<PAGE>   1
 
   
                                                                      EXHIBIT 13
    
 
                              HORIZON GROUP, INC.
                            SELECTED FINANCIAL DATA
 
     The following table sets forth selected financial data of Horizon Group,
Inc. (the "Company"), which includes the results of operations of McArthur/Glen
Realty Corp. ("McArthur/Glen") from July 14, 1995, the date of the merger. The
following information should be read in conjunction with the financial
statements and notes thereto and "Management's Discussion and Analysis of
Results of Operations and Financial Condition" contained elsewhere in this
Annual Report.
 
   
<TABLE>
<CAPTION>
                                                   AS OF OR FOR THE YEAR ENDED DECEMBER 31,
                                          -----------------------------------------------------------
                                             1997         1996         1995        1994      1993(a)
                                             ----         ----         ----        ----      -------
                                           (THOUSANDS, EXCEPT PER SHARE AMOUNTS, NUMBER PROPERTIES,
                                                          AND SHAREHOLDERS OF RECORD)
<S>                                       <C>          <C>          <C>          <C>         <C>
OPERATING DATA:
Revenue.................................  $  155,726   $  153,786   $   93,929   $  43,267   $ 22,247
Expenses................................     153,220      123,929       66,558      26,073     19,274
Impairment and severance................       7,798       65,355           --          --         --
Income (loss) before gain on sale of
  real estate, minority interests and
  extraordinary charge..................      (5,292)     (35,498)      27,371      17,194      2,973
Gain on sale of real estate.............           8          563          776         287        272
Net income (loss) before minority
  interests and extraordinary charge....      (5,284)     (34,935)      28,147      17,481      3,245
Minority interests......................         993        8,080       (6,776)     (2,940)    (2,702)
Extraordinary charge....................      (3,293)        (419)          --          --         --
Net income (loss).......................      (7,584)     (27,274)      21,371      14,541        543
Net income (loss) per common share
  before extraordinary charge and gain
  on sale of real estate(b).............        (.18)       (1.34)        1.47        1.39        .03
Net income (loss) per common share(b)...        (.32)       (1.34)        1.52        1.42        .06
Dividends declared per common
  share(c)..............................       1.050        2.095        2.131       1.755       .247
BALANCE SHEET DATA:
Real estate, net of accumulated
  depreciation..........................  $1,009,599   $  972,334   $1,023,745   $ 287,833   $176,512
Total assets............................   1,072,666    1,059,539    1,059,090     300,043    218,146
Total mortgages and other debt..........     626,097      557,672      503,246      96,929     24,888
Total shareholders' equity (deficit)....     351,234      363,881      341,896     148,849    152,165
OTHER DATA:
Funds From Operations before minority
  interests(d)(e).......................  $   43,406   $   66,258   $   47,549   $  25,656   $  6,860
Cash flows provided by (used in):
  Operating activities..................      46,010       29,947       35,719      26,713      9,557
  Investing activities(e)...............     (75,126)     (59,535)    (150,916)   (114,330)   (93,663)
  Financing activities..................      24,743       39,485      117,592      56,105    118,965
Total gross leasable area (square
  feet).................................       9,907        9,369        8,464       3,124      2,215
Number of properties....................          37           37           35          13         12
SHARES AND SHAREHOLDERS (AT DECEMBER
  31,):
Shares outstanding......................      24,067       22,826       18,552      10,236     10,237
Shareholders of record..................         936          883          642         315        239
</TABLE>
    
 
                                                   (See footnotes on next page.)
 
                                        2
<PAGE>   2
 
-------------------------
(a) The selected financial data includes: for the period up to and including
    November 7, 1993, the combined financial statements of Horizon Group, Inc.
    and certain affiliated partnerships, the impact of the initial public
    offering and related transactions as of November 8, 1993 and for the period
    subsequent to November 8, 1993, the consolidated financial statements of
    Horizon Group, Inc.
 
(b) The earnings per share amounts prior to 1997 have been restated as required
    to comply with Statement of Financial Accounting Standards No. 128. See the
    accompanying notes to the consolidated financial statements. There is no
    difference between basic and diluted earnings per share.
 
(c) Included in 1995 is a special one-time dividend of $.111 per common share,
    declared in connection with the merger with McArthur/Glen.
 
(d) Management believes that in order to facilitate a clear understanding of the
    consolidated historical operating results of the Company, Funds From
    Operations ("FFO") should be considered. Management generally considers FFO
    to be an appropriate measure of the performance of an equity REIT. Funds
    From Operations before minority interests is defined as net income before
    minority interests (computed in accordance with generally accepted
    accounting principles) excluding (1) gains or losses from debt
    restructuring, certain one-time charges and write downs and sales of
    property, (2) depreciation of real estate, (3) amortization other than the
    amortization of deferred financing costs and (4) adjustments for
    unconsolidated partnerships and joint ventures (Funds from Operations as
    defined by the National Association of Real Estate Investment Trusts in
    March 1995). The Company cautions that the calculation of FFO may vary from
    entity to entity and as such the presentation of FFO by the Company may not
    be comparable to other similarly titled measures of other reporting
    companies. FFO does not represent cash flow from operating activities in
    accordance with GAAP and is not indicative of cash available to fund all of
    the Company's cash needs. FFO should not be considered as an alternative to
    net income or any other GAAP measure as an indicator of performance and
    should not be considered as an alternative to cash flow as a measure of
    liquidity or the ability to service debt or to pay dividends. A
    reconciliation of income (loss) before allocation to minority interests to
    FFO is as follows:
 
   
<TABLE>
<CAPTION>
                                                     FOR THE YEAR ENDED DECEMBER 31,
                                           ---------------------------------------------------
                                            1997        1996       1995       1994       1993
                                            ----        ----       ----       ----       ----
<S>                                        <C>        <C>         <C>        <C>        <C>
Net income (loss) before minority
  interests and extraordinary charge       $(5,284)   $(34,935)   $28,147    $17,481    $3,245
FFO Adjustments:
  Depreciation and amortization             39,634      36,367     20,178      8,462     3,887
  Loss on asset impairment                   7,798      65,355         --         --        --
  Merger expenses                            1,001          --         --         --        --
  Gain on sale of assets                        (8)       (563)      (776)      (287)     (272)
  Joint venture adjustments                    265          34         --         --        --
                                           -------    --------    -------    -------    ------
     Total FFO adjustments                  48,690     101,193     19,402      8,175     3,615
                                           -------    --------    -------    -------    ------
FFO                                        $43,406    $ 66,258    $47,549    $25,656    $6,860
                                           =======    ========    =======    =======    ======
</TABLE>
    
 
(e) Certain reclassifications have been made to previously reported balances in
    order to provide comparability to the current year amounts. Those
    reclassifications have not changed previously reported amounts or
    shareholders' equity.
 
                                        3
<PAGE>   3
 
                              HORIZON GROUP, INC.
                    MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                 RESULTS OF OPERATIONS AND FINANCIAL CONDITION
 
GENERAL OVERVIEW
 
     Horizon Group Inc. (the "Company") is a self-administered and self-managed
real estate investment trust ("REIT") that is engaged in the ownership,
acquisition, development and operation of outlet centers. The Company receives
rental revenue through base rent, percentage rent and expense recoveries from
tenants. Base rent represents a minimum amount for which tenants are
contractually obligated. Percentage rent represents an amount tenants are
obligated to pay as additional rent based on a percentage of the tenant's gross
sales in excess of a "breakpoint." Expense recoveries from tenants relate to the
portion of the operating expenses for which the tenants are obligated to
reimburse the Company, including real estate taxes, insurance, utilities and
common area maintenance charges.
 
     The Company has grown by developing new outlet centers, expanding existing
outlet centers, acquiring outlet centers and increasing rental revenue at its
existing outlet centers. At December 31, 1997, the Company operated 37 outlet
centers containing an aggregate of 9.9 million square feet of gross leasable
area ("GLA") in 21 states compared to 37 outlet centers with 9.4 million square
feet of GLA in 20 states at the end of 1996 and 35 factory outlet centers
containing an aggregate of 8.5 million square feet of GLA in 19 states at the
end of 1995. The increase in GLA from 1996 to 1997 was approximately 428,000
square feet of GLA due to the expansion of three outlet centers and the
development of one new outlet center. The Company also acquired an outlet center
adjacent to an existing outlet center owned by the Company that provided
approximately an additional 203,000 square feet. One center of approximately
161,000 square feet was sold for approximately $4.5 million in 1997. The
increase in GLA from 1995 to 1996 was approximately 905,000 square feet of
additional GLA from the expansion of eight outlet centers and the development of
three new outlet centers. The above mentioned factors increasing the GLA of the
Company's properties are collectively referred to as the "Portfolio Expansion."
 
     On July 14, 1995, the Company expanded its operations by merging with
McArthur/Glen Realty Corp. ("McArthur/Glen"), an owner, operator and developer
of factory outlet centers (the "Merger"). At the merger date, McArthur/Glen
operated 20 outlet centers with 3.9 million square feet of GLA. See Note 3 in
the accompanying Consolidated Financial Statements for further information.
 
     The Company's occupancy for stabilized properties was 92%, 89% and 95% at
December 31, 1997, 1996 and 1995, respectively. The Company's properties are
considered to be stabilized if they have been open for twelve months or,
earlier, if they have reached full occupancy (considered by the Company to be
95% occupied).
 
     On November 12, 1997, the Company entered into a merger agreement (which
was amended and restated on February 1, 1998) with Prime Retail, Inc. ("Prime")
which provides for Prime to integrate 22 of the Company's existing outlet
centers into its portfolio and the Company's remaining 13 centers (as well as
two centers currently owned by Prime) to be operated by a newly formed entity.
The shares of the newly formed entity will be distributed following the merger,
on a pro rata basis, to the shareholders of both Prime and the Company. The
transaction will establish Prime as the largest owner/operator and developer of
factory outlet centers in the United States, with 48 centers totaling 13.4
million square feet of GLA in 26 states. The merger is conditioned upon, among
other things, the approvals of each company's shareholders and unit holders and
the satisfaction of other customary conditions.
 
   
     On April 1, 1998, the Company consummated an agreement with Castle & Cooke
Properties, Inc. which released the Company from its obligations under its
long-term lease of the Dole Cannery outlet center in Honolulu, Hawaii, in
connection with the formation of a joint venture with certain affiliates of
Castle & Cooke, Inc. ("Castle & Cooke") to operate such property. Under the
terms of the agreement, Castle & Cooke, the landlord of the project, released
the Company from all post-closing obligations under the lease, which expires in
2045, in exchange for the Company's conveyance to the joint venture of its
rights and obligations under such lease. The agreement also provided that the
Company transfer to such
    
 
                                        4
<PAGE>   4
 
   
joint venture substantially all of the Company's economic interest in its outlet
center in Lake Elsinore, California together with vacant property located
adjacent to the center. The Company expects to record an approximate net loss of
$30.0 million to reflect the transfer of the economic interest in this property.
The Company holds a small minority interest in the joint venture but has no
obligation or commitment with respect to the operations of the Dole Cannery
project following the closing.
    
 
CONSOLIDATED RESULTS OF OPERATIONS
 
1997 COMPARED TO 1996
 
   
     The net loss before minority interests and extraordinary charge was $5.3
million in 1997 compared to net loss before minority interests and extraordinary
charge of $34.9 million in 1996. The loss in 1997 resulted from a $7.8 million
loss on asset impairment and a $1.0 million charge for professional fees
incurred relating to the impending merger with Prime that, as the acquiree under
purchase accounting, is required to be expensed.
    
 
   
     Total revenues increased $1.9 million, or 1.2%, to $155.7 million in 1997
from $153.8 million in 1996. This increase resulted principally from increased
GLA due to the Portfolio Expansion. Base rent increased $1.3 million, or 1.2%,
to $110.8 million in 1997 compared to $109.5 million in 1996. Percent rent was
$3.9 million in 1997 and $3.1 million in 1996, an increase of 25%. The increase
in base rent includes recording $3.0 million of deferred rent relating to the
Company's New Mexico Outlet Center. In July 1997, the Company leased its
Algodones, New Mexico outlet center to Chelsea GCA Realty Partnership, L.P.
("Chelsea") for $4.0 million over a period of two years. The $4.0 million was
prepaid at closing and is non-refundable. Pursuant to its rights under the
lease, Chelsea gave notice in 1997 that it would terminate the lease effective
January 2, 1998, and accordingly, the remaining $3.0 million of deferred rent
was recognized in 1997.
    
 
   
     Tenant expense recoveries decreased $1.1 million, or 3.3%, to $32.7 million
in 1997 compared to $33.8 million in 1996 as a result of additional GLA from the
Portfolio Expansion offset by approximately $1.2 million of operating costs
relating to the Company's Dole Cannery project in Honolulu, Hawaii. As a result,
expense recoveries covered 87.3% of property operating and real estate tax
expenses in 1997 compared to 96.6% in 1996.
    
 
   
     Other income increased $1.0 million, or 13.5%, to $8.4 million in 1997
compared to $7.4 million in 1996 principally from higher temporary tenant
income.
    
 
   
     Property operating and real estate tax expenses increased $2.5 million, or
7.1%, to $37.4 million in 1997 from $35.0 million in 1996 principally from
increased GLA resulting from the Portfolio Expansion.
    
 
     Land lease and other expense increased $10.8 million to $12.3 million in
1997 compared to $1.5 million in 1996, principally due to $8.2 million of space
lease expense, including $4.8 million of straight line expense, associated with
the Dole Cannery project and landlord marketing contributions.
 
   
     General and administrative expenses increased $1.3 million, or 11.1%, to
$13.0 million in 1997 compared to $11.7 million in 1996 principally due to $1.6
million in increased professional fees and leasing costs offset by a $1.0
million decline in the provision for uncollectible accounts. As a result,
general and administrative expenses, as a percentage of total revenues,
increased to 8.4% in 1997 compared to 7.6% in 1996.
    
 
   
     Depreciation and amortization increased $3.4 million, or 9.2%, to $40.5
million in 1997 compared to $37.1 million in 1996 principally from additional
GLA associated with the Portfolio Expansion. Interest expense increased $10.2
million, or 26.4%, to $48.9 million in 1997 compared to $38.7 million in 1996
due to increased debt levels primarily resulting from the Portfolio Expansion
and a $6.3 million decrease in capitalized interest due to decreased development
activity.
    
 
   
     A loss on asset impairment of $6.9 million was recognized in 1997 to reduce
six properties under sales agreements, subject to certain contingencies, to an
amount equal to estimated sales proceeds less costs to dispose and to record a
$0.9 million charge for undeveloped projects that will not be pursued. At
    
                                        5
<PAGE>   5
                              HORIZON GROUP, INC.
                    MANAGEMENT'S DISCUSSION AND ANALYSIS OF
           RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED)
 
September 30, 1997, six outlet centers were classified as held for sale
resulting from these agreements. One center was sold in November 1997 for
approximately $4.5 million. The agreements for the remaining five properties
were terminated. Management then decided to pursue the sale of only one of the
outlet centers. The remaining four outlet centers were reclassified to real
estate assets in the fourth quarter of 1997 at their fair values as of the date
of the decision not to sell.
 
     In 1997, the Company recorded an extraordinary charge of $3.3 million, net
of minority interests, related to the early retirement of debt. The charge
primarily consisted of the write-off of unamortized debt issuance costs
associated with the debt retired.
 
1996 COMPARED TO 1995
 
   
     The net loss before minority interests and extraordinary charge was $34.9
million in 1996 compared to net income before minority interests and
extraordinary charge of $28.1 million in 1995. The loss in 1996 resulted from
charges and asset write-downs aggregating $65.4 million, comprised of a $61.7
million loss primarily for asset impairment, $2.2 million related to
discontinued development projects and $1.5 million in executive severance costs.
    
 
   
     Total revenues increased $59.9 million, or 63.8%, to $153.8 million in 1996
from $93.9 million in 1995. Base rent increased $41.0 million, or 59.9%, to
$109.5 million in 1996 compared to $68.5 million in 1995. Percent rent was $3.1
million in 1996 and $2.4 million in 1995, an increase of 29.2%. These increases
resulted from increased GLA principally from the Portfolio Expansion and a full
year of operations of outlet centers obtained in the Merger compared to a
partial year of operations in 1995.
    
 
   
     Tenant expense recoveries increased $14.9 million, or 78.8%, to $33.8
million in 1996 compared to $18.9 million in 1995 as a result of additional GLA
from the Portfolio Expansion and the Merger. Expense recoveries covered 96.6% of
property operating and real estate tax expenses compared to 92.3% in 1995.
    
 
     Other income increased $3.4 million, or 84.5%, to $7.4 million in 1996
compared to $4.0 million in 1995 from higher lease termination income and income
related to marketing.
 
   
     Property operating and real estate tax expenses have increased $14.5
million, or 70.7%, to $35.0 million in 1996 from $20.5 million in 1995
principally from increased GLA resulting from the Portfolio Expansion and the
Merger.
    
 
     Land lease and other expense increased $.3 million to $1.5 million in 1996
compared to $1.2 million in 1995, principally due to the straight-line lease
expense associated with the Dole Cannery project.
 
   
     General and administrative expenses increased $6.7 million, or 134.0%, to
$11.7 million in 1996 compared to $5.0 million in 1995 from the inclusion of a
full year of expense in 1996 from the Merger, higher provisions for
uncollectible accounts receivable and increased leasing costs. Primarily as a
result of higher provisions for uncollectible accounts receivable and increased
leasing costs, general and administrative expenses, as a percentage of total
revenues, increased to 7.6% in 1996 compared to 5.3% in 1995.
    
 
   
     Depreciation and amortization increased $16.4 million, or 79.2%, to $37.1
million in 1996 compared to $20.7 million in 1995 principally from a full year
of combined operations relating to the Merger and additional GLA associated with
the Portfolio Expansion. Interest expense increased $19.4 million, or 100.8%, to
$38.7 million in 1996 compared to $19.3 million in 1995 due to increased debt
levels primarily resulting from the Portfolio Expansion as well as debt assumed
from the Merger.
    
 
     As a result of the Company's review of the carrying value of its long-lived
assets, the Company was required to recognize write-downs totaling $61.7 million
during the fourth quarter of 1996 primarily
 
                                        6
<PAGE>   6
 
pursuant to the provisions of Statement of Financial Accounting Standards No.
121, "Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of,"
as follows:
 
     - Cost over-runs and limited success in leasing the Company's Dole Cannery
      project in Honolulu, Hawaii required a write-down of the Company's
      investment in that project together with a reserve against a related
      receivable as of December 31, 1996. Beginning in 1997, the Company has
      expensed and not capitalized leasing, interest and operating costs
      incurred on the Dole Cannery project.
 
     - The decision to market for sale two centers that, based on the expected
      net proceeds, required a write-down of the carrying values of such centers
      to their estimated fair value less cost to sell. One of these properties
      was sold in November 1997 and the other property was reclassified to real
      estate as of December 31, 1997.
 
     - Revised occupancy expectations that indicated a permanent impairment of
      value of three other centers. These centers were written-down to estimated
      fair value.
 
     In addition, fourth quarter 1996 results include charges of $2.2 million
related to development projects which will not be pursued and a $1.5 million
charge for executive severance costs.
 
   
     Net income (loss) in 1996 before minority interests and extraordinary
charge, excluding the $65.4 million in charges and write-downs, improved $2.3
million in 1996 compared to 1995. The improvement resulted principally from
increased GLA due to the Merger and the Portfolio Expansion.
    
 
LIQUIDITY AND CAPITAL RESOURCES
 
     During 1997, the Company, through indirect wholly-owned subsidiaries
("Borrower"), entered into a $300.6 million credit facility with Lehman Brothers
Realty Corporation ("Lender"). The initial loan (the "Initial Loan") of $250.6
million included an initial funding at closing of $212.1 million and a
reservation of financing in the amount of $38.5 million for the acquisition of a
specified property (the "Additional Loan"). The Borrower may borrow an
additional $50.0 million in increments of no less than $10.0 million each,
subject to the satisfaction of certain conditions, including predefined debt
service coverage ratios (the "Second Loan" and collectively with the "Initial
Loan," including the "Additional Loan," the "Loan"). Subsequent to the Initial
Loan, the Company borrowed the entire $38.5 million of the Additional Loan for
the acquisition of the specified property and $11.0 million of the Second Loan.
While the Company has additional availability under the Second Loan, additional
borrowings may not be available due to the financial ratios the Company is
required to maintain. The Company repaid $7.7 million of the Loan in connection
with property sales and refinancing. Interest on the Loan is payable at the
following rates: (i) 1.75% over the London interbank offering rate ("LIBOR") for
the Initial Loan, and (ii) 2.25% over LIBOR for the Second Loan or (iii) if the
Loan is converted to a prime rate loan under certain circumstances at the
Lender's discretion, the prime rate plus .75% with respect to the Initial Loan
and plus 1.25% with respect to the Second Loan. The maturity date of the Loan is
July 1, 1999, unless otherwise extended pursuant to the terms of the Loan. The
net proceeds of the Initial Loan were primarily used to retire the Company's
aggregate outstanding balances under the following: (i) a revolving credit
facility with a subsidiary of First Chicago NBD Corporation and other banks
("FCNBD"), (ii) construction financing facilities with Canadian Imperial Bank of
Commerce ("CIBC"), (iii) four mortgage notes payable and (iv) one revolving
credit facility. The Company recorded a $3.3 million extraordinary charge, net
of minority interests, comprised primarily of unamortized debt issuance costs
associated with the debt retired. The Loan is guaranteed by the Company and the
Operating Partnership and is secured by a pool of 16 properties transferred to
Borrower. The Loan requires the Company to maintain certain financial ratios and
restricts the amount of dividends and distributions that can be made.
 
     Additionally, the Company has an unsecured revolving credit facility that
expires in August 1998 for $4.0 million with a Michigan bank for working capital
requirements, which was completely outstanding as of December 31, 1997. Interest
on borrowings under this facility is charged at the prime rate and the facility
is recourse to the Company.
 
                                        7
<PAGE>   7
                              HORIZON GROUP, INC.
                    MANAGEMENT'S DISCUSSION AND ANALYSIS OF
           RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED)
 
   
     In 1996, the Company formed a venture (the "Venture") with a pension fund
(the "Fund") advised by Heitman Capital Management. The Company contributed a
325,000 square foot center in the Finger Lakes region of New York in 1996 and a
67,000 square foot expansion in 1997 to the Venture. In exchange for the
contribution, the Company received $34.9 million and $7.6 million in cash in
1996 and 1997, respectively, and a 50% interest in the Venture. The Fund
contributed, concurrent with the Company's contribution of property, $34.9
million and $7.6 million in cash in 1996 and 1997, respectively, in return for a
$38.2 million preferred equity position that earns a 9.6% return on the
outstanding balance and a 50% ownership in the Venture. The Fund's entire equity
position, upon election of the Fund, is convertible into 2.2 million shares of
the Company's Common Stock. The Venture is a limited liability corporation in
which the Company owns 50% of the voting interest; therefore, the Venture is
accounted for under the equity method of accounting.
    
 
     In 1997, the Company issued .3 million shares of Common Stock under its
Dividend Reinvestment Plan (DRIP) for an aggregate price of $5.9 million. Net
proceeds from the foregoing sales of Common Stock were used to reduce amounts
outstanding under revolving credit facilities. The Company has discontinued
further stock issuances under the DRIP based on the current market price of the
Company's Common Stock.
 
     During 1998, the Company has no plans to expand its outlet centers.
However, the Company plans to spend approximately $19.0 million for tenant
allowances and capital improvements to its outlet centers in 1998. The Company
plans to fund this expansion with existing cash balances, cash flow from
operations and proceeds from the sale of assets.
 
     The Company expects to meet its short-term liquidity requirements generally
through working capital and cash flows from operations. The Company expects to
meet its long-term requirements, such as tenant allowances for new leases and
capital improvements, through the additional borrowing of long-term debt and the
potential offering of equity securities in the private or public capital
markets. As a result of the Company's leverage and the covenants related to its
debt, the Company's ability to obtain additional financing sources is limited.
There can be no assurances that the Company will be able to successfully obtain
such funding sources or, if obtained, on favorable terms.
 
     Total tenant retail sales at Company outlet centers increased in 1997
compared to 1996. Tenant sales, on a comparative store basis, increased
approximately 3.1% in 1997 compared to 1996, comparable to the trend in the
industry. Lower sales by certain tenants may however have an adverse effect on
tenant plans for new store openings. It is the Company's practice to achieve
minimum pre-leasing levels prior to commencing construction activities. The
Company's results of operations are significantly dependent on the overall
health of the retail industry. Should declines in general retail industry
conditions continue to slow tenant leasing commitments, the Company may delay
construction of certain development and expansion projects pending the
attainment of minimum pre-leasing levels. Such a delay may adversely affect the
Company's ability to capitalize and defer a portion of its direct leasing costs
to the extent that the Company does not reduce such overhead costs.
 
     In order to qualify as a Real Estate Investment Trust ("REIT") for federal
income tax purposes, the Company is required to pay dividends to its
Shareholders of at least 95% of its REIT taxable income in addition to
satisfying other requirements. Although the Company intends to make
distributions to its shareholders in accordance with the requirements of the
Internal Revenue Code of 1986, as amended, it also intends to retain such
amounts as it considers necessary from time to time for the acquisition or
development of new properties as suitable opportunities arise, for the expansion
and renovation of its existing factory outlet centers and for the retirement of
debt.
 
                                        8
<PAGE>   8
 
YEAR 2000
 
     The Year 2000 Issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs that have time-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send invoices or
engage in similar normal business activities.
 
     The Company does not believe that the impact of the recognition of the year
2000 by its information and operating technology systems will have a material
adverse effect on the Company's financial condition and results of operations.
The majority of any necessary system changes will be upgraded in the normal
course of business. The Company has initiated formal communications with all of
its significant suppliers to determine the extent to which the Company's
interface systems are vulnerable to those third parties' failure to remediate
their own year 2000 issues. There can be no guarantee that the systems of other
companies, on which the Company's systems rely, will be timely converted and
would not have an adverse effect on the Company's systems.
 
FUNDS FROM OPERATIONS BEFORE MINORITY INTERESTS
 
   
     Management believes that in order to facilitate a clear understanding of
the consolidated historical operating results of the Company, Funds From
Operations ("FFO") should be considered. Management generally considers FFO to
be an appropriate measure of the performance of an equity REIT. Funds From
Operations before minority interests is defined as net income before minority
interests (computed in accordance with generally accepted accounting principles)
excluding (1) gains or losses from debt restructuring, certain one-time charges
and write-downs and sales of property, (2) depreciation of real estate, (3)
amortization other than the amortization of deferred financing costs and (4)
adjustments for unconsolidated partnerships and joint ventures (Funds From
Operations as defined by the National Association of Real Estate Investment
Trusts in March 1995). The Company cautions that the calculation of FFO may vary
from entity to entity and as such the presentation of FFO by the Company may not
be comparable to other similarly titled measures of other reporting companies.
FFO does not represent cash flow from operating activities in accordance with
GAAP and is not indicative of cash available to fund all of the Company's cash
needs. FFO should not be considered as an alternative to net income or any other
GAAP measure as an indicator of performance and should not be considered as an
alternative to cash flow as a measure of liquidity or the ability to service
debt or to pay dividends. Funds From Operations before minority interests in
1997 decreased $22.9 million, or 34.5%, to $43.4 million compared to $66.3
million in 1996. The decline was principally due to the costs associated with
the Dole Cannery project, and increased general and administrative and interest
costs. Funds From Operations before minority interests increased $18.8 million,
or 39.6%, to $66.3 million in 1996 compared to $47.5 million in 1995. The
increase in 1996 was due to a full year of operations of outlet centers obtained
in the Merger compared to a partial year of operations in 1995.
    
 
INFLATION
 
     The Company's leases with the majority of its tenants require the tenants
to reimburse the Company for most operating expenses and increases in common
area maintenance expenses, which reduces the Company's exposure to increases in
costs and operating expenses resulting from inflation.
 
FORWARD LOOKING STATEMENTS
 
     The statements contained herein, which are not historical facts, are
forward looking statements based upon economic forecast, budgets, and other
factors, which, by their nature, involve known risk, uncertainties and other
factors which may cause the actual results, performance or achievements of
Horizon Group, Inc., to be materially different from any future results implied
by such statements. In
 
                                        9
<PAGE>   9
                              HORIZON GROUP, INC.
                    MANAGEMENT'S DISCUSSION AND ANALYSIS OF
           RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED)
 
particular, among the factors that could cause actual results to differ
materially are the following: business conditions and general economy;
competitive factors; interest rates and other risks inherent in the real estate
business. For further information on factors which could impact the Company and
the statements contained herein, reference is made to the Company's other
filings with the Securities and Exchange Commission.
 
                                       10
<PAGE>   10
 
                              HORIZON GROUP, INC.
                     CONSOLIDATED STATEMENTS OF OPERATIONS
 
   
<TABLE>
<CAPTION>
                                                                  YEAR ENDED DECEMBER 31,
                                                              -------------------------------
                                                                1997        1996       1995
                                                                ----        ----       ----
                                                               (THOUSANDS, EXCEPT PER SHARE
                                                                         AMOUNTS)
<S>                                                           <C>         <C>         <C>
REVENUE
  Base rent.................................................  $110,753    $109,462    $68,533
  Percentage rent...........................................     3,924       3,136      2,441
  Expense recoveries........................................    32,686      33,776     18,930
  Other.....................................................     8,363       7,412      4,025
                                                              --------    --------    -------
     TOTAL REVENUE..........................................   155,726     153,786     93,929
                                                              --------    --------    -------
EXPENSES
  Property operating........................................    24,511      23,041     14,351
  Real estate taxes.........................................    12,930      11,913      6,148
  Land leases and other.....................................    12,317       1,476      1,159
  General and administrative................................    13,047      11,749      4,970
  Merger expense............................................     1,001
  Depreciation and amortization.............................    40,525      37,057     20,660
  Impairment and severance..................................     7,798      65,355
  Interest..................................................    48,889      38,693     19,270
                                                              --------    --------    -------
     TOTAL EXPENSES.........................................   161,018     189,284     66,558
                                                              --------    --------    -------
INCOME (LOSS) BEFORE GAIN ON SALE OF REAL ESTATE, MINORITY
  INTERESTS AND EXTRAORDINARY CHARGE........................    (5,292)    (35,498)    27,371
  Gain on sale of real estate...............................         8         563        776
                                                              --------    --------    -------
NET INCOME (LOSS) BEFORE MINORITY INTERESTS AND
  EXTRAORDINARY CHARGE......................................    (5,284)    (34,935)    28,147
  Minority interests........................................       993       8,080     (6,776)
                                                              --------    --------    -------
NET INCOME (LOSS) BEFORE EXTRAORDINARY CHARGE...............    (4,291)    (26,855)    21,371
  Extraordinary charge on debt prepayment, net of minority
     interests..............................................    (3,293)       (419)
                                                              --------    --------    -------
NET INCOME (LOSS)...........................................  $ (7,584)   $(27,274)   $21,371
                                                              ========    ========    =======
Weighted average common shares outstanding -- basic.........    23,848      20,395     14,016
Earnings per share -- basic and diluted:
Net income (loss) per common share before gain on sale of
  real estate and extraordinary charge......................  $   (.18)   $  (1.34)   $  1.47
Gain on sale of real estate.................................                   .02        .05
Net loss on extraordinary charge............................      (.14)       (.02)
                                                              --------    --------    -------
Net income (loss) per common share..........................  $   (.32)   $  (1.34)   $  1.52
                                                              ========    ========    =======
</TABLE>
    
 
See accompanying notes to the consolidated financial statements.
 
                                       11
<PAGE>   11
 
                              HORIZON GROUP, INC.
                          CONSOLIDATED BALANCE SHEETS
 
   
<TABLE>
<CAPTION>
                                                                     DECEMBER 31,
                                                              --------------------------
                                                                 1997            1996
                                                                 ----            ----
                                                                  (THOUSANDS, EXCEPT
                                                                  PER SHARE AMOUNTS)
<S>                                                           <C>             <C>
ASSETS
Real estate, at cost:
  Land......................................................  $  144,589      $  134,506
  Buildings and improvements................................     947,144         830,548
  Construction in progress..................................       3,120          61,157
  Furniture, fixtures and equipment.........................      10,258          11,523
  Less accumulated depreciation.............................     (95,512)        (65,400)
                                                              ----------      ----------
     TOTAL REAL ESTATE......................................   1,009,599         972,334
Cash and cash equivalents...................................      12,091          16,464
Restricted cash.............................................         751
Tenant accounts receivable..................................       6,489           6,471
Due from joint venture......................................      11,639          13,764
Assets held for sale........................................       1,933          13,075
Deferred costs..............................................      18,708          20,145
Other assets................................................      11,456          17,286
                                                              ----------      ----------
     TOTAL ASSETS...........................................  $1,072,666      $1,059,539
                                                              ==========      ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Mortgages and other debt....................................  $  626,097      $  557,672
Accounts payable and accrued expenses.......................      20,516          30,709
Prepaid rents and other tenant liabilities..................       5,769           5,411
Other liabilities...........................................       7,955           5,524
Dividends and distributions payable.........................          15          14,832
                                                              ----------      ----------
     TOTAL LIABILITIES......................................     660,352         614,148
                                                              ----------      ----------
MINORITY INTERESTS..........................................      61,080          81,510
                                                              ----------      ----------
SHAREHOLDERS' EQUITY:
Common stock, $.01 par value, 47,000 shares authorized,
  24,067 and 22,826 issued and outstanding as of December
  31, 1997 and 1996, respectively...........................         241             228
Additional paid-in capital..................................     468,593         448,637
Dividends in excess of net income...........................    (117,600)        (84,984)
                                                              ----------      ----------
     TOTAL SHAREHOLDERS' EQUITY.............................     351,234         363,881
                                                              ----------      ----------
     TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.............  $1,072,666      $1,059,539
                                                              ==========      ==========
</TABLE>
    
 
See accompanying notes to the consolidated financial statements.
 
                                       12
<PAGE>   12
 
                              HORIZON GROUP, INC.
                CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
 
<TABLE>
<CAPTION>
                                                COMMON SHARES      ADDITIONAL    DIVIDENDS IN
                                               ----------------     PAID-IN       EXCESS OF      SHAREHOLDERS'
                                               NUMBER    AMOUNT     CAPITAL       NET INCOME        EQUITY
                                               ------    ------    ----------    ------------    -------------
                                                                         (THOUSANDS)
<S>                                            <C>       <C>       <C>           <C>             <C>
BALANCE, JANUARY 1, 1995...................    10,236     $102      $154,157      $  (5,410)       $148,849
 
Compensation related to stock bonus
  arrangement..............................                               97                             97
Merger with McArthur/Glen..................     7,839       78       191,004                        191,082
Units exchanged for common shares..........       446        5         9,865                          9,870
Stock options exercised....................        31        1           680                            681
Net income.................................                                          21,371          21,371
Dividends declared.........................                                         (30,054)        (30,054)
                                               ------     ----      --------      ---------        --------
BALANCE, DECEMBER 31, 1995.................    18,552      186       355,803        (14,093)        341,896
Compensation related to stock bonus
  arrangement..............................                                9                              9
Issuance of common stock...................     2,367       23        45,101                         45,124
Units exchanged for common shares..........     1,907       19        40,052                         40,071
Net loss...................................                                         (27,274)        (27,274)
Dividends declared.........................                                         (43,617)        (43,617)
Adjustments to minority interest for
  ownership changes........................                            7,672                          7,672
                                               ------     ----      --------      ---------        --------
BALANCE, DECEMBER 31, 1996.................    22,826      228       448,637        (84,984)        363,881
Issuance of common stock...................       320        3         5,937                          5,940
Units exchanged for common shares..........       921       10        14,367                         14,377
Net loss...................................                                          (7,584)         (7,584)
Dividends declared.........................                                         (25,032)        (25,032)
Adjustment to minority interests for
  ownership changes........................                             (348)                          (348)
                                               ------     ----      --------      ---------        --------
BALANCE, DECEMBER 31, 1997.................    24,067     $241      $468,593      $(117,600)       $351,234
                                               ======     ====      ========      =========        ========
</TABLE>
 
See accompanying notes to the consolidated financial statements.
 
                                       13
<PAGE>   13
 
                              HORIZON GROUP, INC.
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
 
   
<TABLE>
<CAPTION>
                                                                       YEAR ENDED DECEMBER 31,
                                                              -----------------------------------------
                                                                 1997           1996           1995
                                                                 ----           ----           ----
                                                                             (THOUSANDS)
<S>                                                           <C>            <C>            <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) before extraordinary charge.............     $  (4,291)     $ (26,855)     $  21,371
Adjustments to reconcile net income (loss) before
  extraordinary charge to net cash provided by operating
  activities:
  Minority interests in net income (loss).................          (993)        (8,080)         6,776
  Depreciation............................................        37,642         35,069         19,655
  Amortization............................................         5,524          2,690          2,081
  Gain on sale of real estate.............................            (8)          (563)          (776)
  Loss on asset impairment................................         7,798         61,653
  Compensation related to stock bonus arrangement.........                            9             97
Changes in assets and liabilities:
  Tenant accounts receivable..............................           (18)            46         (4,198)
  Due from joint venture..................................         2,125        (13,763)
  Deferred costs and other assets.........................         2,727        (15,961)        (7,909)
  Accounts payable and accrued expenses...................        (7,224)        (7,103)           (19)
  Other liabilities.......................................         2,332          1,897           (589)
  Prepaid rents and other tenant liabilities..............           396            908           (770)
                                                               ---------      ---------      ---------
  NET CASH PROVIDED BY OPERATING ACTIVITIES...............        46,010         29,947         35,719
                                                               ---------      ---------      ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
  Expenditures for real estate and improvements...........       (86,618)       (95,943)      (146,165)
  Proceeds from sale of real estate.......................         4,643          1,508          1,185
  Investment in restricted cash...........................          (751)
  Distributions from joint venture........................         7,600         34,900
  Business acquired, net of cash received.................                                      (5,936)
                                                               ---------      ---------      ---------
  NET CASH USED IN INVESTING ACTIVITIES...................       (75,126)       (59,535)      (150,916)
                                                               ---------      ---------      ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
  Proceeds from the issuance of common stock..............         5,940         45,124
  Dividends...............................................       (37,129)       (40,883)       (25,392)
  Distributions to minority interests.....................        (7,493)       (13,054)        (7,086)
  Proceeds from borrowings................................       261,738        197,067        137,451
  Principal payments on mortgages and other debt..........       (42,543)      (115,633)       (27,378)
  Debt issue costs........................................        (5,375)        (6,501)        (2,805)
  Net proceeds (repayments) on revolving credit
     facilities...........................................      (150,395)       (26,635)        42,122
  Proceeds from the exercise of stock options.............                                         680
                                                               ---------      ---------      ---------
  NET CASH PROVIDED BY FINANCING ACTIVITIES...............        24,743         39,485        117,592
                                                               ---------      ---------      ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS......        (4,373)         9,897          2,395
CASH AND CASH EQUIVALENTS:
  BEGINNING OF YEAR.......................................        16,464          6,567          4,172
                                                               ---------      ---------      ---------
  END OF YEAR.............................................     $  12,091      $  16,464      $   6,567
                                                               =========      =========      =========
</TABLE>
    
 
See accompanying notes to the consolidated financial statements.
 
                                       14
<PAGE>   14
 
                              HORIZON GROUP, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 1 -- ORGANIZATION AND BASIS OF PRESENTATION
 
     Horizon Group, Inc. (the "Company") is a self-administered and self-managed
Real Estate Investment Trust ("REIT") that is engaged in the ownership,
acquisition, development and operation of outlet centers. The accompanying
financial statements include the accounts of the Company and its operating
subsidiary, Horizon/Glen Outlet Centers Limited Partnership ("Operating
Partnership"), which was 85.1% and 81.6% owned by the Company, its sole general
partner, as of December 31, 1997 and 1996, respectively.
 
NOTE 2 -- SIGNIFICANT ACCOUNTING POLICIES
 
     CONSOLIDATION -- The accounts of all wholly or majority owned subsidiaries
of the Company and its Operating Partnership have been consolidated in the
accompanying financial statements. All inter-company accounts and transactions
have been eliminated in consolidation.
 
     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 amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
 
     REAL ESTATE AND DEPRECIATION -- Real estate assets consist primarily of
outlet centers and are stated at cost, less accumulated depreciation. Costs
incurred for the acquisition, development, construction and improvement of
properties, as well as significant renovations and betterments to the
properties, are capitalized. Maintenance and repairs are charged to expense as
incurred. Interest costs incurred with respect to qualified expenditures
relating to the construction of assets are capitalized during the construction
period. Leasing costs and costs to obtain or refinance mortgages are capitalized
as incurred.
 
   
     At December 31, 1997 and 1996, the Company had an aggregate cost basis of
$868.9 million and $855.8 million, respectively, in its real estate assets for
federal income tax purposes. The cost of real estate assets are depreciated on
the straight-line method over estimated useful lives which are:
    
 
<TABLE>
<S>                                                   <C>
Buildings                                             31.5 years
Improvements                                          10 years or lease term, if less
Furniture, fixtures or equipment                      3-7 years
</TABLE>
 
     In accordance with FASB Statement No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," the Company
records impairment losses on long-lived assets used in operations when events
and circumstances indicate that the assets might be impaired and the
undiscounted cash flows estimated to be generated by those assets are less than
the carrying amounts of those assets. Impairment losses are measured as the
difference between carrying value and fair value for assets to be held in
portfolio. For assets to be sold, impairment is measured as the difference
between carrying value and fair value, less costs to dispose. Fair value is
based on estimated cash flows discounted at a risk-adjusted rate of interest or
a value derived from comparable sales transactions in the marketplace. During
1997 and 1996, events and circumstances occurred which required a $7.8 million
and $61.7 million loss on the impairment of assets, respectively. See Note 5. It
is reasonably possible that the estimate of the loss on asset impairment may
change in the near term because of the degree of judgment involved in
determining fair value.
 
     Periodically, in the course of reviewing the performance of its outlet
centers, the Company will determine that certain outlet centers no longer meet
the parameters the Company sets forth for its operating properties, and such
outlet centers are designated to be sold based on the Company's intent to sell
such property. As of December 31, 1996, two such centers, Port Huron, Michigan
and Holland,
 
                                       15
<PAGE>   15
                              HORIZON GROUP, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
Michigan were classified as held for sale. As of December 31, 1997, the
Algodones, New Mexico outlet center was classified as held for sale. See Note 5.
 
   
     REVENUE RECOGNITION -- Leases with tenants are accounted for as operating
leases. Minimum annual rentals are generally recognized on a straight-line basis
over the term of the respective lease. As a result of recording rental revenue
on a straight-line basis, the Company has recorded receivables from tenants, net
of reserves, in the amount of $3.3 million and $2.5 million as of December 31,
1997 and 1996, respectively, which the Company expects to collect over the
remaining life of the leases rather than currently. Contingent rentals based on
common area maintenance expenses and certain other expenses are accrued in the
period in which the related expense is incurred. Percentage rents are accrued on
the basis of reported tenant sales. Accounts receivable are reflected net of
reserves of $2.4 million and $2.1 million as of December 31, 1997 and 1996,
respectively. The provision for doubtful accounts in 1997, 1996 and 1995 was
$1.1 million, $2.1 million and $0.3 million, respectively.
    
 
     OTHER REVENUE -- Other revenue consists primarily of development,
management and leasing income related to other unconsolidated or managed
properties, interest income and income related to marketing services that is
recovered from tenants pursuant to lease agreements.
 
     CASH AND CASH EQUIVALENTS -- The Company considers all highly liquid
investments with a maturity of three months or less when purchased to be cash
and cash equivalents.
 
     RESTRICTED CASH -- Restricted cash consists of amounts deposited to secure
outstanding letters of credit and other amounts which use by the Company is
contractually restricted.
 
     DEFERRED COSTS AND OTHER ASSETS -- Leasing costs and direct financing costs
are capitalized at cost. Amortization is recorded on the straight-line method
over a ten year lease period or the life of the loan, respectively.
 
     INCOME TAXES -- The Company elected to be taxed as a REIT under the
Internal Revenue Code of 1986, as amended (the "Code"), commencing with the
taxable year ending December 31, 1994. A corporate REIT is a legal entity that
holds real estate interests, and, through payments of dividends to shareholders,
is permitted to reduce or to avoid the payment of federal income taxes at the
corporate level. As a REIT, the Company generally will not be taxed on income to
the extent it distributes its REIT taxable income as defined in the Code to its
shareholders and satisfies certain other requirements.
 
     MINORITY INTERESTS -- Minority interests include the minority interests of
unitholders in the Operating Partnership and the minority interests of the
Company's consolidated subsidiaries that are not wholly owned. Minority
interests in earnings is calculated based on the proportion of ownership
interest in the earnings of the applicable subsidiary. The unitholder minority
interest is adjusted at each period end to reflect the ownership percentage at
that particular time. The unitholder minority interest in the REIT was 14.9% and
18.4% at December 31, 1997 and 1996, respectively.
 
     STOCK OPTION PLAN -- The Company has elected to apply Accounting Principles
Board Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees," in
accounting for its employee stock options because, as discussed in Note 11, the
alternative fair value accounting provided for under Statement of Financial
Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock Based
Compensation," requires the use of option valuation models that were not
developed for use on valuing employee stock options. Under APB 25, because the
exercise price of the Company's employee stock options equals or exceeds fair
market value of the underlying stock on the date of grant, no compensation
expense is recognized.
 
     NET INCOME (LOSS) PER SHARE -- In February 1997, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 128
("SFAS 128"), "Earnings per Share," which the Company adopted, as required by
SFAS 128, on December 31, 1997. SFAS 128 replaced the calculation
 
                                       16
<PAGE>   16
 
of primary and fully diluted earnings per share with basic and diluted earnings
per share. Unlike primary earnings per share, basic earnings per share excludes
any dilutive effects of options, warrants and convertible securities. Diluted
earnings per share is very similar to the previously reported fully diluted
earnings per share. All earnings per share amounts for all periods have been
presented, and when appropriate, restated to conform to the SFAS 128
requirements. The conversion of Units to Common Shares has been excluded from
the calculation of basic earnings per share due to certain restrictions on the
conversion of Units to Common Shares.
 
     RECLASSIFICATIONS -- Certain reclassifications have been made to previously
reported balances in order to provide comparability to the statements reported
herein. These reclassifications have not changed previously reported results or
shareholders' equity.
 
NOTE 3 -- BUSINESS COMBINATIONS AND ACQUISITIONS
 
     On November 12, 1997, the Company entered into a merger agreement (which
was amended and restated on February 1, 1998) with Prime Retail, Inc. ("Prime")
which provides for Prime to integrate 22 of the Company's existing outlet
centers into its portfolio and the Company's remaining 13 centers (as well as
two centers currently owned by Prime) to be operated by a newly formed entity.
The shares of this newly formed entity will be distributed following the merger,
on a pro rata basis, to the shareholders of both Prime and the Company. The
Company has expensed costs of $1.0 million in 1997 in conjunction with this
merger. The merger is conditioned upon, among other things, the approvals of
each company's shareholders and unit holders and the satisfaction of other
customary conditions.
 
   
     On April 1, 1998, the Company consummated an agreement with Castle & Cooke
Properties, Inc. which released the Company from its obligations under its
long-term lease of the Dole Cannery outlet center in Honolulu, Hawaii, in
connection with the formation of a joint venture with certain affiliates of
Castle & Cooke, Inc. ("Castle & Cooke") to operate such property. Under the
terms of the agreement, Castle & Cooke, the landlord of the project, released
the Company from all post-closing obligations under the lease, which expires in
2045, in exchange for the Company's conveyance to the joint venture of its
rights and obligations under such lease. The agreement also provided that the
Company transfer to such joint venture substantially all of the Company's
economic interest in its outlet center in Lake Elsinore, California together
with vacant property located adjacent to the center. The Company expects to
record an approximate net loss of $30.0 million to reflect the transfer of the
economic interest in this property. The Company holds a small minority interest
in the joint venture but has no obligation or commitment with respect to the
operations of the Dole Cannery project following the closing.
    
 
     In December 1997, the Company acquired a 203,000 square foot outlet center
adjacent to one of the Company's existing centers for $38.5 million, which was
financed in its entirety.
 
   
     In July 1995, McArthur/Glen Realty Corp. ("McArthur/Glen") merged with and
into the Company as the surviving corporation and the operating partnerships of
the respective companies, McArthur/Glen Outlet Centers Limited Partnership
("McArthur/Glen L.P.") and Horizon Outlet Centers Limited Partnership, were
consolidated into the Operating Partnership (the "Merger"). McArthur/Glen
developed, owned and managed outlet centers. Each outstanding share of
McArthur/Glen common stock was converted into .64 shares of the Company's Common
Stock and each outstanding McArthur/Glen L.P. partnership unit was converted
into .64 units of the limited partnership interest of the Operating Partnership.
Each outstanding unit of Horizon Outlet Centers Limited Partnership was
converted into one unit of limited partnership interest in the Operating
Partnership. The purchase price of $600.4 million consisted of cash of $.9
million, cash of $6.3 million representing costs incurred by the Company in
connection with the Merger, 13.2 million of the Company's common shares and
Operating Partnership units with a market value at the Merger date of $322.0
million, and the assumption of $271.2 million in liabilities. The purchase price
was allocated based on estimated fair values at the date of the Merger. In
addition, outstanding employee stock options to purchase McArthur/Glen common
stock were converted into options to purchase approximately 688,000 shares of
the Company's common stock.
    
 
                                       17
<PAGE>   17
                              HORIZON GROUP, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
     The Merger was accounted for using the purchase method in accordance with
Accounting Principles Board Opinion No. 16. The accompanying consolidated
financial statements include the results of operations of McArthur/Glen from the
date of the Merger.
 
     At December 31, 1997 and 1996, the Company had accrued termination and
severance costs of $0.3 million and $1.1 million related to the Merger,
respectively. The Company paid $0.8 million in 1997, $2.5 million in 1996 and
$1.2 million in 1995 for termination and severance costs. During 1996, the
Company reduced the remaining accrual by $3.3 million, which was reflected as an
adjustment of the purchase price.
 
     The following unaudited pro forma summarized results of operations for the
year ended December 31, 1995 assumes the Merger occurred as of January 1, 1995
(in thousands, except per share amounts).
 
<TABLE>
<CAPTION>
                                                              PRO FORMA
                                                                1995
                                                              ---------
<S>                                                           <C>
Total revenue                                                 $131,804
Net income                                                      26,575
Net income per share                                          $   1.46
</TABLE>
 
     The pro forma information is provided for information purposes only. It is
based on historical information and is not necessarily indicative of what actual
results of operations of the Company would have been, assuming the Merger had
been consummated as of January 1, 1995.
 
     In 1995, the Company acquired an outlet center, adjacent to an existing
center owned by the Company, for a purchase price of $8.7 million, consisting
primarily of the assumption of existing mortgage indebtedness and unpaid real
estate tax obligations.
 
NOTE 4 -- LEASES
 
     Space in outlet centers is leased to various tenants under operating leases
which are generally for 5 to 10 year periods. The leases usually grant tenants
renewal options and provide for additional or contingent rents based on certain
operating expenses as well as tenants' sales volume. The Company expects
expiring leases will be renewed or replaced by other leases in the normal course
of business.
 
     Minimum future rentals to be received under non-cancelable leases as of
December 31, 1997 are summarized as follows (in thousands):
 
   
<TABLE>
<S>                                                           <C>
1998                                                          $106,748
1999                                                            95,787
2000                                                            77,397
2001                                                            57,875
2002                                                            37,648
Thereafter                                                      75,683
                                                              --------
Total                                                         $451,138
                                                              ========
</TABLE>
    
 
     The Company is subject to the usual business risks associated with the
collection of the above scheduled rentals.
 
                                       18
<PAGE>   18
 
     The Company leases land and a building for outlet centers under five
operating lease agreements expiring through the year 2093. At December 31, 1997,
future minimum cash rental commitments were as follows (in thousands):
 
   
<TABLE>
<S>                                                            <C>
1998                                                           $ 1,864
1999                                                             1,053
2000                                                             1,053
2001                                                             1,053
2002                                                             1,053
Thereafter                                                      75,091
                                                               -------
Total                                                          $81,167
                                                               =======
</TABLE>
    
 
   
     The Company recognized lease expense of $8.2 million in 1997 and $0.6
million in 1996, on a straight-line basis, for its Dole Cannery project lease
which expires in 2045. As discussed in Note 3 and reflected in the above table,
the Company was released from its obligations under the Dole Cannery lease in
conjunction with its joint venture agreement with Castle & Cooke.
    
 
     In July 1997, the Company entered into an agreement with Chelsea GCA Realty
Partnership, L.P. ("Chelsea") for lease of the Company's outlet center in
Algodones, New Mexico (the "Center"). The term of the lease was two years, but
could be terminated at any time after December 31, 1997 by Chelsea upon 30 days
written notice. The agreement gave Chelsea the right, during the lease term, to
relocate any and all of the tenants to Chelsea's outlet center located in Santa
Fe, New Mexico. Chelsea was responsible for all costs of operating the Center
during the lease term. At closing, Chelsea prepaid the non-refundable $4.0
million rent, $3.0 million for year one and $1.0 million for year two. Rental
payments were recognized for financial statement purposes on a straight-line
basis over an expected two year lease term. In November 1997, Chelsea gave
written notice of termination, effective January 2, 1998. The Company recorded
approximately $3.0 million of deferred rent in 1997 as a result of the revised
lease term.
 
NOTE 5 -- IMPAIRMENT AND SEVERANCE
 
     Results of operations for 1997 include a charge for asset impairment of
$6.9 million to reduce six properties under sales agreements, subject to certain
contingencies, to an amount equal to their estimated sales proceeds, less costs
to dispose. At September 30, 1997, these six outlet centers were classified as
held for sale resulting from these sales agreements. In November 1997, one
property sold for $4.5 million. The remaining sales agreements were subsequently
terminated. It was management's decision to then pursue the sale of only one of
the outlet centers, the Algodones, New Mexico outlet center, which was
classified as held for sale as of December 31, 1997. The remaining four outlet
centers were subsequently reclassified to real estate assets at their fair
values as of the date of the decision not to sell. The results of operations in
1997 also include a $.9 million charge due to discontinued development projects.
 
     Results of operations for 1996 include a charge of $65.4 million, comprised
of a $61.7 million charge for asset impairment, a $2.2 million charge related to
discontinued development projects and a $1.5 million charge for executive
severance costs. The asset impairment loss resulted from (1) cost over-runs and
limited leasing success in its Dole Cannery project, (2) an initiative by the
Company to market two centers for sale and (3) revised occupancy estimates on
three centers that indicated a permanent impairment in their value.
 
                                       19
<PAGE>   19
                              HORIZON GROUP, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
NOTE 6 -- EARNINGS PER SHARE
 
     The following table sets forth the computation of basic and diluted
earnings per share:
 
<TABLE>
<CAPTION>
                                                       1997        1996       1995
                                                       ----        ----       ----
                                                              (IN THOUSANDS,
                                                          EXCEPT PER SHARE DATA)
<S>                                                   <C>        <C>         <C>
Numerator:
  Net income (loss) before gain on sale of real
     estate and extraordinary charge                  $(4,299)   $(27,418)   $20,595
  Gain on sale of real estate                               8         563        776
  Extraordinary charge                                 (3,293)       (419)
                                                      -------    --------    -------
  Net income (loss) -- basic                           (7,584)    (27,274)    21,371
  Minority interest of Unitholders                     (1,362)     (8,108)     6,734
                                                      -------    --------    -------
  Net income (loss) -- diluted                        $(8,946)   $(35,382)   $28,105
                                                      =======    ========    =======
Denominator:
  Weighted average common shares outstanding --
     basic                                             23,848      20,395     14,016
  Effect of converting units to shares                  4,422       5,982      4,522
                                                      -------    --------    -------
  Weighted average common shares outstanding --
     diluted                                           28,270      26,377     18,538
                                                      =======    ========    =======
Basic and diluted earnings per share:
  Net income (loss) before gain on sale of real
     estate and extraordinary charge                  $  (.18)   $  (1.34)   $  1.47
  Gain on sale of real estate                                         .02        .05
  Extraordinary charge                                   (.14)       (.02)
                                                      -------    --------    -------
  Net income (loss)                                   $  (.32)   $  (1.34)   $  1.52
                                                      =======    ========    =======
</TABLE>
 
   
     Outstanding options and convertible venture interests, other than the
unitholders' minority interest, were excluded because the effect of such items
were anti-dilutive for the periods presented.
    
 
NOTE 7 -- DEFERRED COSTS AND OTHER ASSETS
 
   
<TABLE>
<CAPTION>
                                                                   DECEMBER 31,
                                                                ------------------
                                                                 1997       1996
                                                                 ----       ----
<S>                                                             <C>        <C>
Deferred costs consist of the following (in thousands):
Deferred leasing costs                                          $16,838    $14,650
Deferred financing costs                                         10,410     10,533
Other                                                               646        895
                                                                -------    -------
                                                                 27,894     26,078
Accumulated amortization                                         (9,186)    (5,933)
                                                                -------    -------
                                                                $18,708    $20,145
                                                                =======    =======
Other assets consist of the following (in thousands):
Future development projects                                     $ 1,879    $ 3,115
Escrow deposits                                                   4,505      6,064
Investment in Finger Lakes venture                                2,320      2,979
Other                                                             2,752      5,128
                                                                -------    -------
                                                                $11,456    $17,286
                                                                =======    =======
</TABLE>
    
 
                                       20
<PAGE>   20
 
     At December 31, 1997 and 1996, the Company had $11.6 million and $13.8
million, respectively, due from an unconsolidated joint venture in which the
Company has a 45% interest. The amount due represents cash advances for
construction of an expansion to an existing center ("Joint Venture"). The
Company is also a guarantor of a $17.0 million construction loan of the Joint
Venture. The outstanding balance of the loan was $11.6 million at December 31,
1997. Cash receipts from debt obtained and net cash flows generated by the Joint
Venture are applied to outstanding advances to the Joint Venture from its
partners prior to distributions to the partners.
 
   
     In 1996, the Company formed a venture (the "Venture") with a pension fund
(the "Fund") advised by Heitman Capital Management, a company whose chairman of
its board is also the chairman of the board of the Company. The Company
contributed a 325,000 square foot center in the Finger Lakes region of New York
in 1996 and a 67,000 square foot expansion in 1997 to the Venture. In exchange
for the contribution, the Company received $34.9 million and $7.6 million in
cash in 1996 and 1997, respectively, and a 50% interest in the Venture. The Fund
contributed, concurrent with the Company's contribution of property, $34.9
million and $7.6 million in cash in 1996 and 1997, respectively, in return for a
$38.2 million preferred equity position that earns a 9.6% return on the
outstanding balance and a 50% ownership in the Venture. The Fund's entire equity
position, upon election of the Fund, is convertible into 2.2 million shares of
the Company's Common Stock, which represents an exercise price of $19.63 per
share (the approximate market price of the Company's Common Stock on the issue
date). The Venture is a limited liability corporation in which the Company owns
50% of the voting interest, therefore, the Venture is accounted for under the
equity method of accounting.
    
 
NOTE 8 -- MORTGAGES AND OTHER DEBT
 
     Mortgages and other debt consist of the following (in thousands):
 
<TABLE>
<CAPTION>
                                                               DECEMBER 31
                                                           -------------------
                                                             1997       1996
                                                             ----       ----
<S>                                                        <C>        <C>
Mortgage notes payable                                     $621,748   $402,891
Revolving credit facilities                                   4,000    132,675
Construction loans                                                      21,720
Capital lease obligations                                       349        386
                                                           --------   --------
                                                           $626,097   $557,672
                                                           ========   ========
</TABLE>
 
     Debt matures during each of the five years subsequent to 1997 as follows
(in thousands):
 
<TABLE>
<S>                                                           <C>
1998                                                          $  9,566
1999                                                           259,968
2000                                                            29,131
2001                                                            32,319
2002                                                            80,707
Thereafter                                                     214,406
                                                              --------
                                                              $626,097
                                                              ========
</TABLE>
 
     At December 31, 1997 and 1996, the Company had mortgage notes payable with
various lending institutions with outstanding amounts of $621.7 million and
$402.9 million, respectively. Investments in rental property collateralizes all
mortgage notes payable.
 
     During 1997, the Company, through indirect wholly-owned subsidiaries
("Borrower"), entered into a $300.6 million credit facility with Lehman Brothers
Realty Corporation ("Lender"). The initial loan (the "Initial Loan") of $250.6
million included an initial funding at closing of $212.1 million and a
reservation of financing in the amount of $38.5 million for the acquisition of a
specified property (the "Additional Loan"). The Borrower may borrow an
additional $50.0 million in increments of no less than $10.0 million each,
subject to the satisfaction of certain conditions, including predefined debt
service coverage ratios (the "Second Loan" and collectively with the "Initial
Loan," including the "Additional Loan," the "Loan").
 
                                       21
<PAGE>   21
                              HORIZON GROUP, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
Subsequent to the Initial Loan, the Company borrowed the entire $38.5 million of
the Additional Loan for the acquisition of the specified property and $11.0
million of the Second Loan. While the Company has additional availability under
the Second Loan, additional borrowings may not be available due to the financial
ratios the Company is required to maintain. Interest on the Loan is payable at
the following rates: (i) 1.75% over the London interbank offering rate ("LIBOR")
for the Initial Loan, and (ii) 2.25% over LIBOR for the Second Loan or (iii) if
the Loan is converted to a prime rate loan under certain circumstances at the
Lender's discretion, the prime rate plus .75% with respect to the Initial Loan
and plus 1.25% with respect to the Second Loan. The maturity date of the Loan is
July 1, 1999, unless otherwise extended pursuant to the terms of the Loan. The
net proceeds of the Initial Loan were primarily used to retire the Company's
aggregate outstanding balances under the following: (i) a revolving credit
facility with a subsidiary of First Chicago NBD Corporation and other banks
("FCNBD"), (ii) construction financing facilities with Canadian Imperial Bank of
Commerce ("CIBC"), (iii) four mortgage notes payable and (iv) one revolving
credit facility. The Company recorded a $3.3 million extraordinary charge net of
minority interests comprised primarily of unamortized debt issuance costs
associated with the debt retired. The Loan is guaranteed by the Company and the
Operating Partnership and is secured by a pool of 16 properties transferred to
Borrower. The Loan requires the Company to maintain certain financial ratios and
restricts the amount of dividends and distributions that can be made. The
Company is currently in compliance with all its financial covenants relating to
its existing credit facilities at December 31, 1997.
 
     During 1996, the Company received a $99.3 million mortgage and a $65.0
million mortgage from an institutional lender at fixed interest rates of 9.06%
and 8.574%, respectively. Each mortgage has a ten-year term. In addition, the
Company obtained a $10.0 million mortgage from a life insurance company at a
fixed rate of 8.25% with a four-year term. Proceeds from the mortgages were used
to repay amounts outstanding under revolving credit facilities.
 
     Remaining notes payable mature at various dates through 2018. These loans
bear interest at fixed rates ranging between 7.875% and 10.5%. Of the December
31, 1997 mortgage notes payable balance, $61.6 million was assumed on July 14,
1995 in connection with the Merger. The assumed debt was recorded at fair market
value, and at December 31, 1997 a premium of $3.7 million is being amortized
over the life of the respective loans on a straight-line basis resulting in
effective interest rates ranging from 7.9% to 8.16%.
 
     The Company has a $4.0 million revolving credit facility for working
capital requirements, expiring in August 1998, with interest charged at prime.
The outstanding balance on this line was $4.0 million at December 31, 1997. No
amounts were borrowed under this line at December 31, 1996. At December 31,
1996, the Company had a secured revolving line of credit from FCNBD of $205.0
million, of which $132.7 million was outstanding at that date. The FCNBD line
was repaid from proceeds from the Loan during 1997. Interest was based, at the
election of the Company, at prime plus .25% or LIBOR plus 2%. Average daily
short-term interest-bearing borrowings during 1997 and 1996 were $75.3 million
and $165.7 million, with a weighted average interest rate of 7.9% and 7.7%,
respectively. The maximum short-term borrowings outstanding at any month end
during 1997 and 1996 were $151.8 million and $198.7 million, respectively.
 
     At December 31, 1996, the Company had a $125.0 million construction line of
credit (the "Construction Line") with CIBC which was charged interest at the
Company's option, either (i) 1.5% per annum over the greater of the construction
lender's prime rate or the overnight federal funds rate plus 1%, or (ii) LIBOR
plus 2.5%. As of December 31, 1996, borrowings under the Construction Line were
$21.7 million. Average daily short-term interest-bearing borrowings during 1997
and 1996 were $11.9 million and $44.8 million, respectively, with a weighted
average interest rate of 9.4% and 8.6%, respectively. The maximum short-term
borrowings outstanding at any month end during 1997 and 1996
 
                                       22
<PAGE>   22
 
were $28.0 million and $58.4 million, respectively. The Construction Line was
repaid in 1997 with proceeds from the Loan.
 
     At December 31, 1997, the Company had an outstanding $0.7 million letter of
credit which was secured by cash on deposit.
 
     The carrying amounts of the Company's borrowings under its notes payable
and revolving credit agreements approximate their fair value as of December 31,
1997 and 1996. The fair value of the Company's long-term debt is estimated using
discounted cash flow analyses, based on the Company's current incremental
borrowing rates for similar types of borrowing arrangements. The carrying value
of cash and cash equivalents, receivables and payables approximate their fair
value.
 
     Cash paid for interest for the years ended December 31, 1997, 1996 and 1995
(net of interest capitalized of $2.6 million, $8.9 million, and $5.1 million)
was $47.0 million, $38.7 million, and $15.7 million, respectively. Debt issue
cost amortization, classified as a component of interest expense, (net of
amounts capitalized of $0.1 million, $0.2 million, and $0.2 million) was $2.3
million, $1.1 million, and $0.9 million in 1997, 1996 and 1995, respectively.
 
NOTE 9 -- RELATED PARTY TRANSACTIONS
 
     Summary information regarding income from dividends, development, leasing
and management services performed for properties owned by Jeffrey Kerr, who
served as Chief Executive Officer, President and Chairman of the Board of
Directors of the Company until February 8, 1997, and his affiliates, not
included in the consolidation in 1997, 1996, and 1995 are as follows (in
thousands):
 
<TABLE>
<CAPTION>
                                                            1997      1996      1995
                                                            ----      ----      ----
<S>                                                         <C>       <C>       <C>
Development fees                                            $426      $252      $
Leasing fees                                                            32        34
Management fees                                                         30       111
Other                                                                   23        14
                                                            ----      ----      ----
Total                                                       $426      $337      $159
                                                            ====      ====      ====
</TABLE>
 
     In 1996, the Company leased an aircraft from a company owned by Mr. Kerr
for $0.2 million. At December 31, 1996, the Company had a $1.1 million
receivable from Mr. Kerr and his affiliates, which was repaid in 1997.
 
NOTE 10 -- SHAREHOLDERS' EQUITY
 
     COMMON STOCK -- The authorized capital stock of the Company consists of
47,000,000 shares of Common Stock, 3,000,000 shares of Preferred Stock and
10,000,000 shares of Excess Stock, each $.01 par value per share. Each share of
Common Stock entitles the holder to one vote on all matters submitted for a vote
of shareholders, including the election of directors, and, except as otherwise
required by law or except as provided with respect to any other class or series
of stock, the holder of such Common Stock will possess the exclusive voting
power of the Company. There are no shares of Preferred Stock or Excess Stock
currently issued and outstanding.
 
     In 1996, the Company issued 1.5 million shares of Common Stock at a 5%
discount to the then fair market value of $20.00 per share. Proceeds, net of
associated professional fees, were $28.9 million. In addition, the Company
instituted a Dividend Reinvestment Plan in 1996 that allows Shareholders to
reinvest cash dividends into shares of Common Stock at a discount of 0-5% at the
discretion of the Company. During 1997 and 1996, 0.3 million and 0.8 million
common shares were issued for total proceeds of $5.9 million and $16.2 million,
respectively. The Company has discontinued further stock issuances under the
Dividend Reinvestment Plan based on the current market price of the Company's
Common Stock.
 
                                       23
<PAGE>   23
                              HORIZON GROUP, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
     DIVIDENDS IN EXCESS OF NET INCOME -- As described in Note 2, the Company
elected to be treated for federal income tax purposes as a REIT commencing with
the taxable year ending December 31, 1994. The following table illustrates the
reconciliation between net income and dividends in excess of net income and the
related per share data for the three year period ended December 31, 1997. In
1997, 1996 and 1995, dividends declared of $1.05, $2.095 and $2.131 per share
represented a $.018, $1.213 and $1.392 distribution of ordinary income for
federal income tax purposes and a $1.032, $.691 and $.739 return of capital for
federal income tax purposes, respectively.
 
<TABLE>
<CAPTION>
                                                              1997            1996           1995
                                                              ----            ----           ----
                                                             (THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S>                                                         <C>             <C>            <C>
Dividends in excess of net income at beginning of period    $ (84,984)      $(14,093)      $ (5,410)
Net income (loss)                                              (7,584)       (27,274)        21,371
Less: dividends declared                                      (25,032)       (43,617)       (30,054)
                                                            ---------       --------       --------
Dividends in excess of net income at end of period          $(117,600)      $(84,984)      $(14,093)
                                                            =========       ========       ========
Per common share:
  Net income (loss) -- basic and diluted                    $    (.32)      $  (1.34)      $   1.52
  Dividends declared                                        $    1.05       $  2.095       $  2.131
</TABLE>
 
NOTE 11 -- STOCK OPTION PLAN AND STOCK BONUS ARRANGEMENT
 
     Under the Company's 1997 Stock Option Plan, options to acquire 950,000
shares of Common Stock may be granted to key employees, including officers of
the Company, through 2007. The options may be granted at a price not less than
the fair market value of the Common Stock on the date of grant. All options
expire within ten years after the date of grant. During 1997, options to
purchase 545,000 shares were granted. At December 31, 1997, options to purchase
325,000 shares were exercisable.
 
     Under the Company's 1993 Stock Option Plan, options to acquire 950,000
shares of Common Stock may be granted to key employees, including officers of
the Company, through 2003. The options may be granted at a price not less than
the fair market value of the Common Stock on the date of grant. All options
expire within ten years after the date of the grant and become exercisable in
three equal annual installments beginning on the first anniversary of the date
of grant of such option. On the Merger date, all outstanding options became 100%
vested. In 1996, options to purchase 383,677 shares were granted. At December
31, 1997 and 1996, options to acquire 419,669 and 621,000 shares under this
Plan, respectively, were exercisable.
 
     Under the Company's Director Stock Option Plan, 100,000 shares may be
granted to non-employee directors with terms generally comparable to the Stock
Option Plan. The Director Stock Option Plan provides for the grant to each
non-employee director of the Company an option to purchase 5,000 shares of
Common Stock on the date of each election. During 1997, 1996 and 1995, options
to purchase 10,000, 15,000 and 35,000 shares, respectively, were granted. At
December 31, 1997 and 1996, options to acquire 28,333 and 25,000 shares,
respectively, were exercisable.
 
     The Company adopted the McArthur/Glen 1993 Long-term Incentive Plan in
connection with the Merger. Outstanding employee and director options to
purchase 1,074,550 shares of McArthur/Glen were converted into options to
purchase 687,712 shares of Horizon Group, Inc. All converted options were fully
vested and expire within ten years from the original date of grant. No options
are available for future grant under this plan. At December 31, 1997 and 1996,
options to acquire 656,432 shares were exercisable.
 
                                       24
<PAGE>   24
 
     The fair value of options granted for the purpose of presenting pro forma
information, in accordance with SFAS 123, has been estimated using a
Black-Scholes option pricing model with the following weighted-average
assumptions for 1997 and 1996, respectively:
 
<TABLE>
<CAPTION>
                                                               1997      1996
                                                               ----      ----
<S>                                                           <C>       <C>
Expected dividend yield                                          7.0%     7.73%
Expected stock price volatility                                  .268      .211
Risk free interest rate                                          6.0%      6.0%
Expected life of options                                      7 years   7 years
</TABLE>
 
     The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
 
     Net loss and net loss per share (basic and diluted) for 1997, computed on a
pro forma basis under the requirements of SFAS 123 equals $8,070,000 and $.34,
respectively. Net income (loss) and earnings (loss) per share for 1996 and 1995
do not differ materially from the amounts reported in the Company's consolidated
financial statements. The pro forma computations completed for 1997, 1996 and
1995, however, may not be indicative of the effects of SFAS 123 on reported net
income (loss) for future years.
 
     Options granted, exercised and canceled under the Company's Stock Option,
Director Stock Option and Long-term Incentive Plans are summarized below:
 
<TABLE>
<CAPTION>
                                      1997                       1996                       1995
                            ------------------------   ------------------------   ------------------------
                             SHARES        PRICE        SHARES        PRICE        SHARES        PRICE
                             ------        -----        ------        -----        ------        -----
<S>                         <C>         <C>            <C>         <C>            <C>         <C>
Outstanding, Beginning of
  Year                      1,646,709   $19.75-38.28   1,327,932   $21.50-38.28     657,900   $22.88-25.00
Granted                       555,000    10.25-12.82     383,677    19.75-21.63      35,000    22.50-24.38
McArthur/Glen conversion           --             --          --             --     687,712    21.50-38.28
Exercised                          --             --          --             --     (31,280)   21.68-23.44
Canceled                     (503,443)   20.56-25.00     (64,900)   20.56-24.00     (21,400)         24.00
                            ---------   ------------   ---------   ------------   ---------   ------------
Outstanding, End of Year    1,698,266   $10.25-38.28   1,646,709   $19.75-38.28   1,327,932   $21.50-38.28
                            =========   ============   =========   ============   =========   ============
</TABLE>
 
     The following table represents the weighted average per share price option
information:
 
<TABLE>
<CAPTION>
                                                                 1997      1996      1995
                                                                 ----      ----      ----
<S>                                                             <C>       <C>       <C>
Weighted average fair value of options granted                  $ 1.58    $ 1.85    $ 2.27
Weighted average exercise price on grant date                    10.97     21.00     24.11
Weighted average exercise price at December 31,(a)               17.95     23.25     23.25
Weighted average price of options canceled during year           22.72     23.91     24.00
</TABLE>
 
-------------------------
(a) Excludes 184,000 options at $33.59 per share and 159,000 stock options at
    $38.28 per share in 1997 and 224,000 stock options at $33.59 and 115,000
    stock options at $38.28 in 1996 and 1995.
 
     The weighted average remaining contractual life of options outstanding at
December 31, 1997 and 1996 is 7.1 and 7.6 years, respectively.
 
                                       25
<PAGE>   25
                              HORIZON GROUP, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
NOTE 12 -- SUPPLEMENTAL CASH FLOW INFORMATION
 
     Supplemental cash flow information regarding non-cash investing and
financing activities are as follows:
 
   
<TABLE>
<CAPTION>
                                                               1997     1996      1995
                                                               ----     ----      ----
<S>                                                           <C>      <C>       <C>
Reclassification of assets held for sale to real estate
  assets                                                      $6,458
Reclassification of real estate assets to assets held for
  sale                                                         2,638   $13,075
Acquisition of property for debt assumed                                         $8,700
Contribution of assets to Venture                              8,471    36,317
</TABLE>
    
 
NOTE 13 -- CONTINGENCIES
 
     In December 1997, a purported shareholder of the Company filed a class
action lawsuit naming the Company and several of its current and former
directors as defendants. The lawsuit claims, among other things, that the
directors of the Company breached their fiduciary duties to the Company's
shareholders in approving the merger between the Company and Prime and that the
consideration to be paid to the Company's shareholders in such a merger is
unfair and inadequate. The lawsuit requests that the merger be enjoined or, in
the event that the merger is consummated, that the merger be rescinded or
damages be awarded to class members. The Company believes the suit is without
merit and intends to vigorously defend the action. The Company is unable to
predict the likely outcome of the action, but management does not believe the
ultimate outcome of the pending litigation will have a material adverse impact
on the Company's financial position and results of operations.
 
                                       26
<PAGE>   26
NOTE 14 -- QUARTERLY FINANCIAL DATA (Unaudited)
 
     Summarized financial data by quarter for 1997 and 1996 is as follows:
 
   
<TABLE>
<CAPTION>
                                               1ST                  2ND                   3RD                    4TH
                                             QUARTER              QUARTER               QUARTER                QUARTER
                                             -------              -------               -------                -------
                                                                     (THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S>                                           <C>                 <C>                   <C>                   <C>         
1997
Revenue                                       $37,303             $37,281               $38,023               $ 43,119
Expenses                                       35,693              35,486                40,031                 42,010
Impairment                                                                                6,877                    921
Gain on sale of real estate                                                                                          8
                                              -------             -------               -------               --------
Net income (loss) before minority
  interests and extraordinary charge            1,610               1,795                (8,885)                   196
Minority interests                               (278)               (263)                1,496                     38
                                              -------             -------               -------               --------
Net income (loss) before extraordinary
  charge                                        1,332               1,532                (7,389)                   234
Extraordinary charge                                               (3,293)
                                              -------             -------               -------               --------
Net income (loss)                             $ 1,332             $(1,761)              $(7,389)              $    234
                                              =======             =======               =======               ========
Net income (loss) per share -- basic and
  diluted                                     $   .06             $  (.07)              $  (.31)              $    .01
1996
Revenue                                       $37,004             $37,215               $38,651               $ 40,916
Expenses                                       26,788              27,724                31,307                 38,110
Impairment and severance                                                                                        65,355
Gain on sale of real estate                                                                 432                    131
                                              -------             -------               -------               --------
Net income (loss) before minority
  interests and extraordinary charge           10,216               9,491                 7,776                (62,418)
Minority interests                             (2,601)             (2,286)               (1,576)                14,543
                                              -------             -------               -------               --------
Net income (loss) before extraordinary
  charge                                        7,615               7,205                 6,200                (47,875)
Extraordinary charge                             (136)                                     (283)
                                              -------             -------               -------               --------
Net income (loss)                             $ 7,479             $ 7,205               $ 5,917               $(47,875)
                                              =======             =======               =======               ========
Net income (loss) per share -- basic and
  diluted                                     $   .39             $   .37               $   .28               $  (2.16)
1997 price range of
  common stock:
High                                          $    19  3/8        $    13 11/16         $    13  1/2          $     14  3/4
Low                                                12  7/8             10  3/8               11 13/16               10 11/16
1997 dividends per common share               $   .35             $   .35               $   .35               $     --
1996 price range of common stock:
High                                          $    23  1/4        $    21  3/4          $    21  3/8          $     21  3/4
Low                                                20  3/4             19  1/2               19  3/4                19
1996 dividends per common share               $  .505             $  .530               $  .530               $   .530
</TABLE>
    
 
                                       27
<PAGE>   27
 
                         REPORT OF INDEPENDENT AUDITORS
 
To the Shareholders and Board of Directors of Horizon Group, Inc.
 
     We have audited the accompanying consolidated balance sheets of Horizon
Group, Inc. (the "Company") as of December 31, 1997 and 1996, and the related
consolidated statements of operations, shareholders' equity, and cash flows for
each of the three years in the period ended December 31, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated 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 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 financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Horizon Group,
Inc. at December 31, 1997 and 1996, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
 
                                          /s/ Ernst & Young LLP
                                          --------------------------------------
                                          ERNST & YOUNG, LLP
 
Chicago, Illinois
   
March 13, 1998,
    
   
except for the second
    
   
paragraph of Note 3 and
    
   
the fourth and fifth paragraphs
    
   
of Note 4, as to which the date is
    
   
April 1, 1998
    
 
                                       28