<PAGE> 1
[KEVCO LOGO]
1998 ANNUAL REPORT TO SHAREHOLDERS
(INCLUDING FINANCIAL STATEMENTS FOR THE SIX MONTHS ENDED JUNE 30, 1999)
<PAGE> 2
<TABLE>
<CAPTION>
TABLE OF CONTENTS
<S> <C>
DESCRIPTION OF BUSINESS........................................................1
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS......................................................2
SELECTED CONSOLIDATED FINANCIAL DATA..........................................11
CONSOLIDATED BALANCE SHEETS AS OF JUNE 30, 1999 (UNAUDITED) AND
DECEMBER 31, 1998.............................................................12
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE SIX MONTH PERIODS
ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)......................................13
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTH PERIODS
ENDED JUNE 30, 1999 AND 1998 (UNAUDITED)......................................14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)........................15
QUARTERLY RESULTS.............................................................18
EXECUTIVE OFFICERS AND DIRECTORS..............................................19
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK....................20
MARKET PRICES AND DIVIDEND INFORMATION........................................20
ADDITIONAL INFORMATION........................................................21
INDEX TO 1998 FINANCIAL STATEMENTS...........................................F-1
</TABLE>
<PAGE> 3
DESCRIPTION OF BUSINESS
Kevco, Inc. ("Kevco" or the "Company," and includes, unless the context
otherwise requires, its direct and indirect subsidiaries) believes it is the
largest wholesale distributor of building products to the manufactured housing
and recreational vehicle ("RV") industries. Through its 26 distribution centers
(as of September 30, 1999), the Company distributes more than 35,000 different
inventory items to approximately 530 manufactured housing and RV and other
manufacturing facilities throughout the United States. The Company is one of
only a few companies capable of providing national distribution of building
products to the manufactured housing and RV industries.
The Company distributes a full line of products used in the production
of manufactured homes, including plumbing fixtures and supplies, insulation,
roof shingles, patio doors, aluminum, vinyl and wood windows, wood and vinyl
siding, fireplaces, electrical components and hardware, fasteners, power tools
and mill supplies. The Company also manufactures wood products including roof
trusses and lumber cut to customer specifications, laminated wallboard products,
plastic injection molded products and thermoformed bathtubs, shower enclosures
and tub wall surrounds for the manufactured housing and RV industries. In 1998,
approximately 13% of the Company's net sales were derived from plumbing
products, 9% from electrical products, 9% from hardware, fasteners, tools and
mill supplies, 18% from wood products, 5% from thermoformed plastic products, 8%
from laminated wallboards and 38% from other building products. See note 7 to
the consolidated financial statements (unaudited) for the six month periods
ended June 30, 1999 and 1998, and note 13 to the consolidated financial
statements for the years ended December 31, 1998, 1997, and 1996, for additional
segment data.
The Company believes that it provides a cost-effective form of
distribution that offers value to both the Company's suppliers and producers of
manufactured homes and RVs. The Company believes that it provides significant
benefits to its suppliers by placing large orders at regular intervals, thereby
enabling its suppliers to achieve efficient and cost-effective production
planning and economies of scale. In addition, the Company markets and sells its
suppliers' products directly to the manufactured housing and RV industries. As a
result, the Company believes it reduces its suppliers' inventory carrying,
marketing and distribution costs. The Company also believes that it provides
significant benefits to its customers as a result of its ability to respond on a
same day shipment basis to a majority of its customers' orders, thus reducing
the amount of inventory they must maintain. Furthermore, the Company assists its
customers in inventory management, product support, training and implementing
cost saving measures, all of which are services that the Company believes most
building products manufacturers cannot provide in a cost-effective manner. The
Company believes that the specialized product knowledge and high level of
service provided by its personnel result in strong relationships between the
Company and its suppliers and customers.
1
<PAGE> 4
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
GENERAL
Management expects that the Company's performance will be adversely
affected by the general slowdown in the manufactured housing industry that has
resulted from, among other things, excess retail inventory. Management expects
that such excess retail inventory will adversely affect the Company's
performance for at least the next 12 months.
The Company recognizes revenues from product sales at the time of
shipment (or the time of product receipt, in the case of direct shipments from
suppliers to customers). In some cases the Company sells on a commission basis.
Commissions are recognized when earned and represent amounts earned in selling,
warehousing and delivering products for certain manufacturers of building
products with whom the Company has distribution agreements. Commission
arrangements do not require inventory investments or receivables financing and,
therefore, are significantly less expensive to the Company than traditional
sales. To the extent the volume of items warehoused and shipped under commission
arrangements increases faster or slower than the volume of items related to
traditional sales, changes in net sales may not be representative of actual
increases or decreases in shipment volume.
The Company acquired Shelter Components Corporation ("Shelter") in
December 1997. Since that time, the Company has been integrating Shelter into
Kevco by, among other things, consolidating certain corporate functions,
consolidating overlapping distribution warehouses from 47 facilities to 26 and
integrating multiple computer systems into one. The integration efforts are
expected to be substantially complete over the next 12 to 24 months. Additional
costs will continue to be incurred, primarily for systems-related tests,
reducing operating income during the transition period.
ACQUISITIONS
In June 1995, the Company acquired all of the outstanding stock of
Service Supply Systems, Inc. ("Service Supply") for approximately $17.7 million
in cash. As a result of the acquisition of Service Supply, the Company acquired
five distribution and three manufacturing facilities, bringing the number of its
distribution and manufacturing facilities to 21 and 3, respectively, at December
31, 1996. The Service Supply acquisition was accounted for as a purchase and,
accordingly, the operating results of Service Supply have been included in the
operating results of the Company since its acquisition date.
In February 1997, the Company continued its expansion in the wood
manufacturing industry through the acquisition of substantially all of the
assets, and assumption of certain liabilities, of Consolidated Forest Products,
L.L.C. ("Consolidated Forest") (a manufacturer of wood products for the
manufactured housing industry) and consummated the acquisition of all of the
outstanding stock of Bowen Supply, Inc. ("Bowen") (a wholesale distributor of
building products to the manufactured housing and RV industries). The Bowen
acquisition expanded the Company's product lines by adding new products in
electronics, drapery and door hardware, industrial tape, adhesives and caulks.
The Consolidated Forest and Bowen acquisitions were accounted for as purchases
and, accordingly, the operating results of the acquired companies have been
included in the operating results of the Company since their respective
acquisition dates.
Effective December 1, 1997, the Company acquired approximately 95.5% of
the outstanding shares of common stock of Shelter through a tender offer for a
purchase price of $17.50 per share of common stock of Shelter. The Company
acquired the remaining untendered shares through a subsequent merger for a like
price. The Shelter acquisition was accounted for as a purchase and, accordingly,
the operating results of Shelter have been included in the operating results of
the Company since December 1, 1997. On June 27, 1997, prior to the Company's
acquisition of Shelter, Shelter acquired the net assets of Plastic Solutions,
Inc., a manufacturer of injection molded plastic parts.
On December 12, 1997, the Company consummated the acquisition of the
inventory and certain distribution rights of certain building products
distributed by the manufactured housing and recreational vehicle division of
Shepherd Products Company ("Shepherd").
The acquisitions of Shelter, Bowen, Consolidated Forest and Shepherd
(the "1997 Acquisitions") contributed approximately $140.0 million in net sales
for the year ended December 31, 1997. On a pro forma basis, giving effect to the
1997 Acquisitions as if the 1997 Acquisitions had occurred on January 1, 1997,
net sales were approximately $862.0 million.
2
<PAGE> 5
Through the 1997 Acquisitions, and primarily through the Shelter
acquisition, the Company believes it became the largest wholesale distributor of
building products to the manufactured housing and RV industries. Because of the
1997 Acquisitions, the Company's historical results of operations and
period-to-period comparisons of such results and certain financial data may not
be meaningful or indicative of future results.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
Consolidated Statements of Operations data as a percentage of the Company's net
sales.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, YEAR ENDED DECEMBER 31,
-------------------- -------------------------------
1999 1998 1998 1997 1996
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Net sales ......................................... 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales ..................................... 87.6 86.3 87.1 86.5 84.6
----- ----- ----- ----- -----
Gross profit ................................. 12.4 13.7 12.9 13.5 15.4
Commission income ................................. 0.8 0.8 0.9 1.5 2.1
----- ----- ----- ----- -----
13.2 14.5 13.8 15.0 17.5
Selling, general and
administrative expenses ...................... 11.2 10.1 11.1 11.0 11.3
----- ----- ----- ----- -----
Operating income ............................. 2.0 4.4 2.7 4.0 6.2
Other income ...................................... -- -- 0.3 -- --
Interest expense, net ............................. 2.6 2.3 (2.4) (1.2) (0.8)
----- ----- ----- ----- -----
Income (loss) before income taxes ............ (0.6)% 2.1% 0.6% 2.8% 5.4%
===== ===== ===== ===== =====
</TABLE>
See note 7 to the consolidated financial statements (unaudited) for the
six month periods ended June 30, 1999 and 1998, and note 13 to the consolidated
financial statements for the years ended December 31, 1998, 1997 and 1996, for
segment data.
COMPARISON OF SIX MONTH PERIODS ENDED JUNE 30, 1999 AND 1998
Net sales increased by $10.6 million, or 2.4%, to $454.6 million for
the six months ended June 30, 1999 from $444 million for the comparable 1998
period. Increased revenues in both the manufacturing and wood products
operations were partially offset by a $1.9 million decrease in the Company's
distribution operations.
Gross profit decreased by $4.6 million, or 7.6%, to $56.3 million for
the six months ended June 30, 1999 from $60.9 million for the comparable 1998
period, due primarily to lower gross margins as a result of product mix, higher
labor costs and increased overhead. Gross profit, as a percentage of net sales,
decreased to 12.4% in the six months ended June 30, 1999 from 13.7% for the
comparable 1998 period.
Selling, general and administrative expenses increased by $6.2 million,
or 13.8%, to $51.0 million for the six months ended June 30, 1999 from $44.8
million for the comparable 1998 period. The increase was due primarily to
upgrading of information systems, professional service fees and costs associated
with amending the Company's credit agreement in the first two fiscal quarters of
1999. Selling, general and administrative expenses, as a percentage of net
sales, increased to 11.2% for the six months ended June 30, 1999 compared to
10.1% in the comparable 1998 period.
Net interest expense increased by $1.4 million to $11.6 million for the
six months ended June 30, 1999 from $10.2 million for the comparable 1998
period. The increase in net interest expense was due to higher loan amortization
costs and to a higher level of borrowing in the current year.
For the six months ended June 30, 1999, the Company reported a net loss
of $2.0 million compared to a net income of $5.3 million in the comparable 1998
period. The decrease in net income was attributable to a combination of lower
gross margins, an increase in selling, general and administrative expenses, and
higher loan amortization costs.
3
<PAGE> 6
COMPARISON OF YEARS ENDED DECEMBER 31, 1998 AND 1997
Net sales increased by $506.8 million, or 129.7%, to $897.5 million in
1998 from $390.7 million in 1997 due primarily to the acquisition of Shelter in
December 1997. Management believes that net sales, without the effect of the
Shelter acquisition, increased approximately the same as the manufactured
housing shipment increase of 5.5% for 1998 compared to 1997 (approximately
373,000 homes reported shipped in 1998 compared to approximately 353,400 homes
reported shipped in 1997).
Gross profit increased by $63.5 million, or 120.7%, to $116.1 million
in 1998 from $52.6 million in 1997 due primarily to the acquisition of Shelter
in December 1997. Gross profit, as a percentage of net sales, decreased to 12.9%
in 1998 from 13.5% in 1997. The decrease in gross profit, as a percentage of
sales, was primarily a result of wood products margins which, affected by lower
than historical lumber prices, continued to be lower than historical levels, and
start-up costs related to the opening of two wood products manufacturing
facilities in 1998 (such wood products represent approximately 19% of net
sales), as well as an otherwise general decline in margins.
Commission income increased by $1.5 million, or 25.4%, to $7.4 million
in 1998 from $5.9 million in 1997. The increase was primarily attributable to
the acquisition of Shelter in December 1997.
Selling, general and administrative expenses increased by $57.0
million, or 132.9%, to $99.9 million in 1998 from $42.9 million in 1997. The
increase was due primarily to the acquisition of Shelter in December 1997 and
the related integration. Although selling, general and administrative expenses,
as a percentage of net sales, remained consistent with the prior year, in order
to maintain high levels of customer service in a period of considerable
consolidation and integration of Shelter's distribution operations, the Company
incurred costs significantly in excess of anticipated amounts which negatively
impacted earnings and cash flow relating to, among other things, contract labor,
overtime and freight charges. The Company also encountered longer than
anticipated start-up periods for the two wood products facilities that were
opened in 1998.
Net income decreased by $4.4 million, or 70.3%, to $1.9 million in 1998
from $6.3 million in 1997. The decrease in net income was primarily attributable
to lower gross margins, as discussed above, increased interest expense and a
higher effective tax rate. Interest expense increased to $21.1 million in 1998
from $4.8 million in 1997 as a result of debt incurred in connection with the
acquisition of Shelter. Net income was favorably impacted by a $2.5 million gain
included in other income that was the result of an insurance settlement. The
effective tax rate increased to 62.7% in 1998 from 42.0% in 1997 as a result of
non-deductible goodwill resulting primarily from the acquisition of Shelter.
4
<PAGE> 7
COMPARISON OF YEARS ENDED DECEMBER 31, 1997 AND 1996
Net sales increased by $126.5 million, or 47.9%, to $390.7 million in
1997 from $264.2 million in 1996. The 1997 Acquisitions contributed
approximately $140.0 million in sales in 1997. Net sales, without the effect of
the 1997 Acquisitions, decreased from $264.2 million to $250.7 million, or 5.1%.
Management believes that such decrease is primarily attributable to the reported
manufactured housing shipment decline of 2.8% for 1997 compared to 1996
(approximately 353,400 homes reported shipped in 1997 compared to approximately
363,400 homes reported shipped in 1996) as well as a decline in lumber prices in
1997 compared to 1996.
Gross profit increased by $11.9 million, or 29.2%, to $52.6 million in
1997 from $40.7 million in 1996 due primarily to the 1997 Acquisitions. Gross
profit, as a percentage of net sales, decreased to 13.5% in 1997 from 15.4% in
1996. The decrease in gross profit, as a percentage of net sales, was a result
of lower gross margins associated with the Consolidated Forest acquisition and
lower margin dollars earned from wood products as a whole due to declining
lumber prices throughout 1997 (such wood products represented approximately 20%
of net sales in 1997). To a lesser extent, gross margins from non-lumber related
business decreased primarily as a result of temporary price increases of a major
product line.
Commission income increased by $0.4 million, or 7.2%, to $5.9 million
in 1997 from $5.5 million in 1996. The increase was primarily attributable to
the Company's expansion in commission-based distribution arrangements in 1997.
Selling, general and administrative expenses increased by $13.2
million, or 44.5%, to $42.9 million in 1997 from $29.7 million in 1996. The
increase was primarily due to increased sales volume related to the 1997
Acquisitions. Selling, general and administrative expenses, as a percentage of
net sales, decreased to 11.0% for 1997 from 11.3% for 1996. The decrease
reflected the Company's continued efforts in increasing efficiency.
Net income decreased by $2.6 million, or 29.2%, to $6.3 million in 1997
from $8.9 million in 1996 on a pro forma basis giving effect to the Company's
conversion from an S corporation to a C corporation. The decrease in net income
was primarily attributable to (i) lower gross margins as discussed above, (ii)
increased interest expense in 1997 compared to 1996 principally due to
borrowings related to the 1997 Acquisitions and (iii) an increase in the
Company's effective tax rate to 42.0% in 1997 from 38.0% in 1996 resulting
primarily from the non-deductible goodwill recorded in connection with the 1997
Acquisitions.
LIQUIDITY AND CAPITAL RESOURCES
The Company's growth has been financed through cash flow from
operations, borrowings under its bank credit facilities, proceeds from its
November 1996 initial public offering, proceeds from the Transaction (as defined
below), and proceeds from the issuance of $105.0 million of 10 3/8% senior
subordinated notes due 2007.
Net cash used by operating activities was $1.8 million and capital
expenditures were $1.7 million for the six months ended June 30, 1999. Net cash
used by operating activities was approximately $9.1 million in 1998 and net cash
provided by operating activities was $16.4 million and $12.2 million in 1997 and
1996, respectively. The Company is obligated to make payments on various capital
leases in varying amounts, maturing through 2007 as well as payments under
various noncompete and consulting agreements, related to recent acquisitions, in
varying amounts, maturing through 2002.
In December 1997, the Company and its lenders entered into the second
amended and restated credit agreement at the closing of the Shelter acquisition
to allow for aggregate senior borrowings of up to $125.0 million comprised of a
revolving credit facility of $45.0 million and a term loan facility of $80.0
million requiring quarterly installments. The revolving credit facility and
$40.0 million of the term loan facility were (prior to the fourth amended
agreement and waiver described below) to mature in 2003 with the remaining term
loan facility to mature in 2004. The term loan and revolving credit facility
were collateralized by substantially all of the assets of the Company and its
subsidiaries, including the capital stock of such subsidiaries.
Primarily as a result of lower than anticipated net sales to customers
and higher than anticipated selling, general and administrative expense levels
relating to the integration of Shelter during 1998 (as well as the decrease
5
<PAGE> 8
in gross margins described above), the Company did not generate sufficient cash
flow from operations to fund its working capital needs. As a result, the Company
supplemented the funding of operations through borrowings under its credit
facility. At December 31, 1998, the Company was in violation of its leverage
ratio covenant and fixed charge coverage ratio covenant contained in Sections
7.10 and 7.11, respectively, of the Company's second amended and restated credit
agreement.
In February 1999, the Company entered into a third amendment and waiver
to the second amended and restated credit agreement, which provided for an
incremental commitment of $5.0 million due March 31, 1999 and waived any event
of default due to the Company's violation of the leverage ratio covenant and the
fixed charge coverage ratio covenant of such credit agreement through March 31,
1999. In March 1999, the Company requested and obtained an additional $5.0
million incremental commitment (the "Incremental Commitment") and waiver of any
events of default under such credit agreement to April 15, 1999.
In April 1999, the Company entered into a fourth amendment and waiver
to the second amended and restated credit agreement which consisted of an $80.0
million term loan facility and a $45.0 million revolving credit facility. This
amendment contained revised financial covenants effective for the quarters ended
March 31, 1999 through June 30, 2000 and waived certain events of default. Under
this amendment, the Incremental Commitment matured on June 30, 1999, the
revolving credit facility would have matured on June 30, 2000 and the term loan
would have had scheduled quarterly repayments with a final maturity of June 30,
2000.
In July 1999, the Company completed a transaction ("Transaction"),
pursuant to which The Kevco Partners Investment Trust, a Delaware business trust
and an affiliate of Wingate Partners II, L.P. (the "KPI Trust"), acquired, for
an approximate purchase price of $37.0 million, the following securities:
o 2,700,000 newly-issued shares of the Company's common stock ("Common
Stock") for a purchase price of $5.00 per share;
o three warrants ("Warrants") to purchase 675,000 shares, 772,727 shares,
and 295,455 shares, respectively, of a new class of nonvoting common
stock of the Company ("Nonvoting Stock");
o Tranche A Senior Subordinated Exchangeable Notes ("Tranche A Notes") in
the principal amount of $17.0 million; and
o Tranche B Senior Subordinated Exchangeable Notes ("Tranche B Notes"
and, together with the Tranche A Notes, the "Notes") in the principal
amount of $6.5 million.
The Tranche A Notes are exchangeable at the holders' option for
3,090,909 shares of a newly-created series of preferred stock of the Company
designated as Series A 10-3/8% Convertible Pay-in-Kind Voting Preferred Stock
("Voting Preferred Stock") or directly into 3,090,909 shares of Common Stock, in
each case at an initial exchange ratio of $5.50 per share. Shares of Voting
Preferred Stock, when and if issued in exchange for Tranche A Notes, will be
entitled to vote together with the Common Stock on an as converted basis. The
Voting Preferred Stock will be convertible on a share-for-share basis into
Common Stock. The Tranche B Notes are exchangeable at the holders' option for
1,181,818 shares of a second newly-created series of preferred stock of the
Company designated as Series B 10-3/8% Convertible Pay-in-Kind Non-Voting
Preferred Stock ("Nonvoting Preferred Stock" and with the Voting Preferred
Stock, the "Preferred Stock") or directly into 1,181,818 shares of Nonvoting
Stock, in each case at an initial exchange ratio of $5.50 per share. The
Nonvoting Preferred Stock will have limited voting rights in connection with
certain extraordinary corporate events affecting the holders of Nonvoting Stock.
The Nonvoting Preferred Stock will itself be convertible into an equal number of
shares of Nonvoting Stock.
Interest on the Notes may be paid in cash or, at the option of the
Company, continue to accrue unpaid, in which case a noteholder may elect to have
all accrued interest paid in the equivalent value of shares of Nonvoting
Preferred Stock. Dividends on the Nonvoting Preferred Stock and the Voting
Preferred Stock may, at the option of the Company, be paid in cash or in
additional shares of Nonvoting Preferred Stock. The Company can redeem the Notes
and any Preferred Stock issued in exchange for Notes beginning on July 26, 2002.
The Warrants, Notes, and Preferred Stock contain standard anti-dilution
provisions.
6
<PAGE> 9
The KPI Trust currently owns 2,700,000 shares, or approximately 28.3%,
of the outstanding Common Stock. Assuming the exchange of the Tranche A Notes
into Common Stock, the KPI Trust would own an aggregate of 5,790,909 shares, or
approximately 45.8%, of the outstanding Common Stock. After giving effect to the
proposed charter amendment, and assuming the exercise of the Warrants into
Nonvoting Stock and the exchange of the Tranche A Notes and Tranche B Notes into
Common Stock and Nonvoting Stock, respectively, the KPI Trust would own
5,790,909 shares, or approximately 45.8%, of the outstanding Common Stock and
2,925,000 shares of Nonvoting Stock, representing in the aggregate approximately
55.9% of the Company's total common equity (excluding shares potentially
issuable as a result of interest accruing under the Notes or as dividends on the
Voting Preferred Stock and the Nonvoting Preferred Stock).
Concurrently with the closing of the Transaction, the Company entered
into the third amended and restated credit agreement which restructured the
terms and conditions in regard to applicable rates, covenants and maturity.
Under the third amended and restated credit agreement, the Company may borrow
under either a base rate or LIBOR rate with the cost determined based upon
certain compliance ratios established in the covenants. The covenants under the
third amended and restated credit agreement include, but are not limited to, a
leverage ratio, fixed charge coverage ratio and net worth minimum. The $45.0
million revolving credit facility matures in December 2003, the term A Facility
for $36.9 million matures in December 2003 and the term B Facility for $38.8
million matures in December 2004. The Company may also be required to repay
amounts earlier than scheduled as a result of asset sales, excess cash flow from
operations, issuance of new debt or issuance of new equity.
Borrowings under the term loan can be made at either a base rate or
LIBOR, plus a margin determined by the compliance ratios in the covenants.
Interest payments on the revolving credit facility and base rate denominated
term loans are payable quarterly. Interest payments on LIBOR based loans are due
at the end of the contracted term. The term loans require quarterly payments
which increase over the life of each respective term. The term loan and
revolving credit facility are collateralized by substantially all of the assets
of the Company and its subsidiaries, including the capital stock of such
subsidiaries.
In addition to the funds available under the third amended and restated
credit agreement, the Company issued $105.0 million of 10 3/8% senior
subordinated notes due 2007 under the indenture dated as of December 1, 1997, as
supplemented (the "Indenture") to complete the acquisition of Shelter. The
Indenture contains certain covenants that include, but are not limited to,
restrictions or limitations on the following: the incurrence of additional debt
or liens, the payment of dividends by the Company, the sale of certain assets,
the ability to consolidate with or merge into another person, the entering into
certain transactions with affiliates and the engagement in certain lines of
business.
The Indenture and the third amended and restated credit agreement
generally prohibit the payment of dividends by the Company on its common stock.
The Company does not anticipate paying cash dividends on its common stock in the
foreseeable future and intends to retain its earnings to support operations and
repay indebtedness.
For the six months ended June 30, 1999, average days sales in
receivables were 26 days, average days sales in inventory were 43 days and
average days sales in payables were 29 days. For the year ended December 31,
1998, average days sales in receivables were approximately 21 days, average days
sales in inventory were approximately 44 days and average days sales in payables
were approximately 27 days.
YEAR 2000
BACKGROUND. Many computer systems and equipment with embedded computer
chips in use today were designed and developed using two digits, rather than
four, to specify the year. As a result, such systems and equipment may recognize
a date using "00" as the year 1900 rather than the year 2000. This could result
in a system failure or miscalculation causing disruptions of operations.
STATE OF READINESS. During 1998, the Company began its assessment of
Year 2000 issues and established a Year 2000 project plan with the Chief
Information Officer as the project leader and engaged third-party consultants to
assist in the evaluation of systems and issues. The plan can be described in the
following phases:
7
<PAGE> 10
Phase I -- identification and assessment of Year 2000 issues for
the Company's various internal systems and equipment;
Phase II -- remediation, including modification, upgrading and
replacement of hardware and software; and
Phase III -- testing to ensure Year 2000 compliance.
The Company is applying all aspects of this plan with the assistance of
third-party consultants, to both its information technology ("IT") systems and
non-IT systems. The Company's computer equipment and software that is considered
an IT or business system includes systems used to manage customer orders,
inventory, manufacturing, accounting functions and telecommunications. Non-IT
systems include manufacturing equipment, alarm systems, security devices, HVAC
units, fax machines and other miscellaneous systems.
The Company believes that it has identified and assessed the internal
business systems that are susceptible to system failures or processing errors as
a result of the Year 2000 issue. Those systems considered most critical to
continuing operations have received the highest priority. The Company has six
primary business systems that support operations. A majority of the remediation
efforts for these systems will consist of the Company performing an upgrade.
Five of these systems have been upgraded to Year 2000 compliant versions,
thoroughly tested using appropriate Year 2000 scenarios, and successfully placed
into production. The one remaining business system is in testing with scheduled
completion in the fourth quarter of 1999.
In addition to the remediation of the information systems, the Company
is currently addressing its non-IT systems. During 1998, an assessment of the
Company's manufacturing equipment was performed. The results of the assessment
revealed no date sensitive manufacturing equipment, thus decreasing the risk of
any Year 2000 related manufacturing problems. An assessment was performed on the
other miscellaneous non-IT equipment. The results of this assessment revealed no
material Year 2000 issues.
The following chart is for summary purposes only and is qualified in
its entirety by reference to the discussion above.
<TABLE>
<CAPTION>
===============================================================================================
PROGRAM AREA STATE OF READINESS STATUS
===============================================================================================
<S> <C> <C>
INTERNAL IT 5 systems Phase III Complete
-----------------------------------------------------------------------
1 system Phase III (estimated to be completed Q4
1999)
-----------------------------------------------------------------------
NON-IT Manufacturing Not Applicable -- Phase I revealed no date
sensitive equipment
-----------------------------------------------------------------------
Other Not Applicable -- Phase I revealed no date
sensitive equipment
===============================================================================================
</TABLE>
THIRD PARTIES. The Company is reviewing, and has initiated formal
communications with critical third parties that provide or purchase services or
goods that are essential to the Company's operations. This is being done in
order to determine the extent to which the Company is vulnerable to any failure
by such third parties to remediate their respective Year 2000 problems, and to
resolve such problems to the extent practicable. In connection with this
assessment, the Company is reviewing all significant contractual and other
obligations with third parties to ensure compliance in the event of a Year 2000
problem. The assessment of these business partners is ongoing, with all
significant third-party communications completed in the third quarter of 1999.
The related risk assessments are expected to be completed during the fourth
quarter of 1999. The uncertainty associated with third-party readiness, however,
cannot be eliminated as the accuracy and availability of third-party
representations is outside the Company's control. In the event the Company is
unable to obtain satisfactory assurance that a critical third-party
provider/customer has successfully and timely achieved Year 2000 compliance, and
the Company is unable to replace such a provider/customer with an alternative
provider/customer, the Company's operations could be materially adversely
impacted. Currently, there is no known contractual liability to any third party
if all or a portion of the Company's IT or non-IT systems are not Year 2000
compliant.
8
<PAGE> 11
COSTS. The Company currently estimates that its total Year 2000 project
costs will be approximately $1.2 million. Through August 31, 1999, the Company
had spent approximately $0.9 million on Year 2000 project costs. The Company
has funded, and expects to continue to fund, the expenditures related to its
Year 2000 initiatives either through cash generated from operations and current
working capital, or if required, its existing revolving credit facilities.
RISKS. Based on the progress it has made in addressing its Year 2000
issues and its plan and timetable to complete its compliance program, the
Company does not currently foresee significant risks associated with its Year
2000 issues. However, management believes that it is not possible to determine
with complete certainty that all Year 2000 problems affecting the Company have
been identified or will be corrected. Likewise, because of its progress in
addressing the various Year 2000 issues, the Company has not yet determined the
most likely worst case scenario relating to Year 2000 problems. Nevertheless,
management expects that the Company could likely suffer the following
consequences: (1) a significant number of operational inconveniences and
inefficiencies for the Company and its customers that could divert management's
time and attention and financial and human resources from its ordinary business
activities; and (2) a lesser number of serious system and/or operational
failures that may require significant efforts by the Company to prevent or
alleviate material business disruptions.
CONTINGENCY PLANNING. The Company has not yet completed a comprehensive
contingency plan with respect to the year 2000 issue, but intends to have a plan
developed during the fourth quarter of 1999. The contingency planning process is
an ongoing one that will require further modifications as the Company obtains
additional information regarding the Company's progress on the remediation
phases of its IT and non-IT systems, and on the status of third-party Year 2000
readiness. The Company's core business processes, as currently managed by the IT
systems, can, if necessary, operate for a limited time on a manual,
non-computerized basis. If the Company is required to implement any of these
contingency plans, the implementation could have an adverse effect on the
Company's financial condition and results of operations.
CHANGE IN ACCOUNTANTS
PricewaterhouseCoopers LLP served as the Company's independent auditors
for the fiscal year ended December 31, 1998. Effective August 3, 1999, the
Company dismissed PricewaterhouseCoopers LLP and engaged Ernst & Young LLP as
its independent auditors.
o There have been no adverse opinions, disclaimers of opinion, or
qualifications or modifications as to uncertainty, audit scope, or
accounting principles regarding the reports of
PricewaterhouseCoopers LLP on the Company's financial statements
for each of the fiscal years ended December 31, 1998 and 1997.
o The Audit Committee of the Board of Directors approved the change
of accountants and that action was ratified by the Board of
Directors.
o During the fiscal years ended December 31, 1998 and 1997 and the
subsequent interim period to August 3, 1999, there were no
disagreements with PricewaterhouseCoopers LLP on any matter of
accounting principles or practices, financial statement disclosure,
or auditing scope or procedure, which disagreements, if not
resolved to the satisfaction of PricewaterhouseCoopers LLP, would
have caused PricewaterhouseCoopers LLP to make reference to the
subject matter of the disagreements in connection with its report.
9
<PAGE> 12
FORWARD-LOOKING STATEMENTS
This report contains "forward-looking statements" within the meaning of
the Private Securities Litigation Reform Act of 1995. Such forward-looking
statements can be identified by the use of forward-looking terminology, such as
"may," "intend," "will," "expect," "anticipate," "estimate" or "continue" or the
negative thereof or other variations thereon or comparable terminology. Similar
statements herein that describe the Company's business strategy, outlook,
objectives, plans, intentions or goals are also forward-looking statements.
Although the Company believes that the expectations in such forward-looking
statements are reasonable, there can be no assurance that such expectations will
prove to have been correct. All such forward-looking statements are subject to
certain risks and uncertainties that could cause actual results to differ
materially from those in forward-looking statements. These risks and
uncertainties are beyond the ability of the Company to control, and in many
cases, the Company cannot predict all the risks and uncertainties that could
cause its actual results to differ materially from those indicated by the
forward-looking statements. Important factors that could cause actual results to
differ materially from the Company's expectations include, but are not limited
to, the Company's substantial leverage and its effects on the Company's ability
to obtain additional capital as needed, the Company's ability to integrate its
operations and successfully implement new management information systems, the
Company's success in addressing and remediating Year 2000 related issues, the
Company's ability to operate its new manufacturing facilities, customer demand
for manufactured housing and RVs, the effect of economic conditions including
inflation and sensitivity to interest rates, the impact of raw materials prices,
volatility within the manufactured housing industry, the Company's ability to
maintain profitability in the event of the loss of a significant customer and
other risks detailed from time to time in the reports filed by the Company with
the Securities and Exchange Commission, including the Company's Annual Report on
Form 10-K.
10
<PAGE> 13
SELECTED CONSOLIDATED FINANCIAL DATA
(in thousands, except per share data)
The selected consolidated financial data for the five years ended December 31,
1998 are derived from the Company's audited consolidated financial statements
and notes thereto. The selected consolidated financial data for the six months
ended June 30, 1999 are derived from the Company's unaudited consolidated
financial statements and the notes thereto. The selected consolidated financial
data should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
<TABLE>
<CAPTION>
SIX MONTHS YEAR ENDED DECEMBER 31,
ENDED ---------------------------------------------------------
JUNE 30, 1999 1998 1997(1) 1996 1995(2) 1994
------------- --------- --------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Net sales ........................................ $ 454,562 $ 897,450 $ 390,662 $ 264,210 $ 182,519 $ 99,279
Cost of sales .................................... 398,240 781,339 338,045 223,519 155,641 83,356
--------- --------- --------- --------- --------- ---------
Gross profit ................................ 56,322 116,111 52,617 40,691 26,878 15,923
Commission income ................................ 3,500 7,397 5,914 5,497 2,610 1,066
--------- --------- --------- --------- --------- ---------
59,822 123,508 58,531 46,188 29,488 16,989
Selling, general and administrative expenses...... 50,969 99,943 42,922 29,723 20,889 11,941
--------- --------- --------- --------- --------- ---------
Operating income ............................ 8,853 23,565 15,609 16,465 8,599 5,048
Other income ..................................... -- 2,577 -- -- -- 800
Interest expense, net ............................ 11,609 21,143 4,767 2,058 1,337 281
--------- --------- --------- --------- --------- ---------
Income (loss) before income taxes ........... (2,756) 4,999 10,842 14,407 7,262 5,567
Income taxes (benefit) ........................... (786) 3,132 4,554 1,695 45 51
--------- --------- --------- --------- --------- ---------
Net income (loss) ........................... $ (1,970) $ 1,867 $ 6,288 $ 12,712 $ 7,217 $ 5,516
========= ========= ========= ========= ========= =========
Earnings per share - basic ....................... $ (0.29) $ 0.27 $ 0.92
========= ========= =========
Earnings per share - diluted ..................... $ (0.29) $ 0.27 $ 0.90
========= ========= =========
Weighted average shares outstanding - basic ...... 6,856 6,845 6,815
========= ========= =========
Weighted average shares outstanding - diluted .... 6,858 6,865 6,959
========= ========= =========
Pro Forma Information (Unaudited)(3)
Historical income before income taxes............................................. $ 14,407 $ 7,262 $ 5,567
Income tax expense adjustments.................................................... 5,475 2,832 2,171
--------- --------- ---------
Pro forma net income.............................................................. $ 8,932 $ 4,430 $ 3,396
========= ========= =========
Pro forma earnings per share - basic.............................................. $ 1.64 $ 1.01 $ 0.77
========= ========= =========
Pro forma earnings per share - diluted............................................ $ 1.61 $ 0.90 $ 0.69
========= ========= =========
Weighted average shares outstanding - basic....................................... 5,430 4,394 4,394
========= ========= =========
Weighted average shares outstanding - diluted..................................... 5,531 4,946 4,946
========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
SIX MONTHS YEAR ENDED DECEMBER 31,
ENDED ---------------------------------------------------------
JUNE 30, 1999 1998 1997(1) 1996 1995(2) 1994
------------- --------- --------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Balance Sheet Data:
Working capital ....................... $ 80,629 $ 73,134 $ 57,445 $ 24,526 $ 19,744 $ 5,078
Total assets .......................... 338,770 331,835 308,194 55,739 55,669 18,067
Total debt ............................ 216,257 210,579 194,220 9,831 31,263 6,385
Stockholders' equity .................. 40,937 42,887 40,647 34,193 9,556 6,094
</TABLE>
(1) The Company acquired Consolidated Forest Products, L.L.C. on February
27, 1997, Bowen Supply, Inc. on February 28, 1997, Shelter Components
Corporation on December 1, 1997 and Shepherd Products Company on
December 12, 1997. The acquisitions were accounted for as purchases and
accordingly, the operating results of the acquired companies have been
included in the operating results of the Company since their respective
acquisition dates. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Acquisitions."
(2) The Company acquired Service Supply Systems, Inc. ("Service Supply") on
June 30, 1995. The acquisition was accounted for as a purchase and
accordingly, the operating results of Service Supply have been included
in the operating results of the Company since June 30, 1995. See
"Management's Discussion and Analysis and Results of Operations -
Acquisitions."
(3) Prior to its initial public offering, the Company had elected to be
treated as an S corporation under the Internal Revenue Code. As an S
Corporation, the Company was not subject to federal and certain state
income taxes. The pro forma data give effect to the income taxes that
would have been recorded had the Company been taxed as a C corporation.
11
<PAGE> 14
KEVCO, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
----------- ------------
(UNAUDITED)
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents ................................ $ 5,575 $ 799
Trade accounts receivable, less allowance for doubtful
Accounts of $614 and $740 in 1999 and 1998,
respectively............................................ 63,230 51,367
Inventories, less reserve for obsolete inventory of
$2,448 and $2,781 in 1999 and 1998, respectively ....... 93,314 95,999
Assets held for sale ..................................... 475 1,065
Other current assets ..................................... 6,911 8,458
---------- ----------
Total current assets ................................ 169,505 157,688
Property and equipment, net ................................ 42,476 44,994
Intangible assets, net ..................................... 117,852 119,590
Deferred tax asset ......................................... 2,778 2,778
Other assets ............................................... 6,159 6,785
---------- ----------
Total assets ........................................ $ 338,770 $ 331,835
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt ........................ $ 8,139 $ 7,209
Trade accounts payable ................................... 63,677 61,569
Accrued liabilities ...................................... 17,060 15,533
Other current liabilities ................................ -- 243
---------- ----------
Total current liabilities ........................... 88,876 84,554
Long-term debt, less current portion ....................... 208,118 203,370
Deferred compensation obligation ........................... 839 1,024
---------- ----------
Total liabilities ................................... 297,833 288,948
---------- ----------
Stockholders' equity:
Common stock, $.01 par value; 100,000 shares
authorized; 6,856 and 6,853 shares issued and
outstanding in 1999 and 1998, respectively ............. 69 69
Additional paid-in capital ............................... 33,412 33,392
Retained earnings ........................................ 7,456 9,426
---------- ----------
Total stockholders' equity .......................... 40,937 42,887
---------- ----------
Total liabilities and stockholders' equity .......... $ 338,770 $ 331,835
========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
12
<PAGE> 15
KEVCO, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
--------------------------
1999 1998
----------- -----------
<S> <C> <C>
Net sales ............................................. $ 454,562 $ 444,018
Cost of sales ......................................... 398,240 383,124
----------- -----------
Gross profit ..................................... 56,322 60,894
Commission income ..................................... 3,500 3,700
----------- -----------
59,822 64,594
Selling, general and administrative expenses .......... 50,969 44,836
----------- -----------
Operating income ................................. 8,853 19,758
Interest expense ...................................... 11,609 10,206
----------- -----------
Income (loss) before income taxes ................ (2,756) 9,552
Income taxes (benefit) ................................ (786) 4,237
----------- -----------
Net income (loss) ................................ $ (1,970) $ 5,315
=========== ===========
Earnings per share - basic ............................ $ (0.29) $ 0.78
=========== ===========
Earnings per share - diluted .......................... $ (0.29) $ 0.76
=========== ===========
Weighted average shares outstanding - basic ........... 6,856 6,837
=========== ===========
Weighted average shares outstanding - diluted ......... 6,858 6,953
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements
13
<PAGE> 16
KEVCO, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
-------------------------
1999 1998
---------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net (loss) income ................................. $ (1,970) $ 5,315
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization .................. 5,334 3,983
Gain on sale of assets ......................... (787) --
Deferred compensation obligation ............... (185) (146)
Changes in assets and liabilities .............. (4,239) (21,751)
---------- ----------
Net cash used by operating activities .......... (1,847) (12,599)
Cash flows from investing activities:
Purchase of equipment ............................. (1,722) (5,679)
Proceeds from sale of assets ...................... 2,300 709
Proceeds from assets held for sale ................ 880 2,968
Decrease (increase) in other assets ............... 124 (227)
---------- ----------
Net cash (used) provided by investing
activities.................................... 1,582 (2,229)
Cash flows from financing activities:
Proceeds from line of credit, net ................. 11,000 7,418
Proceeds from long-term debt ...................... -- 10,000
Payments of long-term debt ........................ (5,322) (2,786)
Payment for loan origination fees ................. (657) --
Stock options exercised ........................... 20 216
Other ............................................. -- (73)
---------- ----------
Net cash provided by financing activities ...... 5,041 14,775
---------- ----------
Net increase (decrease) in cash and cash
equivalents........................... .............. 4,776 (53)
Beginning cash and cash equivalents ................... 799 271
---------- ----------
Ending cash and cash equivalents ...................... $ 5,575 $ 218
========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
14
<PAGE> 17
KEVCO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. ACCOUNTING POLICIES AND BASIS OF PRESENTATION
The accompanying consolidated financial statements of the Company have
been prepared pursuant to the rules and regulations of the Securities and
Exchange Commission ("SEC"). Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
("GAAP") for complete financial statements. All significant intercompany
transactions and accounts have been eliminated.
In the opinion of management, the consolidated financial statements
contain all adjustments, consisting only of normal recurring adjustments,
considered necessary for a fair statement of the balance sheets as of June 30,
1999 and December 31, 1998, the statements of operations for the six-month
periods ended June 30, 1999 and 1998 and the statements of cash flows for the
six-month periods ended June 30, 1999 and 1998. The results of operations for
the six-month period ended June 30, 1999 are not necessarily indicative of the
results of operations for the entire fiscal year ending December 31, 1999.
2. ACQUISITIONS
During the year ended December 31, 1997, Kevco acquired Shelter
Components Corporation on December 1, 1997 (the "Shelter Acquisition"), the
inventory and certain distribution rights from Shepherd Products Company on
December 12, 1997 (the "Shepherd Acquisition"), Bowen Supply, Inc. on February
28, 1997 (the "Bowen Acquisition") and Consolidated Forest Products, L.L.C. on
February 27, 1997 (the "Consolidated Forest Acquisition") for total purchase
prices approximating $144.8 million, $8.0 million, $20.2 million and $14.1
million, respectively. The acquisitions were made utilizing borrowings under the
Company's amended and restated credit facility and, in the case of the Shelter
Acquisition, net proceeds from the issuance of $105.0 million of 10 3/8% senior
subordinated notes due 2007. Each of the acquisitions was accounted for as a
purchase and the results of operations of the acquired companies were included
in the consolidated results of operations of the Company from their respective
acquisition dates. As a result of the acquisitions, the Company recorded
approximately $115.1 million of goodwill, which reflects the adjustments
necessary to allocate the individual purchase prices to the fair value of assets
acquired, liabilities assumed and additional purchase liabilities recorded.
Additional purchase liabilities included approximately $1.8 million ($0.1
million at June 30, 1999) for severance and related costs associated primarily
with the elimination of certain administrative and corporate positions that were
recorded in connection with the Shelter Acquisition.
3. INVENTORIES
Inventories are comprised of the following (in thousands):
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
-------- --------------
<S> <C> <C>
Raw materials $ 24,174 $23,535
Work in process 511 1,055
Finished goods 7,931 6,961
Goods held for resale 60,698 64,448
-------- -------
$ 93,314 $95,999
======== =======
</TABLE>
4. LONG-TERM DEBT
In December 1997, the Company and its lenders entered into the second
amended and restated credit agreement at closing of the Shelter Acquisition to
allow for aggregate senior borrowings of up to $125.0 million comprised of a
revolving credit facility of $45.0 million and a term loan facility of $80.0
million requiring quarterly installments. The revolving credit facility and
$40.0 million of the term loan facility were (prior to the fourth amended
agreement and waiver described below) to mature in 2003 with the remaining term
loan facility to mature
15
<PAGE> 18
in 2004. The term loan and revolving credit facility were collateralized by
substantially all of the assets of the Company and its subsidiaries as well as
the capital stock of such subsidiaries.
In February 1999, the Company entered into a third amendment and waiver
to the second amended and restated credit agreement, which allowed for an
incremental commitment of $5.0 million due March 31, 1999 and waived any event
of default due to the Company's violation of certain financial covenants
contained in the credit agreement through March 31, 1999. In March 1999, the
Company requested and obtained an additional $5.0 million incremental commitment
and an extension of the maturity date on the aggregate $10.0 million incremental
commitment (the "Incremental Commitment") and waiver of any events of default to
April 15, 1999.
In April 1999, the Company entered into a fourth amendment and waiver
to the second amended and restated credit agreement. This amendment contained
revised financial covenants effective for the quarters ended March 31, 1999
through June 30, 2000 and waived certain events of default. Under this
amendment, the Incremental Commitment matured on June 30, 1999 and the revolving
credit facility and term loan would have matured on June 30, 2000.
In July 1999, the Company entered into the third amended and restated
credit agreement which restructured the terms and conditions in regard to
applicable rates, covenants and maturity. Under the third amended and restated
credit agreement the Company may borrow under either a base rate or LIBOR rate
with the cost determined based upon certain compliance ratios established in the
covenants. The covenants under such credit agreement include, but are not
limited to, a leverage ratio, fixed charge coverage ratio and minimum net worth.
The $45.0 million revolving credit facility matures in December 2003, Facility A
for $36.9 million under the term loan has scheduled quarterly payments starting
in March 2000 through December 2003 and Facility B for $38.8 million under the
term loan has scheduled quarterly payments starting in September 1999 through
December 2004. The Company may also be required to repay amounts earlier than
scheduled as a result of asset sales, excess cash flow from operations, issuance
of new debt or issuance of new equity.
In addition to funds available under the third amended and restated
credit agreement, the Company issued $105.0 million of 10 3/8% senior
subordinated notes due 2007 (the "Senior Notes") under the indenture dated as of
December 1, 1997, as supplemented (the "Indenture"), to complete the Shelter
Acquisition. Interest is payable on June 1 and December 1 of each year
commencing June 1, 1998. The Senior Notes are redeemable, in whole or in part,
at the option of the Company, at any time on or after December 1, 2002, at the
redemption prices set forth in the Indenture. In addition, at any time on or
before December 1, 2000, the Company may redeem up to 35% of the original
aggregate principal amount of the Senior Notes with the net proceeds of a public
equity offering at a redemption price equal to 110.375% of the principal amount
thereof, plus accrued and unpaid interest, if any, thereon to the date of
redemption.
The third amended and restated credit agreement and Indenture contain
certain restrictions and conditions that include cash flow and various financial
ratio requirements, and limitations on incurrence of debt or liens, acquisitions
of property and equipment, distributions to shareholders and certain events
constituting a Change of Control (as defined in the agreements).
5. WINGATE TRANSACTION - SUBSEQUENT EVENT
In July 1999, the Company completed a transaction as a result of which
The Kevco Partners Investment Trust, a Delaware business trust and an affiliate
of Wingate Partners II, L.P. (the "Trust"), acquired an aggregate of $37.0
million in value of Kevco's common stock, convertible debt and warrants. As a
result of the transaction, the Trust now owns approximately 28% of the Company's
outstanding voting common stock. Assuming full conversion of the convertible
debt and exercise of the warrants, the Trust would own approximately 46% of the
voting common stock and all of non-voting common stock of the Company.
16
<PAGE> 19
6. EARNINGS PER SHARE
Basic earnings per share excludes dilution, and diluted earnings per
share reflects the potential dilution that could occur if securities or other
contracts to issue voting common stock were exercised and converted into voting
common stock. The reconciliation between basic and diluted weighted average
shares outstanding, follows:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
1999 1998
--------------- ----------
(IN THOUSANDS)
<S> <C> <C>
Weighted average shares - basic 6,856 6,837
Plus shares applicable to stock
option plans 2 116
----- -----
Weighted average shares - diluted 6,858 6,953
===== =====
</TABLE>
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Liquidity and Capital Resources," for information on the
issuance of new voting common stock subsequent to June 30, 1999.
7. SEGMENT REPORTING
In June 1997, the FASB issued Statement of Financial Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information," which the
Company adopted for the year ended December 31, 1998.
The Company identifies such segments based upon management
responsibility within the United States. The Company operates in three business
segments: Distribution, Manufacturing and Wood Products. The Distribution
segment primarily distributes plumbing products, building products, electrical
components and hardware supplies to the manufactured housing and recreational
vehicle industries; the Manufacturing segment primarily manufactures and
distributes thermoformed products, laminated wallboard products and plastic
injection molded products primarily to the manufactured housing and recreational
vehicle industries; and the Wood Products segment primarily manufactures roof
trusses and lumber cut to customer specifications for use in manufactured homes.
During 1998, the Wood Products segment opened two new facilities which may
result in period-to-period comparisons not being indicative of future results.
The Company measures segment performance based upon revenue and
operating income results. The information in the Corporate/Other category
consists primarily of intercompany eliminations of Manufacturing sales to
Distribution and corporate operating expenses, and is utilized to reconcile to
the consolidated results. Amounts are presented for the six-month periods ended
June 30, 1999 and 1998.
<TABLE>
<CAPTION>
WOOD CORPORATE/ TOTAL
SIX MONTHS ENDED: DISTRIBUTION MANUFACTURING PRODUCTS OTHER COMPANY
---------------- ------------ ------------- -------- --------- -------
<S> <C> <C> <C> <C> <C>
June 30, 1999
Net sales........... $298,953 $ 77,167 $87,858 $ (9,416)(a) $454,562
Operating income.... $ 15,254 $ 4,355 $ 2,667 $(13,423)(b) $ 8,853
June 30, 1998
Net sales........... $300,815 $ 69,764 $80,245 $ (6,806)(a) $444,018
Operating income.... $ 17,722 $ 5,711 $ 3,068 $ (6,743)(b) $ 19,758
</TABLE>
(a) Consists primarily of intercompany eliminations of Manufacturing
sales to Distribution.
(b) Consists primarily of corporate operating expenses.
17
<PAGE> 20
QUARTERLY RESULTS
The following table represents certain unaudited financial information for the
quarters indicated restated for the reclassification of customer rebates from
cost of sales to sales in the first quarter of 1998.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
- --------------------------------------------------------------------------------------------------
(in thousand, except per share data)
<S> <C> <C> <C> <C>
Six Months ended June 30, 1999
Net sales ......................... $ 222,785 231,777
Gross margin ...................... 29,389 30,433
Loss before income taxes .......... (2,533) (233)
Net loss .......................... (1,216) (754)
Earnings per share - basic ........ (0.18) (0.11)
Earnings per share - diluted ...... (0.18) (0.11)
Year ended December 31, 1998
Net sales ......................... $ 212,051 $ 231,967 $ 234,625 $ 218,807
Gross margin ...................... 28,943 31,951 30,144 25,073
Income (loss) before income taxes.. 3,861 5,691 1,044 (5,597)
Net (loss) income ................. 2,128 3,187 513 (3,961)
Earnings per share - basic ........ 0.31 0.47 0.07 (0.58)
Earnings per share - diluted ...... 0.31 0.46 0.07 (0.58)
Year ended December 31, 1997(1)
Net sales ......................... $ 71,461 $ 100,384 $ 97,667 $ 121,150
Gross margin ...................... 10,123 13,871 12,825 15,798
Income before income taxes ........ 3,193 4,434 2,513 702
Net income ........................ 1,916 2,661 1,507 204
Earnings per share - basic ........ 0.28 0.39 0.22 0.03
Earnings per share - diluted ...... 0.27 0.39 0.22 0.03
- --------------------------------------------------------------------------------------------------
</TABLE>
(1) The Company acquired Shelter Components Corporation on December 1, 1997,
Shepherd Products Company on December 12, 1997, Consolidated Forest
Products, L.L.C. on February 27, 1997 and Bowen Supply, Inc. on February
28, 1997. The acquisitions were accounted for as purchases and accordingly,
the operating results of the acquired companies have been included in the
operating results of the Company since their respective acquisition dates.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Acquisitions."
18
<PAGE> 21
DIRECTORS AND EXECUTIVE OFFICERS
DIRECTORS
Frederick B. Hegi, Jr. has served as Chairman of the Board since July 26, 1999.
Mr. Hegi also currently serves as Chairman of the executive committee. He is a
general partner of various Wingate entities, including the indirect general
partner of Wingate Partners II, L.P. Mr. Hegi also is the Chairman of United
Stationers, Inc., a wholesale distributor of paper products and office supplies
("United Stationers"); Chairman of Loomis, Fargo & Co., an armored car service
company; Chairman of Tahoka First Bancorp, Inc., a bank holding company;
Chairman of Cedar Creek Bancshares, Inc., a bank holding company; a director of
Pro Parts Xpress, Inc., a wholesale distributor of automotive parts ("Pro Part
Xpress"); a director of Lone Star Technologies, Inc., a manufacturer of tubular
products; and a director of Texas Capital Bancshares, Inc., a bank holding
company. Mr. Hegi received his B.B.A. from Southern Methodist University, his
M.B.A. from Harvard Business School and his Ph.D. from the University of Texas.
James A. Johnson has served as a director since July 26, 1999. Mr. Johnson also
currently serves on both the compensation committee and the executive committee.
He is a general partner of various Wingate entities, including the indirect
general partner of Wingate Partners II, L.P. Mr. Johnson joined Wingate
Partners, L.P. in 1990. Mr. Johnson currently serves as a director or Pro Parts
Xpress and of United Stationers. Mr. Johnson received his B.S. in industrial
engineering from Stanford University and his M.B.A. from the Stanford Graduate
School of Business.
Jerry E. Kimmel is the founder of the Company and has spent his entire career in
this industry. Mr. Kimmel has served as Vice Chairman of the Board since July
1999 and has served as a director since 1993. Mr. Kimmel also currently serves
on the executive committee. From 1978 to July 1999, Mr. Kimmel served as
President of Kevco. Mr. Kimmel also served as Chairman of the Board and Chief
Executive Officer of the Company from 1993 until July 1999. In 1992, Mr. Kimmel
was inducted into the MH/RV Hall of Fame. Mr. Kimmel served as the Chairman of
the Board of Governors of the Manufactured Housing Institute ("MHI"), a leading
manufactured housing trade group, in 1983 and 1984, and has served in various
other MHI board capacities.
William L. Estes has served as a director of the Company since September 21,
1999. Mr. Estes is currently a member of the audit committee and Chairman of the
compensation committee. Mr. Estes is currently President and Chief Executive
Officer of Consolidated Container Holdings ("CCC"), a $700 million manufacturer
and marketer of rigid plastic containers to the dairy, beverage, food, household
chemical, automotive and industrial chemical sectors. Prior to joining CCC, Mr.
Estes served as President and Chief Executive Officer of Suiza Packaging, a
predecessor company to CCC. From November 1996 to February 1998, Mr. Estes
served as President and Chief Operating Officer of McKesson Corporation's
McKesson-Carrollton operations. From January 1994 to November 1996, Mr. Estes
served in various capacities with FoxMeyer Health Corporation, most recently as
President and Chief Operating Officer. FoxMeyer filed for protection under
Chapter 11 of the U.S. Bankruptcy Code on August 27, 1996. Mr. Estes received
his B.A. in mechanical engineering from the University of Illinois and his
M.B.A. from the Wharton School of Business.
Peter B. McKee has served as a director of the Company since September 21, 1999.
Mr. McKee is currently a member of the compensation committee and Chairman of
the audit committee. From May 1996 to June 1999, Mr. McKee served as the Senior
Vice President and Chief Financial Officer of Allegiance Corporation, a $4.5
billion health care products supplier. From January 1994 to May 1996, Mr. McKee
served as the Senior Vice President and Chief Financial Officer of FoxMeyer
Health Corporation, a $6.0 billion pharmaceutical distributor. FoxMeyer filed
for protection under Chapter 11 of the U.S. Bankruptcy Code on August 27, 1996.
Mr. McKee currently serves as a director of CurranCare, a healthcare consulting
company. Mr. McKee received his B.S. in business administration from
Northwestern University. Mr. McKee also attended the New York University
Graduate School of Business.
Richard Nevins has served as a director of the Company since November 1996. Mr.
Nevins also currently serves on both the audit committee and the compensation
committee. Since July 1998, Mr. Nevins has served as Managing Director of
Jefferies & Company, Inc., an investment banking firm. From 1992 to July 1998,
Mr. Nevins served as President of Richard Nevins & Associates, a financial
advisory firm. Mr. Nevins was elected as a director of Fruehauf Trailer
Corporation in 1995. On October 7, 1996, Fruehauf filed for relief under
Chapter 11. During 1996, Mr. Nevins served as acting Chief Operating Officer and
Chief Restructuring Officer for Sun World International, a California
agricultural firm. From 1995 to 1996, Mr. Nevins served as a director of Ampex
Corporation and from 1993 to 1995 he served as a director of the Actava Group
(now Metromedia International Group). Mr. Nevins received his B.A. in Economics
from the University of California, Riverside and his M.B.A. from Stanford
Graduate School of Business.
19
<PAGE> 22
EXECUTIVE OFFICERS
Information concerning the business experience of Messrs. Hegi and
Johnson is provided under the caption "Directors" above.
Clyde A. Reed, Jr. has served as Executive Vice President of the Company since
1986. From 1991 to July 1999 Mr. Reed served as the Chief Operating Officer of
the company. Mr. Reed also served as a director of the company from 1996 until
his resignation in January 1999.
Dan Russell Hardin has served as the President of the Company's Distribution
Group since July 1999. From 1998 to July 1999, Mr. Hardin served as Executive
Vice President of the Company. Mr. Hardin also served as the Company's Vice
President of Sales from 1995 to 1998. Prior to joining the Company, Mr. Hardin
served as the National Sales Manager of Service Supply Systems, a distribution
company. Mr. Hardin received his B.B.A. in business from the University of
Georgia.
C. Lee Denham currently serves as President of the Sunbelt Wood Components Group
of the Company. Mr. Denham founded Sunbelt Wood Components, Inc., a fabricated
structural products company, in 1981. Mr. Denham received his B.B.A. in
marketing from the University of Georgia.
Robert W. Tennyson has served as the President of the Manufactured Products
Group of the Company since July 1999. From January 1998 to July 1999, Mr.
Tennyson served as the Executive Vice President - Manufacturing of the company.
Prior to joining the company, Mr. Tennyson served as President of Plastic
Solutions, a custom injection molding company which he founded in 1991. Mr.
Tennyson received his B.S. in accounting and economics from Indiana University.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is subject to interest rate risk on its term loans and
revolving credit facility. Interest rates are fixed on the Indenture and
capitalized lease obligations. At June 30, 1999, the Company's exposure to these
risk factors was not significant and had not materially changed from December
31, 1998.
MARKET PRICES AND DIVIDEND INFORMATION
The Company's common stock is traded on The Nasdaq Stock Market under
the symbol "KVCO." At September 30, 1999, there was approximately 87
shareholders of record of the Company's common stock. The prices in the table
below represent the high and low sales price per share of the Company's common
stock for each fiscal quarter from January 1, 1997 through September 30, 1999.
<TABLE>
<CAPTION>
HIGH LOW
---- ---
FISCAL YEAR ENDED
DECEMBER 31, 1997
<S> <C> <C> <C>
1st Quarter $ 18.75 $ 13.75
2nd Quarter 15.50 12.25
3rd Quarter 14.38 10.13
4th Quarter 17.88 11.88
FISCAL YEAR ENDED
DECEMBER 31, 1998
1st Quarter $ 19.00 $ 16.50
2nd Quarter 26.00 18.75
3rd Quarter 22.13 16.00
4th Quarter 18.63 16.13
FISCAL QUARTER ENDED
MARCH 31, 1999 $ 10.50 $ 4.25
FISCAL QUARTER ENDED
JUNE 30, 1999 $ 9.00 $ 4.44
FISCAL QUARTER ENDED
SEPTEMBER 30, 1999 $ 9.00 $ 4.47
</TABLE>
20
<PAGE> 23
The Company has not paid cash dividends on its common stock and does
not intend to declare cash dividends on its common stock in the foreseeable
future.
ADDITIONAL INFORMATION
A COPY OF THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR
ENDED DECEMBER 31, 1998, AS AMENDED, AND THE COMPANY'S QUARTERLY REPORTS ON FORM
10-Q FOR THE FISCAL QUARTERS ENDED MARCH 31, 1999 AND JUNE 30, 1999, ARE
AVAILABLE WITHOUT CHARGE TO SHAREHOLDERS UPON WRITTEN REQUEST. Requests should
be directed to Kevco, Inc., 1300 South University Drive, Suite 200, Fort Worth,
Texas 76107-5734, Attention: James A. Johnson, Executive Vice President and
Secretary.
21
<PAGE> 24
INDEX TO 1998 FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
<S> <C>
CONSOLIDATED BALANCE SHEETS.........................................F-2
CONSOLIDATED STATEMENTS OF INCOME...................................F-3
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY.....................F-4
CONSOLIDATED STATEMENTS OF CASH FLOWS...............................F-5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS..........................F-6
REPORT OF INDEPENDENT ACCOUNTANTS..................................F-20
</TABLE>
F-1
<PAGE> 25
KEVCO, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
DECEMBER 31
-----------------------
1998 1997
---------- ----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ..................................... $ 799 $ 271
Trade accounts receivable, less allowance for
doubtful accounts of $740 and $641 in
1998 and 1997, respectively ............................. 51,367 41,006
Inventories, less reserve for obsolete inventory of $2,781
and $2,692 in 1998 and 1997, respectively ............... 95,999 83,540
Assets held for sale .......................................... 1,065 3,032
Other current assets .......................................... 8,458 4,981
---------- ----------
Total current assets ..................................... 157,688 132,830
Property and equipment, net ..................................... 44,994 42,442
Intangible assets, net .......................................... 119,590 120,190
Deferred income taxes ........................................... 2,778 4,339
Other assets .................................................... 6,785 8,393
---------- ----------
Total assets ............................................ $ 331,835 $ 308,194
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt ............................. $ 7,209 $ 2,932
Trade accounts payable ........................................ 61,569 47,007
Accrued liabilities ........................................... 15,533 24,496
Other current liabilities ..................................... 243 950
---------- ----------
Total current liabilities ................................ 84,554 75,385
Long-term debt, less current portion ............................ 203,370 191,288
Deferred compensation obligation ................................ 1,024 874
---------- ----------
Total liabilities ........................................ 288,948 267,547
---------- ----------
Commitments and contingencies (Note 9)
Stockholders' equity:
Common stock, $.01 par value; 100,000 shares authorized;
6,853 and 6,828 shares issued and outstanding in
1998 and 1997, respectively ............................. 69 68
Additional paid-in capital .................................... 33,392 33,020
Retained earnings ............................................. 9,426 7,559
---------- ----------
Total stockholders' equity ............................... 42,887 40,647
---------- ----------
Total liabilities and stockholders' equity ............... $ 331,835 $ 308,194
========== ==========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-2
<PAGE> 26
KEVCO, INC.
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Net sales ........................................ $ 897,450 $ 390,662 $ 264,210
Cost of sales .................................... 781,339 338,045 223,519
---------- ---------- ----------
Gross profit ................................ 116,111 52,617 40,691
Commission income ................................ 7,397 5,914 5,497
---------- ---------- ----------
123,508 58,531 46,188
Selling, general and administrative expenses ..... 99,943 42,922 29,723
---------- ---------- ----------
Operating income ............................ 23,565 15,609 16,465
Other income ..................................... 2,577 -- --
Interest expense, net ............................ 21,143 4,767 2,058
---------- ---------- ----------
Income before income taxes .................. 4,999 10,842 14,407
Income taxes ..................................... 3,132 4,554 1,695
---------- ---------- ----------
Net income .................................. $ 1,867 $ 6,288 $ 12,712
========== ========== ==========
Earnings per share - basic ....................... $ 0.27 $ 0.92
========== ==========
Earnings per share - diluted ..................... $ 0.27 $ 0.90
========== ==========
Weighted average shares outstanding - basic ...... 6,845 6,815
========== ==========
Weighted average shares outstanding - diluted .... 6,865 6,959
========== ==========
Pro Forma Information (Unaudited)
Historical income before income taxes .......... $ 14,407
Income tax expense adjustments ................. 5,475
----------
Pro forma net income ........................... $ 8,932
==========
Pro forma earnings per share - basic ........... $ 1.64
==========
Pro forma earnings per share - diluted ......... $ 1.61
==========
Weighted average shares outstanding - basic .... 5,430
==========
Weighted average shares outstanding - diluted .. 5,531
==========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-3
<PAGE> 27
KEVCO, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
<TABLE>
<CAPTION>
COMMON STOCK TREASURY STOCK ADDITIONAL
------------------- ---------------- PAID-IN LOAN TO RETAINED
SHARES AMOUNT SHARES AMOUNT CAPITAL SHAREHOLDER EARNINGS TOTAL
------ ------ ------ ------ -------- ----------- -------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995 4,700 $ 47 306 $ (748) $ 3,034 $(3,437) $ 10,660 $ 9,556
Net income................. -- -- -- -- -- -- 12,712 12,712
Distribution to stockholders -- -- -- -- -- -- (14,407) (14,407)
Collections from stockholder -- -- -- -- -- 375 -- 375
Distribution of loan to
stockholders......... -- -- -- -- -- 3,062 (3,062) --
Contributed capital........ -- -- -- -- 86 -- -- 86
Retirement of treasury stock (306) (3) (306) 748 (745) -- -- --
Contribution of S corporation
retained earnings with
changes to C
corporation -- -- -- -- 4,632 -- (4,632) --
status...............
Issuance of stock.......... 2,415 24 -- -- 25,847 -- -- 25,871
----- ---- ------- ------ ------- ------- -------- ---------
Balance at December 31, 1996 6,809 68 -- -- 32,854 -- 1,271 34,193
Net income................. -- -- -- -- -- -- 6,288 6,288
Stock options exercised.... 15 -- -- -- 166 -- -- 166
Issuance of stock.......... 4 -- -- -- -- -- -- --
----- ---- ------- ------ ------- ------- -------- ---------
Balance at
December 31, 1997.... 6,828 68 -- -- 33,020 -- 7,559 40,647
Net income................. -- -- -- -- -- -- 1,867 1,867
Stock options exercised.... 25 1 -- -- 372 -- -- 373
----- ---- ------- ----- -------- ------- -------- ---------
Balance at December 31, 1998 6,853 $ 69 -- $ -- $ 33,392 $ -- $ 9,426 $ 42,887
===== ==== ======= ===== ======== ======= ======== =========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
<PAGE> 28
KEVCO, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income ................................................. $ 1,867 $ 6,288 $ 12,712
Adjustments to reconcile net income to net
cash (used) provided by operating activities:
Depreciation and amortization ......................... 8,928 3,315 1,792
Loss (gain) on sale of assets ......................... 9 (9) (10)
Deferred compensation obligation ...................... 150 60 22
Deferred income taxes ................................. 2,980 452 797
Changes in assets and liabilities, net of effects from
acquisitions
Trade receivables, net ................................ (9,452) 8,998 5,311
Inventories, net ...................................... (13,193) (7,464) (4,521)
Other current assets .................................. (3,445) (2,881) 767
Trade accounts payable ................................ 14,562 9,635 (4,592)
Accrued liabilities ................................... (11,524) (2,023) (124)
----------- ----------- -----------
Net cash (used) provided by operating activities ...... (9,118) 16,371 12,154
Cash flows from investing activities:
Acquisitions of businesses, net of cash acquired ........... -- (161,000) --
Purchase of equipment, proceeds of assets held for sale .... (10,973) (3,577) (1,586)
Insurance proceeds ......................................... 500 -- --
Proceeds from assets held for sale ......................... 3,000 -- --
Proceeds from sale of assets ............................... 759 832 21
(Increase) decrease in other assets ........................ (236) 32 19
----------- ----------- -----------
Net cash used by investing activities ................. (6,950) (163,713) (1,546)
Cash flows from financing activities:
Net proceeds from initial public offering .................. -- -- 25,871
Proceeds (payments) on line of credit, net ................. 9,725 2,675 (6,500)
Payments of long-term debt ................................. (3,366) (1,062) (14,932)
Proceeds from long-term debt ............................... 10,000 175,000 --
Payment of acquired debt ................................... -- (24,592) --
Payment for loan origination fees .......................... (44) (6,637) --
Exercise of stock options .................................. 281 151 --
Distributions paid ......................................... -- -- (14,407)
Capital contributions ...................................... -- -- 86
Collections on loan to stockholder ......................... -- -- 375
----------- ----------- -----------
Net cash provided (used) by financing activities ...... 16,596 145,535 (9,507)
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents ............ 528 (1,807) 1,101
Beginning cash and cash equivalents ............................. 271 2,078 977
----------- ----------- -----------
Ending cash and cash equivalents ................................ $ 799 $ 271 $ 2,078
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-5
<PAGE> 29
KEVCO, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS - (CONTINUED)
(In thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
SUPPLEMENTAL DATA:
Cash paid for interest (none capitalized) .................. $ 19,920 $ 2,727 $ 2,162
Cash paid for income taxes ................................. $ 3,786 $ 6,262 $ 456
NONCASH INVESTING AND FINANCING ACTIVITIES:
Distribution of loan to stockholder ........................ -- -- $ 3,062
Noncompete obligations ..................................... -- $ 492 --
Assets destroyed in fire ................................... $ 1,409 -- --
Changes in estimated fair value of assets acquired and
liabilities assumed ....................................... $ 2,633 -- --
Transfer of buildings to assets held for sale .............. $ 1,065 -- --
Acquisitions:
Fair value of assets acquired ......................... -- $ 255,600 --
Cash paid ............................................. -- 168,700 --
---------- ---------- ----------
Liabilities assumed ............................. -- $ 86,900 --
========== ========== ==========
</TABLE>
The accompanying notes are in integral part of the consolidated financial
statements.
F-6
<PAGE> 30
KEVCO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF OPERATIONS
Kevco, Inc. manufactures and distributes products and materials
primarily for use by the manufactured housing and recreational vehicle
industries.
BASIS OF PRESENTATION
The accompanying consolidated financial statements include the accounts
of Kevco, Inc. and its wholly-owned subsidiaries (the "Company"). All
significant intercompany transactions and accounts have been eliminated. All of
the Company's subsidiaries have guaranteed the 10 3/8% senior subordinated notes
(see Note 6) on a full, unconditional and joint and several basis. As a result,
separate financial statements of the subsidiaries are not included.
CASH AND CASH EQUIVALENTS
For purposes of reporting cash flows, cash and cash equivalents include
cash on hand, deposits with banks and all highly liquid investments with
original maturities of three months or less. The carrying value of cash and cash
equivalents approximates fair value as of December 31, 1998 and 1997.
INVENTORIES
Inventories are stated at the lower of cost or market. Inventories
purchased for resale and manufactured inventories are valued using the first-in,
first-out (FIFO) method. The net carrying value of inventories approximates fair
value as of December 31, 1998 and 1997.
PROPERTY AND EQUIPMENT
Property and equipment are carried at cost less accumulated
depreciation. Additions to and major improvements of property and equipment are
capitalized. Maintenance and repair costs are expensed as incurred. When assets
are retired or otherwise disposed of, their costs and related accumulated
depreciation are removed from the accounts and any resulting gains or losses are
included in the operations for the period. Depreciation is computed using the
straight-line method over the estimated useful lives of the assets. The carrying
value of property and equipment approximates fair value as of December 31, 1998
and 1997.
ASSETS HELD FOR SALE
Assets held for sale consist of certain net assets to be sold as part
of the acquisition of Shelter Components Corporation.
INTANGIBLE ASSETS
Intangible assets are comprised of noncompete agreements and goodwill.
Noncompete agreements are amortized on a straight-line basis over the terms of
the related agreements. The excess of acquisition cost of acquired businesses
over the fair value of net assets acquired ("goodwill") is amortized, using the
straight-line method, over 40 years. The Company reviews goodwill to assess
recoverability periodically. At each balance sheet date, management assesses
whether there has been a permanent impairment in the value of goodwill by
considering factors such as expected future operating income, current operating
results, and other economic factors. Management believes no impairment has
occurred.
F-7
<PAGE> 31
LOAN ORIGINATION COSTS
Loan origination costs, included in other assets, associated with the
acquisition of the Company's senior credit facility and 10 3/8% senior
subordinated notes have been capitalized and are being amortized over the term
of the related debt.
DEFERRED COMPENSATION OBLIGATION
The Company has entered into deferred compensation agreements with
certain employees, whereby payments will be made upon death or retirement for a
ten-year period and such liability has been recorded at the present value of the
anticipated future payments.
REVENUE RECOGNITION
Revenue from product sales is recognized at the time of shipment or the
time of receipt in the case of direct shipments from vendors to customers.
Commissions are recognized as earned.
INCOME TAXES
Income taxes are provided based on earnings reported for tax return
purposes in addition to a provision for deferred income taxes in accordance with
Financial Accounting Standards Board ("FASB") Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes." The provision for income taxes
includes deferred taxes determined by the change in the deferred tax liability
or asset which is computed based on the differences between the financial
statement and income tax bases of assets and liabilities, all of which are
measured by applying enacted tax laws and rates. Deferred tax expense is the
result of changes in the deferred tax liability or asset, adjusted for the
effect of any acquisitions.
INTEREST RATE HEDGE
The Company entered into an interest rate hedge agreement in
conjunction with its primary credit facility to alter interest rate exposure on
both the revolver and the term debt. Amounts expected to be paid or received on
the interest rate hedge are recognized as adjustments to interest expense over
the term of the agreement. Any gain or loss from the termination of this hedge
agreement will be recognized at that time.
CONCENTRATION OF CREDIT RISK
The Company's sales are primarily to the manufactured housing and
recreational vehicle industries across a wide geographical area and generally
require no advance payment from customers. The Company had sales to two
customers representing approximately 15% and 12% respectively in 1998 and 14%
each in 1997.
The Company estimates future credit losses based on continual
evaluation of customers' financial condition, historical loss experience and
current economic conditions. The estimated future credit losses are expensed
through an allowance for doubtful accounts and actual credit losses are charged
to the allowance when incurred.
The Company maintains its cash in bank deposit accounts, which, at
times, may exceed federally insured limits. The Company has not experienced any
losses in such accounts and believes it is not exposed to any significant credit
risk on cash and cash equivalents.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the dates of the financial
statements and the reported amounts of revenues and expenses in the reporting
periods. Actual results could differ from those estimates.
F-8
<PAGE> 32
STOCK SPLIT
On August 29, 1996, the Company effected a .47-for-1 reverse stock
split of its common stock. All share and per share amounts included in the
accompanying financial statements and notes have been restated to reflect the
stock split.
UNAUDITED PRO FORMA NET INCOME
Pro forma net income represents the results of operations adjusted to
reflect a provision for income tax on historical income before income taxes,
which gives effect to the change in the Company's income tax status to a C
corporation prior to the consummation of the Company's initial public offering.
The difference between the pro forma income tax rates utilized and the federal
statutory rate of 35% relates primarily to state income taxes (5%, less effect
of federal tax benefit).
EARNINGS PER SHARE
Earnings per share are calculated for all periods shown in accordance
with FASB Statement of Financial Accounting Standards No. 128 Earnings per
Share, which requires dual presentation of basic and diluted earnings per share
and a reconciliation between the two amounts. Basic earnings per share excludes
dilution, and diluted earnings per share reflects the potential dilution that
could occur if securities or other contracts to issue common stock were
exercised and converted into common stock.
The reconciliation between basic and diluted weighted average shares
outstanding, follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Weighted average shares - basic..... 6,845 6,815 5,430
Plus shares applicable to
stock option plans.............. 20 144 101
----- ----- -----
Weighted average shares -
diluted......................... 6,865 6,959 5,531
===== ===== =====
</TABLE>
Historical earnings per share for 1996 are not presented because they
are not indicative of the ongoing entity. Pro forma earnings per share have been
computed by dividing pro forma net income by the weighted average number of
shares of common stock outstanding during the period. Pro forma earnings per
share data has been presented to reflect the effect of the assumed issuance of
that number of shares of common stock that would generate sufficient cash to pay
an S corporation distribution in an amount equal to previously taxed but
undistributed earnings at December 31, 1996.
SOFTWARE DEVELOPMENT COSTS
Internal and external costs incurred for the development of computer
applications, as well as for upgrades and enhancements that result in additional
functionality of the applications, are capitalized. Internal and external
training and maintenance costs are charged to expense as incurred. When an
application is placed in service, the Company begins amortizing the related
capitalized software costs using the straight-line method and an estimated
useful life varying from three to five years. The costs of identifying,
correcting, reprogramming and testing of computer systems for Year 2000
compliance are expensed as incurred.
START-UP COSTS
Start-up costs consist of salaries, personnel training costs and other
expenses of opening new facilities and are expensed as incurred.
RECENT ACCOUNTING PRONOUNCEMENTS
In February 1998, the FASB issued Statement of Financial Accounting
Standards No. 132 "Employers' Disclosures about Pensions and Other
Postretirement Benefits - an amendment of FASB Statements Number 87, 88,
F-9
<PAGE> 33
and 106" ("FAS 132") that is effective for reporting periods beginning after
December 15, 1997. The required disclosures have been made and adoption of FAS
132 had no effect on the Company's consolidated financial position or results of
operations in 1998.
In March 1998, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants ("AcSEC") issued Statement of
Position 98-1 "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use" ("SOP 98-1") that is effective for reporting periods
beginning after December 15, 1998, but provides for earlier application if
certain conditions are met. The Company has applied the provisions of SOP 98-1
in its financial statements for the year ended December 31, 1998 and its
adoption had no material effect on the Company's consolidated financial position
or results of operations.
In April 1998, the AcSEC issued Statement of Position 98-5 "Reporting
on the Costs of Start-Up Activities" ("SOP 98-5") that is effective for
reporting periods beginning after December 15, 1998. The Company has applied the
provisions of SOP 98-5 in its financial statements for the year ended December
31, 1998 and its adoption had no material effect on the Company's financial
position or results of operations.
In June 1998, the FASB issued Statement of Financial Accounting
Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities"
("FAS 133") that is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. The Company will implement the provisions of FAS 133 as
required. The future adoption of FAS 133 is not expected to have a material
effect on the Company's consolidated financial position or results of
operations.
RECLASSIFICATIONS
Certain amounts in the consolidated financial statements for 1997 and
1996 have been reclassified to conform to the 1998 presentation. These
reclassifications have no effect on stockholders' equity or net income as
previously reported.
2. ACQUISITIONS
During the year ended December 31, 1997, Kevco acquired Shelter
Components Corporation on December 1, 1997 (the "Shelter Acquisition"), the
inventory and certain distribution rights from Shepherd Products Company on
December 12, 1997 (the "Shepherd Acquisition"), Bowen Supply, Inc. on February
28, 1997 (the "Bowen Acquisition") and Consolidated Forest Products, L.L.C. on
February 27, 1997 (the "Consolidated Forest Acquisition") for total purchase
prices approximating $144.8 million, $8.0 million, $20.2 million and $14.1
million, respectively. The acquisitions were made utilizing borrowings under the
Company's amended and restated credit facility and, in the case of the Shelter
Acquisition, net proceeds from the issuance of $105.0 million of 10 3/8% senior
subordinated notes due 2007. Each of the acquisitions was accounted for as a
purchase and the results of operations of the acquired companies were included
in the consolidated results of operations of the Company from their respective
acquisition dates. As a result of the acquisitions, approximately $115.1 million
of goodwill was recorded by the Company, which reflects the adjustments
necessary to allocate the individual purchase prices to the fair value of assets
acquired, liabilities assumed and additional purchase liabilities recorded.
Additional purchase liabilities included approximately $1.8 million ($0.2
million at December 31, 1998) for severance and related costs associated
primarily with the elimination of certain administrative and corporate positions
recorded in connection with the Shelter Acquisition.
F-10
<PAGE> 34
3. INVENTORIES
Inventories are comprised of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1998 1997
---------- ----------
(IN THOUSANDS)
<S> <C> <C>
Raw materials ..................... $ 23,535 $ 17,006
Work-in process ................... 1,055 1,317
Finished goods .................... 6,961 3,760
Goods held for resale ............. 64,448 61,457
---------- ----------
$ 95,999 $ 83,540
========== ==========
</TABLE>
4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------
ESTIMATED
USEFUL
1998 1997 LIVES
---- ---- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Land ......................... $ 2,614 $ 2,631
Buildings .................... 22,296 23,736 31 to 40 years
Machinery and equipment ...... 15,776 13,711 5 to 15 years
Furniture and fixtures ....... 5,161 3,285 3 to 10 years
Transportation equipment ..... 5,312 5,354 3 to 10 years
Leasehold improvements ....... 1,169 682 7 to 15 years
Construction in process ...... 3,773 --
-------- -------
56,101 49,399
Less accumulated
depreciation ................. (11,107) (6,957)
--------- --------
Property and equipment,
net .......................... $ 44,994 $ 42,442
======== ========
</TABLE>
Property and equipment under capital leases consists of buildings of
approximately $2,721,000 and $2,761,000 for the years ended December 31, 1998
and 1997, respectively, and machinery and equipment of approximately $70,000 and
furniture and fixtures of approximately $570,000 for the years ended December
31, 1998 and 1997. Accumulated depreciation was approximately $2,381,000 and
$2,166,000 for the years ended December 31, 1998 and 1997, respectively.
INTANGIBLE ASSETS
Intangible assets consist of the following:
<TABLE>
<CAPTION>
DECEMBER
----------------------------
1998 1997
------------ ------------
(IN THOUSANDS)
<S> <C> <C>
Goodwill .......................... $ 124,233 $ 121,151
Noncompete agreements ............. 1,036 1,036
------------ ------------
125,269 122,187
Less accumulated amortization ..... (5,679) (1,997)
------------ ------------
Intangible assets, net ....... $ 119,590 $ 120,190
============ ============
</TABLE>
F-11
<PAGE> 35
6. LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1998 1997
----------- -----------
<S> <C> <C>
10 3/8% senior subordinated notes due 2007;
interest payable semi-annually ................................... $ 105,000 $ 105,000
Term loan facility payable to banks, due 2000
payable in quarterly installments, with interest payable
monthly at a bank's prime rate plus a margin determined by
operating statistics of the Company (8.80% and
8.42% at December 31, 1998 and 1997, respectively) ............... 79,600 70,000
Revolving credit facility payable to a bank, due 2000, interest
payable monthly at the bank's prime rate plus a margin
determined by operating statistics of the Company (9.00% and
8.50% at December 31, 1998 and 1997, respectively), $23,457
net of outstanding letters of credit of $1,143, was available
under the credit facility at December 31, 1998 ................... 20,400 10,675
Unsecured notes payable, payable in quarterly or annual
installments, with interest from 7.0% to 10.0%, due from
2000 to 2002 ..................................................... 3,617 6,095
Capital lease obligations, collateralized by equipment, maturing
through 2007, payable monthly with interest rates from
7.66% to 26.8% ................................................... 1,521 1,792
Obligations payable under noncompete and consulting agreements, maturing
through 2002, payable monthly with interest rates
from 7.00% to 8.50% .............................................. 441 658
----------- -----------
210,579 194,220
Less current portion ...................................................... (7,209) (2,932)
----------- -----------
$ 203,370 $ 191,288
=========== ===========
</TABLE>
In December 1997, the Company and its lenders entered into the second
amended and restated credit agreement at closing of the Shelter Acquisition to
allow for aggregate senior borrowings of up to $125.0 million comprised of a
revolving credit facility of $45.0 million and a term loan facility of $80.0
million requiring quarterly installments. The revolving credit facility and
$40.0 million of the term loan facility were (prior to the fourth amendment and
waiver described below) to mature in 2003 with the remaining term loan facility
to mature in 2004. The term loan and revolving credit facility were
collateralized by substantially all of the assets of the Company and its
subsidiaries as well as the capital stock of such subsidiaries.
In February 1999, the Company entered into a third amendment and waiver
to its second amended and restated credit agreement, which allowed for an
incremental commitment of $5.0 million due March 31, 1999 and waived any event
of default due to the Company's violation of certain financial covenants
contained in such credit agreement through March 31, 1999. In March 1999, the
Company requested and obtained an additional $5.0 million incremental commitment
and an extension of the maturity date on the aggregate $10.0 million incremental
commitment (the "Incremental Commitment") and waiver of any events of default to
April 15, 1999.
In April 1999, the Company entered into a fourth amendment and waiver
to its second amended and restated credit agreement. This amendment contained
revised financial covenants effective for the quarter ended March 31, 1999
through June 30, 2000 and waived certain events of default. Under this
amendment, the Incremental Commitment matured on June 30, 1999 and the revolving
credit facility and term loan would have matured on June 30, 2000.
In July 1999, the Company entered into the third amended and restated
credit agreement which restructured the terms and conditions in regard to
applicable rates, covenants and maturity. Under the third amended and restated
credit agreement, the Company may borrow under either a base rate or LIBOR rate
with the cost determined based upon certain compliance ratios established in the
covenants. The covenants under such credit agreement include, but are not
limited to, a leverage ratio, fixed charge coverage ratio and minimum net worth.
The $45.0 million revolving credit facility matures in December 2003, Facility A
for $36.9 million under the term loan has scheduled quarterly payments starting
in March 2000 through December 2003 and Facility B for $38.8 million under the
term loan has scheduled quarterly payments starting in September 1999 through
December 2004. The Company may also be required to repay amounts earlier than
scheduled as a result of asset sales, excess cash flow from operations, issuance
of new debt or issuance of new equity.
In addition to funds available under the third amended and restated
credit agreement, the Company issued $105.0 million of 10 3/8% senior
subordinated notes due 2007 (the "Senior Notes") under the indenture dated as of
December 1, 1997, as supplemented (the "Indenture"), to complete the Shelter
Acquisition. Interest is payable on June 1 and December 1
F-12
<PAGE> 36
of each year commencing June 1, 1998. The Senior Notes are redeemable, in whole
or in part, at the option of the Company, at any time on or after December 1,
2002, at the redemption prices set forth in the Indenture. In addition, at any
time on or before December 1, 2000, the Company may redeem up to 35% of the
original aggregate principal amount of the Senior Notes with the net proceeds of
a public equity offering at a redemption price equal to 110.375% of the
principal amount thereof, plus accrued and unpaid interest and liquidated
damages, if any, thereon to the date of redemption.
The third amended and restated credit agreement and Indenture contain
certain restrictions and conditions that include cash flow and various financial
ratio requirements, and limitations on incurrence of debt or liens, acquisitions
of property and equipment, distributions to stockholders and certain events
constituting a Change of Control (as defined in the agreements).
The following are scheduled maturities of debt as of December 31, 1998
(in thousands):
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
------------
<S> <C>
1999........................ $ 7,209
2000 ....................... 95,981
2001 ....................... 1,125
2002 ....................... 414
2003 ....................... 157
Thereafter ......................... 105,693
--------
$210,579
========
</TABLE>
In addition, in order to reduce interest rate risk on the credit
facility, the Company has entered into an interest rate hedge agreement in the
notional amount of $30.0 million, whereby the Company will receive interest
payments should LIBOR increase above 7.0% and, conversely, will make interest
payments should LIBOR decrease below 5.41%, the effect of which limits the
Company's interest expense within the range of 5.41% to 7.0% LIBOR on $30.0
million of debt. Management intends to hold the interest rate hedge until
maturity on January 2, 2001. The Company has incurred no gain or loss related to
this interest rate hedge for the year ended December 31, 1998. The fair value of
the interest rate hedge agreement is approximately $329,000 at December 31,
1998.
The fair value of long-term debt was $202.8 and $194.8 million as of
December 31, 1998 and 1997, respectively. The fair value of the Company's
long-term debt was calculated by discounting future cash flows using an
estimated fair market value interest rate.
7. INCOME TAXES
Prior to November 6, 1996, the Company was treated for federal and
state income tax purposes as an S corporation under Subchapter S of the Internal
Revenue Code. As a result, the Company's earnings for such period were taxed at
the shareholder level. Effective November 6, 1996, the Company terminated its S
corporation status and restructured the organization to create a holding company
with operating company subsidiaries. From November 6, 1996, the Company's
earnings have been taxed as a C corporation and provisions for income taxes have
been reflected in the consolidated financial statements. The Company recorded a
nonrecurring net deferred tax provision of approximately $353,000 associated
with the recognition of a related deferred tax liability due to the termination
of the Company's S corporation status.
The provision for income taxes for the years ended December 31, 1998,
1997 and 1996 consists of the following (in thousands):
F-13
<PAGE> 37
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Federal:
Current ...... $ 535 $ 3,489 $ 559
Deferred ..... 1,895 512 692
State:
Current ...... 318 490 339
Deferred ..... 384 63 105
--------- --------- ---------
$ 3,132 $ 4,554 $ 1,695
========= ========= =========
</TABLE>
Income taxes are provided for the tax effects of transactions reported
in the financial statements and consist of taxes currently due plus deferred
taxes related primarily to differences between the treatment of certain items
for financial statement purposes and the treatment of those items for
corporation tax purposes. The deferred tax assets and liabilities represent the
future tax return consequences of those differences, which will either be
taxable or deductible when the assets and liabilities are recovered or settled.
Components of the Company's deferred tax assets and liabilities at
December 31, 1998 and 1997 were as follows (in thousands):
<TABLE>
<CAPTION>
DEFERRED TAX ASSETS: 1998 1997
--------- ---------
<S> <C> <C>
Accrued liabilities .......................... $ 1,393 $ 1,318
Reserves and allowances ...................... 500 985
Inventory adjustments ........................ 1,586 755
Intangibles .................................. 4,224 4,802
Other ........................................ -- 129
--------- ---------
Total gross deferred tax assets ........... 7,703 7,989
--------- ---------
Deferred tax liabilities:
Property and equipment ....................... (1,841) (1,491)
Other ........................................ (512) (235)
--------- ---------
Total gross deferred tax liabilities ...... (2,353) (1,726)
--------- ---------
Net deferred tax asset ............... $ 5,350 $ 6,263
========= =========
Current deferred tax asset ....................... $ 2,572 $ 1,924
Noncurrent deferred tax asset .................... 2,778 4,339
--------- ---------
Net deferred tax asset ................ $ 5,350 $ 6,263
========= =========
</TABLE>
Management believes that the Company will generate sufficient future
taxable income to realize the entire deferred tax asset and that the realization
of the net deferred tax asset is more likely than not.
The differences between the consolidated provision for income taxes and
income taxes computed using income before income taxes and the U.S. federal
income tax rate for the years ended December 31, 1998, 1997 and 1996 are as
follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1998 1997 1996
---- ---- -----
<S> <C> <C> <C>
Amount computed using statutory rate ........ 34.0% 35.0% 35.0%
Increase (decrease) in taxes
resulting from:
State income taxes, net of federal
tax benefit .............................. 9.3 3.3 1.6
Deferred tax liability related to
S corp termination ....................... -- -- 2.5
Change in method of valuing inventory .... -- -- 2.7
S corp income not subject to federal
tax ...................................... -- -- (30.1)
Non-deductible expenses .................. 21.4 3.1 --
Other, net ............................... (2.0) 0.6 0.1
---- ---- -----
62.7% 42.0% 11.8%
==== ==== =====
</TABLE>
F-14
<PAGE> 38
8. OTHER INCOME
In August 1998, the Company sustained a fire at its Duo-Form plant in
Edwardsburg, Michigan, which destroyed the facility and its contents. The
Company has filed a claim with its insurance carrier and as of December 31,
1998, had received $500,000 in insurance proceeds. A gain from insurance
proceeds of approximately $2,541,000 was recorded at December 31, 1998 related
to the insurance claim.
9. COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases various equipment and buildings under capital and
noncancellable operating leases with an initial term in excess of one year. As
of December 31, 1998, future minimum rental payments required under these
capital and operating leases are summarized as follows (in thousands):
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
---------- ----------
<S> <C> <C>
1999 .............................. $ 485 $ 7,250
2000 .............................. 431 6,033
2001 .............................. 315 4,811
2002 .............................. 304 4,287
2003 .............................. 304 3,361
Thereafter ........................ 966 6,453
---------- ----------
Total .......................... $ 2,805 $ 32,195
========== ==========
Less amount representing
interest .......................... (1,284)
----------
Present value of minimum
lease payments ................. $ 1,521
==========
</TABLE>
Rental expense for operating leases was approximately $11,776,000,
$5,060,000 and $3,839,000 for the years ended December 31, 1998, 1997 and 1996,
respectively.
EMPLOYMENT AGREEMENTS
Effective October 1, 1996, Jerry E. Kimmel entered into a five-year
employment agreement with the Company which provided for an annual base salary
of $250,000. In connection with the consummation of the Wingate transaction (See
Note 14), Mr. Kimmel's employment agreement was terminated, and the Company
entered into a four-year consulting agreement with Mr. Kimmel providing for the
payment of $210,000 annually for general consulting services from time to time
if and when required by the Company.
LITIGATION
There are claims and pending actions incident to the business
operations of the Company. Management does not expect resolution of these
matters to have a material adverse effect on the Company's financial position or
future results of operations or cash flows.
10. RETIREMENT PLAN
The Company has a defined contribution retirement plan that covers
substantially all full-time employees and is qualified under Section 401(k) of
the Internal Revenue Code. Under the plan, employees may voluntarily contribute
a percentage of their compensation to the plan and the Company may make
discretionary contributions. The Company's contributions to the plan for the
years ended December 31, 1998, 1997 and 1996 were $0, $135,000 and $100,000,
respectively.
Effective May 1, 1998, eligible participants of the Health Benefit Plan
for Shelter Components Corporation (the "Plan") were offered enrollment in the
Company's health and welfare benefits. Accordingly, no benefits were payable
under the provisions of the Plan after April 30, 1998 unless the eligible claims
were incurred prior to May 1,
F-15
<PAGE> 39
In July 1998, the Company announced its intent to merge the assets and
liabilities of the Shelter Components Savings Incentive Plan with and into the
Kevco, Inc. 401(k) Profit Sharing Plan on or about September 1, 1998. The
Shelter Components Savings Incentive Plan was terminated in October 1998.
11. RELATED PARTY TRANSACTIONS
The Company leases certain buildings and data processing equipment
under capital leases from partnerships partially owned by Jerry E. Kimmel. Two
of the leased warehouses were financed through economic development and
industrial revenue bonds; one series of which was issued by Newton, Kansas in
the original principal amount of $575,000, and with respect to which, the
Company is the sub-lessee of the premises and a co-guarantor, and one series of
which was issued by Elkhart, Indiana in the original principal amount of
$400,000, and with respect to which, the Company is the lessee of the premises.
Lease payments for the facilities and equipment were approximately $576,000 for
the year ended 1998 and $672,000 for each of the years ended 1997 and 1996. Debt
related to the capital leases was approximately $1,299,000 and $1,398,000 at
December 31, 1998 and 1997, respectively.
The Company loaned Jerry E. Kimmel $5.0 million in 1993, payable in
monthly principal installments of $62,500 plus interest at 9.0% at December 31,
1995, due November 1997. The Company distributed the loan to Mr. Kimmel to the
Company's shareholders effective June 30, 1996.
12. STOCK-BASED COMPENSATION PLANS
The Company sponsors the Kevco, Inc. 1995 Stock Option Plan and the
Kevco, Inc. 1996 Stock Option Plan (the "Plans"), which are stock-based
incentive compensation plans. The Company applies APB Opinion 25 and related
standards in accounting for the Plans.
Under the Plans, the Company is authorized to issue up to 702,735
shares of common stock pursuant to "Awards" granted in the form of incentive
stock options (intended to qualify under Section 422 of the Internal Revenue
Code) and nonqualified stock options. Awards may be granted to selected
employees and directors of the Company. During 1998, 1997 and 1996, the Company
granted only nonqualified stock options under the Plans.
NONQUALIFIED STOCK OPTIONS
The Plans provide that the exercise price of any stock option will be
determined by the board of directors on the date of grant. The stock options
granted after November 1996 vest over 10 years. All options granted prior to
November 1996 vested in November 1996, at the time of the Company's initial
public offering. The options have been granted at prices equal to the market
value of the shares at the date of grant and expire not more than 7 and 10 years
after the date of grant for the 1996 and 1995 plans, respectively. In accordance
with APB 25, the Company has not recognized any compensation cost for these
stock options granted during 1998, 1997 and 1996.
F-16
<PAGE> 40
A summary of the status of the Company's stock options as of December
31, 1998, 1997 and 1996, and the changes during the year ended on those dates is
presented below:
<TABLE>
<CAPTION>
NONQUALIFIED STOCK OPTIONS
-----------------------------------------------------------------------------
1998 1997 1996
----------------------- --------------------- -----------------------
NUMBER OF WEIGHTED NUMBER OF WEIGHTED NUMBER OF WEIGHTED
SHARES OF AVERAGE SHARES OF AVERAGE SHARES OF AVERAGE
UNDERLYING EXERCISE UNDERLYING EXERCISE UNDERLYING EXERCISE
OPTIONS PRICES OPTIONS PRICES OPTIONS PRICES
---------- ----------- ---------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at
beginning of year ................. 421,472 $ 10.76 415,196 $ 10.58 47,854 $ 5.64
Granted ........................... 15,000 $ 19.17 24,500 $ 13.62 393,450 $ 11.17
Exercised ......................... (25,020) $ 11.18 (14,464) $ 10.49 -- N/A
Forfeited ......................... (17,050) $ 14.30 (3,760) $ 11.17 (26,108) $ 10.42
Expired ........................... -- N/A -- N/A -- N/A
Outstanding at end of year ........ 394,402 $ 10.90 421,472 $ 10.76 415,196 $ 10.58
Exercisable at end of year ........ 374,802 $ 10.62 405,072 $ 10.65 415,196 $ 10.58
Weighted-average fair value
of options granted during the
year .............................. -- $ 13.29 -- $ 8.06 -- $ 1.84
</TABLE>
The fair value of each stock option granted is estimated on the date of
grant using the minimum value method of option pricing with the following
weighted-average assumptions for grants in 1998, 1997 and 1996, respectively:
dividend yield of zero percent for all years; risk-free interest rates are
different for each grant and range from 4.65% to 6.19%; the expected lives of
6.3 and 9.5 years, respectively, for the options under the Plans; and expected
volatility of approximately 56.0% and 48.0% for options granted in 1998 and
1997, respectively. In determining the "minimum value," FASB Statement of
Financial Standards No. 123, "Accounting for Stock-Based Compensation," ("FAS
123") does not require the volatility of the Company's common stock underlying
the options to be calculated or considered for options granted in 1996 because
the Company was not publicly-traded when such options were granted.
The following table summarizes information about stock options
outstanding at December 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- ----------------------------------------------------------------------- -----------------------------
RANGE WEIGHTED WEIGHTED WEIGHTED
OF AVERAGE AVERAGE AVERAGE
EXERCISE NUMBER REMAINING EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- ----------------------- ----------- --------- ---------- -------------- -----------
<S> <C> <C> <C> <C> <C>
$ 5.64 42,532 6.0 $ 5.64 42,532 $ 5.64
$ 11.17 321,470 3.9 $ 11.17 321,470 $ 11.17
$ 13.50 to $ 13.88 25,400 8.0 $ 13.63 10,800 $ 13.77
$ 24.50 5,000 9.3 $ 24.50 -- --
---------- ---------
394,402 4.5 $ 10.90 374,802 $ 10.62
========== =========
</TABLE>
NET INCOME AND EARNINGS PER SHARE
Had the compensation cost for the Company's stock-based compensation
plans been determined consistent with FAS 123, the Company's net income and
earnings per share for 1998, 1997 and 1996 would approximate the pro forma
amounts below (in thousands, except per share data):
F-17
<PAGE> 41
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- ------
<S> <C> <C> <C> <C>
Net income..................... As reported.................. $ 1,867 $ 6,288 $ 8,932
Pro forma.................... 1,793 6,237 8,491
Earnings per share - basic..... As reported.................. $ 0.27 $ 0.92 $ 1.64
Pro forma.................... 0.26 0.92 1.56
Earnings per share - diluted... As reported.................. $ 0.27 $ 0.90 $ 1.61
Pro forma.................... 0.26 0.90 1.54
</TABLE>
The effects of applying FAS 123 in this pro forma disclosure are not
indicative of future amounts. FAS 123 does not apply to awards prior to 1995,
and the Company anticipates making awards in the future under its stock-based
compensation plans.
13. SEGMENT REPORTING
In June 1997, the FASB issued Statement of Financial Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information," which the
Company has adopted in the current year.
The Company identifies such segments based upon management
responsibility within the United States. The Company operates in three business
segments: Distribution, Manufacturing and Wood Products.
The Distribution segment primarily distributes plumbing products,
building products, electrical components and hardware supplies to the
manufactured housing and recreational vehicle industries; the Manufacturing
segment primarily manufactures and distributes thermoformed products, laminated
wallboard products and plastic injection molded products primarily to the
manufactured housing and recreational vehicle industries; and the Wood Products
segment primarily manufactures roof trusses and lumber cut to customer
specifications for use in manufactured homes.
As a result of the Company's acquisition strategy, which has impacted
all three segments, year-to-year comparisons may not be indicative of future
results.
The Company measures segment performance based upon revenue and
operating income results. The information in the Corporate/Other category
consists primarily of intercompany eliminations of Manufacturing sales to
Distribution and corporate operating expenses, and is utilized to reconcile to
the consolidated results. Amounts are presented in thousands for each respective
year.
<TABLE>
<CAPTION>
TOTAL
DISTRIBUTION MANUFACTURING WOOD PRODUCTS CORPORATE/OTHER COMPANY
------------ ------------- ------------- --------------- ---------
<S> <C> <C> <C> <C> <C>
1998
Net Sales............ $ 604,497 $140,930 $ 169,869 $(17,846)(a) $ 897,450
Operating Income..... $ 28,449 $ 9,177 $ 5,388 $(19,449)(b) $ 23,565
1997
Net Sales............ $ 248,396 $ 7,518 $ 134,819 $ (71)(a) $ 390,662
Operating Income..... $ 16,709 $ 310 $ 6,631 $ (8,041)(b) $ 15,609
1996
Net Sales............ $ 205,812 -- $ 58,398 -- $ 264,210
Operating Income..... $ 16,119 -- $ 6,743 $ (6,397)(b) $ 16,465
</TABLE>
(a) Consists primarily of intercompany eliminations of Manufacturing sales
to Distribution.
(b) Consists primarily of corporate operating expenses.
F-18
<PAGE> 42
14. SUBSEQUENT EVENT
In July 1999, the Company completed a transaction as a result of which
The Kevco Partners Investment Trust, a Delaware business trust and an affiliate
of Wingate Partners II, L.P. (the "Trust"), acquired an aggregate of $37.0
million in value of Kevco's common stock, convertible debt and warrants. As a
result of the transaction, the Trust now owns approximately 28% of the Company's
outstanding voting common stock. Assuming full conversion of the convertible
debt and exercise of the warrants, the Trust would own approximately 46% of the
voting common stock and all of non-voting common stock of the Company.
F-19
<PAGE> 43
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors
Kevco, Inc.
Fort Worth, Texas
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, stockholders' equity and cash flows present
fairly, in all material respects, the financial position of Kevco, Inc. at
December 31, 1998 and 1997, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
/s/ PRICEWATERHOUSECOOPERS LLP
Fort Worth, Texas
April 12, 1999
F-20
