CAVALIER HOMES INC
10-Q, 1997-11-10
MOBILE HOMES
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                                  UNITED STATES
                        SECURITIES & EXCHANGE COMMISSION
                             Washington, D.C. 20549


                                    FORM 10-Q


  (Mark One)

  [X]    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934

         For the quarterly period ended      September 26, 1997
                                             -------------------
                                                         OR

  [ ]    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934

         For the transition period from                  to
                                        ----------------    ----------------
                         Commission File Number 1-9792
                              Cavalier Homes, Inc.
             (Exact name of Registrant as specified in its charter)


                Delaware                                     63-0949734
  --------------------------------                      --------------------
  (State or other jurisdiction of                          (IRS Employer
   incorporation or organization)                        ation Number)


            Highway 41 North & Cavalier Road, Addison, Alabama 35540
            --------------------------------------------------------
                    (Address of principal executive offices)
                                   (Zip Code)


                                 (205) 747-0044
                                 --------------
              (Registrant's telephone number, including area code)


                                 --------------
  (Former name,  former address and former fiscal year, if changed since last
   year)

  Indicate  by check mark  whether the  registrant  (1) has filed all reports
  required to be filed by Section 13 or 15(d) of the Securities  Exchange Act
  of 1934 during the preceding 12 months (or for such shorter period that the
  registrant was required to file such reports),  and (2) has been subject to
  such filing requirements for the past 90 days. Yes X No

         Indicate  the  number of  shares outstanding of each of the issuer's
  classes of common stock, as of the close of the latest practicable date.

           Class                             Outstanding at November 10, 1997
  ----------------------------               --------------------------------
  Common Stock, $.10 Par Value                     12,312,912 Shares

<PAGE>

                      CAVALIER HOMES, INC. AND SUBSIDIARIES


                                      INDEX


                                                                      Page No.
Part I.  Financial Information  (Unaudited)

         Consolidated Condensed Balance Sheets -                          3
         September 26, 1997 and December 31, 1996

         Consolidated Condensed Statements of Income -                    4
         Thirteen and Thirty-nine Weeks Ended September 26, 1997
         and September 27, 1996

         Consolidated Condensed Statements of Cash Flows -                5
         Thirty-nine Weeks Ended September 26, 1997 and
         September 27, 1996

         Notes to Consolidated Condensed Financial Statements             6

         Management's Discussion and Analysis of Financial Condition      9
         and Results of Operations

Part II. Other Information

         Item 5.  Other Matters                                          13

         Item 6.  Exhibits and Reports on Form 8-K                       14

         Signatures                                                      16




Certain  items in the report  that  follows  are marked  with an  asterisk  (*),
indicating  that they are  subject  to the  "Safe  Harbor"  Statement  under the
Private  Securities  Litigation  Reform  Act of  1995  found  on page 15 of this
report.
                                      -2-
<PAGE>

<TABLE>
<CAPTION>

                      CAVALIER HOMES, INC. AND SUBSIDIARIES
                      CONSOLIDATED CONDENSED BALANCE SHEETS
                             (Dollars in Thousands)
                                   (UNAUDITED)
 
                                                                      
<S>                                                                        <C>                   <C>    

                                                                            September 26,          December 31,
 ASSETS                                                                        1997                   1996
 CURRENT ASSETS:                                                            -------------          ------------
      Cash and cash equivalents                                            $   5,752             $   24,529
      Marketable securities available for sale                                   149                  1,097
      Accounts receivable, less allowance for
             losses of $800                                                   24,454                  3,046
      Notes and installment contracts receivable - current                     1,398                  1,086
      Inventories                                                             14,850                 12,394
      Deferred income taxes                                                    4,754                  4,663
      Other current assets                                                     1,353                  2,475
                                                                            -------------          ------------
             Total current assets                                             52,710                 49,290
                                                                            -------------          ------------
 PROPERTY, PLANT AND EQUIPMENT (Net)                                          28,720                 24,760
                                                                            -------------          ------------
 INSTALLMENT CONTRACTS RECEIVABLE, less
     allowance for credit losses of $1,200 (1997)
     and $941 (1996)                                                          45,324                 34,504
                                                                            -------------          ------------
 GOODWILL, less accumulated amortization of
     $773 (1997) and $588 (1996)                                               2,942                  3,126
                                                                            -------------          ------------
 OTHER ASSETS                                                                  4,221                  3,894
                                                                            -------------          ------------
                                                                           $ 133,917           $    115,574
                                                                            =============          ============
 LIABILITIES AND STOCKHOLDERS' EQUITY
 CURRENT LIABILITIES:
      Current portion of long-term debt                                    $   1,900           $        951
      Accounts payable                                                        11,398                  7,916
      Amounts payable under dealer incentive programs                         10,019                 10,937
      Accrued wages and related withholdings                                   3,019                  1,652
      Accrued incentive compensation                                           1,633                  2,615
      Estimated warranties                                                     7,000                  7,000
      Accrued insurance                                                        1,617                  2,023
      Other accrued expenses                                                   7,692                  7,722
                                                                            -------------          ------------
           Total current liabilities                                          44,278                 40,816
                                                                            -------------          ------------
 DEFERRED INCOME TAXES                                                         1,088                  1,035
                                                                            -------------          ------------
 LONG-TERM DEBT                                                               10,030                  4,918
                                                                            -------------          ------------
 STOCKHOLDERS' EQUITY:
      Series A Junior Participating Preferred Stock,
       $.01 par value; 200,000 shares authorized, none issued
      Preferred stock, $.01 par value;
         300,000 shares authorized, none issued
      Common stock, $.10 par value; authorized
         50,000,000 shares; issued 12,312,912 (1997)
         and 12,169,128 (1996) shares                                          1,231                 1,217
      Additional paid-in capital                                              32,629                31,057
      Retained earnings                                                       44,661                36,531
                                                                            -------------          ------------
          Total stockholders' equity                                          78,521                68,805
                                                                            -------------          ------------
                                                                           $ 133,917           $   115,574
                                                                            =============          ============    





 See Notes to Consolidated Condensed Financial Statements


                                      -3-
</TABLE>
<PAGE>

<TABLE>
<CAPTION>
 
                      CAVALIER HOMES, INC. AND SUBSIDIARIES
                   CONSOLIDATED CONDENSED STATEMENTS OF INCOME
                 (Dollars in Thousands Except Per Share Amounts)
                                   (UNAUDITED)

<S>                                        <C>             <C>                            <C>                  <C>    

                                                 Thirteen Weeks Ended                            Thirty-nine Weeks Ended
                                            ------------------------------                  ---------------------------------
                                             September 26,   September 27,                   September 26,      September 27,
                                                 1997            1996                            1997               1996
                                            --------------  --------------                  --------------     --------------
 REVENUES:                                                                     
      Net sales                            $     83,160    $     88,976                   $     249,397        $     254,598
      Financial services                          1,382             867                           3,820                2,259
                                            --------------  --------------                  --------------     --------------
                                                 84,542          89,843                         253,217              256,857
                                            --------------  --------------                  --------------     --------------
 COST OF SALES                                   68,996          73,226                         205,672              209,682

 SELLING, GENERAL AND ADMINISTRATIVE:
     Manufacturing                               10,501          10,643                          30,402               29,975
     Financial services                             821             550                           2,179                1,417
                                            --------------  --------------                  --------------     --------------
                                                 80,318          84,419                         238,253              241,074
                                            --------------  --------------                  --------------     --------------
 OPERATING PROFIT                                 4,224           5,424                          14,964               15,783
                                            --------------  --------------                  --------------     --------------
 OTHER INCOME(EXPENSE):
     Interest expense:
        Manufacturing                               (48)            (36)                           (127)                 (56)
        Financial services                         (217)           (126)                           (540)                (369)
     Other, net                                     299             750                             984                1,314
                                            --------------  --------------                  --------------     --------------
                                                     34             588                             317                  889
                                            --------------  --------------                  --------------     --------------
 INCOME BEFORE INCOME TAXES                       4,258           6,012                          15,281               16,672
                                            --------------  --------------                  --------------     --------------
 INCOME TAXES                                     1,671           2,403                           6,051                6,667
                                            --------------  --------------                  --------------     --------------
 NET INCOME                                $      2,587    $      3,609                   $       9,230         $     10,005
                                            ==============  ==============                  ==============     ==============
 NET INCOME PER SHARE                      $       0.21    $       0.29  *                $        0.74         $       0.82  *
                                            ==============  ==============                  ==============     ==============
 WEIGHTED AVERAGE SHARES OUTSTANDING         12,469,674      12,412,960  *                   12,426,065           12,223,371  *
                                            ==============  ==============                  ==============     ==============

 *  Adjusted for the five-for-four stock split in November 1996.

 


 See Notes to Consolidated Condensed Financial Statements


                                      -4-
</TABLE>
<PAGE>

<TABLE>
<CAPTION>

                      CAVALIER HOMES, INC. AND SUBSIDIARIES
                 CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
                             (Dollars in Thousands)
                                   (UNAUDITED)

<S>                                                                                        <C>                   <C>   

                                                                                                 Thirty-nine Weeks Ended
                                                                                            -----------------------------------
                                                                                            September 26,         September 27,
                                                                                                1997                 1996
 OPERATING ACTIVITIES:                                                                      -------------         -------------
   Net income                                                                              $      9,230          $     10,005
   Adjustments to reconcile net income to net cash provided by
   (used in) operating activities:
        Depreciation and amortization                                                             3,185                 2,741
        Provision for credit losses and repurchase commitments                                      259                   216
        Gain on sale of property, plant and equipment                                               (49)                  (12)
        Equity in earnings of equity investments                                                   (261)                 (492)
        Compensation related to issuance of stock options                                           134                   169
        Changes in assets and liabilities provided (used) cash, net of
           effects of acquisitions:
             Accounts receivable                                                                (21,408)              (20,449)
             Inventories                                                                         (1,419)               (4,852)
             Accounts payable                                                                     2,660                 6,233
             Amounts payable under dealer incentive programs                                       (918)                3,486
             Estimated warranties                                                                     -                   729
             Other assets and liabilities                                                         1,235                 4,754
                                                                                            -------------          ------------- 
        Net cash provided by (used in) operating activities                                      (7,352)                2,528
                                                                                            -------------          -------------
 INVESTING ACTIVITIES:
   Proceeds from the sale of property, plant and equipment                                           86                    54
   Net cash paid in connection with acquisitions                                                   (871)                 (370)
   Capital expenditures                                                                          (6,650)               (6,473)
   Distribution from equity investments                                                             138                   779
   Proceeds from sale or maturity of marketable securities                                        1,097                 1,475
   Purchase of marketable securities                                                               (149)                    -
   Purchases and originations of notes and installment contracts                                (15,589)              (13,745)
   Principal collected on notes and installment contracts                                         4,100                 2,097
                                                                                            -------------          -------------
        Net cash used in investing activities                                                   (17,838)              (16,183)
                                                                                            -------------          -------------
 FINANCING ACTIVITIES:
   Proceeds from long-term borrowings                                                             7,552                 1,005
   Payments on long-term debt                                                                    (1,491)                 (826)
   Cash dividends paid                                                                           (1,100)                 (840)
   Proceeds from exercise of stock options                                                            4                 3,553
   Proceeds from dividend reinvestment and stock purchase plans                                   1,448                     -
                                                                                            -------------          -------------
        Net cash provided by financing activities                                                 6,413                 2,892
                                                                                            -------------          -------------
 NET DECREASE IN CASH AND CASH EQUIVALENTS                                                      (18,777)              (10,763)
                                                                                            -------------          -------------
 CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD                                                  24,529                21,005
                                                                                            -------------          ------------- 
 CASH AND CASH EQUIVALENTS, END OF PERIOD                                                  $      5,752          $     10,242
                                                                                            =============          ============= 












 See Notes to Consolidated Condensed Financial Statements


                                      -5-
</TABLE>
<PAGE>

                                     PART I.
                      CAVALIER HOMES, INC. AND SUBSIDIARIES
              Notes to Consolidated Condensed Financial Statements
     For the Thirteen and Thirty-nine Week Periods Ended September 26, 1997
                             and September 27, 1996
                 (Dollars in Thousands except per share amounts)

1.       BASIS OF PRESENTATION

                  The accompanying   consolidated condensed financial statements
                  have been prepared in compliance  with Form 10-Q  instructions
                  and thus do not include all of the  information  and footnotes
                  required  by  generally  accepted  accounting  principles  for
                  complete financial  statements.  In the opinion of management,
                  these statements contain all adjustments  necessary to present
                  fairly the  Company's  financial  position as of September 26,
                  1997,  and the results of its  operations for the thirteen and
                  thirty-nine   week  periods  ended   September  26,  1997  and
                  September 27, 1996,  respectively,  and its cash flows for the
                  thirty-nine   week  periods  ended   September  26,  1997  and
                  September 27, 1996,  respectively.  All  adjustments  are of a
                  normal recurring nature.

                  The results  of  operations  for the thirteen and  thirty-nine
                  weeks ended September 26, 1997 are not necessarily  indicative
                  of the results to be expected for the full year.

                  Inventories  consist primarily of raw materials and are stated
                  at the lower of cost (first-in, first-out method) or market.

                  Certain amounts  from the 1996 periods have been  reclassified
                  to   conform   to  the   1997   period   presentation.   These
                  reclassifications  had no effect on results of  operations  or
                  stockholders' equity.

                  Net income per share  is computed  by  dividing  net income by
                  the  weighted   average  number  of  shares  of  common  stock
                  outstanding  during the thirteen and thirty-nine  week periods
                  after  giving  effect  to  the  equivalent  shares  which  are
                  issuable upon the exercise of stock options  determined by the
                  treasury stock method in accordance with APB No. 15.

                  In June 1997, the Company purchased   substantially all of the
                  assets  and  assumed  certain  existing  liabilities  of Pacer
                  Homes, Inc. for a net cash payment of $871.

2.       ACCOUNTING STANDARDS NOT YET ADOPTED

                  During  February  1997,  the Financial   Accounting  Standards
                  Board  ("FASB")  issued  Statement  of  Financial   Accounting
                  Standards  ("SFAS") No. 128,  Earnings  per Share,  which will
                  become  effective  for all  financial  statements  issued  for
                  periods  ending after  December 15,  1997,  including  interim
                  periods.  SFAS No. 128 provides for the  presentation of basic
                  and diluted  earnings  per share on the face of the  financial
                  statements and supersedes  Accounting  Principles  Board (APB)
                  Opinion No. 15, Earnings per Share.  SFAS No. 128 requires the
                  restatement of earnings per share for prior periods  presented
                  after  its  effective  date.  SFAS  No.  128  does  not have a
                  material effect upon the thirteen and thirty-nine week periods
                  ended September 26, 1997 and September 27, 1996, respectively.
                  However,  the impact on other  prior  periods has not yet been
                  determined.

                  The FASB  issued SFAS No. 131,  Disclosures  about Segments of
                  an Enterprise  and Related  Information,  in June 1997,  which
                  supersedes Statement 14, Financial Reporting for Segments of a
                  Business  Enterprise.  SFAS No. 131 modifies  previous  annual
                  segment reporting and requires selected segment information in
                  quarterly  reports.  Statement  No. 131 requires that a public
                  company  report a measure of segment  profit or loss,  certain
                  specific  revenue and expense  items and  segment  assets.  It
                  requires  reconciliations  of total  segment  revenues,  total
                  segment profit or loss, total segment assets and other amounts
                  disclosed  for  segments  to  corresponding   amounts  in  the
                  company's general-purpose financial statements.  The Statement
                  also provides for entity-wide  disclosures  about the products
                  and services a company  provides,  the  material  countries in
                  which  it holds  assets  and  reports  revenue  and its  major
                  customers.  SFAS No.  131  requires  that  companies  disclose
                  segment  data based  upon how  company  management  determines
                  resource   allocations  to  segments  and  measures  segments'


                                      -6-
<PAGE>


                                     PART I.
                      CAVALIER HOMES, INC. AND SUBSIDIARIES
              Notes to Consolidated Condensed Financial Statements
     For the Thirteen and Thirty-nine Week Periods Ended September 26, 1997
                             and September 27, 1996
                 (Dollars in Thousands except per share amounts)

2.       ACCOUNTING STANDARDS NOT YET ADOPTED (continued)


                  performance.   This  Statement  is  effective  for   financial
                  statements issued for fiscal  years  beginning  after December
                  15,  1997.  The adoption of the provisions  of this  Statement
                  is expected to result only in increased disclosures on segment
                  information  and will not  impact the amounts in the financial
                  statements.

3.       SUPPLEMENTAL CASH FLOW DISCLOSURES        
<TABLE>
<S>                                                       <C>             <C>    

                                                            Thirty-nine Weeks Ended
                                                           -----------------------------
                                                          September 26,   September 27,
                                                              1997            1996
                                                           -------------   -------------
                  Cash paid for:    Interest               $    657        $    432
                                    Income taxes           $  5,864        $  4,338

</TABLE>


4.       CREDIT ARRANGEMENTS

                  The Company  has a $23,000 revolving,  warehouse and term-loan
                  agreement (the "Credit Facility") with its primary bank, whose
                  president  is a director of the Company.  The Credit  Facility
                  contains  a  revolving  line  of  credit  which  provides  for
                  borrowings  (including letters of credit) of up to 80% and 50%
                  of the Company's eligible (as defined) accounts receivable and
                  inventories, respectively, up to a maximum of $5,000. Interest
                  is payable  under the  revolving  line of credit at the bank's
                  prime rate (8.5% at September 26, 1997).

                  The warehouse and term-loan  agreement contained in the Credit
                  Facility  provide for borrowings of up to 80% of the Company's
                  eligible  (as defined)  installment  sale  contracts,  up to a
                  maximum  of  $18,000.  Interest  on term  notes is fixed for a
                  period of five  years  from  issuance  at a rate  based on the
                  weekly average yield on five-year treasury securities averaged
                  over the  preceding  13 weeks,  plus 2%,  and  floats  for the
                  remaining  two years at a rate  (subject  to  certain  limits)
                  equal to the  bank's  prime  rate  plus  .75%.  The  warehouse
                  component of the Credit Facility provides for borrowings of up
                  to $2,000 with interest  payable at the bank's prime rate plus
                  1%.  However,  in  no  event  may  the  aggregate  outstanding
                  borrowings under the warehouse and term-loan  agreement exceed
                  $18,000.

                  The   Credit  Facility   contains   certain  restrictive   and
                  financial  covenants,  which,  among other  things,  limit the
                  aggregate of dividend payments and purchases of treasury stock
                  to 50% of  consolidated  net  income  for the two most  recent
                  years, contain restrictions on the Company's ability to pledge
                  assets,   incur  additional   indebtedness  and  make  capital
                  expenditures,  and require  the  Company to  maintain  certain
                  defined financial ratios. Amounts outstanding under the Credit
                  Facility   are  secured  by  the   accounts   receivable   and
                  inventories of the Company,  loans purchased and originated by
                  Cavalier  Acceptance  Corporation,  the Company's wholly owned
                  finance  subsidiary,  and the capital  stock of certain of the
                  Company's  consolidated  subsidiaries.  The bank's  commitment
                  under the Credit Facility will expire in April of 1998.

                  As of  September  26,  1997,  the Company had $8,556  borrowed
                  under the Credit Facility.

5.       STOCKHOLDERS' EQUITY

                  A  five-for-four  stock  split of the  Company's  common stock
                  which was  effected  in the form of a 25% stock  dividend  was
                  distributed on November 15, 1996 to  stockholders of record on
                  October 31, 1996. All historical  dividends and net income per
                  share amounts have been adjusted for the stock split.


                                      -7-
<PAGE>


                                     PART I.
                      CAVALIER HOMES, INC. AND SUBSIDIARIES
              Notes to Consolidated Condensed Financial Statements
     For the Thirteen and Thirty-nine Week Periods Ended September 26, 1997
                             and September 27, 1996
                 (Dollars in Thousands except per share amounts)

5.       STOCKHOLDERS' EQUITY (continued)

                  Cash dividends were paid during this quarter and the previous
                  three quarters as follows (all amounts are per share):
<TABLE>
<S>                        <C>                       <C>                        <C>    

                                                                                Split Adjusted
                              Record Date               Payment Date            Dividend Paid
                           ----------------          -----------------          --------------               
                           July 31, 1997             August 15, 1997            $      .030
                           April 30, 1997            May 15, 1997               $      .030
                           January 31, 1997          February 14, 1997          $      .030
                           October 31, 1996          November 15, 1996          $      .030
</TABLE>

6.       COMMITMENTS AND CONTINGENCIES

                  It  is  a  customary  practice  in  the  manufactured  housing
                  industry  to  enter  into   repurchase   and  other   recourse
                  agreements  with  lending  institutions  which  have  provided
                  wholesale floor plan financing to dealers.  Substantially  all
                  of the Company's sales are made to dealers  located  primarily
                  in the southeast,  southwest and midwest regions of the United
                  States   pursuant  to  repurchase   agreements   with  lending
                  institutions.   These   agreements   generally   provide   for
                  repurchase  of  the   Company's   products  from  the  lending
                  institutions  for  the  balance  due  them  in  the  event  of
                  repossession upon a dealer's default.  Although the Company is
                  contingently liable for approximately $89,000 at September 26,
                  1997,  such  contingency is reduced by the resale value of the
                  homes which may be required to be  repurchased.  Losses  under
                  these  agreements  have not been  significant in the past, and
                  management expects no material loss in excess of the allowance
                  provided of $800. *

                  The  Company's workmen's  compensation,  product liability and
                  general  liability  insurance  coverages  are  provided  under
                  incurred  loss,  retrospectively  rated premium  plans.  Under
                  these plans, the Company incurs insurance  expenses based upon
                  various  rates  applied  to current  payroll  costs and sales.
                  Annually,  such insurance expenses are adjusted by the carrier
                  for loss  experience  factors  subject to minimum  and maximum
                  premium  calculations.  At September 26, 1997, the Company was
                  contingently   liable   for   future   retrospective   premium
                  adjustments  up to a  maximum  of  $7,300  in the  event  that
                  additional losses are reported related to prior periods.

                  The Company is engaged in various legal  proceedings  that are
                  incidental to its business. Certain of the cases filed against
                  the Company and other companies engaged in businesses  similar
                  to the Company  often allege,  among other  things,  breach of
                  contract and warranty, product liability,  personal injury and
                  fraudulent,  deceptive  or collusive  practices in  connection
                  with the Company's operations.  These kinds of suits sometimes
                  seek  certification as class actions,  the imposition of large
                  amounts of  compensatory  and  punitive  damages and trials by
                  jury. Courts have certified several of these types of cases as
                  class  actions in recent  years,  and some cases such as these
                  have  resulted  in  large  damage  awards,   especially  large
                  punitive  damage  awards.  In the opinion of  management,  the
                  ultimate liability, if any, with respect to the proceedings in
                  which the  Company  is  currently  involved  is not  presently
                  expected  to have a material  adverse  effect on the  Company.
                  However,  the  potential  exists  for  unanticipated  material
                  adverse judgments against the Company.*

                  The Company and  certain of its equity  partners  have jointly
                  and severally  guaranteed  revolving  notes for four companies
                  and a letter of credit for one  company  in which the  Company
                  owns various equity  interests.  The guarantees are limited to
                  various  percentages of the  outstanding  debt up to a maximum
                  aggregate guaranty of $2,430. At September 26, 1997, there was
                  a total amount outstanding under the various notes and letters
                  of credit guaranteed by the Company of $4,000.

- ---------------------------------------
* See Safe Harbor Statement on page 15.


                                      -8-
<PAGE>


                                     PART I.
                      CAVALIER HOMES, INC. AND SUBSIDIARIES
                     Management's Discussion and Analysis of
                  Financial Condition and Results of Operations
                               September 26, 1997

General

The  principal  business of the Company since its inception has been the design,
production  and sale of  manufactured  homes.  In the first quarter of 1992, the
Company,  through its wholly owned subsidiary,  Cavalier Acceptance  Corporation
("CAC"),  commenced retail installment sale financing operations, and by the end
of 1993,  these  operations  had become  significant  enough to require  segment
reporting by the Company.

The Company's business is cyclical and seasonal and is influenced by many of the
same economic and demographic factors that affect the housing market as a whole.
According  to the  Manufactured  Housing  Institute,  the  manufactured  housing
industry  posted gains in shipments  from 1992 through  1996,  with  approximate
total annual shipments of 211,000 (1992) increasing to 363,000 (1996),  and with
the greatest gains  occurring in the  southeastern  United  States.  The Company
conducts a substantial portion of its business in the southeastern United States
and attributes  past years' strong shipment growth to a reduction of alternative
housing,   increased  availability  of  retail  financing,   increased  consumer
confidence  and  continuing  strength in the national  economy.  The Company has
increased its production  capacity to better take advantage of the growth in the
industry, increasing the number of manufacturing facilities from four at the end
of 1992 to fourteen at September 26, 1997. The fourteenth manufacturing facility
was added in June  1997  when the  Company  purchased  substantially  all of the
assets  and  assumed  certain  existing  liabilities  of Pacer  Homes,  Inc.,  a
manufacturer in Texas.

The manufactured housing industry has, over the past several years,  experienced
increases in both the number of retail dealers and manufacturing capacity, which
the Company believes is currently  resulting in slower retail  turnover,  higher
dealer  inventories,  lower order  backlogs  and  increased  price  competition.
Industry statistics,  according to the Manufactured Housing Institute, reflect a
decrease in home  shipments of 3.4% through  August 1997 as compared to the same
period in 1996,  with  approximate  year-to-date  shipments  of  237,000  (1997)
compared to 245,000 (1996),  and with the largest declines occurring in Alabama,
Mississippi  and South  Carolina,  three large  markets for the  Company.  It is
possible that these  developments may also signal a return to seasonality in the
Company's manufacturing business,  which was not a significant factor during the
period from 1992  through  1996;  prior to this period,  the greatest  number of
homes in the manufactured housing industry were sold from April through October,
with  lower  shipments  in the  first and last part of the  calendar  year.  The
Company is uncertain  at this time as to what effect these  factors will have on
sales and earnings during the balance of 1997 and thereafter. *

Results of Operations

The following  tables set forth,  for the periods and dates  indicated,  certain
financial and operating data,  including,  as applicable,  the percentage of net
sales or total revenue:
<TABLE>
<CAPTION>

CAVALIER HOMES, INC. AND SUBSIDIARIES
STATISTICAL ANALYSIS
<S>                           <C>              <C>               <C>               <C>               <C>               <C>

STATEMENT OF INCOME SUMMARY                                     For the Thirteen Weeks Ended 
(Dollars in Thousands)         ------------------------------------------------------------------------------------------------ 
                                    September 26, 1997                September 27, 1996                      Difference
                               ----------------------------      -------------------------------     -------------------------- 
Net Sales                     $       83,160    100.0%           $      88,976     100.0%            $      (5,816)    (6.5%)
Cost of Sales                         68,996     83.0%                  73,226      82.3%                   (4,230)    (5.8%)
                              --------------   ------            -------------     ------            --------------
     Gross Profit on Sales    $       14,164     17.0%           $      15,750      17.7%            $      (1,586)   (10.1%)
                              ==============                     =============                       ==============     
Net Sales                     $       83,160                     $      88,976                       $      (5,816)    (6.5%)
Financial Services                     1,382                               867                                 515     59.4%
                              --------------                     -------------                       --------------
     Total Revenue            $       84,542    100.0%           $      89,843     100.0%            $      (5,301)    (5.9%)
                              ==============                     =============                       ==============    
Selling, General
 and Administrative           $       11,322     13.4%           $      11,193      12.5%            $         129      1.2%
Operating Profit              $        4,224      5.0%           $       5,424       6.0%            $      (1,200)   (22.1%)
Other Income (Expense)        $           34        -%           $         588       0.7%            $        (554)   (94.2%)
Net Income                    $        2,587      3.1%           $       3,609       4.0%            $      (1,022)   (28.3%)
</TABLE>

- ---------------------------------------
* See Safe Harbor Statement on page 15.


                                      -9-
<PAGE>

                                     PART I.
                      CAVALIER HOMES, INC. AND SUBSIDIARIES
                     Management's Discussion and Analysis of
                  Financial Condition and Results of Operations
                               September 26, 1997

<TABLE>

<S>                           <C>               <C>              <C>               <C>               <C>               <C>

STATEMENT OF INCOME SUMMARY                                        For the Thirty-nine Weeks Ended
(Dollars in Thousands)         ------------------------------------------------------------------------------------------------
                                    September 26, 1997                   September 27, 1996                   Difference
                               -------------------------------      ------------------------------   --------------------------
Net Sales                     $      249,397    100.0%           $     254,598     100.0%            $      (5,201)    (2.0%)
Cost of Sales                        205,672     82.5%                 209,682      82.4%                   (4,010)    (1.9%)
                              --------------    ------           -------------     ------            --------------   
     Gross Profit on Sales    $       43,725     17.5%           $      44,916      17.6%            $      (1,191)    (2.7%)
                              ==============                     =============                       ==============          
Net Sales                     $      249,397                     $     254,598                       $      (5,201)    (2.0%)
Financial Services                     3,820                            2,259                                1,561     69.1%
                              --------------                     -------------                       --------------   
     Total Revenue            $      253,217    100.0%           $     256,857     100.0%            $      (3,640)    (1.4%)
                              ==============                     =============                       ==============          
Selling, General
 and Administrative           $       32,581     12.9%           $      31,392      12.2%            $       1,189      3.8%
Operating Profit              $       14,964      5.9%           $      15,783       6.1%            $        (819)    (5.2%)
Other Income (Expense)        $          317      0.1%           $         889       0.3%            $        (572)   (64.3%)
Net Income                    $        9,230      3.6%           $      10,005       3.9%            $        (775)    (7.7%)
</TABLE>

<TABLE>

<S>                                                        <C>            <C>                      <C>               <C>    

OPERATING DATA SUMMARY                                         For the Thirteen Weeks                    For the Thirty-nine
(Dollars in Thousands)                                                  Ended                                Weeks Ended
                                                           ---------------------------             ------------------------------
                                                           September 26,  September 27,            September 26,     September 27,
                                                               1997           1996                     1997               1996
                                                           -------------  -------------            -------------     -------------
Installment Loan Originations                              $  4,340       $   4,814                $   14,831        $    13,639
Capital Expenditures                                       $  2,618       $   2,318                $    6,650        $     6,473
Home Shipments                                                3,305           3,763                    10,085             10,728
Floor Section Shipments                                       4,973           5,298                    14,790             15,184
Independent Exclusive Dealers                                   145             107                       145                107
Home Manufacturing Facilities                                    14              13                        14                 13

</TABLE>


Net Sales.  The Company  experienced a decline in net sales for the thirteen and
thirty-nine  week periods  ended  September  26, 1997 over the  comparable  1996
periods of $5,816,000 (6.5%) and $5,201,000  (2.0%),  respectively.  The Company
believes  the decline in net sales for the third  quarter  and the  year-to-date
period is due to increased  competitive  factors in the  industry  caused by the
growth over the last  several  years in the number of dealers  operating  in the
industry and  increased  manufacturing  capacity,  resulting in a slower  retail
turnover  and a build-up  of dealer  inventories,  reduced  order  backlogs  and
increased price  competition.  Homes sold for the third quarter and year-to-date
decreased from the comparable  period in the prior year by 458 homes (12.2%) and
643 homes (6.0%), respectively.  As part of the Company's marketing program, the
exclusive  dealer  distribution  system has grown to 145  independent  exclusive
dealers,  up from 115  dealers at the end of 1996.  The  Company's  product  mix
continues to shift from single-section  homes to multi-section homes. During the
thirteen weeks ended  September 26, 1997,  50% of the Company's  homes sold were
multi-section homes,  compared to 41% for the previous year's comparable period.
For the thirty-nine week period,  multi-section  homes sold accounted for 47% of
1997 homes sold, compared to 42% for the comparable 1996 period.

Financial  Services  Revenue.  Financial  services revenue  (primarily  interest
income  on  retail  installment  contracts)  during  the  current  thirteen  and
thirty-nine week periods increased $515,000 and $1,561,000,  or 59.4% and 69.1%,
respectively, over the comparable periods in the previous year, primarily due to
the growth of the Company's loan portfolio to $48 million, which increased 54.8%
over the  September  1996 loan  portfolio  of $31 million.  While the  financial
services  segment  has  experienced  growth in its loan  portfolio,  the rate of
growth is slowing due to the tightened  market  conditions  of the  manufactured
housing  industry.   *  Installment  loan  originations  for  the  quarter  were
$4,340,000 as compared to the 1996 third quarter of $4,814,000.

Selling, General and Administrative. Selling, general and administrative expense
increased  $1,189,000  during  the  current  thirty-nine  week  period  over the
previous year's comparable  period.  This increase is primarily  attributable to
the costs related to new or expanded manufacturing  facilities of $1,110,000,  a
$621,000 increase in CAC's  administrative  costs consistent with its growth and
expenses  related to the  Company's  expanded  marketing  programs of  $648,000,
partially  offset  by  a  reduction  in  executive  incentive   compensation  of
$1,069,000. Selling, general and administrative expense as a percentage of total
revenue was 12.9% and 12.2% of sales for the thirty-nine  week periods and 13.4%
and 12.5% for the thirteen week periods  ended  September 26, 1997 and September
27, 1996, respectively.

- ---------------------------------------
* See Safe Harbor Statement on page 15.


                                      -10-
<PAGE>


                                     PART I.
                      CAVALIER HOMES, INC. AND SUBSIDIARIES
                     Management's Discussion and Analysis of
                  Financial Condition and Results of Operations
                               September 26, 1997

Other Income (Expense).

Interest  Expense.  Interest expense  increased by $103,000 and $242,000 for the
thirteen and thirty-nine week periods ended September 26, 1997, respectively, as
compared  to the  applicable  1996  periods,  due  to  increased  borrowings  of
$7,552,000 incurred to primarily fund the Company's financial services segment.

Other,  net. Other,  net, declined by $451,000 and $330,000 for the thirteen and
thirty-nine week periods ended September 26, 1997, respectively,  as compared to
the  applicable  1996 periods.  Other,  net, is primarily  comprised of interest
income,  gains or  losses  on sales  of  investments,  and  equity  earnings  in
investments  accounted  for on the equity  basis of  accounting.  The decline in
other,  net, for both periods is primarily  due to a decline in gains from sales
of  investments of $234,000 due to a third quarter 1996 recovery of a previously
written-off  asset,  as well as a slight decline in aggregate  earnings from the
Company's  joint  venture  operations,  recorded  under  the  equity  method  of
accounting, as a result of tightening industry conditions.

Net  Income.   As  discussed  above,   the  manufactured   housing  industry  is
experiencing  an increase in competitive  conditions.  Alabama,  Mississippi and
South Carolina sales were down industry wide 16.1%, 19% and 11.9%, respectively,
through  August  1997 as  compared  to the same  period  in 1996.  These  states
represent  three of the  largest  markets  for the  Company.  Additionally,  the
Company has incurred  certain  start-up costs at its Texas facility  acquired in
June 1997,  as well as costs due to certain labor  shortages and  inefficiencies
associated  with its other  Texas  operations.  As a result  primarily  of these
factors,  net income per share during the current  thirteen and thirty-nine week
periods  was $.21 and  $.74,  respectively,  compared  to $.29 and $.82 from the
previous year's comparable  periods.  Net income per share has been adjusted for
all previous stock splits effected by the Company.

Liquidity and Capital Resources

The  following  table sets forth certain items  relating to the  measurement  of
liquidity  and  capital  resources  from the  Company's  consolidated  condensed
financial statements for the dates indicated:
<TABLE>

<S>                                                                          <C>                            <C>    

BALANCE SHEET SUMMARY                                                                          Balances as of
                                                                             -------------------------------------------------
(Dollars in Thousands)                                                       September 26, 1997             December 31, 1996
                                                                             -------------------------------------------------
Cash and Cash Equivalents                                                      $        5,752                $       24,529
Accounts Receivable                                                            $       24,454                $        3,046
Working Capital                                                                $        8,432                $        8,474
Current Ratio                                                                        1.2 to 1                      1.2 to 1
Long-Term Debt                                                                 $       10,030                $        4,918
Ratio of Long-Term Debt to Equity                                                      1 to 8                       1 to 14
Installment Loan Portfolio                                                     $       47,744                $       36,425

</TABLE>

Working  capital  remained  comparable  from  December 31, 1996 to September 26,
1997,   primarily  due  to  earnings   during  the  period  reduced  by  capital
expenditures  and  originations  of installment  contracts by CAC, which in turn
were offset by long-term debt borrowings and principal  collected on installment
contracts.

The increase in accounts  receivable  from  December  31, 1996 to September  26,
1997, is a normal seasonal occurrence.  As is customary for the Company, most of
its manufacturing operations are idle during the final two weeks of the year for
vacations,  holidays  and reduced  product  demand,  and during  this time,  the
Company collects the majority of its outstanding receivables.

The  Company's   primary   business  segment  is  the  production  and  sale  of
manufactured  housing.  In 1992, the Company began the operations of CAC to fund
installment sale contracts to the retail customers of the Company's  independent
exclusive  dealers.  As the  operations of CAC expanded,  in February  1994, the
Company  entered  into a credit  facility  with its primary  lender (the "Credit
Facility") (see footnote 4 to the consolidated  condensed  financial  statements
included herein) to provide  additional funds for CAC's growth.  As of September
26, 1997,  the Company's  portfolio of  installment  sale contracts had grown to
approximately  $48  million  and  had  been  funded  primarily  with  internally
generated working capital, borrowings under the Credit Facility and a portion of
the net proceeds from an offering of the Company's common stock during 1994.


                                      -11-
<PAGE>


                                     PART I.
                      CAVALIER HOMES, INC. AND SUBSIDIARIES
                     Management's Discussion and Analysis of
                  Financial Condition and Results of Operations
                               September 26, 1997

Since  entering  into  the  Credit  Facility,  the  Company  has  had  aggregate
borrowings of $11.7  million in order to continue to fund the  operations of CAC
and to reduce  the  interest  rate risk of the  Company's  loan  portfolio.  The
Company expects to continue to borrow funds under the Credit Facility to finance
the  continuing  operations  and growth of CAC. * On March 14, 1996, the Company
executed  an  amendment  to the Credit  Facility  which  increased  the  maximum
available  borrowings under the warehouse and term-loan  agreements contained in
the Credit  Facility to $18 million from the previous  limit of $8 million.  The
amendment  increased the total amount of available  borrowings  under the Credit
Facility  (including  the  revolving  line of  credit) to $23  million  from $13
million.  In addition to the increase in available  borrowings  under the Credit
Facility,  the  interest  rate on  prospective  borrowings  under the  term-loan
portion of the agreement was reduced by .40%.

The Credit Facility contains certain  restrictive  covenants which limit,  among
other things,  (1) the aggregate of dividend  payments and purchases of treasury
stock to 50% of consolidated  net income for the two most recent years,  (2) the
Company's  ability to mortgage or pledge assets which exceed,  in the aggregate,
$1  million  without  written  consent  of  the  lender,  (3)  incur  additional
indebtedness,  including lease  obligations,  which exceed in the aggregate $2.5
million and (4) make capital  expenditures in excess of $6 million. In addition,
the Credit  Facility is subject to certain  financial  covenants  requiring  the
Company to  maintain  on a  consolidated  basis  certain  defined  levels of net
working capital (at least $3.5 million), tangible net worth (which must increase
at least $2 million per year,  subject to a carryover for increases in excess of
$2 million in the prior year),  debt-to-equity  ratio (not to exceed 2 to 1) and
cash  flow-to-debt  service ratio (not less than 1.5 to 1). The Credit  Facility
also requires CAC to comply with certain  specified  restrictions  and financial
covenants.

The Company's growth strategy currently includes the continued  expansion of the
financial services segment of its business.  Accordingly,  it is likely that the
Company will incur  additional  debt, or other forms of  financing,  in order to
continue to fund such growth.* The Company currently believes that existing cash
and investment balances and funds available under the Credit Facility,  together
with  cash  provided  by  operations,  will be  adequate  to fund the  Company's
operations and expansion plans for the next twelve months; however, there can be
no assurance to this effect.* In order to provide additional funds for continued
pursuit of the Company's growth  strategies and for operations,  the Company may
incur,  from time to time,  additional short and long-term bank indebtedness and
may issue, in public or private  transactions,  its equity and debt  securities,
the   availability  and  terms  of  which  may  depend  upon  market  and  other
conditions.* The Company may also engage in other transactions,  such as selling
or  securitizing  all or portions of its installment  loan  portfolio,  that are
designed to  facilitate  the ability of the Company to  originate  an  increased
volume  of  loans  and  to  reduce  the  Company's  exposure  to  interest  rate
fluctuations.*   There  can  be  no  assurance  that  such  possible  additional
financing,   or  the   aforementioned   transactions   involving  the  Company's
installment  loan  portfolio,  will be  available  on  terms  acceptable  to the
Company;  if they are not, the Company may be forced to curtail the expansion of
its financial services business and to alter its growth strategies. In addition,
the  Company  may be forced to  curtail  the  growth of its  financial  services
business due to an increase in competitive conditions in the industry. *

The  Company's  capital  expenditures  were  approximately  $6,650,000  for  the
thirty-nine  weeks ended  September 26, 1997, as compared to $6,473,000  for the
comparable period of 1996.  Capital  expenditures  during these periods included
normal  property,  plant  and  equipment  additions  and  replacements  and  the
continued expansion and modernization of certain of the Company's  manufacturing
facilities.

Recent Announcement

As reflected  in Item 5 below,  on August 14, 1997,  the Company  announced  the
execution  of a definitive  agreement to merge a subsidiary  of the Company with
Belmont  Homes,  Inc.  (NASDAQ/NM:BHIX),   subject  among  other  conditions  to
compliance  with  applicable  regulatory  requirements  and the  approval of the
shareholders  of both  companies.  The  Board  of  Directors  of both  companies
unanimously  approved the  transaction.  The agreement calls for the exchange of
0.80 shares of Cavalier Homes,  Inc. common stock for each outstanding  share of
Belmont common stock.  Cavalier will issue  approximately  7.6 million shares of
common stock to provide for the exchange to holders of Belmont common stock. The
business combination is intended to qualify as a tax-free  reorganization to the
shareholders  of Belmont and be  accounted  for as a  pooling-of-interests.  The
applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act
of 1976, as amended, has expired.

- ---------------------------------------
* See Safe Harbor Statement on page 15.


                                      -12-
<PAGE>


                                    PART II.
                      CAVALIER HOMES, INC. AND SUBSIDIARIES
                                Other Information
                                September 26,1997

Belmont  Homes,  Inc.  is  subject  to  the  informational  requirements  of the
Securities  Exchange  Act of  1934  (the  "Exchange  Act"),  and  in  accordance
therewith  files  reports,  proxy  statements  and  other  information  with the
Securities and Exchange Commission (the  "Commission").  Copies of such reports,
proxy statements and other information can be inspected and copied at the public
reference facilities maintained by the Commission at Room 1024, Judiciary Plaza,
450 Fifth Street,  N.W.,  Washington  D.C.  20549 and at the following  Regional
Offices of the Commission:  Seven World Trade Center,  13th Floor, New York, New
York 10048 and Citicorp Center,  500 West Madison Street,  Suite 1400,  Chicago,
Illinois 60661. Copies of such material can be obtained at prescribed rates from
the  Public  Reference  Section  of the  Commission,  450  Fifth  Street,  N.W.,
Washington,  D.C. 20549.  The Commission also maintains a site on the World Wide
Web at  http://www.sec.gov  that contains  reports,  proxy  statements and other
information  regarding registrants that file electronically with the Commission.
The common stock of Belmont is quoted on the Nasdaq  National  Market,  and such
reports,  proxy  statements and other  information  can also be inspected at the
offices of Nasdaq, 1735 K Street,  Washington,  D.C. 20006. The Company makes no
representation and assumes no responsibility for the accuracy or completeness of
any such reports, proxy statements or other information.

There can be no assurance that the proposed  strategic  combination with Belmont
will be consummated. There can also be no representation or assurance made as to
the possible impact of the potential  strategic  combination on the consolidated
financial  condition  and results of  operations  of the  Company  should such a
strategic combination occur.


ITEM 5            OTHER MATTERS

On August  14,  1997,  the  Company  announced  the  execution  of a  definitive
agreement  to  merge a  subsidiary  of the  Company  with  Belmont  Homes,  Inc.
(NASDAQ/NM:BHIX),  subject among other  conditions to compliance with applicable
regulatory  requirements and the approval of the shareholders of both companies.
The Board of Directors of both companies  unanimously  approved the transaction.
The  agreement  calls for the  exchange of 0.80 shares of Cavalier  Homes,  Inc.
common stock for each outstanding  share of Belmont common stock.  Cavalier will
issue  approximately  7.6  million  shares of common  stock to  provide  for the
exchange  to  holders of Belmont  common  stock.  The  business  combination  is
intended to qualify as a tax-free  reorganization to the shareholders of Belmont
and be accounted for as a  pooling-of-interests.  The applicable  waiting period
under the Hart-Scott-Rodino  Antitrust Improvements Act of 1976, as amended, has
expired.

There can be no assurance that the proposed  strategic  combination with Belmont
will be consummated. There can also be no representation or assurance made as to
the possible impact of the potential  strategic  combination on the consolidated
financial  condition  and results of  operations  of the  Company  should such a
strategic combination occur.

The Board of Directors has declared its regular  quarterly cash dividend of $.03
per share payable on November 14, 1997 to  stockholders of record on October 31,
1997.


                                      -13-
<PAGE>


                                    PART II.
                      CAVALIER HOMES, INC. AND SUBSIDIARIES
                                Other Information
                               September 26, 1997


ITEM 6            EXHIBITS AND REPORTS ON FORM 8-K

                  The exhibits  required to be filed with this report are listed
                  below.  The  Company  will  furnish  upon  request the exhibit
                  listed upon the receipt of $15.00 per  exhibit,  plus $.50 per
                  page,  to  cover  the cost to the  Company  of  providing  the
                  exhibit.

                  (a)      (3)      Articles of Incorporation and By-laws.
                                    (a) The Amended and Restated  Certificate of
                                        Incorporation  of the Company,  filed as
                                        Exhibit  3(a)  to the  Company's  Annual
                                        Report on Form  10-K for the year  ended
                                        December  31,  1993,   is   incorporated
                                        herein by reference.
                                    (b) Amendment  to the Amended  and  Restated
                                        Certificate  of   Incorporation  of  the
                                        Company,  filed as  Exhibit  3(b) to the
                                        Company's  Quarterly Report on Form 10-Q
                                        for the quarter  ended June 27, 1997, is
                                        incorporated herein by reference.
                                    (c) The Certificate of Designation of Series
                                        A Junior  Participating  Preferred Stock
                                        of  Cavalier  Homes,  Inc. as filed with
                                        the Office of the Delaware  Secretary of
                                        State on October  24,  1996 and filed as
                                        Exhibit A to Exhibit 4 to the  Company's
                                        Registration Statement on Form 8-A filed
                                        on October  30,  1996,  is  incorporated
                                        herein by reference.
                                    (d) The Amended and Restated  By-laws of the
                                        Company,  filed as  Exhibit  3(d) to the
                                        Company's  Quarterly Report on Form 10-Q
                                        for the quarter  ended June 27, 1997, is
                                        incorporated herein by reference.
                                    (e) Amendment  No.  1  to  the  Amended  and
                                        Restated By-laws of the Company.
                           (4)      Instruments Defining the Rights of  Security
                                    Holders.
                                    (a) Articles  four,  six,  seven,  eight and
                                        nine  of  the   Company's   Amended  and
                                        Restated  Certificate of  Incorporation,
                                        as amended,  referenced  in Exhibit 3(a)
                                        and 3(b) above.
                                    (b) Article II,  Sections 2.1 through  2.18;
                                        Article  III,   Sections  3.1  and  3.2;
                                        Article  IV,   Sections   4.1  and  4.3;
                                        Article VI,  Sections  6.1 through  6.5;
                                        Article VIII,  Sections 8.1 and 8.2; and
                                        Article IX of the Company's  Amended and
                                        Restated By-laws, referenced in Exhibits
                                        3(d) and 3(e) above.
                                    (c) Rights Agreement between Cavalier Homes,
                                        Inc.   and    ChaseMellon    Shareholder
                                        Services, LLC, filed as Exhibit 4 to the
                                        Company's  Current  Report  on Form  8-K
                                        dated October 30, 1996, is  incorporated
                                        herein by reference.
                           (10)     Material Contracts.
                                    (a) Guaranty   Agreement     between   First
                                        Commercial Bank and Cavalier Homes, Inc.
                                        dated   July   15,   1997,  relating  to
                                        guaranty of payments by Lamraft, LP.
                                    (b) Guaranty   Agreement     between   First
                                        Commercial Bank and Cavalier Homes, Inc.
                                        dated   July   15,   1997,  relating  to
                                        guaranty  of   payments   by   Hillsboro
                                        Manufacturing,  LP.
                                    (c) Guaranty   Agreement     between   First
                                        Commercial Bank and Cavalier Homes, Inc.
                                        dated   July   15,   1997,  relating  to
                                        guaranty  of   payments  by  Woodperfect
                                        of Texas, LP.
                                    (d) The  Agreement  and Plan of Merger dated
                                        as of August 14, 1997,  by and among the
                                        Company,  Crimson  Acquisition Corp. and
                                        Belmont Homes,  Inc., filed as Exhibit 2
                                        to the Company's  Current Report on Form
                                        8-K   dated   August   19,   1997,    is
                                        incorporated herein by reference.
                                    (e) Amendment  No.  1 to  the Agreement  and
                                        Plan  of  Merger  referenced  in Exhibit
                                        10(b) above.
                           (11)     Computation of Net Income per Common Share.
                           (27)     Article 5 - Financial Data Schedule for Form
                                    10-Q  submitted  as  Exhibit  27 as an EDGAR
                                    filing only.
                  (b)               The Company  filed a Current  Report on Form
                                    8-K on August 19, 1997,  with respect to the
                                    proposed strategic  combination with Belmont
                                    Homes, Inc.


                                      -14-
<PAGE>


                                    PART II.
                      CAVALIER HOMES, INC. AND SUBSIDIARIES
                                Other Information
                               September 26, 1997

                "Safe Harbor" Statement under the Private Securities  Litigation
Reform Act of 1995:

With the exception of historical factual information, the matters and statements
discussed,  made or incorporated  by reference in this Quarterly  Report on Form
10-Q (including statements regarding trends in the industry and the business and
growth and financing  strategies of the  Company),  as well as those  statements
specifically  designated  with  an  asterisk  (*),  constitute   forward-looking
statements,  contain the words "estimates,"  "projects,"  "intends," "believes,"
"anticipates,"  "expects," and words of similar  import,  are based upon current
expectations and are made pursuant to the safe harbor  provisions of the Private
Securities  Litigation Reform Act of 1995. Such  forward-looking  statements and
words  involve known and unknown  assumptions,  risks,  uncertainties  and other
factors which may cause the actual  results,  performance or achievements of the
Company to be materially  different  from any future  results,  performance,  or
achievements  expressed or implied by such forward-looking  statements or words.
Such assumptions, risks, uncertainties and factors include those associated with
general  economic  and  business  conditions;  manufactured  housing  and retail
consumer financing industry trends, cyclicality and seasonality; availability of
consumer  and dealer  financing;  changes  and  volatility  and  uncertainty  in
interest rates; the sufficiency of reserves established for installment contract
receivables;  warranty,  product  liability,  workers'  compensation  and  other
litigation  arising in the course of the Company's  manufacturing  and financial
services business; contingent repurchase and guaranty obligations; dependence on
key personnel and favorable  relationships with employees;  demographic changes;
whether the  current and  emerging  generations  of retirees  will have the same
interest in purchasing manufactured homes;  competition;  raw material and labor
costs and availability; import protection and regulation; relationships with and
dependence  on  customers,  distributors  and  dealers;  changes in the business
strategy  or  development  plans of the  Company;  the  availability,  terms and
deployment  of  capital;  changes in or the  failure to comply  with  government
regulations;  and the inability or failure to identify or consummate  successful
acquisitions  or to assimilate  the operations of any acquired  businesses  with
those of the Company;  and other assumptions,  risks,  uncertainties and factors
reflected  from time to time in the Company's  filings with the  Securities  and
Exchange  Commission.  The Company expressly  disclaims any obligation to update
any forward-looking  statements as a result of developments  occurring after the
filing of this report.





                                      -15-


<PAGE>


                                    PART II.
                      CAVALIER HOMES, INC. AND SUBSIDIARIES
                                Other Information
                               September 26, 1997



SIGNATURES

Pursuant  to the  requirements  of the  Securities  Exchange  Act of  1934,  the
Registrant  has duly  caused  this  report  to be  signed  on its  behalf by the
undersigned thereunto duly authorized.


                              Cavalier Homes, Inc.
                              ----------------------------------
                              Registrant




Date: November 10, 1997       /s/ David A. Roberson
                              ----------------------------------
                              David A. Roberson - President
                              and Chief Executive Officer


Date: November 10, 1997       /s/ Michael R. Murphy
                              ----------------------------------
                              Michael R. Murphy -
                              Chief Financial Officer (Principal
                              Financial and Accounting Officer)


                                      -16-
<PAGE>



                                 AMENDMENT NO. 1
                             TO AMENDED AND RESTATED
                                     BY-LAWS
                                       OF
                              CAVALIER HOMES, INC.


                      Unless   otherwise   provided   in  the   certificate   of
         incorporation of the corporation,  and subject to the provisions of the
         General  Corporation Law of the State of Delaware concerning the fixing
         of a date for determination of stockholders of record, each stockholder
         shall be entitled  to one vote for each share of capital  stock held by
         such stockholder.  When a quorum is present at any meeting, the vote of
         the holders of a majority of the "total  votes" of the stock present in
         person  or  represented  by  proxy at such  meeting  shall  decide  any
         question,  other than the election of  directors,  brought  before such
         meeting, unless the question is one upon which, by express provision of
         a statute,  the rules of any exchange  (including,  without limitation,
         the New  York  Stock  Exchange,  Inc.)  or other  medium  on which  the
         corporation's stock is listed or that otherwise facilitates the trading
         thereof, or the certificate of incorporation, a different vote (whether
         such different vote would require a higher or lower  threshold of votes
         to decide a question) is required, in which case such express provision
         shall govern and control the decision of such question.  All classes of
         stock of the  corporation  will vote  together as a single class on all
         matters coming before the stockholders, except as otherwise provided by
         the  General  Corporation  Law  of  the  State  of  Delaware  or by the
         certificate of  incorporation.  For purposes of these  by-laws,  "total
         votes" shall be determined (i) by  multiplying  the number of shares of
         each  class of stock  entitled  to vote by the number of votes for each
         share of such class as authorized by the  certificate of  incorporation
         (or in the absence of such express  authorization in the certificate of
         incorporation,  the number of votes for each share as  provided  by the
         General Corporation Law of the State of Delaware), and (ii) by totaling
         the sum of the votes of each class as  determined  in (i),  which shall
         produce the number of "total  votes."  Subject to the provisions of the
         certificate  of  incorporation  and to the rights of the holders of any
         series  of  Preferred   Stock  to  elect   directors   under  specified
         circumstances,  all elections of directors by the  stockholders  of the
         corporation shall be by plurality vote of the "total votes."


         The undersigned hereby certifies that the provision set forth above was
         duly  adopted  by  the  Board of  Directors  of  Cavalier  Homes,  Inc.
         effective September 19, 1997.



                                                    /s/ Michael R. Murphy
                                                    ---------------------
                                                      Michael R. Murphy
                                                          Secretary



<PAGE>









                        LIMITED CREDIT GUARANTY AGREEMENT
                                 (Lamraft L.P.)
                           (Letter of Credit Facility)




                               Dated July 15, 1997




                                       by


                              CAVALIER HOMES, INC.




                                   in favor of

                              FIRST COMMERCIAL BANK















<PAGE>







                                TABLE OF CONTENTS

                                                                           Page

Parties.....................................................................  1
Recitals....................................................................  1

                  ARTICLE I

                                          Provisions of General Application

         SECTION 1.01   Definitions.........................................  1
         SECTION 1.02   Accounting Principles...............................  4
         SECTION 1.03   Action Taken Directly or Indirectly.................  4
         SECTION 1.04   Governing Law.......................................  4
         SECTION 1.05   General Provisions of Construction..................  4
         SECTION 1.06   Effect of Headings and Table of Contents............  5

         ARTICLE II

                                          Guaranty

         SECTION 2.01   Guaranty of Obligations.............................  5
         SECTION 2.02   Character of Obligations Hereunder..................  6

         ARTICLE III

                            Waivers; Termination; No Subrogation

         SECTION 3.01   Waivers.............................................  9
         SECTION 3.02   Termination......................................... 10
         SECTION 3.03   No Right of Subrogation. ........................... 10

         ARTICLE IV

                                     Business Covenants

         SECTION 4.01   Affirmative Covenants............................... 11
         SECTION 4.02   Information as to Guarantor......................... 11

         ARTICLE V

                         Representations, Warranties and Agreements

         SECTION 5.01   Financial Condition................................. 12
         SECTION 5.02   Full Disclosure..................................... 13
         SECTION 5.03   Pending Litigation; No Defaults..................... 13
         SECTION 5.04   Title to Properties................................. 13
         SECTION 5.05   No Defaults......................................... 13
         SECTION 5.06   Governmental Consent................................ 13
         SECTION 5.07   Compliance with Law................................. 13
         SECTION 5.08   Restrictions on Guarantor........................... 14
         SECTION 5.09   Maintenance of Tax Exemption........................ 14
         SECTION 5.10   Indemnification..................................... 14
         SECTION 5.11   Survival of Representations, Warranties
                        and Covenants....................................... 15

         ARTICLE VI

                               Events of Default and Remedies

         SECTION 6.01   Events of Default................................... 15
         SECTION 6.02   Remedies............................................ 17
         SECTION 6.03   Rights and Remedies of Credit Obligor in
                        the Event of Bankruptcy, Etc. of Guarantor.......... 17
         SECTION 6.04   Agreement to Pay Attorneys' Fees.................... 18
         SECTION 6.05   Waiver of Past Defaults............................. 18
         SECTION 6.06   No Additional Waiver Implied by One Waiver.......... 18
         SECTION 6.07   Remedies Subject to Applicable Law.................. 18

         ARTICLE VII

                                   Subordination Agreement.................. 18

         ARTICLE VIII

                              Provisions of General Application

         SECTION 8.01   Jurisdiction........................................ 20
         SECTION 8.02   Benefit of the Agreement............................ 21
         SECTION 8.03   Notices............................................. 21
         SECTION 8.04   Reproduction of Documents........................... 21
         SECTION 8.05   Survival............................................ 22
         SECTION 8.06   Successors and Assigns.............................. 22
         SECTION 8.07   Effective Date of Agreement......................... 22
         SECTION 8.08   Entire Agreement; Counterparts...................... 22
         SECTION 8.09   Severability........................................ 22
         SECTION 8.10   Date For Identification Purposes Only............... 22
         SECTION 8.11   Exceptions to Covenants............................. 23

Testimonium................................................................. 24
Signatures.................................................................. 24


<PAGE>





                                        




                        LIMITED CREDIT GUARANTY AGREEMENT


         THIS  AGREEMENT is executed July 15, 1997, by CAVALIER  HOMES,  INC., a
Delaware  corporation  (the  "Guarantor"),  and FIRST  COMMERCIAL  BANK, a state
banking corporation (the "Credit Obligor"), as lender and secured party.


                                    Recitals

         The  Guarantor  has an  interest  in  Lamraft  L.P.,  a  Texas  limited
partnership (the "Borrower").

         The Borrower  has applied to the Credit  Obligor for the issuance of an
irrevocable,  direct pay, letter of credit to secure $3,000,000  Adjustable Rate
Industrial Development Revenue Bonds, Series 1997 (Lamraft L.P. Project),  dated
July 15, 1997, to be issued by the Hillsboro Industrial Development  Corporation
to finance an  industrial  manufacturing  project  for use by the  Borrower  and
certain other Persons (as defined herein) related to the Borrower.

         The  Credit  Obligor  has  agreed  to issue the  letter of credit  (the
"Letter of Credit") for the benefit of the Borrower, for such purposes, upon the
terms and conditions  and subject to the conditions  precedent set forth in that
certain  Credit  Agreement  of even date  between  the  Borrower  and the Credit
Obligor (the "Credit Agreement").

         The  assumption  of the  obligations  of the Guarantor  hereunder  will
result in direct financial benefits to the Guarantor.

                                    Agreement

         NOW THEREFORE, in consideration of the foregoing Recitals and to induce
the Credit Obligor to enter into the Credit Agreement and to issue the Letter of
Credit, the Guarantor hereby covenants and agrees as follows:


                                    ARTICLE I

                        Provisions of General Application

         SECTION 1.01      Definitions

         For all  purposes  of this  Agreement,  except as  otherwise  expressly
provided or unless the context otherwise requires:

         "Bond  Documents"  shall  mean   collectively  each  of  the  following
documents  as any of the  same  may at any  time  be  amended,  supplemented  or
restated:

                  (a)      the Indenture,

                  (b)      the Loan Agreement,

                  (c)      Remarketing Agreement with respect to the Bonds among
                           the Issuer, Borrower, Trustee, and First Commercial
                           Bank, as remarketing agent.

         "Code" means the Internal Revenue Code of 1986, as amended.

         "Collateral"  shall mean all  properties and interests in properties of
the  Borrower  which secure the Credit  Obligor  Indebtedness  or are  variously
defined,  referenced or described as  "Collateral"  in any of the Credit Obligor
Financing Documents.

         "Credit Agreement" shall have  the  meaning  assigned  in  the recitals
hereto.

         "Credit  Guaranty" shall mean  collectively the Limited Credit Guaranty
Agreements dated as of July 15, 1997 from the Guarantors to the Credit Obligor.

         "Credit Obligor Financing Documents" shall mean collectively the Credit
Agreement,  the Credit  Guaranty,  the Deed of Trust,  as all said documents are
defined in the Recitals hereto, and any and all amendments or supplements to any
thereof.

         "Credit Obligor  Indebtedness"  shall mean all  indebtedness  and other
amounts at any time to be paid to Credit  Obligor by the Borrower or any Obligor
(as defined in the Credit  Agreement)  or any affiliate of any thereof under the
Credit Obligor Financing Documents.

         "Deed of Trust" shall mean the Deed of Trust,  Security  Agreement  and
Fixture Filing dated as of July 15, 1997, by the Borrower to the Credit Obligor.

         "Default"  shall mean an event or  condition  the  occurrence  of which
would,  with or without the lapse of time or the giving of notice or both, be an
Event of Default.

         "Event of Default" shall mean an event as defined in Article VI.

         "Financing Documents" shall  mean  collectively the Bond  Documents and
the Credit Documents.

         "Financing  Participants" shall  mean  the  parties  to  the  Financing
Documents.

         "Guarantor" means  Cavalier Homes, Inc., and  the respective successors
and assigns thereof.

         "Guarantor  Indebtedness" shall mean all indebtedness and other amounts
at any time to be paid by the  Borrower or any Obligor (as defined in the Credit
Agreement) or any affiliate of any thereof to the Guarantor.

         "Guarantors" means collectively the following and the respective heirs,
executors, administrators and assigns thereof:

                  (i)     Lee Roy Jordan,
                  (ii)    Cavalier Homes, Inc.,
                  (iii)   Patriot Homes, Inc.,
                  (iv)    Schult Operating Company, and Schult Homes Corporation
                  (v)     Southern Energy Homes, Inc.

         "Indenture"  shall mean the Trust  Indenture  dated as of July 15, 1997
between the Issuer and the Trustee with respect to the Bonds.

         "Issuer" shall mean the Hillsboro Industrial  Development  Corporation,
and any successor to its functions.

         "Letter of Credit" means the Irrevocable Letter of Credit No. 921 dated
the date of  delivery  thereof, issued by the Credit Obligor for  the benefit of
the Borrower pursuant to the Credit Agreement.

         "Lien" shall mean any interest in Property  securing an obligation owed
to, or a claim by, a Person other than the owner of the  Property,  whether such
interest is based on the common law, statute or contract,  and including but not
limited to the security  interest or lien arising from a mortgage,  encumbrance,
pledge,  conditional sale or trust receipt or a lease assignment or bailment for
security  purposes.  For the purposes of this Agreement,  the Guarantor shall be
deemed to be the owner of any  Property  which it has  acquired or holds or hold
subject to a conditional  sale agreement,  financing lease or other  arrangement
pursuant to which title to the Property  has been  retained by or vested in some
other person for security purposes.

         "Loan  Agreement"  shall mean the Loan  Agreement  dated as of July 15,
1997 between the Issuer and the Borrower with respect to the Project.

         "Material  Adverse  Effect" shall mean any act or circumstance or event
which  (i)  causes an Event of  Default  or  Default,  (ii)  otherwise  might be
material and adverse to the  financial  condition or business  operations of the
Guarantor or (iii) would adversely affect the validity or  enforceability of any
of  the  Financing  Documents  or  any  of the  papers  executed  in  connection
therewith.

         "Maximum Guaranteed Percentage" shall mean twenty-four percent (24%).

         "Person" shall mean and include an individual,  a partnership,  a joint
venture, a corporation,  an association, a trust, an unincorporated organization
and a government or any department, agency or political subdivision thereof.

         "Project"  shall mean the real and personal  property  described in the
Deed of Trust, Loan Agreement and Indenture as the "Project".

         "Property"  shall mean any  interest  in any kind of property or asset,
whether real, personal or mixed, or tangible or intangible.

         "Tribunal"  shall  mean  any  state,  commonwealth,  federal,  foreign,
district, territorial, or other court or governmental department, board, bureau,
agency or instrumentality having jurisdiction over Guarantor.

         SECTION 1.02      Accounting Principles

         The  Guarantor  shall  maintain  books and records in  accordance  with
generally  accepted  accounting  principles  ("GAAP"  as  defined  in the Credit
Agreement) consistently applied.

         SECTION 1.03      Action Taken Directly or Indirectly

         Where any provision in this  Agreement  refers to action to be taken by
any Person, or which such Person is prohibited from taking, such provision shall
be  applicable  whether  such  action is taken  directly or  indirectly  by such
Person.

         SECTION 1.04      Governing Law

         This  Agreement  shall be governed by and construed in accordance  with
the laws of the State of Alabama.

         SECTION 1.05      General Provisions of Construction

         (1)  Capitalized  terms used herein without  definition  shall have the
meaning assigned to them in the Indenture or the Credit Agreement.

         (2) Singular  terms shall  include the plural as well as the  singular,
and vice versa.

         (3)  All  references  in  this  instrument  to  designated  "Articles",
"Sections" and other subdivisions are to the designated  Articles,  Sections and
subdivisions of this instrument as originally executed.

         (4) The terms  "herein",  "hereof" and  "hereunder"  and other words of
similar  import  refer to this  Agreement  as a whole and not to any  particular
Article, Section or other subdivision.

         SECTION 1.06      Effect of Headings and Table of Contents

         The Article and  Section  headings  herein and in the Table of Contents
are for convenience only and shall not affect the construction hereof.


                                   ARTICLE II

                                    Guaranty

         SECTION 2.01      Guaranty of Obligations

         (a)  Subject to and limited by the  provisions  of  subsection  2.01(d)
hereof,  the Guarantor  hereby  absolutely  and  unconditionally  guarantees the
punctual payment when due (whether at stated  maturity,  by acceleration or call
for redemption or  otherwise),  in lawful money of the United States of America,
of all of the following (collectively the "Obligations"):
                  (1) all letter of credit commissions,  fees, charges and costs
         becoming due and payable under the Credit  Agreement in accordance with
         the terms thereof;

                  (2) all  amounts  becoming  due and  payable  under the Credit
         Agreement in  accordance  with the terms  thereof as  reimbursement  of
         amounts paid by the Credit Obligor under the Letter of Credit;

                  (3) all  late  charges  and  all  interest  on  late  payments
         becoming due and payable under the Credit  Agreement in accordance with
         the terms thereof;

                  (4) all  amounts  becoming  due and  payable  under the Credit
         Agreement in accordance  with the terms thereof upon the occurrence and
         continuance of an Event of Default under the Credit Agreement;

                  (5) all  amounts  becoming  due and  payable  under the Credit
         Agreement as  reimbursement  of increased  costs to the Credit  Obligor
         caused  by  changes  in laws or  regulations  or in the  interpretation
         thereof;

                  (6) all other amounts becoming due and payable by the Borrower
         under the Credit Agreement;

                  (7) all amounts becoming due and payable by the Borrower under
         the  terms  of  the  Deed  of  Trust  (including  but  not  limited  to
         reimbursement  for  advancements  made by the Credit Obligor under this
         Deed of Trust) and any other security agreements, guarantees, mortgages
         or  other  documents  now  or  hereafter  evidencing  or  securing  the
         Borrower's  performance of its obligations  under the Credit Agreement;
         and

                  (8) all other indebtedness, obligations (including obligations
         of  performance)  and liabilities of the Borrower to the Credit Obligor
         of every kind and description whatsoever,  direct or indirect, absolute
         or  contingent,  due  or to  become  due,  now  existing  or  hereafter
         incurred, contracted or arising, or acquired by the Credit Obligor from
         any source, joint or several, liquidated or unliquidated, regardless of
         how they arise or by what agreement or instrument they may be evidenced
         or whether they are  evidenced  by any  agreement  or  instrument,  and
         whether incurred as maker,  endorser,  surety,  guarantor or otherwise,
         and any and all  extensions,  restatements,  and renewals of any of the
         same; and

                  (9) all renewals and extensions of any or all the  obligations
         of  the  Borrower   described  in  paragraphs  (1)  through  (8)  above
         (including  without  limitation  any renewal or  extension  of, and any
         substitute  for,  the Letter of Credit),  whether or not any renewal or
         extension agreement is executed in connection therewith.

         (b)  The  guaranty  set  forth  in  this  Section  is an  absolute  and
irrevocable  guaranty of payment and not of collectibility or performance and is
in no way  conditioned  or  contingent  upon any  attempt  to  collect  from the
Borrower or any other  Person,  or to realize upon any  Property  subject to the
Lien of the Indenture or the Deed of Trust, or upon any other direct or indirect
security for the Bonds or the Obligations, or resort to any other remedies.

         (c) Each default in payment of any amount of the Obligations shall give
rise to a separate  cause of action  hereunder and separate suits may be brought
hereunder as each cause of action arises.

         (d) By acceptance hereof, the Credit Obligor covenants and agrees that,
anything herein or in the Financing  Documents to the contrary  notwithstanding,
the  obligations  of, and recourse  against,  the  Guarantor  for payment of any
amounts  pursuant to this Agreement shall be limited to and shall not exceed the
Maximum Guaranteed Percentage of such amounts, as determined on the basis of the
aggregate  amounts described in Section 2.01(a) or otherwise due hereunder which
are  outstanding  at the time demand for payment  thereof is made in  accordance
herewith,  without  regard to or taking into account any demand upon, or payment
or  contribution  by,  any other  Financing  Participant  with  respect  to such
amounts.

         SECTION 2.02      Character of Obligations Hereunder

         (a)  All   obligations  of  the  Guarantor  under  this  Agreement  are
unconditional,   primary,   absolute   and   irrevocable   under   any  and  all
circumstances.  Without limiting the generality of the foregoing, to the fullest
extent  permitted  under  applicable  law,  the  obligations  of  the  Guarantor
hereunder shall not be subject to or impaired by:

                  (i)  any inability or failure on the part of any party thereto
         to perform or comply  with the Financing Documents or the Bonds;

                  (ii) any invalidity or  irregularity in any statutory or other
         proceedings  relating  to  the  formation  or  existence  of any of the
         Financing  Participants,  to  the  issuance  of  the  Bonds  or to  the
         execution and delivery of any Financing Document;

                  (iii)  any   invalidity   or   unenforceability   of,  or  any
         impairment, modification or release of liability of any party under, or
         any  impossibility,  impracticability,  illegality  or  frustration  of
         performance  by any party of,  any of the  Financing  Documents  or the
         Bonds, for any reason whatsoever,  including,  without limitation,  any
         decision  by  any  court   invalidating  or  otherwise   affecting  the
         obligations  of  any  party  under  or in  connection  with  any of the
         Financing Documents or the Bonds;

                  (iv) any  inability  or  failure  on  the  part  of any of the
         Financing  Participants  to perform or comply with any of the Financing
         Documents;

                  (v) any invalidity or unenforceability  of, or any impairment,
         modification  or release of liability of the  Guarantor  under,  or any
         impossibility,   impracticability,   illegality   or   frustration   of
         performance by the Guarantor of this Agreement;

                  (vi) the voluntary or  involuntary  liquidation,  dissolution,
         merger,   consolidation,   sale  or   other   disposition   of  all  or
         substantially all of the assets, marshalling of assets and liabilities,
         receivership,  insolvency,  bankruptcy,  assignment  for the benefit of
         creditors,  reorganization,  moratorium, arrangement,  composition with
         creditors  or  readjustment  of debt of, or other  similar  proceedings
         affecting, any of the Financing Participants;

                  (vii) any  waiver,  consent,  extension,  indulgence  or other
         action or inaction in respect of any  Financing  Document or the Bonds,
         including  any  modification,  amendment  or  supplement  to any of the
         foregoing,  the renewal or extension  of the Bonds,  the release of any
         Property  subject to the Lien of the Indenture or the Deed of Trust, or
         the Loan Agreement or any other similar act;

                  (viii) any right of setoff,  counterclaim  or defense,  or any
         act, omission or breach on the part of the Borrower, the Credit Obligor
         or the Guarantor or any of the other Financing Participants;

                  (ix) any claim  whatsoever  against the Borrower or the Issuer
         or any of the other  Financing Participants;

                  (x) any defect in the title,  compliance with  specifications,
         value,  condition,   design,   operation,   merchantability,   quality,
         durability  or  suitability  of,  consequences  of use or misuse of, or
         unfitness for use of, the Project or any part thereof, any abandonment,
         destruction,  noncompletion,  requisition, condemnation, foreclosure of
         or damage to the  Project  or any part  thereof,  or any event of force
         majeure relating to the Project or any part thereof;

                  (xi) any breach of any representation or warranty relating  to
         the Bonds or the Project;

                  (xii)  any  release,  extinguishment  or  satisfaction  of the
         Borrower's obligations to make payments of Obligations until there have
         been paid to the Credit Obligor in lawful currency of the United States
         an amount  sufficient  to pay all  Obligations  (including  interest on
         overdue amounts of Obligations  including,  to the extent  permitted by
         applicable  law,  interest)  that  would have been due and owing to the
         Credit Obligor by the Borrower had the Borrower's  obligations not been
         so released, extinguished or satisfied;

                  (xiii) the  failure  to give  notice to the  Guarantor  of the
         occurrence of any default or event of default under the Bonds or any of
         the Financing Documents;

                  (xiv) the  compromise,  settlement,  release or termination of
         any or all of the  obligations,  covenants or  agreements of any of the
         parties  to any of the  Financing  Documents  under  the  Bonds  or the
         Financing Documents;

                  (xv) any  assignment,  pledge or  mortgage  of all or any part
         of the  interest of any of the Financing Participants in the Project or
         the Collateral;

                  (xvi) any waiver of the payment,  performance or observance by
         any of the  Financing  Participants  of any  obligation,  agreement  or
         covenant  of any  of  them  contained  in the  Bonds  or the  Financing
         Documents;

                  (xvii) the  extension of the time for payment of any amount of
         the  Obligations or any part thereof or of the time for  performance of
         any other obligations,  agreements or covenants of any of the Financing
         Participants under the Bonds or the Financing Documents;

                  (xviii) the  modification  or amendment  (whether  material or
         otherwise) of any  obligation,  agreement or covenant  contained in the
         Bonds or the Financing Documents;

                  (xix) any  failure,  omission,  or delay on the part of any of
         the Financing  Participants  to enforce,  assert or exercise any right,
         power  or  remedy  conferred  upon  any of  them  by the  Bonds  or the
         Financing Documents;

                  (xx) the bankruptcy, insolvency,  reorganization,  appointment
         of a receiver for, or dissolution of any of the Financing Participants,
         or the entering by any or all of them into an agreement of  composition
         with  creditors,  or the making by any or all of them of an  assignment
         for the benefit of creditors;

                  (xxi) any rights of set-off, recoupment, counterclaim or other
         defense,  whether  similar or  dissimilar to the  foregoing,  which the
         Guarantor   might   otherwise   have  against  any  of  the   Financing
         Participants or any other person;

                  (xxii)  the  default  or  failure  of any  one or  more of the
         Financing  Participants  to perform fully any  obligation,  covenant or
         agreement contained in the Bonds or the Financing Documents;

                  (xxiii)  the  release or  discharge  of any one or more of the
         Financing  Participants  by  operation  of law, to the extent that such
         release or discharge may be lawfully  avoided,  from the performance or
         observance of any  agreement or covenant  contained in the Bonds or the
         Financing Documents;

                  (xxiv)   the  invalidity or  unenforceability  of the Bonds or
         the Financing  Documents or of any provision of such instruments; or

                   (xxv) any other  matter  that  might  otherwise  be raised in
         avoidance  of,  or  in  defense  against,  an  action  to  enforce  the
         obligations of the Guarantor under this Agreement.

         (b) The Guarantor  acknowledges that this Agreement is executed for the
benefit of the Credit  Obligor and that the Credit  Agreement  and the Letter of
Credit will be executed and delivered in reliance on this  Agreement.  No act of
commission or omission of any kind at any time on the part of the Credit Obligor
in respect of any matter whatsoever shall in any way affect or impair any right,
power or benefit of the Credit  Obligor under this  Agreement and, to the extent
permitted by  applicable  law, no setoff,  claim,  reduction,  diminution of any
obligation,  or any defense of any kind or nature which the  Guarantor  may have
against the Credit Obligor shall be available  against the Credit Obligor in any
suit or action  brought by the Credit  Obligor  to enforce  any right,  power or
benefit under this Agreement.


                                   ARTICLE III

                      Waivers; Termination; No Subrogation

         SECTION 3.01      Waivers

         (a) The Guarantor  hereby waives all of the following and all defenses,
counterclaims,  or offsets which the Guarantor may have by reason  thereof:  (1)
notice of acceptance  hereof,  notice of any action taken or omitted in reliance
hereon,  notice of any defaults by the Borrower in the payment of any such sums,
and  notice  of the  creation,  renewal,  or  accrual  of any  liability  of the
Borrower,  (2) any presentment,  demand,  notice or protest of any kind, (3) any
right  (i) to have  joined  any of the  other  Financing  Participants  with the
Guarantor in any suit brought against the Guarantor on this  Agreement,  (ii) to
require  the Credit  Obligor to  forthwith  bring suit  against any of the other
Financing Participants,  and (iii) to require that the Credit Obligor obtain any
judgment against any of the other Financing  Participants in connection with the
enforcement of any rights against the Guarantor hereunder, and (4) any other act
or thing (including without limitation  alteration of the Bonds or the Financing
Documents or debt evidenced thereby or security therefor),  or omission or delay
to do any other act or thing which may, by operation of law or otherwise, in any
manner or to any extent vary the risk of the Guarantor or which might  otherwise
operate as a discharge of the Guarantor.

         (b)  The  Guarantor  hereby  waives,  as to  the  enforcement  of  this
Agreement,  (1) all rights of exemption  that the  Guarantor  may have under the
constitution  and laws of any state as to any levy on and sale of  property  and
(2)   presentation  and  demand  for  payment  (or  protest  of  nonpayment)  of
Obligations or any part thereof.

         SECTION 3.02      Termination

         (a) The  guaranties  set forth in this  Agreement  shall remain in full
force and effect without  reference to future changes in conditions,  including,
to the extent  permitted by  applicable  law,  changes in law,  until the Credit
Obligor shall have been indefeasibly paid in full any and all sums due under the
terms and provisions of the Obligations and the Financing  Documents,  and until
such sums are not  subject  to  rescission  or  repayment  upon any  bankruptcy,
insolvency,  arrangement,  reorganization,  moratorium,  receivership or similar
proceeding  affecting the Issuer,  the Borrower,  the  Guarantor,  or any of the
other Financing Participants.

         (b) In the event any payment on the  Obligations  (whether such payment
is remitted by the Issuer, the Borrower, any Guarantor or any other person, from
realization on collateral,  through setoff or otherwise) must be refunded,  paid
over or  otherwise  released by the Credit  Obligor as a result of such  payment
being (1) a preference or fraudulent transfer under the Bankruptcy Code of 1978,
as amended,  or other state or federal law or (2)  disallowed as a permanent and
irrevocable  payment on the Obligations for any other reason,  then in each such
event this Agreement shall  thereupon,  ipso facto, be reinstated and revived to
the full extent of such refunded, paid over or released payment.

         SECTION 3.03      No Right of Subrogation.

         The  Guarantor  will not exercise any rights of  subrogation  which the
Guarantor may have unless and until this Agreement shall have been terminated as
provided in Section 3.02.  If any payment is made to the Guarantor  with respect
to any payments due by the Guarantor  under this  Agreement at any time prior to
such  termination  of this  Agreement,  he will be paid  forthwith to the Credit
Obligor to be applied to installments due or coming due under the Obligations in
the  order  and  the  manner  provided  in the  Credit  Agreement  or  otherwise
determined by the Credit Obligor.


                                   ARTICLE IV

                               Business Covenants

         SECTION 4.01      Affirmative Covenants

         The Guarantor covenants  that  so  long as this Agreement is in effect,
the Guarantor shall

         (a) Payment of Indebtedness,  Taxes,  etc. (i) Pay all indebtedness and
obligations of the Guarantor  promptly and in accordance with normal terms where
failure to pay would have a Material Adverse Effect,  and (ii) pay and discharge
or  cause  to  be  paid  or  discharged  promptly  all  taxes,  assessments  and
governmental charges or levies imposed upon the Guarantor or upon his income and
profits, or upon any of his Property,  real, personal or mixed, or upon any part
thereof,  before the same shall become in default,  as well as all lawful claims
for labor, materials and supplies or otherwise, which, if unpaid, might become a
lien upon such  properties or any part thereof where failure to pay would have a
Material  Adverse  Effect;  provided,  however,  that the Guarantor shall not be
required to pay and discharge any such tax, assessment, charge, levy or claim so
long as the validity  thereof  shall be  contested in good faith by  appropriate
proceedings.

         (b) Accounts, Financial Information. The Guarantor will maintain proper
books of record and account,  in which full and correct entries will be made, in
accordance with generally accepted  accounting  principles,  of all business and
affairs of the Guarantor. The Guarantor shall furnish to the Credit Obligor with
reasonable  promptness (1) annual financial statements of the Guarantor prepared
and  audited by  certified  public  accountants  in  accordance  with  generally
accepted  accounting  principles,  and (2) such other information  regarding the
operations,  business  affairs and  financial  condition of the Guarantor as the
Credit Obligor may reasonably request.

         (c) Legal Existence. The Guarantor will maintain and preserve its legal
existence  and will not  voluntarily  dissolve  without  first  discharging  its
obligations under this Agreement.

         (d)  Further  Assurances.  On request of the Credit  Obligor,  promptly
correct any  defect,  error or omission  which may be  discovered  in any of the
Financing  Documents  or in  the  contents  of any of  the  papers  executed  in
connection  therewith  or in  the  execution  or  acknowledgement  thereof,  and
execute,  acknowledge  and deliver such further  instruments and do such further
acts as may be necessary  or as may be requested by the Credit  Obligor to carry
out more effectively the purposes of this Agreement and the Financing Documents.

         SECTION 4.02      Information as to Guarantor

         Financial and Business Information.  The Guarantor shall deliver to the
Credit Obligor:

                  (a) Notice of Default or Event of  Default.  Immediately  upon
         becoming  aware  of the  existence  of any  condition  or  event  which
         constitutes  a  default  or an event of  default  under  any  Financing
         Document,  a  written  notice  specifying  the  nature  and  period  of
         existence  thereof and what action the  Guarantor is taking or proposes
         to take with respect thereto;

                  (b) Notice of Claimed Default. Immediately upon becoming aware
         that the holder of any  evidence  of  indebtedness  or  security of the
         Guarantor  has given notice or taken any other action with respect to a
         claimed  default or event of default  thereunder  which  would  cause a
         default or event of default which would have a Material Adverse Effect,
         a written  notice  specifying  the notice given or action taken by such
         holder and the nature of the  claimed  default or event of default  and
         what action the  Guarantor  are taking or proposes to take with respect
         thereto;

                  (c) Requested  Information.  With reasonable  promptness, such
        data and information as from time to time may be reasonably requested;

                  (d) Notice of Litigation.  Immediately  upon becoming aware of
         the  existence of any  proceedings  before any Tribunal  involving  the
         Guarantor  which  involves  the  probability  of any final  judgment or
         liability  against  such  Guarantor  in an amount  which  would  have a
         Material Adverse Effect, a written notice specifying the nature thereof
         and what  action  such  Guarantor  is taking and  proposes to take with
         respect thereto; and

                  (e) Notice from  Regulatory  Agencies.  Promptly  upon receipt
         thereof, information with respect to and copies of any notices received
         from federal or state regulatory  agencies or any Tribunal  relating to
         an order, ruling,  statute or other law or information which might have
         a Material  Adverse Effect on the  franchises,  permits,  licenses,  or
         rights, or the condition, financial or otherwise, of the Guarantor.


                                    ARTICLE V

                   Representations, Warranties and Agreements

         The Guarantor represents, warrants and agrees that:

         SECTION 5.01      Financial Condition

         Since the date of  application  to the Credit Obligor for the Letter of
Credit,  (i)  there  has been no change  in the  business,  prospects,  profits,
Properties  or condition  (financial  or  otherwise)  of the  Guarantor,  except
changes in the ordinary course of business, none of which individually or in the
aggregate has a Material Adverse Effect, (ii) the Guarantor has not incurred any
material  liability which has a Material Adverse Effect,  and (iii) there exists
no  default  under  the  provisions  of  any  instrument   evidencing  any  such
liabilities or under any agreement  relating thereto which would have a Material
Adverse Effect.

         SECTION 5.02      Full Disclosure

         No written  statement  furnished by the Guarantor to the Credit Obligor
contains any untrue  statement  of a material  fact or omits to state a material
fact  necessary  to  make  the  statements   contained  therein  or  herein  not
misleading. There is no fact which the Guarantor has not disclosed to the Credit
Obligor  in  writing  which  has a  Material  Adverse  Effect  or, so far as the
Guarantor can now foresee, will have a Material Adverse Effect.

         SECTION 5.03      Pending Litigation; No Defaults

         There  are  no  proceedings  pending,  or,  to  the  knowledge  of  the
Guarantor, threatened, against or affecting the Guarantor in any court or before
any  governmental  authority or arbitration  board or Tribunal which involve the
possibility  of a Material  Adverse  Effect or the ability of the  Guarantor  to
perform  this  Agreement.  The  Guarantor  is not in default with respect to any
order of any court, governmental authority,  arbitration board or Tribunal which
would have a Material Adverse Effect.

         SECTION 5.04      Title to Properties

         The Guarantor has good and marketable title to the Properties thereof.

         SECTION 5.05      No Defaults

         No event has  occurred  and no  conditions  exist which  would,  in any
material  respect,  upon the issuance of the Letter of Credit,  constitute (i) a
default under any note or other evidence of  indebtedness or under any agreement
of the  Guarantor  if the effect of such default  would have a Material  Adverse
Effect or (ii) a default or event of default  under the  Financing  Documents or
any of them,  and the  Guarantor is not in violation in any material  respect of
any term of any agreement or other instrument to which he is a party or by which
he may be bound that would have a Material Adverse Effect.

         SECTION 5.06      Governmental Consent

         No consent,  approval or authorization  of, or filing,  registration or
qualification  with, any governmental  authority on the part of the Guarantor is
required  in  connection  with  the  execution  and  delivery  of the  Financing
Documents to which the Guarantor is a party.

         SECTION 5.07      Compliance with Law

         The Guarantor:

                  (a) is not in  violation of any laws, ordinances, governmental
         rules or  regulations to which Guarantor is subject, or

                  (b) has not failed to obtain any licenses, permits, franchises
         or other governmental  authorizations necessary to the ownership of the
         Property,  or  to  the  conduct of  the  business, of  Guarantor, which
         violation or failure to obtain would have a Material Adverse Effect.

         SECTION 5.08      Restrictions on Guarantor

         The  Guarantor  is not a  party  to any  contract  or  agreement  which
requires  consent of any creditor of the Guarantor other than the Credit Obligor
or other party thereto to the right or ability of the Guarantor to incur debt or
guarantee indebtedness hereunder.

         SECTION 5.09      Maintenance of Tax Exemption

         The Guarantor represents that he has not taken any action, and he knows
of no action that any other Person has taken,  which would cause interest on the
Bonds to be  includible  in the gross  income of the holder  thereof for federal
income tax  purposes,  and covenant  that he will not take any action or omit to
take any action at any time,  which action or omission  would result in the loss
of the  exemption  from  federal  income  taxation of the interest on the Bonds;
provided  that no such  representation  or covenant is made with  respect to any
Bonds for any period  during  which they are held by a  "substantial  user" or a
"related  person"  as those  terms  are used in  Section  147 of the  Code.  The
Guarantor  further  represents that he will not take or omit to take any action,
or permit any Person to take any action or omit to take any action, which action
or omission  will in any way cause the proceeds from the sale of the Bonds to be
applied,  or result in such proceeds being applied,  in any manner other than as
provided in the Financing Documents

         SECTION 5.10      Indemnification

         (a) The Guarantor  will  indemnify and hold harmless the Credit Obligor
and each Person,  if any, who controls the Credit  Obligor within the meaning of
Section 15 of the  Securities  Act of 1933, as amended,  (the Credit Obligor and
any such person being in this Section  collectively  called a "Holder")  against
any and all  losses,  claims,  damages or  liabilities,  joint and  several,  or
actions in respect  thereof,  to which any Holder may become  subject  under any
statute or common law or otherwise,  insofar as such losses,  claims, damages or
liabilities,  or actions in respect thereof,  arise out of or are based upon any
untrue  statement or alleged  untrue  statement of a material fact  contained in
this Agreement,  including the financial  statements  referred to herein, or any
omission or alleged  omission to state herein a material fact necessary in order
to make the statements herein not misleading;  and will reimburse any Holder for
all legal or other  expenses  reasonably  incurred by such Holder in  connection
with defending any such action or claim.

         (b) If any such action or claim  shall be brought or  asserted  against
any Holder and in respect of which  indemnity may be sought from the  Guarantor,
such Holder shall  promptly  notify the  Guarantor in writing and the  Guarantor
shall assume the defense  thereof,  including the  employment of counsel and the
payment  of all  expenses.  Any Holder  shall have the right to employ  separate
counsel in any such action and participate in the defense thereof,  but the fees
and expenses of such counsel  shall be at the expense of such Holder  unless (a)
the  employment  thereof  at the  expense  of  Guarantor  has been  specifically
authorized by the Guarantor in writing,  (b) the Guarantor have failed to assume
the defense and to employ  counsel,  or (c) the named parties to any such action
(including  any impleaded  parties)  include both such Holder and the Guarantor,
and such Holder shall have been advised by such counsel that there may be one or
more legal  defenses  available to it which are different  from or additional to
those  available to the Guarantor  (in which case,  if such Holder  notifies the
Guarantor in writing that it elects to employ separate counsel at the Guarantor'
expense,  the  Guarantor  shall not have the right to assume the defense of such
action  on  behalf  of such  Holder,  it  being  understood,  however,  that the
Guarantor  shall not, in  connection  with any one such  action or separate  but
substantially similar or related actions in the same jurisdiction arising out of
the same general allegations or circumstances, be liable for the reasonable fees
and expenses of more than one separate  firm of attorneys  for all such Holders,
which firm shall be designated in writing by such  Holders).  Each Holder,  as a
condition of such  indemnity,  shall use its best efforts to cooperate  with the
Guarantor in the defense of any such action or claim. The Guarantor shall not be
liable for any  settlement  of any such action  effected  without  their written
consent,  but if settled with the written consent of the Guarantor,  or if there
be a final judgment for the plaintiff in any such action,  the Guarantor  agrees
to  indemnify  and hold  harmless  any such  Holder from and against any loss or
liability by reason of such settlement or judgment.

         SECTION 5.11      Survival of Representations, Warranties and Covenants

         The   representations,   warranties  and  covenants  of  the  Guarantor
contained in this Agreement,  and any other  document,  instrument and agreement
referred to or  contemplated by this  Agreement,  shall remain  operative and in
full force and effect regardless of (i) any  investigation  made by or on behalf
of the  Borrower,  any  Holder or any other  Person,  or (ii)  delivery  of, and
payment for, the Bonds.


                                   ARTICLE VI

                         Events of Default and Remedies

         SECTION 6.01      Events of Default

         An "Event of Default"  shall exist under this  Agreement  if any of the
following  occurs  and is  continuing  (whatever  the  reason for such event and
whether it shall be voluntary or  involuntary or be effected by operation of law
or pursuant to any judgment,  decree or order of any court or any order, rule or
regulation of any administrative or governmental body):

                  (a) Particular  Covenant  Defaults.  The  Guarantor  fails  to
         perform or observe any covenant or agreement contained in Section  2.01
         for a period of five  Business  Days after  notification  by the Credit
         Obligor of such failure;

                  (b) Other  Defaults.  The  Guarantor  fails to comply with any
         other  provision of this  Agreement,  and such failure  continues for a
         period of thirty days after written  notification by the Credit Obligor
         of such failure;

                  (c)    Warranties    or    Representations.    Any   warranty,
         representation  or other  statement  by or on behalf  of the  Guarantor
         contained  in  this  Agreement,  or  in  any  instrument  furnished  in
         compliance  with  or in  reference  to  this  Agreement,  is  false  or
         misleading  in any material  respect and action which  eliminates  such
         falsity or misleading character is not completed for a period of thirty
         days after written  notification by the Credit Obligor of such false or
         misleading statement;

                  (d) Default on Other Indebtedness. Default by the Guarantor in
         any payment of any  obligation for money received as an advance (or any
         obligation   under  any  conditional  sale  or  other  title  retention
         agreement  or any  obligation  issued  or  assumed  as full or  partial
         payment for property  whether or not secured by purchase  money lien or
         any  obligation  under notes  payable or drafts  accepted  representing
         extensions  of credit)  beyond any grace period  provided  with respect
         thereto, or default in the performance of any other agreement,  term or
         condition  contained in any  agreement  under which such  obligation is
         created  (or any other  default  under any such  agreement  which shall
         occur  and be  continuing  beyond  any  period of grace  provided  with
         respect  thereto),  if the effect of such default would have a Material
         Adverse  Effect,  and such default shall remain uncured for a period of
         ten days after the Guarantor has notice thereof;

                  (e) Involuntary Bankruptcy Proceedings. A receiver, liquidator
         or trustee of the Guarantor, or of any of his Property, is appointed by
         court order and such order  remains in effect for more than sixty days,
         or an order or decree for relief in an involuntary  bankruptcy  case is
         entered  with  respect  to the  Guarantor,  or any of his  Property  is
         sequestered  by court  order and such order  remains in effect for more
         than sixty days, or a petition is filed against the Guarantor under any
         bankruptcy,  reorganization,  arrangement,  insolvency, readjustment of
         debt,  dissolution or liquidation law of any jurisdiction,  whether now
         or hereafter in effect,  and is not  dismissed  within sixty days after
         such filing;

                  (f) Voluntary  Petitions.  The  Guarantor  files a petition in
         voluntary  bankruptcy  or seeking  relief  under any  provision  of any
         bankruptcy,  reorganization,  arrangement,  insolvency, readjustment of
         debt,  dissolution or liquidation law of any jurisdiction,  whether now
         or  hereafter  in effect,  or  consents  to the filing of any  petition
         against him under any such law;

                  (g) General  Assignment  for Benefit of  Creditors,  etc.  The
         Guarantor makes a general  assignment for the benefit of his creditors,
         or is unable to pay his debts generally as they become due, or consents
         to  the  appointment  of a  receiver,  trustee  or  liquidator  of  the
         Guarantor, or of all or any part of his Property;

                  (h) Undischarged  Final Judgments or Settlements.  One or more
         final  judgments  shall  be  entered  against  the  Guarantor,  or  the
         Guarantor  shall  enter  into  settlement  of  any  litigation,   which
         judgments  and  settlements  are not  covered by  insurance,  and which
         judgments and  settlements  will have a Material  Adverse Effect on the
         Guarantor; or

                  (i) Other  Defaults.  The  occurrence  of an event of  default
         under any of the other  Financing  Documents and the  expiration of the
         applicable grace period, if any, specified therein.

         SECTION 6.02      Remedies

         If an Event of  Default  exists,  the  Credit  Obligor  may  proceed to
protect  its  rights  by suit in  equity,  action  at law or  other  appropriate
proceedings,  whether for the specific  performance of any covenant or agreement
of the  Guarantor  herein  contained  or in aid of the  exercise of any power or
remedy granted to the Credit Obligor under any of the other Financing Documents.
The Credit Obligor may proceed directly against the Guarantor  hereunder without
resorting to any other remedies which it may have and without proceeding against
any other security held by the Credit Obligor.

         SECTION 6.03     Rights and Remedies of Credit Obligor in the Event  of
                          Bankruptcy, Etc. of Guarantor

         In case of the pendency of any receivership,  insolvency,  liquidation,
bankruptcy,   reorganization,   arrangement,   composition   or  other  judicial
proceeding, or any general assignment for the benefit of creditors,  relative to
the  Guarantor,  the Credit  Obligor  (irrespective  of whether there has been a
default under this Agreement or any of the other Financing  Documents)  shall be
entitled and  empowered to  intervene in such  proceedings,  to file and prove a
claim or claims  for the whole  amount  owing and  unpaid and to file such other
papers or documents as may be necessary or advisable in order to have the claims
of the Credit Obligor  (including any claim for reasonable  compensation  to the
Credit Obligor, its agents,  attorneys and counsel, and for reimbursement of all
expenses and  liabilities  reasonably  incurred,  and all advances  made, by the
Credit  Obligor  except as a result of its  negligence or bad faith)  allowed in
such judicial  proceedings,  to collect and receive any moneys or other property
payable or deliverable on any such claims, and to take such other action therein
as the  Credit  Obligor  may  deem  necessary  or  appropriate  to  protect  its
interests.

         SECTION 6.04      Agreement to Pay Attorneys' Fees

         In the event the Guarantor  should  default under any of the provisions
of this Agreement and the Credit Obligor should employ  attorneys or incur other
expenses for the collection of any payments due hereunder or the  enforcement of
performance  or  observance  of any  agreement  or  covenant  on the part of the
Guarantor  herein  contained,  the Guarantor will on demand  therefor pay to the
Credit Obligor the reasonable  fees of such attorneys and such other  reasonable
expenses so incurred.

         SECTION 6.05      Waiver of Past Defaults

         The  Credit  Obligor  may  waive  any past  default  hereunder  and its
consequences.  Upon any such waiver,  such default shall cease to exist, and any
Event of Default arising  therefrom shall be deemed to have been cured for every
purpose of this  Agreement but no such waiver shall extend to any  subsequent or
other default or impair any right consequent thereon.

         SECTION 6.06      No Additional Waiver Implied by One Waiver

         If any agreement  contained in this Agreement should be breached by the
Guarantor  and  thereafter  waived by the Credit  Obligor,  such waiver shall be
limited to the particular  breach so waived and shall not be deemed to waive any
other breach hereunder.

         SECTION 6.07      Remedies Subject to Applicable Law

         All  rights,  remedies  and  powers  provided  by this  Article  may be
exercised  only  to the  extent  the  exercise  thereof  does  not  violate  any
applicable  provision of law in the  premises,  and all the  provisions  of this
Article are intended to be subject to all applicable mandatory provisions of law
which  may be  controlling  in the  premises  and to be  limited  to the  extent
necessary so that they will not render this Agreement invalid or unenforceable.


                                   ARTICLE VII
                             Subordination Agreement

         The Guarantor does hereby covenant and agree:

                  (a) That payment of the  Guarantor  Indebtedness  when due and
         payable in each  month  shall be and  hereby is fully  subordinated  in
         priority to the prior payment to Credit  Obligor of the Credit  Obligor
         Indebtedness  when due and  payable in each month,  provided,  however,
         that so long as no event of default  exists  under the  Credit  Obligor
         Financing  Documents the Guarantor may receive payment of the Guarantor
         Indebtedness  when due and  payable  (but not in advance of  originally
         scheduled due dates).

                  (b)  That  anything  in  any  other  contract,   agreement  or
         instrument to the contrary  notwithstanding,  (a) all right,  title and
         interest of the Guarantor in and to the Collateral  shall be and hereby
         are fully  subordinated in priority to the right, title and interest of
         Credit  Obligor  in and to the  Collateral  as  provided  in the Credit
         Obligor  Financing  Documents without regard to the respective dates on
         which  any of such  interests  were  created  and (b) that the claim of
         Credit Obligor upon all the Collateral shall be and hereby is prior and
         superior for all purposes to that of the Guarantor therein.

                  (c) Upon the  occurrence  of a default  under any agreement or
         document   evidencing,   providing   for,  or  securing  the  Guarantor
         Indebtedness  or if  the  Guarantor  Indebtedness  shall  become  or be
         declared immediately due and payable, then an event of default shall be
         deemed  to  have  simultaneously  occurred  under  the  Credit  Obligor
         Indebtedness  and the Credit Obligor  Financing  Documents and the same
         shall also become  immediately  due and  payable,  notwithstanding  any
         inconsistent terms in any document or instrument relating to any of the
         foregoing.  The Guarantor shall not,  without the prior written consent
         of  Credit  Obligor,  accelerate  the  maturity  of, or  institute  any
         proceedings to enforce, any of the Guarantor Indebtedness.

                  (d)  Upon  the  occurrence  and  continuation  of an  event of
         default under any agreement or document  evidencing,  providing for, or
         securing the Guarantor  Indebtedness  or the Credit  Obligor  Financing
         Indebtedness,  Credit  Obligor  shall  first be entitled to receive all
         proceeds and revenues from the  Collateral  when and as the same become
         available,  in payment in full of all Credit Obligor Indebtedness prior
         to any of such proceeds or revenues being distributed to the Guarantor.
         If, before the conditions for defeasance and  termination of the Credit
         Obligor  Financing  Documents  shall have been  satisfied in full,  the
         Guarantor  should  receive any payment or amount in  violation  of this
         Agreement,  or in the event  that any  payment or  distribution  of any
         assets  of the  Borrower  of any kind or  character  (whether  in cash,
         property  or  securities),  shall  be  received  by  the  Guarantor  in
         violation of this Agreement, such payment, amount or distribution shall
         be held in trust for the benefit of, and shall be paid over upon demand
         to, Credit Obligor or its representative for application to the payment
         of the Credit Obligor  Indebtedness  until the Credit Obligor Financing
         Documents shall have been defeased and terminated as provided therein.

                  (e) Upon any payment or  distribution  of any of the assets of
         the Borrower of any kind or character upon any dissolution, winding up,
         total  or  partial  liquidation,  or  reorganization  of the  Borrower,
         whether   in   voluntary   or   involuntary   bankruptcy,   insolvency,
         reorganization  or  receivership  proceedings or upon an assignment for
         the  benefit  of  creditors  or any other  marshalling  of  assets  and
         liabilities of the Borrower or otherwise,  or upon the  acceleration or
         maturity  of the  Credit  Obligor  Indebtedness  and/or  the  Guarantor
         Indebtedness: (a) Credit Obligor shall first be entitled to receive all
         such  assets in  payment  in full of the  Credit  Obligor  Indebtedness
         before the  Guarantor is entitled to receive any amount of such assets;
         and  (b)  any  payment  or  distribution  of any of the  assets  of the
         Borrower  of any  kind or  character  (whether  in  cash,  property  or
         securities)  to which the  Guarantor  would be entitled  except for the
         provisions of this  Agreement  shall be paid or delivered by the person
         making such payment or  distribution,  whether a trustee in bankruptcy,
         receiver,  liquidating trustee, other custodian, agent or other person,
         directly  to  Credit  Obligor  or its  representative,  to  the  extent
         necessary  to pay in full all  indebtedness  owed  thereto,  before any
         payment or distribution of such assets is made to the Guarantor.

                  (f) No right of Credit  Obligor to enforce  the  subordination
         provided  herein  shall  at any  time  or in any way be  prejudiced  or
         impaired  by (a)  any  act or  failure  to act on the  part  of  Credit
         Obligor,  or (b) any  noncompliance by Credit Obligor with the terms of
         any documents or  instruments  executed in  connection  with the Credit
         Obligor Financing  Documents  (regardless of any knowledge thereof that
         Credit Obligor may have or be charged  with),  or (c) any action Credit
         Obligor  may take or refrain  from  taking  with  respect to the Credit
         Obligor  Indebtedness  or  any  security  therefor,  including  without
         limitation  any  modification  of  the  terms  of  the  Credit  Obligor
         Financing  Documents  or the  granting or  effecting  of any release or
         settlement  with  respect to the  Credit  Obligor  Indebtedness  or any
         security therefor. Any waiver by Credit Obligor of any breach hereof by
         the  Guarantor or any  indulgence  by Credit  Obligor to the  Guarantor
         shall apply only to the separate  occasion thereof and shall not affect
         the continuing obligation of the Guarantor hereunder.

                  (g) The  Guarantor  hereby  agrees to execute  and  deliver to
         Credit  Obligor  at its  request  such  other,  further  or  additional
         agreements,  requests,  demands,  notices,  powers of attorney or other
         writings as, in the sole discretion or opinion of Credit  Obligor,  may
         be necessary or convenient in order to carry out the intent and purpose
         hereof, or to effectuate this Agreement.


                                  ARTICLE VIII

                        Provisions of General Application

         SECTION 8.01      Jurisdiction

         The  Guarantor  irrevocably  (a) agrees that any suit,  action or other
legal  proceeding  arising out of this Agreement may be brought in the courts of
record of the State of Alabama or the courts of the United States located in the
State of Alabama;  (b)  consents to the  jurisdiction  of each such court in any
such  suit,  action  or  proceeding,  and (c)  waives  any  objection  which the
Guarantor  may have to trial by jury or to the laying of venue of any such suit,
action or proceeding in any of such courts.

         SECTION 8.02      Benefit of the Agreement

         This  Agreement is entered into by the Guarantor for the benefit of the
Credit Obligor.  The Guarantor agrees to pay all reasonable and necessary costs,
expenses  and fees,  including  all  reasonable  attorneys'  fees,  which may be
incurred  by the Credit  Obligor in  enforcing  or  attempting  to enforce  this
Agreement pursuant to the provisions hereof,  whether the same shall be enforced
by suit or otherwise.

         SECTION 8.03      Notices

         (a) Any request, demand, authorization,  direction, notice, consent, or
other document provided or permitted by this Agreement to be made upon, given or
furnished  to, or filed  with,  the  Guarantor  or the Credit  Obligor  shall be
sufficient  for every  purpose  hereunder if in writing and (except as otherwise
provided in this Agreement) either (i) delivered  personally to the party or, if
such party is not an individual, to an officer, or other legal representative of
the party to whom the same is directed  (provided  that any  document  delivered
personally  to the Credit  Obligor  must be delivered  at its  Principal  Office
during normal business hours) at the addresses  specified  below, or (ii) mailed
by first-class,  registered or certified mail,  postage prepaid to the addresses
specified below;  provided either party may change the address for receiving any
such  notice or  document  by giving  notice of the change to the other party as
provided in this Section:

                  Cavalier Homes, Inc.
                  Highway 41 North Cavalier Road
                  Addison, Alabama  35540

                  First Commercial Bank
                  2000 SouthBridge Parkway
                  Birmingham, Alabama  35209

                  Attn: Commercial Lending

         (b) Any such notice or other  document  shall be deemed  delivered when
actually  received  by the party to whom  directed  (or, if such party is not an
individual,  to an officer,  or other legal  representative of the party) at the
address  specified  pursuant to this Section,  or, if sent by mail, 3 days after
such notice or document is deposited in the United States mail,  proper  postage
prepaid, addressed as provided above.

         SECTION 8.04      Reproduction of Documents

         The  Guarantor  hereby  agrees  that  any  Financing  Document  and all
documents  relating thereto,  including,  without  limitation,  (a) supplements,
consents,  waivers  and  modifications  which may  hereafter  be  executed,  (b)
documents  received by the Credit  Obligor at any closing of any purchase of the
Bonds  and  (c)  financial   statements,   certificates  and  other  information
previously or hereafter  furnished to the Credit  Obligor,  may be reproduced by
the  Credit  Obligor by any  photographic,  photostatic,  microfilm,  microcard,
miniature  photographic  or other  similar  process  and they  may  destroy  any
original  document so reproduced.  To the extent permitted by law, the Guarantor
agrees and stipulates that any such reproduction shall be admissible in evidence
as the original itself in any judicial or administrative  proceeding (whether or
not the original is in existence and whether or not such  reproduction  was made
by them in the regular course of business) and that any  enlargement,  facsimile
or further  reproduction  of such  reproduction  shall likewise be admissible in
evidence.

         SECTION 8.05      Survival

         All  warranties,  representations  and covenants  made by the Guarantor
herein or on any  certificate or other  instrument  delivered by or on behalf of
the Guarantor  under this Agreement shall be considered to have been relied upon
by the  Credit  Obligor  regardless  of any  investigation  made by it or on its
behalf.  All  statements  in any  such  certificate  or other  instrument  shall
constitute warranties and representations by the Guarantor hereunder.

         SECTION 8.06      Successors and Assigns

         The  terms  of this  Agreement  shall  inure to the  benefit  of and be
binding upon the heirs,  executors,  administrators,  successors  and assigns of
each of the parties.

         SECTION 8.07      Effective Date of Agreement
of Agreement

         The obligations of the Guarantor  hereunder shall arise  absolutely and
unconditionally   when  the  Credit  Agreement  shall  have  been  executed  and
delivered.

         SECTION 8.08      Entire Agreement; Counterparts

         This Agreement  constitutes  the entire  agreement,  and supersedes all
prior agreements and understandings,  both written and oral, between the parties
with respect to the subject matter hereof and may be executed  simultaneously in
several  counterparts,  each of which  shall be deemed an  original,  and all of
which together shall constitute one and the same instrument.

         SECTION 8.09      Severability

         The  invalidity  or  unenforceability  of  any  one  or  more  phrases,
sentences,  clauses or sections contained in this Agreement shall not affect the
validity or enforceability of the remaining  portions of this Agreement,  or any
part thereof.

         SECTION 8.10      Date For Identification Purposes Only

         The date of this Agreement is for  identification  purposes only and is
not intended to indicate that this Agreement was executed on such date.

         SECTION 8.11      Exceptions to Covenants

         The Guarantor shall not be deemed to be permitted to take any action or
fail to take  any  action  which  is  permitted  as an  exception  to any of the
covenants  contained herein or which is within the permissible  limits of any of
the covenants  contained  herein if such action or omission  would result in the
breach of any other covenant contained herein.


<PAGE>


         IN WITNESS  WHEREOF,  the  Guarantor  has caused this  Agreement  to be
executed  under  seal in its name and on its  behalf by  officers  thereof  duly
authorized  thereunto,  and the Credit  Obligor has executed  this  Agreement by
causing  its  name  to be  hereunto  subscribed  by one of its  duly  authorized
officers, all as of the day and year first above written.

                                            CAVALIER HOMES, INC.
                        
                                            By:
                                                -----------------------
                                            Its
                                                -----------------------
S E A L

Attest:
        ------------------------
Its:
        ------------------------
                                            Accepted:

                                            FIRST COMMERCIAL BANK


                                            By:
                                                 ---------------------

                                            Its
                                                 ---------------------


<PAGE>





                                                         














                        LIMITED CREDIT GUARANTY AGREEMENT
                         (Hillsboro Manufacturing, L.P.)
                           (Revolving Credit Facility)





                               Dated July 15, 1997




                                       by


                              CAVALIER HOMES, INC.




                                   in favor of

                              FIRST COMMERCIAL BANK














<PAGE>





                                                        

                                TABLE OF CONTENTS

                                                                           Page
Parties.....................................................................  1
Recitals....................................................................  1

                  ARTICLE I

                                          Provisions of General Application

         SECTION 1.01  Definitions..........................................  2
         SECTION 1.02  Accounting Principles................................  4
         SECTION 1.03  Action Taken Directly or Indirectly..................  4
         SECTION 1.04  Governing Law........................................  4
         SECTION 1.05  General Provisions of Construction...................  4
         SECTION 1.06  Effect of Headings and Table of Contents.............  4

         ARTICLE II

                                         Guaranty

         SECTION 2.01  Guaranty of Obligations..............................  5
         SECTION 2.02  Character of Obligations Hereunder...................  6

         ARTICLE III

                           Waivers; Termination; No Subrogation

         SECTION 3.01  Waivers..............................................  9
         SECTION 3.02  Termination.......................................... 10
         SECTION 3.03  No Right of Subrogation. ............................ 10

         ARTICLE IV

                                    Business Covenants

         SECTION 4.01  Affirmative Covenants................................. 10
         SECTION 4.02  Information as to Guarantor........................... 11

         ARTICLE V

                        Representations, Warranties and Agreements

         SECTION 5.01  Financial Condition................................... 12
         SECTION 5.02  Full Disclosure....................................... 12
         SECTION 5.03  Pending Litigation; No Defaults....................... 12
         SECTION 5.04  Title to Properties................................... 13
         SECTION 5.05  No Defaults........................................... 13
         SECTION 5.06  Governmental Consent.................................. 13
         SECTION 5.07  Compliance with Law................................... 13
         SECTION 5.08  Restrictions on Guarantor............................. 13
         SECTION 5.09  Indemnification....................................... 14
         SECTION 5.10  Survival of Representations, Warranties
                       and Covenants......................................... 14

         ARTICLE VI

                              Events of Default and Remedies

         SECTION 6.01  Events of Default..................................... 15
         SECTION 6.02  Remedies.............................................. 16
         SECTION 6.03  Rights and Remedies of Credit Obligor 
                       in the Event of Bankruptcy, Etc. of Guarantor......... 17
         SECTION 6.04  Agreement to Pay Attorneys' Fees...................... 17
         SECTION 6.05  Waiver of Past Defaults............................... 17
         SECTION 6.06  No Additional Waiver Implied by One Waiver............ 17
         SECTION 6.07  Remedies Subject to Applicable Law.................... 17

         ARTICLE VII

                                  Subordination Agreement.................... 18

         ARTICLE VIII

                             Provisions of General Application

         SECTION 8.01  Jurisdiction.......................................... 20
         SECTION 8.02  Benefit of the Agreement.............................. 20
         SECTION 8.03  Notices............................................... 20
         SECTION 8.04  Reproduction of Documents............................. 21
         SECTION 8.05  Survival.............................................. 21
         SECTION 8.06  Successors and Assigns................................ 21
         SECTION 8.07  Effective Date of Agreement........................... 21
         SECTION 8.08  Entire Agreement; Counterparts........................ 21
         SECTION 8.09  Severability.......................................... 22
         SECTION 8.10  Date For Identification Purposes Only................. 22
         SECTION 8.11  Exceptions to Covenants............................... 22

Testimonium.................................................................. 23
Signatures................................................................... 23


<PAGE>




                        LIMITED CREDIT GUARANTY AGREEMENT


         THIS  AGREEMENT is executed July 15, 1997, by CAVALIER  HOMES,  INC., a
Delaware  corporation  (the  "Guarantor"),  and FIRST  COMMERCIAL  BANK, a state
banking corporation (the "Credit Obligor"), as lender and secured party.


                                    Recitals

         The Guarantor has an interest in Hillsboro Manfacturing,  L.P., a Texas
limited partnership (the "Borrower").

         The  Borrower  intends  to  acquire,   construct  and  install  certain
manufacturing facilities in the City of Hillsboro, Texas (the "Project").

         The  Borrower  has  applied  to the Credit  Obligor  for  extension  of
revolving credit  facilities of $1,000,000 to provide  operating capital for the
Project.

         The Credit Obligor has agreed to make such revolving credit  facilities
available  to  the  Borrower,  for  such  purposes,  upon  satisfaction  of  the
conditions precedent thereto set forth herein and that, among other things:

                  (a) the  Borrower  and the  Credit  Obligor  enter  into  that
         certain  Credit  and  Security   Agreement  (the  "Credit   Agreement")
         providing for the extension of such  revolving  credit  facilities  and
         certain security therefor;

                  (b) the Borrower  delivers to the Credit Obligor the Revolving
         Promissory Note provided by the Credit Agreement;

                  (c) the  following  Persons  (as  defined  herein)  having  an
         interest  in the  Borrower  deliver to the Credit  Obligor  the various
         Credit  Guaranty  Agreements  dated July 15,  1997 with  respect to the
         obligations of the Borrower under the Credit Agreement:

                           (i)      Cavalier Homes, Inc.
                           (ii)     Patriot Homes, Inc.
                           (iii)    Schult Operating Company, and Schult Homes
                                    Corporation
                           (iv)     Southern Energy Homes, Inc.

         The  assumption  of the  obligations  of the Guarantor  hereunder  will
result in direct financial benefits to the Guarantor.



<PAGE>


                                    Agreement

         NOW THEREFORE, in consideration of the foregoing Recitals and to induce
the Credit Obligor to enter into the Credit  Agreement and to make available the
said revolving credit  facilities,  the Guarantor hereby covenants and agrees as
follows:


                                    ARTICLE I

                        Provisions of General Application

         SECTION 1.01      Definitions

         For all  purposes  of this  Agreement,  except as  otherwise  expressly
provided or unless the context otherwise requires:

         "Collateral"  shall mean all  properties and interests in properties of
the  Borrower  which secure the Credit  Obligor  Indebtedness  or are  variously
defined,  referenced or described as  "Collateral"  in any of the Credit Obligor
Financing Documents.

         "Credit Agreement"  shall  have  the  meaning  assigned in the recitals
hereto.

         "Credit  Guaranty" shall mean  collectively the Limited Credit Guaranty
Agreements dated as of July 15, 1997 from the Guarantors to the Credit Obligor.

         "Credit Obligor Financing Documents" shall mean collectively the Credit
Agreement,  the  Revolving  Note,  and  the  Credit  Guaranty,  and  any and all
amendments or supplements to any thereof.

         "Credit Obligor  Indebtedness"  shall mean all  indebtedness  and other
amounts at any time to be paid to Credit  Obligor by the Borrower or any Obligor
(as defined in the Credit  Agreement)  or any affiliate of any thereof under the
Credit Obligor Financing Documents.

         "Default"  shall mean an event or  condition  the  occurrence  of which
would,  with or without the lapse of time or the giving of notice or both, be an
Event of Default.

         "Event of Default" shall mean an event as defined in Article VI.

         "Financing Participants" shall mean the parties to the  Credit  Obligor
Financing Documents.

         "Guarantor" means Cavalier Homes, Inc., and the  respective  successors
and assigns thereof.

         "Guarantor  Indebtedness" shall mean all indebtedness and other amounts
at any time to be paid by the  Borrower or any Obligor (as defined in the Credit
Agreement) or any affiliate of any thereof to the Guarantor.

         "Guarantors"   means   collectively  the  following   Persons  and  the
respective heirs, executors, administrators and assigns thereof:

                  (i)     Cavalier Homes, Inc.,
                  (ii)    Patriot Homes, Inc.,
                  (iii)   Schult Operating Company, and Schult Homes Corporation
                  (iv)    Southern Energy Homes, Inc.

         "Lien" shall mean any interest in Property  securing an obligation owed
to, or a claim by, a Person other than the owner of the  Property,  whether such
interest is based on the common law, statute or contract,  and including but not
limited to the security  interest or lien arising from a mortgage,  encumbrance,
pledge,  conditional sale or trust receipt or a lease assignment or bailment for
security  purposes.  For the purposes of this Agreement,  the Guarantor shall be
deemed to be the owner of any  Property  which it has  acquired or holds or hold
subject to a conditional  sale agreement,  financing lease or other  arrangement
pursuant to which title to the Property  has been  retained by or vested in some
other person for security purposes.

         "Material  Adverse  Effect" shall mean any act or circumstance or event
which  (i)  causes an Event of  Default  or  Default,  (ii)  otherwise  might be
material and adverse to the  financial  condition or business  operations of the
Guarantor or (iii) would adversely affect the validity or  enforceability of any
of the Credit  Obligor  Financing  Documents  or any of the papers  executed  in
connection therewith.

         "Maximum Guaranteed Percentage" shall mean thirty percent (30%).

         "Person" shall mean and include an individual,  a partnership,  a joint
venture, a corporation,  an association, a trust, an unincorporated organization
and a government or any department, agency or political subdivision thereof.

         "Property"  shall mean any  interest  in any kind of property or asset,
whether real, personal or mixed, or tangible or intangible.

         "Revolving  Note"  shall mean the Master  Promissory  Note  (Revolving)
executed and delivered by the Borrower to the Credit Obligor pursuant to Section
2.02 of the Credit Agreement.

         "Tribunal"  shall  mean  any  state,  commonwealth,  federal,  foreign,
district, territorial, or other court or governmental department, board, bureau,
agency or instrumentality having jurisdiction over Guarantor.

         SECTION 1.02      Accounting Principles

         The  Guarantor  shall  maintain  books and records in  accordance  with
generally  accepted  accounting  principles  ("GAAP"  as  defined  in the Credit
Agreement) consistently applied.

         SECTION 1.03      Action Taken Directly or Indirectly

         Where any provision in this  Agreement  refers to action to be taken by
any Person, or which such Person is prohibited from taking, such provision shall
be  applicable  whether  such  action is taken  directly or  indirectly  by such
Person.

         SECTION 1.04      Governing Law

         This  Agreement  shall be governed by and construed in accordance  with
the laws of the State of Alabama.

         SECTION 1.05      General Provisions of Construction

         (1)  Capitalized  terms used herein without  definition  shall have the
meaning assigned to them in the Indenture or the Credit Agreement.

         (2) Singular  terms shall  include the plural as well as the  singular,
and vice versa.

         (3)  All  references  in  this  instrument  to  designated  "Articles",
"Sections" and other subdivisions are to the designated  Articles,  Sections and
subdivisions of this instrument as originally executed.

         (4) The terms  "herein",  "hereof" and  "hereunder"  and other words of
similar  import  refer to this  Agreement  as a whole and not to any  particular
Article, Section or other subdivision.

         SECTION 1.06      Effect of Headings and Table of Contents

         The Article and  Section  headings  herein and in the Table of Contents
are for convenience only and shall not affect the construction hereof.


                                   ARTICLE II

                                    Guaranty

         SECTION 2.01      Guaranty of Obligations

         (a)  Subject to and limited by the  provisions  of  subsection  2.01(d)
hereof,  the Guarantor  hereby  absolutely  and  unconditionally  guarantees the
punctual payment when due (whether at stated  maturity,  by acceleration or call
for redemption or  otherwise),  in lawful money of the United States of America,
of all of the following (collectively the "Obligations"):

                  (1) all commissions,  fees, charges and costs becoming due and
         payable  under  the  Credit  Agreement  in  accordance  with the  terms
         thereof;

                  (2) all amounts  becoming due and payable  under the Revolving
         Note (including without limitation principal,  interest,  late charges,
         and interest on overdue amounts);

                  (3) all  amounts  becoming  due and  payable  under the Credit
         Agreement and all future advances and amounts  becoming due and payable
         under the Revolving Note;

                  (4) all  late  charges  and  all  interest  on  late  payments
         becoming due and payable  under the Credit  Agreement and the Revolving
         Note;

                  (5) all  amounts  becoming  due and  payable  under the Credit
         Agreement and the Revolving Note upon the occurrence and continuance of
         an event of default under the Credit Agreement;

                  (6)      all other  amounts  becoming due  and  payable by the
         Borrower  under the Credit  Agreement and the Revolving Note;

                  (7) all other indebtedness, obligations (including obligations
         of  performance)  and liabilities of the Borrower to the Credit Obligor
         of every kind and description whatsoever,  direct or indirect, absolute
         or  contingent,  due  or to  become  due,  now  existing  or  hereafter
         incurred, contracted or arising, or acquired by the Credit Obligor from
         any source, joint or several, liquidated or unliquidated, regardless of
         how they arise or by what agreement or instrument they may be evidenced
         or whether they are  evidenced  by any  agreement  or  instrument,  and
         whether incurred as maker,  endorser,  surety,  guarantor or otherwise,
         and any and all  extensions,  restatements,  and renewals of any of the
         same; and

                  (8) all renewals and extensions of any or all the  obligations
         of  the  Borrower   described  in  paragraphs  (1)  through  (7)  above
         (including  without  limitation  any renewal or  extension  of, and any
         substitute  for,  the  Revolving  Note),  whether or not any renewal or
         extension agreement is executed in connection therewith.

         (b)  The  guaranty  set  forth  in  this  Section  is an  absolute  and
irrevocable  guaranty of payment and not of collectibility or performance and is
in no way  conditioned  or  contingent  upon any  attempt  to  collect  from the
Borrower or any other  Person,  or to realize upon any  Property  subject to the
Lien of the Credit Documents,  or upon any other direct or indirect security for
the Bonds or the Obligations, or resort to any other remedies.

         (c) Each default in payment of any amount of the Obligations shall give
rise to a separate  cause of action  hereunder and separate suits may be brought
hereunder as each cause of action arises.

         (d) By acceptance hereof, the Credit Obligor covenants and agrees that,
anything  herein or in the Credit  Obligor  Financing  Documents to the contrary
notwithstanding,  the  obligations of, and recourse  against,  the Guarantor for
payment of any amounts  pursuant to this Agreement shall be limited to and shall
not exceed the Maximum Guaranteed  Percentage of such amounts,  as determined on
the basis of the aggregate amounts described in Section 2.01(a) or otherwise due
hereunder  which are  outstanding at the time demand for payment thereof is made
in  accordance  herewith,  without  regard to or taking into  account any demand
upon,  or  payment or  contribution  by, any other  Financing  Participant  with
respect to such amounts.

         SECTION 2.02      Character of Obligations Hereunder

         (a)  All   obligations  of  the  Guarantor  under  this  Agreement  are
unconditional,   primary,   absolute   and   irrevocable   under   any  and  all
circumstances.  Without limiting the generality of the foregoing, to the fullest
extent  permitted  under  applicable  law,  the  obligations  of  the  Guarantor
hereunder shall not be subject to or impaired by:

                  (i)  any inability or  ailure on the part of any party thereto
         to perform or comply  with the Credit Obligor Financing Documents;

                  (ii) any invalidity or  irregularity in any statutory or other
         proceedings  relating  to  the  formation  or  existence  of any of the
         Financing  Participants,  or to  the  execution  and  delivery  of  any
         Financing Document;

                  (iii)  any   invalidity   or   unenforceability   of,  or  any
         impairment, modification or release of liability of any party under, or
         any  impossibility,  impracticability,  illegality  or  frustration  of
         performance  by any  party  of,  any of the  Credit  Obligor  Financing
         Documents,  for any reason whatsoever,  including,  without limitation,
         any  decision by any court  invalidating  or  otherwise  affecting  the
         obligations of any party under or in connection  with any of the Credit
         Obligor Financing Documents;

                  (iv)  any  inability  or  failure  on the  part  of any of the
         Financing  Participants  to  perform  or comply  with any of the Credit
         Obligor Financing Documents;

                  (v) any invalidity or unenforceability  of, or any impairment,
         modification  or release of liability of the  Guarantor  under,  or any
         impossibility,   impracticability,   illegality   or   frustration   of
         performance by the Guarantor of this Agreement;

                  (vi) the voluntary or  involuntary  liquidation,  dissolution,
         merger,   consolidation,   sale  or   other   disposition   of  all  or
         substantially all of the assets, marshalling of assets and liabilities,
         receivership,  insolvency,  bankruptcy,  assignment  for the benefit of
         creditors,  reorganization,  moratorium, arrangement,  composition with
         creditors  or  readjustment  of debt of, or other  similar  proceedings
         affecting, any of the Financing Participants;

                  (vii) any  waiver,  consent,  extension,  indulgence  or other
         action or inaction in respect of any Financing Document,  including any
         modification,  amendment or  supplement  to any of the  foregoing,  the
         renewal or extension of the Bonds,  the release of any Property subject
         to the Lien of the Credit Agreement or any other similar act;

                  (viii) any right of setoff,  counterclaim  or defense,  or any
         act, omission or breach on the part of the Borrower, the Credit Obligor
         or the Guarantor or any of the other Financing Participants;

                  (ix) any claim  whatsoever against the  Borrower or any of the
         other Financing Participants;

                  (x) any defect in the title,  compliance with  specifications,
         value,  condition,   design,   operation,   merchantability,   quality,
         durability  or  suitability  of,  consequences  of use or misuse of, or
         unfitness for use of, the Project or any part thereof, any abandonment,
         destruction,  noncompletion,  requisition, condemnation, foreclosure of
         or damage to the  Project  or any part  thereof,  or any event of force
         majeure relating to the Project or any part thereof;

                  (xi) any breach of any  representation or warranty relating to
         the Project;

                  (xii)  any  release,  extinguishment  or  satisfaction  of the
         Borrower's obligations to make payments of Obligations until there have
         been paid to the Credit Obligor in lawful currency of the United States
         an amount  sufficient  to pay all  Obligations  (including  interest on
         overdue amounts of Obligations  including,  to the extent  permitted by
         applicable  law,  interest)  that  would have been due and owing to the
         Credit Obligor by the Borrower had the Borrower's  obligations not been
         so released, extinguished or satisfied;

                  (xiii) the  failure  to give  notice to the  Guarantor  of the
         occurrence of any default or event of default under the Credit  Obligor
         Financing Documents;

                  (xiv) the  compromise,  settlement,  release or termination of
         any or all of the  obligations,  covenants or  agreements of any of the
         parties  to any of the Credit  Obligor  Financing  Documents  under the
         Credit Obligor Financing Documents;

                  (xv) any  assignment,  pledge or  mortgage  of all or any part
         of the  interest of any of the Financing Participants in the Project or
         the Collateral;

                  (xvi) any waiver of the payment,  performance or observance by
         any of the  Financing  Participants  of any  obligation,  agreement  or
         covenant  of any of them  contained  in the  Credit  Obligor  Financing
         Documents;

                  (xvii) the  extension of the time for payment of any amount of
         the  Obligations or any part thereof or of the time for  performance of
         any other obligations,  agreements or covenants of any of the Financing
         Participants under the Credit Obligor Financing Documents;

                  (xviii) the  modification  or amendment  (whether  material or
         otherwise) of any  obligation,  agreement or covenant  contained in the
         Credit Obligor Financing Documents;

                  (xix) any  failure,  omission,  or delay on the part of any of
         the Financing  Participants  to enforce,  assert or exercise any right,
         power  or  remedy  conferred  upon  any of them by the  Credit  Obligor
         Financing Documents;

                  (xx) the bankruptcy, insolvency,  reorganization,  appointment
         of a receiver for, or dissolution of any of the Financing Participants,
         or the entering by any or all of them into an agreement of  composition
         with  creditors,  or the making by any or all of them of an  assignment
         for the benefit of creditors;

                  (xxi) any rights of set-off, recoupment, counterclaim or other
         defense,  whether  similar or  dissimilar to the  foregoing,  which the
         Guarantor   might   otherwise   have  against  any  of  the   Financing
         Participants or any other person;

                  (xxii)  the  default  or  failure  of any  one or  more of the
         Financing  Participants  to perform fully any  obligation,  covenant or
         agreement contained in the Credit Obligor Financing Documents;

                  (xxiii)  the  release or  discharge  of any one or more of the
         Financing  Participants  by  operation  of law, to the extent that such
         release or discharge may be lawfully  avoided,  from the performance or
         observance of any agreement or covenant contained in the Credit Obligor
         Financing Documents;

                  (xxiv)  the  invalidity  or  unenforceability  of  the  Credit
         Obligor Financing Documents or of any provision of such instruments; or

                   (xxv) any other  matter  that  might  otherwise  be raised in
         avoidance  of,  or  in  defense  against,  an  action  to  enforce  the
         obligations of the Guarantor under this Agreement.

         (b) The Guarantor  acknowledges that this Agreement is executed for the
benefit of the Credit  Obligor and that the Credit  Agreement  and the Letter of
Credit will be executed and delivered in reliance on this  Agreement.  No act of
commission or omission of any kind at any time on the part of the Credit Obligor
in respect of any matter whatsoever shall in any way affect or impair any right,
power or benefit of the Credit  Obligor under this  Agreement and, to the extent
permitted by  applicable  law, no setoff,  claim,  reduction,  diminution of any
obligation,  or any defense of any kind or nature which the  Guarantor  may have
against the Credit Obligor shall be available  against the Credit Obligor in any
suit or action  brought by the Credit  Obligor  to enforce  any right,  power or
benefit under this Agreement.


                                   ARTICLE III

                      Waivers; Termination; No Subrogation

         SECTION 3.01      Waivers

         (a) The Guarantor  hereby waives all of the following and all defenses,
counterclaims,  or offsets which the Guarantor may have by reason  thereof:  (1)
notice of acceptance  hereof,  notice of any action taken or omitted in reliance
hereon,  notice of any defaults by the Borrower in the payment of any such sums,
and  notice  of the  creation,  renewal,  or  accrual  of any  liability  of the
Borrower,  (2) any presentment,  demand,  notice or protest of any kind, (3) any
right  (i) to have  joined  any of the  other  Financing  Participants  with the
Guarantor in any suit brought against the Guarantor on this  Agreement,  (ii) to
require  the Credit  Obligor to  forthwith  bring suit  against any of the other
Financing Participants,  and (iii) to require that the Credit Obligor obtain any
judgment against any of the other Financing  Participants in connection with the
enforcement of any rights against the Guarantor hereunder, and (4) any other act
or thing  (including  without  limitation  alteration of the Bonds or the Credit
Obligor Financing Documents or debt evidenced thereby or security therefor),  or
omission or delay to do any other act or thing which may, by operation of law or
otherwise,  in any manner or to any  extent  vary the risk of the  Guarantor  or
which might otherwise operate as a discharge of the Guarantor.

         (b)  The  Guarantor  hereby  waives,  as to  the  enforcement  of  this
Agreement,  (1) all rights of exemption  that the  Guarantor  may have under the
constitution  and laws of any state as to any levy on and sale of  property  and
(2)   presentation  and  demand  for  payment  (or  protest  of  nonpayment)  of
Obligations or any part thereof.

         SECTION 3.02      Termination

         (a) The  guaranties  set forth in this  Agreement  shall remain in full
force and effect without  reference to future changes in conditions,  including,
to the extent  permitted by  applicable  law,  changes in law,  until the Credit
Obligor shall have been indefeasibly paid in full any and all sums due under the
terms  and  provisions  of the  Obligations  and the  Credit  Obligor  Financing
Documents,  and until such sums are not subject to rescission or repayment  upon
any   bankruptcy,   insolvency,   arrangement,    reorganization,    moratorium,
receivership  or similar  proceeding  affecting the Issuer,  the  Borrower,  the
Guarantor, or any of the other Financing Participants.

         (b) In the event any payment on the  Obligations  (whether such payment
is remitted by the Issuer, the Borrower, any Guarantor or any other person, from
realization on collateral,  through setoff or otherwise) must be refunded,  paid
over or  otherwise  released by the Credit  Obligor as a result of such  payment
being (1) a preference or fraudulent transfer under the Bankruptcy Code of 1978,
as amended,  or other state or federal law or (2)  disallowed as a permanent and
irrevocable  payment on the Obligations for any other reason,  then in each such
event this Agreement shall  thereupon,  ipso facto, be reinstated and revived to
the full extent of such refunded, paid over or released payment.

         SECTION 3.03      No Right of Subrogation. 

The  Guarantor  will not exercise any rights of  subrogation  which the
Guarantor may have unless and until this Agreement shall have been terminated as
provided in Section 3.02.  If any payment is made to the Guarantor  with respect
to any payments due by the Guarantor  under this  Agreement at any time prior to
such  termination  of this  Agreement,  he will be paid  forthwith to the Credit
Obligor to be applied to installments due or coming due under the Obligations in
the  order  and  the  manner  provided  in the  Credit  Agreement  or  otherwise
determined by the Credit Obligor.


                                   ARTICLE IV

                               Business Covenants

         SECTION 4.01      Affirmative Covenants

         The  Guarantor  covenants that so long as  this Agreement is in effect,
the Guarantor shall

         (a) Payment of Indebtedness,  Taxes,  etc. (i) Pay all indebtedness and
obligations of the Guarantor  promptly and in accordance with normal terms where
failure to pay would have a Material Adverse Effect,  and (ii) pay and discharge
or  cause  to  be  paid  or  discharged  promptly  all  taxes,  assessments  and
governmental charges or levies imposed upon the Guarantor or upon his income and
profits, or upon any of his Property,  real, personal or mixed, or upon any part
thereof,  before the same shall become in default,  as well as all lawful claims
for labor, materials and supplies or otherwise, which, if unpaid, might become a
lien upon such  properties or any part thereof where failure to pay would have a
Material  Adverse  Effect;  provided,  however,  that the Guarantor shall not be
required to pay and discharge any such tax, assessment, charge, levy or claim so
long as the validity  thereof  shall be  contested in good faith by  appropriate
proceedings.

         (b) Accounts, Financial Information. The Guarantor will maintain proper
books of record and account,  in which full and correct entries will be made, in
accordance with generally accepted  accounting  principles,  of all business and
affairs of the Guarantor. The Guarantor shall furnish to the Credit Obligor with
reasonable  promptness (1) annual financial statements of the Guarantor prepared
and  audited by  certified  public  accountants  in  accordance  with  generally
accepted  accounting  principles,  and (2) such other information  regarding the
operations,  business  affairs and  financial  condition of the Guarantor as the
Credit Obligor may reasonably request.

         (c) Legal Existence. The Guarantor will maintain and preserve its legal
existence  and will not  voluntarily  dissolve  without  first  discharging  its
obligations under this Agreement.

         (d)  Further  Assurances.  On request of the Credit  Obligor,  promptly
correct any  defect,  error or omission  which may be  discovered  in any of the
Credit  Obligor  Financing  Documents  or in the  contents  of any of the papers
executed in connection therewith or in the execution or acknowledgement thereof,
and  execute,  acknowledge  and deliver  such  further  instruments  and do such
further acts as may be necessary or as may be requested by the Credit Obligor to
carry out more effectively the purposes of this Agreement and the Credit Obligor
Financing Documents.

         SECTION 4.02      Information as to Guarantor

         Financial and Business Information.  The Guarantor shall deliver to the
         Credit Obligor:

                  (a) Notice of Default or Event of  Default.  Immediately  upon
         becoming  aware  of the  existence  of any  condition  or  event  which
         constitutes  a  default  or an event of  default  under  any  Financing
         Document,  a  written  notice  specifying  the  nature  and  period  of
         existence  thereof and what action the  Guarantor is taking or proposes
         to take with respect thereto;

                  (b) Notice of Claimed Default. Immediately upon becoming aware
         that the holder of any  evidence  of  indebtedness  or  security of the
         Guarantor  has given notice or taken any other action with respect to a
         claimed  default or event of default  thereunder  which  would  cause a
         default or event of default which would have a Material Adverse Effect,
         a written  notice  specifying  the notice given or action taken by such
         holder and the nature of the  claimed  default or event of default  and
         what action the  Guarantor  are taking or proposes to take with respect
         thereto;

                  (c) Requested  Information.  With reasonable  promptness, such
         data and information as from time to time may be reasonably requested;

                  (d) Notice of Litigation.  Immediately  upon becoming aware of
         the  existence of any  proceedings  before any Tribunal  involving  the
         Guarantor  which  involves  the  probability  of any final  judgment or
         liability  against  such  Guarantor  in an amount  which  would  have a
         Material Adverse Effect, a written notice specifying the nature thereof
         and what  action  such  Guarantor  is taking and  proposes to take with
         respect thereto; and

                  (e) Notice from  Regulatory  Agencies.  Promptly  upon receipt
         thereof, information with respect to and copies of any notices received
         from federal or state regulatory  agencies or any Tribunal  relating to
         an order, ruling,  statute or other law or information which might have
         a Material  Adverse Effect on the  franchises,  permits,  licenses,  or
         rights, or the condition, financial or otherwise, of the Guarantor.


                                    ARTICLE V

                   Representations, Warranties and Agreements

         The Guarantor represents, warrants and agrees that:

         SECTION 5.01      Financial Condition

         Since the date of  application  to the Credit Obligor for the Revolving
Note,  (i)  there  has  been no  change  in the  business,  prospects,  profits,
Properties  or condition  (financial  or  otherwise)  of the  Guarantor,  except
changes in the ordinary course of business, none of which individually or in the
aggregate has a Material Adverse Effect, (ii) the Guarantor has not incurred any
material  liability which has a Material Adverse Effect,  and (iii) there exists
no  default  under  the  provisions  of  any  instrument   evidencing  any  such
liabilities or under any agreement  relating thereto which would have a Material
Adverse Effect.

         SECTION 5.02      Full Disclosure

         No written  statement  furnished by the Guarantor to the Credit Obligor
contains any untrue  statement  of a material  fact or omits to state a material
fact  necessary  to  make  the  statements   contained  therein  or  herein  not
misleading. There is no fact which the Guarantor has not disclosed to the Credit
Obligor  in  writing  which  has a  Material  Adverse  Effect  or, so far as the
Guarantor can now foresee, will have a Material Adverse Effect.

         SECTION 5.03      Pending Litigation; No Defaults

         There  are  no  proceedings  pending,  or,  to  the  knowledge  of  the
Guarantor, threatened, against or affecting the Guarantor in any court or before
any  governmental  authority or arbitration  board or Tribunal which involve the
possibility  of a Material  Adverse  Effect or the ability of the  Guarantor  to
perform  this  Agreement.  The  Guarantor  is not in default with respect to any
order of any court, governmental authority,  arbitration board or Tribunal which
would have a Material Adverse Effect.

         SECTION 5.04      Title to Properties

         The Guarantor has good and marketable title to the Properties thereof.

         SECTION 5.05      No Defaults

         No event has  occurred  and no  conditions  exist which  would,  in any
material  respect,  upon the issuance of the Letter of Credit,  constitute (i) a
default under any note or other evidence of  indebtedness or under any agreement
of the  Guarantor  if the effect of such default  would have a Material  Adverse
Effect or (ii) a default or event of default under the Credit Obligor  Financing
Documents or any of them,  and the Guarantor is not in violation in any material
respect of any term of any agreement or other  instrument to which the Guarantor
is a party or by which the  Guarantor  may be bound  that  would have a Material
Adverse Effect.

         SECTION 5.06      Governmental Consent

         No consent,  approval or authorization  of, or filing,  registration or
qualification  with, any governmental  authority on the part of the Guarantor is
required in connection  with the  execution  and delivery of the Credit  Obligor
Financing Documents to which the Guarantor is a party.

         SECTION 5.07      Compliance with Law

         The Guarantor:

                  (a) is not in  violation of any laws, ordinances, governmental
         rules or  regulations  to  which Guarantor is subject, or

                  (b) has not failed to obtain any licenses, permits, franchises
         or other governmental  authorizations necessary to the ownership of the
         Property, or to the conduct of the business, of Guarantor,

which violation or failure to obtain would have a Material Adverse Effect.

         SECTION 5.08      Restrictions on Guarantor

         The  Guarantor  is not a  party  to any  contract  or  agreement  which
requires  consent of any creditor of the Guarantor other than the Credit Obligor
or other party thereto to the right or ability of the Guarantor to incur debt or
guarantee indebtedness hereunder.

         SECTION 5.09      Indemnification

         (a) The Guarantor  will  indemnify and hold harmless the Credit Obligor
and each Person,  if any, who controls the Credit  Obligor within the meaning of
Section 15 of the  Securities  Act of 1933, as amended,  (the Credit Obligor and
any such person being in this Section  collectively  called a "Holder")  against
any and all  losses,  claims,  damages or  liabilities,  joint and  several,  or
actions in respect  thereof,  to which any Holder may become  subject  under any
statute or common law or otherwise,  insofar as such losses,  claims, damages or
liabilities,  or actions in respect thereof,  arise out of or are based upon any
untrue  statement or alleged  untrue  statement of a material fact  contained in
this Agreement,  including the financial  statements  referred to herein, or any
omission or alleged  omission to state herein a material fact necessary in order
to make the statements herein not misleading;  and will reimburse any Holder for
all legal or other  expenses  reasonably  incurred by such Holder in  connection
with defending any such action or claim.

         (b) If any such action or claim  shall be brought or  asserted  against
any Holder and in respect of which  indemnity may be sought from the  Guarantor,
such Holder shall  promptly  notify the  Guarantor in writing and the  Guarantor
shall assume the defense  thereof,  including the  employment of counsel and the
payment  of all  expenses.  Any Holder  shall have the right to employ  separate
counsel in any such action and participate in the defense thereof,  but the fees
and expenses of such counsel  shall be at the expense of such Holder  unless (a)
the  employment  thereof  at the  expense  of  Guarantor  has been  specifically
authorized by the Guarantor in writing,  (b) the Guarantor have failed to assume
the defense and to employ  counsel,  or (c) the named parties to any such action
(including  any impleaded  parties)  include both such Holder and the Guarantor,
and such Holder shall have been advised by such counsel that there may be one or
more legal  defenses  available to it which are different  from or additional to
those  available to the Guarantor  (in which case,  if such Holder  notifies the
Guarantor in writing that it elects to employ separate counsel at the Guarantor'
expense,  the  Guarantor  shall not have the right to assume the defense of such
action  on  behalf  of such  Holder,  it  being  understood,  however,  that the
Guarantor  shall not, in  connection  with any one such  action or separate  but
substantially similar or related actions in the same jurisdiction arising out of
the same general allegations or circumstances, be liable for the reasonable fees
and expenses of more than one separate  firm of attorneys  for all such Holders,
which firm shall be designated in writing by such  Holders).  Each Holder,  as a
condition of such  indemnity,  shall use its best efforts to cooperate  with the
Guarantor in the defense of any such action or claim. The Guarantor shall not be
liable for any  settlement  of any such action  effected  without  their written
consent,  but if settled with the written consent of the Guarantor,  or if there
be a final judgment for the plaintiff in any such action,  the Guarantor  agrees
to  indemnify  and hold  harmless  any such  Holder from and against any loss or
liability by reason of such settlement or judgment.

         SECTION 5.10      Survival of Representations, Warranties and Covenants

         The   representations,   warranties  and  covenants  of  the  Guarantor
contained in this Agreement,  and any other  document,  instrument and agreement
referred to or  contemplated by this  Agreement,  shall remain  operative and in
full force and effect regardless of (i) any  investigation  made by or on behalf
of the  Borrower,  any  Holder or any other  Person,  or (ii)  delivery  of, and
payment for, the Obligations.


                                   ARTICLE VI

                         Events of Default and Remedies

         SECTION 6.01      Events of Default

         An "Event of Default"  shall exist under this  Agreement  if any of the
following  occurs  and is  continuing  (whatever  the  reason for such event and
whether it shall be voluntary or  involuntary or be effected by operation of law
or pursuant to any judgment,  decree or order of any court or any order, rule or
regulation of any administrative or governmental body):

                  (a) Particular  Covenant   Defaults.  The  Guarantor  fails to
         perform or observe any covenant or agreement contained  in Section 2.01
         for a period of five  Business  Days after  notification  by the Credit
         Obligor of such failure;

                  (b) Other  Defaults.  The  Guarantor  fails to comply with any
         other  provision of this  Agreement,  and such failure  continues for a
         period of thirty days after written  notification by the Credit Obligor
         of such failure;

                  (c)    Warranties    or    Representations.    Any   warranty,
         representation  or other  statement  by or on behalf  of the  Guarantor
         contained  in  this  Agreement,  or  in  any  instrument  furnished  in
         compliance  with  or in  reference  to  this  Agreement,  is  false  or
         misleading  in any material  respect and action which  eliminates  such
         falsity or misleading character is not completed for a period of thirty
         days after written  notification by the Credit Obligor of such false or
         misleading statement;

                  (d) Default on Other Indebtedness. Default by the Guarantor in
         any payment of any  obligation for money received as an advance (or any
         obligation   under  any  conditional  sale  or  other  title  retention
         agreement  or any  obligation  issued  or  assumed  as full or  partial
         payment for property  whether or not secured by purchase  money lien or
         any  obligation  under notes  payable or drafts  accepted  representing
         extensions  of credit)  beyond any grace period  provided  with respect
         thereto, or default in the performance of any other agreement,  term or
         condition  contained in any  agreement  under which such  obligation is
         created  (or any other  default  under any such  agreement  which shall
         occur  and be  continuing  beyond  any  period of grace  provided  with
         respect  thereto),  if the effect of such default would have a Material
         Adverse  Effect,  and such default shall remain uncured for a period of
         ten days after the Guarantor has notice thereof;

                  (e) Involuntary Bankruptcy Proceedings. A receiver, liquidator
         or trustee of the Guarantor, or of any of his Property, is appointed by
         court order and such order  remains in effect for more than sixty days,
         or an order or decree for relief in an involuntary  bankruptcy  case is
         entered  with  respect  to the  Guarantor,  or any of his  Property  is
         sequestered  by court  order and such order  remains in effect for more
         than sixty days, or a petition is filed against the Guarantor under any
         bankruptcy,  reorganization,  arrangement,  insolvency, readjustment of
         debt,  dissolution or liquidation law of any jurisdiction,  whether now
         or hereafter in effect,  and is not  dismissed  within sixty days after
         such filing;

                  (f) Voluntary  Petitions.  The  Guarantor  files a petition in
         voluntary  bankruptcy  or seeking  relief  under any  provision  of any
         bankruptcy,  reorganization,  arrangement,  insolvency, readjustment of
         debt,  dissolution or liquidation law of any jurisdiction,  whether now
         or  hereafter  in effect,  or  consents  to the filing of any  petition
         against him under any such law;

                  (g) General  Assignment  for Benefit of  Creditors,  etc.  The
         Guarantor makes a general  assignment for the benefit of his creditors,
         or is unable to pay his debts generally as they become due, or consents
         to  the  appointment  of a  receiver,  trustee  or  liquidator  of  the
         Guarantor, or of all or any part of his Property;

                  (h) Undischarged  Final Judgments or Settlements.  One or more
         final  judgments  shall  be  entered  against  the  Guarantor,  or  the
         Guarantor  shall  enter  into  settlement  of  any  litigation,   which
         judgments  and  settlements  are not  covered by  insurance,  and which
         judgments and  settlements  will have a Material  Adverse Effect on the
         Guarantor; or

                  (i) Other  Defaults.  The  occurrence  of an event of  default
         under any of the  other  Credit  Obligor  Financing  Documents  and the
         expiration of the applicable grace period, if any, specified therein.

         SECTION 6.02      Remedies

         If an Event of  Default  exists,  the  Credit  Obligor  may  proceed to
protect  its  rights  by suit in  equity,  action  at law or  other  appropriate
proceedings,  whether for the specific  performance of any covenant or agreement
of the  Guarantor  herein  contained  or in aid of the  exercise of any power or
remedy  granted  to the Credit  Obligor  under any of the other  Credit  Obligor
Financing  Documents.  The Credit  Obligor  may  proceed  directly  against  the
Guarantor  hereunder  without  resorting to any other remedies which it may have
and without proceeding against any other security held by the Credit Obligor.

         SECTION 6.03      Rights and Remedies of Credit Obligor in the Event of
 Bankruptcy, Etc. of Guarantor

         In case of the pendency of any receivership,  insolvency,  liquidation,
bankruptcy,   reorganization,   arrangement,   composition   or  other  judicial
proceeding, or any general assignment for the benefit of creditors,  relative to
the  Guarantor,  the Credit  Obligor  (irrespective  of whether there has been a
default  under  this  Agreement  or any of the other  Credit  Obligor  Financing
Documents) shall be entitled and empowered to intervene in such proceedings,  to
file and prove a claim or claims  for the whole  amount  owing and unpaid and to
file such other papers or documents as may be necessary or advisable in order to
have the  claims of the  Credit  Obligor  (including  any  claim for  reasonable
compensation to the Credit Obligor,  its agents,  attorneys and counsel, and for
reimbursement  of all  expenses and  liabilities  reasonably  incurred,  and all
advances made, by the Credit Obligor except as a result of its negligence or bad
faith) allowed in such judicial  proceedings,  to collect and receive any moneys
or other property  payable or  deliverable on any such claims,  and to take such
other action  therein as the Credit Obligor may deem necessary or appropriate to
protect its interests.

         SECTION 6.04      Agreement to Pay Attorneys' Fees

         In the event the Guarantor  should  default under any of the provisions
of this Agreement and the Credit Obligor should employ  attorneys or incur other
expenses for the collection of any payments due hereunder or the  enforcement of
performance  or  observance  of any  agreement  or  covenant  on the part of the
Guarantor  herein  contained,  the Guarantor will on demand  therefor pay to the
Credit Obligor the reasonable  fees of such attorneys and such other  reasonable
expenses so incurred.

         SECTION 6.05      Waiver of Past Defaults

         The  Credit  Obligor  may  waive  any past  default  hereunder  and its
consequences.  Upon any such waiver,  such default shall cease to exist, and any
Event of Default arising  therefrom shall be deemed to have been cured for every
purpose of this  Agreement but no such waiver shall extend to any  subsequent or
other default or impair any right consequent thereon.

         SECTION 6.06      No Additional Waiver Implied by One Waiver

         If any agreement  contained in this Agreement should be breached by the
Guarantor  and  thereafter  waived by the Credit  Obligor,  such waiver shall be
limited to the particular  breach so waived and shall not be deemed to waive any
other breach hereunder.

         SECTION 6.07      Remedies Subject to Applicable Law

         All  rights,  remedies  and  powers  provided  by this  Article  may be
exercised  only  to the  extent  the  exercise  thereof  does  not  violate  any
applicable  provision of law in the  premises,  and all the  provisions  of this
Article are intended to be subject to all applicable mandatory provisions of law
which  may be  controlling  in the  premises  and to be  limited  to the  extent
necessary so that they will not render this Agreement invalid or unenforceable.


                                   ARTICLE VII

                             Subordination Agreement

         The Guarantor does hereby covenant and agree:

                  (a) That payment of the  Guarantor  Indebtedness  when due and
         payable in each  month  shall be and  hereby is fully  subordinated  in
         priority to the prior payment to Credit  Obligor of the Credit  Obligor
         Indebtedness  when due and  payable in each month,  provided,  however,
         that so long as no event of default  exists  under the  Credit  Obligor
         Financing  Documents the Guarantor may receive payment of the Guarantor
         Indebtedness  when due and  payable  (but not in advance of  originally
         scheduled due dates).

                  (b)  That  anything  in  any  other  contract,   agreement  or
         instrument to the contrary  notwithstanding,  (a) all right,  title and
         interest of the Guarantor in and to the Collateral  shall be and hereby
         are fully  subordinated in priority to the right, title and interest of
         Credit  Obligor  in and to the  Collateral  as  provided  in the Credit
         Obligor  Financing  Documents without regard to the respective dates on
         which  any of such  interests  were  created  and (b) that the claim of
         Credit Obligor upon all the Collateral shall be and hereby is prior and
         superior for all purposes to that of the Guarantor therein.

                  (c) Upon the  occurrence  of a default  under any agreement or
         document   evidencing,   providing   for,  or  securing  the  Guarantor
         Indebtedness  or if  the  Guarantor  Indebtedness  shall  become  or be
         declared immediately due and payable, then an event of default shall be
         deemed  to  have  simultaneously  occurred  under  the  Credit  Obligor
         Indebtedness  and the Credit Obligor  Financing  Documents and the same
         shall also become  immediately  due and  payable,  notwithstanding  any
         inconsistent terms in any document or instrument relating to any of the
         foregoing.  The Guarantor shall not,  without the prior written consent
         of  Credit  Obligor,  accelerate  the  maturity  of, or  institute  any
         proceedings to enforce, any of the Guarantor Indebtedness.

                  (d)  Upon  the  occurrence  and  continuation  of an  event of
         default under any agreement or document  evidencing,  providing for, or
         securing the Guarantor  Indebtedness  or the Credit  Obligor  Financing
         Indebtedness,  Credit  Obligor  shall  first be entitled to receive all
         proceeds and revenues from the  Collateral  when and as the same become
         available,  in payment in full of all Credit Obligor Indebtedness prior
         to any of such proceeds or revenues being distributed to the Guarantor.
         If, before the conditions for defeasance and  termination of the Credit
         Obligor  Financing  Documents  shall have been  satisfied in full,  the
         Guarantor  should  receive any payment or amount in  violation  of this
         Agreement,  or in the event  that any  payment or  distribution  of any
         assets  of the  Borrower  of any kind or  character  (whether  in cash,
         property  or  securities),  shall  be  received  by  the  Guarantor  in
         violation of this Agreement, such payment, amount or distribution shall
         be held in trust for the benefit of, and shall be paid over upon demand
         to, Credit Obligor or its representative for application to the payment
         of the Credit Obligor  Indebtedness  until the Credit Obligor Financing
         Documents shall have been defeased and terminated as provided therein.

                  (e) Upon any payment or  distribution  of any of the assets of
         the Borrower of any kind or character upon any dissolution, winding up,
         total  or  partial  liquidation,  or  reorganization  of the  Borrower,
         whether   in   voluntary   or   involuntary   bankruptcy,   insolvency,
         reorganization  or  receivership  proceedings or upon an assignment for
         the  benefit  of  creditors  or any other  marshalling  of  assets  and
         liabilities of the Borrower or otherwise,  or upon the  acceleration or
         maturity  of the  Credit  Obligor  Indebtedness  and/or  the  Guarantor
         Indebtedness: (a) Credit Obligor shall first be entitled to receive all
         such  assets in  payment  in full of the  Credit  Obligor  Indebtedness
         before the  Guarantor is entitled to receive any amount of such assets;
         and  (b)  any  payment  or  distribution  of any of the  assets  of the
         Borrower  of any  kind or  character  (whether  in  cash,  property  or
         securities)  to which the  Guarantor  would be entitled  except for the
         provisions of this  Agreement  shall be paid or delivered by the person
         making such payment or  distribution,  whether a trustee in bankruptcy,
         receiver,  liquidating trustee, other custodian, agent or other person,
         directly  to  Credit  Obligor  or its  representative,  to  the  extent
         necessary  to pay in full all  indebtedness  owed  thereto,  before any
         payment or distribution of such assets is made to the Guarantor.

                  (f) No right of Credit  Obligor to enforce  the  subordination
         provided  herein  shall  at any  time  or in any way be  prejudiced  or
         impaired  by (a)  any  act or  failure  to act on the  part  of  Credit
         Obligor,  or (b) any  noncompliance by Credit Obligor with the terms of
         any documents or  instruments  executed in  connection  with the Credit
         Obligor Financing  Documents  (regardless of any knowledge thereof that
         Credit Obligor may have or be charged  with),  or (c) any action Credit
         Obligor  may take or refrain  from  taking  with  respect to the Credit
         Obligor  Indebtedness  or  any  security  therefor,  including  without
         limitation  any  modification  of  the  terms  of  the  Credit  Obligor
         Financing  Documents  or the  granting or  effecting  of any release or
         settlement  with  respect to the  Credit  Obligor  Indebtedness  or any
         security therefor. Any waiver by Credit Obligor of any breach hereof by
         the  Guarantor or any  indulgence  by Credit  Obligor to the  Guarantor
         shall apply only to the separate  occasion thereof and shall not affect
         the continuing obligation of the Guarantor hereunder.

                  (g) The  Guarantor  hereby  agrees to execute  and  deliver to
         Credit  Obligor  at its  request  such  other,  further  or  additional
         agreements,  requests,  demands,  notices,  powers of attorney or other
         writings as, in the sole discretion or opinion of Credit  Obligor,  may
         be necessary or convenient in order to carry out the intent and purpose
         hereof, or to effectuate this Agreement.


                                  ARTICLE VIII

                        Provisions of General Application

         SECTION 8.01      Jurisdiction

         The  Guarantor  irrevocably  (a) agrees that any suit,  action or other
legal  proceeding  arising out of this Agreement may be brought in the courts of
record of the State of Alabama or the courts of the United States located in the
State of Alabama;  (b)  consents to the  jurisdiction  of each such court in any
such  suit,  action  or  proceeding,  and (c)  waives  any  objection  which the
Guarantor  may have to trial by jury or to the laying of venue of any such suit,
action or proceeding in any of such courts.

         SECTION 8.02      Benefit of the Agreement

         This  Agreement is entered into by the Guarantor for the benefit of the
Credit Obligor.  The Guarantor agrees to pay all reasonable and necessary costs,
expenses  and fees,  including  all  reasonable  attorneys'  fees,  which may be
incurred  by the Credit  Obligor in  enforcing  or  attempting  to enforce  this
Agreement pursuant to the provisions hereof,  whether the same shall be enforced
by suit or otherwise.

         SECTION 8.03      Notices

         (a) Any request, demand, authorization,  direction, notice, consent, or
other document provided or permitted by this Agreement to be made upon, given or
furnished  to, or filed  with,  the  Guarantor  or the Credit  Obligor  shall be
sufficient  for every  purpose  hereunder if in writing and (except as otherwise
provided in this Agreement) either (i) delivered  personally to the party or, if
such party is not an individual, to an officer, or other legal representative of
the party to whom the same is directed  (provided  that any  document  delivered
personally  to the Credit  Obligor  must be delivered  at its  Principal  Office
during normal business hours) at the addresses  specified  below, or (ii) mailed
by first-class,  registered or certified mail,  postage prepaid to the addresses
specified below;  provided either party may change the address for receiving any
such  notice or  document  by giving  notice of the change to the other party as
provided in this Section:

                  c/o Cavalier Homes, Inc.
                  Highway 41 North Cavalier Road
                  Addison, Alabama  35540

                  First Commercial Bank
                  2000 SouthBridge Parkway
                  Birmingham, Alabama  35209

                  Attn: Commercial Lending

         (b) Any such notice or other  document  shall be deemed  delivered when
actually  received  by the party to whom  directed  (or, if such party is not an
individual,  to an officer,  or other legal  representative of the party) at the
address  specified  pursuant to this Section,  or, if sent by mail, 3 days after
such notice or document is deposited in the United States mail,  proper  postage
prepaid, addressed as provided above.

         SECTION 8.04      Reproduction of Documents

         The  Guarantor  hereby  agrees  that  any  Financing  Document  and all
documents  relating thereto,  including,  without  limitation,  (a) supplements,
consents,  waivers  and  modifications  which may  hereafter  be  executed,  (b)
documents  received by the Credit  Obligor at any closing of any purchase of the
Bonds  and  (c)  financial   statements,   certificates  and  other  information
previously or hereafter  furnished to the Credit  Obligor,  may be reproduced by
the  Credit  Obligor by any  photographic,  photostatic,  microfilm,  microcard,
miniature  photographic  or other  similar  process  and they  may  destroy  any
original  document so reproduced.  To the extent permitted by law, the Guarantor
agrees and stipulates that any such reproduction shall be admissible in evidence
as the original itself in any judicial or administrative  proceeding (whether or
not the original is in existence and whether or not such  reproduction  was made
by them in the regular course of business) and that any  enlargement,  facsimile
or further  reproduction  of such  reproduction  shall likewise be admissible in
evidence.

         SECTION 8.05      Survival

         All  warranties,  representations  and covenants  made by the Guarantor
herein or on any  certificate or other  instrument  delivered by or on behalf of
the Guarantor  under this Agreement shall be considered to have been relied upon
by the  Credit  Obligor  regardless  of any  investigation  made by it or on its
behalf.  All  statements  in any  such  certificate  or other  instrument  shall
constitute warranties and representations by the Guarantor hereunder.

         SECTION 8.06      Successors and Assigns

         The  terms  of this  Agreement  shall  inure to the  benefit  of and be
binding upon the heirs,  executors,  administrators,  successors  and assigns of
each of the parties.

         SECTION 8.07      Effective Date of Agreement

         The obligations of the Guarantor  hereunder shall arise  absolutely and
unconditionally   when  the  Credit  Agreement  shall  have  been  executed  and
delivered.

         SECTION 8.08      Entire Agreement; Counterparts

         This Agreement  constitutes  the entire  agreement,  and supersedes all
prior agreements and understandings,  both written and oral, between the parties
with respect to the subject matter hereof and may be executed  simultaneously in
several  counterparts,  each of which  shall be deemed an  original,  and all of
which together shall constitute one and the same instrument.

         SECTION 8.09      Severability

         The  invalidity  or  unenforceability  of  any  one  or  more  phrases,
sentences,  clauses or sections contained in this Agreement shall not affect the
validity or enforceability of the remaining  portions of this Agreement,  or any
part thereof.

         SECTION 8.10      Date For Identification Purposes Only

         The date of this Agreement is for  identification  purposes only and is
not intended to indicate that this Agreement was executed on such date.

         SECTION 8.11      Exceptions to Covenants

         The Guarantor shall not be deemed to be permitted to take any action or
fail to take  any  action  which  is  permitted  as an  exception  to any of the
covenants  contained herein or which is within the permissible  limits of any of
the covenants  contained  herein if such action or omission  would result in the
breach of any other covenant contained herein.


<PAGE>


         IN WITNESS  WHEREOF,  the  Guarantor  has caused this  Agreement  to be
executed  under  seal in its name and on its  behalf by  officers  thereof  duly
authorized  thereunto  and the Credit  Obligor has  executed  this  Agreement by
causing  its  name  to be  hereunto  subscribed  by one of its  duly  authorized
officers, all as of the day and year first above written.

                           CAVALIER HOMES, INC.



                           By:
                              -----------------------------
                           Its
                              -----------------------------
S E A L


Attest
      --------------------
          Secretary



                           Accepted:

                           FIRST COMMERCIAL BANK



                           By:
                              -----------------------------
                           Its
                              -----------------------------


<PAGE>





                                                      

















                        LIMITED CREDIT GUARANTY AGREEMENT
                          (WoodPerfect of Texas, L.P.)
                           (Revolving Credit Facility)





                               Dated July 15, 1997




                                       by


                              CAVALIER HOMES, INC.




                                   in favor of

                              FIRST COMMERCIAL BANK














<PAGE>





                                                         

                                TABLE OF CONTENTS

                                                                           Page

Parties.....................................................................  1
Recitals....................................................................  1

                  ARTICLE I

                                          Provisions of General Application

         SECTION 1.01  Definitions..........................................  2
         SECTION 1.02  Accounting Principles................................  4
         SECTION 1.03  Action Taken Directly or Indirectly..................  4
         SECTION 1.04  Governing Law........................................  4
         SECTION 1.05  General Provisions of Construction...................  4
         SECTION 1.06  Effect of Headings and Table of Contents.............  4

         ARTICLE II

                                         Guaranty

         SECTION 2.01  Guaranty of Obligations..............................  5
         SECTION 2.02  Character of Obligations Hereunder...................  6

         ARTICLE III

                           Waivers; Termination; No Subrogation

         SECTION 3.01  Waivers..............................................  9
         SECTION 3.02  Termination.......................................... 10
         SECTION 3.03  No Right of Subrogation. ............................ 10

         ARTICLE IV

                                    Business Covenants

         SECTION 4.01  Affirmative Covenants................................ 10
         SECTION 4.02  Information as to Guarantor.......................... 11

         ARTICLE V

                        Representations, Warranties and Agreements

         SECTION 5.01  Financial Condition................................... 12
         SECTION 5.02  Full Disclosure....................................... 12
         SECTION 5.03  Pending Litigation; No Defaults....................... 12
         SECTION 5.04  Title to Properties................................... 13
         SECTION 5.05  No Defaults........................................... 13
         SECTION 5.06  Governmental Consent.................................. 13
         SECTION 5.07  Compliance with Law................................... 13
         SECTION 5.08  Restrictions on Guarantor............................. 13
         SECTION 5.09  Indemnification....................................... 14
         SECTION 5.10  Survival of Representations, Warranties
                       and Covenants......................................... 14

         ARTICLE VI

                              Events of Default and Remedies

         SECTION 6.01  Events of Default..................................... 15
         SECTION 6.02  Remedies.............................................. 16
         SECTION 6.03  Rights and Remedies of Credit Obligor in
                       the Event of Bankruptcy, Etc. of Guarantor............ 17
         SECTION 6.04  Agreement to Pay Attorneys' Fees...................... 17
         SECTION 6.05  Waiver of Past Defaults............................... 17
         SECTION 6.06  No Additional Waiver Implied by One Waiver............ 17
         SECTION 6.07  Remedies Subject to Applicable Law.................... 17

         ARTICLE VII

                                  Subordination Agreement.................... 18

         ARTICLE VIII

                             Provisions of General Application

         SECTION 8.01  Jurisdiction.......................................... 20
         SECTION 8.02  Benefit of the Agreement.............................. 20
         SECTION 8.03  Notices............................................... 20
         SECTION 8.04  Reproduction of Documents............................. 21
         SECTION 8.05  Survival.............................................. 21
         SECTION 8.06  Successors and Assigns................................ 21
         SECTION 8.07  Effective Date of Agreement........................... 21
         SECTION 8.08  Entire Agreement; Counterparts........................ 21
         SECTION 8.09  Severability.......................................... 22
         SECTION 8.10  Date For Identification Purposes Only................. 22
         SECTION 8.11  Exceptions to Covenants............................... 22

Testimonium.................................................................. 23
Signatures................................................................... 23


<PAGE>




                        LIMITED CREDIT GUARANTY AGREEMENT


         THIS  AGREEMENT is executed July 15, 1997, by CAVALIER  HOMES,  INC., a
Delaware  corporation  (the  "Guarantor"),  and FIRST  COMMERCIAL  BANK, a state
banking corporation (the "Credit Obligor"), as lender and secured party.


                                    Recitals

         The Guarantor has an interest in  WoodPerfect  of Texas,  L.P., a Texas
limited partnership (the "Borrower").

         The  Borrower  intends  to  acquire,   construct  and  install  certain
manufacturing facilities in the City of Hillsboro, Texas (the "Project").

         The  Borrower  has  applied  to the Credit  Obligor  for  extension  of
revolving credit  facilities of $2,000,000 to provide  operating capital for the
Project.

         The Credit Obligor has agreed to make such revolving credit  facilities
available  to  the  Borrower,  for  such  purposes,  upon  satisfaction  of  the
conditions precedent thereto set forth herein and that, among other things:

                  (a) the  Borrower  and the  Credit  Obligor  enter  into  that
         certain  Credit  and  Security   Agreement  (the  "Credit   Agreement")
         providing for the extension of such  revolving  credit  facilities  and
         certain security therefor;

                  (b) the Borrower  delivers to the Credit Obligor the Revolving
         Promissory Note provided by the Credit Agreement;

                  (c) the  following  Persons  (as  defined  herein)  having  an
         interest  in the  Borrower  deliver to the Credit  Obligor  the various
         Credit  Guaranty  Agreements  dated July 15,  1997 with  respect to the
         obligations of the Borrower under the Credit Agreement:

                           (i)      Lee Roy Jordan
                           (ii)     Cavalier Homes, Inc.
                           (iii)    Patriot Homes, Inc.
                           (iv)     Schult Operating Company, and Schult Homes 
                                    Corporation
                           (v)      Southern Energy Homes, Inc.

         The  assumption  of the  obligations  of the Guarantor  hereunder  will
result in direct financial benefits to the Guarantor.



<PAGE>


                                    Agreement

         NOW THEREFORE, in consideration of the foregoing Recitals and to induce
the Credit Obligor to enter into the Credit  Agreement and to make available the
said revolving credit  facilities,  the Guarantor hereby covenants and agrees as
follows:


                                    ARTICLE I

                        Provisions of General Application

         SECTION 1.01      Definitions

         For all  purposes  of this  Agreement,  except as  otherwise  expressly
provided or unless the context otherwise requires:

         "Collateral"  shall mean all  properties and interests in properties of
the  Borrower  which secure the Credit  Obligor  Indebtedness  or are  variously
defined,  referenced or described as  "Collateral"  in any of the Credit Obligor
Financing Documents.

         "Credit Agreement" shall have the  meaning  assigned  in  the  recitals
hereto.

         "Credit  Guaranty" shall mean  collectively the Limited Credit Guaranty
Agreements dated as of July 15, 1997 from the Guarantors to the Credit Obligor.

         "Credit Obligor Financing Documents" shall mean collectively the Credit
Agreement,  the  Revolving  Note,  and  the  Credit  Guaranty,  and  any and all
amendments or supplements to any thereof.

         "Credit Obligor  Indebtedness"  shall mean all  indebtedness  and other
amounts at any time to be paid to Credit  Obligor by the Borrower or any Obligor
(as defined in the Credit  Agreement)  or any affiliate of any thereof under the
Credit Obligor Financing Documents.

         "Default"  shall mean an event or  condition  the  occurrence  of which
would,  with or without the lapse of time or the giving of notice or both, be an
Event of Default.

         "Event of Default" shall mean an event as defined in Article VI.

         "Financing Participants"  shall  mean the parties to the Credit Obligor
Financing Documents.

         "Guarantor" means  Cavalier Homes, Inc., and the respective  successors
and assigns thereof.

         "Guarantor  Indebtedness" shall mean all indebtedness and other amounts
at any time to be paid by the  Borrower or any Obligor (as defined in the Credit
Agreement) or any affiliate of any thereof to the Guarantor.

         "Guarantors"   means   collectively  the  following   Persons  and  the
respective heirs, executors, administrators and assigns thereof:

                  (i)     Lee Roy Jordan,
                  (ii)    Cavalier Homes, Inc.,
                  (iii)   Patriot Homes, Inc.,
                  (iv)    Schult Operating Company, and Schult Homes Corporation
                  (v)     Southern Energy Homes, Inc.

         "Lien" shall mean any interest in Property  securing an obligation owed
to, or a claim by, a Person other than the owner of the  Property,  whether such
interest is based on the common law, statute or contract,  and including but not
limited to the security  interest or lien arising from a mortgage,  encumbrance,
pledge,  conditional sale or trust receipt or a lease assignment or bailment for
security  purposes.  For the purposes of this Agreement,  the Guarantor shall be
deemed to be the owner of any  Property  which it has  acquired or holds or hold
subject to a conditional  sale agreement,  financing lease or other  arrangement
pursuant to which title to the Property  has been  retained by or vested in some
other person for security purposes.

         "Material  Adverse  Effect" shall mean any act or circumstance or event
which  (i)  causes an Event of  Default  or  Default,  (ii)  otherwise  might be
material and adverse to the  financial  condition or business  operations of the
Guarantor or (iii) would adversely affect the validity or  enforceability of any
of the Credit  Obligor  Financing  Documents  or any of the papers  executed  in
connection therewith.

         "Maximum Guaranteed Percentage" shall mean twenty-four percent (24%).

         "Person" shall mean and include an individual,  a partnership,  a joint
venture, a corporation,  an association, a trust, an unincorporated organization
and a government or any department, agency or political subdivision thereof.

         "Property"  shall mean any  interest  in any kind of property or asset,
whether real, personal or mixed, or tangible or intangible.

         "Revolving  Note"  shall mean the Master  Promissory  Note  (Revolving)
executed and delivered by the Borrower to the Credit Obligor pursuant to Section
2.02 of the Credit Agreement.

         "Tribunal"  shall  mean  any  state,  commonwealth,  federal,  foreign,
district, territorial, or other court or governmental department, board, bureau,
agency or instrumentality having jurisdiction over Guarantor.

         SECTION 1.02      Accounting Principles

         The  Guarantor  shall  maintain  books and records in  accordance  with
generally  accepted  accounting  principles  ("GAAP"  as  defined  in the Credit
Agreement) consistently applied.

         SECTION 1.03      Action Taken Directly or Indirectly

         Where any provision in this  Agreement  refers to action to be taken by
any Person, or which such Person is prohibited from taking, such provision shall
be  applicable  whether  such  action is taken  directly or  indirectly  by such
Person.

         SECTION 1.04      Governing Law

         This  Agreement  shall be governed by and construed in accordance  with
the laws of the State of Alabama.

         SECTION 1.05      General Provisions of Construction

         (1)  Capitalized  terms used herein without  definition  shall have the
meaning assigned to them in the Indenture or the Credit Agreement.

         (2) Singular  terms shall  include the plural as well as the  singular,
and vice versa.

         (3)  All  references  in  this  instrument  to  designated  "Articles",
"Sections" and other subdivisions are to the designated  Articles,  Sections and
subdivisions of this instrument as originally executed.

         (4) The terms  "herein",  "hereof" and  "hereunder"  and other words of
similar  import  refer to this  Agreement  as a whole and not to any  particular
Article, Section or other subdivision.

         SECTION 1.06      Effect of Headings and Table of Contents

         The Article and  Section  headings  herein and in the Table of Contents
are for convenience only and shall not affect the construction hereof.


                                   ARTICLE II

                                    Guaranty

         SECTION 2.01      Guaranty of Obligations

         (a)  Subject to and limited by the  provisions  of  subsection  2.01(d)
hereof,  the Guarantor  hereby  absolutely  and  unconditionally  guarantees the
punctual payment when due (whether at stated  maturity,  by acceleration or call
for redemption or  otherwise),  in lawful money of the United States of America,
of all of the following (collectively the "Obligations"):

                  (1) all commissions,  fees, charges and costs becoming due and
         payable  under  the  Credit  Agreement  in  accordance  with the  terms
         thereof;

                  (2) all amounts  becoming due and payable  under the Revolving
         Note (including without limitation principal,  interest,  late charges,
         and interest on overdue amounts);

                  (3) all  amounts  becoming  due and  payable  under the Credit
         Agreement and all future advances and amounts  becoming due and payable
         under the Revolving Note;

                  (4) all  late  charges  and  all  interest  on  late  payments
         becoming due and payable  under the Credit  Agreement and the Revolving
         Note;

                  (5) all  amounts  becoming  due and  payable  under the Credit
         Agreement and the Revolving Note upon the occurrence and continuance of
         an event of default under the Credit Agreement;

                  (6) all other amounts becoming due and payable by the Borrower
         under the Credit  Agreement and the Revolving Note;

                  (7) all other indebtedness, obligations (including obligations
         of  performance)  and liabilities of the Borrower to the Credit Obligor
         of every kind and description whatsoever,  direct or indirect, absolute
         or  contingent,  due  or to  become  due,  now  existing  or  hereafter
         incurred, contracted or arising, or acquired by the Credit Obligor from
         any source, joint or several, liquidated or unliquidated, regardless of
         how they arise or by what agreement or instrument they may be evidenced
         or whether they are  evidenced  by any  agreement  or  instrument,  and
         whether incurred as maker,  endorser,  surety,  guarantor or otherwise,
         and any and all  extensions,  restatements,  and renewals of any of the
         same; and

                  (8) all renewals and extensions of any or all the  obligations
         of  the  Borrower   described  in  paragraphs  (1)  through  (7)  above
         (including  without  limitation  any renewal or  extension  of, and any
         substitute  for,  the  Revolving  Note),  whether or not any renewal or
         extension agreement is executed in connection therewith.

         (b)  The  guaranty  set  forth  in  this  Section  is an  absolute  and
irrevocable  guaranty of payment and not of collectibility or performance and is
in no way  conditioned  or  contingent  upon any  attempt  to  collect  from the
Borrower or any other  Person,  or to realize upon any  Property  subject to the
Lien of the Credit Documents,  or upon any other direct or indirect security for
the Bonds or the Obligations, or resort to any other remedies.

         (c) Each default in payment of any amount of the Obligations shall give
rise to a separate  cause of action  hereunder and separate suits may be brought
hereunder as each cause of action arises.

         (d) By acceptance hereof, the Credit Obligor covenants and agrees that,
anything  herein or in the Credit  Obligor  Financing  Documents to the contrary
notwithstanding,  the  obligations of, and recourse  against,  the Guarantor for
payment of any amounts  pursuant to this Agreement shall be limited to and shall
not exceed the Maximum Guaranteed  Percentage of such amounts,  as determined on
the basis of the aggregate amounts described in Section 2.01(a) or otherwise due
hereunder  which are  outstanding at the time demand for payment thereof is made
in  accordance  herewith,  without  regard to or taking into  account any demand
upon,  or  payment or  contribution  by, any other  Financing  Participant  with
respect to such amounts.

         SECTION 2.02      Character of Obligations Hereunder

         (a)  All   obligations  of  the  Guarantor  under  this  Agreement  are
unconditional,   primary,   absolute   and   irrevocable   under   any  and  all
circumstances.  Without limiting the generality of the foregoing, to the fullest
extent  permitted  under  applicable  law,  the  obligations  of  the  Guarantor
hereunder shall not be subject to or impaired by:

                  (i) any  inability or failure on the part of any party thereto
         to perform or comply with the Credit Obligor Financing Documents;

                  (ii) any invalidity or  irregularity in any statutory or other
         proceedings  relating  to  the  formation  or  existence  of any of the
         Financing  Participants,  or to  the  execution  and  delivery  of  any
         Financing Document;

                  (iii)  any   invalidity   or   unenforceability   of,  or  any
         impairment, modification or release of liability of any party under, or
         any  impossibility,  impracticability,  illegality  or  frustration  of
         performance  by any  party  of,  any of the  Credit  Obligor  Financing
         Documents,  for any reason whatsoever,  including,  without limitation,
         any  decision by any court  invalidating  or  otherwise  affecting  the
         obligations of any party under or in connection  with any of the Credit
         Obligor Financing Documents;

                  (iv)  any  inability  or  failure  on the  part  of any of the
         Financing  Participants  to  perform  or comply  with any of the Credit
         Obligor Financing Documents;

                  (v) any invalidity or unenforceability  of, or any impairment,
         modification  or release of liability of the  Guarantor  under,  or any
         impossibility,   impracticability,   illegality   or   frustration   of
         performance by the Guarantor of this Agreement;

                  (vi) the voluntary or  involuntary  liquidation,  dissolution,
         merger,   consolidation,   sale  or   other   disposition   of  all  or
         substantially all of the assets, marshalling of assets and liabilities,
         receivership,  insolvency,  bankruptcy,  assignment  for the benefit of
         creditors,  reorganization,  moratorium, arrangement,  composition with
         creditors  or  readjustment  of debt of, or other  similar  proceedings
         affecting, any of the Financing Participants;

                  (vii) any  waiver,  consent,  extension,  indulgence  or other
         action or inaction in respect of any Financing Document,  including any
         modification,  amendment or  supplement  to any of the  foregoing,  the
         renewal or extension of the Bonds,  the release of any Property subject
         to the Lien of the Credit Agreement or any other similar act;

                  (viii) any right of setoff,  counterclaim  or defense,  or any
         act, omission or breach on the part of the Borrower, the Credit Obligor
         or the Guarantor or any of the other Financing Participants;

                  (ix) any  claim  whatsoever against the Borrower or any of the
         other Financing Participants;

                  (x) any defect in the title,  compliance with  specifications,
         value,  condition,   design,   operation,   merchantability,   quality,
         durability  or  suitability  of,  consequences  of use or misuse of, or
         unfitness for use of, the Project or any part thereof, any abandonment,
         destruction,  noncompletion,  requisition, condemnation, foreclosure of
         or damage to the  Project  or any part  thereof,  or any event of force
         majeure relating to the Project or any part thereof;

                  (xi) any breach of any  representation or warranty relating to
         the Project;

                  (xii)  any  release,  extinguishment  or  satisfaction  of the
         Borrower's obligations to make payments of Obligations until there have
         been paid to the Credit Obligor in lawful currency of the United States
         an amount  sufficient  to pay all  Obligations  (including  interest on
         overdue amounts of Obligations  including,  to the extent  permitted by
         applicable  law,  interest)  that  would have been due and owing to the
         Credit Obligor by the Borrower had the Borrower's  obligations not been
         so released, extinguished or satisfied;

                  (xiii) the  failure  to give  notice to the  Guarantor  of the
         occurrence of any default or event of default under the Credit  Obligor
         Financing Documents;

                  (xiv) the  compromise,  settlement,  release or termination of
         any or all of the  obligations,  covenants or  agreements of any of the
         parties  to any of the Credit  Obligor  Financing  Documents  under the
         Credit Obligor Financing Documents;

                  (xv) any  assignment,  pledge or  mortgage  of all or any part
         of the  interest of any of the Financing Participants in the Project or
         the Collateral;

                  (xvi) any waiver of the payment,  performance or observance by
         any of the  Financing  Participants  of any  obligation,  agreement  or
         covenant  of any of them  contained  in the  Credit  Obligor  Financing
         Documents;

                  (xvii) the  extension of the time for payment of any amount of
         the  Obligations or any part thereof or of the time for  performance of
         any other obligations,  agreements or covenants of any of the Financing
         Participants under the Credit Obligor Financing Documents;

                  (xviii) the  modification  or amendment  (whether  material or
         otherwise) of any  obligation,  agreement or covenant  contained in the
         Credit Obligor Financing Documents;

                  (xix) any  failure,  omission,  or delay on the part of any of
         the Financing  Participants  to enforce,  assert or exercise any right,
         power  or  remedy  conferred  upon  any of them by the  Credit  Obligor
         Financing Documents;

                  (xx) the bankruptcy, insolvency,  reorganization,  appointment
         of a receiver for, or dissolution of any of the Financing Participants,
         or the entering by any or all of them into an agreement of  composition
         with  creditors,  or the making by any or all of them of an  assignment
         for the benefit of creditors;

                  (xxi) any rights of set-off, recoupment, counterclaim or other
         defense,  whether  similar or  dissimilar to the  foregoing,  which the
         Guarantor   might   otherwise   have  against  any  of  the   Financing
         Participants or any other person;

                  (xxii)  the  default  or  failure  of any  one or  more of the
         Financing  Participants  to perform fully any  obligation,  covenant or
         agreement contained in the Credit Obligor Financing Documents;

                  (xxiii)  the  release or  discharge  of any one or more of the
         Financing  Participants  by  operation  of law, to the extent that such
         release or discharge may be lawfully  avoided,  from the performance or
         observance of any agreement or covenant contained in the Credit Obligor
         Financing Documents;

                  (xxiv)  the  invalidity  or  unenforceability  of  the  Credit
         Obligor Financing Documents or of any provision of such instruments; or

                   (xxv) any other  matter  that  might  otherwise  be raised in
         avoidance  of,  or  in  defense  against,  an  action  to  enforce  the
         obligations of the Guarantor under this Agreement.

         (b) The Guarantor  acknowledges that this Agreement is executed for the
benefit of the Credit  Obligor and that the Credit  Agreement  and the Letter of
Credit will be executed and delivered in reliance on this  Agreement.  No act of
commission or omission of any kind at any time on the part of the Credit Obligor
in respect of any matter whatsoever shall in any way affect or impair any right,
power or benefit of the Credit  Obligor under this  Agreement and, to the extent
permitted by  applicable  law, no setoff,  claim,  reduction,  diminution of any
obligation,  or any defense of any kind or nature which the  Guarantor  may have
against the Credit Obligor shall be available  against the Credit Obligor in any
suit or action  brought by the Credit  Obligor  to enforce  any right,  power or
benefit under this Agreement.


                                   ARTICLE III

                      Waivers; Termination; No Subrogation

         SECTION 3.01      Waivers

         (a) The Guarantor  hereby waives all of the following and all defenses,
counterclaims,  or offsets which the Guarantor may have by reason  thereof:  (1)
notice of acceptance  hereof,  notice of any action taken or omitted in reliance
hereon,  notice of any defaults by the Borrower in the payment of any such sums,
and  notice  of the  creation,  renewal,  or  accrual  of any  liability  of the
Borrower,  (2) any presentment,  demand,  notice or protest of any kind, (3) any
right  (i) to have  joined  any of the  other  Financing  Participants  with the
Guarantor in any suit brought against the Guarantor on this  Agreement,  (ii) to
require  the Credit  Obligor to  forthwith  bring suit  against any of the other
Financing Participants,  and (iii) to require that the Credit Obligor obtain any
judgment against any of the other Financing  Participants in connection with the
enforcement of any rights against the Guarantor hereunder, and (4) any other act
or thing  (including  without  limitation  alteration of the Bonds or the Credit
Obligor Financing Documents or debt evidenced thereby or security therefor),  or
omission or delay to do any other act or thing which may, by operation of law or
otherwise,  in any manner or to any  extent  vary the risk of the  Guarantor  or
which might otherwise operate as a discharge of the Guarantor.

         (b)  The  Guarantor  hereby  waives,  as to  the  enforcement  of  this
Agreement,  (1) all rights of exemption  that the  Guarantor  may have under the
constitution  and laws of any state as to any levy on and sale of  property  and
(2)   presentation  and  demand  for  payment  (or  protest  of  nonpayment)  of
Obligations or any part thereof.

         SECTION 3.02      Termination

         (a) The  guaranties  set forth in this  Agreement  shall remain in full
force and effect without  reference to future changes in conditions,  including,
to the extent  permitted by  applicable  law,  changes in law,  until the Credit
Obligor shall have been indefeasibly paid in full any and all sums due under the
terms  and  provisions  of the  Obligations  and the  Credit  Obligor  Financing
Documents,  and until such sums are not subject to rescission or repayment  upon
any   bankruptcy,   insolvency,   arrangement,    reorganization,    moratorium,
receivership  or similar  proceeding  affecting the Issuer,  the  Borrower,  the
Guarantor, or any of the other Financing Participants.

         (b) In the event any payment on the  Obligations  (whether such payment
is remitted by the Issuer, the Borrower, any Guarantor or any other person, from
realization on collateral,  through setoff or otherwise) must be refunded,  paid
over or  otherwise  released by the Credit  Obligor as a result of such  payment
being (1) a preference or fraudulent transfer under the Bankruptcy Code of 1978,
as amended,  or other state or federal law or (2)  disallowed as a permanent and
irrevocable  payment on the Obligations for any other reason,  then in each such
event this Agreement shall  thereupon,  ipso facto, be reinstated and revived to
the full extent of such refunded, paid over or released payment.

         SECTION 3.03      No Right of Subrogation. 

         The  Guarantor  will not exercise any rights of  subrogation  which the
Guarantor may have unless and until this Agreement shall have been terminated as
provided in Section 3.02.  If any payment is made to the Guarantor  with respect
to any payments due by the Guarantor  under this  Agreement at any time prior to
such  termination  of this  Agreement,  he will be paid  forthwith to the Credit
Obligor to be applied to installments due or coming due under the Obligations in
the  order  and  the  manner  provided  in the  Credit  Agreement  or  otherwise
determined by the Credit Obligor.


                                   ARTICLE IV

                               Business Covenants

         SECTION 4.01      Affirmative Covenants

         The Guarantor covenants that  so long  as  this Agreement is in effect,
 the Guarantor shall

         (a) Payment of Indebtedness,  Taxes,  etc. (i) Pay all indebtedness and
obligations of the Guarantor  promptly and in accordance with normal terms where
failure to pay would have a Material Adverse Effect,  and (ii) pay and discharge
or  cause  to  be  paid  or  discharged  promptly  all  taxes,  assessments  and
governmental charges or levies imposed upon the Guarantor or upon his income and
profits, or upon any of his Property,  real, personal or mixed, or upon any part
thereof,  before the same shall become in default,  as well as all lawful claims
for labor, materials and supplies or otherwise, which, if unpaid, might become a
lien upon such  properties or any part thereof where failure to pay would have a
Material  Adverse  Effect;  provided,  however,  that the Guarantor shall not be
required to pay and discharge any such tax, assessment, charge, levy or claim so
long as the validity  thereof  shall be  contested in good faith by  appropriate
proceedings.

         (b) Accounts, Financial Information. The Guarantor will maintain proper
books of record and account,  in which full and correct entries will be made, in
accordance with generally accepted  accounting  principles,  of all business and
affairs of the Guarantor. The Guarantor shall furnish to the Credit Obligor with
reasonable  promptness (1) annual financial statements of the Guarantor prepared
and  audited by  certified  public  accountants  in  accordance  with  generally
accepted  accounting  principles,  and (2) such other information  regarding the
operations,  business  affairs and  financial  condition of the Guarantor as the
Credit Obligor may reasonably request.

         (c) Legal Existence. The Guarantor will maintain and preserve its legal
existence  and will not  voluntarily  dissolve  without  first  discharging  its
obligations under this Agreement.

         (d)  Further  Assurances.  On request of the Credit  Obligor,  promptly
correct any  defect,  error or omission  which may be  discovered  in any of the
Credit  Obligor  Financing  Documents  or in the  contents  of any of the papers
executed in connection therewith or in the execution or acknowledgement thereof,
and  execute,  acknowledge  and deliver  such  further  instruments  and do such
further acts as may be necessary or as may be requested by the Credit Obligor to
carry out more effectively the purposes of this Agreement and the Credit Obligor
Financing Documents.

         SECTION 4.02      Information as to Guarantor

         Financial and Business Information.  The Guarantor shall deliver to the
         Credit Obligor:

                  (a) Notice of Default or Event of  Default.  Immediately  upon
         becoming  aware  of the  existence  of any  condition  or  event  which
         constitutes  a  default  or an event of  default  under  any  Financing
         Document,  a  written  notice  specifying  the  nature  and  period  of
         existence  thereof and what action the  Guarantor is taking or proposes
         to take with respect thereto;

                  (b) Notice of Claimed Default. Immediately upon becoming aware
         that the holder of any  evidence  of  indebtedness  or  security of the
         Guarantor  has given notice or taken any other action with respect to a
         claimed  default or event of default  thereunder  which  would  cause a
         default or event of default which would have a Material Adverse Effect,
         a written  notice  specifying  the notice given or action taken by such
         holder and the nature of the  claimed  default or event of default  and
         what action the  Guarantor  are taking or proposes to take with respect
         thereto;

                  (c) Requested  Information.  With reasonable  promptness, such
         data and information as from time to time may be reasonably requested;

                  (d) Notice of Litigation.  Immediately  upon becoming aware of
         the  existence of any  proceedings  before any Tribunal  involving  the
         Guarantor  which  involves  the  probability  of any final  judgment or
         liability  against  such  Guarantor  in an amount  which  would  have a
         Material Adverse Effect, a written notice specifying the nature thereof
         and what  action  such  Guarantor  is taking and  proposes to take with
         respect thereto; and

                  (e) Notice from  Regulatory  Agencies.  Promptly  upon receipt
         thereof, information with respect to and copies of any notices received
         from federal or state regulatory  agencies or any Tribunal  relating to
         an order, ruling,  statute or other law or information which might have
         a Material  Adverse Effect on the  franchises,  permits,  licenses,  or
         rights, or the condition, financial or otherwise, of the Guarantor.


                                    ARTICLE V

                   Representations, Warranties and Agreements

         The Guarantor represents, warrants and agrees that:

         SECTION 5.01      Financial Condition

         Since the date of  application  to the Credit Obligor for the Revolving
Note,  (i)  there  has  been no  change  in the  business,  prospects,  profits,
Properties  or condition  (financial  or  otherwise)  of the  Guarantor,  except
changes in the ordinary course of business, none of which individually or in the
aggregate has a Material Adverse Effect, (ii) the Guarantor has not incurred any
material  liability which has a Material Adverse Effect,  and (iii) there exists
no  default  under  the  provisions  of  any  instrument   evidencing  any  such
liabilities or under any agreement  relating thereto which would have a Material
Adverse Effect.

         SECTION 5.02      Full Disclosure

         No written  statement  furnished by the Guarantor to the Credit Obligor
contains any untrue  statement  of a material  fact or omits to state a material
fact  necessary  to  make  the  statements   contained  therein  or  herein  not
misleading. There is no fact which the Guarantor has not disclosed to the Credit
Obligor  in  writing  which  has a  Material  Adverse  Effect  or, so far as the
Guarantor can now foresee, will have a Material Adverse Effect.

         SECTION 5.03      Pending Litigation; No Defaults

         There  are  no  proceedings  pending,  or,  to  the  knowledge  of  the
Guarantor, threatened, against or affecting the Guarantor in any court or before
any  governmental  authority or arbitration  board or Tribunal which involve the
possibility  of a Material  Adverse  Effect or the ability of the  Guarantor  to
perform  this  Agreement.  The  Guarantor  is not in default with respect to any
order of any court, governmental authority,  arbitration board or Tribunal which
would have a Material Adverse Effect.

         SECTION 5.04      Title to Properties

         The Guarantor has good and marketable title to the Properties thereof.

         SECTION 5.05      No Defaults

         No event has  occurred  and no  conditions  exist which  would,  in any
material  respect,  upon the issuance of the Letter of Credit,  constitute (i) a
default under any note or other evidence of  indebtedness or under any agreement
of the  Guarantor  if the effect of such default  would have a Material  Adverse
Effect or (ii) a default or event of default under the Credit Obligor  Financing
Documents or any of them,  and the Guarantor is not in violation in any material
respect of any term of any agreement or other  instrument to which the Guarantor
is a party or by which the  Guarantor  may be bound  that  would have a Material
Adverse Effect.

         SECTION 5.06      Governmental Consent

         No consent,  approval or authorization  of, or filing,  registration or
qualification  with, any governmental  authority on the part of the Guarantor is
required in connection  with the  execution  and delivery of the Credit  Obligor
Financing Documents to which the Guarantor is a party.

         SECTION 5.07      Compliance with Law

         The Guarantor:

                  (a) is not in violation of any laws, ordinances,  governmental
         rules or  regulations  to which Guarantor is subject, or

                  (b) has not failed to obtain any licenses, permits, franchises
         or other governmental  authorizations necessary to the ownership of the
         Property,  or  to  the  conduct  of  the  business, of Guarantor, which
         violation or failure to obtain would have a Material Adverse Effect.

         SECTION 5.08      Restrictions on Guarantor

         The  Guarantor  is not a  party  to any  contract  or  agreement  which
requires  consent of any creditor of the Guarantor other than the Credit Obligor
or other party thereto to the right or ability of the Guarantor to incur debt or
guarantee indebtedness hereunder.

         SECTION 5.09      Indemnification

         (a) The Guarantor  will  indemnify and hold harmless the Credit Obligor
and each Person,  if any, who controls the Credit  Obligor within the meaning of
Section 15 of the  Securities  Act of 1933, as amended,  (the Credit Obligor and
any such person being in this Section  collectively  called a "Holder")  against
any and all  losses,  claims,  damages or  liabilities,  joint and  several,  or
actions in respect  thereof,  to which any Holder may become  subject  under any
statute or common law or otherwise,  insofar as such losses,  claims, damages or
liabilities,  or actions in respect thereof,  arise out of or are based upon any
untrue  statement or alleged  untrue  statement of a material fact  contained in
this Agreement,  including the financial  statements  referred to herein, or any
omission or alleged  omission to state herein a material fact necessary in order
to make the statements herein not misleading;  and will reimburse any Holder for
all legal or other  expenses  reasonably  incurred by such Holder in  connection
with defending any such action or claim.

         (b) If any such action or claim  shall be brought or  asserted  against
any Holder and in respect of which  indemnity may be sought from the  Guarantor,
such Holder shall  promptly  notify the  Guarantor in writing and the  Guarantor
shall assume the defense  thereof,  including the  employment of counsel and the
payment  of all  expenses.  Any Holder  shall have the right to employ  separate
counsel in any such action and participate in the defense thereof,  but the fees
and expenses of such counsel  shall be at the expense of such Holder  unless (a)
the  employment  thereof  at the  expense  of  Guarantor  has been  specifically
authorized by the Guarantor in writing,  (b) the Guarantor have failed to assume
the defense and to employ  counsel,  or (c) the named parties to any such action
(including  any impleaded  parties)  include both such Holder and the Guarantor,
and such Holder shall have been advised by such counsel that there may be one or
more legal  defenses  available to it which are different  from or additional to
those  available to the Guarantor  (in which case,  if such Holder  notifies the
Guarantor in writing that it elects to employ separate counsel at the Guarantor'
expense,  the  Guarantor  shall not have the right to assume the defense of such
action  on  behalf  of such  Holder,  it  being  understood,  however,  that the
Guarantor  shall not, in  connection  with any one such  action or separate  but
substantially similar or related actions in the same jurisdiction arising out of
the same general allegations or circumstances, be liable for the reasonable fees
and expenses of more than one separate  firm of attorneys  for all such Holders,
which firm shall be designated in writing by such  Holders).  Each Holder,  as a
condition of such  indemnity,  shall use its best efforts to cooperate  with the
Guarantor in the defense of any such action or claim. The Guarantor shall not be
liable for any  settlement  of any such action  effected  without  their written
consent,  but if settled with the written consent of the Guarantor,  or if there
be a final judgment for the plaintiff in any such action,  the Guarantor  agrees
to  indemnify  and hold  harmless  any such  Holder from and against any loss or
liability by reason of such settlement or judgment.

         SECTION 5.10      Survival of Representations, Warranties and Covenants

         The   representations,   warranties  and  covenants  of  the  Guarantor
contained in this Agreement,  and any other  document,  instrument and agreement
referred to or  contemplated by this  Agreement,  shall remain  operative and in
full force and effect regardless of (i) any  investigation  made by or on behalf
of the  Borrower,  any  Holder or any other  Person,  or (ii)  delivery  of, and
payment for, the Obligations.


                                   ARTICLE VI

                         Events of Default and Remedies

         SECTION 6.01      Events of Default

         An "Event of Default"  shall exist under this  Agreement  if any of the
following  occurs  and is  continuing  (whatever  the  reason for such event and
whether it shall be voluntary or  involuntary or be effected by operation of law
or pursuant to any judgment,  decree or order of any court or any order, rule or
regulation of any administrative or governmental body):

                  (a) Particular  Covenant  Defaults.  The Guarantor  fails  to 
         perform or observe any covenant or agreement contained in Section  2.01
         for a period of five  Business  Days after  notification  by the Credit
         Obligor of such failure;

                  (b) Other  Defaults.  The  Guarantor  fails to comply with any
         other  provision of this  Agreement,  and such failure  continues for a
         period of thirty days after written  notification by the Credit Obligor
         of such failure;

                  (c)    Warranties    or    Representations.    Any   warranty,
         representation  or other  statement  by or on behalf  of the  Guarantor
         contained  in  this  Agreement,  or  in  any  instrument  furnished  in
         compliance  with  or in  reference  to  this  Agreement,  is  false  or
         misleading  in any material  respect and action which  eliminates  such
         falsity or misleading character is not completed for a period of thirty
         days after written  notification by the Credit Obligor of such false or
         misleading statement;

                  (d) Default on Other Indebtedness. Default by the Guarantor in
         any payment of any  obligation for money received as an advance (or any
         obligation   under  any  conditional  sale  or  other  title  retention
         agreement  or any  obligation  issued  or  assumed  as full or  partial
         payment for property  whether or not secured by purchase  money lien or
         any  obligation  under notes  payable or drafts  accepted  representing
         extensions  of credit)  beyond any grace period  provided  with respect
         thereto, or default in the performance of any other agreement,  term or
         condition  contained in any  agreement  under which such  obligation is
         created  (or any other  default  under any such  agreement  which shall
         occur  and be  continuing  beyond  any  period of grace  provided  with
         respect  thereto),  if the effect of such default would have a Material
         Adverse  Effect,  and such default shall remain uncured for a period of
         ten days after the Guarantor has notice thereof;

                  (e) Involuntary Bankruptcy Proceedings. A receiver, liquidator
         or trustee of the Guarantor, or of any of his Property, is appointed by
         court order and such order  remains in effect for more than sixty days,
         or an order or decree for relief in an involuntary  bankruptcy  case is
         entered  with  respect  to the  Guarantor,  or any of his  Property  is
         sequestered  by court  order and such order  remains in effect for more
         than sixty days, or a petition is filed against the Guarantor under any
         bankruptcy,  reorganization,  arrangement,  insolvency, readjustment of
         debt,  dissolution or liquidation law of any jurisdiction,  whether now
         or hereafter in effect,  and is not  dismissed  within sixty days after
         such filing;

                  (f) Voluntary  Petitions.  The  Guarantor  files a petition in
         voluntary  bankruptcy  or seeking  relief  under any  provision  of any
         bankruptcy,  reorganization,  arrangement,  insolvency, readjustment of
         debt,  dissolution or liquidation law of any jurisdiction,  whether now
         or  hereafter  in effect,  or  consents  to the filing of any  petition
         against him under any such law;

                  (g) General  Assignment  for Benefit of  Creditors,  etc.  The
         Guarantor makes a general  assignment for the benefit of his creditors,
         or is unable to pay his debts generally as they become due, or consents
         to  the  appointment  of a  receiver,  trustee  or  liquidator  of  the
         Guarantor, or of all or any part of his Property;

                  (h) Undischarged  Final Judgments or Settlements.  One or more
         final  judgments  shall  be  entered  against  the  Guarantor,  or  the
         Guarantor  shall  enter  into  settlement  of  any  litigation,   which
         judgments  and  settlements  are not  covered by  insurance,  and which
         judgments and  settlements  will have a Material  Adverse Effect on the
         Guarantor; or

                  (i) Other  Defaults.  The  occurrence  of an event of  default
         under any of the  other  Credit  Obligor  Financing  Documents  and the
         expiration of the applicable grace period, if any, specified therein.

         SECTION 6.02      Remedies

         If an Event of  Default  exists,  the  Credit  Obligor  may  proceed to
protect  its  rights  by suit in  equity,  action  at law or  other  appropriate
proceedings,  whether for the specific  performance of any covenant or agreement
of the  Guarantor  herein  contained  or in aid of the  exercise of any power or
remedy  granted  to the Credit  Obligor  under any of the other  Credit  Obligor
Financing  Documents.  The Credit  Obligor  may  proceed  directly  against  the
Guarantor  hereunder  without  resorting to any other remedies which it may have
and without proceeding against any other security held by the Credit Obligor.

         SECTION 6.03    Rights  and Remedies of Credit Obligor in the Event of 
         Bankruptcy, Etc. of Guarantor

         In case of the pendency of any receivership,  insolvency,  liquidation,
bankruptcy,   reorganization,   arrangement,   composition   or  other  judicial
proceeding, or any general assignment for the benefit of creditors,  relative to
the  Guarantor,  the Credit  Obligor  (irrespective  of whether there has been a
default  under  this  Agreement  or any of the other  Credit  Obligor  Financing
Documents) shall be entitled and empowered to intervene in such proceedings,  to
file and prove a claim or claims  for the whole  amount  owing and unpaid and to
file such other papers or documents as may be necessary or advisable in order to
have the  claims of the  Credit  Obligor  (including  any  claim for  reasonable
compensation to the Credit Obligor,  its agents,  attorneys and counsel, and for
reimbursement  of all  expenses and  liabilities  reasonably  incurred,  and all
advances made, by the Credit Obligor except as a result of its negligence or bad
faith) allowed in such judicial  proceedings,  to collect and receive any moneys
or other property  payable or  deliverable on any such claims,  and to take such
other action  therein as the Credit Obligor may deem necessary or appropriate to
protect its interests.

         SECTION 6.04      Agreement to Pay Attorneys' Fees

         In the event the Guarantor  should  default under any of the provisions
of this Agreement and the Credit Obligor should employ  attorneys or incur other
expenses for the collection of any payments due hereunder or the  enforcement of
performance  or  observance  of any  agreement  or  covenant  on the part of the
Guarantor  herein  contained,  the Guarantor will on demand  therefor pay to the
Credit Obligor the reasonable  fees of such attorneys and such other  reasonable
expenses so incurred.

         SECTION 6.05      Waiver of Past Defaults

         The  Credit  Obligor  may  waive  any past  default  hereunder  and its
consequences.  Upon any such waiver,  such default shall cease to exist, and any
Event of Default arising  therefrom shall be deemed to have been cured for every
purpose of this  Agreement but no such waiver shall extend to any  subsequent or
other default or impair any right consequent thereon.

         SECTION 6.06      No Additional Waiver Implied by One Waiver

         If any agreement  contained in this Agreement should be breached by the
Guarantor  and  thereafter  waived by the Credit  Obligor,  such waiver shall be
limited to the particular  breach so waived and shall not be deemed to waive any
other breach hereunder.

         SECTION 6.07      Remedies Subject to Applicable Law

         All  rights,  remedies  and  powers  provided  by this  Article  may be
exercised  only  to the  extent  the  exercise  thereof  does  not  violate  any
applicable  provision of law in the  premises,  and all the  provisions  of this
Article are intended to be subject to all applicable mandatory provisions of law
which  may be  controlling  in the  premises  and to be  limited  to the  extent
necessary so that they will not render this Agreement invalid or unenforceable.


                                   ARTICLE VII

                             Subordination Agreement

         The Guarantor does hereby covenant and agree:

                  (a) That payment of the  Guarantor  Indebtedness  when due and
         payable in each  month  shall be and  hereby is fully  subordinated  in
         priority to the prior payment to Credit  Obligor of the Credit  Obligor
         Indebtedness  when due and  payable in each month,  provided,  however,
         that so long as no event of default  exists  under the  Credit  Obligor
         Financing  Documents the Guarantor may receive payment of the Guarantor
         Indebtedness  when due and  payable  (but not in advance of  originally
         scheduled due dates).

                  (b)  That  anything  in  any  other  contract,   agreement  or
         instrument to the contrary  notwithstanding,  (a) all right,  title and
         interest of the Guarantor in and to the Collateral  shall be and hereby
         are fully  subordinated in priority to the right, title and interest of
         Credit  Obligor  in and to the  Collateral  as  provided  in the Credit
         Obligor  Financing  Documents without regard to the respective dates on
         which  any of such  interests  were  created  and (b) that the claim of
         Credit Obligor upon all the Collateral shall be and hereby is prior and
         superior for all purposes to that of the Guarantor therein.

                  (c) Upon the  occurrence  of a default  under any agreement or
         document   evidencing,   providing   for,  or  securing  the  Guarantor
         Indebtedness  or if  the  Guarantor  Indebtedness  shall  become  or be
         declared immediately due and payable, then an event of default shall be
         deemed  to  have  simultaneously  occurred  under  the  Credit  Obligor
         Indebtedness  and the Credit Obligor  Financing  Documents and the same
         shall also become  immediately  due and  payable,  notwithstanding  any
         inconsistent terms in any document or instrument relating to any of the
         foregoing.  The Guarantor shall not,  without the prior written consent
         of  Credit  Obligor,  accelerate  the  maturity  of, or  institute  any
         proceedings to enforce, any of the Guarantor Indebtedness.

                  (d)  Upon  the  occurrence  and  continuation  of an  event of
         default under any agreement or document  evidencing,  providing for, or
         securing the Guarantor  Indebtedness  or the Credit  Obligor  Financing
         Indebtedness,  Credit  Obligor  shall  first be entitled to receive all
         proceeds and revenues from the  Collateral  when and as the same become
         available,  in payment in full of all Credit Obligor Indebtedness prior
         to any of such proceeds or revenues being distributed to the Guarantor.
         If, before the conditions for defeasance and  termination of the Credit
         Obligor  Financing  Documents  shall have been  satisfied in full,  the
         Guarantor  should  receive any payment or amount in  violation  of this
         Agreement,  or in the event  that any  payment or  distribution  of any
         assets  of the  Borrower  of any kind or  character  (whether  in cash,
         property  or  securities),  shall  be  received  by  the  Guarantor  in
         violation of this Agreement, such payment, amount or distribution shall
         be held in trust for the benefit of, and shall be paid over upon demand
         to, Credit Obligor or its representative for application to the payment
         of the Credit Obligor  Indebtedness  until the Credit Obligor Financing
         Documents shall have been defeased and terminated as provided therein.

                  (e) Upon any payment or  distribution  of any of the assets of
         the Borrower of any kind or character upon any dissolution, winding up,
         total  or  partial  liquidation,  or  reorganization  of the  Borrower,
         whether   in   voluntary   or   involuntary   bankruptcy,   insolvency,
         reorganization  or  receivership  proceedings or upon an assignment for
         the  benefit  of  creditors  or any other  marshalling  of  assets  and
         liabilities of the Borrower or otherwise,  or upon the  acceleration or
         maturity  of the  Credit  Obligor  Indebtedness  and/or  the  Guarantor
         Indebtedness: (a) Credit Obligor shall first be entitled to receive all
         such  assets in  payment  in full of the  Credit  Obligor  Indebtedness
         before the  Guarantor is entitled to receive any amount of such assets;
         and  (b)  any  payment  or  distribution  of any of the  assets  of the
         Borrower  of any  kind or  character  (whether  in  cash,  property  or
         securities)  to which the  Guarantor  would be entitled  except for the
         provisions of this  Agreement  shall be paid or delivered by the person
         making such payment or  distribution,  whether a trustee in bankruptcy,
         receiver,  liquidating trustee, other custodian, agent or other person,
         directly  to  Credit  Obligor  or its  representative,  to  the  extent
         necessary  to pay in full all  indebtedness  owed  thereto,  before any
         payment or distribution of such assets is made to the Guarantor.

                  (f) No right of Credit  Obligor to enforce  the  subordination
         provided  herein  shall  at any  time  or in any way be  prejudiced  or
         impaired  by (a)  any  act or  failure  to act on the  part  of  Credit
         Obligor,  or (b) any  noncompliance by Credit Obligor with the terms of
         any documents or  instruments  executed in  connection  with the Credit
         Obligor Financing  Documents  (regardless of any knowledge thereof that
         Credit Obligor may have or be charged  with),  or (c) any action Credit
         Obligor  may take or refrain  from  taking  with  respect to the Credit
         Obligor  Indebtedness  or  any  security  therefor,  including  without
         limitation  any  modification  of  the  terms  of  the  Credit  Obligor
         Financing  Documents  or the  granting or  effecting  of any release or
         settlement  with  respect to the  Credit  Obligor  Indebtedness  or any
         security therefor. Any waiver by Credit Obligor of any breach hereof by
         the  Guarantor or any  indulgence  by Credit  Obligor to the  Guarantor
         shall apply only to the separate  occasion thereof and shall not affect
         the continuing obligation of the Guarantor hereunder.

                  (g) The  Guarantor  hereby  agrees to execute  and  deliver to
         Credit  Obligor  at its  request  such  other,  further  or  additional
         agreements,  requests,  demands,  notices,  powers of attorney or other
         writings as, in the sole discretion or opinion of Credit  Obligor,  may
         be necessary or convenient in order to carry out the intent and purpose
         hereof, or to effectuate this Agreement.


                                  ARTICLE VIII

                        Provisions of General Application

         SECTION 8.01      Jurisdiction

         The  Guarantor  irrevocably  (a) agrees that any suit,  action or other
legal  proceeding  arising out of this Agreement may be brought in the courts of
record of the State of Alabama or the courts of the United States located in the
State of Alabama;  (b)  consents to the  jurisdiction  of each such court in any
such  suit,  action  or  proceeding,  and (c)  waives  any  objection  which the
Guarantor  may have to trial by jury or to the laying of venue of any such suit,
action or proceeding in any of such courts.

         SECTION 8.02      Benefit of the Agreement

         This  Agreement is entered into by the Guarantor for the benefit of the
Credit Obligor.  The Guarantor agrees to pay all reasonable and necessary costs,
expenses  and fees,  including  all  reasonable  attorneys'  fees,  which may be
incurred  by the Credit  Obligor in  enforcing  or  attempting  to enforce  this
Agreement pursuant to the provisions hereof,  whether the same shall be enforced
by suit or otherwise.

         SECTION 8.03      Notices

         (a) Any request, demand, authorization,  direction, notice, consent, or
other document provided or permitted by this Agreement to be made upon, given or
furnished  to, or filed  with,  the  Guarantor  or the Credit  Obligor  shall be
sufficient  for every  purpose  hereunder if in writing and (except as otherwise
provided in this Agreement) either (i) delivered  personally to the party or, if
such party is not an individual, to an officer, or other legal representative of
the party to whom the same is directed  (provided  that any  document  delivered
personally  to the Credit  Obligor  must be delivered  at its  Principal  Office
during normal business hours) at the addresses  specified  below, or (ii) mailed
by first-class,  registered or certified mail,  postage prepaid to the addresses
specified below;  provided either party may change the address for receiving any
such  notice or  document  by giving  notice of the change to the other party as
provided in this Section:

                  c/o Cavalier Homes, Inc.
                  Highway 41 North Cavalier Road
                  Addison, Alabama  35540

                  First Commercial Bank
                  2000 SouthBridge Parkway
                  Birmingham, Alabama  35209

                  Attn: Commercial Lending

         (b) Any such notice or other  document  shall be deemed  delivered when
actually  received  by the party to whom  directed  (or, if such party is not an
individual,  to an officer,  or other legal  representative of the party) at the
address  specified  pursuant to this Section,  or, if sent by mail, 3 days after
such notice or document is deposited in the United States mail,  proper  postage
prepaid, addressed as provided above.

         SECTION 8.04      Reproduction of Documents

         The  Guarantor  hereby  agrees  that  any  Financing  Document  and all
documents  relating thereto,  including,  without  limitation,  (a) supplements,
consents,  waivers  and  modifications  which may  hereafter  be  executed,  (b)
documents  received by the Credit  Obligor at any closing of any purchase of the
Bonds  and  (c)  financial   statements,   certificates  and  other  information
previously or hereafter  furnished to the Credit  Obligor,  may be reproduced by
the  Credit  Obligor by any  photographic,  photostatic,  microfilm,  microcard,
miniature  photographic  or other  similar  process  and they  may  destroy  any
original  document so reproduced.  To the extent permitted by law, the Guarantor
agrees and stipulates that any such reproduction shall be admissible in evidence
as the original itself in any judicial or administrative  proceeding (whether or
not the original is in existence and whether or not such  reproduction  was made
by them in the regular course of business) and that any  enlargement,  facsimile
or further  reproduction  of such  reproduction  shall likewise be admissible in
evidence.

         SECTION 8.05      Survival

         All  warranties,  representations  and covenants  made by the Guarantor
herein or on any  certificate or other  instrument  delivered by or on behalf of
the Guarantor  under this Agreement shall be considered to have been relied upon
by the  Credit  Obligor  regardless  of any  investigation  made by it or on its
behalf.  All  statements  in any  such  certificate  or other  instrument  shall
constitute warranties and representations by the Guarantor hereunder.

         SECTION 8.06      Successors and Assigns

         The  terms  of this  Agreement  shall  inure to the  benefit  of and be
binding upon the heirs,  executors,  administrators,  successors  and assigns of
each of the parties.

         SECTION 8.07      Effective Date of Agreement

         The obligations of the Guarantor  hereunder shall arise  absolutely and
unconditionally   when  the  Credit  Agreement  shall  have  been  executed  and
delivered.

         SECTION 8.08      Entire Agreement; Counterparts

         This Agreement  constitutes  the entire  agreement,  and supersedes all
prior agreements and understandings,  both written and oral, between the parties
with respect to the subject matter hereof and may be executed  simultaneously in
several  counterparts,  each of which  shall be deemed an  original,  and all of
which together shall constitute one and the same instrument.

         SECTION 8.09      Severability

         The  invalidity  or  unenforceability  of  any  one  or  more  phrases,
sentences,  clauses or sections contained in this Agreement shall not affect the
validity or enforceability of the remaining  portions of this Agreement,  or any
part thereof.

         SECTION 8.10      Date For Identification Purposes Only

         The date of this Agreement is for  identification  purposes only and is
not intended to indicate that this Agreement was executed on such date.

         SECTION 8.11      Exceptions to Covenants

         The Guarantor shall not be deemed to be permitted to take any action or
fail to take  any  action  which  is  permitted  as an  exception  to any of the
covenants  contained herein or which is within the permissible  limits of any of
the covenants  contained  herein if such action or omission  would result in the
breach of any other covenant contained herein.


<PAGE>


         IN WITNESS  WHEREOF,  the  Guarantor  has caused this  Agreement  to be
executed  under  seal in its name and on its  behalf by  officers  thereof  duly
authorized  thereunto  and the Credit  Obligor has  executed  this  Agreement by
causing  its  name  to be  hereunto  subscribed  by one of its  duly  authorized
officers, all as of the day and year first above written.

                           CAVALIER HOMES, INC.



                           By:
                               --------------------------
                           Its
                               --------------------------
S E A L


Attest
       ----------------------
              Secretary



                           Accepted:

                           FIRST COMMERCIAL BANK



                           By:
                               ---------------------------- 
                           Its
                               ----------------------------


<PAGE>





                                                         


                          AMENDMENT NO. 1 TO AGREEMENT
                         AND PLAN OF MERGER BY AND AMONG
                              CAVALIER HOMES, INC.,
                          CRIMSON ACQUISITION CORP. AND
                               BELMONT HOMES, INC.


                  This  Amendment  No. 1 to  Agreement  and Plan of Merger (this
Amendment)  is made and entered into as of the 19th day of  September,  1997, by
and among  Cavalier  Homes,  Inc.,  a  Delaware  corporation  (Parent),  Crimson
Acquisition  Corp., a Mississippi  corporation and a wholly owned  subsidiary of
Parent (Sub), and Belmont Homes, Inc., a Mississippi corporation (the Company).

                              W I T N E S S E T H:

                  WHEREAS, Parent, Sub and the Company entered into an Agreement
and Plan of Merger dated as of August 14, 1997 (the Merger Agreement); and

                  WHEREAS,  Parent,  Sub and the  Company  desire  to amend  the
Merger Agreement to reflect the intention of the parties to the Merger Agreement
that in order to effect the assumption of the Belmont 1994 Incentive Stock Plan,
as amended (the Belmont Stock Plan),  by Parent and the continuing  availability
following  the Merger (as  defined  in the  Merger  Agreement)  of the number of
shares reserved for issuance thereunder under Cavalier's 1996 Key Employee Stock
Incentive Plan, as amended (the Cavalier Stock Plan), Parent will use reasonable
efforts  to cause the  Cavalier  Stock  Plan to be  amended  effective  upon the
Effective Time of the Merger to provide that shares of Parent Common Stock equal
to the number of shares of Company  Common Stock which are reserved for issuance
under the Belmont Stock Plan pursuant to options not yet granted under such plan
as of the  Effective  Time,  plus any number of shares  subject  to  outstanding
options  under the Belmont  Stock Plan which,  pursuant to the express  terms of
such  options and the plan under which they were granted and not pursuant to any
action  by  Parent,  Sub or  the  Company  not  consented  to by the  applicable
optionee,  lapse,  expire,  terminate or are cancelled after the Effective Time,
will be available for issuance under the Cavalier Stock Plan,  with such numbers
in each case being multiplied by the Exchange Ratio;

                  NOW,  THEREFORE,  in consideration of the foregoing  premises,
and the mutual and dependent covenants and agreements hereinafter set forth, and
for other good and valuable consideration,  the receipt and sufficiency of which
are hereby acknowledged, Parent, Sub, and the Company hereby agree as follows:

                  1.       Capitalized  Terms.  Capitalized  terms  used but not
defined  herein  shall  have  the respective meanings  ascribed  to them in  the
Merger Agreement.

                  2.       Amendment.  The Merger  Agreement is  hereby  amended
by adding the following  sentence at  the  end of  Section 2.4(a) of the  Merger
Agreement:

                   Prior to the  Effective  Time,  Parent  shall use  reasonable
                  efforts to cause the 1996 Key Employee Stock Incentive Plan of
                  Cavalier Homes, Inc., as amended (the Cavalier Stock Plan), to
                  be amended to provide that shares of Parent Common Stock equal
                  to the  number of shares of  Company  Common  Stock  which are
                  reserved for issuance under the Belmont 1994  Incentive  Stock
                  Plan, as amended (the Belmont Stock Plan), pursuant to options
                  not yet granted under such plan as of the Effective Time, plus
                  any number of shares subject to outstanding  options under the
                  Belmont  Stock Plan which,  pursuant  to the express  terms of
                  such  options and the plan under  which they were  granted and
                  not  pursuant to any action by Parent,  Sub or the Company not
                  consented  to  by  the  applicable  optionee,  lapse,  expire,
                  terminate,  or are cancelled after the Effective Time, will be
                  available  for issuance  under the Cavalier  Stock Plan,  with
                  such  numbers in each case being  multiplied  by the  Exchange
                  Ratio, and shall use reasonable efforts to take such other and
                  further  action as may be necessary to effectuate the purposes
                  of the foregoing.

                  3.       No Other  Amendment.  Except as amended  hereby,  the
Merger  Agreement  shall remain in
full force and effect according to its original tenor.

                  IN WITNESS WHEREOF,  Parent, Sub and the Company have executed
and  delivered  this  Amendment No. 1 to the Agreement and Plan of Merger on the
date first written above.


                                 CAVALIER HOMES, INC.


                       By        /s/ Michael R. Murphy
                                 Its Chief Financial Officer/Secretary-Treasurer


                                 CRIMSON ACQUISITION CORP.

                       By        /s/ Michael R. Murphy
                                 Its Vice President


                                 BELMONT HOMES, INC.

                       By        /s/ G.H. Spann
                                 Its President




<PAGE>

<TABLE>
<CAPTION>

                                                                                                            
 CAVALIER HOMES, INC. AND SUBSIDIARIES
 COMPUTATION OF NET INCOME PER COMMON SHARE

<S>                                                     <C>               <C>                     <C>                <C>    

                                                              Thirteen Weeks Ended                     Thirty-nine Weeks Ended
                                                         ------------------------------           ------------------------------   
                                                         September 26,       September 27,        September 26,      September 27,
                                                            1997                1996                 1997               1996
                                                         -------------       -------------        ------------       -------------

 PRIMARY AND FULLY DILUTED
      Net Income                                        $   2,587,000     $    3,609,000          $  9,230,000       $  10,005,000
                                                         =============       =============        ============       =============
 SHARES:

 Primary
   Average common shares outstanding                       12,296,021         12,117,729            12,240,020          11,731,115

   Dilutive effect if stock options
     were exercised                                           173,653            295,231               186,045             492,256
                                                         -------------       -------------        ------------       -------------
   Average common shares outstanding
     as adjusted (primary)                                 12,469,674         12,412,960            12,426,065          12,223,371
                                                         =============       =============        ============       =============
 Fully Diluted
   Average common shares outstanding                       12,469,674         12,412,960            12,426,065          12,223,371

   Additional dilutive effect if
     stock options were excercised
     (fully)                                                    5,127                  -                 7,376                   -
                                                         -------------       -------------        ------------       -------------
   Average common shares outstanding
     as adjusted (fully diluted)                           12,474,801         12,412,960            12,433,441          12,223,371
                                                         =============       =============        ============       =============

   Primary and Fully Diluted Net Income per
     Common Share                                       $        0.21      $        0.29         $        0.74        $       0.82
                                                         =============       =============        ============       =============
</TABLE>

<TABLE> <S> <C>


<ARTICLE>                     5
<CIK>                        0000789863
<NAME>                       Cavalier Homes, Inc. 
<MULTIPLIER>                 1,000
<CURRENCY>                   U.S. Dollars
       
<S>                             <C>
<PERIOD-TYPE>                   9-mos
<FISCAL-YEAR-END>               Dec-31-1997
<PERIOD-START>                  Jan-01-1997
<PERIOD-END>                    Sep-26-1997
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