CAVALIER HOMES INC
10-Q, 1998-11-04
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 25, 1998
                                        ------------------
                                       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                                (IRS Employer
of incorporation or organization)                         Identification Number)


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


                                 (256) 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 2, 1998
- ----------------------------                     -------------------------------
Common Stock, $.10 Par Value                             19,633,151 Shares



<PAGE>


                      CAVALIER HOMES, INC. AND SUBSIDIARIES


                                      INDEX


                                                                        Page No.
Part I.  Financial Information  (Unaudited)

         Consolidated Condensed Balance Sheets -                           3
         September 25, 1998  and December 31, 1997

         Consolidated Condensed Statements of Income -                     4
         Thirteen and Thirty-nine Weeks Ended September 25, 1998
         and September 26, 1997

         Consolidated Condensed Statements of Cash Flows -                 5
         Thirty-nine Weeks Ended September 25, 1998  and
         September 26, 1997

         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 1.  Legal Proceedings                                        15

         Item 5.  Other Matters                                            15

         Item 6.  Exhibits and Reports on Form 8-K                         16

         Signatures                                                        
                                                                           18


















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 17 of this
report.





<PAGE>


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

                                                                                               September 25,     December 31,
ASSETS                                                                                              1998              1997
                                                                                              ----------------  ----------------
CURRENT ASSETS:
<S>                                                                                         <C>               <C>              
     Cash and cash equivalents                                                              $          41,304 $          37,276
     Certificates of deposit, maturing within one year                                                      -             4,000
     Accounts receivable, less allowance for
            losses of $1,190 (1998) and $1,175 (1997)                                                  36,641             8,449
     Notes and installment contracts receivable - current                                               1,313             1,561
     Inventories                                                                                       39,399            29,697
     Deferred income taxes                                                                              8,418             7,240
     Other current assets                                                                               2,609             1,292
                                                                                              ----------------  ----------------

            Total current assets                                                                      129,684            89,515
                                                                                              ----------------  ----------------

PROPERTY, PLANT AND EQUIPMENT (Net)                                                                    57,849            53,434
                                                                                              ----------------  ----------------

INSTALLMENT CONTRACTS RECEIVABLE, less
    allowance for credit losses of $740 (1998)
    and $1,272 (1997)                                                                                  23,802            46,614
                                                                                              ----------------  ----------------

GOODWILL, less accumulated amortization of
  $3,882  (1998) and $3,102  (1997)                                                                    20,217            19,551
                                                                                              ----------------  ----------------

OTHER ASSETS                                                                                            3,412             2,440
                                                                                              ----------------  ----------------

TOTAL                                                                                       $         234,964 $         211,554
                                                                                              ================  ================

LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
     Current portion of long-term debt                                                      $             393 $           3,271
     Notes payable                                                                                      3,276                 -
     Accounts payable                                                                                  20,825             9,575
     Amounts payable under dealer incentive programs                                                   16,395            14,614
     Accrued compensation and related withholdings                                                     10,115             4,294
     Estimated warranties                                                                              12,200            11,700
     Accrued merger and related costs                                                                     627             5,178
     Other accrued expenses                                                                            21,005            12,399
                                                                                              ----------------  ----------------

          Total current liabilities                                                                    84,836            61,031
                                                                                              ----------------  ----------------

DEFERRED INCOME TAXES                                                                                     498               297
                                                                                              ----------------  ----------------

LONG-TERM DEBT                                                                                          3,850            15,808
                                                                                              ----------------  ----------------

OTHER LONG-TERM LIABILITIES                                                                             2,146               867
                                                                                              ----------------  ----------------

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;  50,000,000  shares  authorized,  20,247,051
       shares issued and 19,772,451 outstanding (1998);
       19,941,357 shares issued and outstanding (1997)                                                  2,025             1,994
     Additional paid-in capital                                                                        60,414            57,228
     Retained earnings                                                                                 85,858            74,329
     Treasury Stock, at cost (474,600 shares)                                                          (4,663)                -
                                                                                              ----------------------------------


         Total stockholders' equity                                                                   143,634           133,551
                                                                                              ----------------  ----------------

TOTAL                                                                                       $         234,964 $         211,554
                                                                                              ================  ================


            See Notes to Consolidated Condensed Financial Statements
</TABLE>







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

                                                              Thirteen Weeks Ended                  Thirty-nine Weeks Ended
                                                       ----------------------------------     ----------------------------------
                                                        September 25,      September 26,        September 25,     September 26,
                                                             1998              1997                  1998              1997
                                                       ---------------   ----------------     ----------------  ----------------
REVENUES:
<S>                                                  <C>               <C>                  <C>               <C>              
     Net sales                                       $        156,346  $         138,276    $         446,085 $         423,977
     Financial services                                         1,152              1,382                4,605             3,820
                                                       ---------------   ----------------     ----------------  ----------------

                                                              157,498            139,658              450,690           427,797
                                                       ---------------   ----------------     ----------------  ----------------


COST OF SALES                                                 126,864            115,444              365,772           354,512


SELLING, GENERAL AND ADMINISTRATIVE:
    Manufacturing                                              21,632             17,356               60,880            49,757
    Financial services                                            904                855                2,632             2,275
                                                       ---------------   ----------------     ----------------  ----------------

                                                              149,400            133,655              429,284           406,544
                                                       ---------------   ----------------     ----------------  ----------------

OPERATING PROFIT                                                8,098              6,003               21,406            21,253
                                                       ---------------   ----------------     ----------------  ----------------

OTHER INCOME (EXPENSE):
    Interest expense:
       Manufacturing                                             (107)              (157)                (380)             (580)
       Financial services                                           -               (217)                (281)             (540)
    Life Insurance Proceeds                                         -                  -                    -             1,500
    Other, net                                                    759                353                1,643             1,218
                                                       ---------------   ----------------     ----------------  ----------------

                                                                  652                (21)                 982             1,598
                                                       ---------------   ----------------     ----------------  ----------------

INCOME BEFORE INCOME TAXES                                      8,750              5,982               22,388            22,851

INCOME TAXES                                                    3,530              2,343                9,057             8,439
                                                       ---------------   ----------------     ----------------  ----------------

NET INCOME                                           $          5,220  $           3,639    $          13,331 $          14,412
                                                       ===============   ================     ================  ================

BASIC NET INCOME PER SHARE                           $           0.26  $            0.18    $             .67 $             .73
                                                       ===============   ================     ================  ================

DILUTED NET INCOME PER SHARE                         $           0.26  $            0.18    $             .66 $             .72  
                                                       ===============   ================     ================  ================

WEIGHTED AVERAGE SHARES OUTSTANDING                        20,072,336         19,869,210           20,029,432        19,813,209
                                                       ===============   ================     ================  ================

WEIGHTED AVERAGE SHARES OUTSTANDING,
   ASSUMING DILUTION                                       20,307,857         20,055,274           20,304,704        20,011,665
                                                       ===============   ================     ================  ================






            See Notes to Consolidated Condensed Financial Statements
</TABLE>










<TABLE>
<CAPTION>

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

                                                                                                    Thirty-nine Weeks Ended
                                                                                              ----------------------------------

                                                                                                September 25,     September 26,
                                                                                                    1998              1997
                                                                                              ----------------  ----------------
OPERATING ACTIVITIES:
<S>                                                                                         <C>               <C>              
  Net income                                                                                $          13,331 $          14,412
  Adjustments to reconcile net income to net cash provided by operating activities:
       Depreciation and amortization                                                                    6,124             5,582
       Provision for credit losses and repurchase commitments                                            (517)              279
       Gain on sale of installment contracts                                                           (1,517)                -
       Loss on sale of property, plant and equipment                                                       60               250
       Equity in net income of unconsolidated affiliates                                                 (252)             (261)
       Minority interest in net income of consolidated subsidiaries                                       314               109
       Compensation related to the issuance of stock options                                              231               134
       Changes in assets and liabilities provided (used) cash, net of effects of acquisitions:
            Accounts receivable                                                                       (28,165)          (25,055)
            Inventories                                                                                (6,844)           (2,624)
            Accounts payable                                                                           11,194             6,173
            Other assets and liabilities                                                               10,887             4,238
                                                                                              ----------------  ----------------

       Net cash provided by operating activities                                                        4,846             3,237
                                                                                              ----------------  ----------------

INVESTING ACTIVITIES:
  Net cash paid in connection with acquisitions                                                        (2,358)             (871)
  Proceeds from the sale of property, plant and equipment                                                  64                86
  Capital expenditures                                                                                 (8,925)           (7,889)
  Purchases of certificates of deposit                                                                 (6,044)             (345)
  Maturities of certificates of deposit                                                                10,044             4,544
  Distribution from equity investments                                                                    124               138
  Proceeds from sale or maturity of marketable securities                                                   -             1,097
  Purchase of marketable securities                                                                         -              (149)
  Purchases and originations of notes and installment contracts                                       (13,812)          (15,589)
  Proceeds from sale of installment contracts                                                          35,040                 -
  Principal collected on notes and installment contracts                                                3,862             4,100
 Increase in value of cash surrender value of life insurance                                             (917)                -
                                                                                              ----------------  ----------------

       Net cash provided by (used in) investing activities                                             17,078           (14,878)
                                                                                              ----------------  ----------------

FINANCING ACTIVITIES:
  Net payments on notes payable                                                                           420                 -
  Payments on long-term debt                                                                          (14,836)          (11,889)
  Proceeds from long-term borrowings                                                                        -             8,552
  Cash dividends paid                                                                                  (1,802)           (1,100)
  Proceeds from exercise of stock options                                                                 171                 4
  Net proceeds from sales of common stock                                                               2,814             1,448
  Purchase of treasury stock                                                                           (4,663)                -
                                                                                              ----------------  ----------------

       Net cash used in financing activities                                                          (17,896)           (2,985)
                                                                                              ----------------  ----------------

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                                    4,028           (14,626)
                                                                                              ----------------  ----------------

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD                                                         37,276            29,751
                                                                                              ----------------  ----------------

CASH AND CASH EQUIVALENTS, END OF PERIOD                                                    $          41,304 $          15,125
                                                                                              ================  ================









            See Notes to Consolidated Condensed Financial Statements
</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 25, 1998 and September 26, 1997
                (Dollars in Thousands, Except Per Share Amounts)

1.       BUSINESS COMBINATION AND BASIS OF PRESENTATION

o                 On  December  31, 1997,  Belmont Homes, Inc.  ("Belmont")  was
                  merged  with  and  into  a subsidiary of Cavalier Homes,  Inc.
                  ("Cavalier"), and 7,555,121 shares of Cavalier's common  stock
                  were  issued in  exchange  for all of the  outstanding  common
                  stock of  Belmont.  The merger was  accounted for as a pooling
                  of interests, and, accordingly, the accompanying  consolidated
                  condensed  financial  statements have been restated to include
                  the financial  position,  results of operations and cash flows
                  of  Belmont for all  periods  presented.  Previously  reported
                  amounts for the  individual companies have been  adjusted  for
                  the     effect     of     former   equity    investments    in
                  unconsolidated  joint  ventures  which  are  now  consolidated
                  subsidiaries  and  for  reclassification  of  certain  Belmont
                  amounts to conform to Cavalier's presentation.

o                 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 25,
                  1998, and the results of its operations and its cash flows for
                  the thirteen and thirty-nine  week periods ended September 25,
                  1998 and September 26, 1997, respectively. All adjustments are
                  of a normal, recurring nature.

o                 The results of  operations  for the thirteen  and  thirty-nine
                  week  periods  ended  September  25, 1998 are not  necessarily
                  indicative  of the results to be  expected  for the full year.
                  The  information  included in this Form 10-Q should be read in
                  conjunction  with  Management's  Discussion  and  Analysis and
                  financial   statements  and  notes  thereto  included  in  the
                  Company's 1997 Annual Report on Form 10-K.

o                 Per share amounts are calculated in accordance  with Statement
                  of  Financial  Accounting  Standards  No. 128,  "Earnings  Per
                  Share". Earnings per share, basic and diluted, are computed by
                  dividing  net income by the  weighted  average  common  shares
                  outstanding  (basic EPS) or  weighted  average  common  shares
                  outstanding assuming dilution (diluted EPS) as detailed below:

<TABLE>
<CAPTION>
                                                             Thirteen Weeks Ended                  Thirty-nine Weeks Ended
                                                       ----------------------------------     ----------------------------------
                                                       September 25,      September 26,        September 25,     September 26,
                                                            1998              1997                 1998              1997
                                                       ---------------   ----------------     ----------------  ----------------

<S>                                                        <C>                <C>                  <C>               <C>       
  Weighted average common shares                           20,072,336         19,869,210           20,029,432        19,813,209
  
      outstanding (basic)

  Dilutive effect if stock options
    were exercised                                            235,521            186,064              275,272           198,456
                                                       ---------------   ----------------     ----------------  ----------------

 Weighted average common shares
      outstanding, assuming dilution (diluted)             20,307,857         20,055,274           20,304,704        20,011,665
                                                       ===============   ================     ================  ================

</TABLE>


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

o                 Certain amounts from the prior periods have been  reclassified
                  to conform to the 1998 presentation.

o                 During   1998,   the  Company   acquired  the  assets  of  two
                  manufactured  housing  retail  organizations  for a  net  cash
                  payment of $2,358.  The  acquisitions  were  accounted  for as
                  purchases  and resulted in $1,447 of goodwill,  which is being
                  amortized using the  straight-line  method over 15 years.  The
                  results of operations  of the acquired  companies are included
                  with those of Cavalier from the respective acquisition dates.








<PAGE>


                                     PART I.
                      CAVALIER HOMES, INC. AND SUBSIDIARIES
              Notes to Consolidated Condensed Financial Statements
               For the Thirteen and Thirty-nine Week Periods Ended
                   September 25, 1998 and September 26, 1997
                (Dollars in Thousands, Except Per Share Amounts)

2.                ACCOUNTING STANDARD NOT YET ADOPTED

         In June 1997, the FASB issued SFAS No. 131,  Disclosures about Segments
         of an Enterprise and Related  Information.  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.*


<TABLE>
<CAPTION>
3.                SUPPLEMENTAL CASH FLOW DISCLOSURES             Thirty-nine Weeks Ended
                                                             -------------------------------
                                                             September 25,     September 26,
                                                                1998              1997
                                                             -------------------------------
<S>                                                             <C>             <C>    
         Cash paid for:    Interest                             $   632         $ 1,089
                           Income taxes                         $ 8,622         $ 8,401
</TABLE>

4.       CREDIT ARRANGEMENTS

         In June  1998,  the  Company  executed  an amended  $35,000  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 $10,000. Interest is payable under the
         revolving  line of credit at the bank's  prime rate (8.50% at September
         25,  1998),  or, if elected by the Company,  the 90-day LIBOR Rate plus
         2.5% (7.8125% at September 25, 1998).

         The warehouse and term-loan agreements 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  $25,000.
         Interest  on the 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 1.95%,
         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
         $25,000 with interest  payable at the bank's prime rate, or, if elected
         by the Company,  the 90-day LIBOR Rate plus 2.5%.  However, in no event
         may the  aggregate  outstanding  borrowings  under  the  warehouse  and
         term-loan agreement exceed $25,000.

         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, restrict 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
         ("CAC"), and the capital stock of certain of the Company's consolidated
         subsidiaries.  The bank's  commitment under the Credit Facility expires
         in April 2000.

         No amounts were outstanding  under the Credit Facility at September 25,
         1998.

5.       STOCKHOLDERS' EQUITY

o                 The Company  paid cash  dividends  during this quarter and the
                  previous  three  quarters  as  follows  (all  amounts  are per
                  share):

<TABLE>
                           <S>                       <C>                        <C>
                               Record Date              Payment Date            Dividend Paid
                               -----------              ------------            -------------
                           July 31, 1998             August 14, 1998            $      .030
                           April 30, 1998            May 15, 1998               $      .030
                           January 30, 1998          February 16, 1998          $      .030
                           October 31, 1997          November 14, 1997          $      .018
</TABLE>
- ---------------------------------------
* See Safe Harbor Statement on page 17.

<PAGE>


                                     PART I.
                      CAVALIER HOMES, INC. AND SUBSIDIARIES
              Notes to Consolidated Condensed Financial Statements
                  For the Thirteen and Thirty-nine Week Periods
                Ended September 25, 1998 and September 26, 1997
                (Dollars in Thousands, Except Per Share Amounts)


5.       STOCKHOLDERS' EQUITY (Continued)

o                 During the third quarter of 1998,  Cavalier  initiated a stock
                  repurchase  program to repurchase 500,000 shares of its common
                  stock.  At  September  25,  1998,   474,600  shares  had  been
                  repurchased for $4,663 which is recorded as treasury stock.

6.       COMMITMENTS AND CONTINGENCIES

o                 It is customary  practice  for  companies 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 and are 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  an amount  estimated to be $211,000
                  under  these  agreements  as  of  September  25,  1998,   such
                  contingency  is  mitigated  by  the  fact  that (i)  sales  of
                  manufactured homes are spread  over a relatively  large number
                  of dealers;  (ii)  the price the  Company is  obligated to pay
                  under such repurchase agreements generally  declines  over the
                  period of the agreement; and (iii) the Company  may be able to
                  reduce its losses by the resale  value of the homes which  may
                  be required to be  repurchased.  The Company has an  allowance
                  for  losses of $1,190  based on prior  experience  and current
                  market  conditions.   Management  expects no  material loss in
                  excess of the allowance.*

o                 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 25, 1998, the Company was
                  contingently   liable   for   future   retrospective   premium
                  adjustments  up to a  maximum  of  $5,700  in the  event  that
                  additional losses are reported related to prior periods.

o                 The Company is engaged in various legal  proceedings  that are
                  incidental  to and  arise  in  the  course  of  its  business.
                  Certain of  the cases  filed   against  the  Company and other
                  companies engaged in businesses similar to the Company allege,
                  among other things,  breach of contract and warranty,  product
                  liability,  personal  injury  and  fraudulent,   deceptive  or
                  collusive  practices  in  connection  with  their  businesses.
                  These  kinds of  suits are  typical  of  suits that  have been
                  filed in recent years,  and they sometimes seek  certification
                  as  class  actions,   the  imposition  of  large   amounts  of
                  compensatory and punitive  damages and trials by jury.  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.

o                 The Company and  certain of  its equity partners  have jointly
                  and severally  guaranteed  revolving notes for  two  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
                  guaranty  of  $1,500.   At  September  25, 1998,   $3,000  was
                  outstanding under the various guarantees, of which the Company
                  had guaranteed $720.

- ---------------------------------------
* See Safe Harbor Statement on page 17.

<PAGE>


                                     PART I.
                      CAVALIER HOMES, INC. AND SUBSIDIARIES
                     Management's Discussion and Analysis of
                  Financial Condition and Results of Operations
                               September 25, 1998

General

Cavalier's  principal  business,  since its  inception  in 1984,  is to  design,
produce and sell  manufactured  homes. In 1992, the Company,  through its wholly
owned subsidiary, CAC, started retail installment financing.

Effective  December 31, 1997,  the Company  merged (the  "Merger")  with Belmont
Homes, Inc. ("Belmont"),  whose shares were traded on The Nasdaq National Market
under the symbol "BHIX". In the Merger, Belmont became a wholly owned subsidiary
of the Company, and each Belmont share issued and outstanding  immediately prior
to the effective time of the Merger was converted into the right to receive 0.80
shares of the common stock of the Company.  The Company issued  7,555,121 shares
of its common  stock in the Merger in  exchange  for the  outstanding  shares of
Belmont  common  stock.  The Merger was  accounted for as a pooling of interests
and,  accordingly,  the  Company's  financial  statements  have been restated to
include the financial position,  results of operations and cash flows of Belmont
for all periods  presented.  The  information  herein is presented on a combined
basis.

As of September  1998,  the Company had acquired the assets of two  manufactured
home  retail   organizations.   The  results  of   operations  of  the  acquired
organizations   are  included  with  those  of  Cavalier  from  the   respective
acquisition dates. These acquisitions were in key markets served by the Company.
The  Company's  retail  business  includes  four  retail  sales  centers  in the
southeastern  United States,  with  year-to-date  revenues of  $4,615,000.  Some
portion of manufactured housing revenues are eliminated in consolidation because
homes sold by the  Company's  manufacturing  plants to  Company-owned  retailers
cannot be  recognized as sales on a  consolidated  basis until homes are sold to
retail  customers.  The Company's  major marketing  strategy  remains focused on
building distribution through exclusive independent dealer relationships. In the
future the Company may supplement the independent  dealer network with franchise
dealerships  and company sales centers in certain key markets.* The Company may,
in the future, also acquire other retailers.*

The Company's business is cyclical and seasonal and is influenced by many of the
same  economic and  demographic  factors  which  affect the housing  market as a
whole.  The  manufactured  housing industry  experienced  significant  growth in
shipments  from 1992  through  1996.  The  Company  attributes  this growth to a
reduction in alternative  housing,  increased  availability of retail financing,
increased consumer  confidence and continuing  strength in the national economy.
As a result, the manufactured housing industry has, over the past several years,
experienced  increases  in both the number of retail  dealers and  manufacturing
capacity. The Company believes these increases are currently resulting in slower
retail turnover,  higher dealer inventories and increased price competition.  In
1997,  the industry  reported a 2.8% decline in shipments  from 1996,  its first
decrease in shipments in six years.

Industry  shipments  in 1998 have  improved  over  1997,  with the  Manufactured
Housing Institute reporting floor shipments  increased  7.0% through August 1998
over 1997.  Multi-section  shipments  represented  60.2% of  industry  shipments
through  August   1998  versus  56.4%  through  the   same  period  in  1997.  A
single-section  home is comprised of one floor,  while a  multi-section  home is
comprised of two or more floors.

- ---------------------------------------
* See Safe Harbor Statement on page 17.

<PAGE>


                                     PART I.
                      CAVALIER HOMES, INC. AND SUBSIDIARIES
                     Management's Discussion and Analysis of
                  Financial Condition and Results of Operations
                               September 25, 1998

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>
<S>                                  <C>                    <C>    <C>                    <C>    <C>                <C>
STATEMENT OF INCOME SUMMARY                                         For the Thirteen Weeks Ended
                                        -------------------------------------------------------------------------------------
(Dollars in Thousands)                      September 25, 1998            September 26, 1997              Difference
                                        ---------------------------   ---------------------------  --------------------------

Net Sales                             $       156,346       100.0%  $      138,276        100.0% $       18,070        13.1%
Cost of Sales                                 126,864        81.1%         115,444         83.5%         11,420         9.9%
                                        --------------  -----------   -------------  ------------  -------------

     Gross Profit on Sales            $        29,482        18.9%  $       22,832         16.5% $        6,650        29.1%
                                        ==============                =============                =============

Net Sales                             $       156,346               $      138,276               $       18,070        13.1%
Financial Services                              1,152                        1,382                         (230)      -16.6%
                                        --------------                -------------                -------------

     Total Revenue                    $       157,498       100.0%  $      139,658        100.0% $       17,840        12.8%
                                        ==============                =============                =============

Selling, General and Administrative   $        22,536        14.3%  $       18,211         13.0% $        4,325        23.7%
Operating Profit                      $         8,098         5.1%  $        6,003          4.3% $        2,095        34.9%
Other Income                          $           652         0.4%  $          (21)         0.0% $          673     -3204.8%
Net Income                            $         5,220         3.3%  $        3,639          2.6% $        1,581        43.4%

STATEMENT OF INCOME SUMMARY                                       For the Thirty-Nine Weeks Ended
                                        -------------------------------------------------------------------------------------
(Dollars in Thousands)                      September 25, 1998            September 26, 1997              Difference
                                        ---------------------------   ---------------------------  --------------------------

Net Sales                             $       446,085       100.0%  $      423,977        100.0% $       22,108         5.2%
Cost of Sales                                 365,772        82.0%         354,512         83.6%         11,260         3.2%
                                        --------------  -----------   -------------  ------------  -------------

     Gross Profit on Sales            $        80,313        18.0%  $       69,465         16.4% $       10,848        15.6%
                                        ==============                =============                =============

Net Sales                             $       446,085               $      423,977               $       22,108         5.2%
Financial Services                              4,605                        3,820                          785        20.5%
                                        --------------                -------------                -------------

     Total Revenue                    $       450,690       100.0%  $      427,797        100.0% $       22,893         5.4%
                                        ==============                =============                =============

Selling, General and Administrative   $        63,512        14.1%  $       52,032         12.2% $       11,480        22.1%
Operating Profit                      $        21,406         4.7%  $       21,253          5.0% $          153         0.7%
Other Income                          $           982         0.2%  $        1,598          0.4% $         (616)      -38.5%
Net Income                            $        13,331         3.0%  $       14,412          3.4% $       (1,081)       -7.5%
</TABLE>




<TABLE>
<CAPTION>

                                                           For the Thirteen Weeks                  For the Thirty-nine Weeks
OPERATING DATA SUMMARY                                            Ended                                      Ended
                                                        ---------------------------                --------------------------
(Dollars in Thousands)                                  September 25, September 26,                September 25,   September 26,
                                                           1998           1997                         1998          1997
                                                        -----------   -------------                -------------   ----------
<S>                                                   <C>           <C>                          <C>             <C>        
Installment Loan Purchases                            $      6,475  $        4,340               $       13,464  $    14,831
Capital Expenditures                                  $      4,505  $        2,933               $        8,925  $     7,889
Home Shipments                                               6,285           5,782                       18,099       18,105
Floor Shipments                                              9,371           8,396                       26,915       25,588
Independent Exclusive Dealer Locations                         219             145                          219          145
Home Manufacturing Facilities                                   23              22                           23           22
</TABLE>

Net Sales.  Net sales for the third  quarter  increased  $18,070,000  (13.1%) as
compared to the same period in 1997,  and increased  $22,108,000  (5.2%) for the
nine months ending  September  25, 1998.  The increase in sales for both periods
over  1997  is in part  attributable  to  improved  industry  conditions.  Floor
shipments  increased by 11.6% for the third quarter and 5.2%  year-to-date  over
1997. Homes sold for the quarter  increased 8.7% over the third quarter of 1997,
with no percentage change for the nine month period.  During the quarter, 49% of
the  Company's  homes sold were  multi-section  homes,  compared  to 45% for the
previous year's comparable  period,  with year-to-date  multi-section home sales
increasing  to 49% compared to 41% for the prior year.  As part of the Company's
marketing  program,  the exclusive dealer  distribution  system has grown to 219
independent exclusive dealer locations,  up from 145 dealer locations at the end
of the third quarter of 1997.


<PAGE>


                                     PART I.
                      CAVALIER HOMES, INC. AND SUBSIDIARIES
                     Management's Discussion and Analysis of
                  Financial Condition and Results of Operations
                               September 25, 1998

Financial  Services Revenue.  Financial  services revenue increased $785,000 for
the year over 1997 primarily due to a gain on the sale of a significant  portion
of CAC's loan  portfolio in the first quarter of 1998 as well as the  subsequent
periodic resale of loans. The effect of the portfolio sale on financial services
revenue has been to reduce the amount of  interest  income on the portion of the
portfolio sold.  Financial  services revenue  decreased for the third quarter of
1998  as  compared  to  1997 by  $230,000  due  primarily  to the  reduced  loan
portfolio.

Selling, General and Administrative. Selling, general and administrative expense
increased $4,325,000 during the quarter and $11,480,000  year-to-date over 1997.
These  increases are primarily due to $1,439,000  for the quarter and $3,840,000
year-to-date for expanded sales and marketing activities  including  recruiting,
set-up,  and  maintenance  for our  exclusive  dealer  network and the continued
development of a retail franchise program.  Additionally,  selling,  general and
administrative expense increased $685,000 for the quarter and $1,881,000 for the
year due to higher costs for employee benefits,  primarily workers  compensation
and health  insurance.  Other factors  contributing  to the increase in selling,
general  and  administrative  expenses  are  the  retail  acquisitions,  opening
additional  home  manufacturing  facilities  and  the  expansion  of the  supply
distribution business.  Quarterly selling, general and administrative expense as
a percentage of total  revenue was 14.3% (1998) and 13.0%  (1997).  Year-to-date
expense as a percentage of total revenue was 14.1% (1998) and 12.2% (1997).

Other Income (Expense).

Interest  Expense.  Interest  expense  decreased  year-to-date  by $457,000  and
$266,000 for the quarter compared to 1997 due to the payoff in March 1998 of the
financial  services  debt  which was paid with the  proceeds  from the sale of a
portion of CAC's loan portfolio, as well as the payoff in September 1997 of debt
that had been used to support the 1996 Bellcrest Homes, Inc. acquisition.

Life  Insurance  Proceeds.  The Company  recorded a  non-recurring  gain on life
insurance  proceeds  during the  thirty-nine  weeks ended  September 26, 1997 of
$1,500,000  million as a result of the death of  Belmont's  President  and Chief
Executive Officer, Jerold Kennedy.

Other, net. Other, net increased by $405,000 for the quarter as compared to 1997
and increased  $426,000 for the thirty-nine week period ended September 25, 1998
as compared to 1997. Other, net is primarily comprised of interest income, gains
or losses on sales of investments,  equity earnings in investments accounted for
on the equity basis of accounting  and an allocation of minority  interest.  The
increase in other, net is primarily due to increased interest income on earnings
from the cash proceeds of the sale of a portion of CAC's loan portfolio.

Net  Income.  Net income for the  thirteen  weeks ended  September  25, 1998 was
$5,220,000  compared to $3,639,000 for the comparable  1997 period.  Diluted net
income per share during the current  quarter is $.26 as compared to $.18 for the
previous year's comparable period. Year-to-date net income at September 25, 1998
was $13,331,000  compared to $14,412,000 for 1997, which included  $1,500,000 of
life insurance proceeds, or $.07 per share diluted. Diluted net income per share
year-to-date was $.66 compared to $.72 in 1997. While net income  (excluding the
effect of life insurance proceeds received during the 1997 year-to-date  period)
improved over the prior year periods due primarily to increased  sales resulting
in part from improved industry conditions,  net income for the third quarter and
year-to-date was affected by continuing  competition in the manufactured housing
industry  as well as the  impact  of the  process  of  integrating  Belmont  and
Cavalier.

Currently,  the Company is  experiencing  tightened  supply from its traditional
vendors of certain  types of raw  materials  required for the  production of its
manufactured  homes.  The Company is  attempting  to obtain these  products from
other vendors and to purchase  substitute  products,  which may result in higher
than  normal  costs.  The  possibility  exists that the Company may be unable to
recover  these  additional  costs  through  price  increases or that  substitute
products or suppliers may become  scarce.  The Company is uncertain at this time
as to the extent and duration of these  developments and as to what effect these
factors may have on the Company's future sales and earnings. *

Installment Loan Purchases.  During the third quarter of 1998,  installment loan
purchases were  $6,475,000  compared to $4,340,000 for the comparable  period in
1997. The increase is due to improved  dealer  incentives  offered by CAC during
the  quarter  which are  comparable  to  incentives  offered by other  financing
sources.  Year-to-date,  installment  loan  purchases  decreased to  $13,464,000
compared to $14,831,000 for 1997 as a result of competitive conditions,  due, in
part, to higher dealer incentives offered by other financing sources.

- ---------------------------------------
* See Safe Harbor Statement on page 17.

<PAGE>


                                     PART I.
                      CAVALIER HOMES, INC. AND SUBSIDIARIES
                     Management's Discussion and Analysis of
                  Financial Condition and Results of Operations
                               September 25, 1998

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>
<CAPTION>
BALANCE SHEET SUMMARY                                                             Balances as of
                                                                   ------------------------------------------------
(Dollars in Thousands)                                             September 25, 1998            December 31, 1997
                                                                   ------------------            ------------------

<S>                                                                 <C>                          <C>           
Cash and Cash Equivalents                                           $       41,304               $       37,276
Certificates of deposit maturing within one year                    $            -               $        4,000
Accounts Receivable                                                 $       36,641               $        8,449
Working Capital                                                     $       44,847               $       28,484
Current Ratio                                                             1.5 to 1                     1.5 to 1
Long-Term Debt                                                      $        3,850               $       15,808
Ratio of Long-Term Debt to Equity                                          1 to 38                       1 to 8
Installment Loan Portfolio                                          $       25,380               $       49,146
</TABLE>

The  Company's  strong cash position  enabled it to initiate a stock  repurchase
program of 500,000 shares during the third quarter.  The Company  completed this
repurchase  subsequent to the end of the third quarter.  The Company's  Board of
Directors  then  authorized  the  repurchase  of up to an  additional  1,500,000
shares, of which, 198,900 shares had been repurchased as of November 2, 1998.

The increase in working capital and the decreases in long-term debt and the debt
to equity  ratio  were due to the sale of a portion  of CAC's  installment  loan
portfolio  having an outstanding  principal  balance of $33,523,000  for cash of
$35,040,000, of which approximately $14 million was used to retire debt.

The increase in accounts  receivable  from  December  31, 1997 to September  25,
1998, 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  capital  expenditures  were  approximately  $8,925,000  for  the
thirty-nine  weeks ended  September 25, 1998, as compared to $7,889,000  for the
comparable period of 1997.  Capital  expenditures  during these periods included
normal property,  plant and equipment additions and replacements,  the continued
expansion  and   modernization   of  certain  of  the  Company's   manufacturing
facilities,  as well as the 1998 purchase of a Texas manufacturing facility that
was previously leased.

The  Company's   primary   business  segment  is  the  production  and  sale  of
manufactured homes. In 1992, the Company began the operations of CAC to fund the
purchase of installment  sale contracts  originated with 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") to provide additional funds for CAC's growth.

The Credit Facility presently consists of a $35 million revolving, warehouse and
term-loan  agreement.  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 $10  million.  Interest  is payable  under the
revolving  line of credit at the  bank's  prime  rate,  or,  if  elected  by the
Company, the 90-day LIBOR Rate plus 2.5%.

The warehouse and term-loan  agreements contained in the Credit Facility provide
for borrowings of up to 80% of the Company's  eligible (as defined)  installment
sales contracts,  up to a maximum of $25 million.  Interest on the 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 1.95%, with a floating rate for the remaining two years (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 $25 million
with interest  payable at the bank's prime rate,  or, if elected by the Company,
the  90-day  LIBOR  Rate  plus  2.5%.  However,  in no event  may the  aggregate
outstanding  borrowings  under the warehouse and term-loan  agreement exceed $25
million.


<PAGE>


                                     PART I.
                      CAVALIER HOMES, INC. AND SUBSIDIARIES
                     Management's Discussion and Analysis of
                  Financial Condition and Results of Operations
                               September 25, 1998

Liquidity and Capital Resources (Continued)

The Credit Facility contains certain  restrictive  covenants which limit,  among
other things,  the Company's ability to (i) make dividend payments and purchases
of treasury stock in an aggregate  amount which exceeds 50% of consolidated  net
income for the two most  recent  years,  (ii)  mortgage or pledge  assets  which
exceed, in the aggregate,  $1 million without written notice to the lender,(iii)
incur additional indebtedness,  including lease obligations, which exceed in the
aggregate  $10  million  and (iv)  make  capital  expenditures  in excess of $14
million.  In addition,  the Credit Facility contains 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.

Since its  inception,  CAC has been  restricted in the amounts of loans it could
purchase based on underwriting standards, as well as the availability of working
capital and funds  borrowed  under its credit line with its primary  lender.  In
February 1998, CAC entered into an agreement  (the "Retail  Finance  Agreement")
with another  lender  providing  for the  periodic  resale of a portion of CAC's
loans that meet established  criteria.  The effect of these  transactions on net
income has been to reduce the amount of financial services revenue from interest
income on this portion of the portfolio,  offset by reduced  interest expense on
retired debt and earnings on the remaining  proceeds.  The Company  believes the
periodic sale of installment  contracts under the Retail Finance  Agreement will
reduce  requirements  for both  working  capital and  borrowings,  increase  the
Company's liquidity, reduce the Company's exposure to interest rate fluctuations
and  enhance  the ability of CAC to  increase  its volume of loan  purchases.  *
Pursuant to the Retail  Finance  Agreement,  the Company may sell a  substantial
portion of its  existing  installment  loan  portfolio  in fiscal year 1999,  in
addition to the periodic sale of installment  contracts  purchased by CAC in the
future.* There can be no assurance,  however, that additional sales will be made
under this  agreement,  or that CAC and the Company  will be able to realize the
expected benefits from such agreement.

The Company's  growth  strategy  currently  includes the continued  expansion of
financial services,  component supply operations, its independent dealer network
and the pursuit of  additional  acquisitions.  The Company may incur  additional
debt, or other forms of  financing,  in order to continue to fund the pursuit of
such growth  strategies.  * The Company  currently  believes  existing  cash and
investment  balances  (which include  proceeds from the sale of a portion of its
installment loan portfolio described above) and funds available under the Credit
Facility,  together with cash provided by  operations,  will be adequate to fund
the  Company's  operations  and plans for the next  twelve  months.* 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 will depend upon market and other conditions.* The Company may continue
to 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  and has entered into such a
transaction  pursuant  to the Retail  Finance  Agreement,  as further  described
above.* There can be no assurance that such possible  additional  financing,  or
the aforementioned  potential  transactions  involving the Company's installment
loan  portfolio,  will be available on terms  acceptable  to the Company.  It is
possible  that a future lack of  financing  or a prolonged  downturn in industry
conditions  could  cause the  Company  to curtail  the  expansion  of  financial
services or otherwise alter its growth strategies. *

Year 2000 Compliance

Many of the Company's  computer  systems and software  products,  as well as the
systems and products of third  parties  doing  business  with the  Company,  are
subject to the "Year  2000"  issue,  which is the  inability  of a  computer  to
correctly   process  dates  after  December  31,  1999.   This  inability  could
potentially  cause  affected   computers  to  shut  down  or  perform  incorrect
calculations,   ultimately   resulting  in  a  system  failure,   disruption  of
operations,  and the  inability to engage in normal  business  activities.  This
issue also affects  products or systems which contain  embedded  computer  chips
with date sensitive  programming such as security systems,  telephone  equipment
and office equipment. As a result, many companies' software and computer systems
need to be upgraded or replaced in order to address the Year 2000 issue.

The Company has  implemented  a  program  to  evaluate  the  risks and  problems
associated  with  the  Year 2000  issue.  This program identifies four stages as
follows:
    1)   The preliminary  assessment of each computer system and  microprocessor
         the Company utilizes for Year 2000  compliance  is  completed,  and the
         testing of  these  systems and  microprocessors  is  approximately  45%
         completed.  As a result of this assessment,  the Company  believes that
         most of the  significant  systems and  microprocessors  it utilizes are
         currently  Year  2000 compliant  or  will be with the  installation  of
         available upgrades,  except for an accounting system used by two of the
         Company's  subsidiaries.* Plans are underway to identify an appropriate
         accounting system for  these subsidiaries.

- ---------------------------------------
* See Safe Harbor Statement on page 17.

<PAGE>



                                     PART I.
                      CAVALIER HOMES, INC. AND SUBSIDIARIES
                     Management's Discussion and Analysis of
                  Financial Condition and Results of Operations
                               September 25, 1998

Year 2000 Compliance (Continued):

    2)   The  identification  of Year 2000 compliance by significant or critical
         third parties is in process and is expected to be completed by December
         31, 1998.* The scheduled  completion date to replace third parties,  if
         needed, is July 1999.*
    3)   The completion of any Company system  conversions and verification that
         all  Company  systems  are  Year  2000  compliant  are  expected  to be
         completed by October 1999.*
    4)   The development of a contingency plan is the last phase and is expected
         to be  completed  by October 1999.*

The  costs  incurred  to date to  address  the  Year  2000  issue  have not been
material; however, the Company expects to incur between $300,000 and $500,000 as
an expense during 1998 and 1999 to complete the  assessment and  implementation,
and to fund such cost from  operations.*  This  anticipated  cost is required to
replace  non-compliant  microprocessors and to purchase and implement accounting
software for two of the Company's subsidiaries. This estimate assumes that third
parties have correctly  assessed and  communicated  to the Company the status of
their Year 2000 compliance,  and that material Year 2000 compliance  issues with
respect to third  parties who have not  communicated  with the Company  will not
arise in the future.  Because of this reliance and the subjective  nature of the
Year 2000  compliance  issue,  the  actual  costs to  address  and  resolve  any
non-compliance issues may differ materially from those anticipated.

The  Company  could  be  affected  if the Year  2000  issue  affects  suppliers'
abilities to provide raw  materials  needed in the  manufacturing  process.  The
Company is also  dependent on third parties or government  agencies to 1) supply
sufficient  electrical power,  utilities,  transportation  and other services to
sustain the  manufacturing  process and CAC's  operations,  2) process,  pay and
maintain  records  of certain  employee  benefits,  3) supply  funds in a timely
fashion for its  dealers and retail  customers  to purchase  homes,  and 4) fund
sales of  portions  of CAC's loan  portfolio.  Any  failure on the part of these
third parties could have a material  adverse  effect on the business  operations
and financial performance of the Company.*

If the  Company's  efforts to resolve  the Year 2000 issue are not  adequate  or
implemented in a timely manner, the Company could experience a disruption in its
normal  business  activities.  Management of the Company  believes that the most
reasonably  likely worst case scenario  would be the delay in  collections  from
third party  financing  agents which could  result in  liquidity  issues for the
Company,  as well as the  delay of  financial  reporting  due to any  accounting
processes which may need to be performed manually until all Year 2000 issues are
resolved.*  However,  the  potential  consequences  of the Year  2000  issue are
inherently uncertain, and consequently, no assurance can be given that this will
be the reasonably likely worst case scenario.



- ---------------------------------------
* See Safe Harbor Statement on page 17.

<PAGE>


                                    PART II.
                      CAVALIER HOMES, INC. AND SUBSIDIARIES
                                Other Information
                               September 25, 1998

ITEM 1            LEGAL PROCEEDINGS

Reference is made to the legal proceedings  previously reported in the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 1997 under the
heading "Item 3 - Legal  Proceedings",  and in the Company's Quarterly Report on
Form 10-Q for the period ended June 26, 1998, under the heading "Part II, Item 1
- - Legal Proceedings."

In September  1998,  the Company and certain of its  subsidiaries,  along with a
number  of  other  manufactured  housing  producers,  the  Manufactured  Housing
Institute,  and the Manufactured Housing Association for Regulatory Reform, were
named as  defendants  in a lawsuit  purporting  to be  brought  on behalf of all
Kentucky residents who owned manufactured homes produced by the defendants.  The
complaint was filed in the  Commonwealth  of Kentucky  Pendleton  Circuit Court,
Case No.  98-CI-00143,  and  alleges  that the  defendants  engaged in  wrongful
conduct and fraudulent  misrepresentation and concealment, and that manufactured
housing units are unsafe  and/or  dangerous  for  residential  use because their
design  allegedly  makes them more  susceptible  to fire.  The  plaintiffs  seek
compensatory  and punitive  damages,  a  requirement  to retrofit  manufacturing
housing  units with  sprinkler  systems,  and other  equitable and legal relief.
Plaintiffs  seek to bring the lawsuit as a class  action,  but the court has not
yet ruled as to whether class action status is proper.  The Company believes the
claims are without merit and intends to vigorously  defend the case. The outcome
of this litigation and its effect on the Company cannot presently be determined,
however,  and the possibility exists for an adverse resolution of the litigation
which  could have a material  adverse  effect on the results of  operations  and
financial condition of the Company.

ITEM 5            OTHER MATTERS

The Board of Directors  declared the quarterly  cash dividend of $.04 per share,
an increase of 33%,  payable on November 16, 1998 to  stockholders  of record on
October 30, 1998.

In accordance  with the provisions of Rule 14a-8 under the  Securities  Exchange
Act of 1934, as amended (the "Exchange Act"),  stockholders  wishing to submit a
proposal to be considered for inclusion in the Company's  proxy statement and on
the proxy  solicitation/voting  instruction  card for the Company's  1999 Annual
Meeting of Stockholders must submit the proposal in writing to the Company on or
before December 11, 1998.

In addition,  the Securities and Exchange Commission recently amended Rule 14a-4
promulgated under the Exchange Act. As amended, Rule 14a-4 provides that a proxy
solicited by management of the Company may confer  discretionary  authority upon
management  of the  Company  to  vote  on a  matter  for an  annual  meeting  of
stockholders  if the Company did not have notice of such matters at least (i) 45
days prior to the first  anniversary  date of the  mailing  of the prior  year's
proxy statement (the "Proxy Rules Date") or (ii) that amount of time required by
the advance notice provisions of the Company's Amended and Restated By-laws,  as
amended (the "By-laws Date").  The proxy statement for the Company's 1998 Annual
Meeting  of  Stockholders   was  mailed  to  stockholders  on  April  10,  1998;
accordingly,  the Proxy  Rules Date is  February  24,  1999.  In  addition,  the
Company's Amended and Restated By-laws, as amended (the "By-laws"), establish an
advance  notice  procedure  with regard to  stockholder  proposals to be brought
before an annual meeting of stockholders,  which procedure was recently amended.
For business to be properly  brought  before an annual meeting by a stockholder,
the  stockholder  must give  notice  not less than 45 days nor more than 90 days
prior to the  first  anniversary  of the date on which the  prior  year's  proxy
materials  were  mailed;  provided,  however,  that in the event the 1999 annual
meeting is more than 30 days before or more than 60 days after  (other than as a
result of adjournment)  the anniversary date of the prior year's annual meeting,
notice must be delivered  no earlier  than 90 days prior to such annual  meeting
and not later  than the later of the 60th day prior to such  meeting or the 10th
day after the Company publicly  announces the date of such meeting.  The Company
currently  expects the 1999 Annual Meeting of  Stockholders to be held within 30
days of the  anniversary of the 1998 Annual  Meeting.  Therefore,  a stockholder
must notify the Company  between  January  10, 1999 and  February  24, 1999 of a
proposal  for the 1999  Annual  Meeting of  Stockholders  which the  stockholder
intends to present other than by inclusion in the Company's proxy material.


<PAGE>


                                    PART II.
                      CAVALIER HOMES, INC. AND SUBSIDIARIES
                                Other Information
                               September 25, 1998

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,
                      and the  amendment  thereto,  filed as Exhibit 3(b) to the
                      Company's  Quarterly  Report on Form 10-Q for the  quarter
                      ended  September  26,  1997,  is  incorporated  herein  by
                      reference.
                  (b) 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  September  26, 1997,  and the
                      amendment  thereto  filed as Exhibit 3(e) to the Company's
                      Quarterly  Report  on  Form  10-Q  for the  quarter  ended
                      September 26, 1997, is incorporated herein by reference.
                  (c) Amendment to the  Company's Amended and Restated  By-laws,
                      as amended.
                  (d) The   Certificate   of  Designation  of  Series  A  Junior
                      Participating  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.

         (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, included in Exhibit 3(a) 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, included in Exhibit 3(b) and
                      Exhibit 3(c) above.
                  (c) Rights Agreement  between  Cavalier Homes,  Inc. and Chase
                      Mellon  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) Form of Indemnification Agreement by and between  Cavalier
                      Homes,  Inc. and each member of its Board of Directors.
                  (b) Retention and Severance Agreement,  dated August 26, 1998,
                      by and between Cavalier Homes, Inc. and Barry B. Donnell.
                  (c) Retention and Severance Agreement,  dated August 26, 1998,
                      by and between Cavalier Homes, Inc. and David A. Roberson.
                  (d) Retention and Severance Agreement,  dated August 26, 1998,
                      by and between Cavalier Homes, Inc. and Michael R. Murphy.
                  (e) Cavalier  Homes,   Inc.  Amended  and  Restated   Dividend
                      Reinvestment  Plan,  filed as Appendix A to the Prospectus
                      appearing in the Company's  Post-Effective Amendment No. 1
                      to  Form  S-3,   Registration  No.  333-48111,   filed  on
                      September 29, 1998, is incorporated herein by reference.

        (11)      Statement re: Computation of Net Income per Common Share.

        (27)      Article 5 - Financial  Data  Schedule and  Restated  Financial
                  Data  Schedule  for Form 10-Q  submitted  as  Exhibit 27 as an
                  EDGAR filing only.

(b)      Current Report on Form 8-K.

                  None.



<PAGE>


                                    PART II.
                      CAVALIER HOMES, INC. AND SUBSIDIARIES
                                Other Information
                               September 25, 1998

        "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,  the business and
growth  and  financing  strategies  of the  Company,  the  Company's  plans  and
expectations  regarding  the merger  with  Belmont and the  achievement  of cost
savings and synergies,  the Company's  anticipation  regarding results in future
periods and the Company's plans and expectations regarding the Year 2000 issue),
as well as those  statements  specifically  designated  with an asterisk (*), or
which  contain  the  words  "estimates",   "projects",   "intends",  "believes",
"anticipates",  "expects",  "may",  "appears",  and  words  of  similar  import,
constitute  forward-looking  statements, 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  included in the
Company's  Annual  Report on Form 10-K for the period  ended  December 31, 1997,
including,  without  limitation,  under the  heading  "Item 1.  Business  - Risk
Factors" and 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;  the
inability or failure to identify or  consummate  successful  acquisitions  or to
assimilate the operations of any acquired  businesses with those of the Company;
the  ability of the  Company  and third  parties  with whom it does  business to
identify and correct, with respect to the Year 2000 issue, all relevant computer
codes  and  embedded  chips,   unanticipated   delays  or  difficulties  in  the
implementation of the Company's Year 2000 project plans and the ability of third
parties to redress their respective  computer systems as they relate to the Year
2000 issue; 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.








<PAGE>


                                    PART II.
                      CAVALIER HOMES, INC. AND SUBSIDIARIES
                                Other Information
                               September 25, 1998



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 4, 1998                      /s/ David A. Roberson               
                                            ------------------------------------
                                            David A. Roberson - President
                                            and Chief Executive Officer


Date: November 4, 1998                      /s/ Michael R. Murphy               
                                            ------------------------------------
                                            Michael R. Murphy -
                                            Chief Financial Officer (Principal
                                            Financial and Accounting Officer)




                         CERTIFICATE REGARDING AMENDMENT
                                     TO THE
                              AMENDED AND RESTATED
                              BY-LAWS, AS AMENDED,
                                       OF
                              CAVALIER HOMES, INC.


         The undersigned, Michael R. Murphy, the Vice President, Chief Financial
Officer and  Secretary-Treasurer of Cavalier Homes, Inc., a Delaware corporation
(the "Corporation"), does hereby certify as follows:

         1. Section  2.4(a)(2) of the Amended and Restated  By-Laws,  as amended
(the "ByLaws"), of the Corporation has been amended and restated in its entirety
by replacing such subsection with the following:

                  (a)(2)  For  nominations  or  other  business  to be  properly
brought  before an annual  meeting by a  stockholder  pursuant  to clause (C) of
Paragraph  (a)(1) of this by-law,  the stockholder must have given timely notice
thereof in writing to the secretary of the  corporation  and such other business
must be otherwise be a proper matter for  stockholder  action.  To be timely,  a
stockholder's  notice  shall be  delivered  to the  secretary  at the  principal
executive offices of the corporation not later than the close of business on the
forty-fifth  (45th) day nor earlier than the close of business on the  ninetieth
(90th) day prior to the first  anniversary of the date on which the  corporation
first  mailed  its  proxy  materials  for the prior  year's  annual  meeting  of
Stockholders;  provided,  however, that in the event that the date of the annual
meeting is more than  thirty (30) days before or more than sixty (60) days after
(other than as a result of adjournment) the anniversary date of the prior year's
annual meeting,  notice by the stockholder to be timely must be so delivered not
earlier  than the close of  business on the  ninetieth  (90th) day prior to such
annual  meeting  and not later  than the close of  business  on the later of the
sixtieth  (60th)  day  prior to such  annual  meeting  or the tenth  (10th)  day
following  the day on which public  announcement  of the date of such meeting is
first made by the corporation.  In no event shall the public  announcement of an
adjournment of an annual meeting  commence a new time period for the giving of a
stockholder's  notice as described above.  Such  stockholder's  notice shall set
forth (A) as to each  person  whom the  stockholder  proposes  to  nominate  for
election or  re-election as a director all  information  relating to such person
that is required to be  disclosed  in  solicitations  of proxies for election of
directors in an election  contest,  or is otherwise  required to be disclosed in
solicitations of proxies for election of directors in an election contest, or is
otherwise required, in each case pursuant to Regulation 14A under the Securities
Exchange  Act of  1934,  as  amended  (the  "Exchange  Act"),  and  Rule  14a-11
thereunder  (including such person's written consent to being named in the proxy
statement as a nominee and to serving as a director if  elected);  (B) as to any
other  business  that the  stockholder  proposes to bring before the meeting,  a
brief description of the business desired to be brought before the meeting,  the
reasons for conducting such business at the meeting and any material interest in
such business of such  stockholder  and the beneficial  owner,  if any, on whose
behalf the proposal is made; and (C) as to the stockholder giving the notice and
the beneficial owner, if any, on whose behalf the nomination or proposal is made
(i)  the  name  and  address  of  such  stockholder,   as  they  appear  on  the
corporation's books, and of such



<PAGE>


beneficial  owner  and (ii) the class  and  number of shares of the  corporation
which are owned  beneficially  and of record by such  stockholder and beneficial
owner.

         2. The foregoing  amendment to the By-laws of the  Corporation was duly
adopted in accordance with the provisions of the General  Corporation Law of the
State of Delaware and the Corporation's By-laws.

         IN WITNESS WHEREOF, the undersigned has executed this certificate as of
the 2nd day of November, 1998.


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

                            INDEMNIFICATION AGREEMENT


         This Agreement (the  "Agreement")  is made as of this 21st day of July,
1998,  by  and  between  Cavalier  Homes,  Inc.,  a  Delaware  corporation  (the
"Company"), and ________________________ ("Indemnitee").


                              W I T N E S S E T H:

                  WHEREAS, it is essential to the  Company and  its stockholders
         to attract and retain qualified and capable directors and officers; and

                  WHEREAS,  Indemnitee  is unwilling to serve,  or continue,  in
         Indemnitee's   present  capacity   without   assurances  that  adequate
         liability  insurance,  indemnification or a combination thereof is, and
         will continue to be, provided; and

                  WHEREAS,  the Amended and Restated By-laws of the Company (the
         "Bylaws")  require the Company to indemnify  its directors and officers
         and allows the Company to indemnify employees; and

                  WHEREAS,  the  Company,  in  order  to  induce  Indemnitee  to
         continue to serve the Company,  has agreed to provide  Indemnitee  with
         the benefits contemplated by this Agreement; and

                  WHEREAS, as   a  result  of   the  provision of such benefits,
         Indemnitee has agreed to serve or continue to serve the Company;

                  NOW, THEREFORE, in consideration of the promises,  conditions,
         representations   and  warranties  set  forth  herein,   including  the
         Indemnitee's  continued  service  to  the  Company,  the  adequacy  and
         sufficiency  of  which  are  hereby   acknowledged,   the  Company  and
         Indemnitee hereby agree as follows:


         1.       Definitions.  The   following  terms, as used herein, have the
following respective meanings:

                  (a) The  "Act"  means  the    Securities Exchange Act of 1934,
as amended.

                  (b) An  "Affiliate"  of a  specified  Person  is a Person  who
directly,  or  indirectly  through  one or more  intermediaries,  controls or is
controlled by, or is under common control with, the Person specified.



                                                         1

<PAGE>



                  (c) The term "Associate", when used to indicate a relationship
with any  Person,  means (i) any  corporation  or  organization  (other than the
Company or a Subsidiary) of which such Person is an officer, director or partner
or is,  directly,  or indirectly,  the Beneficial  Owner of ten percent (10%) or
more of any class of Equity Securities,  (ii) any trust or other estate in which
such  Person has a  substantial  beneficial  interest or as to which such Person
serves as trustee or in a similar  fiduciary  capacity  (other  than an Employee
Plan  Fiduciary),  (iii) any  Relative  of such  Person,  or (iv) any officer or
director of any corporation controlling or controlled by such Person.

                  (d) "Beneficial  Ownership" shall be determined,  and a Person
shall be the Beneficial  Owner of all securities  which such Person is deemed to
own  beneficially,  pursuant to Rule 13d-3 (or any  successor  rule or statutory
provision), or, if Rule 13d-3 shall be rescinded and there shall be no successor
rule or statutory provision thereto,  pursuant to Rule 13d-3 as in effect on the
date hereof;  provided,  however,  that a Person  shall,  in any event,  also be
deemed to be the Beneficial  Owner of any Voting Share: (a) of which such Person
or  any of  its  Affiliates  or  Associates  is,  directly  or  indirectly,  the
Beneficial  Owner,  or (b) of which  such  Person  or any of its  Affiliates  or
Associates  has (i) the right to  acquire  (whether  such  right is  exercisable
immediately  or only after the  passage  of time),  pursuant  to any  agreement,
arrangement or understanding or upon the exercise of conversion rights, exchange
rights,  warrants,  or options,  or otherwise,  or (ii) sole or shared voting or
investment  power with respect thereto  pursuant to any agreement,  arrangement,
understanding,  relationship  or  otherwise  (but  shall not be deemed to be the
Beneficial  Owner of any Voting  Shares  solely by reason of a  revocable  proxy
granted  for  a  particular  meeting  of  stockholders,  pursuant  to  a  public
solicitation  of  proxies  for such  meeting,  with  respect  to shares of which
neither such Person nor any such Affiliate or Associate is otherwise  deemed the
Beneficial  Owner), or (c) of which any other Person is, directly or indirectly,
the Beneficial  Owner if such first mentioned Person or any of its Affiliates or
Associates  acts with such other  Person as a  partnership,  syndicate  or other
group pursuant to any agreement, arrangement or understanding for the purpose of
acquiring,  holding,  voting or disposing of any shares of capital  stock of the
Company; and provided further,  however,  that (i) no director or officer of the
Company, nor any Associate or Affiliate of any such director or officer,  shall,
solely by reason of any or all of such  directors  and officers  acting in their
capacities as such, be deemed for any purposes hereof to be the Beneficial Owner
of any  Voting  Shares of which any  other  such  director  or  officer  (or any
Associate or  Affiliate  thereof) is the  Beneficial  Owner and (ii) no Employee
Plan  Fiduciary  or any  Associate  or  Affiliate  of  any  such  Employee  Plan
Fiduciary,  shall,  solely by  reason of being an  Employee  Plan  Fiduciary  or
Associate or Affiliate of an Employee Plan Fiduciary, be deemed for any purposes
hereof to be the Beneficial Owner of any Voting Shares held by or under any such
plan.

                  (e) The "Board of  Directors"  means the Board of Directors of
the Company.

                  (f) A  "Change in Control" shall be deemed to have occurred if

                           (i) any  Person  (other  than (A) the  Company or any
         Subsidiary,  (B) any pension, profit sharing,  employee stock ownership
         or other employee  benefit plan of the Company or any Subsidiary or any
         trustee of or  fiduciary  with  respect to any such plan when acting in
         such capacity, or (C) any Person who is as of the date and time of this
         Agreement the  Beneficial  Owner of twenty percent (20%) or more of the
         total voting  power of the Voting  Shares)  becomes,  after the date of
         this Agreement,


                                                         2

<PAGE>



         the  Beneficial  Owner of twenty  percent (20%) or more, but no greater
         than  fifty  percent  (50%),  of the total  voting  power of the Voting
         Shares,  unless  prior  thereto the  Continuing  Directors  approve the
         transaction  that results in such Person becoming the Beneficial  Owner
         of twenty  percent  (20%) or more,  but no greater  than fifty  percent
         (50%), of the total voting power of the Voting Shares;

                           (ii) any Person  (other  than (A) the  Company or any
         Subsidiary,  (B) any pension, profit sharing,  employee stock ownership
         or other employee  benefit plan of the Company or any Subsidiary or any
         trustee of or  fiduciary  with  respect to any such plan when acting in
         such capacity, or (C) any Person who is as of the date and time of this
         Agreement the  Beneficial  Owner of twenty percent (20%) or more of the
         total voting power of the Voting Shares) is or becomes,  after the date
         of this  Agreement,  the  Beneficial  Owner of more than fifty  percent
         (50%) of the total voting power of the Voting Shares, regardless of the
         whether the transaction or event by which the fifty percent (50%) level
         is exceeded is approved by the Continuing Directors;

                           (iii)  At any time  Continuing  Directors  no  longer
         constitute a   majority of   the  Board of Directors of the Company; or

                           (iv)   The   consummation   of   (A)  a   merger   or
         consolidation  of the  Company,  statutory  share  exchange,  or  other
         similar  transaction  (other than such a transaction that is solely for
         the  purpose of changing  the  domicile of the  Company)  with  another
         corporation, partnership, or other entity or enterprise in which either
         the Company is not the surviving or continuing corporation or shares of
         common stock of the Company are to be converted  into or exchanged  for
         cash,  securities  other than  common  stock of the  Company,  or other
         property,  (B) a sale or disposition of all or substantially all of the
         assets of the Company, or (C) the dissolution of the Company.


                  (g) "Claim" means any threatened, pending or completed action,
suit,  arbitration  or  proceeding  against or  directed at  Indemnitee  whether
brought  by or in the right of the  Company  or  otherwise,  or any  inquiry  or
investigation  against or directed at Indemnitee  that  Indemnitee in good faith
believes might lead to the institution of any such action, suit,  arbitration or
proceeding, whether civil, criminal, administrative,  investigative or other, or
any appeal therefrom.

                  (h)  "Continuing  Directors"  means  directors  (i)  who  were
directors of the Company at the  beginning of the 24-month  period ending on the
date the  determination  is made (the  "Period"),  or (ii)  whose  election,  or
nomination for election,  by the Company's  stockholders  was approved by (A) at
least a majority of the  directors who are in office at the time of the election
or nomination  and who either (i) were directors at the beginning of the Period,
or (ii) were elected, or nominated for election, by a at least a majority of the
directors who were in office at the time of the election or nomination  and were
directors  at the  beginning  of the Period,  or (B) a committee of the Board of
Directors elected or approved by at least a majority of the directors who are in
office at the time of the election or approval of such  committee and who either
(i) were  directors at the  beginning of the Period,  or (ii) were  elected,  or
nominated for election, by at least a majority of the directors


                                                         3

<PAGE>



who were in office at the time of such election or nomination and were directors
at the beginning of the Period.

                  (i) "D & O Insurance" means any valid directors' and officers'
liability  insurance  policy  maintained  by the  Company for the benefit of the
Indemnitee, if any.

                  (j)  "Determination"  means a determination,  and "Determined"
means a matter which has been  determined  based on the facts known at the time,
by: (i) a majority vote of a quorum of Disinterested  Directors, or (ii) if such
quorum is not obtainable,  or even if obtainable,  if a quorum of  Disinterested
Directors  so  directs,  by  Independent  Legal  Counsel  in a  written  opinion
addressed to the Company and Indemnitee, or in the event there has been a Change
in Control,  by (A) Special  Independent Counsel (in a written opinion addressed
to the Company and Indemnitee) selected by Indemnitee as set forth in Section 6,
or (B) a majority  vote of a quorum of  Disinterested  Directors of the Board of
Directors  of the  Company or of the  ultimate  parent  entity of the Company or
Independent  Legal Counsel as set forth in Section 6, or (iii) a majority of the
Disinterested  Stockholders  of the Company,  or (iv) a final  adjudication by a
court of competent jurisdiction.

                  (k)  "Disinterested  Director" means a director of the Company
(or, if  applicable,  the ultimate  parent entity of the Company) who is not and
was  not  a  party  to  the  Claim  giving  rise  to  the  subject  matter  of a
Determination.

                  (l)  "Disinterested  Stockholder"  means a stockholder  of the
Company  who is not and was not a party to the Claim  giving rise to the subject
matter of a Determination.

                  (m) An "Employee Plan Fiduciary"  means a Person who serves in
a fiduciary  capacity  with  respect to an employee  benefit plan (as defined in
Section 3(3) of the Employee Retirement Income Security Act of 1974, as amended)
of the Company or any Subsidiary.

                  (n) "Equity Security" has the meaning given to such term under
Rule 3a11-1 of the General Rules and Regulations under the Act.

                  (o) "Excluded Claim" means any payment for Losses and Expenses
in  connection  with any Claim:  (i) based upon or  attributable  to  Indemnitee
gaining in fact any  personal  profit or advantage  to which  Indemnitee  is not
entitled;  or (ii) for the  return by  Indemnitee  of any  remuneration  paid to
Indemnitee  without the  previous  approval of the  stockholders  of the Company
which is illegal;  or (iii) for an  accounting  of profits in fact made from the
purchase or sale by Indemnitee  of securities of the Company  within the meaning
of  Section  16 of the Act;  or (iv)  resulting  from  Indemnitee's  fraudulent,
deliberately dishonest or willful misconduct,  conduct in bad faith or a knowing
violation of law  (including  criminal  law); or (v) the payment of which by the
Company under this  Agreement is not permitted by applicable  law; or (vi) based
upon or attributable to an intentional  infliction of harm on the Company or its
stockholders;  or (vii)  based upon any  violation  of Section  174 of the State
Corporation Law, as amended.

                  (p)  "Expenses"  means any  reasonable  expenses  incurred  by
Indemnitee  as a  result  of a Claim  or  Claims  made  against  Indemnitee  for
Indemnifiable Events, including,  without limitation,  reasonable attorneys fees
and all other reasonable costs, expenses and obligations paid


                                                         4

<PAGE>



or incurred in connection with investigating,  defending,  being a witness in or
participating  in (including on appeal) or preparing to defend,  be a witness in
or participate in any Claim relating to any Indemnifiable Event.

                  (q) "Fines"  means any fine,  penalty  or, with  respect to an
employee benefit  plan, any excise tax or penalty assessed with respect thereto.

                  (r)  "Indemnifiable  Event"  means  any  event or  occurrence,
occurring prior to or after the date of this Agreement, related to the fact that
Indemnitee is or was a director,  officer, employee, trustee, agent or fiduciary
of the  Company,  or is or  was  serving  at the  request  of the  Company  as a
director,  officer,  employee,  trustee, committee member, agent or fiduciary of
another corporation, partnership, joint venture, employee benefit plan, trust or
other  enterprise,  or by reason  of  anything  done or not done by  Indemnitee,
including, but not limited to, any breach of duty, neglect, error, misstatement,
misleading  statement,  omission,  or other act done or wrongfully  attempted by
Indemnitee,  or any of the  foregoing  alleged  by  any  claimant,  in any  such
capacity.

                  (s)  "Independent  Legal Counsel" means a law firm or a member
of a law firm that (i)  neither is nor in the past five years has been  retained
to represent any material matter by the Company,  any Subsidiary,  Indemnitee or
any other party to the Claim,  (ii) under  applicable  standards of professional
conduct then  prevailing  would not have a conflict of interest in  representing
either the Company or Indemnitee in an action to determine  Indemnitee"s  rights
to indemnification  under this Agreement,  and (iii) is reasonably acceptable to
the Company and Indemnitee.

                  (t)  "Losses"  means any amounts or sums which  Indemnitee  is
legally  obligated  to pay  as a  result  of a  Claim  or  Claims  made  against
Indemnitee for Indemnifiable  Events  including,  without  limitation,  damages,
attorneys' fees,  judgments and sums or amounts paid in settlement of a Claim or
Claims, and Fines.

                  (u) "Person" means any individual,  partnership,  corporation,
limited liability partnership,  limited liability corporation, limited liability
company, business trust, joint stock company, trust, unincorporated association,
joint venture, governmental authority or other entity of whatever nature.

                  (v) "Relative"  means a Person's  spouse,  parents,  children,
siblings, mothers- and fathers-in-law,  sons- and daughters-in-law and brothers-
and sisters-in-law.

                  (w)  "Reviewing  Party" means any  appropriate  person or body
consisting  of a member or members of the  Company's  Board of  Directors or any
other person or body appointed by the Board (including Independent Legal Counsel
and Special Independent  Counsel) who is not a party to the particular Claim for
which Indemnitee is seeking indemnification.

                  (x)  A "Rule" shall  refer  to a rule of the General Rules and
Regulations under the Act.



                                                         5

<PAGE>



                  (y) A "Special  Independent  Counsel" means  Independent Legal
Counsel that shall have the authority and responsibility more fully set forth in
Section 6 hereof and shall be compensated by the Company as more fully set forth
in said section.

                  (z) The  "State Corporation Law" means the General Corporation
Law of the State of Delaware.

                  (aa)  "Subsidiary"  means any  corporation  of which more than
fifty  percent  (50%) of any class of Equity  Security  is  owned,  directly  or
indirectly, by the Company.

                  (bb) "Voting Shares" means any issued and  outstanding  shares
of capital  stock of the Company  entitled to vote  generally in the election of
directors.

         2. Basic  Indemnification  Agreement.  In  consideration  of, and as an
inducement to, the Indemnitee  rendering  valuable services to the Company,  the
Company agrees that in the event  Indemnitee is or becomes a party to or witness
or other  participant  in, or is  threatened to be made a party to or witness or
other  participant  in,  a Claim by  reason  of (or  arising  in part out of) an
Indemnifiable  Event,  the Company shall  advance  Expenses to and indemnify and
hold Indemnitee  harmless to the fullest extent  authorized by law,  against any
and all Expenses  and Losses  (including  all  interest,  assessments  and other
charges paid or payable in  connection  with or in respect of such  Expenses and
Losses of such  Claim),  whether or not such Claim  proceeds  to  judgment or is
settled or otherwise is brought to a final disposition, subject in each case, to
the further provisions of this Agreement.

         3. Limitations on  Indemnification.  Notwithstanding  the provisions of
Section 2, Indemnitee shall not be indemnified and held harmless from any Losses
or Expenses (a) which have been Determined, as provided herein, to constitute an
Excluded Claim;  (b) to the extent  Indemnitee is indemnified by the Company and
has  actually   received  payment  pursuant  to  the  By-laws,   Certificate  of
Incorporation,  D&O Insurance,  or otherwise;  or (c) other than pursuant to the
last  sentence  of Section  4(d) or  Section  13, in  connection  with any Claim
initiated  by  Indemnitee,  unless  the  Company  has  joined in or the Board of
Directors has authorized such Claim.  Indemnitee  shall have the right to appeal
any  Determination to a court of competent  jurisdiction and if successful shall
be entitled to receive  indemnification  against or for any Losses and  Expenses
incurred in connection with such appeal.

         4.       Indemnification Procedures

                  (a) Within ten (10) days after receipt by Indemnitee of notice
of any Claim,  Indemnitee shall, if indemnification  with respect thereto may be
sought  from the  Company  under  this  Agreement,  notify  the  Company  of the
commencement  thereof and shall include in or with the notice such documentation
and  information  as is  reasonably  available to  Indemnitee  and is reasonably
necessary  to  determine  whether and to what extent  Indemnitee  is entitled to
indemnification.  The Secretary of the Company  shall,  promptly upon receipt of
such a notice from  Indemnitee,  advise the Board of  Directors  in writing that
Indemnitee has requested  indemnification.  The foregoing  notwithstanding,  any
failure by  Indemnitee  to notify the Company of the  commencement  of any Claim
will not  relieve the Company of any  liability  that it may have to  Indemnitee
hereunder, except


                                                         6

<PAGE>



to the extent that the Company  demonstrates  that the defense of such action is
prejudiced  by  Indemnitee's  failure  to give such  notice.  Indemnitee  agrees
further not to make any admission or effect any settlement  with respect to such
Claim without the consent of the Company, except any Claim with respect to which
the Indemnitee has undertaken the defense in accordance  with the second to last
sentence of Section 4(d).

                  (b) If, at the time of the receipt of such notice, the Company
has D&O  Insurance  in  effect,  the  Company  shall give  prompt  notice of the
commencement of such Claim to the insurers in accordance with the procedures set
forth in the respective  policies.  The Company shall  thereafter use reasonable
efforts to cause such insurers to pay, on behalf of  Indemnitee,  all Losses and
Expenses payable as a result of such Claim.

                  (c) To the extent  the  Company  does not,  at the time of the
Claim,  have applicable D&O Insurance,  or if a  Determination  is made that any
Expenses  arising out of such Claim will not be payable  under the D&O Insurance
then in effect, or in the event and to the extent that the D&O Insurance then in
effect fails to pay Expenses  arising out of such Claim or the insurer  fails to
assume the  defense of the Claim,  the  Company  shall be  obligated  to pay the
Expenses  of any Claim in  advance  of the  final  disposition  thereof  and the
Company, if appropriate,  shall be entitled to assume the defense of such Claim,
with  counsel  reasonably  satisfactory  to  Indemnitee  , upon the  delivery to
Indemnitee  of written  notice of its election so to do. After  delivery of such
notice,  the Company will not be liable to Indemnitee  under this  Agreement for
any  legal  or  other  Expenses  subsequently  incurred  by  the  Indemnitee  in
connection  with such defense other than  reasonable  Expenses of  investigation
incurred by Indemnitee at the request of the Company;  provided that  Indemnitee
shall have the right to employ his or her own counsel in such Claim but the fees
and expenses of such counsel  incurred after delivery of notice from the Company
of its assumption of such defense shall be at the Indemnitee's expense; provided
further that if: (i) the  employment  of counsel by  Indemnitee at the Company's
expense has been  previously  authorized  by the  Company;  (ii) there is, under
applicable  standards  of  professional  conduct,  a conflict of interest on any
significant  issue  between the  positions of the Company and  Indemnitee in the
conduct of any such  defense;  or (iii) the  Company  shall not,  in fact,  have
employed  counsel to assume the defense of such action,  the reasonable fees and
expenses of counsel shall be at the expense of the Company;  provided,  however,
that the  Indemnitee  together with all other parties being  indemnified  by the
Company  under  agreements  similar  to this  Agreement  or the  Certificate  of
Incorporation  or  By-laws,  shall be entitled as a group to retain only one law
firm to represent  them in any single action  unless there is, under  applicable
standards of professional  conduct,  a conflict on any significant issue between
the positions of any two or more such indemnitees, in which case each indemnitee
with respect to whom such a conflict  exists (or group of indemnitees  who among
them have no such  conflict)  may retain one  separate  law firm.  In  addition,
Indemnitee  shall  have the  right to  appeal  any  Determination  to a court of
competent  jurisdiction,   and  if  successful  shall  be  entitled  to  receive
indemnification  against and for Losses and Expenses incurred in connection with
such appeal.

                  (d) All payments on account of the  Company's  indemnification
obligations  under  this  Agreement  shall be made  within  sixty  (60)  days of
Indemnitee's  written request therefor (which shall in no event be made prior to
Indemnitee being liable therefor) unless a Determination is made that the Claims
giving rise to Indemnitee's request are Excluded Claims or otherwise not payable
under this  Agreement,  provided  that all payments on account of the  Company's
obligation to pay


                                                         7

<PAGE>



Expenses under Section 4(c) of this Agreement prior to the final  disposition of
any Claim shall be made within twenty (20) days of Indemnitee's  written request
therefor  (which  shall in no event be made  prior to  Indemnitee  being  liable
therefor) and such obligation shall not be subject to any such Determination but
shall be subject to Section  4(e) of this  Agreement.  In the event the  Company
takes the position  that the  Indemnitee is not entitled to  indemnification  in
connection with any Claim,  the Indemnitee  shall have the right at Indemnitee's
own expense to undertake  defense of any such Claim,  insofar as such proceeding
involves Claims against the  Indemnitee,  by written notice given to the Company
within ten (10) days after the Company has notified the Indemnitee in writing of
its contention that the Indemnitee is not entitled to indemnification.  If it is
subsequently   determined  in   connection   with  such   proceeding   that  the
Indemnifiable Events are not Excluded Claims and that the Indemnitee, therefore,
is entitled to be  indemnified  under the  provisions  of Section 2 hereof,  the
Company shall promptly indemnify the Indemnitee.

                  (e)  Indemnitee  hereby  expressly  undertakes  and  agrees to
reimburse  the  Company  for all  Losses  and  Expenses  paid by the  Company in
connection with any Claim against Indemnitee in the event and only to the extent
that a determination  shall have been made by a court of competent  jurisdiction
in a decision from which there is no further right to appeal that  Indemnitee is
not  entitled to be  indemnified  by the  Company  for such Losses and  Expenses
because the Claim is an Excluded  Claim or because  Indemnitee  is otherwise not
entitled to payment under this Agreement; and, further, Indemnitee shall pay the
costs and  expenses of the Company if it obtains such a  determination  and such
court further  determines  that the position of such  Indemnitee was not made in
good faith or was frivolous.

                  (f)  Indemnitee  agrees to cooperate with any Persons making a
Determination with respect to Indemnitee's  entitlement to indemnification under
this  Agreement,  including  providing  to such Person upon  reasonable  advance
request any  documentation  or information  which is not privileged or otherwise
protected from disclosure and which is reasonably available to Indemnitee and is
reasonably necessary to such Determination.  Any Expenses incurred by Indemnitee
in so cooperating with the Persons making such  Determination  shall be borne by
the Company (irrespective of the Determination as to Indemnitee's entitlement to
indemnification)  and the  Company  hereby  indemnifies  and  agrees to hold the
Indemnitee harmless therefrom.

         5.  Settlement.  The  Company  shall have no  obligation  to  indemnify
Indemnitee  under this Agreement for any amounts paid in settlement of any Claim
effected without the Company's prior written  consent.  The Company shall not be
required  to obtain the consent of  Indemnitee  to the  settlement  of any Claim
which the Company has undertaken to defend if the Company  assumes full and sole
responsibility  for such  settlement  and the  settlement  grants  Indemnitee  a
complete and unqualified release in respect of the potential liability.  Neither
the Company nor  Indemnitee  shall  unreasonably  withhold  their consent to any
proposed settlement.

         6.  Change in Control; Extraordinary Transactions.  (a) The Company and
Indemnitee  agree  that if there is a Change of Control of the sort set forth in
clause (i) of Section 1(f), then all  Determinations  thereafter with respect to
the rights of  Indemnitee  to be paid Losses and Expenses  under this  Agreement
shall be made by a majority vote of a quorum of  Disinterested  Directors of the
Company,  or if the  Company  is a  Subsidiary  of any other  Person,  then by a
majority  vote of a quorum of  Disinterested  Directors of the  ultimate  parent
entity of the Company, or if such


                                                         8

<PAGE>



a quorum is not obtainable,  or even if obtainable, if a quorum of Disinterested
Directors  of the  Company  or the  ultimate  parent  entity of the  Company  so
directs,  by  Independent  Legal Counsel in a written  opinion  addressed to the
Company  and  Indemnitee,  or,  in  any  such  case,  by a  court  of  competent
jurisdiction.  The  Company  and  Indemnitee  agree that if there is a Change in
Control of the  Company  other than a Change of Control of the sort set forth in
clause (i) of Section 1(f), then all  Determinations  thereafter with respect to
the rights of  Indemnitee  to be paid Losses and Expenses  under this  Agreement
shall be made only by a Special  Independent  Counsel selected by Indemnitee and
approved by the Company (which approval shall not be  unreasonably  withheld) or
by a court of competent jurisdiction.  The Company shall pay the reasonable fees
of such Special Independent Counsel and shall indemnify such Special Independent
Counsel against any and all reasonable expenses (including reasonable attorneys'
fees),  claims,  liabilities  and  damages  arising  out of or  relating to this
Agreement or its engagement pursuant hereto.

                  (b) The Company  covenants  and agrees that, in the event of a
Change in Control  of the sort set forth in clause  (iv) of  Section  1(f),  the
Company  will use all  reasonable  efforts  (i) to have the  obligations  of the
Company under this Agreement  expressly assumed by the surviving,  purchasing or
succeeding  entity, or (ii) otherwise to adequately provide for the satisfaction
of the  Company's  obligations  under  this  Agreement,  in a manner  reasonably
acceptable to the Indemnitee.

         7. No Presumption.  For purposes of this Agreement,  the termination of
any  Claim  by  judgment,  order,  settlement  (whether  with or  without  court
approval) or conviction,  or upon a plea of nolo contendere,  or its equivalent,
shall not, of itself,  create a  presumption  that  Indemnitee  did not meet any
particular standard of conduct or have any particular belief or that a court has
determined that indemnification is not permitted by applicable law.

         8.  Non-exclusivity,  Duration,  Etc.  The  rights  of  the  Indemnitee
hereunder shall be in addition to any other rights Indemnitee may have under the
Certificate of Incorporation,  the By-laws, the State Corporation Law, any other
agreement, any vote of Disinterested  Stockholders or Disinterested Directors or
otherwise,  both as to action in the  Indemnitee's  official  capacity and as to
action  in any other  capacity  by  holding  such  office,  and the  rights  and
obligations  under this Agreement  shall continue in full force and effect after
the  Indemnitee  ceases to serve the Company as a director,  officer,  employee,
agent or fiduciary,  and for so long as the  Indemnitee  shall be subject to any
Claim by reason of (or arising in part out of) an Indemnifiable  Event and until
all applicable  statutes of limitation have expired. To the extent that a change
in the State  Corporation Law (whether by statute or judicial  decision) permits
greater  indemnification by agreement than would be afforded currently under the
By-laws, Certificate of Incorporation or this Agreement, it is the intent of the
parties  hereto  that  Indemnitee  shall  enjoy by this  Agreement  the  greater
benefits  so afforded  by such  change.  In the event that a change in the State
Corporation Law (whether by statute or judicial  decision)  narrows the right of
the Company to indemnify its directors, officers, employees or fiduciaries, such
change, to the extent not otherwise required by such law, statute or decision to
be applied to this  Agreement,  shall not affect this  Agreement or the parties'
rights and obligations hereunder.

         9.  Liability  Insurance.  To  the  extent  the  Company  maintains  an
insurance  policy or  policies  providing  directors'  and  officers'  liability
insurance,  Indemnitee,  if an  officer or  director  of the  Company,  shall be
covered by such policy or   policies,  in accordance with its or their terms, to


                                                         9

<PAGE>



the maximum extent of the coverage  available for any director or officer of the
Company.  The Company shall have no obligation to maintain  insurance  providing
directors' and officers'  liability  coverage if the Company  determines in good
faith that such insurance is not reasonably  available or is too expensive,  the
premium costs for such insurance are  disproportionate to the amount of coverage
provided, or the coverage provided by such insurance is limited by exclusions so
as to provide an insufficient benefit.

         10.  Subrogation.  In the event of payment  under this  Agreement,  the
Company  shall be  subrogated to the extent of such payment to all of the rights
of recovery of  Indemnitee,  who shall execute all papers  required and shall do
everything that may be necessary to secure such rights,  including the execution
of such documents  necessary to enable the Company  effectively to bring suit to
enforce such rights.

         11.  Partial  Indemnity,  Etc.  If  Indemnitee  is  entitled  under any
provision  of this  Agreement  to  indemnification  by the Company for some or a
portion of the Expenses and Losses of a Claim but not,  however,  for all of the
total amount thereof,  the Company shall nevertheless  indemnify  Indemnitee for
the portion thereof to which Indemnitee is entitled.  Moreover,  notwithstanding
any other  provision of this  Agreement,  to the extent that Indemnitee has been
successful  on the merits or otherwise in defense of any or all Claims  relating
in whole or in part to any  Indemnifiable  Event or in  defense  of any issue or
matter therein,  including  dismissal  without  prejudice,  Indemnitee  shall be
indemnified against all Expenses incurred in connection therewith. In connection
with any  Determination  as to whether  Indemnitee is entitled to be indemnified
hereunder,  the  burden  of proof  shall be on the  Company  to  establish  that
Indemnitee is not so entitled.

         12.  Liability  of Company.  The  Indemnitee  agrees  that  neither the
stockholders  nor the directors  nor any officer,  employee,  representative  or
agent of the Company  shall be  personally  liable for the  satisfaction  of the
Company's obligations under this Agreement, and the Indemnitee shall look solely
to the assets of the Company for satisfaction of any claims hereunder.

         13.      Enforcement.

                  (a) Indemnitee's  right to   indemnification  and other rights
under this Agreement shall be  specifically  enforceable by Indemnitee and shall
be enforceable  notwithstanding any adverse Determination by the Company's Board
of Directors,  Independent Legal Counsel, the Special Independent Counsel or the
Company's  stockholders,  and no such  Determination  shall create a presumption
that Indemnitee is not entitled to be indemnified hereunder.

                  (b) In the event that any  action is instituted  by Indemnitee
under  this  Agreement,  or to  enforce  or  interpret  any of the terms of this
Agreement,  to the extent that  Indemnitee is the  prevailing  party  Indemnitee
shall be entitled to be paid all court costs and reasonable expenses,  including
reasonable counsel fees, incurred by Indemnitee with respect to such action.

         14. Severability.  In the event that any provision of this Agreement is
determined by a court to require the Company to do or to fail to do an act which
is in violation of  applicable  law,  such  provision  (including  any provision
within a single section, paragraph or sentence) shall be limited


                                                        10

<PAGE>



or  modified  in its  application  to the minimum  extent  necessary  to avoid a
violation  of law,  and,  as so limited or  modified,  such  provisions  and the
balance of this Agreement shall be enforceable in accordance with their terms to
the fullest extent permitted by law.

         15. Governing Law. This Agreement shall be governed by and construed in
accordance with the laws of the State of Delaware  applicable to agreements made
and to be performed entirely within such State,  without reference to the choice
of law provisions of such State.

         16. Consent to Jurisdiction. The Company and the Indemnitee each hereby
consent to the non-exclusive  jurisdiction of the courts of the State of Alabama
for all purposes in connection with any action or proceeding which arises out of
or relates to this  Agreement  and agree that any action  instituted  under this
Agreement  may be  brought  in the  state  and  Federal  courts  of the State of
Alabama.

         17. Notices. All notices or other communications  required or permitted
hereunder  shall be  sufficiently  given  for all  purposes  if in  writing  and
personally delivered,  telegraphed, telexed, sent by facsimile transmission sent
by registered or certified mail, return receipt requested, with postage prepaid,
or by nationally recognized overnight courier,  addressed as follows, or to such
other address as the parties shall have given notice of pursuant hereto:

                  (a)      If to the Company to:

                           Cavalier Homes, Inc.
                           Highway 41 North and Cavalier Road
                           Addison, Alabama 35540
                           Fax: 205/747-3044
                           Attn: __________________

                           With a copy to:






                  (b)      If to the Indemnitee, to:

                           Mr. Barry B. Donnell
                           Cavalier Homes, Inc.
                           719 Scott Avenue, Suite 600
                           P.O. Box 5003
                           Wichita Falls, TX  76307
                           Fax: 940/766-4616

         18. Counterparts. This Agreement may be signed in counterparts, each of
which  shall  be an  original  and all of  which,  when  taken  together,  shall
constitute one and the same instrument.


                                                        11

<PAGE>



         19.  Successors and Assigns.  This Agreement  shall be (i) binding upon
all  successors  and assigns of the  Company,  including  any direct or indirect
successor  by   purchase,   merger,   consolidation   or  otherwise  to  all  or
substantially all of the business and/or assets of the Company, and (ii) binding
upon and inure to the benefit of any successors and assigns, heirs, and personal
or legal representatives of Indemnitee.

         20.  Amendment;  Waiver.  No amendment,  modification,  termination  or
cancellation  of this  Agreement  shall be  effective  unless  made in a writing
signed by each of the parties hereto. No waiver of any of the provisions of this
Agreement  shall be deemed or shall  constitute a waiver of any other  provision
hereof  (whether or not similar)  nor shall such waiver  constitute a continuing
waiver.


                                             [SIGNATURE PAGE FOLLOWS]




                                                        12

<PAGE>


                  IN WITNESS  WHEREOF,  the Company and Indemnitee have executed
this Agreement as of the day and year first above written.


                                              CAVALIER HOMES, INC.

                                              By:                               

                                              ----------------------------------
                                                         Printed Name

                                              Title:                            


ATTEST:

By:                                                  

- ---------------------------------
           Printed Name

Title:                                               


                                              INDEMNITEE

                                              [L.S.]
                                              ----------------------------------



                                                        13


                                 August 26, 1998




Mr. Barry B. Donnell
Cavalier Homes, Inc.
719 Scott Avenue, Suite 600
Wichita Falls, TX 76307

                           Re:      Retention and Severance Agreement


Dear Mr. Donnell:

         Cavalier Homes, Inc., a Delaware corporation (the "Company"), considers
the establishment and maintenance of a sound and vital senior management team to
be essential to protecting  and enhancing the best  interests of the Company and
its  stockholders.   In  this  connection,   the  Company  recognizes  that  the
possibility  of a change  in  control  may  exist in the  future,  and that such
possibility,  and  the  uncertainty  and  questions  which  it may  raise  among
management,  may result in the departure or distraction of management  personnel
to the detriment of the Company and its stockholders.  Accordingly, the Board of
Directors of the Company (the "Board") has  determined  that  appropriate  steps
should  be  taken  to  reinforce  and  encourage  the  continued  attention  and
dedication of members of the Company's senior management, including yourself, to
their  assigned  duties  without  distraction  in the  face  of the  potentially
disturbing  circumstances arising from the possibility of a change in control of
the Company.  The Board has also  determined  that  appropriate  steps should be
taken to encourage senior management's participation, in the event of a proposed
change of  control,  in the  successful  completion  of the  change  of  control
transaction while  maintaining their focus on business  performance and strategy
execution.

         In order to induce  you to remain in the employ of the  Company  and in
consideration of your agreeing to remain in the employ of the Company subject to
the terms and conditions set forth below,  this letter  agreement sets forth the
benefits  which the  Company  agrees  will be  provided to you in the event your
employment  with the Company is terminated  subsequent to a change in control of
the  Company  (as  defined  in  Section 2 of this  letter  agreement)  under the
circumstances described below.

         1. Company's Right to Terminate.  You  acknowledge  that this Agreement
does not operate as an employment  contract nor establish any right of continued
employment  with the Company and that the Company may terminate your  employment
at any time,  subject  to  providing  the  benefits  hereinafter  specified,  if
applicable, in accordance with the terms hereof.




<PAGE>


Mr. Barry Donnell
August 26, 1998
Page 2                  


         2. Change in Control.  No benefits  shall be payable  hereunder  unless
there shall have been a change in control of the Company, as set forth below and
such change of control occurs prior to the termination of your  employment.  For
purposes  of this  Agreement,  a "change in control of the  Company"  means with
respect to the Company, if subsequent to the date of this Agreement:

                  (a) Any person, entity or "group" (within the meaning of Rules
13d-1  through  13d-6 of the  Securities  Exchange Act of 1934,  as amended (the
"Exchange  Act")) (other than any  subsidiary or affiliate as of the date hereof
of the Company or any employee  benefit plan of the Company) (i) has acquired or
agreed to  acquire  beneficial  ownership  of 20% or more of the  voting  and/or
economic  interest in the capital stock of the Company,  or (ii) has obtained or
agreed to obtain the power (whether or not exercised) to elect a majority of the
board of directors of the Company; or

                  (b) A majority of the board of directors of the Company  shall
consist  at such time of  individuals  other  than (x)  members  of the board of
directors  on the date hereof and (y) other  members of such board of  directors
nominated,  recommended, elected, or approved to succeed or become a director by
a majority of such members  referred to in clause (x) or a nominating  committee
elected or appointed by such members  referred to in clause (x) or by members so
nominated, recommended, elected or approved (such directors described in clauses
(x) and  (y)  above  being  hereinafter  sometimes  referred  to as  "Continuing
Directors"); or

                  (c) The approval by the  stockholders  of the Company of (i) a
merger or  consolidation  of the Company,  statutory  share  exchange,  or other
similar transaction with another  corporation,  partnership,  or other entity or
enterprise  in which  either the  Company  is not the  surviving  or  continuing
corporation  (other  than such a  transaction  that is solely for the purpose of
changing  the  domicile of the Company) or shares of common stock of the Company
are to be converted  into or exchanged  for cash,  securities  other than common
stock of the Company,  or other  property,  (ii) a sale or disposition of all or
substantially all of the assets of the Company,  or (iii) the dissolution of the
Company; or

                  (d) Any  transaction  or event  relating to the Company occurs
which is (or which  would be if the  Company  had a class of  equity  securities
registered  under  Section 12 of the  Exchange  Act)  required  to be  described
pursuant to the  requirements  of Item 6(e) of Schedule  14A of  Regulation  14A
promulgated under the Exchange Act.

         3. Termination   Following  Change  in  Control.  If any of the  events
described  in Section 2 hereof  constituting  a change in control of the Company
shall have occurred, you shall be entitled to the benefits provided in Section 4
hereof  upon  the  subsequent  voluntary  or  involuntary  termination  of  your
employment,  whether by you or by the Company, if such termination occurs within
the period  beginning on the date that the change of control is  completed  (the
"Change of Control Date") and ending on the second  anniversary of the Change of
Control Date (the "Trigger



<PAGE>


Mr. Barry Donnell
August 26, 1998
Page 3                  


Period")  unless such  termination  is (i) because of your death or  Retirement,
(ii) by the  Company  for Cause or (iii) by the  Company  or you for  Disability
(such  termination  within such period, as limited by clauses (i) through (iii),
being sometimes  referred to hereinafter as a "Payment  Trigger").  In the event
your employment is terminated  within the Trigger Period,  whether by you or the
Company,  following  the  occurrence of any of the events set forth at paragraph
(c)  below,  such  termination  of your  employment  shall  be  deemed  to be an
involuntary  termination of your employment by the Company and shall entitle you
to the benefits provided in Section 4 hereof.

                  (a)      Disability; Retirement.

                           (i)   "Disability"  shall  mean  a  disability  which
         entitles  you  to a  disability  benefit  under  a  disability  program
         sponsored  or  maintained  by the  Company;  provided,  that if no such
         program is applicable to you, then "Disability"  shall mean that, based
         on  medical  evidence  reasonably   satisfactory  to  the  Compensation
         Committee  of the Board,  you are  totally  and  permanently  unable to
         engage  in any  occupation  or  gainful  employment  for  which you are
         reasonably suited by background, training, education or experience.

                           (ii)  Termination  by the  Company  or  you  of  your
         employment  based on "Retirement"  shall mean termination in accordance
         with the  Company's  retirement  policy,  including  early  retirement,
         generally applicable to its salaried employees.

                  (b) Cause.  Termination by the Company of your  employment for
         "Cause" shall mean termination based upon on any of the following:

                           (i)   dishonesty or fraud by you   in connection with
         your employment;

                           (ii)  appropriation  (or attempted  appropriation) by
         you  of a  material  business  opportunity  of the  Company,  including
         attempting to secure or securing any personal profit in connection with
         any transaction entered into on behalf of the Company;

                           (iii) misappropriation   by    you    (or   attempted
         misappropriation) of any of the Company's funds or property;

                           (iv)  your conviction  of, or indictment  for (or its
         procedural  equivalent)  or  entering  of a  guilty  plea or plea of no
         contest  with  respect  to,  a felony  or any  other  criminal  offense
         involving moral turpitude (other than traffic offenses); or




<PAGE>


Mr. Barry Donnell
August 26, 1998
Page 4                  


                           (v) willful  misconduct by you in the  performance of
         your duties with the Company,  as determined by the good faith judgment
         of the Compensation Committee of the Board.

For purposes of this paragraph, no act, or failure to act, on your part shall be
considered  "willful"  unless  done,  or omitted to be done,  by you not in good
faith and without any reasonable  belief that your action or omission was in the
best interest of the Company.  Notwithstanding  the foregoing,  you shall not be
deemed to have been  terminated for Cause unless and until there shall have been
delivered to you a copy of a Notice of  Termination  (as defined below) from the
Chief  Executive  Officer of the Company or the  Compensation  Committee  of the
Board,  after reasonable notice to you and an opportunity for you, together with
your counsel, to be heard before the Compensation Committee of the Board (or, if
there be no such committee or such committee delivers the Notice of Termination,
the  Board  of  Directors),  finding  that in the  good  faith  opinion  of such
committee  (or the Board) you were  guilty of conduct set forth above in clauses
(i),  (ii),  (iii),  (iv) or (v) of the first  sentence  of this  paragraph  and
specifying the particulars thereof in detail.

                  (c) Constructive  Termination.  Your employment will be deemed
to have been  involuntarily  terminated by the Company upon the  termination  of
your employment,  whether by you or by the Company,  following the occurrence of
any of the following  without your prior  written  consent (any such event being
sometimes referred to hereinafter as your "Constructive Termination"):

                           (i)   subsequent   to  a   change in   control of the
         Company, any reduction in   your  title,  duties,  responsibilities  or
         authority with the Company immediately prior to the change in  control,
         except in connection  with  the  termination  of  your  employment  for
         Cause,  Disability,  Retirement  or  as  a  result  of  your  death  or
         voluntarily by you; or 

                           (ii)  subsequent  to  a  change  in  control  of  the
         Company,  a  reduction  by the Company in your base salary as in effect
         immediately prior to the change in control; or

                           (iii) subsequent  to a  change  in   control  of  the
         Company,  a failure by the Company to continue any bonus plans in which
         you are presently  entitled to  participate as the same may be modified
         from time to time prior to (but not in anticipation  of) such change in
         control,  or as the same  may be  modified  following  such  change  in
         control as may be  required  by or  desirable  for the  Company  due to
         changes to (x) the  Internal  Revenue  Code of 1986,  as  amended  (the
         "Code"),   (y)  applicable   accounting  rules  or  principles  or  (z)
         applicable  laws or regulations,  including,  without  limitation,  the
         Employee  Retirement Income and Security Act of 1974, as amended,  (the
         "Bonus Plans") or a failure by the Company to continue you



<PAGE>


Mr. Barry Donnell
August 26, 1998
Page 5                  


         as a  participant  in the Bonus Plans on at least the same basis as you
         are  participating in accordance with the Bonus Plans immediately prior
         to the change in control; or

                           (iv)  subsequent  to  a  change  in  control  of  the
         Company,  the  failure by the Company to continue in effect any benefit
         or compensation plan, life insurance plan,  health-and-accident plan or
         disability plan in which you are participating immediately prior to the
         change  in  control  of  the  Company  (or  plans  providing  you  with
         substantially  similar  benefits),  the  taking  of any  action  by the
         Company which would materially  adversely affect your  participation in
         or materially  reduce your benefits  under any of such plans or deprive
         you of any material fringe benefit enjoyed by you immediately  prior to
         the change in  control,  or the  failure by the  Company to provide you
         with the number of paid vacation days to which you are then entitled in
         accordance  with  the  Company's   normal  vacation  policy  in  effect
         immediately prior to the change in control; or

                           (v)   subsequent  to  a  change  in  control  of  the
         Company, the failure by the Company to obtain  the assumption of or the
         agreement to perform this Agreement by any successor as contemplated in
         Section 7 hereof; or

                           (vi)  subsequent  to  a  change  in  control  of  the
         Company, a change in the location of your employment greater than fifty
         (50) miles from your office location immediately prior to the change in
         control; or

                           (vii) subsequent  to a   change  in  control  of  the
         Company,  any purported  termination  of your  employment  which is not
         effected   pursuant  to  a  Notice  of   Termination   satisfying   the
         requirements of paragraph (d) below (and, if applicable,  paragraph (b)
         above); or

                           (viii)subsequent  to  a  change   in  control  of the
         Company, (A) at the direction or with the concurrence of members of the
         Board or  management  of the Company who became such members  following
         the change in control, a material business  strategic plan,  direction,
         policy or  program of the  Company  is  altered  in a  material  manner
         (hereinafter  a "Policy  Change"),  and (B) you  disagree in good faith
         with such  Policy  Change and  believe  in good faith that such  Policy
         Change will have a material  adverse effect on the Company and so state
         in a written  notice  delivered to the Board within thirty (30) days of
         becoming  aware (or thirty (30) days after you,  exercising  reasonable
         diligence, should have become aware) of such Policy Change, and (C) the
         Policy  Change is not reversed  within  thirty (30) days of the date on
         which  your  written  notice  is  received  by the  Board,  and (D) you
         terminate  your  employment  with  the  Company  as a  result  of  such
         disagreement and belief.




<PAGE>


Mr. Barry Donnell
August 26, 1998
Page 6                  


                  (d) Notice of  Termination.  Any purported  termination by the
Company  pursuant to your Disability or Retirement,  as defined in paragraph (a)
above,  or for Cause,  as defined in paragraph (b) above,  or by you pursuant to
your  Disability or  Retirement,  as defined in paragraph (a) above or by you or
the  Company  based on an event  of  Constructive  Termination,  as  defined  in
paragraph (c) above,  shall be  communicated by written Notice of Termination to
the  other  party  hereto.  For  purposes  of  this  Agreement,   a  "Notice  of
Termination"  shall mean a notice which shall indicate the specific  termination
provision in this Agreement relied upon and shall set forth in reasonable detail
the facts and  circumstances  claimed to provide a basis for termination of your
employment under the provision so indicated.

                  (e) Date of Termination.  "Date of Termination" shall mean (A)
if your employment is terminated for  Disability,  thirty (30) days after Notice
of  Termination  is given  (provided  that you  shall not have  returned  to the
performance  of your  duties on a  full-time  basis  during such thirty (30) day
period), (B) if you employment is terminated due to your death, the date of your
death, (C) if your employment is terminated pursuant to paragraph (b) above, the
date  specified  in the  Notice  of  Termination,  (D)  if  your  employment  is
terminated for Retirement, the date specified in the Notice of Termination,  and
(E) if your  employment is terminated for any other reason,  the date on which a
Notice of Termination  is given;  provided that if within thirty (30) days after
any  Notice  of  Termination  is  given  the  party  receiving  such  Notice  of
Termination  notifies  the other  party  that a dispute  exists  concerning  the
termination,  the Date of Termination  shall be the date on which the dispute is
finally  determined,  either by mutual written agreement of the parties, or by a
final judgment,  order or decree of a court of competent  jurisdiction (the time
for appeal  therefrom  having  expired  and no appeal  having  been  perfected);
provided  further,  however,  that if such  disputed  termination  constitutes a
Payment  Trigger,  the Trigger  Period shall not run pending  resolution  of the
dispute  but  shall  recommence  upon  the  date  that the  dispute  is  finally
determined (as set forth in the preceding proviso).

         4. Certain Benefits Upon Termination. (a) If, after a change in control
of the  Company  shall  have  occurred,  as  defined  in  Section 2 above,  your
employment  with the  Company  shall be  terminated  (including  a  Constructive
Termination)  within  the  Trigger  Period by the  Company or you other than for
Cause,  Disability,  Retirement  or death,  and other  than by your  voluntarily
terminating your employment with the Company,  then you shall be entitled to the
benefits provided below:

                           (i)   the Company shall pay to you within thirty (30)
days following the Date of Termination in a lump sum cash payment your full base
salary through the Date of Termination  at the rate in effect at the time Notice
of Termination is given plus (A) credit  for any  vacation earned but not taken,
(B) the amount, if any, of any bonus or long-term incentive  compensation  for a
past fiscal year which has been earned  but  not  yet been paid  to you, (C) the
amount,  if any, of any bonus for the  current  year to be paid as a  percentage
of Company  profit based on the Company's results through the most recent fiscal
quarter as of the Date of Termination without



<PAGE>


Mr. Barry Donnell
August 26, 1998
Page 7                  


pro-ration,  (D) a pro-rated payment, based on the Company's results through the
most recent  fiscal  quarter as of the Date of  Termination  under the Company's
performance  based  long-term  incentive  program for the long-term  performance
period that next ends  following  the Date of  Termination,  and (E) a pro-rated
payment,  based on the Company's  results as of the Date of Termination,  of any
other bonus due under any other Bonus Plans;

                           (ii)  in lieu of any  further salary  payments to you
for periods subsequent to the  Date  of  Termination, the  Company  shall pay as
severance pay to you within thirty (30) days following the Date of Termination a
lump sum cash amount equal to 2.99  times  the  sum of (A) the   amount  of your
annual  base  salary at the highest rate in effect during the twelve (12) months
immediately  preceding the  Date of  Termination,  and  (B) the  average  annual
bonus  received by you with respect to the three (3) years immediately preceding
the Date of Termination,  and (C)(x)  the  most  recent   amount   earned by you
(whether  in stock or  cash  or a  combination   thereof)  under  the  Company's
performance based long-term incentive program established  under  the  Company's
Executive  Incentive  Compensation Plan or,  (y) if  the   Date  of  Termination
giving  rise to your  right  to  benefits hereunder occurs before the end of the
initial  Long-Term  Performance Period established under the long-term incentive
program so that benefits have not  yet  accrued  under  the  long-term incentive
program,  the  target  amount  established  for  you under the  program  for the
Long-Term Performance Period next ending; and

                           (iii) the  Company  shall  maintain in full force and
effect, for your continued benefit  until  the earlier  of (A)  three  (3) years
after the Date of  Termination or (B) you obtain substantially the same coverage
from a new employer,  all life insurance,  medical,  health  and  accident,  and
disability   plans,  programs  or  arrangements  in  which you  were entitled to
participate  immediately prior to the Date of   Termination,  provided that your
continued  participation  is possible under the general terms and  provisions of
such plans and programs.  In the event that your participation in any such  plan
or program is barred, the Company shall use reasonable   efforts  to  arrange to
provide  you  with  benefits  substantially   similar  to  those  which  you are
entitled  to  receive  under  such  plans and programs.

                  (b) If,  after a change in control of the  Company  shall have
occurred,  as defined in Section 2 above, you shall  voluntarily  terminate your
employment with the Company within the Trigger Period other than for Disability,
Retirement or death or in connection with an event of Constructive  Termination,
then you shall be entitled to the benefits set forth below:

                           (i)   the Company shall pay to you within thirty (30)
days following the Date of Termination in a lump sum cash payment your full base
salary through the Date of  Termination at the rate in effect at the time Notice
of Termination is given plus (A) credit for any  vacation earned but  not taken,
(B) the amount,  if any, of any bonus or  long-term incentive  compensation  for
a past fiscal year which has been earned but not yet been paid to you,  (C)  the
amount,  if any, of any bonus for the  current  year to be paid as a  percentage
of Company  profit based on the Company's results through the most recent fiscal
quarter as of the Date of Termination without



<PAGE>


Mr. Barry Donnell
August 26, 1998
Page 8                  


pro-ration,  (D) a pro-rated payment, based on the Company's results through the
most recent  fiscal  quarter as of the Date of  Termination  under the Company's
performance  based  long-term  incentive  program for the long-term  performance
period that next ends  following  the Date of  Termination,  and (E) a pro-rated
payment,  based on the Company's  results as of the Date of Termination,  of any
other bonus due under any other Bonus Plans;

                           (ii)  in lieu of any further  salary  payments to you
for periods subsequent to  the  Date  of Termination, the  Company  shall pay as
severance pay to you within thirty (30) days following the Date of Termination a
lump sum cash amount equal to  the  sum  of  (A)  the amount of your annual base
salary  at  the  highest   rate  in  effect   during   the  twelve  (12)  months
immediately  preceding  the  Date  of Termination,  and (B) the  average  annual
bonus  received by you with respect to the three (3) years immediately preceding
the Date of Termination,  and  (C) (x)  the most  recent  amount  earned  by you
(whether in stock or  cash  or a   combination  thereof)   under  the  Company's
performance  based  long-term  incentive program established under the Company's
Executive Incentive Compensation Plan or, (y) if the Date of Termination  giving
rise to your right to benefits  hereunder occurs before  the end of the  initial
Long-Term Performance Period established under the long-term  incentive  program
so that  benefits  have not yet accrued  under the long-term  incentive program,
the target amount  established for   you   under   the program for the Long-Term
Performance Period next ending; and

                           (iii) the  Company  shall  maintain in full force and
effect, for your  continued  benefit   until   the  earlier  of  (A)  the  first
anniversary  of the  Date  of Termination  or (B)  you obtain substantially  the
same  coverage  from a new employer,  all life  insurance,  medical,  health and
accident,  and  disability plans,  programs  or  arrangements  in which you were
entitled to  participate immediately  prior to the Date of Termination, provided
that  your  continued participation  is possible  under  the  general  terms and
provisions of such plans and programs.  In the event that your  participation in
any such plan or program is barred,  the Company shall use  reasonable   efforts
to arrange to provide you with benefits substantially similar to those which you
are entitled to receive under such plans and programs.

                  (c) You shall not be required  to  mitigate  the amount of any
payment provided for in this Section 4 by seeking other employment or otherwise,
nor shall the amount of any payment provided for in this Section 4 be reduced by
any  compensation  earned by you as the result of employment by another employer
after the Date of Termination,  or otherwise.  In the event that you voluntarily
terminate  your   employment   with  the  Company  and  are  paid  the  benefits
contemplated by paragraph (b) of this Section 4 and, at any time within five (5)
years  following the receipt of such payment,  you are reemployed by the Company
or any subsidiary  thereof in a position  where your duties or  responsibilities
with the Company or such subsidiary are commensurate with those of your position
with  the  Company  immediately  prior  to  the  original  termination  of  your
employment  which  gave rise to the  Company's  payment of  benefits  under this
Section 4, you shall, on the date of such reemployment, be obligated to repay to
the Company, in cash, an amount equal to the benefit paid to you under paragraph
(b) of this Section 4, plus any amounts paid to you under Section 5 hereof



<PAGE>


Mr. Barry Donnell
August 26, 1998
Page 9                  


in connection with the payments to you pursuant to paragraph (b) of this Section
4 (and not previously repaid by you pursuant to the terms of Section 5).

         5.    Tax Gross-Up.

                  (a) If you become entitled to any payments or benefits whether
pursuant  to the terms of this  Agreement  or any  other  plan,  arrangement  or
agreement  with the  Company,  any person  whose  actions  result in a change in
control or any  person  affiliated  with the  Company  or such  persons  (in the
aggregate, "Payments" or singularly, "Payment") which are subject to taxes under
Section  4999 (or any  successor  provision  thereto)  of the Code (the  "Excise
Tax"), the Company shall pay to you an additional  amount  ("Gross-Up  Payment")
such that the net amount  retained by you, after deduction of (A) any Excise Tax
on Payments, (B) any federal, state and local income tax and Excise Tax upon the
payment provided for by this Section, and (C) any interest and penalties imposed
because the Excise Tax is not paid during the period  beginning with the earlier
of the date (i) the IRS issues a notice  stating  that an Excise Tax is due with
respect to a Payment,  (ii) you deliver to the Company an opinion of tax counsel
selected by you and  reasonably  acceptable to the Company that all or a portion
of the  Payment is subject to the  Excise Tax and  setting  forth the  estimated
amount of the Excise Tax on the Payment,  and (iii) the Company  delivers to you
an opinion of tax counsel  selected by the Company and reasonably  acceptable to
you that all or a portion  of the  payment  is  subject  to the  Excise  Tax and
setting forth the estimated amount of the Excise Tax on the Payment (the "Excise
Tax  Imposition  Date") and ending ten (10) days after the Excise Tax Imposition
Date,  shall be equal  to the full  amount  of the  Payments.  For  purposes  of
determining  the  amount  of the  Gross-Up  Payment,  you shall be deemed to pay
federal income taxes at the highest  marginal rate of federal income taxation in
the  calendar  year in which the  Gross-Up  Payment  is to be made and state and
local  income taxes at the highest  marginal  rates of taxation in the state and
locality of your  residence on the date the Gross-Up  Payment is to be made, net
of the maximum  reduction in federal  income taxes which could be obtained  from
deduction of such state and local taxes.

                  (b) The Gross-Up Payment for any Payment made shall be paid to
you  within  ten (10) days after the  Excise  Tax  Imposition  Date,  unless the
Company undertakes to indemnify you as provided in Section 5 (c).

                  (c) In lieu of paying the  Gross-Up  Payment for any  Payment,
the  Company  may elect to  undertake,  at its sole  expense,  the  defense  and
settlement of any assessment by the IRS of the Excise Tax on any Payment. In the
alternative,  the  Company  may elect to pay the  Gross-Up  Payment  and seek to
recover  the Excise  Tax by  pursuing  a claim for a refund.  If the  Company so
elects to undertake the defense or  settlement  of any  assessment by the IRS of
the Excise Tax on any Payment or the  recovery of the Excise Tax through a claim
for refund,  the Company shall protect,  defend,  indemnify and hold you forever
harmless  from and against the Excise Tax on such Payment and payments  pursuant
to this  Section 5(c) and any  federal,  state and local income tax  (determined
pursuant to the last sentence of Section  5(a)) upon  payments  pursuant to this
Section 5(c) and any



<PAGE>


Mr. Barry Donnell
August 26, 1998
Page 10                  


and all liabilities,  demands,  claims, actions, causes of action,  assessments,
losses,  costs, damages or expenses,  including attorneys' and accountants' fees
in connection with any thereof,  and any interest and penalties sustained by you
as a result of or arising out of or by virtue of the Company's undertaking.  You
shall  cooperate with the Company as reasonably  requested by the Company in the
conduct of such defense, settlement or refund claim.

                  (d) If the Excise Tax is determined to be less than the amount
taken into account in determining the Gross-Up  Payment paid pursuant to Section
5(a),  you shall repay to the  Company  within ten (10) days after the time that
the amount of such reduction in Excise Tax is finally  determined the portion of
the Gross-Up Payment  attributable to such reduction plus interest on the amount
of such repayment at the rate provided in Section  1274(b)(2)(B) of the Code for
debt instruments with a maturity after issuance equal to the period beginning on
the date the  Gross-Up  Payment  was made and  ending  on the date of  repayment
required by this  sentence,  or in the case of a refund,  plus  interest paid on
such  refund.  If the Excise Tax is  determined  to exceed the amount taken into
account in determining  the Gross-Up  Payment paid pursuant to Section 5(a) (the
"Excise Tax Deficit"),  the Company within ten (10) days after the time that the
amount of the Excise Tax Deficit is finally  determined shall make an additional
payment to you in an amount  equal to (i) the Excise Tax  Deficit,  plus (ii) an
amount equal to any interest  and  penalties  payable to the IRS with respect to
the Excise Tax Deficit,  plus (iii) any federal,  state and local income tax and
Excise Tax  (determined  pursuant  to the last  sentence  of Section  5(a)) upon
payments made pursuant to this sentence.

         6.   Term of Agreement.   This  Agreement shall become effective on the
date hereof  and, subject to the first sentence of the second  paragraph of this
Section 6, shall continue in effect until the earliest of the following:

                  (i)  a Date of Termination  in accordance with Section 3(e) or
         other  termination  of your  employment  with the  Company  shall  have
         occurred prior to a change in control of the Company; or

                  (ii) if a Payment  Trigger shall have occurred during the term
         of  this  Agreement,   the  performance  by  the  Company  of  all  its
         obligations, and the satisfaction by the Company of all its obligations
         and liabilities, under this Agreement;

                  (iii)the date that is the fifth (5th)  anniversary of the date
         of this Agreement;  provided,  however,  that if a change in control of
         the Company occurs prior to such fifth (5th) anniversary, the Company's
         obligation  to you under this  Agreement  due to such change in control
         shall not lapse upon the fifth (5th)  anniversary,  but shall  continue
         through the final day of the Trigger Period that begins



<PAGE>


Mr. Barry Donnell
August 26, 1998
Page 11                  


         with such change in control if such final day of the Trigger  Period is
         later than such fifth (5th) anniversary.

                  Any change in control of the  Company  during the term of this
Agreement that for any reason ceases to constitute a change in control or is not
followed by a Payment  Trigger shall not effect a  termination  or lapse of this
Agreement,  and, in such event,  this  Agreement  shall continue to apply to the
event of any subsequent  change in control of the Company occurring prior to the
end of the term of this  Agreement.  Any  transfer of your  employment  from the
Company  to a  subsidiary,  from  a  subsidiary  to the  Company,  or  from  one
subsidiary to another  subsidiary  shall not  constitute a  termination  of your
employment for purposes of this Agreement.

         7.   Successors; Binding Agreement.

                  (a) The Company will require any successor  (whether direct or
indirect,   by  purchase,   merger,   consolidation  or  otherwise)  to  all  or
substantially all of the business and/or assets of the Company,  by agreement in
form and substance satisfactory to you, to expressly assume and agree to perform
this  Agreement in the same manner and to the same extent that the Company would
be required to perform it if no such succession had taken place.  Failure of the
Company  to  obtain  such  agreement  prior  to the  effectiveness  of any  such
succession  shall be a breach of this  Agreement  and,  if such  failure  occurs
subsequent to a change in control of the Company,  shall  constitute an event of
Constructive  Termination  and entitle you to  compensation  from the Company in
accordance with Section 4 hereof,  except that for purposes of implementing  the
foregoing,  the date on which any such  succession  becomes  effective  shall be
deemed the Date of Termination. As used in this Agreement,  "Company" shall mean
the Company as  hereinbefore  defined and any  successor to its business  and/or
assets as aforesaid  which  executes and delivers the agreement  provided for in
this Section 7 or which otherwise  becomes bound by all the terms and provisions
of this Agreement by operation of law.

                  (b)  This  Agreement  shall  inure  to the  benefit  of and be
enforceable   by   your   personal   or   legal   representatives,    executors,
administrators,  successors, heirs, distributees,  devisees and legatees. If you
should die while any amount  would still be payable to you  hereunder if you had
continued to live, all such amounts,  unless otherwise provided herein, shall be
paid in accordance with the terms of this Agreement to your devisee,  legatee or
other designee or, if there be no such designee, to your estate.

         8.   Notice.  For the purposes of this Agreement, notices and all other
communications  provided for in this Agreement  shall be in writing and shall be
deemed to have been duly given when delivered  personally or mailed by certified
or registered mail, return receipt requested,  postage prepaid, addressed to the
respective  addresses  set forth on the first page of this  Agreement,  provided
that all  notices to the  Company  shall be  directed  to the  attention  of the
President of the Company with a copy to the Secretary of the Company, or to such
other address as either party may have



<PAGE>


Mr. Barry Donnell
August 26, 1998
Page 12                  


furnished to the other in writing in accordance herewith,  except that notice of
change of address shall be effective only upon receipt.

         9.   Miscellaneous.  No  provisions of this  Agreement may be modified,
waived or discharged unless such waiver,  modification or discharge is agreed to
in writing  signed by you and such officer as may be  authorized by the Board of
Directors  of the  Company.  No waiver by either party hereto at any time of any
breach by the other  party  hereto of, or  compliance  with,  any  condition  or
provision of this  Agreement to be performed by such other party shall be deemed
a waiver of similar or dissimilar provisions or conditions at the same or at any
prior or subsequent time. No agreements or  representations,  oral or otherwise,
express or implied,  with respect to the subject matter hereof have been made by
either  party which are not  expressly  set forth in this  Agreement;  provided,
however, that this Agreement shall not supersede or in any way limit the rights,
duties or  obligations  you may have under any other written  agreement with the
Company.  The validity,  interpretation,  construction  and  performance of this
Agreement  shall be governed by the laws of the State of Alabama  without regard
to principles regarding conflicts of laws.

         10.  Counterparts.     This Agreement may be  executed in  one  or more
counterparts, each of which shall be deemed to be an original but all  of  which
together will constitute one and the same instrument.

         11.  Enforcement;  Expenses.  The provisions of this Agreement shall be
regarded as  divisible,  and if any of said  provisions  or any part thereof are
declared  invalid or  unenforceable  by a court of competent  jurisdiction,  the
validity and  enforceability of the remainder of such provisions or parts hereof
and the applicability  thereof shall not be affected thereby.  The Company shall
pay all fees,  costs and expenses  (including,  without  limitation,  reasonable
attorneys'  fees and the costs of  investigating  any potential  claim) (herein,
collectively,  "Costs")  incurred by you in connection  with any dispute arising
under or relating to this Agreement or any action(s) or proceeding(s) to enforce
your  rights  under  this  Agreement,  should  you  prevail  in such  action  or
proceeding,  and, in addition to paying your Costs, the Company shall pay to you
(i)  interest on such Costs and on the  aggregate  amount of the benefits due to
you under Section 4 above (said benefits being referred to in this Section 11 as
the "Termination Benefits") from your Date of Termination to the date such Costs
and  Termination  Benefits  are paid to you at an annual rate equal to the prime
lending rate charged by First  Commercial  Bank,  or the successor  thereto,  in
effect on the Date of Termination,  and (ii) liquidated and agreed  compensatory
damages  in an amount  equal to  twenty-five  percent  (25%) of the  Termination
Benefits.

         12. Jurisdiction;  Service of Process. Any action or proceeding seeking
to  enforce  any  provision  of,  or based on any  right  arising  out of,  this
Agreement  may be brought  against  either party only in the courts of the state
and county in which you are  employed  by the  Company  and each of the  parties
consents to the  jurisdiction of such courts (and of the  appropriate  appellate
courts) in any such action or proceeding  and waives any objection to venue laid
therein. Process in any action or



<PAGE>


Mr. Barry Donnell
August 26, 1998
Page 13                  

proceeding referred to in the preceding sentence may be served on  either  party
anywhere in the world.

         If this letter correctly sets forth our agreement on the subject matter
hereof,  kindly sign and return to the Company the enclosed  copy of this letter
which will then constitute our agreement on this subject.

                     CAVALIER HOMES, INC.


                                       /s/ DAVID A. ROBERSON 
                                       -----------------------------------------
                                       Its President and Chief Executive Officer


AGREED TO THIS 26TH DAY OF AUGUST, 1998.


                                       /s/ BARRY B. DONNELL
                                       -----------------------------------------
                                       Barry B. Donnell


                                  August 26, 1998




Mr. David A. Roberson
Cavalier Homes, Inc.
Highway 41 North and Cavalier Road
Addison, AL 35540

                           Re:      Retention and Severance Agreement


Dear Mr. Roberson:

         Cavalier Homes, Inc., a Delaware corporation (the "Company"), considers
the establishment and maintenance of a sound and vital senior management team to
be essential to protecting  and enhancing the best  interests of the Company and
its  stockholders.   In  this  connection,   the  Company  recognizes  that  the
possibility  of a change  in  control  may  exist in the  future,  and that such
possibility,  and  the  uncertainty  and  questions  which  it may  raise  among
management,  may result in the departure or distraction of management  personnel
to the detriment of the Company and its stockholders.  Accordingly, the Board of
Directors of the Company (the "Board") has  determined  that  appropriate  steps
should  be  taken  to  reinforce  and  encourage  the  continued  attention  and
dedication of members of the Company's senior management, including yourself, to
their  assigned  duties  without  distraction  in the  face  of the  potentially
disturbing  circumstances arising from the possibility of a change in control of
the Company.  The Board has also  determined  that  appropriate  steps should be
taken to encourage senior management's participation, in the event of a proposed
change of  control,  in the  successful  completion  of the  change  of  control
transaction while  maintaining their focus on business  performance and strategy
execution.

         In order to induce  you to remain in the employ of the  Company  and in
consideration of your agreeing to remain in the employ of the Company subject to
the terms and conditions set forth below,  this letter  agreement sets forth the
benefits  which the  Company  agrees  will be  provided to you in the event your
employment  with the Company is terminated  subsequent to a change in control of
the  Company  (as  defined  in  Section 2 of this  letter  agreement)  under the
circumstances described below.

         1. Company's Right to Terminate.  You  acknowledge  that this Agreement
does not operate as an employment  contract nor establish any right of continued
employment  with the Company and that the Company may terminate your  employment
at any time,  subject  to  providing  the  benefits  hereinafter  specified,  if
applicable, in accordance with the terms hereof.




<PAGE>


Mr. David Roberson
August 26, 1998
Page 2                  


         2. Change in Control.  No benefits  shall be payable  hereunder  unless
there shall have been a change in control of the Company, as set forth below and
such change of control occurs prior to the termination of your  employment.  For
purposes  of this  Agreement,  a "change in control of the  Company"  means with
respect to the Company, if subsequent to the date of this Agreement:

                  (a) Any person, entity or "group" (within the meaning of Rules
13d-1  through  13d-6 of the  Securities  Exchange Act of 1934,  as amended (the
"Exchange  Act")) (other than any  subsidiary or affiliate as of the date hereof
of the Company or any employee  benefit plan of the Company) (i) has acquired or
agreed to  acquire  beneficial  ownership  of 20% or more of the  voting  and/or
economic  interest in the capital stock of the Company,  or (ii) has obtained or
agreed to obtain the power (whether or not exercised) to elect a majority of the
board of directors of the Company; or

                  (b) A majority of the board of directors of the Company  shall
consist  at such time of  individuals  other  than (x)  members  of the board of
directors  on the date hereof and (y) other  members of such board of  directors
nominated,  recommended, elected, or approved to succeed or become a director by
a majority of such members  referred to in clause (x) or a nominating  committee
elected or appointed by such members  referred to in clause (x) or by members so
nominated, recommended, elected or approved (such directors described in clauses
(x) and  (y)  above  being  hereinafter  sometimes  referred  to as  "Continuing
Directors"); or

                  (c) The approval by the  stockholders  of the Company of (i) a
merger or  consolidation  of the Company,  statutory  share  exchange,  or other
similar transaction with another  corporation,  partnership,  or other entity or
enterprise  in which  either the  Company  is not the  surviving  or  continuing
corporation  (other  than such a  transaction  that is solely for the purpose of
changing  the  domicile of the Company) or shares of common stock of the Company
are to be converted  into or exchanged  for cash,  securities  other than common
stock of the Company,  or other  property,  (ii) a sale or disposition of all or
substantially all of the assets of the Company,  or (iii) the dissolution of the
Company; or

                  (d) Any  transaction  or event  relating to the Company occurs
which is (or which  would be if the  Company  had a class of  equity  securities
registered  under  Section 12 of the  Exchange  Act)  required  to be  described
pursuant to the  requirements  of Item 6(e) of Schedule  14A of  Regulation  14A
promulgated under the Exchange Act.

         3.  Termination  Following  Change  in  Control.  If any of the  events
described  in Section 2 hereof  constituting  a change in control of the Company
shall have occurred, you shall be entitled to the benefits provided in Section 4
hereof  upon  the  subsequent  voluntary  or  involuntary  termination  of  your
employment,  whether by you or by the Company, if such termination occurs within
the period  beginning on the date that the change of control is  completed  (the
"Change of Control Date") and ending on the second  anniversary of the Change of
Control Date (the "Trigger



<PAGE>


Mr. David Roberson
August 26, 1998
Page 3                  


Period")  unless such  termination  is (i) because of your death or  Retirement,
(ii) by the  Company  for Cause or (iii) by the  Company  or you for  Disability
(such  termination  within such period, as limited by clauses (i) through (iii),
being sometimes  referred to hereinafter as a "Payment  Trigger").  In the event
your employment is terminated  within the Trigger Period,  whether by you or the
Company,  following  the  occurrence of any of the events set forth at paragraph
(c)  below,  such  termination  of your  employment  shall  be  deemed  to be an
involuntary  termination of your employment by the Company and shall entitle you
to the benefits provided in Section 4 hereof.

                  (a)      Disability; Retirement.

                           (i)  "Disability"   shall  mean  a  disability  which
         entitles  you  to a  disability  benefit  under  a  disability  program
         sponsored  or  maintained  by the  Company;  provided,  that if no such
         program is applicable to you, then "Disability"  shall mean that, based
         on  medical  evidence  reasonably   satisfactory  to  the  Compensation
         Committee  of the Board,  you are  totally  and  permanently  unable to
         engage  in any  occupation  or  gainful  employment  for  which you are
         reasonably suited by background, training, education or experience.

                           (ii) Termination  by  the  Company  or  you  of  your
         employment  based on "Retirement"  shall mean termination in accordance
         with the  Company's  retirement  policy,  including  early  retirement,
         generally applicable to its salaried employees.

                  (b) Cause.  Termination by the Company of your  employment for
"Cause" shall mean termination based upon on any of the following:

                           (i)  dishonesty  or  fraud by  you in connection with
         your employment;

                           (ii)  appropriation  (or attempted  appropriation) by
         you  of a  material  business  opportunity  of the  Company,  including
         attempting to secure or securing any personal profit in connection with
         any transaction entered into on behalf of the Company;

                           (iii)   misappropriation   by   you   (or   attempted
         misappropriation) of any of the Company's funds or property;

                           (iv) your  conviction  of, or indictment  for (or its
         procedural  equivalent)  or  entering  of a  guilty  plea or plea of no
         contest  with  respect  to,  a felony  or any  other  criminal  offense
         involving moral turpitude (other than traffic offenses); or




<PAGE>


Mr. David Roberson
August 26, 1998
Page 4                  


                           (v) willful  misconduct by you in the  performance of
         your duties with the Company,  as determined by the good faith judgment
         of the Compensation Committee of the Board.

For purposes of this paragraph, no act, or failure to act, on your part shall be
considered  "willful"  unless  done,  or omitted to be done,  by you not in good
faith and without any reasonable  belief that your action or omission was in the
best interest of the Company.  Notwithstanding  the foregoing,  you shall not be
deemed to have been  terminated for Cause unless and until there shall have been
delivered to you a copy of a Notice of  Termination  (as defined below) from the
Chief  Executive  Officer of the Company or the  Compensation  Committee  of the
Board,  after reasonable notice to you and an opportunity for you, together with
your counsel, to be heard before the Compensation Committee of the Board (or, if
there be no such committee or such committee delivers the Notice of Termination,
the  Board  of  Directors),  finding  that in the  good  faith  opinion  of such
committee  (or the Board) you were  guilty of conduct set forth above in clauses
(i),  (ii),  (iii),  (iv) or (v) of the first  sentence  of this  paragraph  and
specifying the particulars thereof in detail.

                  (c) Constructive  Termination.  Your employment will be deemed
to have been  involuntarily  terminated by the Company upon the  termination  of
your employment,  whether by you or by the Company,  following the occurrence of
any of the following  without your prior  written  consent (any such event being
sometimes referred to hereinafter as your "Constructive Termination"):

                           (i) subsequent to a change in control of the Company,
         any reduction in your title, duties, responsibilities or authority with
         the  Company  immediately  prior to the  change in  control,  except in
         connection   with  the   termination  of  your  employment  for  Cause,
         Disability,  Retirement or as a result of your death or  voluntarily by
         you; or

                           (ii)  subsequent  to  a  change  in  control  of  the
         Company,  a  reduction  by the Company in your base salary as in effect
         immediately prior to the change in control; or

                           (iii)  subsequent  to a  change  in  control  of  the
         Company,  a failure by the Company to continue any bonus plans in which
         you are presently  entitled to  participate as the same may be modified
         from time to time prior to (but not in anticipation  of) such change in
         control,  or as the same  may be  modified  following  such  change  in
         control as may be  required  by or  desirable  for the  Company  due to
         changes to (x) the  Internal  Revenue  Code of 1986,  as  amended  (the
         "Code"),   (y)  applicable   accounting  rules  or  principles  or  (z)
         applicable  laws or regulations,  including,  without  limitation,  the
         Employee  Retirement Income and Security Act of 1974, as amended,  (the
         "Bonus Plans") or a failure by the Company to continue you



<PAGE>


Mr. David Roberson
August 26, 1998
Page 5                  


         as a  participant  in the Bonus Plans on at least the same basis as you
         are  participating in accordance with the Bonus Plans immediately prior
         to the change in control; or

                           (iv)  subsequent  to  a  change  in  control  of  the
         Company,  the  failure by the Company to continue in effect any benefit
         or compensation plan, life insurance plan,  health-and-accident plan or
         disability plan in which you are participating immediately prior to the
         change  in  control  of  the  Company  (or  plans  providing  you  with
         substantially  similar  benefits),  the  taking  of any  action  by the
         Company which would materially  adversely affect your  participation in
         or materially  reduce your benefits  under any of such plans or deprive
         you of any material fringe benefit enjoyed by you immediately  prior to
         the change in  control,  or the  failure by the  Company to provide you
         with the number of paid vacation days to which you are then entitled in
         accordance  with  the  Company's   normal  vacation  policy  in  effect
         immediately prior to the change in control; or

                           (v) subsequent to a change in control of the Company,
         the failure by the Company to obtain the assumption of or the agreement
         to perform this Agreement by any successor as contemplated in Section 7
         hereof; or

                           (vi)  subsequent  to  a  change  in  control  of  the
         Company, a change in the location of your employment greater than fifty
         (50) miles from your office location immediately prior to the change in
         control; or

                           (vii)  subsequent  to a  change  in  control  of  the
         Company,  any purported  termination  of your  employment  which is not
         effected   pursuant  to  a  Notice  of   Termination   satisfying   the
         requirements of paragraph (d) below (and, if applicable,  paragraph (b)
         above); or

                           (viii)  subsequent  to a  change  in  control  of the
         Company, (A) at the direction or with the concurrence of members of the
         Board or  management  of the Company who became such members  following
         the change in control, a material business  strategic plan,  direction,
         policy or  program of the  Company  is  altered  in a  material  manner
         (hereinafter  a "Policy  Change"),  and (B) you  disagree in good faith
         with such  Policy  Change and  believe  in good faith that such  Policy
         Change will have a material  adverse effect on the Company and so state
         in a written  notice  delivered to the Board within thirty (30) days of
         becoming  aware (or thirty (30) days after you,  exercising  reasonable
         diligence, should have become aware) of such Policy Change, and (C) the
         Policy  Change is not reversed  within  thirty (30) days of the date on
         which  your  written  notice  is  received  by the  Board,  and (D) you
         terminate  your  employment  with  the  Company  as a  result  of  such
         disagreement and belief.


1/0388171.03

<PAGE>


Mr. David Roberson
August 26, 1998
Page 6                  


                  (d) Notice of  Termination.  Any purported  termination by the
Company  pursuant to your Disability or Retirement,  as defined in paragraph (a)
above,  or for Cause,  as defined in paragraph (b) above,  or by you pursuant to
your  Disability or  Retirement,  as defined in paragraph (a) above or by you or
the  Company  based on an event  of  Constructive  Termination,  as  defined  in
paragraph (c) above,  shall be  communicated by written Notice of Termination to
the  other  party  hereto.  For  purposes  of  this  Agreement,   a  "Notice  of
Termination"  shall mean a notice which shall indicate the specific  termination
provision in this Agreement relied upon and shall set forth in reasonable detail
the facts and  circumstances  claimed to provide a basis for termination of your
employment under the provision so indicated.

                  (e) Date of Termination.  "Date of Termination" shall mean (A)
if your employment is terminated for  Disability,  thirty (30) days after Notice
of  Termination  is given  (provided  that you  shall not have  returned  to the
performance  of your  duties on a  full-time  basis  during such thirty (30) day
period), (B) if you employment is terminated due to your death, the date of your
death, (C) if your employment is terminated pursuant to paragraph (b) above, the
date  specified  in the  Notice  of  Termination,  (D)  if  your  employment  is
terminated for Retirement, the date specified in the Notice of Termination,  and
(E) if your  employment is terminated for any other reason,  the date on which a
Notice of Termination  is given;  provided that if within thirty (30) days after
any  Notice  of  Termination  is  given  the  party  receiving  such  Notice  of
Termination  notifies  the other  party  that a dispute  exists  concerning  the
termination,  the Date of Termination  shall be the date on which the dispute is
finally  determined,  either by mutual written agreement of the parties, or by a
final judgment,  order or decree of a court of competent  jurisdiction (the time
for appeal  therefrom  having  expired  and no appeal  having  been  perfected);
provided  further,  however,  that if such  disputed  termination  constitutes a
Payment  Trigger,  the Trigger  Period shall not run pending  resolution  of the
dispute  but  shall  recommence  upon  the  date  that the  dispute  is  finally
determined (as set forth in the preceding proviso).

         4. Certain Benefits Upon Termination. (a) If, after a change in control
of the  Company  shall  have  occurred,  as  defined  in  Section 2 above,  your
employment  with the  Company  shall be  terminated  (including  a  Constructive
Termination)  within  the  Trigger  Period by the  Company or you other than for
Cause,  Disability,  Retirement  or death,  and other  than by your  voluntarily
terminating your employment with the Company,  then you shall be entitled to the
benefits provided below:

                           (i)   the Company shall pay to you within thirty (30)
days following the Date of Termination in a lump sum cash payment your full base
salary through the Date of Termination  at the rate in effect at the time Notice
of Termination is  given plus (A) credit for any vacation earned but  not taken,
(B) the amount,  if any, of any bonus or long-term incentive compensation  for a
past fiscal  year  which has been earned  but not yet been paid to you,  (C) the
amount,  if any, of any bonus for the  current  year to be paid as a  percentage
of Company profit based on the Company's  results through the most recent fiscal
quarter as of the Date of Termination without



<PAGE>


Mr. David Roberson
August 26, 1998
Page 7                  


pro-ration,  (D) a pro-rated payment, based on the Company's results through the
most recent quarter as of the Date of Termination, with respect to the long-term
incentive  compensation payable under the Company's  performance based long-term
incentive program for the long-term  performance period that next ends following
the Date of  Termination,  and (E) a pro-rated  payment,  based on the Company's
results as of the Date of  Termination,  of any other  bonus due under any other
Bonus Plans;

                           (ii)  in lieu of any  further salary  payments to you
for  periods  subsequent  to the Date of  Termination, the  Company shall pay as
severance pay to you within thirty (30) days following the Date of Termination a
lump sum  cash amount equal  to 2.99  times  the sum of (A) the  amount  of your
annual  base  salary at the highest rate in effect during the twelve (12) months
immediately  preceding  the  Date of  Termination,  and (B) the  average  annual
bonus  received by you with respect to the three (3) years immediately preceding
the  Date of  Termination, or with  respect to the  period  beginning January 1,
1996 and ending December 31 of the calendar  year  immediately  preceding on the
Date of  Termination,  if such  period is less  than three  years at the Date of
Termination, and (C) (x) the most  recent amount earned by you (whether in stock
or  cash  or a  combination  thereof)  under  the  Company's  performance  based
long-term incentive program  established under the Company's Executive Incentive
Compensation Plan or, (y) if the Date of  Termination  giving rise to your right
to  benefits  hereunder  occurs  before   the  end  of  the  initial   Long-Term
Performance  Period  established  under the long-term incentive  program so that
benefits have not yet accrued under the long-term incentive program,  the target
amount  established for you  under  the program  for the  Long-Term  Performance
Period next ending; and

                           (iii) the  Company  shall  maintain in full force and
effect, for your continued benefit  until the  earlier of  (A)  three  (3) years
after the Date of  Termination or (B) you obtain substantially the same coverage
from a  new  employer,  all life insurance,  medical,  health and accident,  and
disability  plans,  programs  or  arrangements  in which you  were  entitled  to
participate  immediately prior to the  Date of  Termination,  provided that your
continued  participation  is possible  under the general terms and provisions of
such plans and programs.  In the event  that your participation in any such plan
or program is barred, the Company shall  use  reasonable  efforts to  arrange to
provide you with benefits substantially similar to those which you are  entitled
to  receive  under  such  plans and programs.

                  (b) If,  after a change in control of the  Company  shall have
occurred,  as defined in Section 2 above, you shall  voluntarily  terminate your
employment with the Company within the Trigger Period other than for Disability,
Retirement or death or in connection with an event of Constructive  Termination,
then you shall be entitled to the benefits set forth below:

                           (i)   the Company shall pay to you within thirty (30)
days following the Date of Termination in a lump sum cash payment your full base
salary through the Date of Termination  at the rate in effect at the time Notice
of Termination is given plus  (A) credit for any  vacation earned but not taken,
(B) the amount,  if any, of any bonus or long-term incentive



<PAGE>


Mr. David Roberson
August 26, 1998
Page 8                  


compensation  for a past fiscal year which has been earned but not yet been paid
to you, (C) the amount,  if any, of any bonus for the current year to be paid as
a percentage of Company profit based on the Company's  results  through the most
recent fiscal quarter as of the Date of Termination  without  pro-ration,  (D) a
pro-rated  payment,  based on the  Company's  results  through  the most  recent
quarter as of the Date of Termination,  with respect to the long-term  incentive
compensation  payable under the Company's  performance based long-term incentive
program for the long-term  performance  period that next ends following the Date
of Termination,  and (E) a pro-rated payment,  based on the Company's results as
of the Date of Termination, of any other bonus due under any other Bonus Plans;

                           (ii)   in lieu of any further salary payments to  you
for  periods  subsequent  to  the Date  of Termination, the Company shall pay as
severance pay to you within  thirty (30) days  following the Date of Termination
a lump sum cash amount equal to 2.99  times  the sum of (A) the  amount  of your
annual  base  salary at the highest rate in effect during the twelve (12) months
immediately preceding the Date of Termination, and (B) the average annual  bonus
received by you with  respect to the three (3)  years immediately  preceding the
Date of Termination, or  with respect to the  period  beginning  January 1, 1996
and ending December 31 of the calendar  year  immediately  preceding on the Date
of  Termination,  if  such  period  is  less  than  three  years  at the Date of
Termination, and (C) (x) the most  recent amount earned by you (whether in stock
or  cash  or a  combination  thereof)  under  the  Company's  performance  based
long-term  incentive program established under the Company's Executive Incentive
Compensation Plan or, (y) if the Date of  Termination  giving rise to your right
to benefits hereunder occurs before the end of the initial Long-Term Performance
Period established under the long-term incentive  program so that  benefits have
not yet accrued  under  the  long-term  incentive  program,  the  target  amount
established for you under the program for  the Long-Term Performance Period next
ending; and 
                           (iii)  the Company  shall  maintain in full force and
effect, for  your  continued   benefit  until  the  earlier  of  (A)  the  first
anniversary  of the  Date  of Termination  or (B)  you  obtain substantially the
same  coverage  from a new employer,  all life  insurance,  medical,  health and
accident,  and  disability plans,  programs  or  arrangements  in which you were
entitled to participate immediately prior to the Date of  Termination,  provided
that  your  continued participation  is possible  under  the  general  terms and
provisions of such plans and programs.  In the event that your  participation in
any such plan or program is barred,  the Company  shall use  reasonable  efforts
to arrange to provide you with benefits substantially similar to those which you
are entitled to receive under such plans and programs.

                  (c) You shall not be required  to  mitigate  the amount of any
payment provided for in this Section 4 by seeking other employment or otherwise,
nor shall the amount of any payment provided for in this Section 4 be reduced by
any  compensation  earned by you as the result of employment by another employer
after the Date of Termination,  or otherwise.  In the event that you voluntarily
terminate  your   employment   with  the  Company  and  are  paid  the  benefits
contemplated by paragraph (b) of this Section 4 and, at any time within five (5)
years following the receipt of such



<PAGE>


Mr. David Roberson
August 26, 1998
Page 9                  


payment,  you are  reemployed  by the  Company  or any  subsidiary  thereof in a
position  where  your  duties  or  responsibilities  with  the  Company  or such
subsidiary  are  commensurate  with  those of your  position  with  the  Company
immediately prior to the original termination of your employment which gave rise
to the  Company's  payment of benefits  under this Section 4, you shall,  on the
date of such  reemployment,  be obligated to repay to the Company,  in cash,  an
amount equal to the benefit paid to you under  paragraph  (b) of this Section 4,
plus any  amounts  paid to you under  Section 5 hereof  in  connection  with the
payments to you pursuant to paragraph (b) of this Section 4 (and not  previously
repaid by you pursuant to the terms of Section 5).

         5.       Tax Gross-Up.

                  (a) If you become entitled to any payments or benefits whether
pursuant  to the terms of this  Agreement  or any  other  plan,  arrangement  or
agreement  with the  Company,  any person  whose  actions  result in a change in
control or any  person  affiliated  with the  Company  or such  persons  (in the
aggregate, "Payments" or singularly, "Payment") which are subject to taxes under
Section  4999 (or any  successor  provision  thereto)  of the Code (the  "Excise
Tax"), the Company shall pay to you an additional  amount  ("Gross-Up  Payment")
such that the net amount  retained by you, after deduction of (A) any Excise Tax
on Payments, (B) any federal, state and local income tax and Excise Tax upon the
payment provided for by this Section, and (C) any interest and penalties imposed
because the Excise Tax is not paid during the period  beginning with the earlier
of the date (i) the IRS issues a notice  stating  that an Excise Tax is due with
respect to a Payment,  (ii) you deliver to the Company an opinion of tax counsel
selected by you and  reasonably  acceptable to the Company that all or a portion
of the  Payment is subject to the  Excise Tax and  setting  forth the  estimated
amount of the Excise Tax on the Payment,  and (iii) the Company  delivers to you
an opinion of tax counsel  selected by the Company and reasonably  acceptable to
you that all or a portion  of the  payment  is  subject  to the  Excise  Tax and
setting forth the estimated amount of the Excise Tax on the Payment (the "Excise
Tax  Imposition  Date") and ending ten (10) days after the Excise Tax Imposition
Date,  shall be equal  to the full  amount  of the  Payments.  For  purposes  of
determining  the  amount  of the  Gross-Up  Payment,  you shall be deemed to pay
federal income taxes at the highest  marginal rate of federal income taxation in
the  calendar  year in which the  Gross-Up  Payment  is to be made and state and
local  income taxes at the highest  marginal  rates of taxation in the state and
locality of your  residence on the date the Gross-Up  Payment is to be made, net
of the maximum  reduction in federal  income taxes which could be obtained  from
deduction of such state and local taxes.

                  (b) The Gross-Up Payment for any Payment made shall be paid to
you  within  ten (10) days after the  Excise  Tax  Imposition  Date,  unless the
Company undertakes to indemnify you as provided in Section 5 (c).

                  (c) In lieu of paying the  Gross-Up  Payment for any  Payment,
the  Company  may elect to  undertake,  at its sole  expense,  the  defense  and
settlement of any assessment by the IRS of the Excise Tax on any Payment. In the
alternative, the Company may elect to pay the Gross-Up



<PAGE>


Mr. David Roberson
August 26, 1998
Page 10                  


Payment and seek to recover the Excise Tax by pursuing a claim for a refund.  If
the Company so elects to undertake the defense or  settlement of any  assessment
by the IRS of the Excise Tax on any  Payment or the  recovery  of the Excise Tax
through a claim for refund,  the Company shall  protect,  defend,  indemnify and
hold you forever  harmless  from and against the Excise Tax on such  Payment and
payments  pursuant to this Section 5(c) and any federal,  state and local income
tax  (determined  pursuant to the last  sentence of Section  5(a)) upon payments
pursuant to this  Section  5(c) and any and all  liabilities,  demands,  claims,
actions,  causes of action,  assessments,  losses,  costs,  damages or expenses,
including  attorneys' and accountants' fees in connection with any thereof,  and
any interest and penalties  sustained by you as a result of or arising out of or
by virtue of the Company's undertaking.  You shall cooperate with the Company as
reasonably  requested by the Company in the conduct of such defense,  settlement
or refund claim.

                  (d) If the Excise Tax is determined to be less than the amount
taken into account in determining the Gross-Up  Payment paid pursuant to Section
5(a),  you shall repay to the  Company  within ten (10) days after the time that
the amount of such reduction in Excise Tax is finally  determined the portion of
the Gross-Up Payment  attributable to such reduction plus interest on the amount
of such repayment at the rate provided in Section  1274(b)(2)(B) of the Code for
debt instruments with a maturity after issuance equal to the period beginning on
the date the  Gross-Up  Payment  was made and  ending  on the date of  repayment
required by this  sentence,  or in the case of a refund,  plus  interest paid on
such  refund.  If the Excise Tax is  determined  to exceed the amount taken into
account in determining  the Gross-Up  Payment paid pursuant to Section 5(a) (the
"Excise Tax Deficit"),  the Company within ten (10) days after the time that the
amount of the Excise Tax Deficit is finally  determined shall make an additional
payment to you in an amount  equal to (i) the Excise Tax  Deficit,  plus (ii) an
amount equal to any interest  and  penalties  payable to the IRS with respect to
the Excise Tax Deficit,  plus (iii) any federal,  state and local income tax and
Excise Tax  (determined  pursuant  to the last  sentence  of Section  5(a)) upon
payments made pursuant to this sentence.

         6. Term of Agreement. This Agreement shall become effective on the date
hereof  and,  subject  to the first  sentence  of the second  paragraph  of this
Section 6, shall continue in effect until the earliest of the following:

                  (i) a Date of Termination  in accordance  with Section 3(e) or
         other  termination  of your  employment  with the  Company  shall  have
         occurred prior to a change in control of the Company; or

                  (ii) if a Payment  Trigger shall have occurred during the term
         of  this  Agreement,   the  performance  by  the  Company  of  all  its
         obligations, and the satisfaction by the Company of all its obligations
         and liabilities, under this Agreement;




<PAGE>


Mr. David Roberson
August 26, 1998
Page 11                  


                  (iii) the date that is the fifth (5th) anniversary of the date
         of this Agreement;  provided,  however,  that if a change in control of
         the Company occurs prior to such fifth (5th) anniversary, the Company's
         obligation  to you under this  Agreement  due to such change in control
         shall not lapse upon the fifth (5th)  anniversary,  but shall  continue
         through  the final day of the  Trigger  Period  that  begins  with such
         change in control if such final day of the Trigger Period is later than
         such fifth (5th) anniversary.

                  Any change in control of the  Company  during the term of this
Agreement that for any reason ceases to constitute a change in control or is not
followed by a Payment  Trigger shall not effect a  termination  or lapse of this
Agreement,  and, in such event,  this  Agreement  shall continue to apply to the
event of any subsequent  change in control of the Company occurring prior to the
end of the term of this  Agreement.  Any  transfer of your  employment  from the
Company  to a  subsidiary,  from  a  subsidiary  to the  Company,  or  from  one
subsidiary to another  subsidiary  shall not  constitute a  termination  of your
employment for purposes of this Agreement.

         7.       Successors; Binding Agreement.

                  (a) The Company will require any successor  (whether direct or
indirect,   by  purchase,   merger,   consolidation  or  otherwise)  to  all  or
substantially all of the business and/or assets of the Company,  by agreement in
form and substance satisfactory to you, to expressly assume and agree to perform
this  Agreement in the same manner and to the same extent that the Company would
be required to perform it if no such succession had taken place.  Failure of the
Company  to  obtain  such  agreement  prior  to the  effectiveness  of any  such
succession shall be a breach of this Agreement and shall, if such failure occurs
subsequent  to a  change  in  control  of the  Company,  constitute  an event of
Constructive  Termination  and entitle you to  compensation  from the Company in
accordance with Section 4 hereof,  except that for purposes of implementing  the
foregoing,  the date on which any such  succession  becomes  effective  shall be
deemed the Date of Termination. As used in this Agreement,  "Company" shall mean
the Company as  hereinbefore  defined and any  successor to its business  and/or
assets as aforesaid  which  executes and delivers the agreement  provided for in
this Section 7 or which otherwise  becomes bound by all the terms and provisions
of this Agreement by operation of law.

                  (b)  This  Agreement  shall  inure  to the  benefit  of and be
enforceable   by   your   personal   or   legal   representatives,    executors,
administrators,  successors, heirs, distributees,  devisees and legatees. If you
should die while any amount  would still be payable to you  hereunder if you had
continued to live, all such amounts,  unless otherwise provided herein, shall be
paid in accordance with the terms of this Agreement to your devisee,  legatee or
other designee or, if there be no such designee, to your estate.




<PAGE>


Mr. David Roberson
August 26, 1998
Page 12                  


         8. Notice.  For the purposes of this  Agreement,  notices and all other
communications  provided for in this Agreement  shall be in writing and shall be
deemed to have been duly given when delivered  personally or mailed by certified
or registered mail, return receipt requested,  postage prepaid, addressed to the
respective  addresses  set forth on the first page of this  Agreement,  provided
that all  notices to the  Company  shall be  directed  to the  attention  of the
Chairman  of the  Board  of the  Company  with a copy  to the  Secretary  of the
Company,  or to such other  address as either  party may have  furnished  to the
other in writing in accordance herewith, except that notice of change of address
shall be effective only upon receipt.

         9.  Miscellaneous.  No  provisions  of this  Agreement may be modified,
waived or discharged unless such waiver,  modification or discharge is agreed to
in writing  signed by you and such officer as may be  authorized by the Board of
Directors  of the  Company.  No waiver by either party hereto at any time of any
breach by the other  party  hereto of, or  compliance  with,  any  condition  or
provision of this  Agreement to be performed by such other party shall be deemed
a waiver of similar or dissimilar provisions or conditions at the same or at any
prior or subsequent time. No agreements or  representations,  oral or otherwise,
express or implied,  with respect to the subject matter hereof have been made by
either  party which are not  expressly  set forth in this  Agreement;  provided,
however, that this Agreement shall not supersede or in any way limit the rights,
duties or  obligations  you may have under any other written  agreement with the
Company.  The validity,  interpretation,  construction  and  performance of this
Agreement  shall be governed by the laws of the State of Alabama  without regard
to principles regarding conflicts of laws.

         10.      Counterparts.  This Agreement may be  executed in  one or more
counterparts, each  of which shall be deemed to be  an original but all of which
together will constitute one and the same instrument.

         11.  Enforcement;  Expenses.  The provisions of this Agreement shall be
regarded as  divisible,  and if any of said  provisions  or any part thereof are
declared  invalid or  unenforceable  by a court of competent  jurisdiction,  the
validity and  enforceability of the remainder of such provisions or parts hereof
and the applicability  thereof shall not be affected thereby.  The Company shall
pay all fees,  costs and expenses  (including,  without  limitation,  reasonable
attorneys'  fees and the costs of  investigating  any potential  claim) (herein,
collectively,  "Costs")  incurred by you in connection  with any dispute arising
under or relating to this Agreement or any action(s) or proceeding(s) to enforce
your  rights  under  this  Agreement,  should  you  prevail  in such  action  or
proceeding,  and, in addition to paying your Costs, the Company shall pay to you
(i)  interest on such Costs and on the  aggregate  amount of the benefits due to
you under Section 4 above (said benefits being referred to in this Section 11 as
the "Termination Benefits") from your Date of Termination to the date such Costs
and  Termination  Benefits  are paid to you at an annual rate equal to the prime
lending rate charged by First  Commercial  Bank,  or the successor  thereto,  in
effect on the Date of Termination,  and (ii) liquidated and agreed  compensatory
damages  in an amount  equal to  twenty-five  percent  (25%) of the  Termination
Benefits.



<PAGE>


Mr. David Roberson
August 26, 1998
Page 13                  

         12. Jurisdiction;  Service of Process. Any action or proceeding seeking
to  enforce  any  provision  of,  or based on any  right  arising  out of,  this
Agreement  may be brought  against  either party only in the courts of the state
and county in which you are  employed  by the  Company  and each of the  parties
consents to the  jurisdiction of such courts (and of the  appropriate  appellate
courts) in any such action or proceeding  and waives any objection to venue laid
therein.  Process  in any  action or  proceeding  referred  to in the  preceding
sentence may be served on either party anywhere in the world.

         If this letter correctly sets forth our agreement on the subject matter
hereof,  kindly sign and return to the Company the enclosed  copy of this letter
which will then constitute our agreement on this subject.

                                                   CAVALIER HOMES, INC.


                                                   /s/ MICHAEL R. MURPHY
                                                   -----------------------------
                                                   Its Vice President


AGREED TO THIS 26TH DAY OF AUGUST, 1998.


/s/ DAVID A. ROBERSON
- -------------------------------
David A. Roberson


                                                  August 26, 1998




Mr. Michael R. Murphy
Cavalier Homes, Inc.
Highway 41 North and Cavalier Road
Addison, AL 35540

                           Re:      Retention and Severance Agreement


Dear Mr. Murphy:

         Cavalier Homes, Inc., a Delaware corporation (the "Company"), considers
the establishment and maintenance of a sound and vital senior management team to
be essential to protecting  and enhancing the best  interests of the Company and
its  stockholders.   In  this  connection,   the  Company  recognizes  that  the
possibility  of a change  in  control  may  exist in the  future,  and that such
possibility,  and  the  uncertainty  and  questions  which  it may  raise  among
management,  may result in the departure or distraction of management  personnel
to the detriment of the Company and its stockholders.  Accordingly, the Board of
Directors of the Company (the "Board") has  determined  that  appropriate  steps
should  be  taken  to  reinforce  and  encourage  the  continued  attention  and
dedication of members of the Company's senior management, including yourself, to
their  assigned  duties  without  distraction  in the  face  of the  potentially
disturbing  circumstances arising from the possibility of a change in control of
the Company.  The Board has also  determined  that  appropriate  steps should be
taken to encourage senior management's participation, in the event of a proposed
change of  control,  in the  successful  completion  of the  change  of  control
transaction while  maintaining their focus on business  performance and strategy
execution.

         In order to induce  you to remain in the employ of the  Company  and in
consideration of your agreeing to remain in the employ of the Company subject to
the terms and conditions set forth below,  this letter  agreement sets forth the
benefits  which the  Company  agrees  will be  provided to you in the event your
employment  with the Company is terminated  subsequent to a change in control of
the  Company  (as  defined  in  Section 2 of this  letter  agreement)  under the
circumstances described below.

         1. Company's Right to Terminate.  You  acknowledge  that this Agreement
does not operate as an employment  contract nor establish any right of continued
employment  with the Company and that the Company may terminate your  employment
at any time,  subject  to  providing  the  benefits  hereinafter  specified,  if
applicable, in accordance with the terms hereof.




<PAGE>


Mr. Michael Murphy
August 26, 1998
Page 2                  


         2. Change in Control.  No benefits  shall be payable  hereunder  unless
there shall have been a change in control of the Company, as set forth below and
such change of control occurs prior to the termination of your  employment.  For
purposes  of this  Agreement,  a "change in control of the  Company"  means with
respect to the Company, if subsequent to the date of this Agreement:

                  (a) Any person, entity or "group" (within the meaning of Rules
13d-1  through  13d-6 of the  Securities  Exchange Act of 1934,  as amended (the
"Exchange  Act")) (other than any  subsidiary or affiliate as of the date hereof
of the Company or any employee  benefit plan of the Company) (i) has acquired or
agreed to  acquire  beneficial  ownership  of 20% or more of the  voting  and/or
economic  interest in the capital stock of the Company,  or (ii) has obtained or
agreed to obtain the power (whether or not exercised) to elect a majority of the
board of directors of the Company; or

                  (b) A majority of the board of directors of the Company  shall
consist  at such time of  individuals  other  than (x)  members  of the board of
directors  on the date hereof and (y) other  members of such board of  directors
nominated,  recommended, elected, or approved to succeed or become a director by
a majority of such members  referred to in clause (x) or a nominating  committee
elected or appointed by such members  referred to in clause (x) or by members so
nominated, recommended, elected or approved (such directors described in clauses
(x) and  (y)  above  being  hereinafter  sometimes  referred  to as  "Continuing
Directors"); or

                  (c) The approval by the  stockholders  of the Company of (i) a
merger or  consolidation  of the Company,  statutory  share  exchange,  or other
similar transaction with another  corporation,  partnership,  or other entity or
enterprise  in which  either the  Company  is not the  surviving  or  continuing
corporation  (other  than such a  transaction  that is solely for the purpose of
changing  the  domicile of the Company) or shares of common stock of the Company
are to be converted  into or exchanged  for cash,  securities  other than common
stock of the Company,  or other  property,  (ii) a sale or disposition of all or
substantially all of the assets of the Company,  or (iii) the dissolution of the
Company; or

                  (d) Any  transaction  or event  relating to the Company occurs
which is (or which  would be if the  Company  had a class of  equity  securities
registered  under  Section 12 of the  Exchange  Act)  required  to be  described
pursuant to the  requirements  of Item 6(e) of Schedule  14A of  Regulation  14A
promulgated under the Exchange Act.

         3.  Termination  Following  Change  in  Control.  If any of the  events
described  in Section 2 hereof  constituting  a change in control of the Company
shall have occurred, you shall be entitled to the benefits provided in Section 4
hereof  upon  the  subsequent  voluntary  or  involuntary  termination  of  your
employment,  whether by you or by the Company, if such termination occurs within
the period  beginning on the date that the change of control is  completed  (the
"Change of Control Date") and ending on the second  anniversary of the Change of
Control Date (the "Trigger



<PAGE>


Mr. Michael Murphy
August 26, 1998
Page 3                  


Period")  unless such  termination  is (i) because of your death or  Retirement,
(ii) by the  Company  for Cause or (iii) by the  Company  or you for  Disability
(such  termination  within such period, as limited by clauses (i) through (iii),
being sometimes  referred to hereinafter as a "Payment  Trigger").  In the event
your employment is terminated  within the Trigger Period,  whether by you or the
Company,  following  the  occurrence of any of the events set forth at paragraph
(c)  below,  such  termination  of your  employment  shall  be  deemed  to be an
involuntary  termination of your employment by the Company and shall entitle you
to the benefits provided in Section 4 hereof.

                  (a)      Disability; Retirement.

                           (i)  "Disability"   shall  mean  a  disability  which
         entitles  you  to a  disability  benefit  under  a  disability  program
         sponsored  or  maintained  by the  Company;  provided,  that if no such
         program is applicable to you, then "Disability"  shall mean that, based
         on  medical  evidence  reasonably   satisfactory  to  the  Compensation
         Committee  of the Board,  you are  totally  and  permanently  unable to
         engage  in any  occupation  or  gainful  employment  for  which you are
         reasonably suited by background, training, education or experience.

                           (ii)  Termination  by the  Company  or  you  of  your
         employment  based on "Retirement"  shall mean termination in accordance
         with the  Company's  retirement  policy,  including  early  retirement,
         generally applicable to its salaried employees.

                  (b) Cause.  Termination by the Company of your  employment for
"Cause" shall mean termination based upon on any of the following:

                           (i)   dishonesty  or  fraud by you in connection with
         your employment;

                           (ii)  appropriation  (or attempted  appropriation) by
         you  of a  material  business  opportunity  of the  Company,  including
         attempting to secure or securing any personal profit in connection with
         any transaction entered into on behalf of the Company;

                           (iii)   misappropriation   by   you   (or   attempted
         misappropriation) of any of the Company's funds or property;

                           (iv) your  conviction  of, or indictment  for (or its
         procedural  equivalent)  or  entering  of a  guilty  plea or plea of no
         contest  with  respect  to,  a felony  or any  other  criminal  offense
         involving moral turpitude (other than traffic offenses); or




<PAGE>


Mr. Michael Murphy
August 26, 1998
Page 4                  


                           (v) willful  misconduct by you in the  performance of
         your duties with the Company,  as determined by the good faith judgment
         of the Compensation Committee of the Board.

For purposes of this paragraph, no act, or failure to act, on your part shall be
considered  "willful"  unless  done,  or omitted to be done,  by you not in good
faith and without any reasonable  belief that your action or omission was in the
best interest of the Company.  Notwithstanding  the foregoing,  you shall not be
deemed to have been  terminated for Cause unless and until there shall have been
delivered to you a copy of a Notice of  Termination  (as defined below) from the
Chief  Executive  Officer of the Company or the  Compensation  Committee  of the
Board,  after reasonable notice to you and an opportunity for you, together with
your counsel, to be heard before the Compensation Committee of the Board (or, if
there be no such committee or such committee delivers the Notice of Termination,
the  Board  of  Directors),  finding  that in the  good  faith  opinion  of such
committee  (or the Board) you were  guilty of conduct set forth above in clauses
(i),  (ii),  (iii),  (iv) or (v) of the first  sentence  of this  paragraph  and
specifying the particulars thereof in detail.

                  (c) Constructive  Termination.  Your employment will be deemed
to have been  involuntarily  terminated by the Company upon the  termination  of
your employment,  whether by you or by the Company,  following the occurrence of
any of the following  without your prior  written  consent (any such event being
sometimes referred to hereinafter as your "Constructive Termination"):

                           (i) subsequent to a change in control of the Company,
         any reduction in your title, duties, responsibilities or authority with
         the  Company  immediately  prior to the  change in  control,  except in
         connection   with  the   termination  of  your  employment  for  Cause,
         Disability,  Retirement or as a result of your death or  voluntarily by
         you; or

                           (ii)  subsequent  to  a  change  in  control  of  the
         Company,  a  reduction  by the Company in your base salary as in effect
         immediately prior to the change in control; or

                           (iii)  subsequent  to a  change  in  control  of  the
         Company,  a failure by the Company to continue any bonus plans in which
         you are presently  entitled to  participate as the same may be modified
         from time to time prior to (but not in anticipation  of) such change in
         control,  or as the same  may be  modified  following  such  change  in
         control as may be  required  by or  desirable  for the  Company  due to
         changes to (x) the  Internal  Revenue  Code of 1986,  as  amended  (the
         "Code"),   (y)  applicable   accounting  rules  or  principles  or  (z)
         applicable  laws or regulations,  including,  without  limitation,  the
         Employee  Retirement Income and Security Act of 1974, as amended,  (the
         "Bonus Plans") or a failure by the Company to continue you



<PAGE>


Mr. Michael Murphy
August 26, 1998
Page 5                  


         as a  participant  in the Bonus Plans on at least the same basis as you
         are  participating in accordance with the Bonus Plans immediately prior
         to the change in control; or

                           (iv)  subsequent  to  a  change  in  control  of  the
         Company,  the  failure by the Company to continue in effect any benefit
         or compensation plan, life insurance plan,  health-and-accident plan or
         disability plan in which you are participating immediately prior to the
         change  in  control  of  the  Company  (or  plans  providing  you  with
         substantially  similar  benefits),  the  taking  of any  action  by the
         Company which would materially  adversely affect your  participation in
         or materially  reduce your benefits  under any of such plans or deprive
         you of any material fringe benefit enjoyed by you immediately  prior to
         the change in  control,  or the  failure by the  Company to provide you
         with the number of paid vacation days to which you are then entitled in
         accordance  with  the  Company's   normal  vacation  policy  in  effect
         immediately prior to the change in control; or

                           (v) subsequent to a change in control of the Company,
         the failure by the Company to obtain the assumption of or the agreement
         to perform this Agreement by any successor as contemplated in Section 7
         hereof; or

                           (vi)  subsequent  to  a  change  in  control  of  the
         Company, a change in the location of your employment greater than fifty
         (50) miles from your office location immediately prior to the change in
         control; or

                           (vii)  subsequent  to a  change  in  control  of  the
         Company,  any purported  termination  of your  employment  which is not
         effected   pursuant  to  a  Notice  of   Termination   satisfying   the
         requirements of paragraph (d) below (and, if applicable,  paragraph (b)
         above); or

                           (viii)  subsequent  to a  change  in  control  of the
         Company, (A) at the direction or with the concurrence of members of the
         Board or  management  of the Company who became such members  following
         the change in control, a material business  strategic plan,  direction,
         policy or  program of the  Company  is  altered  in a  material  manner
         (hereinafter  a "Policy  Change"),  and (B) if the  individual  who was
         serving as President and Chief Executive  Officer of the Company at the
         time of the change in control is continuing to serve in such  capacity,
         said  officer  disagrees  with such Policy  Change in a written  notice
         delivered to the Board within thirty (30) days of his becoming aware of
         such Policy Change, and (C) you disagree in good faith with such Policy
         Change and  believe in good faith that such  Policy  Change will have a
         material adverse effect on the Company and so state in a written notice
         delivered  to the Board within  thirty (30) days of becoming  aware (or
         thirty (30) days after you,  exercising  reasonable  diligence,  should
         have become aware) of such Policy Change,  and (D) the Policy Change is
         not reversed within thirty (30) days of the date on which



<PAGE>


Mr. Michael Murphy
August 26, 1998
Page 6                  


         your  written  notice is received by the Board,  and (E) you  terminate
         your employment with the Company as a result of such  disagreement  and
         belief.

                  (d) Notice of  Termination.  Any purported  termination by the
Company  pursuant to your Disability or Retirement,  as defined in paragraph (a)
above,  or for Cause,  as defined in paragraph (b) above,  or by you pursuant to
your  Disability or  Retirement,  as defined in paragraph (a) above or by you or
the  Company  based on an event  of  Constructive  Termination,  as  defined  in
paragraph (c) above,  shall be  communicated by written Notice of Termination to
the  other  party  hereto.  For  purposes  of  this  Agreement,   a  "Notice  of
Termination"  shall mean a notice which shall indicate the specific  termination
provision in this Agreement relied upon and shall set forth in reasonable detail
the facts and  circumstances  claimed to provide a basis for termination of your
employment under the provision so indicated.

                  (e) Date of Termination.  "Date of Termination" shall mean (A)
if your employment is terminated for  Disability,  thirty (30) days after Notice
of  Termination  is given  (provided  that you  shall not have  returned  to the
performance  of your  duties on a  full-time  basis  during such thirty (30) day
period), (B) if you employment is terminated due to your death, the date of your
death, (C) if your employment is terminated pursuant to paragraph (b) above, the
date  specified  in the  Notice  of  Termination,  (D)  if  your  employment  is
terminated for Retirement, the date specified in the Notice of Termination,  and
(E) if your  employment is terminated for any other reason,  the date on which a
Notice of Termination  is given;  provided that if within thirty (30) days after
any  Notice  of  Termination  is  given  the  party  receiving  such  Notice  of
Termination  notifies  the other  party  that a dispute  exists  concerning  the
termination,  the Date of Termination  shall be the date on which the dispute is
finally  determined,  either by mutual written agreement of the parties, or by a
final judgment,  order or decree of a court of competent  jurisdiction (the time
for appeal  therefrom  having  expired  and no appeal  having  been  perfected);
provided  further,  however,  that if such  disputed  termination  constitutes a
Payment  Trigger,  the Trigger  Period shall not run pending  resolution  of the
dispute  but  shall  recommence  upon  the  date  that the  dispute  is  finally
determined (as set forth in the preceding proviso).

         4. Certain Benefits Upon Termination. (a) If, after a change in control
of the  Company  shall  have  occurred,  as  defined  in  Section 2 above,  your
employment  with the  Company  shall be  terminated  (including  a  Constructive
Termination)  within  the  Trigger  Period by the  Company or you other than for
Cause,  Disability,  Retirement  or death,  and other  than by your  voluntarily
terminating your employment with the Company,  then you shall be entitled to the
benefits provided below:

                           (i)   the Company shall pay to you within thirty (30)
days following the Date of Termination in a lump sum cash payment your full base
salary through the Date of  Termination at the rate in effect at the time Notice
of Termination is given plus (A)  credit for any  vacation earned but not taken,
(B) the amount,  if any, of any bonus or long-term incentive



<PAGE>


Mr. Michael Murphy
August 26, 1998
Page 7                  


compensation  for a past fiscal year which has been earned but not yet been paid
to you, (C) the amount,  if any, of any bonus for the current year to be paid as
a percentage of Company profit based on the Company's  results  through the most
recent fiscal quarter as of the Date of Termination  without  pro-ration,  (D) a
pro-rated payment, based on the Company's results through the most recent fiscal
quarter as of the Date of  Termination  under the  Company's  performance  based
long-term incentive program for the long-term  performance period that next ends
following the Date of  Termination,  and (E) a pro-rated  payment,  based on the
Company's  results as of the Date of  Termination,  of any other bonus due under
any other Bonus Plans;

                           (ii)   in lieu of any further salary payments  to you
for  periods  subsequent  to  the  Date of Termination, the Company shall pay as
severance pay to you within  thirty (30) days  following the Date of Termination
a lump sum cash amount equal to 2.00  times  the sum of (A) the  amount  of your
annual  base  salary at the highest rate in effect during the twelve (12) months
immediately  preceding the Date of Termination, and (B) the average annual bonus
received by you with  respect to the three (3)  years immediately  preceding the
Date of Termination, or  with respect to the  period  beginning  January 1, 1997
and ending on December 31 of the calendar  year  immediately  preceding the Date
of  Termination,  if  such  period  is  less  than  three  years  at the Date of
Termination, and (C) (x) the most  recent amount earned by you (whether in stock
or  cash or  a  combination  thereof)  under  the  Company's  performance  based
long-term incentive program  established under the Company's Executive Incentive
Compensation Plan or, (y) if the Date of  Termination  giving rise to your right
to benefits hereunder occurs before the end of the initial Long-Term Performance
Period established under the long-term incentive  program so that benefits  have
not  yet  accrued  under  the  long-term  incentive  program,  the target amount
established for you under the program for  the Long-Term Performance Period next
ending; and

                           (iii) the  Company  shall  maintain in full force and
effect, for  your continued  benefit  until the  earlier of (A)  three (3) years
after the Date of  Termination or (B) you obtain substantially the same coverage
from a new employer,  all life insurance,  medical,  health  and  accident,  and
disability  plans,  programs  or  arrangements  in  which  you  were entitled to
participate  immediately prior to the  Date of  Termination,  provided that your
continued  participation  is possible  under the general terms and provisions of
such plans and programs.  In the event  that your participation in any such plan
or program is barred, the Company shall  use  reasonable  efforts to  arrange to
provide you with benefits substantially similar to those which you are  entitled
to  receive  under  such  plans and programs.

                  (b) If,  after a change in control of the  Company  shall have
occurred,  as defined in Section 2 above, you shall  voluntarily  terminate your
employment with the Company within the Trigger Period other than for Disability,
Retirement or death or in connection with an event of Constructive  Termination,
then you shall be entitled to the benefits set forth below:

                           (i)   the Company shall pay to you within thirty (30)
days following the Date of Termination in a lump sum cash payment your full base
salary through the Date of



<PAGE>


Mr. Michael Murphy
August 26, 1998
Page 8                  


Termination  at the rate in effect at the time  Notice of  Termination  is given
plus (A) credit for any vacation earned but not taken,  (B) the amount,  if any,
of any bonus or long-term  incentive  compensation  for a past fiscal year which
has been  earned but not yet been paid to you,  (C) the  amount,  if any, of any
bonus for the current year to be paid as a percentage of Company profit based on
the Company's  results  through the most recent fiscal quarter as of the Date of
Termination without pro-ration,  (D) a pro-rated payment, based on the Company's
results  through the most recent  fiscal  quarter as of the Date of  Termination
under the  Company's  performance  based  long-term  incentive  program  for the
long-term  performance  period that next ends following the Date of Termination,
and (E) a pro-rated  payment,  based on the Company's  results as of the Date of
Termination, of any other bonus due under any other Bonus Plans;

                           (ii)   in lieu of any further salary  payments to you
for  periods  subsequent  to  the  Date of Termination, the Company shall pay as
severance pay to you within  thirty (30) days  following the Date of Termination
a lump sum cash  amount equal  to the sum of (A) the amount of your annual  base
salary  at  the  highest  rate  in   effect  during   the  twelve  (12)   months
immediately  preceding  the  Date  of  Termination,  and (B) the average  annual
bonus received by you with respect to the three (3) years immediately  preceding
the Date of Termination, or with respect to the period beginning January 1, 1997
and ending on December 31 of the calendar year immediately preceding the Date of
Termination, if such period is less than three years at the Date of Termination,
and (C) (x) the most recent  amount earned by you (whether in stock or cash or a
combination thereof) under the Company's  performance based long-term  incentive
program established under the  Company's Executive  Incentive Compensation  Plan
or,  (y)  if the Date of  Termination  giving  rise to  your  right  to benefits
hereunder  occurs before the  end of the  initial Long-Term  Performance  Period
established under the long-term incentive  program so that benefits have not yet
accrued  under the  long-term incentive  program,  the target amount established
for you under the program for  the Long-Term Performance Period next ending; and

                           (iii) the  Company  shall  maintain in full force and
effect,  for  your  continued  benefit  until  the  earlier  of  (A)  the  first
anniversary  of the  Date  of Termination or (B)  you  obtain substantially  the
same  coverage  from a new employer,  all life  insurance,  medical,  health and
accident,  and  disability plans,  programs  or  arrangements  in which you were
entitled to participate immediately prior to the Date of  Termination,  provided
that  your  continued participation  is possible  under the general   terms  and
provisions of such plans and programs.  In the event that your  participation in
any such plan or program is barred, the Company shall use reasonable  efforts to
arrange to  provide you with benefits  substantially similar  to those which you
are entitled to receive under such plans and programs.

                  (c) You shall not be required  to  mitigate  the amount of any
payment provided for in this Section 4 by seeking other employment or otherwise,
nor shall the amount of any payment provided for in this Section 4 be reduced by
any  compensation  earned by you as the result of employment by another employer
after the Date of Termination,  or otherwise.  In the event that you voluntarily
terminate  your   employment   with  the  Company  and  are  paid  the  benefits
contemplated



<PAGE>


Mr. Michael Murphy
August 26, 1998
Page 9                  


by  paragraph  (b) of this  Section  4 and,  at any time  within  five (5) years
following the receipt of such payment,  you are reemployed by the Company or any
subsidiary thereof in a position where your duties or responsibilities  with the
Company or such subsidiary are commensurate with those of your position with the
Company  immediately prior to the original  termination of your employment which
gave rise to the Company's  payment of benefits under this Section 4, you shall,
on the date of such reemployment, be obligated to repay to the Company, in cash,
an amount equal to the benefit paid to you under  paragraph  (b) of this Section
4, plus any amounts paid to you under  Section 5 hereof in  connection  with the
payments to you pursuant to paragraph (b) of this Section 4 (and not  previously
repaid by you pursuant to the terms of Section 5).

         5.       Tax Gross-Up.

                  (a) If you become entitled to any payments or benefits whether
pursuant  to the terms of this  Agreement  or any  other  plan,  arrangement  or
agreement  with the  Company,  any person  whose  actions  result in a change in
control or any  person  affiliated  with the  Company  or such  persons  (in the
aggregate, "Payments" or singularly, "Payment") which are subject to taxes under
Section  4999 (or any  successor  provision  thereto)  of the Code (the  "Excise
Tax"), the Company shall pay to you an additional  amount  ("Gross-Up  Payment")
such that the net amount  retained by you, after deduction of (A) any Excise Tax
on Payments, (B) any federal, state and local income tax and Excise Tax upon the
payment provided for by this Section, and (C) any interest and penalties imposed
because the Excise Tax is not paid during the period  beginning with the earlier
of the date (i) the IRS issues a notice  stating  that an Excise Tax is due with
respect to a Payment,  (ii) you deliver to the Company an opinion of tax counsel
selected by you and  reasonably  acceptable to the Company that all or a portion
of the  Payment is subject to the  Excise Tax and  setting  forth the  estimated
amount of the Excise Tax on the Payment,  and (iii) the Company  delivers to you
an opinion of tax counsel  selected by the Company and reasonably  acceptable to
you that all or a portion  of the  payment  is  subject  to the  Excise  Tax and
setting forth the estimated amount of the Excise Tax on the Payment (the "Excise
Tax  Imposition  Date") and ending ten (10) days after the Excise Tax Imposition
Date,  shall be equal  to the full  amount  of the  Payments.  For  purposes  of
determining  the  amount  of the  Gross-Up  Payment,  you shall be deemed to pay
federal income taxes at the highest  marginal rate of federal income taxation in
the  calendar  year in which the  Gross-Up  Payment  is to be made and state and
local  income taxes at the highest  marginal  rates of taxation in the state and
locality of your  residence on the date the Gross-Up  Payment is to be made, net
of the maximum  reduction in federal  income taxes which could be obtained  from
deduction of such state and local taxes.

                  (b) The Gross-Up Payment for any Payment made shall be paid to
you  within  ten (10) days after the  Excise  Tax  Imposition  Date,  unless the
Company undertakes to indemnify you as provided in Section 5 (c).

                  (c) In lieu of paying the  Gross-Up  Payment for any  Payment,
the  Company  may elect to  undertake,  at its sole  expense,  the  defense  and
settlement of any assessment by the IRS of



<PAGE>


Mr. Michael Murphy
August 26, 1998
Page 10                  


the Excise Tax on any Payment. In the alternative,  the Company may elect to pay
the Gross-Up  Payment and seek to recover the Excise Tax by pursuing a claim for
a refund. If the Company so elects to undertake the defense or settlement of any
assessment  by the IRS of the Excise Tax on any  Payment or the  recovery of the
Excise Tax  through a claim for  refund,  the  Company  shall  protect,  defend,
indemnify and hold you forever  harmless from and against the Excise Tax on such
Payment and payments  pursuant to this  Section 5(c) and any federal,  state and
local income tax (determined pursuant to the last sentence of Section 5(a)) upon
payments  pursuant to this  Section 5(c) and any and all  liabilities,  demands,
claims,  actions,  causes of  action,  assessments,  losses,  costs,  damages or
expenses,  including  attorneys' and  accountants'  fees in connection  with any
thereof,  and any  interest  and  penalties  sustained  by you as a result of or
arising out of or by virtue of the Company's  undertaking.  You shall  cooperate
with the Company as  reasonably  requested by the Company in the conduct of such
defense, settlement or refund claim.

                  (d) If the Excise Tax is determined to be less than the amount
taken into account in determining the Gross-Up  Payment paid pursuant to Section
5(a),  you shall repay to the  Company  within ten (10) days after the time that
the amount of such reduction in Excise Tax is finally  determined the portion of
the Gross-Up Payment  attributable to such reduction plus interest on the amount
of such repayment at the rate provided in Section  1274(b)(2)(B) of the Code for
debt instruments with a maturity after issuance equal to the period beginning on
the date the  Gross-Up  Payment  was made and  ending  on the date of  repayment
required by this  sentence,  or in the case of a refund,  plus  interest paid on
such  refund.  If the Excise Tax is  determined  to exceed the amount taken into
account in determining  the Gross-Up  Payment paid pursuant to Section 5(a) (the
"Excise Tax Deficit"),  the Company within ten (10) days after the time that the
amount of the Excise Tax Deficit is finally  determined shall make an additional
payment to you in an amount  equal to (i) the Excise Tax  Deficit,  plus (ii) an
amount equal to any interest  and  penalties  payable to the IRS with respect to
the Excise Tax Deficit,  plus (iii) any federal,  state and local income tax and
Excise Tax  (determined  pursuant  to the last  sentence  of Section  5(a)) upon
payments made pursuant to this sentence.

         6. Term of Agreement. This Agreement shall become effective on the date
hereof  and,  subject  to the first  sentence  of the second  paragraph  of this
Section 6, shall continue in effect until the earliest of the following:

                  (i) a Date of Termination  in accordance  with Section 3(e) or
         other  termination  of your  employment  with the  Company  shall  have
         occurred prior to a change in control of the Company; or

                  (ii) if a Payment  Trigger shall have occurred during the term
         of  this  Agreement,   the  performance  by  the  Company  of  all  its
         obligations, and the satisfaction by the Company of all its obligations
         and liabilities, under this Agreement;



<PAGE>


Mr. Michael Murphy
August 26, 1998
Page 11                  


                  (iii) the date that is the fifth (5th) anniversary of the date
         of this Agreement;  provided,  however,  that if a change in control of
         the Company occurs prior to such fifth (5th) anniversary, the Company's
         obligation  to you under this  Agreement  due to such change in control
         shall not lapse upon the fifth (5th)  anniversary,  but shall  continue
         through  the final day of the  Trigger  Period  that  begins  with such
         change in control if such final day of the Trigger Period is later than
         such fifth (5th) anniversary.

                  Any change in control of the  Company  during the term of this
Agreement that for any reason ceases to constitute a change in control or is not
followed by a Payment  Trigger shall not effect a  termination  or lapse of this
Agreement,  and, in such event,  this  Agreement  shall continue to apply to the
event of any subsequent  change in control of the Company occurring prior to the
end of the term of this  Agreement.  Any  transfer of your  employment  from the
Company  to a  subsidiary,  from  a  subsidiary  to the  Company,  or  from  one
subsidiary to another  subsidiary  shall not  constitute a  termination  of your
employment for purposes of this Agreement.

         7.       Successors; Binding Agreement.

                  (a) The Company will require any successor  (whether direct or
indirect,   by  purchase,   merger,   consolidation  or  otherwise)  to  all  or
substantially all of the business and/or assets of the Company,  by agreement in
form and substance satisfactory to you, to expressly assume and agree to perform
this  Agreement in the same manner and to the same extent that the Company would
be required to perform it if no such succession had taken place.  Failure of the
Company  to  obtain  such  agreement  prior  to the  effectiveness  of any  such
succession  shall be a breach of this  Agreement  and,  if such  failure  occurs
subsequent to a change in control of the Company,  shall  constitute an event of
Constructive  Termination  and entitle you to  compensation  from the Company in
accordance with Section 4 hereof,  except that for purposes of implementing  the
foregoing,  the date on which any such  succession  becomes  effective  shall be
deemed the Date of Termination. As used in this Agreement,  "Company" shall mean
the Company as  hereinbefore  defined and any  successor to its business  and/or
assets as aforesaid  which  executes and delivers the agreement  provided for in
this Section 7 or which otherwise  becomes bound by all the terms and provisions
of this Agreement by operation of law.

                  (b)  This  Agreement  shall  inure  to the  benefit  of and be
enforceable   by   your   personal   or   legal   representatives,    executors,
administrators,  successors, heirs, distributees,  devisees and legatees. If you
should die while any amount  would still be payable to you  hereunder if you had
continued to live, all such amounts,  unless otherwise provided herein, shall be
paid in accordance with the terms of this Agreement to your devisee,  legatee or
other designee or, if there be no such designee, to your estate.



<PAGE>


Mr. Michael Murphy
August 26, 1998
Page 12                  


         8. Notice.  For the purposes of this  Agreement,  notices and all other
communications  provided for in this Agreement  shall be in writing and shall be
deemed to have been duly given when delivered  personally or mailed by certified
or registered mail, return receipt requested,  postage prepaid, addressed to the
respective  addresses  set forth on the first page of this  Agreement,  provided
that all  notices to the  Company  shall be  directed  to the  attention  of the
President of the Company with a copy to the Secretary of the Company, or to such
other  address  as either  party may have  furnished  to the other in writing in
accordance herewith,  except that notice of change of address shall be effective
only upon receipt.

         9.  Miscellaneous.  No  provisions  of this  Agreement may be modified,
waived or discharged unless such waiver,  modification or discharge is agreed to
in writing  signed by you and such officer as may be  authorized by the Board of
Directors  of the  Company.  No waiver by either party hereto at any time of any
breach by the other  party  hereto of, or  compliance  with,  any  condition  or
provision of this  Agreement to be performed by such other party shall be deemed
a waiver of similar or dissimilar provisions or conditions at the same or at any
prior or subsequent time. No agreements or  representations,  oral or otherwise,
express or implied,  with respect to the subject matter hereof have been made by
either  party which are not  expressly  set forth in this  Agreement;  provided,
however, that this Agreement shall not supersede or in any way limit the rights,
duties or  obligations  you may have under any other written  agreement with the
Company.  The validity,  interpretation,  construction  and  performance of this
Agreement  shall be governed by the laws of the State of Alabama  without regard
to principles regarding conflicts of laws.

         10.      Counterparts.   This Agreement may be executed  in one or more
counterparts, each  of which shall be deemed to be an original  but all of which
together will constitute one and the same instrument.

         11.  Enforcement;  Expenses.  The provisions of this Agreement shall be
regarded as  divisible,  and if any of said  provisions  or any part thereof are
declared  invalid or  unenforceable  by a court of competent  jurisdiction,  the
validity and  enforceability of the remainder of such provisions or parts hereof
and the applicability  thereof shall not be affected thereby.  The Company shall
pay all fees,  costs and expenses  (including,  without  limitation,  reasonable
attorneys'  fees and the costs of  investigating  any potential  claim) (herein,
collectively,  "Costs")  incurred by you in connection  with any dispute arising
under or relating to this Agreement or any action(s) or proceeding(s) to enforce
your  rights  under  this  Agreement,  should  you  prevail  in such  action  or
proceeding,  and, in addition to paying your Costs, the Company shall pay to you
(i)  interest on such Costs and on the  aggregate  amount of the benefits due to
you under Section 4 above (said benefits being referred to in this Section 11 as
the "Termination Benefits") from your Date of Termination to the date such Costs
and  Termination  Benefits  are paid to you at an annual rate equal to the prime
lending rate charged by First  Commercial  Bank,  or the successor  thereto,  in
effect on the Date of Termination,  and (ii) liquidated and agreed  compensatory
damages  in an amount  equal to  twenty-five  percent  (25%) of the  Termination
Benefits.



<PAGE>


Mr. Michael Murphy
August 26, 1998
Page 13                  

         12. Jurisdiction;  Service of Process. Any action or proceeding seeking
to  enforce  any  provision  of,  or based on any  right  arising  out of,  this
Agreement  may be brought  against  either party only in the courts of the state
and county in which you are  employed  by the  Company  and each of the  parties
consents to the  jurisdiction of such courts (and of the  appropriate  appellate
courts) in any such action or proceeding  and waives any objection to venue laid
therein.  Process  in any  action or  proceeding  referred  to in the  preceding
sentence may be served on either party anywhere in the world.

         If this letter correctly sets forth our agreement on the subject matter
hereof,  kindly sign and return to the Company the enclosed  copy of this letter
which will then constitute our agreement on this subject.

                                                     CAVALIER HOMES, INC.


                                                     /s/ DAVID A. ROBERSON
                                                     ---------------------------
                                                     Its  President  and  Chief
                                                     Executive Officer


AGREED TO THIS 21ST DAY OF AUGUST, 1998.


/s/ MICHAEL R. MURPHY
- ----------------------------
Michael R. Murphy


<TABLE>
<CAPTION>

                                   PART II. - EXHIBIT 11
                           CAVALIER HOMES, INC. AND SUBSIDIARIES
                        COMPUTATION OF NET INCOME PER COMMON SHARE


                                                             Thirteen Weeks Ended                  Thirty-nine Weeks Ended
                                                       ----------------------------------     ----------------------------------
                                                       September 25,      September 26,        September 25,     September 26,
                                                            1998              1997                 1998              1997
                                                       ---------------   ----------------     ----------------  ----------------

BASIC & DILUTED
<S>                                                  <C>               <C>                  <C>               <C>              
     Net Income                                      $      5,220,000  $       3,639,000    $      13,331,000 $      14,412,000
                                                       ===============   ================     ================  ================

SHARES:


  Weighted average common shares                           20,072,336         19,869,210           20,029,432        19,813,209
  
      outstanding (basic)

  Dilutive effect if stock options
    were exercised                                            235,521            186,064              275,272           198,456
                                                       ---------------   ----------------     ----------------  ----------------

 Weighted average common shares
      outstanding, assuming dilution (diluted)             20,307,857         20,055,274           20,304,704        20,011,665
                                                       ===============   ================     ================  ================




  Basic net income per share                         $           0.26  $            0.18                 0.67 $            0.73
                                                       ===============   ================     ================  ================ 

  Diluted net income per share                       $           0.26  $            0.18                 0.66 $            0.72
                                                       ===============   ================     ================  ================
</TABLE>
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.

<TABLE> <S> <C>
                                               
<ARTICLE>           5

<MULTIPLIER>                                                                1000
                                                     
This  schedule   contains  summary   financial   information
extracted  from  the  Cavalier  Homes,   Inc.   Consolidated
Condensed  Balance  Sheets as of September 25, 1998, and the
Consolidated  Condensed  Statements of Income and Cash Flows
for  the  Thirteen  Weeks  ended   September  25,  1998  and
September 26, 1997, in each case unaudited, and is qualified
in its entirety by reference to such financial statements.
<S>                                                                          <C>             <C>
<PERIOD-TYPE>                                                                       9-mos          9-mos
<FISCAL-YEAR-END>                                                             Dec-31-1998    Dec-31-1997
<PERIOD-END>                                                                  Sep-25-1998    Sep-26-1997
<CASH>                                                                              41304          19169
<SECURITIES>                                                                            0              0
<RECEIVABLES>                                                                       36641          35407
<ALLOWANCES>                                                                         1190            860
<INVENTORY>                                                                         39399          31833
<CURRENT-ASSETS>                                                                   129684          96797
<PP&E>                                                                              80900          69310
<DEPRECIATION>                                                                      23051          16382
<TOTAL-ASSETS>                                                                     236964         216705
<CURRENT-LIABILITIES>                                                               84836          66289
<BONDS>                                                                                 0              0
                                                                   0              0
                                                                             0              0
<COMMON>                                                                             2025           1988
<OTHER-SE>                                                                         141409         135560
<TOTAL-LIABILITY-AND-EQUITY>                                                       234964         216705
<SALES>                                                                            446085         423977
<TOTAL-REVENUES>                                                                   450690         427797
<CGS>                                                                              365772         354512
<TOTAL-COSTS>                                                                           0              0
<OTHER-EXPENSES>                                                                        0              0
<LOSS-PROVISION>                                                                    (517)            279
<INTEREST-EXPENSE>                                                                    661           1120
<INCOME-PRETAX>                                                                     22388          22851
<INCOME-TAX>                                                                         9057           8439
<INCOME-CONTINUING>                                                                 13331          14412
<DISCONTINUED>                                                                          0              0
<EXTRAORDINARY>                                                                         0              0
<CHANGES>                                                                               0              0
<NET-INCOME>                                                                        13331          14412
<EPS-PRIMARY>                                                                        0.67           0.73
<EPS-DILUTED>                                                                        0.66           0.72
        


</TABLE>


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