<PAGE>   1

                       SECURITIES AND EXCHANGE COMMISSION

                             WASHINGTON, D.C. 20549

                                    FORM 10-K

                  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
                     OF THE SECURITIES EXCHANGE ACT OF 1934


        FOR THE YEAR ENDED                         COMMISSION FILE NUMBER
         DECEMBER 31, 1998                               333-46959

                         LIBERTY GROUP OPERATING, INC.
             (Exact Name of Registrant as Specified in its Charter)

                 DELAWARE                                      36-4197636
      (State or Other Jurisdiction of                       (I.R.S. Employer
      Incorporation or Organization)                       Identification No.)

  3000 DUNDEE ROAD, SUITE 203, NORTHBROOK, ILLINOIS              60062
 (Address of Principal Executive Offices)                      (Zip Code)


        Registrant's telephone number, including area code (847) 272-2244

        Securities registered pursuant to Section 12(b) of the Act: NONE

          Securities registered pursuant to Section 12(g) of the Act:

                   9 3/8% SENIOR SUBORDINATED NOTES DUE 2008

         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. [x]

         The number of shares outstanding of the Registrant's Common Stock, par
value $.01 per share, as of March 30, 1999 was 80,000. All Common Stock is owned
by affiliates of the Registrant and there is no public market for the Common
Stock.
<PAGE>   2
                                TABLE OF CONTENTS

Part I 

Item 1.   Business.

Item 2.   Properties.

Item 3.   Legal Proceedings.

Item 4.   Submission of Matters to a Vote of Security Holders.

Part II

Item 5.   Market for Registrant's Common Equity and Related Stockholder Matters.

Item 6.   Selected Financial Data

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


Item 7A.  Quantitative and Qualitative Disclosures about Market Risk.

Item 8.   Financial Statements and Supplementary Data

Item 9.   Changes in and Disagreements with Accountants on Accounting and
          Financial Disclosure

Part III

Item 10.  Directors and Executive Officers of Registrant

Item 11.  Executive Compensation

Item 12.  Security Ownership of Certain Beneficial Owners and Management

Item 13.  Certain Relationships and Related Transactions

Part IV

Item 14.  Exhibits, Financial Statement Schedules, and Reports on Form 8-K

          (a) Financial Statements, Financial Statement Schedules and Exhibits.

          (b) Reports on Form 8-K.
<PAGE>   3


                         LIBERTY GROUP PUBLISHING, INC.


DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

This Form 10-K contains certain "forward-looking statements" (as defined in
Section 21E of the Securities Exchange Act of 1934) that reflect the Company's
expectations regarding its future growth, results of operations, performance
and business prospects and opportunities. Words such as "anticipates,"
"believes," "plans," "expects," "estimates" and similar expressions have been
used to identify these forward-looking statements, but are not the exclusive
means of identifying these statements. These statements reflect the Company's
current beliefs and are based on information currently available to the
Company. Accordingly, these statements are subject to known and unknown risks,
uncertainties and other factors that could cause the Company's actual growth,
results, performance and business prospects and opportunities to differ from
those expressed in, or implied by, these statements. These risks, uncertainties
and other factors include the Company's ability to serve, and retain existing
customers as well as its ability to attract new advertising and subscription
customers; the Company's ability to continue its acquisition strategy; the
Company's ability to adjust to changes in technology, customer preferences,
enhanced competition and new competitors in its community markets; collection
of receivables; general economic and business conditions, which may reduce
demand for advertising and its ability to attract and retain key employees. The
Company is not obligated to update or revise these forward-looking statements
to reflect new events or circumstances.

ITEM 1.  BUSINESS

OVERVIEW

The Company is a leading U.S. publisher of local newspapers and related
publications that are the dominant source of local news and print advertising in
their markets. The Company owns and operates 251 publications in 15 states. The
Company's total revenues are derived from advertising (73% of 1998 total
revenues), circulation (20%) and job printing and other (7%).

The Company's primary operating costs and expenses are comprised of operating
costs and selling, general and administrative expenses. Salaries and employee
benefits are the Company's largest operating costs. The Company has been able to
control salaries and employee benefit expenses by realizing efficiencies from
the implementation of new technologies and the achievement of synergies from its
strategy of clustering its newspaper operations.

INITIAL ACQUISITION

Liberty Group Publishing, Inc. ("LGP") was formed for purposes of acquiring a
portion of the daily and weekly newspapers owned by American Publishing Company
or its subsidiaries ("APC"), a wholly-owned subsidiary of Hollinger
International Inc.("Hollinger"). LGP is a holding company for its wholly-owned
subsidiary Liberty Group Operating, Inc ("Operating Company"). The consolidated
financial statements include the accounts of Operating Company and its
consolidated subsidiaries (the "Company").

On January 27, 1998, the Company's parent acquired from Hollinger virtually all
of the assets and assumed certain liabilities that were used primarily in the
business of publishing, marketing and distributing certain local newspapers (the
"Initial Acquisition"). The initial purchase price including fees and expenses
was $322.4 million. The effective date of the Initial Acquisition was January 1,
1998.

In the accompanying financial statements the terms "Liberty Group Operating" or
the "Company" when used with respect to periods prior to January 1, 1998 refer
to the combined group of newspapers sold by APC (the Local Newspaper Group of
American Publishing Company) and when used with
<PAGE>   4


respect to periods subsequent to January 1, 1998 refers to Liberty Group
Operating, Inc. and its consolidated subsidiaries. The combined historical
financial information of the newspapers acquired from APC prior to the Initial
Acquisition on January 1, 1998 is referred to as "Predecessor" while the
consolidated financial information of the newspapers subsequent to the date of
the Initial Acquisition is referred to as "Successor."

The Company has accounted for the Initial Acquisition using the purchase method
of accounting. Accordingly, the costs of the Initial Acquisition have been
allocated to the assets acquired and liabilities assumed based upon their
respective fair values using independent valuations. The costs of certain
intangible assets acquired of $296.5 million are being amortized over periods
ranging from 5 to 40 years. Because of the purchase price allocation, the
accompanying financial statements of Successor are not directly comparable to
those of Predecessor.

Certain administrative services, including accounting, payroll, administration,
tax services and financial reporting, were historically performed for the
Company by APC. The Company was charged directly by APC for certain of such
services and also paid a management fee to APC that was based upon a percentage
of total revenues. At the end of January 1998, the management fee to APC was
replaced by a Transitional Services Agreement that allows for certain
administrative services to be provided by APC at cost until the 
establishes its administrative services in-house. The Company provides all of
its administration in-house as of April 1, 1999 and has terminated the
Transitional Services Agreement effective March 31, 1999.

Prior to the Initial Acquisition, the Company operated as a business unit of APC
and as such did not file separate tax returns. The income tax provision included
in the Predecessor's financial statements was computed as if the Predecessor
were a separate company. Subsequent to the Initial Acquisition, the Company has
been and anticipates that it will be, for the foreseeable future, in a tax loss
position. Given the uncertainty as to the timing of the Company's ability to
utilize such losses to offset future taxable income, the Company does not
presently anticipate recording any tax benefit associated with its pre-tax
losses. In addition, due to the acquisition of the Company's assets from APC,
the Company's asset values and capital structure are materially different than
those set forth in the Predecessor's financial statements for periods preceding
the Initial Acquisition and, accordingly, historical interest expense is not
indicative of the interest expense that the Company incurs as a separate
company.

The results of operations and cash flows of the Predecessor have been
consolidated with those of the Company from January 1, 1998, the effective date
upon which the Company and APC agreed as to the change of control of the
newspapers to the Company.

In addition, during 1998, the Company acquired 91 publications in 18
transactions for a total acquisition cost of $61.8 million.


INITIAL CAPITALIZATION - BORROWINGS

The Initial Acquisition, including the payment of related fees and expenses, was
financed in part by: (i) $180.0 million from the issuance and sale by the
Operating Company of $180.0 million aggregate principal amount of 9.375%
                                                   
<PAGE>   5

Senior Subordinated Notes (the "Notes") due February 1, 2008 and (ii) $50.5
million from the issuance and sale by LGP of $89.0 million aggregate principal
amount of 11.625% Senior Discount Debentures (the "Debentures") due February 1,
2009.

The Notes were issued by the Operating Company and are general unsecured
obligations of the Operating Company. The Notes are irrevocably and
unconditionally joint and severally guaranteed by each of the Operating
Company's existing and future subsidiaries. The Notes are redeemable for cash at
the option of the Operating Company anytime after February 1, 2003 at stipulated
redemption amounts or, in certain limited circumstances, are partially
redeemable on or prior to February 1, 2001 at a redemption amount of 109.375% of
their principal amount. In the event of a change in control of the Operating
Company or the Company, the Company must offer to repurchase the Notes at 101%
of their principal amount.

The Debentures issued by LGP are general unsecured obligations and pay no cash
interest until February 1, 2003. The Debentures will, however, accrete on a
semi-annual equivalent bonds basis to a full principal amount of $89.0 million
on February 1, 2003. Thereafter, cash interest on the Debentures will accrue and
be payable semi-annually on February 1 and August 1 of each year. The Debentures
are redeemable for cash at the option of LGP any time after February 1, 2003 at
stipulated redemption amounts or, in certain limited circumstances, are
partially redeemable on or prior to February 1, 2001 at a redemption amount of
111.625% of their accreted value. In the event of a change in control of LGP,
LGP must offer to repurchase the Debentures at 101% of their accreted value.

On January 27, 1998 the Operating Company entered into a five-year $125.0
million revolving credit facility (the "Revolving Credit Facility"). The
Revolving Credit Facility is secured by substantially all of the tangible and
intangible assets of the Operating Company. Borrowings under the revolving
credit facility bear interest at an annual rate, at the Company's option equal
to the Base Rate (as defined in the credit agreement) or the Eurodollar Rate (as
defined in the credit agreement) plus a margin that varies based upon a ratio
set forth in the credit agreement (the "Applicable Margin"). Under the terms of
the Revolving Credit Facility, the Company pays a fee equal to the Applicable
Margin for Eurodollar Rate Advances (as defined in the credit agreement) per
annum on the aggregate amount of outstanding letters of credit. The Operating
Company also pays a fee on the unused portion of the Revolving Credit Facility.
At December 31, 1998 the Operating Company has utilized $46.0 million of the
Revolving Credit Facility.


INITIAL CAPITALIZATION - EQUITY

LGP has the authority to issue up to 21,255,000 shares of capital stock, of
which 21,175,000 shares are designated as Preferred Stock, par value $0.01 per
share, and 80,000 shares are designated as Common Stock, par value $0.01 per
share. The Initial Acquisition, including the payment of related fees and
expenses, was financed in part from the proceeds of (i) $45.0 million from the
issuance and sale of 1.8 million shares of 14.75% Senior Mandatory Redeemable
Exchangeable Cumulative Preferred Stock (the "Senior Preferred Stock"), (ii)
$49.0 million from the issuance and sale of 49,000 shares of 10% Series B Junior
Mandatory Redeemable Cumulative Preferred Stock (the "Junior Preferred Stock"),
and (iii) $8.0 million from the issuance and sale of 80,000 shares of Common
Stock. 100% of the Junior Preferred Stock and 90% of the Common Stock issued by
LGP is owned by Green Equity Investors II, L.P. the controlling stockholder of
LGP. 10% of the Common Stock is owned by the Company's senior management team.

All of the Company's issued and outstanding capital stock is owned by LGP.  The
Company has no outstanding capital stock other than common stock, nor are there
any outstanding options, warrants, or other rights to purchase the Company's
capital stock.  
<PAGE>   6


RECENT ACQUISITIONS AND DISPOSITIONS

The following newspapers were acquired by the Company during 1998:

<TABLE>
<CAPTION>
TITLE                               LOCATION                  TYPE OF PAPER      CIRCULATION
<S>                                 <C>                       <C>                <C>
Catskill Shopper                    Liberty, NY               Shopper            41,000
Carbondale News                     Carbondale, PA            Weekly              7,000
Moscow/Hamlin Villager              Hamlin, PA                Weekly              4,000
Kansas City Kansan                  Kansas City, KS           Daily              10,000
Journal-Herald                      Kansas City, KS           Weekly             21,000
The Dwight Star & Herald            Dwight, IL                Weekly              2,000
Gardner Chronicle                   Dwight, IL                Weekly              1,000
Courier Press                       Dwight, IL                Weekly              1,000
The Register                        Dwight, IL                Shopper             1,000
The Business Record                 Syracuse, NY              Monthly            16,000
The Gridley Herald                  Gridley, CA               Weekly              3,000
The Gridley Shopping News           Gridley, CA               Shopper             8,000
The Corning-Elmira Pennysaver       Painted Post, NY          Shopper            32,000
The E-Z Shopper                     Horseheads, NY            Shopper            29,000
Wellington Daily News               Wellington, KS            Daily               2,000
The Mac Shopper                     McPherson, KS             Shopper            13,000
The Macomb Journal                  Macomb, IL                Daily               8,000
The South Idaho Press               Burley, ID                Daily               6,000
The Wood River Journal              Hailey, ID                Weekly              1,000
The Minidoka County News            Minidoka, ID              Weekly              2,000
The Beauregard Daily News           Sulphur, LA               Daily               5,000
The Leesville Daily Leader          Sulphur, LA               Daily               5,000
The Southwest Daily News            Sulphur, LA               Daily               5,000
The Iowa News                       Sulphur, LA               Weekly              1,000
The Mossbluff News                  Sulphur, LA               Weekly              1,000
The Vinton News                     Sulphur, LA               Weekly              2,000
The Newton Press                    Newton, IL                Weekly              3,000
The Teutopolis Press                Teutopolis, IL            Weekly              2,000
The Springfield Shopper             Springfield, IL           Shopper            30,000
Press Publications                  Elmhurst, IL              34 Publications   112,000
Mainstream Publications             Southwestern MN           9 Publications     73,000
The Mineral Daily News              Keyser, WV                Daily               5,000
The Ascension Citizen               Gonzales, LA              Weekly              8,000
Journal Extra                       Macomb, IL                Weekly              8,000
Sunrise Shopper                     Burley, ID                Weekly              1,000
The News Review                     Burley, ID                Weekly              7,000
Your Home Magazine                  Hailey, ID                Monthly            12,000
Wood River Dining                   Hailey, ID                Annual             12,000
Explorer                            Hailey, ID                Bi Annual          12,000
Kansas City Kansan Sunday           Kansas City, KS           Weekly             10,000
Wynadott County Shopper             Kansas City, KS           Shopper            46,000
Chronicle Shopper                   Leavenworth, KS           Shopper            23,000
Nickel Ads                          Gonzales, LA              Shopper            26,000
The Star Watch                      Gonzales, LA              Shopper             8,000
Guardian                            Sulphur, LA               Shopper            13,000
Westlake News                       Westlake, LA              Weekly              1,000
Devil's Lake Daily Journal          Devil's Lake, ND          Daily               5,000
Country Peddler                     Devil's Lake, ND          Weekly             22,000
Mountain Echo                       Keyser, WV                Weekly              6,000
Today's Shopper                     Keyser, WV                Shopper            16,000
</TABLE>

The following newspapers were disposed of by the Company during 1998:

<TABLE>
<CAPTION>
TITLE                               LOCATION                  TYPE OF PAPER      CIRCULATION
<S>                                 <C>                       <C>                <C>
The Tonawanda News                  Tonawanda, NY             4 Publications     12,000
Albion Journal Register             Albion, IL                2 Publications      1,200
</TABLE>
<PAGE>   7
SUBSEQUENT EVENTS:

In January of 1999, the Company purchased all of the stock of Life Printing &
Publishing a chain of 17 weekly publications in Oak Brook, Illinois with a
combined circulation of 120,000. In February 1999, the Company has also
purchased the 31,000 circulation Halstad Shopper located in Halstad, Minnesota.

INDUSTRY BACKGROUND

Newspaper publishing is the oldest and largest segment of the media industry.
Due to a focus on local news, newspapers remain the dominant medium for local
advertising. Newspapers continue to be the best medium for retail advertising
which emphasizes the price of goods, in contrast to television which is
generally used for image advertising.

Readers of daily and Sunday newspapers tend to be more highly educated and have
higher incomes than non-newspaper readers. Management believes that newspapers
continue to be the most cost-effective means for advertisers to reach this
highly targeted demographic group.

Advertising revenues are the largest component of a newspaper's revenues
followed by circulation revenues. Advertising rates at each newspaper are based
upon market size, circulation, readership, demographic makeup of the market, and
the availability of alternative advertising media in the marketplace. While
circulation revenue is not as significant as advertising revenue, circulation
trends can impact the decisions of advertisers and advertising rates.

Newspaper advertising revenues are cyclical and are generally affected by
changes in national and regional economic conditions. Classified advertising,
which makes up approximately one-third of newspaper advertising revenues, is the
most sensitive to economic improvements or slowdowns as it is primarily affected
by the demand for employment, real estate transactions and automotive sales.

OPERATING STRATEGY

The Company's strategy is to increase revenues and cash flows through local news
leadership; revenue enhancement; strategic technological investments; high
quality editorial content and presentation; circulation growth; geographic
clustering; targeted marketing programs; and cost control, as described below:

LOCAL NEWS LEADERSHIP. The Company's newspapers generally have the largest local
news gathering resources in their markets. As a result of emphasizing
<PAGE>   8
local content, including youth sports, community events, business, politics, and
entertainment, the Company's newspapers generate reader loyalty and create
franchise value. Because the Company's provision of local news is a typically
unique product in its markets, its newspapers differentiate themselves from
other forms of media and satisfy the demands of both its reader and advertisers.

REVENUE ENHANCEMENT. The Company aggressively capitalizes on the good name and
reputation it has built in each of its local communities to reach out to
non-traditional newspaper customers through the development of milestone
programs, on-line activities and ancillary product marketing.

STRATEGIC TECHNOLOGICAL INVESTMENTS.  The Company has committed to develop and
maintain websites for all of its daily newspapers and certain of its weekly
papers. The websites provide an online editorial presence and full online
classified services for the Company's newspapers and will allow the Company to
take advantage of the increasing use of the Internet and the potential
advertising opportunities. Although the Company believes that providing an
online product is important to broadening the presence of its newspapers in
their respective  communities and ultimately increasing the Company's revenues
through such value added services, the Company believes almost all of its
customers prefer the  newspaper in a printed form. By being the leading,
provider of local news in  most of its markets, management believes that its
newspapers are well positioned to enhance and expand their leadership position
among local advertisers, whether in print or electronic form.

HIGH QUALITY EDITORIAL CONTENT AND PRESENTATION. The Company's newspapers are
committed to editorial excellence, providing the proper mix of local and
national news to effectively serve the needs of their local markets. The
Company's newspapers often receive awards for excellence in various areas in
their respective regions and categories. In addition, the Company's newspapers
are designed to attract readers through attractive layouts and color
enhancements. Geographic clustering allows for better quality equipment than
smaller markets might otherwise warrant, resulting in a significant increase in
newspaper quality.

CIRCULATION GROWTH. The Company believes that circulation growth is important to
the creation of long-term franchise value at its newspapers. Accordingly, the
Company has and will continue to invest in telemarketing and promotional
campaigns to increase circulation and readership.

GEOGRAPHIC CLUSTERING. The Company has acquired and assembled newspapers, and
may continue to acquire newspapers, in contiguous markets ("clustering").
Clustering enables the Company to realize operating efficiencies and economic
synergies, such as the sharing of management, accounting and production
functions. In addition, the Company seeks to increase operating cash flows at
acquired newspapers through cost reductions, including labor and web width
reductions, as well as overall improved cost management. Clustering also enables
management to maximize revenues through the cross selling of advertising among
contiguous newspaper markets. As a result of clustering, management believes
that the Company's newspapers are able to obtain higher operating margins than
they would otherwise be able to achieve on a stand-alone basis.

COST CONTROL. Each of the Company's newspapers emphasizes cost control with a
particular focus on managing staffing requirements. In addition, the Company
further controls labor costs through investments in state-of-the-art production
equipment that improves production efficiencies. Management is equally focused
on newsprint cost control.
<PAGE>   9
The Company takes advantage of group discounts for its major operating and
capital costs including newsprint, ink, supplies, computers, software, and
printing equipment.

Management believes that successful implementation of the operating strategy
described above will position the Company to continue to achieve internal
growth. The Company also continues to seek strategic or targeted newspaper
acquisitions and dispositions such as the acquisitions previously discussed. The
Company continually reviews newspaper acquisition candidates for acquisitions
that would contribute to the Company's overall growth strategy, whether through
revenue growth and/or cost reduction opportunities, and represent attractive
values based on price.

ADVERTISING, CIRCULATION AND PRINTING REVENUES.

Advertising revenue includes DISPLAY (local and national department stores,
specialty shops and other retailer), NATIONAL (national advertising accounts),
and CLASSIFIED advertising (employment, automotive, real estate and personals).
Management believes that classified advertising is more volatile than other
newspaper revenues. Classified advertising for the Company represents a smaller
portion of its revenues than other newspapers in the industry. As a result,
management believes its revenue stream is more predictable than other newspaper
companies. The contribution of Display, National, Classified, Circulation, and
Job Printing & Other revenue to total revenues for fiscal years 1998 and 1997
were as follows:

<TABLE>
<CAPTION>
                                                   Years ended December 31,
                                                 1998                     1997

<S>                                              <C>                      <C>
               Display                            56%                      55%

               National                            2%                       2%

               Classified                         15%                      13%

               Circulation                        20%                      22%

               Job Printing & Other                7%                       8%

                                                 100%                     100%
</TABLE>

NEWSPRINT.

Newsprint represents one of the largest costs of producing a newspaper. The
Company's newspapers buy newsprint from a number of suppliers, resulting in an
adequate supply of newsprint at market prices. In 1998 and 1997, the Company
consumed approximately 17,000 and 16,000 short tons of newsprint, respectively,
and, during the same periods, incurred newsprint expense of approximately $7.2
million and $6.1 million respectively. Newsprint expense as a percentage of
revenue for 1998 and 1997 was 6.4% and 6.2%, respectively. Newsprint expense
varies between years because of fluctuations in prices and consumption.

EMPLOYEE RELATIONS.
The Company employs approximately 1,715 full-time employees and 907 part-time
employees. Less than 2% of its employees belong to labor unions. There has never
been a strike or work stoppage against any of the Company's newspapers during
the Company's ownership, and the Company believes that its relations with its
employees are generally good.
<PAGE>   10

SEASONALITY.

Newspaper companies tend to follow a distinct and recurring seasonal pattern,
with high advertising revenues in months containing significant events or
holidays. Accordingly, due to generally poor weather and a lack of holidays, the
Company's first fiscal quarter is the Company's weakest revenue quarter of the
year.

COMPETITION.

Each of the Company's newspapers competes to varying degrees with magazines,
radio, television and cable television, as well as with some weekly publications
and other advertising media, including electronic media, for advertising and
circulation revenue. Competition for newspaper advertising is largely based upon
circulation, price and the content of the newspaper. LGP's newspapers are the
dominant local news and information source, with strong name recognition in
their market and minimal direct competition from similar daily newspapers
published in their markets. However, as with most suburban and smaller daily
newspapers, some circulation competition exists from larger daily newspapers
which are usually published in nearby metropolitan areas. Management believes
larger daily newspapers with circulation in LGP's newspaper markets generally do
not compete in any meaningful way for local advertising revenues, a newspaper's
main source of revenues. LGP's daily newspapers capture the largest share of
local advertising as a result of their direct coverage of the market. In
addition, management believes advertisers generally regard newspaper advertising
as the most effective method of advertising promotions and pricing as compared
to television, which is generally used to advertise image. The Company may from
time to time compete with other companies, which have greater financial
resources than the Company.


ELECTRONIC MEDIA.

Many newspaper companies are now publishing news and other content on the world
wide web. In addition, there are several new start-up companies which have
developed sites on the world wide web which are, by design, advertising and/or
subscription supported. Many of these sites target specific types of advertising
such as employment and automotive classified.

The Company has developed a strategy which it believes will allow it to leverage
its strong local franchise and participate in the advertising growth on the
Internet.

The Company is in the process of establishing a local website for each of its
daily newspapers. In addition, the Company is continuing to develop strategic
alliances to enhance content, functionality and delivery. The Company believes
the design, functionality, and content of its websites will allow the Company to
expand its leadership position among local advertisers and create additional
revenue streams in the future.
<PAGE>   11

ITEM 2.  PROPERTIES


        The Company's executive offices are located in an office park in
Northbrook, Illinois, where the Company leases approximately 3,000 square feet
under a lease terminating in 2001.  The Company also maintains locations and
offices at numerous locations throughout the United States for its publications
and printing operations.  The Company does not believe that any of these
properties are material to the Company.

         The following table summarizes the publications owned by the Company as
of December 31 1998:

        (D=DAILY, W=WEEKLY, S=SHOPPER, T=TOTAL MARKET COVERAGE, F=FREE,
                           A=ANNUAL, BI-A=BI-ANNUAL)

ARIZONA
GLOBE
  ARIZONA SILVER BELT (W)
  GILA COUNTY ADVANTAGE (S)
  MOCCASIN (W)

ARKANSAS
HEBER SPRINGS
  THE SUN TIMES (W)
HELENA
  THE DAILY WORLD (D)
  DAILY WORLD TMC (T)
NEWPORT
  NEWPORT DAILY INDEPENDENT (D)
  NEWPORT DAILY INDEPENDENT TMC (T)
STUTTGART
  STUTTGART DAILY LEADER (D)
  THE STUTTGART DAILY TMC (T)

CALIFORNIA
GRIDLEY
  THE GRIDLEY HERALD (W)
  THE GRIDLEY SHOPPING NEWS (S)
MOUNT SHASTA
  DUNSMUIR NEWS (W)
  MOUNT SHASTA HERALD (W)
  SUPERSAVER ADVERTISER (S)
  VOICE OF THE MOUNTAIN (T)
  WEED PRESS (W)
TAFT
  DAILY MIDWAY DRILLER (D)
  THE WESTSIDE SHOPPING NEWS (T)
YREKA
  SISKIYOU DAILY NEWS (D)
  SISKIYOU DAILY NEWS "EXTRA" (T)

IDAHO
BURLEY
  SOUTH IDAHO PRESS (D)
  SUNRISE SHOPPER (W)
  THE NEWS REVIEW (W)
HAILEY
  WOOD RIVER JOURNAL (W)
  YOUR HOME MAGAZINE (M)
  WOOD RIVER JOURNAL DINING (A)
  EXPOLORER (BI-A)
MINODOKA
  MINODOKA COUNTY NEWS (W)

ILLINOIS
BENTON
  BENTON EVENING NEWS (D)
  THE BENTON STANDARD (W)
CANTON
  DAILY LEDGER (D)
  SPOON RIVER ADVERTISER (S)
CARMI
  THE CARMI TIMES (D)
  THE WEEKLY TIMES (W)
  WHITE COUNTY SHOPPER NEWS (S)
CHESTER
  CHESTER HERALD TRIBUNE (W)
CHRISTOPHER
  CHRISTOPHER PROGRESS (W)
DUQUOIN
  THE ASHLEY NEWS (W)
  DUQUOIN EVENING CALL (D)
  PERRY COUNTY EXTRA (S)
DWIGHT
  DWIGHT STAR & HERALD (W)
  THE REGISTER (S)
  GARDNER CHRONICLE (W)
  COURIER PRESS (HERSCHER) (W)
ELMHURST - PRESS PUBLICATIONS
  ELMHURST PRESS (W)
  THE PRESS - OAK BROOK (W)
  THE PRESS - ADDISON (W)
  THE PRESS  - WOOD DALE (W)
  THE PRESS - BENSENVILLE (W)
  VILLA PARK ARGUS (W)
  THE PRESS  OAKBROOK TERRACE (W)
  LOMBARD SPECTATOR (W)
  LEMONT METROPOLITAN (W)
  BOLINGBROOK METROPOLITAN (W)
  DARIEN METROPOLITAN (W)
  ROMEOVILLE METROPOLITAN (W)
  WESTCHESTER NEWS (W)
  WEST COOK COUNTY PRESS (W)
  WEST COOK PRESS COUNTRYSIDE (W)
  PRESS - BLOOMINGDALE (W)
  PRESS - GLENDALE HEIGHTS (W)
  PRESS - ROSELLE (W)
  PRESS - ITASCA (W)
  PRESS - CAROL STREAM (W)
  PRESS - BARTLETT (W)
  PRESS - HANOVER PARK/STREAMWOOD (W)
  MARENGO PRESS (W)
  HUNTLEY/FARMSIDE PRESS (W)
  GLEN ELLYN PRESS (F)
  WHEATON PRESS (F)
  NAPERVILLE PRESS (F)
  ORLAND/TINLEY VILLAGER (F)
  BATAVIA WINDMILL (F)
  SUGAR GROVE HERALD (F)
  BLACKBERRY PRESS (F)
  NORTH AURORA HERALD (F)
  WEST COOK PRESS - LAGRANGE (F)
  STRICTLY CLASSIFIED (F)
FAIRBURY
  THE BLADE (W)
FLORA
  CCAP SPECIAL (T)
  DAILY ADVOCATE PRESS (D)
<PAGE>   12
GALATIA
  MONEY STRETCHER (S)
GALESBURG
  PENNYSAVER PRESS (S)
HARRISBURG
  ELDORADO DAILY JOURNAL (D)
  HARRISBURG DAILY REGISTER (D)
HERRIN
  THE SPOKESMAN (W)
  THE SPOKESMAN SUNDAY (T)
MACOMB
  MACOMB JOURNAL (D)
  JOURNAL EXTRA (W)
MARION
  MARION DAILY REPUBLICAN (D)
  MARION DAILY EXTRA (T)
MONMOUTH
  DAILY REVIEW ATLAS (D)
  OQUAWKA CURRENT (W)
  PENNYSAVER (S)
MURPHYSBORO
  MURPHYSBORO AMERICAN (W)
  AMERICAN MONDAY (T)
NEWTON
  NEWTON PRESS-MENTOR (W)
NORRIS CITY
  NORRIS CITY BANNER (W)
OLNEY
  JASPER COUNTY NEWS EAGLE ADVANTAGE (T)
  THE OLNEY DAILY MAIL (D)
  THE WEEKLY MAIL (W)
PONTIAC
  DAILY LEADER (D)
  HOME TIMES (W)
  LIVINGSTON SHOPPING NEWS (S)
SHAWNEETOWN
  GALLATIN DEMOCRAT (W)
  RIDGWAY NEWS (W)
SPRINGFIELD
  SPRINGFIELD SHOPPER (S)
TEUTOPOLIS
  TEUTOPOLIS PRESS (W)
WEST FRANKFORT
  DAILY AMERICAN (D)
  TRADER (W)
  FRANKLIN PRESS (T)

IOWA
CHARLES CITY
  CHARLES CITY PRESS (D)
  THE EXTRA (T)
  SIX COUNTY SHOPPER (S)

KANSAS
ATCHISON
  THE ATCHISON DAILY GLOBE (D)
  ATCHISON AREA ADVERTISER (T)
AUGUSTA
  AUGUSTA DAILY GAZETTE (D)
  AUGUSTA ADVERTISER (T)
DERBY
  DAILY REPORTER (D)
  THE RECORD (W)
  THE WEEKLY SHOPPER (S)
  THE WICHITA JOURNAL (W)
EL DORADO
  THE EL DORADO TIMES (D)
  EL DORADO TIMES WEEKLY (T)
  SHOPPERS GUIDE (S)
KANSAS CITY
  KANSAS CITY KANSAN (D)
  KANSAS CITY KANSAS "SUNDAY" (W)
  WYNDOTT COUNTY SHOPPER (S)
LEAVENWORTH
  THE LEAVENWORTH TIMES (D)
  THE LEAVENWORTH TIMES SUNDAY (W)
  RIVER BEND JOURNAL (T)
  CHRONICLE SHOPPER (S)
MCPHERSON
  MCPHERSON SENTINEL (D)
  THE SENTINEL AD-VISER (T)
  MAC SHOPPER (S)
SHAWNEETOWN
  JOURNAL-HERALD (W)
WELLINGTON
  DAILY NEWS (D)

LOUISIANA
DERIDDER
  BEAUREGARD DAILY NEWS (D)
<PAGE>   13
GONZALES
  ASCENSION CITIZEN (W)
  NICKEL ADS (S)
  THE STAR WATCH (T)
IOWA
  IOWA NEWS (W)
LEESVILLE
  LEESVILLE DAILY LEADER (D)
MOSS BLUFF
  MOSS BLUFF NEWS (W)
SULPHUR
  SOUTHWEST DAILY NEWS (D)
  GUARDIAN (S)
VINTON
  VINTON NEWS (W)
WESTLAKE
  WESTLAKE NEWS (W)

MICHIGAN
CHEBOYGAN
  CHEBOYGAN DAILY TRIBUNE (D)
  SHOPPERS FAIR (S)
IONIA
  SENTINEL-STANDARD (D)
  SENTINEL STANDARD TMC (T)
SAULT STE MARIE
  THE EVENING NEWS (D)
  TRI COUNTY BUYERS GUIDE (T)

MINNESOTA
CROOKSTON
  CROOKSTON DAILY TIMES (D)
  CROOKSTON VALLEY SHOPPER (S)
GRANITE FALLS
  GRANITE FALLS/CLARKSFIELD ADVOCATE-TRIBUNE (W)
MONTEVIDEO
  MONTEVIDEO AMERICAN NEWS (W)
  THE STAR ADVISOR (S)
REDWOOD FALLS
  REDWOOD FALLS GAZETTE (W)
  REDWOOD FALLS LIVEWIRE (S)
ST. JAMES
  ST. JAMES PLAIN DEALER (W)
  TOWN AND COUNTRY SHOPPER (S)
SLEEPY EYE
  SLEEPY EYE HERALD DISPATCH (W)
  THE SLEEPY EYE REMINDER (S)

MISSOURI
BOONVILLE
  BOONVILLE DAILY NEWS (D)
  THE RECORD (T)
BROOKFIELD
  DAILY NEWS BULLETIN (D)
CAMDENTON
  LAKE SUN LEADER (D)

CARTHAGE
  THE CARTHAGE PRESS (D)
  THE CARTHAGE PRESS SCOPE (T)
CHILLICOTHE
  C.T. EXTRA (S)
  CONSTITUTION TRIBUNE (D)
GREENFIELD
  LAKE STOCKTON SHOPPER (S)
  MILLER PRESS (W)
  THE VEDETTE (W)
KIRKSVILLE
  KIRKSVILLE CRIER (S)
  KIRKSVILLE DAILY EXPRESS & NEWS (D)
MACON
  CHRONICLE HERALD (D)
  MACON JOURNAL (T)
MARCELINE
  MARCELINE PRESS (W)
  SHO-ME SHOPPER (S)
MEXICO
  THE MEXICO LEDGER (D)
  THE MEXICO LEDGER TMC (T)
MONROE CITY
  MARK TWAIN REGIONAL NEWS (F)
  MONROE CITY NEWS (W)
NEOSHO
  NEOSHO DAILY NEWS (D)
  NEOSHO DAILY NEWS "ETC." (T)
  NEOSHO DAILY NEWS "SUNDAY" (W)
OSAGE BEACH
  VACATION NEWS (F)
ROLLA
  ROLLA DAILY NEWS (D)
  ROLLA DAILY NEWS "PLUS" (T)
ST. JAMES
  ADVERTISER (T)
  ST. JAMES LEADER JOURNAL (W)
WAYNESVILLE
  THE DAILY GUIDE (D)
  DAILY GUIDE EXTRA (T)
  FORT WOOD CONSTITUTION (F)

NEW YORK
BATH
  STEUBEN COURIER ADVOCATE (F)
CANISTEO
  HORNELL CANISTEO PENN-E-SAVER (S)
DANSVILLE
  GENESEE COUNTY EXPRESS (W)
  GENESEEWAY SHOPPER (S)
FT. PLAIN
  MOHAWK VALLEY PENNYSAVER (S)
HERKIMER
  THE EVENING TELEGRAM (D)
  IMAGES (F)
HORNELL
  EVENING TRIBUNE (D)
  THE SPECTATOR (SUNDAY) (W)
  THE TRIBUNE EXTRA (T)
<PAGE>   14
HORSEHEADS
  THE SHOPPER (S)
LIBERTY
  CATSKILL SHOPPER (S)
LITTLE FALLS
  THE EVENING TIMES (D)
  TIMES-SAVER (T)
PAINTED POST
  CORNING-ELMIRA PENNYSAVER (S)
PENN YAN
  CHRONICLE AD-VISER (S)
  THE CHRONICLE-EXPRESS (W)
SAUGERTIES
  MOUNTAIN PENNYSAVER (F)
  SAUGERTIES PENNYSAVER(S)
  SAUGERTIES POST STAR (W)
SYRACUSE
  THE BUSINESS RECORD (W)

WELLSVILLE
  ALLEGANY CO. PENNYSAVER (S)
  WELLSVILLE DAILY REPORTER (D)
  WELLSVILLE DAILY TMC (T)

NORTH DAKOTA
DEVILS LAKE
  DEVILS LAKE DAILY JOURNAL (D)
  THE COUNTY PEDDLER (W)

PENNSYLVANIA
CARBONDALE
  THE CARBONDALE NEWS (W)
CORRY
  CORRY JOURNAL (D)
  CORRY JOURNAL TMC (T)
HONESDALE
  THE INDEPENDENT EXTRA (T)
  THE WAYNE INDEPENDENT (D)
KANE
  KANE REPUBLICAN (D)
MILTON
  LEWISBURG DAILY JOURNAL (D)
  MILTON DAILY STANDARD (D)
  THE STANDARD-JOURNAL (T)
MOSCOW/HAMLIN
  THE VILLAGER (W)
PUNXSUTAWNEY
  COUNTRY NEIGHBORS (F)
  THE PUNXSUTAWNEY SPIRIT (D)
  THE (PUNXSUTAWNEY) SPIRIT TMC (T)
RIDGWAY
  THE RIDGWAY RECORD (D)
  SHOP-RIGHT (S)
SAINT MARY'S
  THE DAILY PRESS (D)
  THE DAILY PRESS TMC (T)
SAYRE
  THE EVENING TIMES (D)
  THE TIMES EXTRA (T)
TITUSVILLE
  TITUSVILLE HERALD (D)
  TITUSVILLE HERALD TMC (T)
WARREN
  WARREN COUNTY GUIDE (F)
WAYNESBORO
  THE RECORD HERALD (D)
  RECORD HERALD SHOPPERS EXPRESS (S)

WEST VIRGINIA
KEYSER
  MINERAL DAILY NEWS TRIBUNE (D)
  NEWS TRIBUNE & MOUNTAIN ECHO (W)
  TODAY'S SHOPPER (S)
<PAGE>   15

ITEM 3. LEGAL PROCEEDINGS.

The Company is involved in a number of legal proceedings which have arisen in
the ordinary course of business. In the opinion of management, the outcome of
these legal proceedings will not have a material adverse impact on the Company's
financial position or results of operations.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

None

                                   PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

There is no public market for the Company's Common Stock. All of the Company's
issued and outstanding capital stock is owned by LGP.  The Company has no
outstanding capital stock other than common stock, nor are there any outstanding
options, warrants, or other rights to purchase the Company's capital stock.  

ITEM 6. SELECTED FINANCIAL DATA.

The following table sets forth selected historical financial data of the
Company. The selected historical financial data as of and for the years ended
December 31, 1995, 1996, 1997 and 1998, are derived from the historical
financial statements of the Company. The selected historical financial data for
the year ended December 31, 1994 has been derived from the unaudited financial
statements of the Company and include, in the opinion of the Company, all
adjustments necessary to present fairly the data for such periods. The data
presented below should be read in conjunction with the financial statements,
including the notes thereto, and with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" appearing elsewhere in this
Form 10-K.

<TABLE>
<CAPTION>
                                                            Year Ended December 31,
                                                            -----------------------
                                             1994       1995       1996       1997         1998
                                             ----       ----       ----       ----         ----
                                                            (dollars in thousands)
<S>                                           <C>        <C>        <C>        <C>       <C>
STATEMENT OF OPERATIONS DATA:                             (Predecessor)                 (Successor)
Revenues:
  Advertising . . . . . . . . . . . . . . .  $56,770    $60,255    $67,756    $69,602      81,554
  Circulation . . . . . . . . . . . . . . .   17,766     19,058     21,064     21,451      22,844
  Job printing and other. . . . . . . . . .    7,328      8,054      8,722      7,666       8,133
                                             -------    -------    -------    -------    --------
Total Revenues. . . . . . . . . . . . . . .   81,864     87,367     97,542     98,719     112,531
Operating Costs . . . . . . . . . . . . . .   33,707     36,429     39,660     39,309      45,976
                                        
Selling, general and  administrative. . . .   25,428     27,482     29,919     29,171      32,329
                                             -------    -------    -------    -------    --------
Newspaper EBITDA. . . . . . . . . . . . . .   22,729     23,456     27,963     30,240      34,226
Corporate Expenses. . . . . . . . . . . . .                                                 3,736
Non Cash Compensation . . . . . . . . . . .                                                   238 
                                             -------    -------    -------    -------    --------
EBITDA. . . . . . . . . . . . . . . . . . .   22,729     23,456     27,963     30,240      30,252
Depreciation and amortization . . . . . . .    7,722      7,290      7,854      7,470      11,917
                                             -------    -------    -------    -------    --------
Income from operations. . . . . . . . . . .   15,007     16,166     20,109     22,769      18,335
Interest expense. . . . . . . . . . . . . .   10,991     11,195     10,968     10,551      19,300
                                             -------    -------    -------    -------    --------
Income before income taxes. . . . . . . . .    4,016      4,971      9,141     12,218        (965) 
Income taxes. . . . . . . . . . . . . . . .    1,687      2,338      4,006      5,271          --
                                             -------    -------    -------    -------    --------
  Net Income (Loss) . . . . . . . . . . . .   $2,329     $2,633     $5,135     $6,947        (965)
                                             =======    =======    =======    =======    ========
</TABLE>

Newspaper EBITDA includes income from operations adjusted to exclude 
depreciation and amortization expense, Corporate expenses, and non-cash 
compensation.
<PAGE>   16

<TABLE>
<CAPTION>
                                                                    AS OF DECEMBER 31,
                                                                    ------------------
                                                 1994         1995         1996        1997         1998
                                                 ----         ----         ----        ----         ----
                                                                   (DOLLARS IN THOUSANDS)
                                                                 (Predecessor)                   (Successor)
BALANCE SHEET DATA:
<S>                                             <C>         <C>          <C>          <C>          <C>
Cash and cash equivalents                       $  1,746    $  1,929     $  1,768     $ $1,452     $ $1,025
Total assets                                     111,256     120,170      112,974      109,700      406,401
Total debt                                            --          --           --           --      227,834
Stockholders' equity (deficit)                    98,636     106,945      102,980       99,139      147,696 

OTHER DATA:
Ratio of earnings to fixed charges(1)               1.4x         1.4x        1.8x          2.2x        1.0x
</TABLE>

                        NOTES TO SELECTED FINANCIAL DATA

(1)      For purposes of computing the ratio of earnings to fixed charges,
         "earnings" consist of income before income taxes plus fixed charges.
         "Fixed charges" consist of interest on all indebtedness and
         amortization of deferred financing costs.  The ratio of earnings to
         fixed charges is helpful to investors as it provides a measure,
         generally calculated consistently by all companies, of a company's
         ability to meet its debt service requirements. For the year ended
         December 31, 1997 earnings were sufficient to cover fixed charges by
         $12.2 million and for the year ended December 31, 1998 earnings were
         insufficient to cover fixed charges by $1.0 million.


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS


         The following discussion should be read in conjunction with the
historical financial statements of the Company, including the notes thereto. The
historical financial data of the Company for the period before January 1, 1998
refers to the operations of the Company when it was owned by American Publishing
Company ("APC"), a wholly owned subsidiary of Hollinger International, Inc.
Effective January 1, 1998 the Company purchased substantially all of the assets
and assumed certain liabilities that were used in the business of publishing and
distributing certain local newspapers ("the Initial Acquisition"). The
discussion and analysis below includes certain forward-looking statements (as
such terms are defined in Section 21E of the Securities Exchange Act of 1934)
pertaining to, among other things, competition in its markets, availability of
adequate acquisition opportunities, price and availability of newsprint,
significant use of leverage, general economic conditions, and environmental
matters. These statements are based on the beliefs, assumptions made by, and
information currently available to, the Company's management. The Company's
actual growth, results, performance and business prospects in 1999, and beyond
could differ materially from those expressed in, or implied by, such
forward-looking statements. See "Disclosure Regarding Forward-Looking
Statements" on page 3 for a discussion of features that could cause or
contribute to such material differences.

OVERVIEW

         The Company is a leading U.S. publisher of local newspapers and related
publications that are the dominant source of local news and print advertising in
their markets. The Company's revenues are derived from advertising (73% of 1998
total revenues), circulation (20%) and job printing and other (7%).

         The Company's primary costs and expenses are comprised of operating
costs and selling, general and administrative expenses. Salaries and employee
benefits are the Company's largest operating costs. The Company has been able to
control salaries and employee benefit expenses by realizing efficiencies from
the implementation of new technologies and the achievement of synergies from its
strategy of geographically clustering its newspaper operations.
<PAGE>   17


         Liberty Group Publishing, Inc. ("LGP") was formed for purposes of
acquiring a portion of the daily and weekly newspapers owned by American
Publishing Company or its subsidiaries ("APC"), a wholly-owned subsidiary of
Hollinger International Inc.("Hollinger"). LGP is a holding company for its
wholly-owned subsidiary Liberty Group Operating, Inc ("Operating Company"). The
consolidated financial statements include the accounts of Operating Company and
its consolidated subsidiaries (the "Company").

         On January 27, 1998, the Company's parent acquired from Hollinger
virtually all of the assets and assumed certain liabilities that were used
primarily in the business of publishing, marketing and distributing certain
local newspapers (the "Initial Acquisition"). The initial purchase price
including fees and expenses was $322.4 million. The effective date of the
Initial Acquisition was January 1, 1998.

         In the accompanying financial statements the terms "Liberty Group
Operating" or the "Company" when used with respect to periods prior to January
1, 1998 refer to the combined group of newspapers sold by APC and when used with
respect to periods subsequent to January 1, 1998 refers to Liberty Group
Operating, Inc. and its consolidated subsidiaries. The combined historical
financial information of the newspapers acquired from APC prior to the Initial
Acquisition on January 1, 1998 is referred to as "Predecessor" while the
consolidated financial information of the Company subsequent to the date of the
Initial Acquisition is referred to as "Successor."

         The Company has accounted for the Initial Acquisition using the
purchase method of accounting. Accordingly, the costs of the Initial Acquisition
have been allocated to the assets acquired and liabilities assumed based upon
their respective fair values using independent valuations. The costs of certain
intangible assets acquired of $296.5 million are being amortized over periods
ranging from 5 to 40 years. Because of the purchase price allocation, the
accompanying financial statements of Successor are not directly comparable to
those of Predecessor.

         Certain administrative services, including accounting, payroll,
administration, tax services and financial reporting, were historically
performed for the Company by APC. The Company was charged directly by APC for
certain of such services and also paid a management fee to APC that was based
upon a percentage of total revenues. At the end of January 1998, the management
fee to APC was replaced by a Transitional Services Agreement that allows for
certain administrative services to be provided by APC at cost until the Company
can establish capabilities to provide its administrative services in-house. The
Company provides all of its administration in-house as of April 1, 1999 and has
terminated the Transitional Services Agreement effective March 31, 1999.

         Prior to the Initial Acquisition, the Company operated as a business
unit of APC and as such did not file separate tax returns. The income tax
provision included in the Predecessor's financial statements was computed as if
the Predecessor were a separate company. Subsequent to the Initial Acquisition,
the Company has been and anticipates that it will be, for the foreseeable
future, in a tax loss position. Given the uncertainty as to the timing of the
Company's ability to utilize such losses to offset
<PAGE>   18


future taxable income, the Company does not presently anticipate recording any
tax benefit associated with its pre-tax losses. In addition to the Initial
Acquisition, due to the acquisition of the Company's assets from APC, the
Company's asset values and capital structure are materially different than those
set forth in the Predecessor's financial statements for periods preceding the
Initial Acquisition and, accordingly, historical interest expense is not
indicative of the interest expense that the Company incurs as a separate
company.

         The results of operations and cash flows of the Predecessor have been
consolidated with those of the Company from January 1, 1998, the effective date
upon which the Company and APC agreed as to the change of control of the
newspapers to the Company.

      In addition to the Initial Acquisition, during 1998, the Company acquired
91 publications in 18 transactions for a total acquisition cost of $61.8 
million.

RESULTS OF OPERATIONS

         The following table summarizes the Company's historical results of
operations as a percentage of total revenues for the years ended December 31,
1996, 1997 and 1998.

   
<TABLE>
<CAPTION>
                                                                                               Year to Year
                                                      Year ended December 31,                Percentage Change
                                                  1996         1997          1998          1997             1998
                                                                                            to               to
                                                     Predecessor           Successor       1996             1997
                                                                                           ----             ----
Revenues:
<S>                                            <C>         <C>           <C>             <C>              <C>
Advertising                                        69%        70%           73%              3%              17%
Circulation                                        22                       20              (2)               6 
                                                              22
Job printing and other                              9          8             7             (12)               6 
    

Total revenues                                    100        100           100               1               14 
Operating costs                                    41         40            41              (1)              17 
Selling, general and administrative                30         29            32              (3)              24 
Depreciation and amortization                       8          8            11              (5)              60 
                                               ------      -----         -----             ----           -----
Income from operations                             21         23            16              13               19   
Interest expense                                   11         11            17              (4)              83
                                               ------      -----         -----            ----            -----
Income before income taxes                          9         12            (1)             34             (108)
Income taxes                                        4          5             -              32             (100)
                                               ------      -----         -----            ----            -----
Net income (loss)                                   5          7            (1)             35             (114)
EBITDA                                             29%        31%           27%              8%              (0)%

</TABLE>

EBITDA includes income from operations adjusted to exclude depreciation and
amortization expense.


  YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997

Total revenues for the year ended December 31, 1998 increased by $13.8 million,
or 14%, to $112.5 million. The increase in revenue was primarily due to
acquisitions with same store increases in advertising revenue offset by declines
in printing revenue. The increase in total revenues for the year ended December
31, 1998 was comprised of a $11.9 million or 17% increase in advertising revenue
and a $1.4 million or 6% increase in circulation revenue, and a $0.5 million or
6% increase in job printing and other revenue.

Operating costs for the year ended December 31, 1998 were $46.0 million or 41%
of revenue which was an increase of $6.7 million over the year ended December
31, 1997 when operating costs were $39.3 million or 40% of revenue. This
increase was primarily driven by higher newsprint prices, and the increase in
the minimum wage that went into effect in September of 1997.

Selling, general and administrative expenses for the year ended December 31,
1998 increased by $7.1 million, to $36.3 million or 32% of revenues from $29.2
million for the year ended December 31, 1997 when expenses were 29% of
revenues. The increase in selling, general and administrative expenses as a
percentage of revenue for the year ended December 31, 1998 was primarily due to
increases in management costs associated with becoming an independent company
including management fees paid to the controlling stockholder, and by the
increase in the minimum wage that went into effect in September of 1997.

Depreciation and amortization expense for the year ended December 31, 1998
increased by $4.4 million, to $11.9 million from $7.5 million for the year
<PAGE>   19


ended December 31, 1997, as a result of the write-up in basis of assets acquired
in the Initial Acquisition as well as subsequent acquisitions.

Income from operations for the year decreased by $4.5 million from $22.8 million
or 23% of revenues to $18.3 million or 16% of revenues primarily due to higher
depreciation and amortization charges as a result of the write-up in basis of
assets acquired in the Initial Acquisition as well as subsequent acquisitions.

EBITDA for the year ended December 31, 1998 increased by $0.1 million, to $30.3
million from $30.2 million for the year ended December 31, 1997. The decrease in
EBITDA as a percentage of revenue during the year ended December 31, 1998 was
due to higher administrative expenses, increased newsprint costs, and the effect
of the increase in the minimum wage in September of 1997.

EBITDA includes income from operations adjusted to exclude depreciation and
amortization expenses. The Company believes that EBITDA provides additional
information for determining its ability to meet future debt service
requirements. However, EBITDA is not a defined term under Generally Accepted
Accounting Principles ("GAAP") and is not indicative of operating income or cash
flow from operations as determined under GAAP.

For the year ended December 31, 1998, the Company incurred a net loss of $1.0
million which is not directly comparable to the prior year due primarily to
higher depreciation and amortization expenses, increased interest expense, and
higher administrative expenses associated the Initial Acquisition and subsequent
acquisitions.

YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996

         Total Revenues. Total revenues for the year ended December 31, 1997
increased by $1.2 million, or 1%, to $98.7 million from $97.5 million for the
year ended December 31, 1996. The increase in total revenues was comprised of a
$1.9 million increase in advertising revenue and a $0.4 million increase in
circulation revenue offset by a $1.1 million decrease in job printing and other
revenue. During the year ended December 31, 1997, the Company acquired
publications in two markets. The publications acquired during the year ended
December 31, 1997 contributed $0.8 million to total revenues for such period.
The increase in advertising revenue during the year ended December 31, 1997 was
primarily due to general continued strength in demand for advertising in the
Company's markets. The increase in circulation revenue during the year ended
December 31, 1997 was primarily due to increases in the cover prices of selected
newspaper publications. The decrease in job printing and other revenue during
the year ended December 31, 1997 was primarily due to the Company pursuing fewer
opportunities for commercial printing than in the prior year.

         Operating Costs. Operating costs for the year ended December 31, 1997
decreased by $0.4 million, or 1%, to $39.3 million from $39.7 million for the
year ended December 31, 1996. Operating costs decreased as a percentage of total
revenues to 40% for the year ended December 31, 1997 from 41% for the year
ended December 31, 1996. Approximately $1.3 million of the decrease in operating
costs as a percentage of total revenues during the year ended December 31, 1997
was due to declines in newsprint prices and approximately $0.7 million of the
decrease was due to the continued successful implementation of cost controls at
the Company's publications.

         Selling, General and Administrative. Selling, general and
administrative expenses for the year ended December 31, 1997 decreased by $0.7
million, or 3%, to $29.2 million from $29.9 million for the year ended December
31, 1996. Selling, general and administrative expenses decreased as a percentage
of total revenues to 29% for the year ended December 31, 1997 from 30% for
the year ended December 31, 1996. The decrease in selling, general and
administrative expenses during the year ended December 31, 1997 was primarily
due to the continued implementation of cost controls at the company's 
publications.

         Depreciation and Amortization. Depreciation and amortization for the
year ended December 31, 1997 decreased by $0.4 million, or 4%, to $7.5 million
from $7.9 million for the year ended December 31, 1996. As a percentage of
revenues, depreciation and amortization was 8% in 1997 and 1996.
<PAGE>   20


         Income from Operations. Income from operations for the year ended
December 31, 1997 increased by $2.7 million, or 13%, to $22.8 million from
$20.1 million for the year ended December 31, 1996. Income from operations as a
percentage of total revenues increased to 23% for the year ended December 31,
1997 from 21% for the year ended December 31, 1996. The increase in income
from operations was primarily due to higher total revenues and lower operating
costs described above.

         EBITDA. EBITDA for the year ended December 31, 1997 increased by $2.3
million, or 8%, to $30.2 million from $28.0 million for the year ended December
31, 1996. EBITDA margin increased to 30.6% for the year ended December 31, 1997
from 28.7% for the year ended December 31, 1996. The increase in EBITDA and
EBITDA margin during the year ended December 31, 1997 was primarily due to
higher total revenues and lower operating costs described above.

 LIQUIDITY AND CAPITAL RESOURCES

         Cash Flows From Operating Activities. Net cash provided by operating
activities for the year ended December 31, 1998 increased by $7.3 million to
$21.9 million compared with $14.6 million for the year ended December 31, 1997.
The increase in net working capital is due to increases in accounts receivable
and inventory offset by increases in accounts payable and accrued charges.

         Cash Flows From Investing Activities. Net cash used in investing
activities for the year ended December 31, 1998 reflects the Initial Acquisition
of substantially all of the assets and liabilities of 166 newspapers, plus
associated fees and expenses totaling $322.4 million. The Company acquired an
additional 91 publications during 1998 for $61.8  million. As a result, cash
flow from investing activities is not comparable to the prior period. The
Company's capital expenditures consist of the purchase of machinery, equipment,
furniture and fixtures relating to its publishing operations. The Company has no
material commitments for capital expenditures, but will continue to pursue its
strategy of opportunistically purchasing local newspapers in contiguous markets
and clusters of local newspapers in new markets. The Company will only pursue
acquisitions that it believes would contribute to the Company's overall cash
flow growth.

         Cash Flows From Financing Activities. Net cash flows from financing
activities for the year ended December 31, 1998 reflect the initial
capitalization of the Company through the issuance of Common Stock and Senior
Subordinated Notes, net of associated fees, and is not directly comparable to
the prior year. The Company is subject to certain covenants that limit its
ability to pay dividends and make other restricted payments and does not expect
to pay cash dividends in the foreseeable future

         Liquidity. The Company's principal sources of funds will be cash
provided by operating activities and borrowings under its Revolving Credit
Facility. The Company believes that such funds will provide the Company with
sufficient liquidity and capital resources to meet its current and financial
obligations for the foreseeable future. See Note 7 to the Consolidated Financial
Statements for a summary of the terms of the Revolving Credit Facility. The
Company's parent is dependent upon the cash flows of the Company to fund the
repayment of its borrowings and the redemption requirements under its respective
preferred stock agreements.

         The Company is highly leveraged and has indebtedness that is
substantial in relation to its stockholders' deficit, tangible equity and cash
flow. Total interest expense for the year ended December 31, 1998 was $19.3
million and amortization of debt issuance costs of $1.0 million. The degree to
which the Company is leveraged could have important consequences, including the
following: (i) for the fiscal year ending December 31, 1998, a substantial
portion of the Company's cash flow from operations must be dedicated to the
payment of interest on the Notes and interest on its other indebtedness, thereby
reducing the funds available to the Company for other purposes; (ii)
indebtedness under the Revolving Credit Facility is at variable rates of
interest, which causes the Company to be vulnerable to increases in interest
rates; (iii) the Company is substantially more leveraged than certain of it
competitors, which might place the Company at
<PAGE>   21

a competitive disadvantage; (iv) the Company may be hindered in its ability to
adjust rapidly to changing market conditions; (v) the Company's substantial
degree of leverage could make it more vulnerable in the event of a downturn in
general economic condition or other adverse events in its business; and (vi) the
Company's ability to obtain additional financing for working capital, capital
expenditures, acquisitions or general corporate purposes may be impaired.

YEAR 2000 

         The Company has implemented a program to assess, remediate and mitigate
the potential impact of the Year 2000 problem throughout the Company. A Year
2000 problem will occur where date-sensitive software uses two digit year date
fields, sorting the year 2000 ("00") before the year 1999 ("99"). The Year 2000
problem can arise in software, technology equipment, or any other equipment or
process that uses embedded software, resulting in data corruption and
processing errors.

         The Company has evaluated its internal software and computer systems.
Costs associated with addressing the risk of operational disruption from
internal software system failures relating to Year 2000 issues amounted to
approximately $0.5 million in 1998 and are estimated to approximate $0.2 million
in 1999.

         Management believes that the Company's systems will be substantially
Year 2000 ready prior to the commencement of the year 2000. The Company does not
have a material business risk from such Year 2000 issues provided the Company's
suppliers, vendors, service providers and customers, over which the Company has
no control, successfully address their own Year 2000 issues. The Company will
attempt to assess and monitor its suppliers, vendors, service providers and
customers Year 2000 remediation efforts.


RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS

         The Company implemented Statement of Financial Accounting Standards 
No. 131 "Disclosures about Segments of an Enterprise and Related Information" 
as of January 1, 1998.  This Statement establishes standards for the way public 
businesses report information about operating segments in annual financial 
statements and in interim financial reports. The commonality of products and 
operating characteristics, combined with the lack of distinction by customer, 
have resulted in management's determination that no reportable segments exist. 
Geographic disclosures are not appropriate as the Company's operations are 
contained solely within the U.S.

         During 1998, the American Institute of Certified Public Accountants 
issued Statement of Position 98-1, "Accounting for the Costs of Computer 
Software Developed or Obtained for Internal Use", and Statement of Position 
98-5, "Reporting on the Costs of Start-Up Activities", both of which will be 
effective for the Company's 1999 financial statements. The Company is currently 
assessing the impacts of these new statements but does not expect any material 
effect on its consolidated financial position, liquidity, or results of 
operations.

QUARTERLY COMPARISONS

         Newspaper companies tend to follow a distinct and recurring seasonal
pattern, with high advertising revenues in months containing significant events
or holidays. Accordingly, due to generally poor weather and a lack of holidays,
the Company's first fiscal quarter is the Company's weakest revenue quarter of
the year.

The following tables set forth an unaudited summary of quarterly financial data.
This quarterly information has been prepared on the same basis as the annual
consolidated financial statements and, in management's opinion, reflects all
adjustments necessary for a fair presentation of the information for the periods
presented. The operating results for any quarter are not necessarily indicative
of results for any future period.

<TABLE>
<CAPTION>
                                                    First             Second            Third            Fourth
                                                   Quarter           Quarter           Quarter          Quarter
                                                   -------           -------           -------          -------
                                                                             (in thousands)
                                                                               (unaudited)
<S>                                            <C>               <C>               <C>               <C>
1997: Predecessor
Total revenues                                 $  22,480         $  25,397         $  25,382         $  25,460
Income from operations                             4,649             6,395             5,964             5,761
Net Income                                         1,143             2,137             1,867             1,800
 
1998: Successor
Total revenues                                 $  22,986         $  26,543         $  29,040         $  33,962
Income from operations                             3,107             4,871             4,915             5,442
Net income (loss)                                 (1,068)               64                48                (9)
</TABLE>

<PAGE>   22


ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company has a $125.0 million Revolving Credit Facility that matures in
January of 2003. Borrowings under the Revolving Credit Facility bear interest at
an annual rate, at the Company's option equal to the Base Rate (as defined in
the Credit Agreement) or the Eurodollar Rate (as defined in the Credit
Agreement) plus a margin that varies based upon a ratio set forth in the Credit
Agreement. As a result the Company's interest expense will be affected by
changes in the Base Rate or in the Eurodollar Rate. At December 31, 1998, the
Company had borrowed  $46 million under this Revolving Credit Facility.


ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The information in response to this item is included in the financial statements
and notes thereto, and related Independent Auditors' Report, appearing on pages
F-1 to F-14 of this Form 10-K, and in Item 7 of this Form 10-K under the heading
"Quarterly Comparisons."

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE.

None

ITEM 10. DIRECTORS AND OFFICERS OF REGISTRANT

         The following table sets forth the name, age and position of
individuals who serve as directors of the Company and executive officers of the
Company. Each director of the Company will hold office until the next annual
meeting of the stockholders or until his successor has been elected. Qualified
officers of the Company are elected by their respective Boards of Directors and
serve at the discretion of such Boards.

<TABLE>
<CAPTION>
         NAME                              AGE                        POSITION
         ----                              ---                        --------

<S>                                         <C>        <C>
Kenneth L. Serota                           37         President and Chief Executive Officer and
                                                       Director
Kenneth W. Cope                             63         Executive Vice President and Director
Scott T. Champion                           37         Executive Vice President
Kevin O'Shea                                39         Senior Vice President and Chief Financial
                                                       Officer
Gene A. Hall                                47         Senior Vice President
Joseph C. Piccirillo                        63         Senior Vice President
Leonard I. Green                            65         Chairman of the Board of Directors
Gregory J. Annick                           35         Director
John G. Danhakl                             43         Director
Peter J. Nolan                              40         Director
</TABLE>


        Kenneth L. Serota is President and Chief Executive Officer. Mr. Serota
is also a director of LGP. He served as Vice President--Law & Finance and
Secretary of Hollinger from May 1995 to December 1997 and as a director of APC
from 1996 to 1997. Prior thereto, Mr. Serota served as Senior Vice President of
a privately held frozen food manufacturer from June 1992 through March 1995.
Previously, Mr. Serota served as an attorney and a
<PAGE>   23
certified public accountant in private practice. Mr. Serota has significant
experience negotiating and closing acquisitions of newspaper publications and
primarily focuses his efforts on executing the Company's acquisition program and
overseeing all administrative functions of LGP.

         Kenneth W. Cope is Executive Vice President and has primary
responsibility for newspaper publications in the western region of the United
States. Mr. Cope is also a director of LGP. He served as Deputy Chairman of APC 
from August 1996 to January 1998. Prior thereto, he served as Executive Vice 
President and a member of APC's Board of Directors from 1989 to 1996. Mr. Cope 
had been employed at APC since 1987 and had completed more than 50 acquisitions
of local publications during his tenure at APC. Prior to his employment at APC,
Mr. Cope was an owner of the Neosho Daily News in Neosho, Missouri, which is a
publication acquired by the Company in the Initial Acquisition. Mr. Cope has 
more than 38 years' experience in the newspaper industry. Mr. Cope is also a 
director of Community Bank & Trust.

         Scott T. Champion is Executive Vice President - Operations and has
primary responsibility for all community newspaper publications. He served as a
Senior Vice President of the Company for 1998. Prior thereto, he served as a
Senior Vice President, Regional Manager, and District Manager of APC and had
been employed at APC since 1988. Prior to his employment at APC, Mr. Champion
served as the publisher of a group of privately owned newspaper publications.
Mr. Champion currently serves as the publisher of the Daily Review Atlas and
Pennysaver in Monmouth, Illinois, which publications were acquired by the
Company in the Initial Acquisition, and has served in such position since 1984.
Mr. Champion has more than 18 years' experience in the newspaper industry.

         Kevin O'Shea is Senior Vice President and the Chief Financial Officer.
Mr. O'Shea served as Vice President and Corporate Treasurer of Bell & Howell
Company from February 1996 to March 1998. From 1989 to 1996, Mr. O'Shea served
as Vice President and Corporate Treasurer of Spencer Stuart, a global consulting
firm. Prior thereto, Mr. O'Shea served as Vice President and treasurer/group
controller for The Pritzker Organization, a large and diversified family holding
company.

         Gene A. Hall is Senior Vice President and has primary responsibility
for newspaper publications in the midwestern region of the United States. He
served as a Senior Vice President of APC from 1992 to 1998. Prior thereto, he
served as a regional manager of APC and had been employed at APC since 1988.
Prior to his employment at APC, Mr. Hall was the owner and publisher of the
Charles City Press, Six County Shopper and The Extra in Charles City, Iowa. Mr.
Hall currently serves as the publisher of the Charles City Press, Six County
Shopper and The Extra, which publications were acquired by the Company in the
Initial Acquisition, and has served in such positions since 1986. Mr. Hall has
more than 28 years' experience in the newspaper industry. Mr. Hall is also a
director of First Security Bank & Trust.

         Joseph C. Piccirillo is Senior Vice President and has primary
responsibility for newspaper publications in the eastern region of the United
States. He served as a Senior Vice President of APC from 1994 to 1998. Prior
thereto, he served as a regional manager of APC and had been employed at APC
since 1987. Prior to his employment at APC, Mr. Piccirillo served as regional
manager for the Bradford, Pennsylvania newspaper group that formed the core
group of APC. Mr. Piccirillo currently serves as the publisher of The Ridgway
Record and Shop-Right in Ridgway, Pennsylvania, which publications were acquired
by the Company in the Initial Acquisition, and has served in such position since
1971. Mr. Piccirillo has more than 40 years' experience in the newspaper
industry.
<PAGE>   24
Leonard I. Green is the Chairman of the Board of Directors of LGP.  He has been
an executive officer and an equity owner of Leonard Green & Partners, L.P., a
merchant banking firm that manages GEI, since the formation of Leonard Green &
Partners, L.P. and GEI in 1994 by the principals of Leonard Green & Associates,
L.P. ("LGA"). Mr. Green has also been, individually or through a corporation, a
partner in LGA, a merchant banking firm, since its inception in 1989. Prior to
forming LGA, Mr. Green had been a partner of Gibbons, Green, van Amerongen for
more than five years. Mr. Green is also a director of Rite Aid Corporation,
Carr-Gottstein Foods Co., Communications & Power Industries, Inc. and Hechinger
Company.

Gregory J. Annick is a director of LGP. He has been an executive officer and an
equity owner, through a trust, of Leonard Green & Partners, L.P., a merchant
banking firm that manages GEI, since the formation of LGP and GEI in 1994 by the
principals of LGA. He joined LGA as an associate in 1989, became a principal in
1993, and through a corporation became a partner of LGA in 1994. From 1988 to
1989, Mr. Annick was an associate with the merchant banking firm of Gibbons,
Green, van Amerongen. Before that time, Mr. Annick was a financial analyst in
mergers and acquisitions with Goldman, Sachs & Co. Mr. Annick is also a director
of Carr-Gottstein Foods Co., Communications & Power Industries, Inc., Leslie's
Poolmart, Inc. and Hechinger Company.

John G. Danhakl is a director of LGP. He has been an executive officer and an
equity owner of Leonard Green & Partners, L.P., a merchant banking firm that
manages GEI, since 1995. Mr. Danhakl had previously been a Managing Director at
Donaldson, Lufkin & Jenrette Securities Corporation ("DLJ") and had been with
DLJ since 1990. Prior to joining DLJ, Mr. Danhakl was a Vice President at Drexel
Burnham Lambert Incorporated ("Drexel"). Mr. Danhakl is also a director of Big 5
Corp., Communications & Power Industries, Inc., Leslie's Poolmart, Inc.,
Hechinger Company, Twinlab Corporation and The Arden Group, Inc.

Peter J. Nolan is a director of LGP. He has been an executive officer and an
equity owner of Leonard Green & Partners, L.P., a merchant banking firm that
manages GEI, since April 1997. Mr. Nolan had previously been a Managing Director
of DLJ and Co-Head of DLJ's Los Angeles Investment Banking Division and had been
with DLJ since 1990. Prior to joining DLJ, Mr. Nolan was a First Vice President
at Drexel. Mr. Nolan is also a director of Wavetek Corporation.


Item 11. Executive Compensation.

<TABLE>
<CAPTION>
                            Salary      Bonus      Other         Total     
                            --------------------------------------------   
<S>                        <C>        <C>        <C>            <C>        
Kenneth L. Serota          $338,242   $150,000    $380,175(1)   $868,417   
President and CEO                                                          
                                                                           
Kenneth W. Cope                                                            
Executive V.P.              184,615     30,000      23,959       238,574   
                                                                           
Kevin O'Shea                                                               
Sr. V.P. - CFO              116,923     75,000       5,106       197,029   
                                                                           
Scott Champion                                                             
Executive V.P.               58,344     94,455      26,680       179,479   
                                                                           
Gene Hall                                                                  
Senior V.P.                  45,538     83,751      30,386       159,672   
</TABLE>

(1) Mr. Serota's other compensation consists of a transfer of 1,600 common
shares from the controlling stockholder valued at $160,000, plus the related tax
gross-up of $132,237, upon the commencement of his employment, plus $77,169 in
loan forgiveness pursuant to his employment agreement, plus a $5,000
contribution to a deferred compensation plan and a car allowance of $5,769.


<PAGE>   25


ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

<TABLE>
<CAPTION>
                                             % Owned           No. of Shares
                                             -------           -------------
<S>                                            <C>                <C>
Common Stock:

Liberty Group Publishing, Inc.                 100%               100
3000 Dundee Road, Suite 203
Northbrook, Illinois  60062
</TABLE>                                                             

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

EMPLOYMENT AGREEMENT

         LGP and Kenneth Serota have entered into an employment agreement, dated
as of November 21, 1997 (the "Employment Agreement"), whereby Mr. Serota has 
agreed to serve as President and Chief Executive Officer of the Company for
a period of three years commencing January 1, 1998 and for additional successive
one-year periods thereafter, unless either party gives timely notice to the
other that the employment term shall not be so extended. The Employment
Agreement provides for a base salary of $350,000, $375,000 and $400,000 for the
years 1998, 1999 and 2000, respectively, and those benefits generally
available to the employees of the Company, including life insurance, health
insurance, deferred compensation and profit sharing. In addition to receiving a
base salary, Mr. Serota is eligible to receive a bonus based on the attainment
of applicable performance standards agreeable to the Company and Mr. Serota,
including standards based on annual revenue growth, EBITDA growth, completion of
reasonably acceptable acquisitions and growth of acquired properties. The
Employment Agreement also provides, subject to certain exceptions, that upon a
termination of Mr. Serota's employment during the term thereof (other than for
"cause" as defined therein or voluntary resignation), the Company is generally
obligated to pay Mr. Serota the greater of one year's salary or an amount equal
to his base salary for the remaining term under the
<PAGE>   26
Employment Agreement plus, in either case, a portion of his bonus for the year
of termination. The Company has also loaned to Mr. Serota $250,000 pursuant to
an Unsecured Promissory Note dated January 27, 1998. The amount of the loan will
be forgiven by the Company pro rata on a daily basis during the initial
three-year term of the Employment Agreement and shall be forgiven in its
entirety if Mr. Serota is terminated by the Company without cause, if Mr. Serota
terminates his employment for good reason (as defined therein), death or
disability, or upon the consummation of an initial public offering of securities
of the Company.

         On January 27, 1998, in satisfaction of the Company's obligations under
the terms of the Employment Agreement, GEI transferred to Mr. Serota 2% of the
fully-diluted equity of LGP and, in addition, Mr. Serota purchased from GEI an
additional 2% of the fully-diluted equity of LGP for the price and on
the terms and conditions such equity was purchased by GEI. The Company loaned to
Mr. Serota 50% of the purchase price of such shares pursuant to a Secured
Recourse Promissory Note dated January 27, 1998. Such loan bears interest at a
rate equal to the applicable federal rate for loans of the same maturity as of
the date of the loan. The outstanding principal amount of the loan, together
with all interest accrued thereon, will be due and payable in full upon the
earlier of (i) a change in control (as defined in the Employment Agreement) or
(ii) January 1, 2001. The Employment Agreement provides certain "call" rights to
the Company, which are generally exercisable upon Mr. Serota's termination of
employment with the Company's Parent.

MANAGEMENT SHARES

         On January 27, 1998, GEI transferred an aggregate of 3,200 shares of
Common Stock of LGP ("Management Shares") to the Chief Executive Officer of the
Company, Mr. Serota, pursuant to a management stockholders agreement (the
"Management Stockholders Agreement"). The Management Stockholders Agreement
contains a "call" option exercisable by LGP upon termination of Mr. Serota's
employment with LGP or Liberty Group Operating, a right of first refusal in
favor of Mr. Serota, certain "piggyback" registration rights, "tag-along" sale
rights and "drag-along" sale obligations consistent with the terms of the
Employment Agreement. In addition, LGP or GEI may sell shares of LGP Common
Stock to other current or prospective officers and employees of Liberty Group
Operating (together with the Senior Management Investors, the "Management
Investors"). As of the date hereof, a total of 4,800 Management Shares have been
transferred to employees other than Mr. Serota at a price of $100 per share, for
total consideration of $480,000.

         Shares of LGP Common Stock were sold to Management Investors
pursuant to Management Subscription and Stockholders Agreements among LGP, GEI
and the respective Management Investor (each such agreement, a "Management
Share Agreement"). Pursuant to the Management Share Agreements, transfers of
the Management Shares (other than transfers to certain related transferees)
are subject to various restrictions, including a right of first refusal in
favor of LGP. Each Management Share Agreement also contains a "call" option
exercisable by LGP upon termination of the Management Investor's employment
with LGP, Liberty Group Operating and their subsidiaries. The Management Share
Agreements also contain certain "piggyback" registration rights, "tag-along"
sale rights and "drag-along" sale obligations. These rights and obligations
lapse upon the occurrence of certain events. Each Management Share Agreement
contains a noncompetition provision which prohibits a Management Investor from
competing, directly or indirectly, with the Company's publications located
within certain designated communities for a period of three years from the
termination date of such Management Investor's employment with the Company or
its subsidiaries.

COMPENSATION OF DIRECTORS

         Individuals who are officers of Liberty Group Operating and LGP, as 
well as Messrs. Green, Annick, Danhakl and Nolan, do not receive any
<PAGE>   27


compensation directly for their service on LGP's and Liberty Group Operating's 
Boards of Directors. Liberty Group Operating has agreed, however, to pay LGP 
certain fees for various management, consulting and financial planning 
services, including assistance in strategic planning, providing market and
financial analyses, negotiating and structuring financing and exploring
expansion opportunities. See "Certain Relationships and Related Transactions
-- Management Fees".


MANAGEMENT FEES

         Upon the consummation of the Initial Acquisition, Leonard Green &
Partners L.P.  received a fee of $6.8 million for its services in arranging and
structuring the Initial Acquisition. Leonard Green & Partners L.P. is an
affiliate of Green Equity Investors II, L.P., an investment partnership which
owns approximately 90% of LGP Common Stock and all outstanding shares of LGP
Junior Preferred Stock. LGP, in turn, owns 100% of the outstanding common stock
of Liberty Group Operating.

          In connection with the Initial Acquisition, Liberty Group Operating
entered into a Management Agreement with Leonard Green & Partners L.P. pursuant
to which Liberty Group Operating agreed to pay Leonard Green & Partners L.P. an
annual management fee of $1.0 million. Such fee is payable in equal monthly
installments, but is subordinated in right of payment to the Senior Discount
Debentures of the Company's parent and the Senior Subordinated Notes. See
"Directors and Officers of Registrant."  "Executive Compensation" and "Security
Ownership of Certain Beneficial Owners and Management."
<PAGE>   28
PART IV 
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM
                 8-K

(a) 1.            Financial Statements, Financial Statement Schedules and
                  Exhibits.

                  Independent Auditors' Report.

                  Consolidated Balance Sheets as of December 31, 1997 and 1998.

                  Consolidated Statements of Operations for the years ended
                  December 31, 1996, 1997, and 1998.
                  
                  Consolidated Statements of Stockholders' Equity (Deficit) for
                  the years ended December 31, 1996, 1997, and 1998.

                  Consolidated Statements of Cash Flows for the years ended
                  December 31, 1996, 1997, and 1998.

                  Notes to Consolidated Financial Statements.

2.                The following financial statement schedule of the Company and
                  the related report of independent auditors are intended as
                  pages S-1 and S-2 of this Form 10-K: Report of Independent
                  Auditors Schedule II - Valuation and Qualifying Accounts.
                  All other financial statement schedules are omitted because
                  such schedules are not required or the information required
                  has been presented in the aforementioned financial statements.

3.                The following exhibits are filed with this Form 10-K or
                  incorporated by reference as set forth below.

                                  EXHIBIT INDEX

<TABLE>
<CAPTION>
Exhibit
Number          Exhibit                                                                 Location

<S>             <C>                                                                     <C>
1.1             Purchase Agreement, dated January 15, 1998, among Liberty Group         Incorporated by reference to
                Publishing, Inc., Donaldson, Lufkin & Jenrette Securities               exhibits included on the Company's
                Corporation, Citicorp Securities, Inc., BT Alex. Brown and Chase        Registration Statement on Form S-4
                Securities, Inc.                                                        (Registration No.: 333-46957)

1.2             Purchase Agreement, dated January 20, 1998, between Liberty Group       Incorporated by reference to
                Publishing, Inc. and Donaldson, Lufkin & Jenrette Securities            exhibits included on the Company's
                Corporation.                                                            Registration Statement on Form S-4
                                                                                        (Registration No.: 333-46957)

2.5             Amendment to Asset Purchase Agreement, dated as of January 14, 1998,    Incorporated by reference to
                among Liberty Group                                                     exhibits included on the Company's
                Publishing, Inc., Green Equity Investors II, L.P. (as guarantor),       Registration Statement on Form S-4
                Liberty Group Operating, Inc., Hollinger International Inc., APAC-90    (Registration No.: 333-46957)
                Inc., American Publishing (1991)Inc. and APAC-95 Inc.
</TABLE>
<PAGE>   29
<TABLE>
<S>             <C>                                                                     <C>
2.6             Amendment to Asset Purchase Agreement, dated as of January 14, 1998,    Incorporated by reference to
                among Liberty Group Publishing, Inc., Green Equity Investors II, L.P.   exhibits included on the Company's
                (as guarantor), Liberty Group                                           Registration Statement on Form S-4
                Operating, Inc., Hollinger International Inc., American Publishing      (Registration No.: 333-46957)
                Company of Illinois, APAC-90 Inc., American Publishing (1991) Inc.
                and APAC-95 Inc.

2.7             Amendment to Exchange Agreement, dated as of January 14, 1998,          Incorporated by reference to
                between American Publishing Company of Illinois and Chicago Deferred    exhibits included on the Company's
                Exchange Corporation.                                                   Registration Statement on Form S-4
                                                                                        (Registration No.: 333-46957)

2.8             Amendment to Qualified Exchange Trust Agreement, dated as of January    Incorporated by reference to
                14, 1998, among The Chicago Trust Company, as Trustee under Trust No.   exhibits included on the Company's
                38347501, Chicago Deferred Exchange Corporation and American            Registration Statement on Form S-4
                Publishing Company of Illinois.                                         (Registration No.: 333-46957)


2.9             Agreement, dated January 15, 1998, among Liberty Group Publishing,      Incorporated by reference to
                Inc., Green Equity Investors II, L.P. (as guarantor), Liberty Group     exhibits included on the Company's
                Operating, Inc., Hollinger International Inc., American Publishing      Registration Statement on Form S-4
                Company of Illinois, APAC-90 Inc., American Publishing (1991) Inc.      (Registration No.: 333-46957)
                and APAC-95 Inc.

2.10            Agreement, dated January 23, 1998, among American Publishing Company    Incorporated by reference to
                of Illinois, Chicago Deferred Exchange Corporation and The Chicago      exhibits included on the Company's
                Trust Company.                                                          Registration Statement on Form S-4
                                                                                        (Registration No.: 333-46957)

2.11            Agreement, dated January 26, 1998, among Liberty Group Publishing,      Incorporated by reference to
                Inc., Green Equity Investors II, L.P. (as guarantor), Liberty Group     exhibits included on the Company's
                Operating, Inc., Hollinger International Inc., American Publishing      Registration Statement on Form S-4
                Company of Illinois, APAC-90 Inc., American Publishing (1991) Inc.      (Registration No.: 333-46957)
                and APAC-95 Inc.

3.1             Second Restated Certificate of Incorporation of Liberty Group           Incorporated by reference to
                Publishing, Inc.                                                        exhibits included on the Company's
                                                                                        Registration Statement on Form S-4
                                                                                        (Registration No.: 333-46957)
</TABLE>
<PAGE>   30
<TABLE>
<S>             <C>                                                                     <C>
3.2             Amendment to Restated Certificate of Incorporation.                     Incorporated by reference to
                                                                                        exhibits included on the Company's
                                                                                        Registration Statement on Form S-4
                                                                                        (Registration No.: 333-46957)

3.2             By-laws of Liberty Group Publishing, Inc. (reflects all amendments      Incorporated by reference to
                through September 24, 1997)                                             exhibits included on the Company's
                                                                                        Registration Statement on Form S-4
                                                                                        (Registration No.: 333-46957)

4.1             $125,000,000 Revolving Credit Agreement among Liberty Group             Incorporated by reference to
                Operating, Inc. and the Banks named therein.                            exhibits included on the Company's
                                                                                        Registration Statement on Form S-4
                                                                                        (Registration No.: 333-46957)

4.1             Indenture, dated as of January 27, 1998, among Liberty Group            Incorporated by reference to
                Operating, Inc. and State Street Bank and Trust Company, as Trustee,    exhibits included on the Company's
                including form of 11 5/8% Senior Discount Debentures due 2009.          Registration Statement on Form S-4
                                                                                        (Registration No.: 333-46957)

4.3             Indenture, dated as of January 27, 1998, among Liberty Group            Incorporated by reference to
                Publishing, Inc. and State Street Bank and Trust Company, as Trustee    exhibits included on the Company's
                including form of 14 3/4% Senior Mandatory Redeemable Exchangeable      Registration Statement on Form S-4
                Cumulative Preferred Stock and 11 5/8% Senior Discount Debentures       (Registration No.: 333-46957)
                due 2009.

</TABLE>
                                                                    
                                                                    ,
                                                                    
                                                                    
                                                                    
<PAGE>   31
<TABLE>
<S>             <C>                                                                     <C>

10.1            Employment Agreement dated November 27, 1997 between Liberty Group      Incorporated by reference to
                Publishing, Inc. and Kenneth L. Serota.                                 exhibits included on the Company's
                                                                                        Registration Statement on Form S-4
                                                                                        (Registration No.: 333-46957)

10.2            Management Stockholders Agreement, dated as of                          Incorporated by reference to
                January 27, 1998, among Liberty Group Publishing, Inc., Green Equity    exhibits included on the Company's
                Investors II, L.P. and Kenneth L. Serota.                               Registration Statement on Form S-4
                                                                                        (Registration No.: 333-46957)

10.3            Non-Competition Agreement, dated as of January 27, 1998, between        Incorporated by reference to
                Liberty Group Operating, Inc. and Hollinger International Inc.          exhibits included on the Company's
                                                                                        Registration Statement on Form S-4
                                                                                        (Registration No.: 333-46957)

                                                                                       
                                                                                       

10.4            Transitional Services Agreement, dated as of January 27, 1998,          Incorporated by reference to
                between American Publishing Management Services Inc. and Liberty        exhibits included on the Company's
                Group Operating, Inc.                                                   Registration Statement on Form S-4
                                                                                        (Registration No.: 333-46957)

10.5            Credit Agreement, dated as of January 27, 1998, among Liberty Group     Incorporated by reference to
                Operating, Inc. (as borrower), Liberty Group Publishing, Inc. (as       exhibits included on the Company's
                parent guarantor), the Subsidiary Guarantors named therein, Citicorp    Registration Statement on Form S-4
                USA, Inc.(as administrative agent and swingline lender), Citibank,      (Registration No.: 333-46957)
                N.A.(as issuing bank), Wells Fargo Bank, N.A. (as documentation
                agent), BT  Alex. Brown Incorporated (as syndication agent),
                Bank of America, NT & SA and Citicorp Securities, Inc. (as arranger).
</TABLE>
<PAGE>   32
<TABLE>
<S>             <C>                                                                     <C>
10.6            Pledge Agreement, dated as of January 27, 1998, from Liberty Group      Incorporated by reference to
                Publishing, Inc., Liberty Group Arizona Holdings, Inc., Liberty Group   exhibits included on the Company's
                Arkansas Holdings, Inc., Liberty Group California Holdings, Inc.,       Registration Statement on Form S-4
                Liberty Group Illinois Holdings, Inc., Liberty Group Iowa Holdings,     (Registration No.: 333-46957)
                Inc., Liberty Group Kansas Holdings,
                Inc., Liberty Group Michigan Holdings, Inc., Liberty Group Minnesota
                Holdings, Inc., Liberty Group Missouri Holdings, Inc., Liberty Group
                New York Holdings, Inc., Liberty Group Pennsylvania
                Holdings, Inc., Liberty Group Management Services, Inc. to the
                lenders under the Credit Agreement.

10.7            Pledge Agreement, dated as of January 27, 1998, from Liberty Group      Incorporated by reference to
                Operating, Inc. to the lenders under the Credit Agreement.              exhibits included on the Company's
                                                                                        Registration Statement on Form S-4
                                                                                        (Registration No.: 333-46957)

10.8            Registration Rights Agreement, dated as of January 27, 1998, among      Incorporated by reference to
                Liberty Group Publishing, Inc., the Subsidiary Guarantors               exhibits included on the Company's
                named therein, Donaldson, Lufkin & Jenrette Securities Corporation,     Registration Statement on Form S-4
                Citicorp Securities, Inc. BT Alex. Brown and Chase Securities, Inc.     (Registration No.: 333-46957)

10.9            Registration Rights Agreement, dated as of January 27, 1998, between    Incorporated by reference to
                Liberty Group Publishing, Inc. and Donaldson,                           exhibits included on the Company's
                Lufkin & Jenrette Securities Corporation.                               Registration Statement on Form S-4
                                                                                        (Registration No.: 333-46957)
10.10           Liberty Group Publishing, Inc.'s Publishers Deferred Compensation       Attached.
                Plan.                                                                                                   

10.11           Liberty Group Publishing, Inc.'s Executive Benefit Plan.                Attached.

10.12           Liberty Group Publishing, Inc.'s Executive Deferral Plan.               Attached.

</TABLE>
<PAGE>   33
<TABLE>
<S>             <C>                                                                     <C>
27              Financial Data Schedule.                                                Attached.

                The Company agreed to furnish to the Commission, upon request, a
                copy of each agreement with respect to long-term debt not filed
                herewith in reliance upon the exemption from filing applicable
                to any series of debt which does not exceed 10% of the total
                consolidated assets of the Company


(b)             Reports on Form 8-K.
</TABLE>

No reports on Form 8-K were filed during the year ended December 31, 1998. On
January 28, 1999, the Company filed Form 8-K for its acquisition of Life
Printing & Publishing Co., Inc. a group of 17 weekly publications based in Oak
Brook, Illinois, and certain real property in Oak Brook, Illinois owned by Jongo
Real Estate Partnership.
<PAGE>   34
                          INDEPENDENT AUDITORS' REPORT


To the Stockholders and Board of Directors
Liberty Group Operating, Inc.:


We have audited the accompanying consolidated balance sheet of Liberty Group
Operating, Inc. and subsidiaries (Successor) as of December 31, 1998, and the
combined statement of net assets of the Local Newspaper Group of American
Publishing Company (Predecessor) as of December 31, 1997, and the related
consolidated statements of operations, stockholders' equity (deficit), and cash
flows for the year ended December 31, 1998 (Successor period), and the related
combined statements of operations and changes in net assets and cash flows for
each of the years in the two-year period ended December 31, 1997 (Predecessor
periods).  These consolidated and combined financial statements are the
responsibility of the Companies' management.  Our responsibility is to express
an opinion on these consolidated and combined financial statements based on our
audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards 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. An audit also includes
assessing the accounting principles used in and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the aforementioned Successor consolidated financial statements 
present fairly, in all material respects, the financial position of Liberty 
Group Operating, Inc. and subsidiaries as of December 31, 1998, and the 
results of their operations and their cash flows for the Successor period, in 
conformity with generally accepted accounting principles.  Further, in our 
opinion, the aforementioned Predecessor combined financial statements present 
fairly, in all material respects, the financial position of the Local Newspaper 
Group of American Publishing Company as of December 31, 1997, and the results 
of their operations and their cash flows for the Predecessor periods, in 
conformity with generally accepted accounting principles.

As discussed in note 1 to the consolidated financial statements, effective 
January 1, 1998, Liberty Group Operating, Inc. and subsidiaries acquired the 
assets and assumed certain liabilities of the Local Newspaper Group of American 
Publishing Company in a business combination accounted for as a purchase.  As a 
result of the acquisition, the consolidated financial information for the 
periods after the acquisition is presented on a different cost basis than for 
the periods before the acquisition and, therefore, is not comparable.



                                                     /s/ KPMG LLP


Chicago, Illinois
March 30, 1999


                                      F-1
<PAGE>   35

                 LIBERTY GROUP OPERATING, INC. AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEETS
                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
                                                            DECEMBER 31,
                                                          1997         1998
                                                          ----         ----
<S>                                                  <C>           <C>
                                                     (Predecessor) (Successor)
Assets
Current Assets:                                      
Cash and cash equivalents                              $   1,452    $   1,025
Accounts receivable, net of allowance
for doubtful accounts of $1,014 and $1,182
in 1997 and 1998, respectively                            10,308       15,021
Inventory                                                  1,947        2,200
Prepaid expenses                                             278          240
Other current assets                                          --          144
                                                       ---------    ---------
Total current assets                                      13,985       18,630

Property, plant and equipment, net                        20,503       29,283
Intangible assets, net                                    75,212      350,754
Deferred financing costs, net                                 --        7,680
Other assets                                                  --           54
                                                       ---------    ---------
Total assets                                           $ 109,700    $ 406,401
                                                       ---------    ---------


Liabilities and stockholders' equity (deficit)
Current Liabilities:
Borrowings under revolving credit facility             $      --    $  46,000
Current portion of long-term liabilities                     338          388
Accounts payable                                           1,119        2,157
Accrued expenses                                           2,223       14,482
Deferred revenue                                           4,411        5,777
                                                       ---------    ---------
Total current liabilities                                  8,091       68,804

Long-term liabilities:
Senior subordinated notes                                     --      180,000
Long-term liabilities, less current portion                  706        1,446
Deferred income taxes                                      1,764        8,455
                                                       ---------    ---------
Total liabilities                                         10,561      258,705

Stockholders' equity(deficit)
Common stock, $0.01 par value, 1,000 shares 
authorized, 100 shares issued and outstanding at 
December 31, 1998                                             --           --
Additional paid in capital                                    --      148,661
Accumulated deficit                                           --         (965)
Net assets                                                99,139           --
                                                       ---------    ---------
Total stockholders' equity (deficit)                      99,139      147,696
                                                       ---------    ---------
<
Total liabilities and stockholders' equity (deficit)   $ 109,700    $ 406,401
                                                       ---------    ---------
</TABLE>


                                      F-2


         See accompanying notes to consolidated financial statements.
<PAGE>   36
                LIBERTY GROUP OPERATING, INC. AND SUBSIDIARIES

                    CONSOLIDATED STATEMENTS OF OPERATIONS
                             (DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
                                                    YEARS ENDED DECEMBER 31,
                                                -------------------------------
                                                1996         1997          1998
                                                ----         ----          ----
                                           (Predecessor) (Predecessor) (Successor)
REVENUES:
<S>                                          <C>          <C>          <C>
   Advertising                               $  66,816    $  69,602    $  81,554
   Circulation                                  22,004       21,451       22,844
   Job printing and other                        8,722        7,666        8,133
                                             ---------    ---------    ---------
Total revenues                                  97,542       98,719      112,531
OPERATING COSTS AND EXPENSES:
   Operating costs                              39,660       39,309       45,976
   Selling, general and administrative          29,919       29,171       36,303
   Depreciation and amortization                 7,854        7,470       11,917
                                             ---------    ---------    ---------
Income from operations                          20,109       22,769       18,335
Interest expense                                10,968       10,551       19,300
                                             ---------    ---------    ---------
Income (loss) before income taxes                9,141       12,218         (965)
Income taxes                                     4,006        5,271           --
                                             ---------    ---------    ---------
Net income (loss)                                5,135        6,947         (965)
                                             =========    =========    =========   
</TABLE>


          See accompanying notes to consolidated financial statements.



                                      F-3
<PAGE>   37

                LIBERTY GROUP OPERATING, INC. AND SUBSIDIARIES

           CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
                             (DOLLARS IN THOUSANDS)


<TABLE>
<CAPTION>
                                      Common       Common     Additional
                                      Stock        Stock       Paid-In       Net       Accumulated
                                      Shares       Amount      Capital     Assets        Deficit        Total
                                      ------      --------    --------     ------      -----------    --------
<S>                                   <C>         <C>          <C>        <C>             <C>         <C> 
Balances at 12/31/95                   --         $   --           --      106,945          --         106,945

Net income                             --             --           --        5,135          --           5,135

Transfers to APC, net                  --             --           --       (9,100)         --          (9,100)
                                     ------       --------     -------    --------       ------       -------- 

Balances at 12/31/96                   --             --           --      102,980          --         102,980

Net income                             --             --           --        6,947          --           6,947

Transfers to APC, net                  --             --           --      (10,788)         --         (10,788)
                                     ------       --------     -------    --------       ------       -------- 

Balances at 12/31/97                   --             --           --       99,139          --          99,139

Reorganization of company              --             --           --      (99,139)         --         (99,139)

Issuance of common stock              100             --       148,501        --            --         148,501

Common stock issued in exchange   
 for services                          --             --           160        --            --             160

Net loss                               --             --           --         --          (965)           (965)
                                     ------       --------     -------    --------       ------       -------- 
Balances at 12/31/98                  100         $   --       148,661        --          (965)       (147,696)
                                     ======       ========     =======    ========       ======       ======== 
</TABLE>
    

          See accompanying notes to consolidated financial statements.




                                      F-4
<PAGE>   38
                 LIBERTY GROUP OPERATING, INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                             (DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                           YEARS ENDED DECEMBER 31,
                                                                   --------------------------------------
                                                                       1996         1997         1998
                                                                   -----------   -----------  ------------
                                                                  (Predecessor) (Predecessor) (Successor)
<S>                                                                <C>          <C>           <C>
Cash flows from operating activities:
   Net income (loss)                                                $   5,135    $   6,947    $    (965)
   Adjustments to reconcile net earnings to net
   cash provided by operating activities:
      Depreciation and amortization                                     7,854        7,470       11,917
      Amortization of debt issue costs                                     --           --          928
      Noncash compensation                                                 --           --          238

   Changes in assets and liabilities, net of
   acquisitions:
      Accounts receivable, net                                           (376)         311         (805)
      Inventories                                                       1,850         (336)         103
      Prepaid expenses and other assets                                    (1)         (19)         972
      Accounts payable                                                   (577)         (85)        (209)
      Accrued expenses                                                    228          207        9,072
      Deferred revenue                                                    190           82          113
                                                                    ---------    ---------    ---------
Net cash flows provided by operating activities:                       14,303       14,577       21,364
                                                                    ---------    ---------    ---------

Cash flows from investing activities:
      Purchases of property, plant and equipment                       (3,081)      (1,713)      (2,232)
      Acquisitions, net of cash acquired                               (1,439)      (1,657)    (386,446)
                                                                    ---------    ---------    ---------
Net cash flows used in investing activities:                           (4,520)      (3,370)    (388,678)
                                                                    ---------    ---------    ---------

Cash flows from financing activities:
      Net proceeds from issuing long-term debt                             --           --      172,464
      Net borrowings (repayments) under revolving credit facility          --           --       46,000
      Net proceeds from issuing common stock                               --           --      148,423
      Payments on long term liabilities                                  (844)        (735)          --
      Transfers to APC, net                                            (9,100)     (10,788)          --
                                                                    ---------    ---------    ---------
Net cash provided by (used in) financing activities                    (9,944)     (11,523)     366,887
                                                                    ---------    ---------    ---------

Net decrease in cash and cash equivalents                                (161)        (316)        (427)
Cash and cash equivalents, at beginning of period                       1,929        1,768        1,452
Cash and cash equivalents, at end of period                         $   1,768    $   1,452    $   1,025

Supplemental cash flow disclosure -
      Cash interest paid                                                   --           --       10,913
      Repayment of stock subscription through
        forgiveness of debt                                                --           --           78
</TABLE>


          See accompanying notes to consolidated financial statements.


                                       F-5
<PAGE>   39
                LIBERTY GROUP OPERATING, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

(1)  DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

  (a)  DESCRIPTION OF BUSINESS

         The Company is a leading U.S. publisher of local newspapers and related
publications that are the dominant source of local news and print advertising in
their markets. The Company owns and operates 251 publications in 15 states. The
Company's total revenues are derived from advertising (73% of 1998 total
revenues), circulation (20%) and job printing and other (7%). Raw materials,
mainly newsprint and ink, are readily available from a number of suppliers. No
single customer accounts for a significant percentage of revenues.

  (b)  BASIS OF PRESENTATION

          Liberty Group Operating, Inc. was formed for purposes of acquiring a
portion of the daily and weekly newspapers owned by American Publishing Company
or its subsidiaries ("APC"), a wholly-owned subsidiary of Hollinger
International Inc. ("Hollinger"). Its parent, Liberty Group Publishing, Inc.
(LGP), is a holding company for its wholly-owned subsidiary Liberty Group
Operating, Inc. ("Operating Company"). The consolidated financial statements
include the accounts of Operating Company and their consolidated subsidiaries
(the "Company").

          On January 27, 1998, the Company's parent acquired from Hollinger
virtually all of the assets and assumed certain liabilities that were used
primarily in the business of publishing, marketing and distributing certain
local newspapers (the "Initial Acquisition"). The initial purchase price
including fees and expenses was $322,378. The effective date of the Initial
Acquisition was January 1, 1998.

         Prior to the Initial Acquisition, the Company's operations represented
a portion of APC and the Company's operations were financed through APC. The
accompanying consolidated financial statements represent all of the assets and
associated revenues, expenses, and cash flows of the Company, assuming that the
Company was organized for all periods as a separate legal entity. Intercompany
transactions between newspapers owned by the Company have been eliminated.

         The historical interest expense represents an allocation of APC's
interest expense (calculated as APC's weighted average interest rate of 10.45%
and 10.64% for the years ended December 31, 1996 and 1997, respectively, applied
to the average balances of the net assets of the Business for each respective
period). Because the Company's capital structure changed significantly as a
result of the Initial Acquisition, historical interest expense is not
necessarily indicative of the interest expense that the Company would have
incurred as a separate independent entity.

         In the accompanying financial statements the terms "Liberty Group
Operating" or the "Company" when used with respect to periods prior to January
1, 1998 refer to the combined group of newspapers sold by APC (the Local
Newspaper Group of American Publishing Company) and when used with respect to
periods subsequent to January 1, 1998 refers to Liberty Group Publishing, Inc.
and its consolidated subsidiaries.  The combined historical financial
information of the newspapers acquired from APC prior to the Initial Acquisition
on January 1, 1998 is referred to as "Predecessor" while the consolidated
financial information of the newspaper subsequent to the date of the Initial
Acquisition is referred to as "Successor."

         The Company has accounted for the Initial Acquistion using the purchase
method of accounting.  Accordingly, the costs of the Initial Acquisition have
been allocated to the assets acquired and liabilities assumed based upon their
respective fair values using independent valuations.  The costs of certain
intangible assets acquired of $296.5 million are being amortized over periods
ranging from 5 to 40 years.  Because of the purchase price allocation, the
accompanying financial statements of Successor are not directly comparable to
those of Predecessor.

  (c)  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 date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

  (d)  INVENTORIES

         Inventories consist principally of newsprint, which is valued at the
lower of cost or net realizable value. Cost is determined using the first-in,
first-out (FIFO) or moving-average method.

  (e)  PROPERTY, PLANT AND EQUIPMENT

         Property, plant and equipment is recorded at cost. Routine maintenance
and repairs are expensed as incurred.

         Depreciation is calculated under the straight-line method over the
estimated useful lives, principally 25 years for buildings and improvements and
5 to 10 years for machinery and equipment. Leasehold improvements are amortized
using the straight-line method over the shorter of the lease term or estimated
useful life of the asset.

  (f)  INTANGIBLE ASSETS

         Intangible assets consist principally of circulation-related assets,
noncompetition agreements with former owners of acquired newspapers, and the
excess of acquisition costs over estimated fair value of net assets acquired

                                      F-6
<PAGE>   40
(goodwill). The fair market value of intangible assets purchased is determined
primarily through the use of independent appraisals. Amortization is calculated
using the straight-line method over the respective estimated useful lives
ranging from 33 years for circulation related assets, up to 10 years for
noncompetition agreements depending upon the specifics of the agreement, and 40
years for advertiser lists and goodwill.

         The Company assesses the recoverability of its long-lived assets, such
as property, plant and equipment and intangible assets, whenever events or
changes in business circumstances indicate the carrying amount of the assets, or
related group of assets, may not be fully recoverable. Factors leading to
impairment include a combination of historical losses, anticipated future losses
and inadequate cash flow. The assessment of recoverability is based on
management's estimate. If undiscounted operating cash flows do not exceed the
net book value of the long-lived assets, then a permanent impairment has
occurred. The Company would record the difference between the net book value of
the long-lived asset and the fair value of such asset as a charge against income
in the consolidated statement of operations if such a difference arose.

  (g)  REVENUE RECOGNITION

         Circulation revenue, which is billed to the customers at the beginning
of the subscription period, is recognized on a straight-line basis over the term
of the related subscription. Advertising revenue is recognized upon publication
of the advertisements. The revenue for job printing is recognized upon delivery.

  (h)  INCOME TAXES

         Subsequent to the Initial Acquisition, the Company has been, and
anticipates that it will be for the foreseeable future, in a tax loss position.
Given the uncertainty as to the timing of the Company's ability to utilize such
losses to offset future taxable income, the Company does not presently
anticipate recording any tax benefit associated with its pre-tax losses. Prior
to the Initial Acquisition, the Company represents a business unit of APC and as
such did not file separate income tax returns. The income tax provision included
in the accompanying consolidated statements of operations has been computed as
if the Company were a separate company.

         Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to the difference between financial statement carrying
amounts of existing assets and liabilities and their respective tax basis.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. Historical results of the
predecessor reflect current income taxes as transfers to APC as APC is
responsible for the payment of income tax liabilities. State income taxes were
computed utilizing a blended state rate of 5%, which is net of federal income
tax benefit.

  (i)  FAIR VALUE OF FINANCIAL INSTRUMENTS AND LONG-LIVED ASSETS

         The Company has reviewed the following financial instruments and
determined that their fair values approximated their carrying values as of
December 31, 1998: cash equivalents; borrowings under line of credit; accounts
receivable; accounts payable and accrued expenses; Senior Subordinated Notes;
and long-term liabilities. 



                                      F-7
<PAGE>   41


  (j)  CASH AND CASH EQUIVALENTS

         Cash and cash equivalents represent cash and highly liquid certificates
of deposit with a maximum term at origination of three months or less.

  (k)  RECLASSIFICATIONS
 
         Certain amounts in prior years' financial statements and related notes 
have been reclassified to conform to the 1998 presentation.



(2)  ACQUISITIONS

         During 1998, the Company acquired substantially all of the assets of
166 newspapers for $322,378. The Company also acquired certain other newspapers
for an aggregate purchase price of approximately $61,787. The purchase prices
were allocated to the assets using the purchase method of accounting. The excess
of the purchase prices over the estimated fair value of the tangible and
identifiable intangible assets acquired (goodwill) was $125,496 for the year
ended December 31, 1998. Results of the acquired newspaper businesses have been
included in consolidated statements of operations since the dates of
acquisition.                     

         The following unaudited pro forma summary presents the Company's
results of operations as if the acquisitions accounted for as purchases had
occurred at the beginning of the period. This summary is provided for
informational purposes only. It does not necessarily reflect the actual results
that would have occurred had the acquisitions been made as of the beginning of
the period or of results that may occur in the future.

<TABLE>
<CAPTION>
                                              1998
                                             
                                          (in thousands)
<S>                                        <C>
Revenues                                      $139,800
Net income (loss)                                1,297
</TABLE>


(3)  PROPERTY, PLANT AND EQUIPMENT

         Property, plant and equipment consisted of the following:

<TABLE>
<CAPTION>
                                      DECEMBER 31,
                                  -------------------
                                    1997       1998
                                    ----       ----

<S>                              <C>         <C>
Land                             $  2,131    $  5,032
Buildings and improvements         13,906      14,558
Machinery and equipment            19,781       9,106
Furniture and fixtures             10,425       1,905
                                 --------    --------
                                   46,243      30,601
Less accumulated depreciation     (25,740)     (1,318)
                                 --------    --------
                                 $ 20,503    $ 29,283
                                 ========    ========
</TABLE>


(4)  INTANGIBLE ASSETS

         Intangible assets consisted of the following:

<TABLE>
<CAPTION>
                                          DECEMBER 31,
                                         1997         1998
                                         ----         ----

<S>                                     <C>          <C>
Non-compete agreements                    28,646       18,423
Subscriber lists                          50,741       41,100
Advertiser lists                          21,214      162,220
Archives                                   1,210       14,114
Goodwill                                  37,760      125,496
                                        --------     --------
                                         139,571      361,353        
Less accumulated amortization            (64,359)     (10,599) 
                                        --------     --------
                                        $ 75,212     $350,754
                                        ========     ========
</TABLE>


                                      F-8
<PAGE>   42

(5)  ACCRUED EXPENSES

         Accrued expenses consisted of the following:

<TABLE>
<CAPTION>
                                          DECEMBER 31,
                                          ------------
                                        1997        1998
                                        ----        ----
<S>                                   <C>         <C>
Accrued payroll                       $  944     $ 1,184
Accrued vacation                         309         312
Accrued bonus                            554       5,452
Accrued interest                          --       7,459
Accrued other                            416          75
                                      ------     -------
                                      $2,223     $14,482
                                      ======     =======
</TABLE>

(6) LONG-TERM DEBT

         Long-term debt at December 31, 1997 and 1998 consists of the following:

<TABLE>
<CAPTION>
                                                            1997                1998
                                                            ----                ----
<S>                                                         <C>             <C>
Liberty Group Operating, Inc.
9.37% Senior Subordinated Notes
Due February 1, 2008                                         -0-           $180,000
Less current installments                                    -0-                -0-
Long-term debt, excluding current installments

         Total                                               -0-           $180,000
                                                             ===           ========
</TABLE>


The aggregate maturities of long-term debt for each of the five years subsequent
to December 31, 1998 are as follows:; 1999, $0; 2000, $0; 2001,$0; 2002, $0; and
2003, $0; and thereafter $180,000.

The Initial Acquisition, including the payment of related fees and expenses, was
financed in part by: (i) $180,000 from the issuance and sale by the Operating
Company of $180,000 aggregate principal amount of 9.375% Senior Subordinated
Notes (the "Notes") due February 1, 2008 and (ii) $50,500 from the issuance and
sale by LGP of $89,000 aggregate



                                      F-9
<PAGE>   43
principal amount of 11.625% Senior Discount Debentures (the "Debentures") due
February 1, 2009. LGP is dependent upon the cash flows of the Operating Company
to service these debt repayment requirements.

The Notes were issued by the Operating Company and are general unsecured
obligations of the Operating Company. The Notes are irrevocably and
unconditionally joint and severally guaranteed by each of the Operating
Company's existing and future subsidiaries. The Notes are redeemable for cash at
the option of the Operating Company anytime after February 1, 2003 at stipulated
redemption amounts or, in certain limited circumstances, are partially
redeemable on or prior to February 1, 2001 at a redemption amount of 109.375% of
their principal amount. In the event of a change in control of the Operating
Company or the Company, the Company must offer to repurchase the Notes at 101%
of their principal amount.



(7)  REVOLVING CREDIT FACILITY

On January 27, 1998 the Operating Company entered into a five-year $125,000
revolving credit facility (the "Revolving Credit Facility"). The Revolving
Credit Facility is secured by substantially all of the tangible and intangible
assets of the Operating Company. Borrowings under the revolving credit facility
bear interest at an annual rate, at the Company's option equal to the Base Rate
(as defined in the credit agreement) or the Eurodollar Rate (as defined in the
credit agreement) plus a margin that varies based upon a ratio set forth in the
credit agreement (the "Applicable Margin"). Under the terms of the Revolving
Credit Facility, the Company pays a fee equal to the Applicable Margin for
Eurodollar Rate Advances (as defined in the credit agreement) per annum on the
aggregate amount of outstanding letters of credit. The Operating Company also
pays a fee on the unused portion of the Revolving Credit Facility. At December
31, 1998 the Operating Company has utilized $46,000 of the Revolving Credit
Facility. The Average Interest Rate on these Borrowings was slightly more than
7% per annum at December 31, 1998.


(8)  LONG-TERM LIABILITY

         The long-term liability principally represents amounts due under
non-interest- bearing non-compete agreements through 2008.

         The aggregate amount of principal payments at December 31, 1998
follows:
<TABLE>
<S>                                                                <C>
1999                                                              $  388
2000                                                                 270
2001                                                                 260
2002                                                                 260
2003                                                                 179
Thereafter                                                           395
                                                                  ------
                                                                  $1,752
                                                                  ======
</TABLE>

(9) ISSUANCE OF COMMON STOCK

On the date of the Initial Acquisition, the Company issued 100 shares of Common
Stock, par value $0.01 per share, to LGP. No other shares common shares were
issued during the year.



                                      F-10
<PAGE>   44
(10)  INCOME TAXES

Income taxes for the periods shown below consisted of:

<TABLE>
<CAPTION>
                                                                                 CURRENT        DEFERRED            TOTAL
                                                                                 -------        --------            -----

<S>                                                                              <C>            <C>                 <C>
Year ended December 31, 1998:
   U.S. Federal                                                                   $   --          $   --            $   --
   State and local                                                                    --              --                --
                                                                                  ------          ------            ------
 
Year ended December 31, 1997:
   U.S. Federal                                                                    4,009             659             4,668
   State and local                                                                   603              --               603
                                                                                  ------          ------            ------
                                                                                   4,612             659             5,271
                                                                                  ======           =====            ======
Year ended December 31, 1996:
   U.S. Federal                                                                    3,599            (102)            3,497
   State and local                                                                   509              --               509
                                                                                  ------          ------            ------
                                                                                   4,108            (102)            4,006
                                                                                  ======          ======            ======
</TABLE>

         In 1996, 1997, and 1998, income tax expense (benefit) differed from the
amounts computed by applying the U.S. Federal income tax rate of 35% in 1996 and
1997 and 34% in 1998 to earnings (loss) before income tax expense as a result of
the following:


                                        
                                      F-11
<PAGE>   45
<TABLE>
<CAPTION>
                                                  YEARS ENDED DECEMBER 31,             
                                              -------------------------------   
                                              1996             1997       1998
                                              ----             ----       ----   
<S>                                           <C>             <C>       <C>     
Computed "expected" tax expense (benefit)     $3,199          $4,276       (328)
Increase in income taxes resulting from:                                     
  Amortization of nondeductible goodwill         344             344         89 
  State and local income taxes                   463             651         --    
  Nondeductible expenses                          --              --         12 
  Change in Federal valuation allowance           --              --        227  
                                              ------          ------    -------     
                                              $4,006          $5,271    $    --
                                              ======          ======    =======    
</TABLE>                                        


         The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and liabilities at 1997 and 1998 are
presented below:

<TABLE>
<CAPTION>
                                                                           1997                 1998      
                                                                           ----                 ----

<S>                                                                       <C>              <C>       

Deferred tax assets:

  Accounts receivable, principally
    due to allowance for doubtful accounts                                 $  405              $  473 
  Accrued expenses                                                            124               1,643
  Net operating losses                                                         --               3,198
                                                                           ------             ------- 

Gross deferred tax assets                                                     529               5,314
less: valuation allowance                                                      --                (266)
                                                                           ------             ------- 
  Net deferred tax assets                                                     529               5,048
                                                                           ------             ------- 

Deferred tax liabilities:
Long-lived assets, principally due to differences
  in depreciation and amortization                                          2,293               5,082
Intangible assets, principally due to
  differences in amortization                                                  --               8,421
                                                                           ------             ------- 
                                                                            2,293              13,503
                                                                           ------             ------- 
  Net deferred tax liability                                               $1,764             $ 8,455 
                                                                           ======             =======
</TABLE>

At December 31, 1998, the Company maintains net operating loss carryforwards 
for federal and state income tax purposes of $7,996, which are available to 
offset future taxable income, if any, and which begin to expire in 2018.

In assessing the realizability of deferred tax assets, management considers 
whether it is more likely than not that some portion or all of the deferred 
tax assets will not be realized.  The ultimate realization of deferred tax 
assets is dependent upon the generation of future taxable income during the 
periods in which those temporary differences become deductible.  Management 
considers the scheduled reversal of deferred tax liabilities, projected future 
taxable income, and tax planning strategies in making this assessment.  Based 
upon the lack of historical taxable income and projections for future taxable 
income over the periods which the deferred tax assets are deductible, 
management believes that a portion of the recorded deferred tax assets will not 
be recoverable.  Accordingly, the Company has recorded a valuation allowance 
against certain federal and state deferred tax assets during 1998 amounting to 
$266.

The Company acquired deferred tax liabilities of $8,455 in 1998 through 
corporate acquisitions.


(11)  EMPLOYEE BENEFIT PLANS

         During 1998, the Company's parent established certain benefit plans for
employees of the Company and its subsidiaries.

         LGP established a defined contribution plan conforming to IRS
rules for 401(k) plans, for all of its employees satisfying minimum service
requirements as set forth under the plan. The plan allows for a discretionary
matching contribution. The Company did not make a matching contribution in 1998.


          LGP established three non-qualified deferred compensation plans, as
described below, for certain employees of the Company and its subsidiaries.

          LGP established the Liberty Group Publishing, Inc. Publishers'
Deferred Compensation Plan ("Publishers Plan"), a non-qualified deferred
compensation plan for the benefit of certain designated publishers of the
Company's newspapers. Under the Publishers' Plan, the Company credits an amount
to a bookkeeping account established for each participating publisher pursuant
to a pre-determined formula which is based upon the gross operating profits of
each such publisher's newspaper. The bookkeeping account is credited with
earnings and losses based upon the investment choices selected by the
participant. The amounts credited to the bookkeeping account on behalf of each
participating publisher vest on an installment basis over a period of 15 years.
A participating publisher forfeits all amounts under the Publishers' Plan in the
event that the publisher's employment with the Company is terminated for "cause"
as defined in the Publishers' Plan. Amounts credited to a participating
publisher's bookkeeping account are distributable upon termination of the
publisher's employment with the Company, and will be made in a lump sum or
installments as elected by the publisher.


                                      F-12
<PAGE>   46
          LGP established the Liberty Group Publishing, Inc. Executive Benefit
Plan ("Executive Benefit Plan"), a non-qualified deferred compensation plan for
the benefit of certain key employees of the Company and its subsidiaries. Under
the Executive Benefit Plan, the Company credits an amount, determined by the
Company's sole discretion, to a bookkeeping account established for each
participating key employee. The bookkeeping account is credited with earnings
and losses based upon the investment choices selected by the participant. The
amounts credited to the bookkeeping account on behalf of each participating key
employee vest on an installment basis over a period of 5 years. A participating
key employee forfeits all amounts under the Executive Benefit Plan in the event
that the key employee's employment with the Company is terminated for "cause" as
defined in the Executive Benefit Plan. Amounts credited to a participating key
employee's bookkeeping account are distributable upon termination of the key
employee's employment with the Company, and will be made in a lump sum or
installments as elected by the key employee.

          LGP established the Liberty Group Publishing, Inc. Executive Deferral
Plan ("Executive Deferral Plan"), a non-qualified deferred compensation plan for
the benefit of certain key employees of the Company and its subsidiaries. Under
the Executive Deferral Plan, eligible key employees may elect to defer a portion
of their compensation for payment at a later date. Currently, the Executive
Deferral Plan allows a participating key employee to defer up to 100% of his or
her annual compensation until termination of employment or such earlier period
as elected by the participating key employee. Amounts deferred are credited to a
bookkeeping account established by the Company for this purpose. The bookkeeping
account is credited with earnings and losses based upon the investment choices
selected by the participant. Amounts deferred under the Executive Deferral Plan
are fully vested and nonforfeitable. The amounts in the bookkeeping account are
payable to the key employee at the time and in the manner elected by the key
employee.

(12)  RELATED PARTY TRANSACTIONS 

EXECUTIVE STOCK INVESTMENTS

          During 1998, the majority common stockholder of LGP transferred 1,600
common shares of LGP to the Chief Executive Officer upon the commencement of his
employment. This transaction was treated as a compensation expense and an
additional contribution to paid in capital.

The Company has loaned the Chief Executive Officer $250 pursuant to an
Unsecured Promissory Note. The Loan will be forgiven on a pro rata Daily Basis
from January 28, 1998 to January 28, 2001. The Loan will be forgiven in its
entirety if the Chief Executive Officer is terminated by the Company without
cause or if the Chief Executive Officer terminates his employment for good
reason (as defined in the agreement) death, disability, or upon the consummation
of an initial public offering of securities of the Company or its parent.

In addition, certain other executives were given the opportunity to purchase 
common stock in LGP. Under the plan, each executive paid cash for 50% 
of their stock investment and executed a five year note for the remaining 50%. 
The Company has the right to repurchase the common stock at the original cost 
if the executive terminates his employment or is terminated for cause.

MANAGEMENT FEES

During 1998, the Company paid $917 in management fees to the majority common 
stockholder of its parent.




                                      F-13

<PAGE>   47


(14)     SUBSEQUENT EVENTS

         In January of 1999, the Company purchased all of the stock of Life
Printing & Publishing a chain of 17 weekly publications in Oak Brook, Illinois
with a combined circulation of 120,000. In February 1999, the Company has also
purchased the 31,000 circulation Halstad Shopper located in Halstad, Minnesota.



                                      F-14
<PAGE>   48
                          INDEPENDENT AUDITORS' REPORT


To the Stockholders and Board of Directors
Liberty Group Operating, Inc.:

Under date of March 30, 1999, we reported on the consolidated balance sheet of
Liberty Group Operating, Inc. and subsidiaries (Successor) as of December 31,
1998, and the combined statement of net assets of the Local Newspaper Group of
American Publishing Company (Predecessor) as of December 31, 1997, and the
related consolidated statements of operations, stockholders' equity (deficit)
and cash flows for the year ended December 31, 1998 (Successor period), and the
related combined statements of operations and changes in net assets and cash
flows for each of the years in the two-year period ended December 31, 1997, as
contained in the 1998 Form 10-K. In connection with our audits of the
aforementioned consolidated and combined financial statements, we also audited
the related financial statement schedule. The financial statement schedule is
the responsibility of the Companies' management. Our responsibility is to
express an opinion on the financial statement schedule based on our audits.

In our opinion, such financial statement schedule, when considered
in relation to the basic consolidated and combined financial statements taken as
a whole, presents fairly, in all material respects, the information set forth
therein.

                                                     /s/ KPMG LLP


Chicago, Illinois
March  30, 1999





                                      S-1
<PAGE>   49
                                   SCHEDULE II

                LIBERTY GROUP OPERATING, INC. AND SUBSIDIARIES

                        VALUATION AND QUALIFYING ACCOUNTS

<TABLE>
<CAPTION>
                                  
           ALLOWANCE FOR
             DOUBTFUL                               BEGINNING            BAD DEBT                                   ENDING
             ACCOUNTS                                BALANCE             EXPENSE             WRITE-OFFS             BALANCE
------------------------------------------------------------------------------------------------------------------------------
<S>                                                 <C>                 <C>                   <C>                  <C>
Year ended December 31, 1996                            968               601                   (547)                1,022     
Year ended December 31, 1997                          1,022               763                   (771)                1,014     
Year ended December 31, 1998                        $ 1,014             $ 694                 $ (526)              $ 1,182     
</TABLE>





           
           
           


      
      
      

            
            
            


          
          
          
                                      S-2
<PAGE>   50
                                   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.


Dated: March 31, 1999            LIBERTY GROUP OPERATING, INC. (Registrant)
                                                                     
                                 By  /s/ Kenneth L. Serota               
                                     ------------------------------- 
                                     Kenneth L. Serota,       
                                     President and           
                                     Chief Executive Officer 
                                 
     Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on behalf of the
Registrant in the capacities on the dates indicated.



Dated: March 31, 1999            /s/ Kenneth L. Serota         
                                 -----------------------------------
                                     Kenneth L. Serota,             
                                     President and
                                     Chief Executive Officer  
                                                                    
                                     
Dated: March 31, 1999            /s/ Kevin O'Shea
                                 -----------------------------------
                                     Kevin O'Shea,
                                     Senior Vice President,
                                     Chief Financial Officer
                                     and Secretary
                                     
Dated: March 31, 1999            /s/ Leonard Green
                                 -----------------------------------
                                     Leonard Green, Director
                                     
Dated: March 31, 1999            /s/ Peter Nolan
                                 -----------------------------------
                                     Peter Nolan, Director
                                     
Dated: March 31, 1999            /s/ Greg Annick
                                 -----------------------------------
                                     Greg Annick, Director
                                     
Dated: March 31, 1999            /s/ John Danhakl
                                 -----------------------------------
                                     John Danhakl, Director