit) $ 42,324 $ 52,941 $ (38,057) 9 NOTES TO SELECTED CONSOLIDATED FINANCIAL DATA (In thousands) (1) The Company recorded a $2,823 store closing charge related to seven stores closed in January 2001. The charge was recorded to write-off the fixed assets, to recognize expenses attributable to closing the stores, and to accrue for the remaining lease obligations. Additionally, a charge of $1,423 was recorded in cost of sales to reflect a reduction to inventory attributable to the closeout of the inventory. In the aggregate, the Company recorded a $4,246 charge related to the closing of these seven stores. (2) The Company's reorganization value in excess of amounts allocable to identifiable assets, established in accordance with "fresh-start" reporting, of $40,908 was amortized on a straight-line basis over three years. The excess reorganization value was fully amortized during the Company's 1999 third quarter ended September 11, 1999. (3) As a result of the Company's Restructuring, the Company recorded certain reorganization expenses separately in accordance to SOP 90-7. Reorganization items for 1996 consist of: (a) $7,200 of allowed claims in excess of liabilities; (b) $4,250 in professional fees; (c) $6,386 in employee buyout expenses; and (d) $8,160 in adjusting certain assets and liabilities to estimated fair value. (4) Extraordinary items during 1996 consist of obligations of the Company that were discharged by the Bankruptcy Court pursuant to the Company's Plan of Reorganization. (5) Common Stock held by management investors prior to the Effective Date is presented as redeemable common stock and excluded from stockholder's equity since the Company had agreed to repurchase such shares under certain defined conditions, such as death, retirement or permanent disability. 10 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of Operations General The table below sets forth selected items from the Company's Consolidated Statements of Operations as a percentage of net sales for the periods indicated: Fiscal Year 2000 1999 1998 Sales, net 100.00% 100.00% 100.00% Cost of sales 76.68 76.02 75.96 Gross profit 23.32 23.98 24.04 Selling and administrative expenses. 22.18 21.55 21.59 Store closing charge 0.47 - - Amortization of excess reorganization value - 1.23 2.58 Asset impairment - 0.17 - Operating profit (loss) 0.67 1.03 (0.13) Gain (loss) on disposal of assets (0.01) - 0.01 Interest income 0.13 0.10 0.08 Interest expense (1.77) (1.61) (1.60) Loss before income taxes (0.98) (0.48) (1.64) Income tax provision - (0.28) (0.36) Net loss (0.98)% (0.76)% (2.00)% Comparison of Fifty-Two Weeks Ended December 30, 2000 ("2000"), with Fifty-Two Weeks Ended January 1, 2000 ("1999"). Net sales increased $41.2 million, or 7.4%, from $559.6 million for 1999 to $600.8 million for 2000. The increase in sales is attributable to the acquisition of nine stores in April 1999, the acquisition of four stores in November 1999, the acquisition of three stores in February 2000, and the acquisition of three stores in April 2000, partially offset by a 4.4% decrease in comparable store sales and the closing of one store in 1999. The decrease in comparable store sales is the result of competitive openings during fiscal year 2000, the advancement of purchases by customers into the final week of 1999 due to uncertainty with the year 2000 year-end transition, a labor dispute at AWG, and the cycling of strong promotions in 1999. There were 13 significant competitive openings during 2000, consisting of: six Wal-Mart Neighborhood Markets and three Wal-Mart Supercenters, in Oklahoma City; one Wal-Mart Neighborhood Market in Tulsa; one United Supermarket in Amarillo, Texas; and, one Wal-Mart Supercenter and one independent store, in rural Oklahoma. Based upon currently available public information, the Company anticipates that during 2001, Wal-Mart will open two Supercenters and four Neighborhood Markets and Albertsons will open one store, while regional chains and independents could open 3 additional stores, for a total of ten competitive openings. Of these ten stores, the Company expects that there will be two supercenters and one neighborhood market in Oklahoma City; three neighborhood markets, one Albertsons and one independent in the Tulsa Market; and, one independent each in Amarillo and rural Oklahoma. The AWG labor dispute involved AWG's warehousing and transportation employees and impacted the Company's sales through informational leaflets dissuading customers from patronizing Company stores, through inaccurate store order fulfillment, and late deliveries. Although the labor dispute was resolved in mid-June 2000, management believes that the impact of the dispute continued into the beginning of the first few weeks of the third quarter. The most significant impact of the labor dispute is the reduced annual AWG patronage rebate which had an estimated $1.6 million negative impact on the Company's results. 11 During the fourth quarter of 2000, the Company made the decision to close seven stores that had become unprofitable and in which the Company saw limited potential. These seven stores in the aggregate had sales of $32.5 million, and were closed by the end of January 2001. In the fourth quarter of 2000, the Company recorded closed store expenses in the amount of $4.2 million. These expenses include a $1.4 million charge relating to the closeout of inventory which is included in cost of sales, and a $2.8 million charge relating to expenses incurred to close the stores, the write-off of fixed assets and the accrual of remaining lease obligations. The Company also has plans for an ongoing store development and remodeling program, and believes that it will continue to experience temporary disruptions and lost sales during store remodelings in the future. The extent to which this program is executed is contingent upon the availability of capital. Based in part on the anticipated impact of proposed and recent new store openings and remodelings by competitors, management believes that market conditions will remain highly competitive, placing continued pressure on comparable store sales and net sales. Management believes that comparable store sales will decline approximately 7.8%, during the first quarter of 2001. In response to this highly competitive environment, the Company intends to utilize it's merchandising strategy to emphasize a competitive pricing structure, as well as leadership in quality products and services, selection and convenient store locations. The in-store merchandising strategy combines a strong presentation of fresh products along with meaningful values throughout the store on a wide variety of fresh and shelf stable products each week. The Company's main vehicle of value delivery is its Homeland Savings Card, a customer loyalty card program, which allows customers with the card the opportunity to purchase over 2,000 items at a reduced cost each week. Additionally, the Company continues the use of market research in order to maintain a better understanding of customer behavior and trends in certain markets. Finally, the Company intends to upgrade its stores by focusing its discretionary capital expenditures on projects that will improve the overall appeal of its stores to targeted customers. Gross profit as a percentage of sales decreased 0.7% from 24.0% for 1999, to 23.3% for 2000. The decrease in gross profit margin is primarily attributable to the reduction in the annual AWG patronage rebate due to the AWG labor dispute and the one-time charge for the seven closed stores, both issues which have been previously discussed. Excluding these two events, gross profit as a percentage of sales decreased 0.2% from 24.0% for the 52 weeks ended January 1, 2000, to 23.8% for the 52 weeks ended December 30, 2000. The remaining decrease in gross margin reflects the impact of specific promotional activities as the Company responded to certain new competitive store openings; special advertisements for the grand openings of the Company's acquired stores; and, the increased cost of goods for pharmaceutical products. Selling and administrative expenses as a percentage of sales increased 0.6% from 21.6% for 1999, to 22.2% for 2000. The increase in the expense ratio is attributable to increased occupancy costs associated with the acquired stores; to increased depreciation costs attributable to the Company's capital expenditure program for store remodels and maintenance and modernization; to increased labor costs; to increases in the cost of store supplies; to increases in utility costs; to start-up expenses related to the Company's February and April 2000 acquisitions as well as the opening of the Company's new store in September, partially offset by a reduction in the reserves for doubtful accounts due to a collection of a fully reserved receivable of $0.6 million and improved collections experience and a reduction in general liability reserves due to improved claims experience. The Company continues to review alternatives to reduce selling and administrative expenses and cost of sales in order to provide opportunities to pass additional savings along to its customers in the form of price reductions in certain categories. The Company recorded a store closing charge of $2.8 million in 2000 related to the closing of seven stores in January 2001. The store closing charge relates to expenses incurred to close the stores, to write-off fixed assets and to accrue remaining lease obligations. Additionally, the Company recorded, as a charge to cost of sales in 2000, a $1.4 million expense 12 related to the closeout of merchandise for these stores. Combining these two elements, the total estimated cost of closing these stores was $4.2 million. The amortization of the excess reorganization value amounted to $6.9 million in 1999. The excess reorganization value was amortized over three years, on a straight-line basis, and became fully amortized in the third quarter of 1999. The Company recorded an asset impairment provision in 1999 in the amount of $0.9 million related to a previously closed store. The provision reduced the carrying value of the real property to a current estimate of fair value. Operating profit decreased $1.8 million from $5.8 million for 1999, to $4.0 million for 2000. Excluding the $4.2 million store closing costs from the 2000 results and the amortization of excess reorganization value and asset impairment from the 1999 results, operating profit decreased $5.3 million from $13.6 million for 1999, to $8.3 million for 2000. The decline in operating profit reflects the decline in gross profit as a percentage of sales combined with the increase in selling and administrative expenses. Interest expense, net of interest income, increased $1.5 million from $8.4 million in 1999 to $9.9 million in 2000. The increase reflects additional interest expense attributable to the acquired stores and increases in variable interest rates, partially offset by additional interest income from the interest bearing certificates of AWG. During 2001, the Company anticipates that interest expense will increase primarily due to the increased debt. See "Liquidity and Capital Resources." The Company did not record income tax expense or benefit for 2000. In accordance with SOP 90-7, the tax benefit realized from utilizing pre- reorganization net operating loss carryforwards is recorded as a reduction of the reorganization value in excess of amounts allocable to identifiable assets rather than realized as a benefit on the statement of operations. Additionally, upon the completion of the amortization of reorganization value in excess of amounts allocable to identifiable assets, the tax benefit realized from utilizing pre-reorganization net operating loss carryforwards is recorded as a reduction of other intangibles existing at the reorganization date until reduced to zero and then as an increase to stockholder's equity. At December 30, 2000, the Company had a tax net operating loss carryforward of approximately $32.5 million, which may be utilized to offset future taxable income to the limited amount of $11.4 million in 2001 and $3.3 million per year thereafter. Due to the uncertainty of realizing future tax benefits, a full valuation allowance was deemed necessary to offset entirely the net deferred tax assets as of December 30, 2000. Net loss increased $1.6 million from a net loss of $4.3 million, $0.87 per share for 1999, to a net loss of $5.9 million, or $1.20 per share for 2000. Excluding the $4.2 million store closing costs from the 2000 results, the amortization of excess reorganization value and asset impairment from the 1999 results, and the loss on disposal of assets from both years, net income declined $4.8 million from net income of $3.2 million, or $0.65 per share in 1999, to a net loss of $1.6 million or $0.32 per share for 2000. EBITDA (as defined hereinafter) decreased $4.2 million from $24.3 million, or 4.4% of sales, in 1999 to $20.1 million, or 3.4% of sales in 2000. The Company believes that EBITDA is a useful supplemental disclosure for the investment community. EBITDA, however, should not be construed as a substitute for earnings or cash flow information required under generally accepted accounting principles. Comparison of Fifty-Two Weeks Ended January 1, 2000 ("1999"), with Fifty-Two Weeks Ended January 2, 1999 ("1998"). Net sales increased $30.0 million, or 5.7%, from $529.6 million for 1998 to $559.6 million for 1999. The increase in sales is attributable to the acquisition of nine stores in April 1999, the acquisition of four stores in November 1999, and a 1.2% increase in comparable store sales, partially offset by the closing of one store in 1999. The increase in comparable store sales 13 during 1999 was achieved despite 8 competitive openings, including 4 new Albertson's, 3 new Wal-Mart Supercenters and 1 new independent store, the loss of sales during the remodeling of Company stores, and limited inflation in selected food categories. Sales in comparable stores were positively impacted by grand opening events at certain of the Company's stores, incremental improvements from continued usage of frequency card based promotions and direct marketing efforts, and additional sales in the final week of the year attributable to year 2000 events. Gross profit as a percentage of sales of 24.0% was the same as in 1998. Gross profit margin reflects the impact of specific promotional activities as the Company responded to certain new competitive store openings and special advertisements for the grand openings of the Company's remodeled and acquired stores; the increased cost of goods for pharmaceutical products; and, the increased shrink in certain perishable departments. The pressure on gross profit margin described above was offset by a general improvement in the management of promotional spending and the implementation of initiatives to lower cost of goods. Selling and administrative expenses as a percentage of sales of 21.6% was the same as in 1998. The expense ratio includes improvements in labor productivity; reductions in costs associated with advertising expenditures; increased sales which has allowed the Company to leverage certain fixed and administrative costs; the reduction in reserves for general liability expenses as a result of improved claims experience by the Company; and, the return of net premiums relating to the final settlement of pre-bankruptcy workers compensation claims. The improvements in the expense ratio described above were offset by an increase in expenses associated with the acquired stores, an increase in depreciation costs attributable to the Company's capital expenditure program for store remodels and maintenance and modernization, and an increase in the reserve for doubtful accounts relating to the uncertainty of an accounts receivable from one of the Company's vendors. The amortization of the excess reorganization value amounted to $6.9 million in 1999. The excess reorganization value was amortized over three years, on a straight-line basis, and became fully amortized in the third quarter of 1999. The Company recorded an asset impairment provision in the amount of $0.9 million related to a previously closed store. The provision reduced the carrying value of the real property to a current estimate of fair value. Interest expense, net of interest income, increased $0.3 million from $8.1 million in 1998 to $8.4 million in 1999. The increase reflects additional interest expense attributable to the acquired stores and increases in variable interest rates, partially offset by additional interest income from the interest bearing certificates of AWG. See "Liquidity and Capital Resources." The Company recorded $1.6 million of income tax expense for 1999, of which $1.5 million was deferred income tax. At January 1, 2000, the Company had a tax net operating loss carryforward of approximately $29.5 million. EBITDA increased $1.4 million from $22.9 million, or 4.3% of sales, in 1998 to $24.3 million, or 4.4% of sales in 1999. Liquidity and Capital Resources Debt. The primary sources of liquidity for the Company's operations have been borrowings under credit facilities and internally generated funds. On December 17, 1998, the Company entered into a Loan Agreement with National Bank of Canada ("NBC"), as agent and lender, and two other lenders, Heller Financial, Inc. and IBJ Whitehall Business Credit, Inc., under which these lenders provide a working capital and letter of credit facility ("Revolving Facility"), a term loan ("Term Loan") and an acquisition term loan ("Acquisition Term Loan") through August 2, 2002. 14 The Loan Agreement, as amended, permits the Company to borrow under the Revolving Facility up to the lesser of (a) $37.0 million or (b) the applicable borrowing base. The Company, with the consent of lenders, can access an over-advance facility which allows the Company to borrow amounts above the borrowing base but not above the total Revolving Facility. The lenders have consented to the use of the over-advance facility through April 30, 2001. Funds borrowed under the Revolving Facility are available for general corporate purposes of the Company. Effective April 24, 2001, the Loan Agreement was amended and the changes are hereinafter discussed within this Liquidity and Capital Resources section. The Term Loan, which had an outstanding balance as of December 30, 2000, of $8.8 million, represents the remaining balance of $5.0 borrowed under the prior loan agreement to finance costs and expenses associated with the consummation of the restructuring of the Company under its bankruptcy reorganization proceedings in August, 1996, plus $5.0 million borrowed in connection with the termination of the Acquisition Term Loan, permitting a corresponding reduction in the Revolving Facility, in April 2000. The Company is required to make quarterly principal paydowns of approximately $0.6 million. The interest rate payable quarterly, or monthly if the borrowings are characterized as a London Interbank Offered Rate Loan, under the Loan Agreement is based on the prime rate publicly announced by National Bank of Canada from time to time in New York, New York plus a percentage which varies based on a number of factors, including: (a) whether it is the Revolving Facility or the Term Loan; (b) the time period; and (c) whether the Company elects to use a London Interbank Offered Rate. The obligations of the Company under the Loan Agreement are secured by liens on, and security interests in, substantially all of the assets of Homeland and are guaranteed by Holding, with a pledge of its Homeland stock to secure its obligation. The Loan Agreement includes certain customary restrictions on acquisitions, asset dispositions, capital expenditures, consolidations and mergers, distributions, divestitures, indebtedness, liens and security interests and transactions with affiliates and payment of dividends. The Loan Agreement also requires the Company to comply with certain financial and other covenants. In addition, the Loan Agreement provides for acceleration of principal and interest payments in the event of certain material adverse changes, as determined by the lender. As of August 2, 1996, the Company entered into an Indenture with Fleet National Bank (predecessor to State Bank and Trust Company), as trustee, under which the Company issued $60.0 million of 10% Senior Subordinated Notes due 2003 ("New Notes"). The New Notes, which are unsecured, will mature on August 1, 2003. Interest on the New Notes accrues at the rate of 10% per annum and is payable on February 1 and August 1 of each year. The Indenture contains certain customary restrictions on acquisitions, asset sales, consolidations and mergers, distributions, indebtedness, transactions with affiliates and payment of dividends. Working Capital and Capital Expenditures. The Company's primary sources of capital have been borrowing availability under the Revolving Facility and cash flow from operations, to the extent available. The Company uses the available capital resources for working capital needs, capital expenditures and repayment of debt obligations. The Company's EBITDA (earnings before net interest expense, taxes, depreciation and amortization, store closing charges, asset impairment, and gain/loss on disposal of assets), as presented below, is the Company's measurement of internally-generated operating cash for working capital needs, capital expenditures and payment of debt obligations: 15 52 Weeks Ended 52 Weeks Ended 52 Weeks Ended December 30, 2000 January 1, 2000 January 2, 1999 Loss before income taxes $ (5,889) $ (2,726) $ (8,716) Interest income (751) (569) (426) Interest expense 10,612 9,011 8,484 (Gain) loss on disposal of assets 61 15 (34) Store closing charges 4,246 - - Amortization of excess reorganization value - 6,890 13,672 Asset impairment - 925 - Depreciation and amortization 11,849 10,774 9,923 EBITDA $ 20,128 $ 24,340 $ 22,903 As a percentage of sales 3.35% 4.35% 4.32% As a multiple of interest expense, net of interest income 2.04x 2.88x 2.84x Net cash provided by operating activities decreased $8.4 million, from $13.2 million in 1999 to $4.8 million in 2000. The increase principally reflects the decrease in EBITDA, trade payables and other liabilities partially offset by decreases in accounts receivable and inventory. Net cash used in investing activities decreased $1.5 million, from $10.6 million in 1999 to $9.1 million in 2000. The Company invested $5.5 million, $9.0 million, and $12.4 million in capital expenditures for 2000, 1999, and 1998, respectively. In April 1999, the Company completed its acquisition of nine stores from AWG, in eastern Oklahoma. The net purchase price was $1.3 million which represents $5.6 million for real property, and fixtures and equipment, plus $2.3 million for inventory, $0.2 million for transaction costs, offset by $6.8 million in long-term debt assumed by the Company. The Company acquired title to one store and leases the remaining eight from AWG. The one store to which Homeland acquired title in Pryor, Oklahoma, was closed (and subsequently sold to a non-grocery user) as a result of the proximity to an existing Company store. The Company financed this acquisition principally through the assumption of $6.8 million in long-term debt, together with increased borrowings under its Revolving Facility. The debt incurred by the Company to AWG is secured by liens on, and security interest in, the assets associated with the nine stores. Subsequent to the closing of the acquisition, the Company repaid a portion of its indebtedness to AWG which related to inventory and the Pryor store which was sold. Therefore, AWG released its security interest in the assets relating to the Pryor store and the inventory. In November 1999, the Company completed its acquisition of four stores from Brattain Foods, Inc. ("BFI"), in Muskogee, Oklahoma. The net purchase price was $1.1 million which represents $6.0 million for fixtures and equipment, plus $1.9 million for inventory, $0.2 million for transaction costs, offset by $7.0 million of long-term debt (BFI's obligation to AWG) assumed by the Company. The Company leased three of the stores from AWG and leased the fourth from a third party. The Company financed this acquisition principally through the assumption of $7.0 million in long-term debt, together with increased borrowings under its Revolving Facility. The debt incurred by the Company to AWG is secured by liens on, and security interest in, the assets associated with the four stores. Subsequent to the closing of the acquisition, the Company repaid a portion of its indebtedness to AWG, which related to inventory and therefore, AWG released its security interest in the inventory. 16 In February 2000, the Company completed its acquisition of three stores from Belton Food Center, Inc. ("BFC") in Oklahoma City. The net purchase price, prior to the closed store reserve discussed below, was $0.2 million which represents $4.2 million for fixtures and equipment, and leasehold improvements, plus $2.0 million for inventory and $0.2 million for transaction costs, offset by $6.2 million of long-term debt (BFC's obligation to AWG) assumed by the Company. The Company leases all three of the stores from AWG. The Company financed this acquisition principally through the assumption of $6.2 million in long-term debt, together with increased borrowings under its Revolving Facility. The debt incurred by the Company to AWG is secured by liens on, and security interest in, the assets associated with the three stores. Subsequent to the closing of the acquisition, the Company repaid a portion of its indebtedness to AWG, which related to inventory and therefore, AWG released its security interest in the inventory. In April 2000, the Company closed one of the acquired stores due to its proximity to other Company stores and established a reserve, which approximated $1.3 million, for future rent payments and other holding costs. Establishment of the reserve increased the goodwill balance associated with the acquisition. In October 2000, the lease on the closed store was assigned relulting in a reduction in the reserve and goodwill of $0.5 million. Substantially all other costs reserved were paid in 2000. In April 2000, the Company completed its acquisition of three Baker's Supermarkets. The purchase price was approximately $4.2 million, which represents $2.4 million for fixtures and equipment, leasehold improvements, and a non-compete agreement, $1.6 million for inventory, and approximately $0.2 million in transaction costs. In conjunction with the transaction, the Company also recorded $1.6 million of identified intangibles and $1.6 million in liabilities related to an unfavorable contract. The The unfavorable contract represents a five-year minimum purchase commitment and is expected to result in payments of $449, $864 and $321 in 2001, 2002 and 2003, respectively. The related intangible asset is amortized on a straight-line basis over the life of the contract. The Company will sublease the three stores. On September 15, 2000, the Company subsequently leased a fourth location upon the completion of its construction. Concurrent with the opening of the acquired store, the Company closed an existing store resulting in a charge to operations of approximately $0.3 million, which included future rent payments, other holding costs, and the write-off of property, plant and equipment. Payments of rent and other holding costs are expected to continue through 2001. The Company financed this acquisition principally through increased borrowings under its working capital facility. As of December 30, 2000, the Company had an outstanding balance on these assumed obligations to AWG of $10.3 million. The loans have a seven year term with principal and interest payments scheduled each week, and have a variable interest rate equal to the prime rate plus 100 basis points. Under the various agreements with respect to these acquisitions, the individual markets where the stores are located are subject to non-compete, supply and right-of- first-refusal agreements with AWG. In addition to the other customary terms associated with a right-of-first refusal agreement, the right-of-first refusal agreement provides for the repurchase by AWG of the stores based upon the occurrence of certain exercise events. The exercise events include, among other events, a change in control of Homeland and a transfer of more than 20% of the ownership interest of Holding or Homeland. Net cash provided by financing activities increased $7.1 million, from $2.9 million used in financing activities in 1999 to $4.2 million provided by financing activities in 2000. The increase primarily reflects the increase in the Term Loan and lower principal payments of the obligations during 2000. The Company considers its capital expenditure program a strategic part of the overall plan to support its market competitiveness. Cash capital expenditures for 2001 are expected to be at approximately $2.0 million. The Loan Agreement limits the Company's capital expenditures for 2001 to $5.0 million. The estimated 2001 capital expenditures of $2.0 is expected to be invested primarily in the on-going maintenance and modernization of certain 17 stores and does not include provisions for acquisitions. The funds for the capital expenditures are expected to be provided by internally-generated cash flows from operations and borrowings under the Loan Agreement. As of December 30, 2000, the Company had under its Revolving Facility $29.2 million of borrowings, $30,000 letter of credit outstanding and $6.0 million of availability. The markets in which the Company operates remain increasingly competitive negatively affecting the the Company's liquidity. The Company's near and long-term operating strategies focus on improving sales, improving operational efficiencies, and the productivity of assets. The Company intends to pursue its merchandising strategy in an attempt to increase its sales and the Company has devised plans to improve its gross margin and expense performance. Also, if necessary, the Company will close or sell under- performing stores or assets. Currently, the Company has letters of intent regarding certain asset sales to transfer leases and sell property related to four of the seven stores closed in January 2001 and to sell a parcel of undeveloped land. The estimated proceeds from these asset sales are $1.4 million and the transactions are subject to, among other things the signing of definitive agreements for each transaction. The Company has also retained McDonald Investments Inc. as a financial advisor to explore options for re- financing and raising capital. Adequate liquidity in 2001 is predicated on the Company's ability to achieve improvements in gross margin and expense performance over historical results and successful completion of the $1.4 million asset sale in the second quarter of 2001. Improvement over historical gross margin and expense performance is expected to occur in part as a result of the January closing of seven underperforming stores. Further improvement in gross margin is projected to result from an increase in the annual AWG patronage rebate as AWG is expected to return to a more historic level of profitability. The Company's lowest level of liquidity is expected to occur in the third quarter of 2001. If the Company is successful in meeting its cash flow projections, including completion of the asset sale in the second quarter of 2001, sufficient borrowings under the Revolving Facility will be available to meet the Company's liquidity needs during the third and fourth quarters of 2001. Furthermore, the projections do not include the potential favorable cash flow impact of closing or selling additional underperforming stores or assets. The Company believes that it continues to have the support of the agent and the lenders to the Loan Agreement. Effective April 24, 2001, the Company entered into an amendment to the Loan Agreement which, among other things, amends the financial covenants pertaining to minimum availability, EBITDA, funded debt to EBITDA ratio, and capital expenditures. In addition to the covenant changes, the Loan Agreement was amended to increase the applicable interest rates by 25 basis points and limit the use of London Interbank Offered rates. The Company does not expect the increase in rates will have a material impact on its ability to meet its cash flow projections or financial covenants. Based on its current projections, management believes that the Company will be able to meet the revised covenants set forth in the Loan Agreement, as amended, throughout 2001. If the Company is unable to meet these revised covenants, the Company will need to obtain waivers or classify the related borrowings as current obligations. There can be no assurances the Company will be able to obtain such waivers. However, since the amendment to the financial covenants is applicable only through 2001 and since the Loan Agreement matures on August 2, 2002, the Company intends to refinance its existing Loan Agreement indebtedness during 2001. There can be no assurance that the Company will be able to successfully refinance its existing indebtedness on terms that are acceptable to it. The Company believes that cash on hand, net cash flow from operations, proceeds from certain expected asset sales and borrowings under the Revolving Facility will be sufficient to fund its cash requirements through fiscal year 2001, which will consist primarily of payment of principal and interest on outstanding indebtedness, working capital requirements and capital expenditures. However, there can be no assurance that the asset sales will be consummated as planned. The Company's future operating performance and ability to service or refinance its current indebtedness will be subject to future economic conditions and to financial, business and other factors, many of which are beyond the Company's control. Information discussed herein includes statements that are forward- looking in nature, as defined in the Private Securities Litigation Reform Act. As with any forward-looking statements, these statements are subject to a number of factors and assumptions, including competitive activities, economic conditions in the market area and results of its future capital expenditures. 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. Inflation/Deflation Although the Company does not expect inflation or deflation to have a material impact in the future, there can be no assurance that the Company's business will not be affected by inflation or deflation in future periods. Recent Accounting Pronouncements The Financial Accounting Standards Board (the "FASB") Statment of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended by Statements 137 and 138, requires adoption by the Company on January 1, 2001. This statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those financial instruments at fair value. The accounting for changes in the fair value of a derivative instrument depends on the intended use of the derivative and its resulting designation. The adoption of this standard did not have a material effect on the Company's financial statements. In September 2000, the FASB issued Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - A Replacement for FASB Statement No. 125". This Statement is effective for transfers occurring March 31, 2001 and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. The Company does not expect the adoption of this standard will have a material effect on its financial statements. 18 ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. None. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Company's consolidated financial statements and notes thereto are included in this report following the signature pages. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 19 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT In accordance with the provisions of General Instruction G (3), the information required by this item will be contained in the Company's Proxy Statement for its Annual Stockholders Meeting to be held May 31, 2001, to be filed with the Securities and Exchange Commission within 120 days after December 30, 2000, and is incorporated herein by reference thereto. ITEM 11. EXECUTIVE COMPENSATION In accordance with the provisions of General Instruction G (3), the information required by this item will be contained in the Company's Proxy Statement for its Annual Stockholders Meeting to be held May 31, 2001, to be filed with the Securities and Exchange Commission within 120 days after December 30, 2000, and is incorporated herein by reference thereto. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT In accordance with the provisions of General Instruction G (3), the information required by this item will be contained in the Company's Proxy Statement for its Annual Stockholders Meeting to be held May 31, 2001, to be filed with the Securities and Exchange Commission within 120 days after December 30, 2000, and is incorporated herein by reference thereto. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS In accordance with the provisions of General Instruction G (3), the information required by this item will be contained in the Company's Proxy Statement for its Annual Stockholders Meeting to be held May 31, 2001, to be filed with the Securities and Exchange Commission within 120 days after December 30, 2000, and is incorporated herein by reference thereto. 20 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K The following documents are filed as part of this Report: (a) Financial Statements and Exhibits. 1. Financial Statements. The Company's financial statements are included in this report following the signature pages. See Index to Financial Statements on page F-1. 2. Exhibits. See attached Exhibit Index on page E-1. (b) Reports on Form 8-K. No reports on Form 8-K were filed during the last quarter of the period covered by this report. 21 SIGNATURES 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. HOMELAND HOLDING CORPORATION Date: April 24, 2001 By: / s / David B. Clark David B. Clark, President & C.E.O. 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 and in the capacities and on the dates indicated. Signature Title Date / s / John A. Shields Chairman of the Board April 24, 2001 John A. Shields / s / David B. Clark President, Chief Executive April 24, 2001 David B. Clark Officer and Director (Principal Executive Officer) / s / Wayne S. Peterson Senior Vice President/ April 24, 2001 Wayne S. Peterson Finance, C.F.O. and Secretary (Principal Financial Officer) / s / Deborah A. Brown Vice President, Controller, April 24, 2001 Deborah A. Brown Treasurer and Asst. Secretary (Principal Accounting Officer) II-1 Signature Title Date / s / Robert E. (Gene) Burris Director April 24, 2001 Robert E. (Gene) Burris / s / Edward B. Krekeler, Jr. Director April 24, 2001 Edward B. Krekeler, Jr. / s / Laurie M. Shahon Director April 24, 2001 Laurie M. Shahon / s / William B. Snow Director April 24, 2001 William B. Snow / s / David N. Weinstein Director April 24, 2001 David N. Weinstein II-2 INDEX TO FINANCIAL STATEMENTS HOMELAND HOLDING CORPORATION Consolidated Financial Statements Report of Independent Accountants F-2 Consolidated Balance Sheets as of December 30, 2000, and January 1, 2000 F-3 Consolidated Statements of Operations and Comprehensive Income for the 52 weeks ended December 30, 2000, January 1, 2000, and January 2, 1999 F-5 Consolidated Statements of Stockholders' Equity for the 52 weeks ended December 30, 2000, January 1, 2000, and January 2, 1999 F-6 Consolidated Statements of Cash Flows for the 52 weeks ended December 30, 2000, January 1, 2000, and January 2, 1999 F-7 Notes to Consolidated Financial Statements F-9 F-1 Report of Independent Accountants To the Board of Directors and Stockholders of Homeland Holding Corporation In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations and comprehensive income, stockholders' equity and cash flows present fairly, in all material respects, the financial position of Homeland Holding Corporation and its subsidiaries (the "Company") at December 30, 2000 and January 1, 2000, and the results of their operations and their cash flows for the 52 weeks ended December 30, 2000, January 1, 2000, and January 2, 1999, in conformity with accounting principles generally accepted in the United States of America. 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 auditing standards generally accepted in the United States of America, 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 our opinion. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 13 to the financial statements, the increasingly competitive market conditions under which the Company operates has negatively impacted the Company's liquidity and may continue to in the future. This raises substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 13. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. PRICEWATERHOUSECOOPERS LLP March 14, 2001, except for Note 13, as to which the date is April 24, 2001 F-2 HOMELAND HOLDING CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share amounts) December 30, January 1, 2000 2000 Current assets: Cash and cash equivalents $ 10,198 $ 10,237 Receivables, net of allowance for uncollectible accounts of $331 and $1,361 14,079 15,028 Inventories 54,707 52,663 Prepaid expenses and other current assets 1,610 2,176 Total current assets 80,594 80,104 Property, plant and equipment: Land and land improvements 8,797 9,046 Buildings 21,691 21,962 Fixtures and equipment 43,305 36,818 Leasehold improvements 21,202 20,446 Software 7,760 7,181 Leased assets under capital leases 9,886 8,737 Construction in progress 165 19 112,806 104,209 Less, accumulated depreciation and amortization 41,036 30,728 Net property, plant and equipment 71,770 73,481 Other assets and deferred charges 27,394 22,045 Total assets $ 179,758 $ 175,630 Continued The accompanying notes are an integral part of these consolidated financial statements F-3 HOMELAND HOLDING CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS, Continued (In thousands, except share and per share amounts) LIABILITIES AND STOCKHOLDERS' EQUITY December 30, January 1, 2000 2000 Current liabilities: Accounts payable - trade $ 28,869 $ 30,744 Salaries and wages 2,107 3,168 Taxes 3,606 3,616 Accrued interest payable 2,819 2,671 Other current liabilities 7,013 6,992 Current portion of long-term debt 3,860 2,918 Current portion of obligations under capital leases 564 501 Total current liabilities 48,838 50,610 Long-term obligations: Long-term debt 104,592 94,668 Obligations under capital leases 1,996 1,197 Other noncurrent liabilities 3,235 1,501 Total long-term obligations 109,823 97,366 Commitments and contingencies - - Stockholders' equity: Common stock $0.01 par value, authorized - 7,500,000 shares, issued 4,925,871 shares and 4,917,860 shares at December 30, 2000, and January 1, 2000, respectively 49 49 Additional paid-in capital 56,274 56,254 Accumulated deficit (34,538) (28,649) Accumulated other comprehensive income (688) - Total stockholders' equity 21,097 27,654 Total liabilities and stockholders' equity $ 179,758 $ 175,630 The accompanying notes are an integral part of these consolidated financial statements. F-4 HOMELAND HOLDING CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (In thousands, except share and per share amounts) 52 weeks 52 weeks 52 weeks ended ended ended December 30, January 1, January 2, 2000 2000 1999 Sales, net $ 600,835 $ 559,554 $ 529,576 Cost of sales 460,735 425,394 402,261 Gross profit 140,100 134,160 127,315 Selling and administrative expenses 133,244 120,594 114,335 Amortization of excess reorganization value - 6,890 13,672 Store closing charge 2,823 - - Asset Impairment - 925 - Operating profit (loss) 4,033 5,751 (692) Gain (loss) on disposal of assets (61) (15) 34 Interest income 751 569 426 Interest expense (10,612) (9,011) (8,484) Loss before income taxes (5,889) (2,706) (8,716) Income tax provision - (1,588) (1,875) Net loss $ (5,889) $ (4,294) $ (10,591) Other comprehensive loss Minimum pension liability adjustment $ (688) $ - $ - Comprehensive loss $ (6,577) $ (4,294) $ (10,591) Basic and diluted earnings per share: Net loss per share $ (1.20) $ (0.87) $ (2.18) Weighted average shares outstanding 4,923,236 4,911,958 4,857,130 The accompanying notes are an integral part of these consolidated financial statements. F-5 HOMELAND HOLDING CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In thousands, except share and per share amounts) Additional Common Stock Paid-In Shares Amount Capital Balance, January 3, 1998 4,820,637 $ 48 $ 56,040 Net loss - - - Issuance of common stock 83,780 1 134 Balance, January 2, 1999 4,904,417 49 56,174 Net loss - - - Issuance of common stock 13,443 - 80 Balance, January 1, 2000 4,917,860 49 56,254 Net loss - - - Other comprehensive loss Minimum pension liability adjustment - - - Issuance of common stock 8,011 - 20 Balance, December 30, 2000 4,925,871 $ 49 $ 56,274 Continued HOMELAND HOLDING CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Continued) (In thousands, except share and per share amounts) Accumulated Other Total Accumulated Comprehensive Stockholders' Deficit Income Equity Balance, January 3, 1998 $(13,764) $ - $ 42,324 Net loss (10,591) - (10,591) Issuance of common stock - - 135 Balance, January 2, 1999 (24,355) - 31,868 Net loss (4,294) - (4,294) Issuance of common stock - - 80 Balance, January 1, 2000 (28,649) - 27,654 Net loss (5,889) - (5,889) Other comprehensive loss Minimum pension liability adjustment - (688) (688) Issuance of common stock - - 20 Balance, December 30, 2000 $(34,538) $ (688) $ 21,097 The accompanying notes are an integral part of these consolidated financial statements. F-6 HOMELAND HOLDING CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands, except share and per share amounts) 52 weeks 52 weeks 52 weeks ended ended ended December 30, January 1, January 2, 2000 2000 1999 Cash flows from operating activities: Net loss $ (5,889) $ (4,294) $ (10,591) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization 11,008 10,427 9,802 Amortization of beneficial interest in operating leases 121 121 121 Amortization of excess reorganization value - 6,890 13,672 Amortization of goodwill 720 226 - Amortization of financing costs 62 42 120 Loss (gain) on disposal of assets 61 15 (34) Store closing costs 4,246 - - Asset impairment - 925 - Deferred income taxes - 1,451 1,699 Change in assets and liabilities: (Increase)decrease in receivables 949 (1,858) (950) (Increase)decrease in inventories 55 (2,355) (334) (Increase)decrease in prepaid expenses and other current assets 400 458 54 (Increase) in other assets and deferred charges (2,478) (2,498) (2,487) Increase(decrease)in accounts payable - trade (1,875) 4,597 479 Increase(decrease) in salaries and wages (1,061) 293 319 Increase(decrease) in taxes 47 426 (512) Increase(decrease) in accrued interest payable 148 49 3 Increase(decrease) in other current liabilities (1,397) (1,813) (1,494) Increase(decrease) in other non-current liabilities (316) 69 (531) Net cash provided by operating activities 4,801 13,171 9,336 Continued The accompanying notes are an integral part of these consolidated financial statements. F-7 HOMELAND HOLDING CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued (In thousands, except share and per share amounts) 52 weeks 52 weeks 52 weeks ended ended ended December 30, January 1, January 2, 2000 2000 1999 Cash flows from investing activities: Capital expenditures (5,497) (8,980) (12,404) Store acquisitions (4,224) (2,374) - Cash received from sale of assets 659 750 775 Net cash used in investing activities (9,062) (10,604) (11,629) Cash flows from financing activities: Borrowings under term loan 5,000 - - Payments under term loan (2,019) (1,667) (1,667) Borrowings under revolving credit loans 160,126 142,707 129,567 Payments under revolving credit loans (154,075) (137,400) (122,340) Principal payments under notes payable (50) (46) (61) Principal payments under AWG notes (4,278) (5,294) - Principal payments under capital lease obligations (502) (1,237) (1,412) Proceeds from issuance of common stock 20 80 135 Net cash provided by (used in) financing activities 4,222 (2,857) 4,222 Net increase (decrease) in cash and cash equivalents (39) (290) 1,929 Cash and cash equivalents at beginning of period 10,237 10,527 8,598 Cash and cash equivalents at end of period $ 10,198 $ 10,237 $ 10,527 Supplemental information: Cash paid during the period for interest $ 10,442 $ 8,993 $ 8,419 Cash paid during the period for income taxes $ 30 $ 110 $ 100 Supplemental schedule of non-cash investing activities: Capital lease obligations assumed $ 1,363 $ - $ 453 Debt assumed in acquisitions $ 6,162 $ 13,706 $ - The accompanying notes are an integral part of these consolidated financial statements. F-8 HOMELAND HOLDING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands, except share and per share amounts) 1. Organization: Homeland Holding Corporation ("Holding"), a Delaware corporation, was incorporated on November 6, 1987, but had no operations prior to November 25, 1987. Effective November 25, 1987, Homeland Stores, Inc. ("Homeland"), a wholly-owned subsidiary of Holding, acquired substantially all of the net assets of the Oklahoma Division of Safeway Inc. Holding, its consolidated subsidiary, Homeland, Homeland's wholly-owned subsidiary, SLB Marketing, Inc., and SLB's wholly-owed subsidiary, JCH Beverage, Inc., are collectively referred to herein as the "Company." The Company is a leading supermarket chain in the Oklahoma, southern Kansas and Texas Panhandle regions. The Company operates in four distinct market places: Oklahoma City, Oklahoma; Tulsa, Oklahoma; Amarillo, Texas; and certain rural areas of Oklahoma, Kansas and Texas. Holding has guaranteed substantially all of the debt issued by Homeland. Holding is a holding company with no significant operations other than its investment in Homeland. Separate financial statements of Homeland are not presented herein since they are identical to the consolidated financial statements of Holding in all respects except for stockholders' equity which is as follows: December 30, January 1, 2000 2000 Homeland stockholder's equity: Common stock, $.01 par value, authorized, issued and outstanding 100 shares $ 1 $ 1 Additional paid-in capital 56,322 56,302 Accumulated deficit (34,538) (28,649) Accumulated other comprehensive income (688) - Total Homeland stockholder's equity $ 21,097 $ 27,654 2. Summary of Significant Accounting Policies: Fiscal year - The Company has adopted a fiscal year which ends on the Saturday nearest December 31. Basis of consolidation - The consolidated financial statements include the accounts of Homeland Holding Corporation and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Revenue recognition - The Company recognizes revenue at the "point of sale," which occurs when groceries and related merchandise are sold to its customers. The Company was required to adopt Securities and Exchange Commission Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" in the fourth quarter of 2000. The impact of adopting this guidance had no effect on the Company's financial statements for any year presented. Concentrations of credit and business risk - The Company purchases approximately 70% of its products from Associated Wholesale Grocers, Inc. ("AWG"). Although there are similar wholesalers that could supply the Company with merchandise, if AWG were to discontinue shipments, this could have a material adverse effect on the Company's financial condition. The Company receives certain rebates and allowances from AWG as well as an annual distribution from AWG's cooperative arrangements. A portion of F-9 HOMELAND HOLDING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands, except share and per share amounts) 2. Summary of Significant Accounting Policies, continued: the annual distribution is in the form of cash, while the remainder is in the form of patronage certificates. Receivables from AWG and the AWG patronage refund certificates subject the Company to a concentration of credit risk. Other financial instruments which potentially subject the Company to concentrations of credit risk consist of principally of temporary cash investments and non-AWG receivables. The Company places its temporary cash investments with high quality financial institutions. Concentration of credit risk with respect to non-AWG receivables are limited due to the diverse nature of those receivables, including the large number of retail customers within the region and receivables from vendors throughout the country. Cash and cash equivalents - For purposes of the statements of cash flows, the Company considers all short-term investments with an original maturity of three months or less when purchased to be cash equivalents. Book overdrafts of $6,361 and $4,101, as of December 30, 2000 and January 1, 2000, respectively, are included in accounts payable. Inventories - Inventories are stated at the lower of cost or market, with cost being determined primarily using the gross margin method. Property, plant and equipment - In conjunction with the emergence from Chapter 11 proceedings in August, 1996, the Company implemented "fresh- start" reporting and, accordingly, all property, plant and equipment was restated to reflect reorganization value, which approximates fair value in continued use. Depreciation and amortization, including amortization of leased assets under capital leases, are computed on a straight-line basis over the lesser of the estimated useful life of the asset or the remaining term of the lease. Property, plant and equipment acquired subsequent to "fresh start" are stated at cost. Depreciation and amortization of newly acquired assets, for financial reporting purposes, are based on the following estimated lives: Estimated lives Buildings 10 - 40 Fixtures and equipment 5 - 12.5 Leasehold improvements 15 Software 3 - 5 The costs of repairs and maintenance are expensed as incurred, and the costs of renewals and betterments are capitalized and depreciated at the appropriate rates. Upon sale or retirement, the cost and related accumulated depreciation are eliminated from the respective accounts and any resulting gain or loss is included in the results of operations for that period. Reorganization value in excess of amounts allocable to identifiable assets - The Company's reorganization value in excess of amounts allocable to identifiable assets, established in accordance with "fresh start" reporting, had been amortized on a straight-line basis over three years and became fully amortized in the third quarter of 1999. Store Closings / Asset Impairment - Provision is made on a current basis for the write-down of identified owned-store closings to their net realizable value. For identified leased-store closings, leasehold improvements are written down to their net realizable value and a provision is made on a current basis if anticipated expenses are in excess of expected sublease rental income. The Company's long-lived assets, including goodwill, are reviewed for impairment and written down to fair value whenever events or changes in circumstances indicate that the carrying value may not be recovable. Goodwill has primarily been recorded in conjunction with the four separate store F-10 HOMELAND HOLDING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands, except share and per share amounts) 2. Summary of Significant Accounting Policies, continued: acquisitions. For purposes of review, goodwill and the assets of those stores associated with a specific acquisition are combined to determine if impairment is appropriate. Other assets and deferred charges - Other assets and deferred charges consist primarily of patronage refund certificates issued by AWG (as part of its year-end distribution of income from AWG's cooperative operations), beneficial interests in operating leases, and goodwill and intangibles acquired in the Company's 1999 and 2000 acquisitions. The beneficial interest in operating leases is being amortized on a straight-line basis over the remaining terms of the leases, including all available renewal option periods, and the goodwill is being amortized over a 15 year period. The AWG patronage refund certificates which bear annual interest of 6%, are redeemable for cash seven years from the date of issuance. The carrying value of certificates, including those earned not yet received, at December 30, 2000 and January 1, 2000 was $13,884 and $11,726, respectively. Goodwill, net of accumulated amortization, was $10,043 and $8,011 at December 30, 2000 and January 1, 2000, respectively. Earnings per share - The Company presents the two earnings per share ("EPS") amounts as required under Statement of Accounting Standard No. 128, Earnings Per Share ("SFAS 128"). Basic EPS is computed using the weighted average number of common shares outstanding. Diluted earnings per share is computed using the weighted average number of common shares outstanding and equivalent shares based on the assumed exercise of stock options and warrants (using the treasury method). Advertising costs - Costs of advertising are expensed as incurred. Gross advertising costs for 2000, 1999, and 1998, were $9,743, $9,112, and $8,349, respectively. Income taxes - The Company provides for income taxes based on enacted tax laws and statutory tax rates at which items of income and expense are expected to be settled in the Company's income tax return. Certain items of revenue and expense are reported for Federal income tax purposes in different periods than for financial reporting purposes, thereby resulting in deferred income taxes. Deferred taxes also are recognized for operating losses that are available to offset future taxable income and tax credits that are available to offset future Federal income taxes. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. Self-insurance reserves - The Company is self-insured for property loss, general liability and employee medical coverage subject to specific retention levels. Estimated costs of these self-insurance programs are accrued based on projected settlements for claims using actuarially determined loss development factors based on the Company's prior experience with similar claims. Any resulting adjustments to previously recorded reserves are reflected in current operating results. Pre-opening costs - Store pre-opening costs are charged to expense as incurred. Use of estimates - 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 dates of the financial statements and the reported amounts of revenues and expenses F-11 HOMELAND HOLDING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands, except share and per share amounts) 2. Summary of Significant Accounting Policies, continued: during the reporting periods. The most significant assumptions and estimates relate to the reserve for self-insurance programs, reserves for closed stores, the deferred income tax valuation allowance, the accumulated benefit obligation relating to the employee retirement plan and the allowance for bad debts. It is reasonably possible that the Company's estimates for such items could change in the near term. In the second quarter of 2000, the Company collected a receivable from a vendor of approximately $600 that had been reserved for as of January 1, 2000. Reclassifications - Certain January 1, 2000 and January 2, 1999 amounts have been reclassified to conform with December 30, 2000 presentation. Recent Accounting Pronouncements: The Financial Accounting Standards Board (the "FASB") Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended by Statements 137 and 138, requires adoption by the Company on January 1, 2001. This statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those financial instruments at fair value. The accounting for changes in the fair value of a derivative instrument depends on the intended use of the derivative and its resulting designation. The adoption of this standard did not have a material effect on the Company's financial statements. In September 2000, the FASB issued Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - A Replacement for FASB Statement No. 125". This Statement is effective for transfers occurring after March 31, 2001 and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. The Company does not expect the adoption of this standard will have a material effect on its financial statements. 3. Store Acquisitions: In April 1999, the Company completed its acquisition of nine stores from AWG, in eastern Oklahoma. The net purchase price was $1.3 million which represents $5.6 million for real property, and fixtures and equipment, plus $2.3 million for inventory, $0.2 million for transaction costs, offset by $6.8 million in long-term debt assumed by the Company. The Company acquired title to one store and leases the remaining eight from AWG. The one store to which Homeland acquired title in Pryor, Oklahoma, was closed (and subsequently sold to a non-grocery user) as a result of the proximity to an existing Company store. The Company financed this acquisition principally through the assumption of $6.8 million in long-term debt, together with increased borrowings under its Revolving Facility. The debt incurred by the Company to AWG is secured by liens on, and security interest in, the assets associated with the nine stores. Subsequent to the closing of the acquisition, the Company repaid a portion of its indebtedness to AWG which related to inventory and the Pryor store which was sold. Therefore, AWG released its security interest in the inventory and the assets relating to the Pryor store. In November 1999, the Company completed its acquisition of four stores from Brattain Foods, Inc. ("BFI"), in Muskogee, Oklahoma. The net purchase price was $1.1 million which represents $6.0 million for fixtures and equipment, plus $1.9 million for inventory, $0.2 million for transaction costs, offset by F-12 HOMELAND HOLDING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands, except share and per share amounts) 3. Store Acquisitions, continued: $7.0 million of long-term debt (BFI's obligation to AWG) assumed by the Company. The Company will lease three of the stores from AWG and lease the fourth from a third party. The Company financed this acquisition principally through the assumption of $7.0 million in long-term debt, together with increased borrowings under its Revolving Facility. The debt incurred by the Company to AWG is secured by liens on, and security interest in, the assets associated with the four stores. Subsequent to the closing of the acquisition, the Company repaid a portion of its indebtedness to AWG, which related to inventory and therefore, AWG released its security interest in the inventory. In February 2000, the Company completed its acquisition of three stores from Belton Food Center, Inc. ("BFC") in Oklahoma City. The net purchase price, prior to the closed store reserve discussed below, was $0.2 million which represents $4.2 million for fixtures and equipment and leasehold improvements, plus $2.0 million for inventory and $0.2 million for transaction costs, offset by $6.2 million of long-term debt (BFC's obligation to AWG) assumed by the Company. The Company leases all three of the stores from AWG. The Company financed this acquisition principally through the assumption of $6.2 million in long-term debt, together with increased borrowings under its Revolving Facility. The debt incurred by the Company to AWG is secured by liens on, and security interest in, the assets associated with the three stores. Subsequent to the closing of the acquisition, the Company repaid a portion of its indebtedness to AWG, which related to inventory and therefore, AWG released its security interest in the inventory. In April 2000, the Company closed one of the acquired stores due to its proximity to other Company stores and established a reserve, which approximated $1.3 million, for future rent payments and other holding costs. Establishment of the reserve increased the goodwill balance associated with the acquisition. In October 2000, the lease on the closed store was assigned resulting in a reduction in the reserve and goodwill of $0.5 million. Substantially all other costs reserved were paid in 2000. In April 2000, the Company completed its acquisition of three Baker's Supermarkets. The purchase price was approximately $4.2 million, which represents $2.4 million for fixtures and equipment, leasehold improvements and a non-compete agreement, $1.6 million for inventory, and approximately $0.2 million in transaction costs. In conjunction with the transaction, the Company also recorded $1.6 million of identified intangibles and $1.6 million in liabilities related to an unfavorable contract. The unfavorable contract represents a five-year minimum purchase commitment and is expected to result in payments of $449, $864 and $321 in 2001, 2002 and 2003, respectively. The related intangible asset is amortized on straight-line basis over the life of the contract. The Company will sublease the three stores. On September 15, 2000, the Company subsequently leased a fourth location upon the completion of its construction. Concurrent with the opening of the acquired store, the Company closed an existing store resulting in a charge to operations of approximately $0.3 million, which included future rent payments, other holding costs, and the write-off of property, plant and equipment. Payments of rent and other holding costs are expected to continue through 2001. The Company financed this acquisition principally through increased borrowings under its working capital facility. All of the above acquisitions were accounted for using the purchase method of accounting. The result of operations from these stores from the acquisition dates through fiscal year-end are included in the fiscal 1999 and 2000 Consolidated Statements of Operations and Comprehensive Income. F-13 HOMELAND HOLDING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands, except share and per share amounts) 4. Store Closings / Asset Impairment: In December 2000, the Company committed to a plan to close seven stores in January 2001 and recorded a store closing charge of $4,246. The charge included the write-down of property, plant and equipment and other assets of $2,010, inventory write-downs of $1,423, which was recorded as a part of cost of sales, and holding costs of $813. Holding costs primarily consist of obligations under operating leases and related expenses expected to be paid over the remaining lease terms which range from 2001 to 2004. During 1999, the Company made the decision to dispose of a previously closed store and related assets. The Company decided to sell these assets rather than continue the previous plan of leasing the assets. The carrying value of the assets held for sale was reduced to a value of $385, based on current estimates of selling value less costs to dispose. The resulting adjustment of $925 was recorded. In 2000, the assets were sold for an amount which approximated the then carrying value. 5. Long-Term Debt: Long-term debt at year-end consists of: December 30, January 1, 2000 2000 10% Notes due 2003 (the "Notes") $ 60,000 $ 60,000 Revolving Facility 29,245 23,194 Term Loan 8,814 5,833 AWG Loans 10,295 8,412 Note Payable 98 147 108,452 97,586 Less current portion 3,860 2,918 Long-term debt due after one year $ 104,592 $ 94,668 The Notes bear an interest rate of 10%, which is payable semi-annually each February 1 and August 1. The Notes are uncollateralized and will mature on August 1, 2003. The Indenture relating to the Notes has certain customary restrictions on consolidations and mergers, indebtedness, issuance of preferred stocks, asset sales and payment of dividends. The Company's Revolving Facility and Term Loan are maintained under a single loan agreement (the "Loan Agreement"). The Revolving Facility permits the Company to borrow up to the lesser of $37,000 or the applicable borrowing base. Pursuant to an amendment to the Loan Agreement, the Company, with the consent of the lenders, can access an over-advance facility which allows the Company to borrow amounts above the borrowing base but not above the total Revolving Facility. This over-advance facility, currently set at $2,000, is available to the Company through April 30, 2001. At December 30, 2000, the Company had availability of $6,041 under the Revolving Facility. The Term Loan represents the remaining balance of $5,000 borrowed under a prior loan agreement plus $5,000 borrowed in connection with the April 2000 termination of a previously available acquisition term loan. The interest rate under the Loan Agreement, as amended, is based on the Prime Rate, as defined, plus a percentage that varies based on a number of factors, including (a) whether it is a Revolving Facility or the Term Loan, (b) the time period, (c) whether the Company elects to use the London Interbank F-14 HOMELAND HOLDING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands, except share and per share amounts) 5. Long-Term Debt, continued: Offered Rate ("LIBOR"). Interest for borrowings under the LIBOR rate is payable monthly. Interest for other borrowings is payable quarterly. At December 30, 2000, the interest rate on borrowings on the Revolving Facility was 9,26% (weighted average) and the Term Loan was 9.76% (weighted average). The Revolving Facility provides for certain mandatory prepayments based on occurrence of certain defined and specified transactions. The Term Loan requires quarterly principal payments of $595 and will mature, along with the Revolving Facility, on August 2, 2002. The obligations of the Company under the Loan Agreement are collateralized by liens on, and a security interest in, substantially all of the assets of Homeland and are guaranteed by Holding. The Loan Agreement, among other things, requires a maintenance of EBITDA, consolidated fixed charge ratio, debt-to- EBITDA ratio, current ratio, excess cash flow paydown, each as defined, and limits the Company's capital expenditures, incurrence of additional debt, consolidation and mergers, acquisitions and payments of dividends. In addition, the Loan Agreement provides for acceleration of principal and interest payments in the event of certain material adverse changes, as determined by the lender. As discussed in Note 13, the Loan Agreement was amended further effective April 24, 2001. The obligations of the Company as it relates to AWG Loans are secured by liens on, and security interest in, the fixtures and equipment associated with the stores acquired in 1999 and 2000, as referenced in Note 3. Each of the AWG Loans is a seven-year note, which is amortized weekly, and has interest rates associated with it equal to the prime rate plus 1%. At December 30, 2000, the interest rate was 10.50%. At December 30, 2000, the aggregate annual debt maturities were as follows: 2001 $ 3,860 2002 37,296 2003 61,766 2004 1,926 2005 2,140 Thereafter 1,464 $108,452 The Company has outstanding at December 30, 2000, $30 in letters of credit which are not reflected in the accompanying financial statements. The letters of credit are issued under the credit agreements and the Company paid associated fees of $4, $12, and $43, in 2000, 1999, and 1998, respectively. F-15 HOMELAND HOLDING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands, except share and per share amounts) 6. Stockholders' Equity: At December 30, 2000, the Company has warrants outstanding to purchase 263,158 shares of common stock. Each warrant entitles the holder to purchase one share of common stock at an exercise price of $11.85 at any time up to August 2, 2001. 7. Fair Value of Financial Instruments: The carrying amounts of cash and cash equivalents, receivables, AWG patronage refund certificates, accounts payable and accrued expenses and other liabilities are reasonable estimates of their fair values at December 30, 2000 and January 1, 2000. Based on borrowing rates currently available to the Company for borrowings with similar terms and maturities, the Company believes the carrying amount of borrowings under the Loan Agreement and the AWG Loans approximate fair value at December 30, 2000 and January 1, 2000. The fair value of publicly-traded debt is valued based on quoted market values. At December 30, 2000, the carrying amount and the fair value of the Notes were $60,000 and $28,200, respectively. On March 14, 2001, the fair value of the Notes is $13,2000. At January 1, 2000, the carrying amount and the fair value of the Notes were $60,000 and $48,330, respectively. 8. Income Taxes: The components of the income tax provision for 2000, 1999, and 1998 were as follows: 52 Weeks 52 Weeks 52 Weeks Ended Ended Ended December 30, 2000 January 1, 2000 January 2, 1999 Federal and State: Current - AMT $ - $ (137) $ (176) Deferred - (1,451) (1,699) Total income tax provision $ - $ (1,588) $ (1,875) A reconciliation of the income tax benefit provision at the statutory Federal income tax rate to the Company's effective tax rate is as follows: 52 Weeks 52 Weeks 52 Weeks Ended Ended Ended December 30, 2000 January 1, 2000 January 2, 1999 Federal income tax benefit at statutory rate $ 2,061 $ 947 $ 3,051 Amortization of intangibles - (2,412) (4,785) Change in valuation allowance and other (2,061) (123) (141) Total income tax provision $ - $ (1,588) $ (1,875) F-16 HOMELAND HOLDING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands, except share and per share amounts) 8. Income Taxes, continued: The components of deferred tax assets and deferred tax liabilities are as follows: December 30, January 1, 2000 2000 Current assets (liabilities): Allowance for uncollectible receivables $ 126 $ 517 Inventory 541 - Prepaid pension (108) (224) Other, net 131 22 Net current deferred tax assets 690 315 Noncurrent assets (liabilities): Property, plant and equipment 3,029 2,221 Employee compensation and benefits 285 285 Self-insurance reserves 487 606 Net operating loss carryforwards 12,338 11,210 AMT credit carryforwards 959 963 Capital leases (42) (71) Other, net 870 627 Net noncurrent deferred tax assets 17,926 15,841 Total net deferred tax assets 18,616 16,156 Valuation allowance (18,616) (16,156) Net deferred tax assets $ - $ - Due to the uncertainty of realizing the future tax benefits, a full valuation allowance was deemed necessary to entirely offset the net deferred tax assets as of December 30, 2000, and January 1, 2000. At December 30, 2000, the Company had the following operating loss and tax credit carryforwards available for tax purposes: Expiration Amount Dates Federal regular tax net operating loss carryforwards $32,469 2002-2010 Federal AMT credit carryforwards against regular tax $959 indefinite The net operating loss carryforwards are subject to utilization limitations due to ownership changes. The net operating loss carryforwards may be utilized to offset future taxable income as follows: $11,368 in 2001, $3,251 in each of years 2002 through 2007 and $1,595 in 2008. Loss carryforwards not utilized in any year that they are available may be carried over and utilized in subsequent years, subject to their expiration provisions. In accordance with SOP 90-7, the tax benefit realized from utilizing the pre-reorganization net operating loss carryforwards is recorded first as a reduction of the reorganization value in excess of amounts allocable to identifiable assets, then as a reduction of noncurrent intangible assets existing at the reorganization date, and finally as an increase to stockholders' equity rather than realized as a benefit in the statement of operations. The Company recorded $1,451 and $1,699 of reductions to reorganization value and/or intangible assets in 1999 and 1998, respectively. F-17 HOMELAND HOLDING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands, except share and per share amounts) 9. Incentive Compensation Plans: The Company has bonus arrangements for store management and other key management personnel. During 2000, 1999, and 1998, approximately $734, $1,760, and $1,480, respectively, were charged to costs and expenses for such bonuses. In December 1996, the Board of Directors of the Company adopted the Homeland Holding Corporation 1996 Stock Option Plan (the "Stock Option Plan"). In 1997, the Company established the 1997 Non-Employee Directors Stock Option Plan (the "Directors Stock Option Plan"). The Company applies APB Opinion No. 25, "Accounting for Stock Issued to Employees" and related Interpretations in accounting for these plans. SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") was issued by the FASB in 1995 and, if fully adopted, changes the methods for recognition of expense on plans similar to the Company's. Adoption of SFAS 123 is optional; however, pro forma disclosures as if the Company adopted the cost recognition requirements under SFAS 123 in 2000, 1999, and 1998 are presented below. The Stock Option Plan and the Directors Stock Option Plan, to be administered by the Board of Directors (the "Board"), or a committee of the Board (the "Committee"), provides for the granting of options to purchase up to an aggregate of 832,222 and 200,000 shares of Common Stock, respectively. Options granted under the plans must be "non-qualified options." The option price of each option is determined by the Board or the Committee and it must be not less than the fair market value at the date of grant. Unless the Board or the Committee otherwise determines, options must become exercisable ratably over a five-year period, a two-year period in regards to the Directors Stock Option Plan, or immediately in the event of a "change of control" as defined in each of the plans. Each option must be evidenced by a written agreement and must expire and terminate on the earliest of: (a) ten years from the date the option is granted; (b) termination for cause; or (c) three months after termination for other than cause. Options granted under the Company's stock option plans have exercise prices ranging from $2.00 to $7.63 per share and have a weighted average remaining contractual life of 8.5 years. A summary of the status of the Company's outstanding stock options as of December 30, 2000, January 1, 2000, and January 2, 1999, and changes during the years ended on those dates is as follows: 2000 1999 1998 Wgtd. Avg. Wgtd. Avg. Wgtd. Avg. Exercise Exercise Exercise Shares Price Shares Price Shares Price Outstanding as of beginning of year 542,000 $5.38 429,000 $6.09 198,500 $7.48 Granted 425,000 3.29 120,500 3.01 319,000 5.64 Exercised - - - - 13,200 6.50 Forfeited 5,000 7.63 7,500 7.63 75,300 7.80 Outstanding at end of year 962,000 $4.08 542,000 $5.38 429,000 $6.09 F-18 HOMELAND HOLDING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands, except share and per share amounts) 9. Incentive Compensation Plans, continued: Stock options outstanding and exercisable on December 30, 2000 are as follows: Weighted average Weighted average Range of exercise Shares under exercise price remaining contractual prices per share option per share life in years Outstanding: $2.00 - $4.00 725,500 $3.10 8.9 4.75 - 7.63 236,500 7.11 7.0 $2.00 - $7.63 962,000 $4.08 8.5 Exercisable: $2.00 - $4.00 120,100 $2.81 4.75 - 7.63 181,000 7.25 $2.00 - $7.63 301,100 $5.48 The weighted average fair value of options granted during 2000, 1999, and 1998 was $1.36, $1.46 and $2.83, respectively. No compensation was charged against income in 2000, 1999, and 1998. The fair value of the options granted was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions used: 2000 1999 1998 Expected dividend yield 0% 0% 0% Expected stock price volatility 41% 40% 37% Weighted average risk-free interest rate 6.0% 5.8% 5.3% Weighted average expected life of options 6 years 6 years 6 years Had compensation cost of the Company's option plans been determined using the fair value at the grant date of awards consistent with the method of SFAS 123, the Company's net loss and net loss per common share would have been reduced to the pro forma amounts indicated in the table below: 2000 1999 1998 Net loss - as reported $ (5,889) $ (4,294) $ (10,591) Net loss - pro forma $ (6,165) $ (4,466) $ (10,722) Basic and diluted EPS - as reported $ (1.20) $ (0.87) $ (2.18) Basic and diluted EPS - pro forma $ (1.25) $ (0.91) $ (2.21) No options or warrants outstanding at December 30, 2000, January 1, 2000, and January 2, 1999, were included in the computation of diluted earnings per share because the effect would be antidilutive to applicable periods. Pursuant to the terms of the Union Agreements, the Company established an employee stock bonus plan for the benefit of the unionized employees (the "Stock Bonus Plan"). The Stock Bonus Plan consists of three separate elements: (a) the issuance of 58,025 shares of Common Stock each plan F-19 HOMELAND HOLDING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands, except share and per share amounts) 9. Incentive Compensation Plans, continued: year of the three year period ended July 31, 1999; (b) up to 58,025 shares of Common Stock may be purchased by the plan participants during each plan year of the three year period ending July 31, 2000 (the "Stock Purchase") and (c) the granting of 58,025 shares of Common Stock for each plan year of the three year period ended July 31, 1999 upon the Company's achievement of certain escalating EBITDA-based performance goals. The purchase price of the shares under the Stock Purchase element shall be equal to their appraised value or at fair value if the shares are readily tradable on a securities market. For each share of Common Stock purchased by a participant under the Stock Purchase element, the Company will match 33 1/3% of such purchase in the form of stock. The Stock Bonus Plan does not fall under the provisions of SFAS 123. 10. Retirement Plans: Effective January 1, 1988, the Company adopted a non-contributory, defined benefit retirement plan for all executive and administrative personnel. Benefits are based on length of service and career average pay with the Company. The Company's funding policy is to contribute an amount equal to or greater than the minimum funding requirement of the Employee Retirement Income Security Act of F-20 HOMELAND HOLDING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands, except share and per share amounts) 10. Retirement Plans, continued: 1974, but not in excess of the maximum deductible limit. Plan assets were invested in mutual funds during 2000, 1999, and 1998. Information regarding the plan follows: 2000 1999 Change in benefit obligation: Benefit obligation at beginning of year $ 10,528 $ 11,432 Service cost 473 562 Interest cost 857 792 Actuarial (gain) loss 644 (1,980) Benefits paid (320) (278) Benefit obligation at end of year $ 12,182 $ 10,528 Change in plan assets: Fair value of plan assets at beginning of year $ 11,234 $ 10,692 Actual return on plan assets 126 820 Employer contribution - - Benefits paid (320) (278) Fair value of plan assets at end of year $ 11,040 $ 11,234 Reconciliation of funded status: Funded status $ (1,142) $ 707 Unrecognized actuarial (gain)loss 1,465 (66) Unrecognized prior service cost (40) (51) Prepaid benefit cost $ 283 $ 590 Amounts recognized in the financial statement of financial position consist of: Prepaid benefit cost $ - $ 590 Accrued benefit liability (405) - Accumulated other comprehensive income 688 - Net amount recognized $ 283 $ 590 Weighted-average assumptions as of end of year: Discount rate 7.50% 7.75% Expected return on plan assets 9.00% 9.00% Rate of compensation increase Before Age 35 5.50% 5.50% Ages 35 - 49 4.50% 4.50% After Age 49 3.50% 3.50% Components of net periodic pension cost: 2000 1999 1998 Service cost $ 473 $ 562 $ 514 Interest cost 857 792 725 Expected return on plan assets (1,012) (953) (868) Amortization of prior service cost (11) (11) (11) Recognized net actuarial loss 0 11 46 Net periodic pension cost $ 307 $ 401 $ 406 F-21 HOMELAND HOLDING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands, except share and per share amounts) 10. Retirement Plans, continued: The Company also contributes to various union-sponsored, multi-employer defined benefit plans in accordance with collective bargaining agreements. The Company could, under certain circumstances, be liable for the Company's unfunded vested benefits or other costs of these multi-employer plans. The allocation to participating employers of the actuarial present value of vested and nonvested accumulated benefits in multi-employer plans as well as net assets available for benefits is not available and, accordingly, is not presented. The costs of these plans for 2000, 1999, and 1998, were $1,226, $1,271, and $1,235, respectively. Effective January 1, 1988, the Company adopted a defined contribution plan covering substantially all non-union employees of the Company. Participants may contribute from 1% to 12% of their pre-tax compensation. The plan allows for a discretionary Company matching contribution formula based on the Company's operating results. The Company did not make any contributions to this plan in 2000, 1999, or 1998. 11. Leases: The Company leases 70 of its retail store locations under noncancellable agreements, which expire at various times between 2001 and 2030. These leases, which include both capital leases and operating leases, generally are subject to six five-year renewal options. Most leases also require the payment of taxes, insurance and maintenance costs and many of the leases covering retail store properties provide for additional contingent rentals based on sales in excess of certain stipulated amounts. Leased assets under capital leases consists of the following: December 30, January 1, 2000 1999 Buildings $ 2,426 $ 2,554 Equipment 4,494 3,169 Beneficial interest in capital leases 2,966 3,014 9,886 8,737 Less accumulated amortization 4,833 4,163 Net leased assets $ 5,053 $ 4,574 F-22 HOMELAND HOLDING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands, except share and per share amounts) 11. Leases, continued: Future minimum lease payments under capital leases and noncancellable operating leases as of December 30, 2000, are as follows: Capital Operating Fiscal Year Leases Leases 2001 $ 803 $ 9,953 2002 708 8,427 2003 713 7,891 2004 182 7,300 2005 182 6,648 Thereafter 924 23,353 Total minimum obligations 3,512 $ 63,572 Less estimated interest 952 Present value of net minimum obligations 2,560 Less current portion 564 Long-term obligations under capital leases $ 1,996 Rent expense for 2000, 1999 and 1998 is as follows: 2000 1999 1998 Minimum rents $ 9,789 $ 7,200 $ 6,680 Contingent rents 83 86 115 $ 9,872 $ 7,286 $ 6,795 12. Commitments and Contingencies: In 1995, the Company and AWG entered into a seven-year supply agreement (the "Supply Agreement"), whereby the Company became a retail member of the AWG cooperative and AWG became the Company's primary supplier (see Note 2 - Concentrations of credit and business risk). The terms of the Supply Agreement allow the Company to purchase products at the lowest prices and best terms available to AWG members and also entitle the Company to participate in its store cost savings programs and receive member rebates and refunds on purchases. In addition, the Supply Agreement includes certain Volume Protection Rights, as defined therein. The Company has entered into employment contracts with certain key executives providing for the payment of minimum salary and bonus amounts in addition to certain other benefits in the event of termination of the executives or change of control of the Company. The Company is party to various lawsuits arising from the 1996 Chapter 11 proceedings and also in the normal course of business. Management believes that the ultimate outcome of these matters will not have a material effect on the Company's consolidated financial position, results of operations and cash flows. Approximately 92% of the Company's employees are union members. The collective bargaining agreements associated with the majority of these employees expire in August 2001. Preliminary negotiations have begun and the Company intends that new agreements will be in place prior to the expiration dates. However, the negotiated wages and benefits under those contracts could significantly impact the operating results of the Company. F-23 HOMELAND HOLDING CORPORATION & SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (In thousands, except share and per share amounts) 13. Business Conditions and Liquidity: In 2000, the Company incurred a net loss of $5.9 million. Futhermore, the markets in which the Company operates remain increasingly competitive negatively affecting the Company's liquidity. These factors raise substantial doubt about the Company's ability to continue as a going concern. The Company's near and long-term operating strategies focus on improving sales, improving operational efficiencies, and the productivity of assets. The Company intends to pursue its merchandising strategy in an attempt to increase its sales and the Company has devised plans to improve its gross margin and expense performance. Also, if necessary, the Company will close or sell under-performing stores or assets. Currently, the Company has letters of intent regarding certain asset sales to transfer leases and sell property related to four of the seven stores closed in January 2001 and to sell a parcel of undeveloped land. The estimated proceeds from these asset sales are $1.4 million and the transactions are subject to among other things the signing of definitive agreements for each transaction. The Company has also retained McDonald Investments Inc. as a financial advisor to explore options for re-financing and raising capital. Adequate liquidity in 2001 is predicated on the Company's ability to achieve improvements in gross margin and expense performance over historical results and successful completion of the $1.4 million asset sale in the second quarter of 2001. Improvement over historical gross margin and expense performance is expected to occur in part as a result of the January closing of seven underperforming stores. Further improvement in gross margin is projected to result from an increase in the annual AWG patronage rebate as AWG is expected to return to a more historic level of profitability. The Company's lowest level of liquidity is expected to occur in the third quarter of 2001. If the Company is successful in meeting its cash flow projections, including completion of the asset sale in the second quarter of 2001, sufficient borrowings under the Revolving Facility will be available to meet the Company's liquidity needs during the third and fourth quarters of 2001. Furthermore, the projections do not include the potential favorable cash flow impact of closing or selling additional underperforming stores or assets. The Company believes that it continues to have the support of the agent and the lenders to the Loan Agreement. Effective April 24, 2001, the Company entered into an amendment to the Loan Agreement which, among other things, amends the financial covenants pertaining to minimum availability, EBITDA, funded debt to EBITDA ratio, and capital expenditures. In addition to the covenant changes, the Loan Agreement was amended by increasing the applicable interest rates by 25 basis points and limiting the use of London Interbank Offered rates, although the Company does not expect these changes will have a material impact on its ability to meet its cash flow projections or financial covenants. Based on its current projections, management believes that the Company will be able to meet the revised covenants set forth in the Loan Agreement, as amended, throughout 2001. If the Company is unable to meet these revised covenants, the Company will need to obtain waivers or classify the related borrowings as current obligations. There can be no assurances the Company will be able to obtain such waivers. However, since the amendment to the financial covenants is applicable only through 2001 and since the Loan Agreement matures on August 2, 2002, the Company intends to refinance its existing Loan Agreement indebtedness during 2001. There can be no assurance that the Company will be able to successfully refinance its existing indebtedness on terms that are acceptable to it. The Company believes that cash on hand, net cash flow from operations, proceeds from certain expected asset sales and borrowings under the Revolving Facility will be sufficient to fund its cash requirements through fiscal year 2001, which will consist primarily of payment of principal and interest on outstanding indebtedness, working capital requirements and capital expenditures. However, there can be no assurance that the asset sales will be consummated as planned. The Company's future operating performance and ability to service or refinance its current indebtedness will be subject to future economic conditions and to financial, business and other factors, many of which are beyond the Company's control. F-24 EXHIBIT INDEX Exhibit No. Description 2a Disclosure Statement for Joint Plan of Reorganization of Homeland Stores, Inc. ("Homeland") and Homeland Holding Corporation ("Holding") dated as of May 13,1996. (Incorporated by reference to Exhibit 2a to Form 8-K dated May 31, 1996.) 2b First Amended Joint Plan of Reorganization, as modified, of Homeland and Holding, dated July 19, 1996. (Incorporated by reference to Exhibit 2b to Form 10-Q for the quarterly period ended June 15, 1996.) 3a Restated Certificate of Incorporation of Holding, dated August 2, 1996. (Incorporated by reference to Form 10 filed as of November 20, 1996.) 3b By-laws of Holding, as amended and restated on November 14, 1989 and further amended on September 23, 1992. (Incorporated by reference to Exhibit 3b to Form 10-Q for quarterly period ended June 19, 1993.) 3c Restated Certificate of Incorporation of Homeland, dated August 2, 1996. (Incorporated by reference to Form 10 filed as of November 20, 1996.) 3d By-laws of Homeland, as amended and restated on November 14, 1989, and further amended on September 23, 1992. (Incorporated by reference to Exhibit 3d to Form 10-Q for quarterly period ended June 19, 1993.) 4a Indenture, dated as of August 2, 1996, among Homeland, Fleet National Bank, as Trustee, and Holding, as Guarantor. (Incorporated by reference to Exhibit T3C to Form T-3 of Homeland, SEC File No. 22-22239.) 4b Warrant Agreement, dated as of August 2, 1996, between Holding and Liberty Bank and Trust Company of Oklahoma City, N.A., as Warrant Agent. (Incorporated by reference to Exhibit 4h to Amendment No. 1 to Form 10.) 4c Equity Registration Rights Agreement, dated as of August 2, 1996, by Holding for the benefit of holders of Old Common Stock. (Incorporated by reference to Exhibit 4i to Amendment No. 1 to Form 10.) 4d Noteholder Registration Rights Agreement, dated as of August 2, 1996, by Holding for the benefit of holders of Old Notes. (Incorporated by reference to Exhibit 4j to Amendment No. 1 to Form 10.) 10a 1 Homeland Profit Plus Plan, effective as of January 1, 1988. (Incorporated by reference to Exhibit 10q to Form S-1 Registration Statement, Registration No. 33-22829.) 10a.1 1 Homeland Profit Plus Plan, effective as of January 1, 1989. (Incorporated by reference to Exhibit 10q.1 to Form 10-K for the fiscal year ended December 29, 1990.) E-1 Exhibit No. Description 10b Homeland Profit Plus Trust, dated March 8, 1988, between Homeland and the individuals named therein, as Trustees. (Incorporated by reference to Exhibit 10r to Form S-1 Registration Statement, Registration No. 33-22829.) 10c Homeland Profit Plus Trust, dated January 1, 1989, between Homeland and Bank of Oklahoma, N.A., as Trustee. (Incorporated by reference to Exhibit 10r.1 to Form 10-K for the fiscal year ended December 29, 1990.) 10d.1 1 1995 Homeland Management Incentive Plan. (Incorporated by reference to Exhibit 10s.7 to Form 10-K for fiscal year ended December 30, 1995.) 10d.21 1996 Homeland Management Incentive Plan. (Incorporated by reference to Exhibit 10.d3 to Form 10-K for fiscal year ended December 28, 1996.) 10d.31 1997 Homeland Management Incentive Plan. 10e 1 Form of Homeland Employees' Retirement Plan, effective as of January 1, 1988. (Incorporated by reference to Exhibit 10t to Form S-1 Registration Statement, Registration No. 33-22829.) 10e.1 1 Amendment No. 1 to Homeland Employees' Retirement Plan effective January 1, 1989. (Incorporated herein by reference to Form 10-K for fiscal year ended December 30, 1989.) 10e.2 1 Amendment No. 2 to Homeland Employees' Retirement Plan effective January 1, 1989. (Incorporated herein by reference to Form 10-K for fiscal year ended December 30, 1989.) 10e.3 1 Third Amendment to Homeland Employees' Retirement Plan effective as of January 1, 1988. (Incorporated herein by reference to Exhibit 10t.3 to Form 10-K for fiscal year ended December 29, 1990.) 10e.4 1 Fourth Amendment to Homeland Employees' Retirement Plan effective as of January 1, 1989. (Incorporated herein by reference to Exhibit 10t.4 to Form 10-K for the fiscal year ended December 28, 1991.) 10e.5 1 Fifth Amendment to Homeland Employees' Retirement Plan effective as of January 1, 1989. (Incorporated herein by reference to Form 10-Q for the quarterly period ended September 9, 1995.) 10f 1 Executive Officers Medical/Life Insurance Benefit Plan effective as of December 9, 1993. (Incorporated by reference to Exhibit 10kk to Form 10-K for the fiscal year ended January 1, 1994.) 10g Asset Purchase Agreement, dated as of February 6, 1995, between Homeland and Associated Wholesale Grocers, Inc. (Incorporated by reference to Exhibit 10pp.1 to Form 10-K for fiscal year ended December 30, 1995.) E-2 Exhibit No. Description 10h1 Employment Agreement dated as of February 25, 1998, between Homeland and Steven M. Mason. 10i1 Employment Agreement dated as of February 17, 1998, between Homeland and David B. Clark. 10j Indenture, dated as of August 2, 1996, among Homeland, Fleet National Bank, as Trustee, and Holding, as Guarantor. (Incorporated by reference to Exhibit 10aaa to Form 8-K dated September 30, 1996.) 10k1 Employee Stock Bonus Plan for union employees effective as of August 2, 1996. (Incorporated by reference to Exhibit 10s to Form 10-K for fiscal year ended December 28, 1996.) 10l1 Management Stock Option Plan effective as of December 11, 1996. (Incorporated by reference to Exhibit 10t to Form 10-K for fiscal year ended December 28, 1996.) 10m Loan Agreement dated as of December 17, 1998, among IBJ Schroder Business Credit Corporation, Heller Financial, Inc., and National Bank of Canada, Homeland and Holding. 10n1 1998 Homeland Management Incentive Plan. 10o1 Employment Agreement dated as of July 6, 1998, between Homeland and Wayne S. Peterson. 10p1 Employment Agreement dated as of September 14, 1998, between Homeland and John C. Rocker. 10q1 Letter agreement regarding severance arrangements dated as of December 8, 1998, between Homeland and Steven M. Mason. 10r1 Letter agreement regarding severance arrangements dated as of December 8, 1998, between Homeland and Prentess E. Alletag, Jr. 10s1 Letter agreement regarding severance arrangements dated as of December 8, 1998, between Homeland and Deborah A. Brown. 10t1 Stock Option Agreement dated as of October 21, 1998, between Homeland and Wayne S. Peterson. 10u1 Stock Option Agreement dated as of September 14, 1998, between Homeland and John C. Rocker. 10v1 Letter agreement regarding severance arrangements dated as of December 8, 1999, between Homeland and Prentess E. Alletag, Jr.. 10w1 Letter agreement regarding severance arrangements dated as of December 8, 1999, between Homeland and Deborah A. Brown. 10x*1 Letter agreement regarding severance arrangements dated as of December 8, 1999, between Homeland and Steven M. Mason. E-3 Exhibit No. Description 10y1 Letter agreement regarding severance arrangements dated as of December 8, 1999, between Homeland and John C. Rocker. 10z First Amendment to Loan Agreement dated as of December 17, 1998, among IBJ Whitehall Business Credit Corporation, Heller Financial, Inc., and National Bank of Canada, Homeland and Holding. 10aa Second Amendment to Loan Agreement dated as of December 17, 1998, among IBJ Whitehall Business Credit Corporation, Heller Financial, Inc., and National Bank of Canada, Homeland and Holding. 10ab Third Amendment to Loan Agreement dated as of December 17, 1998, among IBJ Whitehall Business Credit Corporation, Heller Financial, Inc., and National Bank of Canada, Homeland and Holding. 10ac Fourth Amendment to Loan Agreement dated as of December 17, 1998, among IBJ Whitehall Business Credit Corporation, Heller Financial, Inc., and National Bank of Canada, Homeland and Holding. 10ad Fifth Amendment to Loan Agreement dated as of December 17, 1998, among IBJ Whitehall Business Credit Corporation, Heller Financial, Inc., and National Bank of Canada, Homeland and Holding. 10ae Sixth Amendment to Loan Agreement dated as of April 25, 2000, among IBJ Whitehall Business Credit Corporation, Heller Financial, Inc., and National Bank of Canada, Homeland and Holding. 10af Letter Agreement and Promissory Note to David B. Clark regarding relocation expenses. 10ag* Seventh Amendment to Loan Agreement dated as of December 22, 2000, among IBJ Whitehall Business Credit Corporation, Heller Financial, Inc., and National Bank of Canada, Homeland and Holding. 10ah* Letter Agreement regarding severance arrangements dated as of December 15, 2000, between Homeland and Prentess E. Alletag, Jr. 10ai* Letter Agreement regarding severance arrangements dated as of December 15, 2000, between Homeland and Deborah A. Brown. 10aj* Letter Agreement regarding severance arrangements dated as of December 15, 2000, between Homeland and Steven M. Mason. 10ak* Letter Agreement regarding severance arrangements dated as of December 15, 2000, between Homeland and John C. Rocker. 10al* Letter Agreement regarding change of control arrangements dated as of December 26, 2000, between Homeland and Prentess E. Alletag, Jr. 10am* Letter Agreement regarding change of control arrangements dated as of December 26, 2000, between Homeland and Deborah A. Brown E-4 10an* Letter Agreement regarding change of control arrangements dated as of December 26, 2000, between Homeland and David B. Clark. 10ao* Letter Agreement regarding change of control arrangements dated as of December 26, 2000, between Homeland and Steven M Mason. 10ap* Letter Agreement regarding change of control arrangements dated as of December 26, 2000, between Homeland and Wayne S. Peterson. 10aq* Letter Agreement regarding change of control arrangements dated as of December 26, 2000, between Homeland and John C. Rocker. 21* Subsidiaries. 23* Consent of Independent Accountants. 27* Financial Data Schedule. E-5 * Filed herewith (1) Management contract or compensatory plan.