ITEM 1. BUSINESS.
GENERAL
Kevco, Inc. ("Kevco" or the "Company," and includes, unless the context otherwise requires, its direct and indirect subsidiaries) believes it is the largest wholesale distributor of building products to the manufactured housing and recreational vehicle ("RV") industries. Except as otherwise indicated, information contained herein relating to Kevco is as of December 31, 1998. Through its 27 distribution centers (as of March 17, 1999), the Company distributes more than 75,000 different inventory items to approximately 530 manufactured housing and RV and other manufacturing facilities throughout the United States. Kevco is one of only a few companies capable of providing national distribution of building products to the manufactured housing and RV industries. In addition, the Company also manufactures wood products, laminated wallboard, thermoformed bathtubs and shower enclosures for the manufactured housing industry. From 1994 to 1998, the Company's net sales increased from $99.3 million to $897.5 million, a compound annual growth rate of approximately 73%. Since its founding in 1964, the Company's growth has been fueled by internal growth and acquisitions. On November 6, 1996, the Company consummated its initial public offering. During the second quarter of 1998, the Company's subsidiary structure was reorganized.
The Company believes that it provides a cost-effective form of distribution that offers value to both the Company's suppliers and producers of manufactured homes and RVs. Kevco believes that it provides significant benefits to its suppliers by placing large orders at regular intervals, thereby enabling its suppliers to achieve efficient and cost-effective production planning and economies of scale. In addition, Kevco markets and sells its suppliers' products directly to the manufactured housing and RV industries. As a result, the Company believes it reduces its suppliers' inventory carrying, marketing and distribution costs. The Company also believes that it provides significant benefits to its customers as a result of its ability to respond on a same day shipment basis to a majority of its customers' orders, thus reducing the amount of inventory they must maintain. Furthermore, Kevco assists its customers in inventory management, product support, training and implementing cost saving measures, all of which are services that the Company believes most building products manufacturers cannot provide in a cost-effective manner. The Company believes that the
specialized product knowledge and high level of service provided by Kevco personnel result in strong relationships between Kevco and its suppliers and customers.
The Company distributes a full line of plumbing fixtures and supplies as well as a variety of other building products, including insulation, roof shingles, patio doors, aluminum, vinyl and wood windows, wood and vinyl siding, fireplaces, electrical components and hardware, fasteners, power tools and mill supplies. The Company also manufactures wood products including roof trusses and lumber cut to customer specifications, laminated wallboard products, plastic injection molded products and thermoformed bathtubs, shower enclosures and tub wall surrounds. In 1998, approximately 13% of the Company's net sales were derived from plumbing products, 9% from electrical products, 9% from hardware, fasteners, tools and mill supplies, 18% from wood products, 5% from thermoformed plastic products, 8% from laminated wallboards and 38% from other building products. See note 13 to the consolidated financial statements for additional segment data.
INDUSTRY
For the year ended December 31, 1998, approximately 90% of the Company's net sales were to producers of manufactured homes. A manufactured home is a complete single-family residence that is built in a factory and transported to a site. Manufactured homes offer most of the amenities of, and are generally built with the same materials as, site-built homes.
Manufactured housing has historically served as one of the most affordable alternatives for the home buyer. According to the U.S. Department of Commerce, in 1997 the average cost per square foot was $25.78 for a single-section manufactured home and $30.65 for a multi-section manufactured home, as compared to an average cost of $61.47 per square foot for a site-built home, each excluding land costs. In 1997, reported sales of new manufactured homes totaled approximately $14.5 billion (at retail). Approximately 373,000 manufactured homes were reported as shipped in 1998 (which would represent approximately 29.6% of all new single family homes sold in 1998).
The Company believes steady employment growth, greater availability of retail financing for the home buyer and enhanced quality of manufactured homes have contributed to industry conditions. Although the manufactured housing industry has experienced significant growth over the past five years, the industry is cyclical and is affected by many of the same factors that influence the housing industry generally, including inflation, interest rates, availability of financing, regional economic and demographic conditions, consumer confidence levels and retail inventory levels, as well as the affordability and availability of alternative housing, such as apartments, condominiums and conventional, site-built homes.
The ten highest volume producers of manufactured homes in 1997 reportedly accounted for approximately 80% of total manufactured home shipments in that year. Management believes that only a few distributors are capable of distributing a broad line of building products to meet the needs of these manufacturers on a national basis.
For the year ended December 31, 1998, approximately 7% of the Company's net sales were to producers of RVs. RVs are motorized and non-motorized vehicles that provide comfortable, self-contained living facilities for short periods of time, but are not generally designed for permanent living. RV shipments to retailers reportedly totaled approximately 293,000 units in 1998. Historically, demand for RVs has been influenced by a number of factors, including the availability and terms of financing to dealers and retail purchasers, the abundance of motor vehicle fuels and fuel prices, as well as general economic conditions.
BUSINESS STRATEGY
Kevco's primary objective is to maintain and strengthen its position as one of the largest national distributors of building products to the manufactured housing and RV industries. To achieve its objective, the Company has adopted a strategy based on the following key elements:
PROVIDE SUPERIOR CUSTOMER SERVICE. The Company believes its success is primarily attributable to its emphasis on customer service and that providing a high level of customer service leads to long-term relationships with customers. The Company's operating philosophy is based on a commitment to Total Quality Management, which emphasizes at every level an awareness of, and accountability for, customer needs and effective communication both internally and externally. Consistent with this commitment, the Company strives to achieve maximum responsiveness to customer orders and to assist its customers in controlling costs, improving their materials resource planning and facilitating their just-in-time inventory procurement needs. The Company's sales representatives, who have an average of approximately ten years of experience with the Company, play an important role in training customers in the proper installation of products and assisting in their inventory management.
REALIZE SHELTER ACQUISITION BENEFITS. The Company believes that its continued success will depend in part on its effectively integrating the Company's operations with those it acquired through the acquisition of Shelter. The Company has prioritized the integration of its various distribution information systems into a single hardware and software platform, which the Company believes will ultimately result in better inventory management and lower distribution costs. The Company intends to continue to reduce administrative and facility redundancies such as through the integration and streamlining of the Company's accounting systems, the consolidation of warehouses and the sale or subletting of vacant facilities. The Company is also exploring methods of reducing its debt leverage, created in part as a result of the Shelter acquisition in order to enhance its competitiveness. Until such integration is substantially complete, levels of debt reduced and profitability restored, the Company does not anticipate effectuating additional acquisitions.
LEVERAGE NATIONAL DISTRIBUTION NETWORK. Kevco intends to continue to use its national distribution network as a platform for internal growth. The Company believes that its national distribution network has allowed it to develop close relationships with leading product manufacturers and to become the exclusive supplier of certain product lines to the manufactured housing and RV industries. In addition, the Company believes that its national presence provides it with a competitive advantage due to its ability to service effectively the building products needs of its customers' manufacturing facilities, several of which are located in remote, rural areas. This capability has led to several national customer accounts. As one of the largest national distributors of building products in the United States to the manufactured housing and RV industries, the Company has substantial purchasing power and is able to realize economies of scale.
INCREASE CUSTOMER PENETRATION AND PRODUCT OFFERINGS. Kevco supplies over 90% of all manufactured housing plants in the United States with one or more product lines. This established customer base provides the Company with an opportunity to supply a greater portion of its customers' building products needs as the customers seek to reduce the number of their suppliers. With its existing national distribution infrastructure, the Company believes that additional products from its existing product lines can be offered to customers without significant additional overhead cost.
SUPPLIER/CUSTOMER RELATIONSHIPS
Kevco acts with its suppliers and customers to provide value-added services in the distribution of manufactured home and RV building products by managing inventories, providing product support and training, introducing cost saving measures and providing a marketing and distribution network with warehousing capabilities. The Company believes that the specialized product knowledge and high level of service provided by Kevco personnel results in strong ties between Kevco and its customers and suppliers.
INVENTORY MANAGEMENT. Kevco's customers generally attempt to minimize inventories and to maximize the use of their facilities for the assembly of manufactured homes and RVs. For this reason, Kevco actively manages customers' inventories of products supplied by Kevco. Kevco sales representatives generally visit customers' plants weekly to count inventories, review production schedules, prepare purchase orders and schedule deliveries in order to achieve the Company's goal of being a just-in-time supplier. In addition, because of their detailed awareness of existing building codes for manufactured homes and RVs, Kevco's sales representatives are able to assist customers in planning for, and maintaining product inventories in accordance with, building code changes.
PRODUCT SUPPORT AND TRAINING. At their weekly visits, sales representatives also take the opportunity to resolve product problems and train customer employees in the proper installation of products. Kevco has found that its willingness and availability to solve product problems has resulted in its customers first turning to Company representatives, rather than Kevco's suppliers, when they have problems with or questions about products. This benefits both Kevco's customers and suppliers in that Kevco provides customer support that the supplier might otherwise have to provide in order to achieve the same level of customer satisfaction, and Kevco's customers receive support from individuals with expertise in serving the manufactured housing and RV industries. Kevco has also found that its customers benefit from the training given by sales representatives in the proper installation of products, since Kevco's sales representatives generally have significant expertise in the installation and service of the products they sell. Sales representatives also take the opportunity during their weekly visits to promote other Kevco products, thus educating customers as to additional products the customers can purchase from Kevco and receive similar product support.
COST SAVING MEASURES. The Company's sales force also works with the Company's customers and suppliers in suggesting and implementing cost saving measures. Kevco actively works to find ways for producers of manufactured homes or RVs to reduce the number of stock-keeping units ("SKUs") they use in production in order to further reduce their inventories. In its wood products operations, Kevco builds steel forms to its customers' specifications to ensure the dimensional tolerances of the roof trusses it manufactures, as strict adherence to design specifications translates into reduced manufacturing costs for Kevco's customers. Additionally, developing and following QS-9000 based policies and procedures has provided substantial savings on the products produced by Kevco, and the engineering staff of Kevco is prepared to assist customers with parts consolidation and redesign.
MARKETING/DISTRIBUTION NETWORK. Kevco believes that its suppliers also benefit by utilizing Kevco's extensive marketing and distribution network. The Company also believes that it is generally not cost effective for its suppliers to provide the same level of service and delivery responsiveness as Kevco to producers of manufactured homes and RVs.
TOTAL QUALITY MANAGEMENT
Kevco is committed to maintaining Total Quality Management throughout its operations. The key elements of this operating philosophy are (i) to increase customer satisfaction by seeking to meet or exceed all customer requirements and ensuring that all associates are "customer focused," which the Company believes results in Kevco becoming the supplier of choice, (ii) to create the mindset and awareness within all of its associates that each is responsible and accountable for the results of Kevco's operations and (iii) to work with Kevco's suppliers and customers to create an environment where all are working together to improve the value of the products supplied to the manufactured home or RV consumer. The Company's executive office and profit centers hold weekly Total Quality Management meetings attended by all employees. The meetings focus on training and on reaffirming Kevco's mission, quality and value statements in order to achieve the goal of being the distributor, customer and employer of choice. An integral part of the entire quality process is creating a culture where communication can flourish among all internal and external parties, including associates, customers and suppliers.
PRODUCTS
The Company believes it distributes one of the most comprehensive product lines to the manufactured housing and RV industries. Prior to the acquisition of Shelter, Kevco distributed approximately 10,000 SKUs and Shelter distributed approximately 62,000 SKUs. Some of Kevco's and Shelter's SKUs overlap, and the Company continues to rationalize and reduce total SKUs as Shelter is integrated into the Company's operations. The following is a brief description of the products the Company distributes:
PLUMBING PRODUCTS. Kevco distributes a wide variety of plumbing fixtures and supplies including tubs, toilets, faucets, ABS pipe, connectors, fittings, drain waste vent systems and potable water systems. Kevco supplies substantially everything necessary to carry water into and out of a manufactured home or RV.
BUILDING PRODUCTS. Kevco distributes a wide variety of building products, including windows, wood moulding, vinyl siding, visqueen, gypsum board, parquet wood flooring, insulation, roof shingles, patio doors, fireplaces, kitchen cabinetry and water heaters.
WOOD PRODUCTS. Kevco manufactures roof trusses and lumber cut to customer specifications for use in manufactured homes. Roof trusses are rectangular or triangular structures that form the principal roof support for a manufactured home. Kevco also distributes plywood and mill direct lumber.
HARDWARE, FASTENERS, POWER TOOLS AND MILL SUPPLIES. Kevco distributes screws, bolts and nuts of various sizes and dimensions, lock sets, cabinet door pulls, hinges, door slides and drapery hardware, stationary power tools, table saws, hoists and related equipment used in the manufactured home and RV manufacturing cycle, including complete plant set-ups, plastic film, tape, glue, caulking, chemicals and abrasives.
ELECTRICAL COMPONENTS. Kevco distributes electrical components, including wire, wiring devices, power generators, load-centers, circuit breakers, panels and 110 and 12 volt lighting.
THERMOFORMED PRODUCTS. Kevco manufactures and distributes bathtubs, shower enclosures and tub wall surrounds for the manufactured housing and RV industry using the thermoforming process.
LAMINATED WALLBOARD PRODUCTS. Kevco manufactures and distributes laminated wallboard products primarily for the manufactured housing and RV industries and, to a lesser extent, manufactures laminated wall shelving systems for the retail home improvement industry.
PLASTIC INJECTION MOLDED PRODUCTS. Kevco manufactures custom thermoplastic injection molded products for the automotive, sporting goods, medical and manufactured housing industries. Kevco also designs parts and builds injection molds for its customers.
SALES AND MARKETING
Kevco's marketing programs center on fostering strong customer relationships and providing superior customer service. Kevco believes its competitive advantage lies in its breadth of product offerings and the knowledge and expertise of its sales representatives, as well as its just-in-time delivery capabilities, regular calling program, dedication to Total Quality Management and competitive pricing.
The Company's national accounts are each supported by a senior account executive. As a company, Kevco provides technical support through its marketing group and service support through its local business units, each unit being supported by a sales manager and an operational manager. Each customer within a business unit's geographical reach is contacted weekly by the Company's local sales team. Because of the specific nature of the wood products business, these sales forces generally work independently. Each sales representative works within an assigned sales territory associated with one of Kevco's distribution centers or manufacturing facilities and is actively supported by a manager at such distribution center or facility.
Sales representatives, consisting of salespersons and sales managers, are all Company employees and are generally compensated on a salary and incentive-based compensation arrangement. The incentive portion of a salesperson's compensation is based on a percentage of the profits of the sales region "profit center" in which that salesperson operates. The incentive portion of the sales manager's compensation is determined by a variety of factors, which include the profit center's sales and returns as well as a discretionary element.
Kevco maintains active customer relationships with approximately 530 manufactured home production plants and RV production plants in 45 states. The Company's two largest customers, Champion Enterprises, Inc. and Fleetwood Enterprises, Inc., accounted for approximately 15% and 12%, respectively of Kevco's net sales in 1998. Although the Company has ongoing supply relationships with these customers, it does not have a formal supply contract with these customers or most of its other customers. The Company's business could be adversely affected if these customers, or other major customers, substantially reduced or discontinued purchases from the Company. Further, the Company can give no assurance that its sales to such customers will continue at historical levels. The Company believes that it has good relationships with each of its manufactured home and RV customers.
DISTRIBUTION
Kevco distributes products through 27 distribution centers strategically located near its customers' manufacturing plants in order to provide prompt delivery and responsive customer service. In most cases, the Company's desired service area is within a 250-mile radius of each distribution center. The Company generally uses a decentralized management structure that emphasizes individual distribution center profit-and-loss responsibility. A distribution center is typically comprised of warehouse and receiving space, secure outdoor holding space and office space. Local sales efforts are coordinated and supported at the distribution centers. The remaining distribution center activities relate to receiving, storing and delivering products.
Substantially all of Kevco's distribution centers are equipped with real-time management information systems that allow the distribution centers to control and monitor inventory levels, perform invoicing and order entry, and establish delivery schedules and routes. Corporate management also uses the Company's information systems to monitor sales, inventory and profitability by distribution center. As a result of the Shelter acquisition, the Company maintains multiple management information systems, some of which co-exist in individual warehouse distribution centers. The Company is currently in the process of merging the multiple systems into one, with the process scheduled to be complete in early 2000. Although each system provides accurate management and financial information, the multiple systems are less efficient than one system in disseminating management information on a timely and accurate basis.
Inventories are kept on the perpetual method, with daily physical counts of at least five items in each warehouse. A complete physical inventory count is performed twice a year. For book and tax purposes, the Company records purchased inventories under the FIFO method.
In most cases, the Company warehouses products before distributing them to customers. Kevco delivers the products it sells either by Company truck or common carrier. Delivery is a key component of Kevco's dedication to customer service and is a competitive requirement. In some instances, suppliers will "drop ship" products directly to Kevco's customers, with Kevco retaining responsibility for selling, billing and collection. Also, under certain arrangements, the Company receives fees for warehousing, delivering, selling or other services without taking title to the products. Kevco records such fees as commission income in the Consolidated Statements of Income.
PURCHASING AND SUPPLIERS
Kevco obtains its products from more than 1,000 different manufacturers. As a distributor, Kevco plays a valued role in linking product manufacturers with customers and provides the level of customer service and just-in-time delivery its customers require. Kevco's position in the marketplace has, from time to time, enabled it to take advantage of volume discounts, product promotions and other buying opportunities from suppliers, which allow the Company to market a wide variety of products to its customers at attractive prices.
The Company generally sells products from manufacturers on a non-exclusive basis without geographical restrictions. In certain limited instances, a supplier will grant Kevco the exclusive right to market its products in the manufactured housing or RV industries. Management believes that its national distribution capability will allow the Company to increase the number of products it distributes on a national and/or exclusive basis.
The Company generally negotiates the price and other purchase terms with its vendors on a company-wide or regional basis. Payment, discount and volume purchase programs are negotiated directly by the Company with its major suppliers, with a significant portion of the Company's purchases made from suppliers offering these programs. Distribution center managers are responsible for inventory selection and ordering on terms negotiated centrally, so that the Company remains responsive to local market demand. Distribution center managers are also responsible for inventory management.
While the loss of a major supplier could have a material adverse effect on the Company's business, the Company believes alternative suppliers for similar products in each of its product lines are generally available. In addition, raw material used by the Company for its manufactured products are generally available from a number of sources and loss of any one source would not have a material adverse effect on the Company. The Company believes its relations with its suppliers are generally good, though the Company believes that its substantial leverage and decline in profitability has strained its relationship with its suppliers. In the event a group of the Company's suppliers were to decline to sell product to the Company on credit at a time when the Company did not have the necessary liquidity to make payment within normal payment terms or otherwise make acceptable payment assurances, the Company's business could be materially and adversely affected unless alternative suppliers were then willing to sell such product to the Company on credit.
The Company has established a Supplier Certification Program, in which the Company identifies the performance level of a supplier to Kevco and benchmarks such performance on a regular basis. Such benchmarking criteria include minimum order fill rates and other factors.
MANUFACTURING
Kevco manufactures wood products, laminated wallboard products, plastic injection molded products and thermoformed bathtubs, shower enclosures and tub wall surrounds.
The Company manufactures wood products for distribution principally to producers of manufactured homes. Kevco's wood products include roof trusses and lumber cut to customer specifications for structural support within the manufactured home unit. Each of the Company's roof trusses is built to meet the customer's specific requirements.
Kevco utilizes automated saws to reduce the cutting time needed to process raw wood, and fabricates steel forms based on customer specifications in order to ensure the dimensional tolerances of its roof trusses. The quality and structural strength of roof trusses are monitored closely by manufactured home producers. Wind zone construction standards require that roof trusses sold for use in certain regions meet increased strength benchmarks. Roof trusses that meet exacting specifications can reduce customer installation costs. The Company believes that its ability to produce roof trusses of consistent quality that adhere to customer specifications provides a competitive advantage.
The Company's wood products customers include producers of manufactured homes as well as contract, "cut-to-order" customers outside of the manufactured housing industry. Substantially all of Kevco's wood product sales are to manufactured home producers. Kevco has roof truss manufacturing facilities in Alabama (2), Arizona, Georgia, North Carolina, Tennessee and Texas.
The Company manufactures laminated wallboard products primarily for the manufactured housing and RV industries and, to a lesser extent, manufactures laminated wall shelving systems for the retail home improvement industry. Decorative paper or vinyl wall coverings are laminated onto 4' x 8' sheets of gypsum, MDF or lauan and are shipped directly to the customers from one of Kevco's six manufacturing facilities located in Indiana, Georgia, North Carolina, Tennessee and Texas (2).
The Company manufactures bathtubs, shower enclosures and tub wall surrounds for the manufactured housing and RV industry using the thermoforming process. Thermoforming is the heating of plastic sheet to a softening temperature and forcing the hot flexible material over a mold by the use of mechanical and vacuum pressure. Allowed to cool, the plastic retains the shape and detail of the mold.
The Company designs, builds and molds high tolerance functional component parts. The process uses custom built molds and thermoplastic molding machines to liquify, inject and form parts for its customers. This process can accommodate small and large parts and hold tolerances up to .002 of an inch. Kevco has 27 molding machines ranging in size from 35 ton to 700 ton of clamp pressure.
WARRANTY AND RETURNS
Kevco's customers generally rely on the warranties issued by the manufacturer of the products sold by the Company. Kevco generally provides a one year limited warranty on the products it sells, which warranty covers the product and service calls. The Company's warranty on the product itself is generally not utilized because the product manufacturer provides a more comprehensive warranty. The Company's warranty expense in 1998 was negligible. Kevco also has an informal, unwritten return policy under which, for one year following sale, Kevco will generally accept the nonwarranty return of unused products, after inspection by Kevco personnel, for a restocking charge.
In the event a manufactured home experiences a failure of a roof truss manufactured by the Company, the Company will inspect the home to determine whether there is a covered defect in the roof truss. If a covered defect is discovered, the Company generally pays to replace the roof truss and the roof. The Company has had one claim in the past three years. The Company also maintains a limited warranty on its thermoformed products, which generally ranges from one to five years, covers defects in materials and workmanship by repair or replacement of the defective item and excludes labor and consequential damages.
COMPETITION
The building products wholesale distribution industry is highly competitive. Numerous companies, both public and private, are in direct competition with the Company and many of those competitors have longer operating histories and greater financial and other resources than the Company. The Company believes its prices, wide array of products and ability to deliver on short notice are competitive.
The Company believes that its business strategy has permitted it to compete effectively in its marketing areas. While price is an important competitive factor in the Company's business, the Company believes that its sales are principally dependent upon its service, technical expertise, reputation and experience. The Company's principal competitive strengths include (i) quality assurance, service and installation support, (ii) a wide array of products and product availability due to the Company's ability to attract major product manufacturers and (iii) the prompt and reliable delivery of products to customers.
Certain product manufacturers sell and distribute their products directly to producers of manufactured homes and RVs. However, the Company believes that, for most product manufacturers, providing the same level of service and offering the same delivery responsiveness as Kevco is not cost-effective.
EMPLOYEES
As of December 31, 1998, the Company employed 2,153 persons. The Company is a party to (i) a collective bargaining agreement, which covers certain employees at one of the Company's facilities in Elkhart, Indiana and (ii) a collective bargaining agreement effective through March 31, 1999, which covers certain employees at a plastics operation plant in Texas. The Company has not experienced any work stoppages as a result of labor disputes and the Company considers its employee relations to be good.
REGULATION
The Company's suppliers and customers are subject to a variety of federal, state and local laws and regulations. The National Manufactured Housing Construction and Safety Standards Act of 1974 and regulations promulgated thereunder by HUD impose comprehensive national construction standards for manufactured homes and preempt conflicting state and local regulations. HUD has adopted regulations that divide the United States into three "Wind Zones" and impose more stringent construction standards for homes to be sold in areas designated as Wind Zones II or III. These regulations have resulted in higher manufacturing and dealer costs. The Company cannot predict if additional regulations will be adopted or the effect any such regulations would have on the Company. To the extent regulations make manufactured housing less competitive with other housing alternatives, the Company's operations could be negatively impacted.
MANAGEMENT
The following table sets forth certain information as of March 25, 1999, concerning the Company's officers and certain key employees. Inclusion in this list as an officer or key employee is not intended to act as an admission that such individual is or will become subject to Section 16 under the Exchange Act.
Jerry E. Kimmel is a founder of the Company and has spent his entire career in this industry. Mr. Kimmel has served as President of Kevco since 1978 and has served as Chairman of the Board and Chief Executive Officer of the Company since 1993. In 1992, Mr. Kimmel was inducted into the MH/RV Hall of Fame. Mr. Kimmel served as the Chairman of the Board of Governors of the Manufactured Housing Institute ("MHI"), a leading manufactured housing trade group, in 1983 and 1984, and has served in various other MHI board capacities.
Clyde A. Reed, Jr. joined the Company in 1965 and has served as Executive Vice President since 1986 and Chief Operating Officer since 1991. From 1978 to 1986, Mr. Reed served as Vice President of the Company. Mr. Reed served as a director of the Company from November 1996 to January 1999.
Ellis L. McKinley, Jr. joined the Company in 1995, has served as Vice President and Chief Financial Officer since such time and has served as director and Treasurer of the Company since November 1996. From 1994 to 1995, Mr. McKinley was Vice President of Finance, Chief Financial Officer, Secretary and Treasurer of Renters Choice, Inc. From 1976 until 1994, Mr. McKinley was employed with Grant Thornton, a public accounting firm in Dallas, Texas, where he served as an audit partner from 1987 through 1994. Mr. McKinley received his B.B.A. in Accounting from the University of Texas in 1976.
Richard S. Tucker has served as a director of the Company since 1976, as an assistant secretary of the Company since 1988 and as the Secretary of the Company since November 1996. Since 1995, Mr. Tucker has been a partner in the law firm of Jackson Walker L.L.P., the Company's outside legal counsel. From 1984 to 1995, Mr. Tucker was a member of the law firm of Simon, Anisman, Doby, & Wilson, a Professional Corporation, located in Fort Worth, Texas. Mr. Tucker received his B.B.A. in Accounting from the University of Texas in 1966 and his J.D. from Southern Methodist University School of Law in 1969.
C. Lee Denham has served as President of Kevco Manufacturing, L.P. since its formation in 1998 and of its predecessor, Kevco's former subsidiary Sunbelt, since November 1996 and as Vice President of the Sunbelt division of Kevco from 1995 to November 1996. Mr. Denham was division manager of Sunbelt from 1991 to 1995. From 1981 to 1991, Mr. Denham was President of Sunbelt. From 1970 until founding Sunbelt in 1981, Mr. Denham was employed by Universal Forest Products, Inc. Mr. Denham received his B.B.A. in Marketing from the University of Georgia in 1970.
Gregory G. Kimmel joined the Company in 1994 and has served as Vice President since January 1996, as Vice President, Corporate Development since August 1997, Senior Vice President, Corporate Development since January 1998 and as a director of the Company since May 1997. Mr. Kimmel received his B.S. in Education from McMurry University in 1994. Gregory G. Kimmel is the son of Jerry E. Kimmel, the Chairman, President and Chief Executive Officer of the Company.
FACTORS THAT COULD AFFECT FUTURE PERFORMANCE
This report contains forward-looking statements that involve risks and uncertainties. Actual results could differ from those discussed in the forward-looking statements as a result of certain factors, including those set forth below and elsewhere in this report.
SALES BY SUPPLIERS
The Company generally purchases its products from suppliers on open account. In the event that a group of the Company's suppliers were to decline to sell product to the Company on credit at a time when the Company did not have the necessary liquidity to make payment within normal payment terms or otherwise make acceptable payment assurances, the Company's business could be materially and adversely affected unless alternative suppliers were then willing to sell such product to the Company on credit. Further, a perceived strain between the Company and its suppliers could ultimately strain the Company's relationship with its customers, which could have a material adverse effect on the Company.
NASDAQ LISTING
The Company's Common Stock is currently listed for trading on The Nasdaq National Market System ("NASDAQ"). Under applicable NASDAQ listing standards, the Company is required to have two independent directors. One of the Company's independent directors, Martin C. Bowen, resigned effective as of December 2, 1998, and the Company has not nominated a successor independent director to stand for election at the Company's 1999 annual meeting of shareholders. Further, since September 1, 1997, Richard Nevins, the Company's other independent director, has acted as a consultant at times for the Company and at times for Jerry E. Kimmel, the Company's Chairman of the Board, President and Chief Executive Officer. As such, NASDAQ may not consider Mr. Nevins to be an independent director for such purposes. The Company has had informal discussions with NASDAQ regarding its independent director status; however, NASDAQ has not formally notified the Company that its shares of Common Stock are subject to delisting as a result of this noncompliance. Ordinarily, before delisting, NASDAQ would provide notice and an opportunity to effectuate a plan for compliance with listing requirements.
If the Company is unable to comply with such listing requirement, the shares of the Company's Common Stock could be delisted by NASDAQ, which could result in a substantial reduction in the liquidity and price of the Company's Common Stock.
RISKS RELATED TO THE INTEGRATION OF KEVCO AND SHELTER
The integration of Shelter with the Company involves the integration of two companies that have previously operated independently. The assimilation of the companies requires the integration and coordination of the Company's product offering, management, systems, manufacturing and sales and marketing efforts. The Company has already experienced greater than anticipated expenses relating to the nonuniform information systems and accounting systems acquired with Shelter and the Company may continue to experience greater than expected integration related costs. In addition, the process of integrating the operations of Kevco and Shelter requires substantial attention from management and could cause the interruption of, or a loss of momentum in, the business activities of the Company, which could have an adverse effect on the Company's financial position, results of operations and cash flows. Accordingly, no assurance can be given that further difficulties will not be encountered in integrating the operations of Kevco and Shelter or that the efficiencies and benefits expected from such integration will ultimately be realized.
YEAR 2000
The Company is in the process of addressing and attempting to ensure its Year 2000 readiness. The Year 2000 problem concerns systems and equipment designed and developed using two digits, rather than four, to specify the year, which may result in the inability of information systems to properly recognize date-sensitive information on and beyond January 1, 2000. Certain risks and uncertainties relating specifically to the Company's Year 2000 efforts include, but are not limited to, the availability of qualified personnel and other information technology resources; the ability to identify and remediate all date sensitive lines of computer code or to replace embedded computer chips in affected systems or equipment; and the actions of various third parties with respect to Year 2000 problems. While the Company believes its efforts will provide reasonable assurance that material disruptions will not occur due to internal failure and is attempting to assess and minimize potential disruption due to third party failure, the potential for interruption still exists and may materially adversely affect the Company's business. See "Management's Discussion and Analysis of Financial Condition and Results of Operation - Year 2000."
SUBSTANTIAL LEVERAGE
The Company has a substantial amount of indebtedness. As of December 31, 1998, the Company had approximately $210.6 million of consolidated indebtedness and a percentage of debt to total capitalization of 83.1%. The degree to which the Company is leveraged could have important consequences to the Company including the following: (i) funds available to the Company for its operations and general corporate purposes or for capital expenditures have been and will continue to be reduced as a result of the dedication of a substantial portion of the Company's consolidated cash flow from operations to the payment of the principal and interest on its indebtedness, (ii) the Company may be more highly leveraged than certain of its competitors, which may place it at a competitive disadvantage, (iii) the agreements governing the Company's and its subsidiaries' long-term indebtedness and bank loans contain restrictive financial and operating covenants, and an event of default (not cured or waived) under financial and operating covenants contained in the Company's or its subsidiaries' debt instruments could occur and have a material adverse effect on the Company, (iv) certain of the borrowings under debt agreements of the Company and its subsidiaries have floating rates of interest, which causes the Company and its subsidiaries to be vulnerable to increases in interest rates and (v) the Company's substantial degree of leverage could make it more vulnerable to a downturn in general economic conditions and raise concerns about the Company's liquidity with the Company's vendors and customers.
The ability of the Company and its subsidiaries to make principal and interest payments under long-term indebtedness and bank loans will be dependent upon their future performance, which is subject to financial, economic and other factors affecting the Company and its subsidiaries, some of which are beyond their control. There can be no assurance that the current level of operating results of the Company and its subsidiaries will improve. The Company believes that it will need to access the capital markets in the future in order to provide the funds necessary to repay a significant portion of its indebtedness. There can be no assurance that any such refinancing will be possible or that any additional financing can be obtained, particularly in view of the Company's anticipated high levels of debt and the debt incurrence restrictions under its existing debt agreements. If no such refinancing or additional financing were available, the Company and/or its subsidiaries could default on their respective debt obligations. In such case, virtually all other debt of the Company and its subsidiaries could be immediately due and payable.
CYCLICAL NATURE AND SEASONALITY OF THE MANUFACTURED HOUSING AND RV MARKETS
Over 90% of the Company's net sales for the year ended December 31, 1998, were to producers of manufactured homes and RVs. The manufactured housing market historically has been cyclical and is influenced by many of the same national and regional economic and demographic factors that affect the broader housing market, including consumer confidence, interest rates, availability and terms of financing, regional population and employment trends, availability and cost of alternative housing and general economic conditions, including recessions. The RV market has also historically been cyclical and is also influenced by factors such as interest rates, availability and terms of financing and general economic conditions, as well as gasoline prices. The Company may be adversely affected by these factors. The Company's operating results for the past few years do not reflect the seasonality that historically has been seen in the manufactured housing and RV industries.
COMPETITION
The wholesale distribution industry relating to producers of manufactured homes and RVs is highly competitive, and the barriers to entry are relatively low. Competition exists in terms of price, product quality and features, service, warranty terms and distribution facility location. The manufactured roof truss industry is also highly competitive. There are numerous companies, both public and private, that are in direct competition with the Company, and many of these competitors have been operating longer and have substantially greater financial and other resources than the Company. A downturn in the manufactured housing or RV industries could result in increased competition adversely affecting the Company's results of operations or financial condition. In addition, there are certain product manufacturers that sell and distribute their products directly to manufactured home and RV producers. There can be no assurance that additional manufacturers of products distributed by the Company will not elect to sell and distribute directly in the future. No assurance can be given that the Company will be able to compete effectively in the future.
ITEM 2.
ITEM 2. PROPERTIES.
FACILITIES
The following table sets forth certain information as of March 25, 1999, with respect to the Company's distribution and manufacturing facilities, which are leased unless otherwise indicated. The Company also leases its executive offices of approximately 12,000 square feet in Fort Worth, Texas and the location that formed the executive offices of Shelter, of approximately 19,000 square feet, in Elkhart, Indiana. The Company also leases six and owns four former distribution facilities, which were closed to achieve efficiencies and eliminate redundancies following the acquisition of Shelter. Such vacant facilities are in various stages of being sublet or sold. Substantially all of the Company's assets, including its owned facilities and its leasehold interests, are encumbered by liens granted under security agreements in favor of the Company's lenders under the Company's senior credit facilities.
- ------------------------- * Company owned facility.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
LITIGATION
The Company is, and may be in the future, party to litigation arising in the course of its business. While the Company has no reason to believe that any pending claims are material, there can be no assurance that the Company's insurance coverage will be adequate to cover all liabilities arising out of such claims or that any such claims will be covered by the Company's insurance. Any material claim that is not covered by insurance may have an adverse effect on the Company's business. Claims against the Company, regardless of their merit or outcome, may also have an adverse effect on the Company's reputation and business.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Company did not submit any matter to a vote of security holders during the fourth quarter of the fiscal year covered by this report.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANTS COMMON STOCK AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock has been traded on The Nasdaq Stock Market under the symbol "KVCO" since November 1, 1996. The following table sets forth the high and low sales prices of the Company's Common Stock for each quarterly period within the two most recent fiscal years.
On March 25, 1999, the last reported sale price of the Common Stock on The Nasdaq Stock Market was $5.50 and as of such date there were approximately 85 shareholders of record of the Common Stock. The Company's transfer agent is ChaseMellon Shareholder Services, L.L.C.
The Company has not paid any cash dividends on its Common Stock during the past two fiscal years. The Company does not anticipate paying cash dividends on its Common Stock in the foreseeable future and intends to retain its earnings to support operations and repay indebtedness. The Company's indenture dated as of December 1, 1997 related to the issuance of $105 million of 10 3/8% senior subordinated notes due 2007 ("Indenture") and the Company's credit agreement generally prohibit the payment of dividends by the Company on its Common Stock. Additionally, the Indenture restricts the payment of dividends by restricted subsidiaries to the Company.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
SELECTED CONSOLIDATED FINANCIAL DATA (in thousands, except per share data)
The selected consolidated financial data for the five years ended December 31, 1998 are derived from the Company's audited consolidated financial statements. The selected consolidated financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and notes thereto.
(1) The Company acquired Shelter Components Corporation on December 1, 1997, Bowen Supply, Inc. on February 28, 1997 and Consolidated Forest Products, L.L.C. on February 27, 1997. The acquisitions were accounted for as purchases and accordingly, the operating results of the acquired companies have been included in the operating results of the Company since their respective acquisition dates. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Acquisitions."
(2) The Company acquired Service Supply Systems, Inc. ("Service Supply") on June 30, 1995. The acquisition was accounted for as a purchase and accordingly, the operating results of Service Supply have been included in the operating results of the Company since June 30, 1995. See "Management's Discussion and Analysis and Results of Operations - Acquisitions."
(3) Prior to the initial public offering, the Company had elected to be treated as an S corporation under the Internal Revenue Code. As an S corporation, the Company was not subject to federal and certain state income taxes. The pro forma data give effect to the income taxes that would have been recorded had the Company been taxed as a C corporation.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
GENERAL
From 1994 through 1998, the Company experienced significant growth in sales. This growth was the result of internal expansion, including the opening of new distribution centers, as well as the acquisition of distribution and manufacturing facilities from Service Supply. Through the acquisition of Service Supply in June 1995, for approximately $17.7 million in cash, the Company acquired five distribution and three manufacturing facilities, bringing the number of its distribution and manufacturing facilities to 21 and three, respectively at December 31, 1996. In 1997, Kevco continued its expansion strategy through the acquisitions of Consolidated Forest Products, L.L.C. ("Consolidated Forest") and Bowen Supply, Inc. ("Bowen") in February 1997 for an aggregate purchase price of $34.3 million, the acquisition of Shelter Components Corporation ("Shelter") in December 1997 for a purchase price of $144.8 million, the acquisition in December 1997 of inventory and certain distribution rights of certain building products distributed by Shepherd Products Company for a cash purchase price of $6.0 million with future payment obligations as disclosed herein and the opening of one new distribution facility and one new manufacturing facility. The expansion in 1997 increased the number of Kevco's distribution facilities and manufacturing facilities to 47 and 17, respectively, at December 31, 1997. During 1998, the Company has been integrating Shelter into Kevco by, among other things, consolidating certain corporate functions, consolidating overlapping distribution warehouses from 47 to 27 and integrating multiple Shelter and Kevco computer systems. Also in 1998, the Company opened two new wood products manufacturing facilities.
The integration of the Shelter distribution operations (including integration of information systems), while maintaining high levels of customer service, has resulted in increased costs which has negatively impacted gross margins and selling, general and administrative expenses. The length and cost of the integration process has exceeded anticipated amounts in part because of unanticipated difficulties relating to the merging of Shelter's information and accounting systems with those of the Company. Although management believes these costs will diminish as the integration process is completed, they have prevented the Company from thus far realizing the savings and other synergies originally anticipated. The Company has also encountered longer start-up periods than planned for the two new wood products facilities that were opened earlier in the year.
Management expects the consolidation of the operations of the companies acquired in 1997 to result in substantial cost savings to the combined company in the future. The Company intends to continue to seek to capitalize on the significant common geographic presence of Kevco, Shelter and Bowen and shared customer relationships to obtain market share and sales cost reductions. In addition, the Company intends to continue to seek to obtain greater utilization of its existing corporate administrative resources to reduce the combined overhead expense. The Company also intends to continue to pursue opportunities to achieve greater benefits over time through the combination of multiple warehouse facilities into single, larger facilities in certain markets and the achievement of economies of scale in purchasing materials and supplies as a larger combined entity. There can be no assurance that the Company will be able to successfully implement such cost savings measures, that the cost savings discussed will be realized or that there will not be significant delays in achieving such cost savings.
The Company recognizes revenues from product sales at the time of shipment (or the time of product receipt, in the case of direct shipments from suppliers to customers). In some cases the Company sells on a commission basis. Commissions are recognized when earned and represent amounts earned in selling, warehousing and delivering products for certain manufacturers of building products with which the Company has distribution agreements. Commission arrangements do not require inventory investment or receivable financing, and therefore are significantly less expensive to the Company than traditional sales. To the extent the volume of items warehoused and shipped under commission arrangements increases faster or slower than the volume of items related to traditional sales, changes in net sales may not be representative of actual shipment volume increases or decreases.
ACQUISITIONS
In February 1997, the Company continued its expansion in the wood manufacturing industry through the acquisition of substantially all of the assets, and assumption of certain liabilities, of Consolidated Forest (a manufacturer of wood products for the manufactured housing industry) and consummated the acquisition of all of the outstanding stock of Bowen (a wholesale distributor of building products to the manufactured housing and RV industries). The Bowen acquisition expanded the Company's product lines by adding new products in electronics, drapery and door hardware, industrial tape, adhesives and caulks. The Consolidated Forest and Bowen acquisitions were accounted for as purchases and, accordingly, the operating results of the acquired companies have been included in the operating results of the Company since their respective acquisition dates.
Effective December 1, 1997, the Company acquired approximately 95.5% of the common stock of Shelter through a tender offer for a purchase price of $17.50 per share of common stock of Shelter; the Company acquired the remaining untendered shares through a subsequent merger for a like price. The Shelter acquisition was accounted for as a purchase and, accordingly, the operating results have been included in the operating results of the Company since December 1, 1997. On June 27, 1997, prior to the acquisition of Shelter by Kevco, Shelter acquired the net assets of Plastic Solutions, Inc., a manufacturer of injection molded plastic parts.
On December 12, 1997, the Company consummated the acquisition of the inventory and certain distribution rights of certain building products distributed by the manufactured housing and recreational vehicle division of Shepherd Products Company.
The acquisitions of Shelter, Bowen and Consolidated Forest contributed approximately $140.0 million in net sales for the year ended December 31, 1997. On a pro forma basis, giving effect to the acquisitions consummated in 1997 described above as if the acquisitions had occurred on January 1, 1997, net sales were approximately $862.0 million.
Through the acquisitions consummated in 1997, and primarily through the Shelter acquisition, Kevco believes it became the largest wholesale distributor of building products to the manufactured housing and recreational vehicle industries. Because of the acquisitions in 1997, the Company's historical results of operations and period-to-period comparisons of such results and certain financial data may not be meaningful or indicative of future results.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain Statements of Income data as a percentage of Kevco's net sales.
See note 13 to the consolidated financial statements for segment data.
COMPARISON OF YEARS ENDED DECEMBER 31, 1998 AND 1997
Net sales increased by $506.8 million, or 129.7%, to $897.5 million in 1998 from $390.7 million in 1997 due primarily to the acquisition of Shelter in December 1997. Management believes that net sales, without the effect of the Shelter acquisition, increased approximately the same as the manufactured housing shipment increase of 5.5% for 1998 compared to 1997 (approximately 373,000 homes reported shipped in 1998 compared to approximately 353,400 homes reported shipped in 1997).
Gross profit increased by $63.5 million, or 120.7%, to $116.1 million in 1998 from $52.6 million in 1997 due primarily to the acquisition of Shelter in December 1997. Gross profit, as a percent of net sales, decreased to 12.9% in 1998 from 13.5% in 1997. The decrease in gross profit, as a percent of sales, was primarily a result of wood products margins which, affected by lower than historical lumber prices, continued to be lower than historical levels, to start-up costs related to the opening of two wood products manufacturing facilities (such wood products represent approximately 19% of net sales) and to increased costs as a result of the consolidation and integration of Shelter distribution operations (including integration of information systems), as well as an otherwise general decline in margins.
Commission income increased by $1.5 million, or 25.4%, to $7.4 million in 1998 from $5.9 million in 1997. The increase was primarily attributable to the acquisition of Shelter in December 1997.
Selling, general and administrative expenses increased by $57.0 million, or 132.9%, to $99.9 million in 1998 from $42.9 million in 1997. The increase was due primarily to the acquisition of Shelter in December 1997 and the related integration. Although selling, general and administrative expenses, as a percent of net sales, remained consistent with the prior year, in order to maintain high levels of customer service in a period of considerable consolidation and integration of Shelter distribution operations (including integration of information systems), the Company has incurred costs significantly in excess of anticipated amounts which have negatively impacted earnings and cash flow relating to, among other things, contract labor, overtime and freight charges. The Company has also encountered longer than anticipated start-up periods for two new wood products facilities that were opened earlier in the year.
Net income decreased by $4.4 million, or 70.3%, to $1.9 million in 1998 from $6.3 million in 1997. The decrease in net income was primarily attributable to lower gross margins, as discussed above, increased interest expense and a higher effective tax rate. Interest expense increased to $21.1 million in 1998 from $4.8 million in 1997 as a result of debt incurred in connection with the acquisition of Shelter. Net income was favorably impacted by a $2.5 million gain included in other income that was the result of an insurance settlement. The effective tax rate increased to 62.7% in 1998 from 42.0% in 1997 as a result of non-deductible goodwill resulting primarily from the acquisition of Shelter.
COMPARISON OF YEARS ENDED DECEMBER 31, 1997 AND 1996
Net sales increased by $126.5 million, or 47.9%, to $390.7 million in 1997 from $264.2 million in 1996. The acquisitions of Shelter, Bowen and Consolidated Forest (the "1997 Acquisitions") contributed approximately $140.0 million in sales in 1997. Net sales, without the effect of the 1997 Acquisitions, decreased from $264.2 million to $250.7 million, or 5.1%. Management believes that such decrease is primarily attributable to the reported manufactured housing shipment decline of 2.8% for 1997 compared to 1996 (approximately 353,400 homes reported shipped in 1997 compared to approximately 363,400 homes reported shipped in 1996) as well as a decline in lumber prices in 1997 compared to 1996.
Gross profit increased by $11.9 million, or 29.2%, to $52.6 million in 1997 from $40.7 million in 1996 due primarily to the 1997 Acquisitions. Gross profit, as a percent of net sales, decreased to 13.5% in 1997 from 15.4% in 1996. The decrease in gross profit, as a percent of net sales, was a result of lower gross margins associated with the Consolidated Forest acquisition and lower margin dollars earned from wood products as a whole due to declining lumber prices throughout 1997 (such wood products represented approximately 20% of net sales in 1997). To a lesser extent, gross margins from non-lumber related business decreased primarily as a result of temporary price increases of a major product line.
Commission income increased by $0.4 million, or 7.2%, to $5.9 million in 1997 from $5.5 million in 1996. The increase was primarily attributable to Kevco's expansion in commission-based distribution arrangements in 1997.
Selling, general and administrative expenses increased by $13.2 million, or 44.5%, to $42.9 million in 1997 from $29.7 million in 1996. The increase was primarily due to increased sales volume related to the 1997 Acquisitions. Selling, general and administrative expenses, as a percent of net sales, decreased to 11.0% for 1997 from 11.3% for 1996. The decrease reflected Kevco's continued efforts in increasing efficiency.
Net income decreased by $2.6 million, or 29.2%, to $6.3 million in 1997 from $8.9 million in 1996 on a pro forma basis giving effect to the Company's conversion from an S corporation to a C corporation. The decrease in net income was primarily attributable to (i) lower gross margins as discussed above, (ii) increased interest expense in 1997 compared to 1996 principally due to borrowings related to the 1997 Acquisitions and (iii) an increase in the Company's effective tax rate to 42.0% in 1997 from 38.0% in 1996 resulting primarily from the non-deductible goodwill recorded in connection with the 1997 Acquisitions.
LIQUIDITY AND CAPITAL RESOURCES
The Company's growth has been financed through cash flow from operations, borrowings under its bank credit facilities, proceeds from the November 1996 initial public offering, proceeds from the issuance of $105 million of 10 3/8% senior subordinated notes due 2007 and the expansion of trade credit. Net cash used by operating activities was approximately $9.1 million in 1998 and net cash provided by operating activities, $16.4 million and $12.2 million in 1997 and 1996, respectively. Kevco is obliged to make payments on various capital leases in varying amounts, maturing through 2007 as well as payments under various noncompete and consulting agreements, related to recent acquisitions, in varying amounts, maturing through 2002. See Notes 2, 4 and 6 to the consolidated financial statements.
In connection with the acquisition of Shelter, the Company entered into a second amended and restated credit agreement, which increased the aggregate borrowings available under the amended credit agreement to $125.0 million consisting of an $80.0 million term loan facility, requiring quarterly installments, and a $45.0 million revolving credit facility. The revolving credit facility and a portion of the term loan were (prior to the fourth amended agreement described below) to mature in 2003 with the remaining term loan to mature in 2004. See Note 6 to the consolidated financial statements.
Borrowings under the term loan and revolving credit facility require monthly, bi-monthly or quarterly interest payments (depending on whether interest accrues based on prime rate or LIBOR) calculated as a blend of the bank's prime rate and LIBOR based on pricing options selected by the Company plus a margin determined by operating statistics of the Company. The term loan and revolving credit facility are collateralized by substantially all of the assets of the Company and its subsidiaries as well as the capital stock of such subsidiaries. The related credit agreement contains certain restrictions and conditions that include cash flow and various financial ratio requirements, and limitations on incurrence of debt or liens, acquisitions of property and equipment, distributions to stockholders and certain events constituting a Change of Control (as defined in the credit agreement).
In addition to the funds available under the amended credit agreement, the Company issued $105 million of 10 3/8% senior subordinated notes due 2007 under the indenture dated as of December 1, 1997, as supplemented, (the "Indenture") to complete the acquisition of the outstanding shares of Shelter. The Indenture contains certain covenants that include, but are not limited to, restrictions or limitations on the following: the incurrence of additional debt or liens, the payment of dividends by the Company, the payment of dividends by restricted subsidiaries to the Company, the sale of certain assets, the ability to consolidate with or merge into another person, the entering into certain transactions with affiliates and the engagement in certain lines of business.
The Indenture and credit agreement generally prohibit the payment of dividends by the Company on its common stock. The Company does not anticipate paying cash dividends on its common stock in the foreseeable future and intends to retain its earnings to support operations and repay indebtedness.
Primarily as a result of lower than anticipated net sales to customers and higher than anticipated SG&A levels relating to the integration of Shelter during 1998 (as well as the decrease in gross margins described above), the Company did not generate sufficient cash flow from operations to fund its working capital needs. As a result, the Company supplemented the funding of operations through borrowings under its credit facility. At December 31, 1998, the Company was in violation of its leverage ratio covenant and fixed charge ratio covenant contained in Sections 7.10 and 7.11, respectively, of the Company's second amended and restated credit agreement.
On December 23, 1998, the Company and Jerry E. Kimmel, the Company's President, Chief Executive Officer, Chairman of the Board and principal stockholder, entered into separate stock purchase agreements with Wingate Partners, II, L.P. ("Wingate") pursuant to which Wingate agreed to purchase a total of $40 million of common stock and warrants. Of that amount, $32 million of common stock and a warrant would have been purchased from the Company and $8 million of common stock and a warrant would have been purchased from Mr. Kimmel. The total purchase was to include both voting common shares and a new class of non-voting common shares.
The agreement between the Company and Wingate provided for the purchase of 4,413,793 newly issued shares of Kevco common stock from the Company at $7.25 per share and a warrant to purchase 882,759 additional newly issued shares of common stock at $10.25 per share. The agreement between Mr. Kimmel and Wingate provided for the purchase of 1,103,448 shares of Kevco common stock from Mr. Kimmel, at $7.25 per share and a warrant to purchase 220,690 additional shares of common stock from Mr. Kimmel at $10.25 per share. Following these transactions, Wingate would have owned approximately 40% of the outstanding shares of voting common stock, would own shares of a new class of non-voting common stock and would own warrants to acquire additional shares of voting and non-voting common stock.
As a part of such transaction, Fred Hegi of Wingate would have become Chairman of the Board, President and Chief Executive Officer of Kevco and Jerry E. Kimmel would have assumed a new position of Vice Chairman of the Board and would continue to own approximately 28% of Kevco's voting common stock. On February 15, 1999, Wingate delivered a notice to the Company and Mr. Kimmel stating that it was terminating such agreements. The Company is currently discussing with Wingate the possibility of investing in the Company on other terms. There can be no assurance that an agreement to invest can be reached on terms acceptable to the Company and as a result, approximately $783,000 of fees related to the Wingate transaction were included in SG&A in 1998.
In February 1999, the Company entered into a third amendment and waiver to its credit agreement, which provided for an incremental commitment of $5.0 million due March 31, 1999 and waived any event of default due to the Company's violation of the leverage ratio covenant and the fixed charge coverage ratio covenant of such credit agreement through March 31, 1999. In March 1999, the Company requested and obtained an additional $5.0 million incremental commitment and an extension of the maturity date on the aggregate $10 million incremental commitment (the "Incremental Commitment") and waiver of any events of default to April 15, 1999.
In April 1999, the Company entered into a fourth amendment and waiver to its credit agreement. This amendment contains revised financial covenants effective for the quarter ended March 31, 1999 through June 30, 2000 and waived certain events of default. Under this amendment, the Incremental Commitment matures on June 30, 1999 and the revolving credit facility and term loan facility mature on June 30, 2000. As of March 23, 1999, the Company had approximately $31.0 million available under its credit facility and the Incremental Commitment. The Company is also exploring strategic alternatives to improve its liquidity, including equity or debt financing and selected divestitures. Based on, among other things, its internal budgets and cash flow projections, the Company believes it has sufficient cash to fund the Company's planned obligations and debt service through 1999. No assurance can be made that the Company would be able to access additional capital or that additional capital would be available on terms acceptable to the Company.
YEAR 2000
BACKGROUND. Many computer systems and equipment with embedded computer chips in use today were designed and developed using two digits, rather than four, to specify the year. As a result, such systems and equipment may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculation causing disruptions of operations.
STATE OF READINESS. During 1998, the Company began its assessment of Year 2000 issues and established a Year 2000 project plan with the Chief Information Officer as the project leader and engaged third party consultants to assist in the evaluation of systems and issues. The plan can be described in the following phases:
Phase I -- identification and assessment of the Year 2000 issues for the Company's various internal systems and equipment;
Phase II -- remediation, including modification, upgrading and replacement of hardware and software; and
Phase III -- testing to ensure Year 2000 compliance.
The Company is applying all aspects of this plan, with the assistance of third party consultants, to both its information technology ("IT") systems and non-IT systems. The Company's computer equipment and software that is considered an IT or business system includes systems used to manage customer orders, inventory, manufacturing, accounting functions, and telecommunications. Non-IT systems include manufacturing equipment, alarm systems, security devices, HVAC units, fax machines, and other miscellaneous systems.
The Company believes that it has identified and assessed the internal business systems that are susceptible to system failures or processing errors as a result of the Year 2000 issue. Those systems considered most critical to continuing operations have received the highest priority. The Company has six primary business systems that support operations. A majority of the remediation efforts for these systems will consist of the Company performing an upgrade. Two of these systems have been upgraded to Year 2000 compliant versions, thoroughly tested using appropriate Year 2000 scenarios, and successfully placed into production. The four remaining business systems are in the process of remediation, and the scheduled date for completion of testing is August 1999.
In addition to the remediation of the information systems, the Company is currently addressing its non-IT systems. During 1998, an assessment of the Company's manufacturing equipment was performed. The results of the assessment revealed no date sensitive manufacturing equipment, thus decreasing the risk of any Year 2000 related manufacturing problems. Currently, an assessment of other miscellaneous non-IT equipment is being performed which is expected to be completed, and, if necessary, remediated in July 1999.
The following chart is for summary purposes only and is qualified in its entirety by reference to the discussion above.
THIRD PARTIES. The Company is reviewing, and has initiated formal communications with critical third parties that provide or purchase services or goods that are essential to Kevco's operations. This is being done in order to determine the extent to which the Company is vulnerable to any failure by such third parties to remediate their respective Year 2000 problems, and to resolve such problems to the extent practicable. In connection with this assessment, the Company is reviewing all significant contractual and other obligations with third parties to ensure compliance in the event of a Year 2000 problem. The assessment of these business partners will be ongoing, but all significant third party communications and the related risk assessments are expected to be completed by July 1999. The uncertainty associated with third party readiness, however, cannot be eliminated as the accuracy and availability of third party representations is not within the Company's control. In the event that the Company is unable to obtain satisfactory assurance that a critical third party provider/customer has successfully and timely achieved Year 2000 compliance, and the Company is unable to replace such a provider/customer with an alternative provider/customer, the Company's operations could be materially adversely impacted. Currently, there is no known contractual liability to any third party if all or a portion of the Company's IT or non-IT systems are not Year 2000 compliant.
COSTS. The Company currently estimates that its total Year 2000 project cost will be approximately $0.6 million. Through December 31, 1998, the Company has expended approximately $0.2 million. The Company has funded, and expects to continue to fund, the expenditures related to its Year 2000 initiatives either through cash generated from operations and current working capital, or if required, its existing revolving credit facilities.
RISKS. Based on the progress it has made in addressing its Year 2000 issues and its plan and timetable to complete its compliance program, the Company does not currently foresee significant risks associated with its Year 2000 issues. However, management believes that it is not possible to determine with complete certainty that all Year 2000 problems affecting the Company have been identified or will be corrected. Likewise, because of its constant progress in addressing the various Year 2000 issues, the Company has not yet determined the most likely worst case scenario relating to Year 2000 problems. Nevertheless, management expects that the Company could likely suffer the following consequences: (1) a significant number of operational inconveniences and inefficiencies for the Company and its customers that could divert management's time and attention and financial and human resources from its ordinary business activities; and (2) a lesser number of serious system and/or operational failures that may require significant efforts by the Company to prevent or alleviate material business disruptions.
CONTINGENCY PLANNING. The Company has not yet completed a comprehensive contingency plan with respect to the Year 2000 issue, but intends to have a plan developed by August 1999. The contingency planning process is an ongoing one which will require further modifications as the Company obtains additional information regarding the Company's progress on the remediation phases of its IT and non-IT systems, and on the status of third party Year 2000 readiness. The Company's core business processes, as currently managed by the IT systems, can, if necessary, operate for a limited time period on a manual, non-computerized basis. If the Company is required to implement any of these contingency plans, the implementation could have an adverse effect on the Company's financial condition and results of operations.
ASSET MANAGEMENT
The Company actively manages its assets and liabilities. For the year ended December 31, 1998, days sales in average receivables was approximately 21 days, days sales in average inventory was approximately 44 days and days sales in average payables was approximately 27 days.
QUARTERLY RESULTS
The following table represents certain unaudited financial information for the quarters indicated restated for the reclassification of customer rebates from cost of sales to sales in the first quarter of 1998.
(1) The Company acquired Shepherd Products Company on December 12, 1997, Shelter Components Corporation on December 1, 1997, Bowen Supply, Inc. on February 28, 1997 and Consolidated Forest Products, L.L.C. on February 27, 1997. The acquisitions were accounted for as purchases and accordingly, the operating results of the acquired companies have been included in the operating results of the Company since their respective acquisition dates. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Acquisitions."
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements and supplementary data required by this item are included herein on pages through.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
There were no changes in or disagreements with accountants on accounting and financial disclosure during the years ended December 31, 1998 and 1997.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information concerning the directors of the Company is set forth in the proxy statement to be delivered to shareholders in connection with the Company's annual meeting of shareholders to be held in 1999 (the "Proxy Statement") under the heading "Election of Directors," which information is incorporated herein by reference. The name, age and position of each executive officer of the Company is set forth under the heading "Executive Officers" in Item 1 of this report, which information is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
The information concerning executive compensation is set forth in the Proxy Statement under the heading "Management Compensation," which information is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information concerning security ownership of certain beneficial owners and management is set forth in the Proxy Statement under the heading "Principal Shareholders and Management Ownership," which information is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information concerning relationships and related transactions is set forth in the Proxy Statement under the heading "Certain Transactions" or under the heading "Compensation Committee Interlocks and Insider Participation," which information is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) 1. INDEX TO FINANCIAL STATEMENTS.
The following Financial Statements are included herein:
Report of Independent Accountants ................................
Consolidated Balance Sheets of December 31, 1998 and 1997 ........
Consolidated Statements of Income for the Years Ended December 31, 1998, 1997 and 1996 .................................
Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 1998, 1997 and 1996 .............
Consolidated Statements of Cash Flows for the Years Ended December 31, 1998, 1997 and 1996 .................................
Notes to Consolidated Statements .................................
2. INDEX TO FINANCIAL SCHEDULES.
No schedules are included because of the absence of conditions under which they are required or because information is disclosed in the financial statements or notes thereto.
3. EXHIBITS
The exhibits filed as a part of this report are listed under "Exhibits" at subsection (c) of this Item.
(b) REPORTS OF FORM 8-K:
The Company filed a Current Report on Form 8-K dated December 23, 1998, announcing the entering of a stock purchase agreement with Wingate Partners II, L.P. ("Wingate") and the entering of a stock purchase agreement between Wingate and Jerry E. Kimmel.
EXHIBIT NUMBER DESCRIPTION OF EXHIBITS - ------- -----------------------
2.1 Merger Agreement, dated June 6, 1995 by and among Kevco, Inc. and Service Supply Systems, Inc., joined by a wholly-owned subsidiary of Kevco, Inc.(1)
2.2 Form of Plan and Agreement of Merger between Kevco Texas, Inc. and Kevco Delaware, Inc.(1)
2.3 Form of Bill of Sale and General Assignment from Kevco Delaware, Inc., as Assignor, to Sunbelt Wood Components, Inc., as Assignee.(1)
2.4 Form of Assumption Agreement between Kevco Delaware, Inc. and Sunbelt Wood Components, Inc.(1)
2.5 Asset Purchase Agreement by and among Consolidated Forest Products, Inc., Consolidated Forest Products, L.L.C. and the members of Consolidated Forest Products, L.L.C.(2)
2.6 Stock Purchase Agreement by and among Kevco Delaware, Inc. and the shareholders of Bowen Supply, Inc.(2)
2.7 Agreement and Plan of Merger, dated as of October 21, 1997, between Kevco, Inc., SCC Acquisition Corp. and Shelter Components Corporation.(6)
2.8 Stock Purchase Agreement dated as of December 23, 1998 between Wingate Partners II, L.P. and the Company.(11)(8)
2.9 Stock Purchase Agreement dated as of December 23, 1998 among Wingate Partners II, L.P., Jerry E. Kimmel, and the Company.(11)(8)
2.10 Letter, dated February 15, 1999, to Kevco, Inc. from Wingate Partners II, L.P.(13)
2.11 Letter, dated February 15, 1999, to Jerry E. Kimmel from Wingate Partners II, L.P.(13)
3.1 Articles of Incorporation of Kevco, Inc., as amended.(1)
3.2 Bylaws of Kevco, Inc.(1)
4.1 Form of certificate evidencing ownership of the Common Stock of Kevco, Inc.(1)
10.1 Amendment No. 2 to 1995 Stock Option Plan (Amended and Restated 1995 Stock Option Plan of Kevco, Inc.) and Supplementary Letter.(1)*
10.2 1996 Stock Option Plan of Kevco, Inc., as amended, and Supplementary Letter.(1)*
10.3 Form of Amended and Restated Employment Agreement between Gerald E. Kimmel and Kevco, Inc., joined therein by Kevco Delaware, Inc. and Sunbelt Wood Components, Inc.(1)*
10.4 Employment Agreement between C. Lee Denham and Kevco, Inc. dated June 30, 1995.(1)*
10.5 Lease between K & E Land & Leasing and Kevco, Inc. dated December 1, 1977.(1)
10.6 Amendment No. 1 to Lease, by and between K & E Land & Leasing and Kevco, Inc. dated March , 1982.(1) ---
10.7 Amendment No. 2 to Lease, by and between K & E Land & Leasing and Kevco, Inc. dated May 30, 1983.(1)
10.8 Amendment No. 3 to Lease, by and between K & E Land & Leasing and Kevco, Inc. dated February 1, 1993.(1)
10.9 Lease dated April 1, 1980 between City of Newton, Kansas and K & E Land & Leasing.(1)
10.10 Sublease and Lease Guarantee Agreement dated April 1, 1980 between K & E Land & Leasing and Kevco, Inc.(1)
10.11 Amendment No. 1 to Sublease and Lease Guaranty Agreement by and between K & E Land & Leasing and Kevco, Inc. dated May 30, 1983.(1)
10.12 Lease Agreement dated October 12, 1987 between 1741 Conant Partnership & Kevco Inc.(1)
10.13 Equipment Lease Agreement dated January 1, 1991 between K & E Land & Leasing and Kevco, Inc.(1)
10.14 Amendment No. 1 to Equipment Lease Agreement between K & E Land & Leasing and Kevco, Inc. dated February 12, 1993.(1)
10.15 Amendment No. 2 to Equipment Lease Agreement between K & E Land & Leasing and Kevco, Inc. dated October 26, 1993.(1)
10.16 Amendment No. 3 to Equipment Lease Agreement between K & E Land & Leasing and Kevco, Inc. dated May 23, 1994.(1)
10.17 Deferred Compensation Agreement between Kevco, Inc. and Clyde A. Reed, Jr. dated May 24, 1977.(1)*
10.18 Amendment No. 1 to Deferred Compensation Agreement dated May , 1980.(1)*
10.19 Amendment No. 2 to Deferred Compensation Agreement dated March 10, 1992.(1)*
10.20 Amended and Restated Health and Accident Plan of Kevco, Inc.(1)*
10.21 Investment and Tax Advice Plan of Kevco, Inc.(1)*
10.22 Credit Agreement among Kevco, Inc., certain Lenders and NationsBank of Texas, N.A., as Administrative Lender dated June 30, 1995.(1)
10.23 First Amendment to Credit Agreement, dated as of September 1, 1995, among Kevco, Inc., the banks listed on the signature pages thereof, and NationsBank of Texas, N.A.(1)
10.24 Second Amendment to Credit Agreement, dated as of November 29, 1995, among Kevco, Inc., the banks listed on the signature pages thereof, and NationsBank of Texas, N.A.(1)
10.25 Revolving Credit Note of Kevco, Inc. to NationsBank of Texas, N.A. dated September 1, 1995 in the amount of $14,285,714.28.(1)
10.26 Term Loan Note of Kevco, Inc. to NationsBank of Texas, N.A. dated September 1, 1995 in the amount of $10,714,285.72.(1)
10.27 Revolving Credit Note of Kevco, Inc. to The Sumitomo Bank, Ltd. dated February 2, 1996 in the amount of $5,714,285.72.(1)
10.28 Term Loan Note of Kevco, Inc. to The Sumitomo Bank, Ltd. dated February 2, 1996 in the amount of $4,285,714.28.(1)
10.29 PaineWebber Standardized 401(K) Profit-Sharing Adoption Agreement (No. 005) (To be used with Basic Plan Document No. 03 Only) for Kevco, Inc. dated May 24, 1996 and PaineWebber Defined Contribution Plan.(1)
10.30 Promissory Note of Gerald E. Kimmel to Kevco, Inc. dated October 26, 1993 in the amount of $5,000,000.(1)
10.31 Amendment No. 4 to Lease dated December 1, 1977 by and between K&E Land & Leasing and Kevco, Inc. dated October 26, 1993.(1)
10.32 Assignment and Acceptance dated February 2, 1996 between The Daiwa Bank, Limited and The Sumitomo Bank, Ltd., Chicago Branch.(1)
10.33 Form of Tax Indemnification and Distribution Agreement.(1)
10.34 Form of Promissory Note made by Kevco Texas, Inc. in the amount of $3,733,000 (the Prior S Corporation Earnings Note).(1)
10.35 Form of Promissory Note made by Kevco Texas, Inc. (the Future S Corporation Earnings Note).(1)
10.36 Form of Assignment of $5,000,000 Note made by Kevco, Inc. (n/k/a Kevco Delaware, Inc.).(1)
10.37 Form of Adoption Agreement by Kevco, Inc. and Kevco Texas, Inc. (re: 1995 Stock Option Plan and 1996 Stock Option Plan).(1)
10.38 Amendment No. 1 dated September 21, 1988, to Lease Agreement by 1741 Conant Partnership as lessor and Kevco, Inc. (n/k/a Kevco Delaware, Inc.).(1)
10.39 Letter Agreement dated June 22, 1982, between Kevco, Inc. (n/k/a Kevco Delaware, Inc.) and K&E Land & Leasing. (re: lease rentals).(1)
10.40 Letter Agreement dated October 1, 1996 by Kevco, Inc., K&E Land & Leasing, and 1741 Conant Partnership (re: lease rental).(1)
10.41 Form of Parent Pledge Agreement.(1)
10.42 Consent and Waiver, dated as of October 21, 1996, by and among NationsBank of Texas, N.A., The Sumitomo Bank, Ltd. and Kevco Texas, Inc.(1)
10.43 Amended and Restated Credit Agreement, dated as of February 27, 1997, by and among Kevco Delaware, Inc., certain lenders and NationsBank of Texas, N.A.(4)
10.44 Amendment No. 1 to Amended and Restated 1995 Stock Option Plan of Kevco, Inc. (10)
10.45 Senior Commitment Letter dated October 27, 1997 from NationsBank of Texas, N.A. and NationsBanc Montgomery Securities, Inc.(6)
10.46 First Amendment to Amended and Restated Credit Agreement dated as of November 25, 1997 between Kevco Delaware, Inc., certain lenders and NationsBank of Texas, N.A.(7)
10.47 Second Amended and Restated Credit Agreement dated December 1, 1997 between Kevco, Inc., certain lenders and NationsBank of Texas, N.A.(7)(8)
10.48 Revolving Credit Note dated December 1, 1997 between Kevco, Inc. and NationsBank of Texas, N.A. in the original principal amount of $11,666,666.66.(7)
10.49 Revolving Credit Note dated December 1, 1997 between Kevco, Inc. and National City Bank of Kentucky in the original principal amount of $8,166,666.67.(7)
10.50 Revolving Credit Note dated December 1, 1997 between Kevco, Inc. and Guaranty Federal Bank, F.S.B. in the original principal amount of $7,000,000.00.(7)
10.51 Revolving Credit Note dated December 1, 1997 between Kevco, Inc. and The Sumitomo Bank, Limited in the original principal amount of $8,166,666.67.(7)
10.52 Facility A Term Loan Note dated December 1, 1997 between Kevco, Inc. and NationsBank of Texas, N.A. in the original principal amount of $13,333,333.34.(7)
10.53 Facility A Term Loan Note dated December 1, 1997 between Kevco, Inc. and National City Bank Kentucky in the original principal amount of $9,333,333.33.(7)
10.54 Facility A Term Loan Note dated December 1, 1997 between Kevco, Inc. and Guaranty Federal Bank, F.S.B. in the original principal amount of $8,000,000.00.(7)
10.55 Facility A Term Loan Note dated December 1, 1997 between Kevco, Inc. and The Sumitomo Bank, Limited in the original principal amount of $9,333,333.33.(7)
10.56 Facility B Term Loan Note dated December 1, 1997 between Kevco, Inc. and NationsBank of Texas, N.A. in the original principal amount of $50,000,000.00.(7)
10.57 Security Agreement dated December 1, 1997 between Kevco, Inc. and NationsBank of Texas, N.A. as Administrative Agent.(7)
10.58 Registration Rights Agreement dated December 1, 1997 by and among Kevco, Inc., as Issuer, the Subsidiaries of Kevco, Inc. identified therein as Subsidiary Guarantors and Donaldson, Lufkin & Jenrette Securities Corporation and NationsBanc Montgomery Securities, Inc., as Initial Purchasers.(9)
10.59 Indenture dated December 1, 1997 among Kevco, Inc., SCC Acquisition Corp., Kevco Delaware, Inc., Sunbelt Wood Components, Inc., Consolidated Forest Products, Inc., Bowen Supply, Inc. and Encore Industries, Inc., as Subsidiary Guarantors and United States Trust Company of New York, as Trustee.(9)
10.60 Supplemental Indenture between Shelter Components Corporation, a Subsidiary of Kevco, Inc., and United States Trust Company of New York, as Trustee.(9)
10.61 Supplemental Indenture dated as of December 1, 1997 between Shelter Distribution, L.P., a Subsidiary of Kevco, Inc., and United States Trust Company of New York, as Trustee.(9)
10.62 Supplemental Indenture dated as of December 1, 1997 between DCM, Inc., a Subsidiary of Kevco, Inc., and United States Trust Company of New York, as Trustee.(9)
10.63 Supplemental Indenture dated as of December 1, 1997 between Duo-Form of Michigan, Inc., a Subsidiary of Kevco, Inc., and United States Trust Company of New York, as Trustee.(9)
10.64 Supplemental Indenture dated as of December 1, 1997 between Design Components, Inc., a Subsidiary of Kevco, Inc., and United States Trust Company of New York, as Trustee.(9)
10.65 Supplemental Indenture dated as of December 1, 1997 between Shelter Components of Indiana, Inc., a Subsidiary of Kevco, Inc., and United States Trust Company of New York, as Trustee.(9)
10.66 Supplemental Indenture dated as of December 1, 1997 between BPR Holdings, Inc., a Subsidiary of Kevco, Inc., and United States Trust Company of New York, as Trustee.(9)
10.67 First Amendment to Credit Agreement dated February 12, 1998 between Kevco, Inc., certain lenders and NationsBank of Texas, N.A.(10)
10.68 Registered Global Note dated March 5, 1998 among Kevco, Inc., Kevco Delaware, Inc., Sunbelt Wood Components, Inc., Bowen Supply, Inc., Encore Industries, Inc., Shelter Components Corporation, BPR Holdings, Inc., Shelter Components of Indiana, Inc., Design Components, Inc., Duo-Form of Michigan, Inc., DCM, Inc. and Shelter Distribution, L.P., as Subsidiary Guarantors and United States Trust Company of New York, as Trustee.(12)
10.69 Second Amendment to Credit Agreement, dated as of October 27, 1998 (but effective as of September 30, 1998), entered into and among Kevco, Inc., a Texas corporation, the banks listed on the signature pages (collectively, the "Lenders"), and NationsBank, N.A. (successor by merger to NationsBank of Texas, N.A.), as the Administrative Agent.(13)
10.70 Waiver entered into as of the 30th day of December 1998, by and among the banks listed on the signature pages (the "Lenders"), Kevco, Inc., a Texas corporation (the "Borrower"), and NationsBank, N.A. (successor by merger to NationsBank of Texas, N.A.), as Administrative Agent for the Lenders to the extent and in the manner provided for in the Credit Agreement.(13)
10.71 Second Waiver entered into as of the 15th day of February, 1999, by and among the banks listed on the signature pages (the "Lenders"), Kevco, Inc.,a Texas corporation (the "Borrower"), and NationsBank, N.A. (successor by merger to NationsBank of Texas, N.A.), as Administrative Agent for the Lenders to the extent and in the manner provided for in the Credit Agreement. (13)
10.72 Third Amendment and Waiver entered into as of the 25th day of February, 1999, by and among the banks listed on the signature pages (the "Lenders"), Kevco, Inc., a Texas corporation, and NationsBank, N.A. (successor by merger to NationsBank of Texas, N.A.), as Administrative Agent for the Lenders to the extent and in the manner provided for in the Credit Agreement.(13)
10.73 Letter agreement waiver extension, dated March 22, 1999, between Kevco, Inc., NationsBank, N.A., as Administrative Agent and Lender, and the other parties thereto.(13)
21.1 Subsidiaries.(13)
23.1 Consent of PricewaterhouseCoopers LLP.(13)
24.1 Power of Attorney.(contained on the signature page of this Annual Report on Form 10-K)
27.1 Financial Data Schedule.(13)
- -------------------
(1) Previously filed as an exhibit to the Company's Registration Statement on Form S-1 (No. 333-11173) and incorporated herein by reference.
(2) Previously filed as an exhibit to the Company's Current Report on Form 8-K dated February 27, 1997, and incorporated herein by reference.
(3) Previously filed as an exhibit to the Company's registration statement on Form S-8 (No. 333-19959), and incorporated herein by reference.
(4) Previously filed as an exhibit to the Company's Quarterly Report on Form 10-Q, for the quarter ended March 31, 1997 and incorporated herein by reference.
(5) Previously filed as an exhibit to the Company's Quarterly Report on Form 10-Q, for the quarter ended June 30, 1997 and incorporated herein by reference.
(6) Previously filed as an exhibit to the Company's Tender Offer Statement on Schedule 14D-1, filed October 28, 1997, and incorporated herein by reference.
(7) Previously filed as an exhibit to the Company's Tender Offer Statement on Schedule 14D-1/A, filed December 12, 1997, and incorporated herein by reference.
(8) Schedules and similar attachments to this exhibit have not been previously file herewith, but the nature of their contents is described in the body of this exhibit. The Company agrees to furnish a copy of any such omitted schedules and attachments to the Securities and Exchange Commission upon request.
(9) Previously filed as an exhibit to the Company's registration statement on Form S-4 (No. 333-43691), and incorporated herein by reference.
(10) Previously filed as an exhibit to the Company's Annual Report on Form 10-K, for the year ended December 31, 1998 and incorporated herein by reference.
(11) Previously filed as an exhibit to the Company's Current Report on Form 8-K dated December 23, 1998, and incorporated herein by reference.
(12) Previously filed as an exhibit to the Company's Quarterly Report on Form 10-Q, for the quarter ended March 31, 1998, and incorporated herein by reference.
(13) Filed herewith.
* Management contract or compensatory plan or arrangement.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders and Board of Directors Kevco, Inc. Fort Worth, Texas
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, stockholders' equity and cash flows present fairly, in all material respects, the financial position of Kevco, Inc. at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
Fort Worth, Texas April 12, 1999
KEVCO, INC. CONSOLIDATED BALANCE SHEETS (in thousands, except per share data)
The accompanying notes are an integral part of the consolidated financial statements.
KEVCO, INC. CONSOLIDATED STATEMENTS OF INCOME (in thousands, except per share data)
The accompanying notes are an integral part of the consolidated financial statements.
KEVCO, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (in thousands)
The accompanying notes are an integral part of the consolidated financial statements.
KEVCO, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
The accompanying notes are an integral part of the consolidated financial statements.
KEVCO, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS - (CONTINUED) (In thousands)
The accompanying notes are in integral part of the consolidated financial statements.
KEVCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF OPERATIONS
Kevco, Inc. manufactures and distributes products and materials primarily for use by the manufactured housing and recreational vehicle industries.
BASIS OF PRESENTATION
The accompanying consolidated financial statements include the accounts of Kevco, Inc. and its wholly-owned subsidiaries (the "Company"). All significant intercompany transactions and accounts have been eliminated. All of the Company's subsidiaries have guaranteed the 10 3/8% senior subordinated notes (see Note 6) on a full, unconditional and joint and several basis. As a result, separate financial statements of the subsidiaries are not included.
CASH AND CASH EQUIVALENTS
For purposes of reporting cash flows, cash and cash equivalents include cash on hand, deposits with banks and all highly liquid investments with original maturities of three months or less. The carrying value of cash and cash equivalents approximates fair value as of December 31, 1998 and 1997.
INVENTORIES
Inventories are stated at the lower of cost or market. Inventories purchased for resale and manufactured inventories are valued using the first-in, first-out (FIFO) method. The net carrying value of inventories approximates fair value as of December 31, 1998 and 1997.
PROPERTY AND EQUIPMENT
Property and equipment are carried at cost less accumulated depreciation. Additions to and major improvements of property and equipment are capitalized. Maintenance and repair costs are expensed as incurred. When assets are retired or otherwise disposed of, their costs and related accumulated depreciation are removed from the accounts and any resulting gains or losses are included in the operations for the period. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. The carrying value of property and equipment approximates fair value as of December 31, 1998 and 1997.
ASSETS HELD FOR SALE
Assets held for sale consist of certain net assets to be sold as part of the acquisition of Shelter Components Corporation.
INTANGIBLE ASSETS
Intangible assets are comprised of noncompete agreements and goodwill. Noncompete agreements are amortized on a straight-line basis over the terms of the related agreements. The excess of acquisition cost of acquired businesses over the fair value of net assets acquired ("goodwill") is amortized, using the straight-line method, over 40 years. The Company reviews goodwill to assess recoverability periodically. At each balance sheet date, management assesses whether there has been a permanent impairment in the value of goodwill by considering factors such as expected future operating income, current operating results, and other economic factors. Management believes no impairment has occurred.
LOAN ORIGINATION COSTS
Loan origination costs, included in other assets, associated with the acquisition of the Company's senior credit facility and senior subordinated notes have been capitalized and are being amortized over the term of the related debt.
DEFERRED COMPENSATION OBLIGATION
The Company has entered into deferred compensation agreements with certain employees, whereby payments will be made upon death or retirement for a ten year period and such liability has been recorded at the present value of the anticipated future payments.
REVENUE RECOGNITION
Revenue from product sales is recognized at the time of shipment or the time of receipt in the case of direct shipments from vendors to customers. Commissions are recognized as earned.
INCOME TAXES
Income taxes are provided based on earnings reported for tax return purposes in addition to a provision for deferred income taxes in accordance with Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." The provision for income taxes includes deferred taxes determined by the change in the deferred tax liability or asset which is computed based on the differences between the financial statement and income tax bases of assets and liabilities, all of which are measured by applying enacted tax laws and rates. Deferred tax expense is the result of changes in the deferred tax liability or asset, adjusted for the effect of any acquisitions.
INTEREST RATE HEDGE
The Company entered into an interest rate hedge agreement in conjunction with its primary credit facility to alter interest rate exposure on both the revolver and the term debt. Amounts expected to be paid or received on the interest rate hedge are recognized as adjustments to interest expense over the term of the agreement. Any gain or loss from the termination of this hedge agreement will be recognized at that time.
CONCENTRATION OF CREDIT RISK
The Company's sales are primarily to the manufactured housing and recreational vehicle industries across a wide geographical area and generally require no advance payment from customers. The Company had sales to two customers representing approximately 15% and 12% respectively in 1998 and 14% each in 1997.
The Company estimates future credit losses based on continual evaluation of customers' financial condition, historical loss experience and current economic conditions. The estimated future credit losses are expensed through an allowance for doubtful accounts and actual credit losses are charged to the allowance when incurred.
The Company maintains their cash in bank deposit accounts, which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts and believes they are not exposed to any significant credit risk on cash and cash equivalents.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses in the reporting periods. Actual results could differ from those estimates.
STOCK SPLIT
On August 29, 1996, the Company effected a .47-for-1 reverse stock split of its common stock. All share and per share amounts included in the accompanying financial statements and notes have been restated to reflect the stock split.
UNAUDITED PRO FORMA NET INCOME
Pro forma net income represents the results of operations adjusted to reflect a provision for income tax on historical income before income taxes, which gives effect to the change in the Company's income tax status to a C corporation prior to the consummation of the Company's initial public offering. The difference between the pro forma income tax rates utilized and the federal statutory rate of 35% relates primarily to state income taxes (5%, less effect of federal tax benefit).
EARNINGS PER SHARE
Earnings per share is calculated for all periods shown in accordance with FASB Statement of Financial Accounting Standards No. 128 Earnings per Share, which requires dual presentation of basic and diluted earnings per share and a reconciliation between the two amounts. Basic earnings per share excludes dilution, and diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock.
The reconciliation between basic and diluted weighted average shares outstanding, follows:
Historical earnings per share for 1996 is not presented because it is not indicative of the ongoing entity. Pro forma earnings per share has been computed by dividing pro forma net income by the weighted average number of shares of common stock outstanding during the period. Pro forma earnings per share data has been presented to reflect the effect of the assumed issuance of that number of shares of common stock that would generate sufficient cash to pay an S corporation distribution in an amount equal to previously taxed but undistributed earnings at December 31, 1996.
Software Development Costs
Internal and external costs incurred for the development of computer applications, as well as for upgrades and enhancements that result in additional functionality of the applications, are capitalized. Internal and external training and maintenance costs are charged to expense as incurred. When an application is placed in service, the Company begins amortizing the related capitalized software costs using the straight-line method and an estimated useful life varying from three to five years. The costs of identifying, correcting, reprogramming and testing of computer systems for Year 2000 compliance are expensed as incurred.
Start-Up Costs
Start-up costs consist of salaries, personnel training cost and other expenses of opening new facilities and are expensed as incurred.
Recent Accounting Pronouncements
In February 1998, the FASB issued Statement of Financial Accounting Standards No. 132 "Employers' Disclosures about Pensions and Other Postretirement Benefits - an amendment of FASB Statements Number 87, 88, and 106" ("FAS 132") that is effective for reporting periods beginning after December 15, 1997. The required disclosures have been made and adoption of FAS 132 had no effect on the Company's consolidated financial position or results of operations in 1998.
In March 1998, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants ("AcSEC") issued Statement of Position 98-1 "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" ("SOP 98-1") that is effective for reporting periods beginning after December 15, 1998, but provides for earlier application if certain conditions are met. The Company has applied the provisions of SOP 98-1 in its financial statements for the year ended December 31, 1998 and its adoption had no material effect on the Company's consolidated financial position or results of operations.
In April 1998, the AcSEC issued Statement of Position 98-5 "Reporting on the Costs of Start-Up Activities" ("SOP 98-5") that is effective for reporting periods beginning after December 15, 1998. The Company has applied the provisions of SOP 98-5 in its financial statements for the year ended December 31, 1998 and its adoption had no material effect on the Company's financial position or results of operations.
In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities" ("FAS 133") that is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. The Company will implement the provisions of FAS 133 as required. The future adoption of FAS 133 is not expected to have a material effect on the Company's consolidated financial position or results of operations.
Reclassifications
Certain amounts in the consolidated financial statements for 1997 and 1996 have been reclassified to conform to the 1998 presentation. These reclassifications have no effect on stockholders' equity or net income as previously reported.
2. ACQUISITIONS
During the year ended December 31, 1997, Kevco acquired Shelter Components Corporation on December 1, 1997 (the "Shelter Acquisition"), the inventory and certain distribution rights from Shepherd Products Company on December 12, 1997 (the "Shepherd Acquisition"), Bowen Supply, Inc. on February 28, 1997 (the "Bowen Acquisition") and Consolidated Forest Products, L.L.C. on February 27, 1997 (the "Consolidated Forest Acquisition") for total purchase prices approximating $144.8 million, $8.0 million, $20.2 million and $14.1 million, respectively. The acquisitions were made utilizing borrowings under the Company's amended and restated credit facility and, in the case of the Shelter Acquisition, net proceeds from the issuance of $105 million of 10 3/8% senior subordinated notes due 2007. Each of the acquisitions was accounted for as a purchase and the results of operations of the acquired companies were included in the consolidated results of operations of the Company from their respective acquisition dates. As a result of the acquisitions, approximately $115.1 million of goodwill was recorded by the Company, which reflects the adjustments necessary to allocate the individual purchase prices to the fair value of assets acquired, liabilities assumed and additional purchase liabilities recorded. Additional purchase liabilities included approximately $1.8 million ($0.2 million at December 31, 1998) for severance and related costs associated primarily with the elimination of certain administrative and corporate positions was recorded in connection with the Shelter Acquisition.
3. INVENTORIES
Inventories are comprised of the following:
4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
Property and equipment under capital leases consists of buildings of approximately $2,721,000 and $2,761,000 for the years ended December 31, 1998 and 1997, respectively and machinery and equipment of approximately $70,000 and furniture and fixtures of approximately $570,000 for the years ended December 31, 1998 and 1997. Accumulated depreciation was approximately $2,381,000 and $2,166,000 for the years ended December 31, 1998 and 1997, respectively.
5. INTANGIBLE ASSETS
Intangible assets consist of the following:
6. LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
In December 1997, Kevco and its lenders entered into the second amended and restated credit agreement at closing of the Shelter Acquisition to allow for aggregate senior borrowings of up to $125 million comprised of a revolving credit facility of $45 million and a term loan facility of $80 million requiring quarterly installments. The revolving credit facility and $40 million of the term loan facility were (prior to the fourth amended agreement and waiver described below) to mature in 2003 with the remaining term loan facility to mature in 2004. The term loan and revolving credit facility are collateralized by substantially all of the assets of the Company and its subsidiaries as well as the capital stock of such subsidiaries.
In February 1999, the Company entered into a third amendment and waiver, which allowed for an incremental commitment of $5.0 million due March 31, 1999 and waived any event of default due to the Company's violation of certain financial covenants contained in the credit agreement through March 31, 1999. In March 1999, the Company requested and obtained an additional $5.0 million incremental commitment and an extension of the maturity date on the aggregate $10 million incremental commitment (the "Incremental Commitment") and waiver of any events of default to April 15, 1999.
In April 1999, the Company entered into a fourth amendment and waiver to its credit agreement. This amendment contains revised financial covenants effective for the quarter ended March 31, 1999 through June 30, 2000 and waived certain events of default. Under this amendment, the Incremental Commitment matures on June 30, 1999 and the revolving credit facility and term loan mature on June 30, 2000. No assurance can be made that the Company would be able to access additional capital or that additional capital would be available on terms acceptable to the Company.
In addition to funds available under the credit agreement, the Company issued $105 million of 10 3/8% senior subordinated notes due 2007 (the "Notes") under the indenture dated as of December 1, 1997, as supplemented, (the "Indenture"), to complete the acquisition of Shelter. Interest is payable on June 1 and December 1 of each year commencing June 1, 1998. The Notes are redeemable, in whole or in part, at the option of the Company, at any time on or after December 1, 2002, at the redemption prices set forth in the Indenture. In addition, at any time on or before December 1, 2000, the Company may redeem up to 35% of the original aggregate principal amount of the Notes with the net proceeds of a public equity offering at a redemption price equal to 110.375% of the principal amount thereof, plus accrued and unpaid interest and liquidated damages, if any, thereon to the date of redemption.
The credit agreement and Indenture contain certain restrictions and conditions that include cash flow and various financial ratio requirements, and limitations on incurrence of debt or liens, acquisitions of property and equipment, distributions to stockholders and certain events constituting a Change of Control (as defined in the agreements).
The following are scheduled maturities of debt (in thousands):
In addition, in order to reduce interest rate risk on the credit facility, the Company has entered into an interest rate hedge agreement in the notional amount of $30.0 million, whereby the Company will receive interest payments should LIBOR increase above 7.0% and, conversely, will make interest payments should LIBOR decrease below 5.41%, the effect of which limits the Company's interest expense within the range of 5.41% to 7.0% LIBOR on $30.0 million of debt. Management intends to hold the interest rate hedge until maturity on January 2, 2001. The Company has incurred no gain or loss related to this interest rate hedge for the year ended December 31, 1998. The fair value of the interest rate hedge agreement is approximately $329,000 at December 31, 1998.
The fair value of long-term debt was $202.8 and $194.8 million as of December 31, 1998 and 1997, respectively. The fair value of the Company's long-term debt was calculated by discounting future cash flows using an estimated fair market value interest rate.
7. INCOME TAXES
Prior to November 6, 1996, the Company was treated for federal and state income tax purposes as an S corporation under Subchapter S of the Internal Revenue Code. As a result, the Company's earnings for such period were taxed at the stockholder level. Effective November 6, 1996, the Company terminated its S corporation status and restructured the organization to create a holding company with operating company subsidiaries. From November 6, 1996, the Company's earnings have been taxed as a C corporation and provisions for income taxes have been reflected in the consolidated financial statements. The Company recorded a nonrecurring net deferred tax provision of approximately $353,000 associated with the recognition of a related deferred tax liability due to the termination of the Company's S corporation status.
The provision for income taxes for the years ended December 31, 1998, 1997 and 1996 consists of the following (in thousands):
Income taxes are provided for the tax effects of transactions reported in the financial statements and consist of taxes currently due plus deferred taxes related primarily to differences between the treatment of certain items for financial statement purposes and the treatment of those items for corporation tax purposes. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled.
Components of the Company's deferred tax assets and liabilities at December 31, 1998 and 1997 were as follows (in thousands):
Management believes that the Company will generate sufficient future taxable income to realize the entire deferred tax asset and that the realization of the net deferred tax asset is more likely than not.
The differences between the consolidated provision for income taxes and income taxes computed using income before income taxes and the U.S. federal income tax rate for the years ended December 31, 1998, 1997 and 1996 are as follows:
8. OTHER INCOME
In August 1998, the Company sustained a fire at its Duo-Form plant in Edwardsburg, Michigan, which destroyed the facility and contents. The Company has filed a claim with its insurance carrier and as of December 31, 1998, had received $500,000 in insurance proceeds. A gain from insurance proceeds of approximately $2,541,000 was recorded at December 31, 1998 related to the insurance claim.
9. COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases various equipment and buildings under capital and noncancellable operating leases with an initial term in excess of one year. As of December 31, 1998, future minimum rental payments required under these capital and operating leases are summarized as follows (in thousands):
Rental expense for operating leases was approximately $11,776,000, $5,060,000 and $3,839,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
EMPLOYMENT AGREEMENTS
The Company has entered into an employment agreement with its majority stockholder for a five-year term renewable annually.
LITIGATION
There are claims and pending actions incident to the business operations of the Company. Management does not expect resolution of these matters to have a material adverse effect on the Company's financial position or future results of operations or cash flows.
10. RETIREMENT PLAN
The Company has a defined contribution retirement plan which covers substantially all full-time employees and is qualified under Section 401(k) of the Internal Revenue Code. Under the plan, employees may voluntarily contribute a percentage of their compensation to the plan and the Company may make discretionary contributions. The Company's contributions to the plan for the years ended December 31, 1998, 1997 and 1996 were $0, $135,000 and $100,000, respectively.
Effective April 30, 1998, the Company terminated the Health Benefit Plan for Shelter Components Corporation and eligible employees were offered enrollment in Kevco Inc.'s health and welfare benefits effective May 1, 1998. Any remaining benefits were paid by November 30, 1998.
In July 1998, the Company announced its intent to merge the assets and liabilities of the Shelter Components Savings Incentive Plan with and into the Kevco, Inc. 401(k) Profit Sharing Plan on or about September 1, 1998. The Shelter Components Savings Incentive Plan was terminated in October 1998.
11. RELATED PARTY TRANSACTIONS
The Company leases certain buildings and data processing equipment under capital leases from partnerships partially owned by the majority stockholder of the Company. Two of the leased warehouses were financed through economic development and industrial revenue bonds; one series of which was issued by Newton, Kansas in the original principal amount of $575,000, and with respect to which, the Company is the sub-lessee of the premises and a co-guarantor, and one series of which was issued by Elkhart, Indiana in the original principal amount of $400,000, and with respect to which, the Company is the lessee of the premises. Lease payments for the facilities and equipment were approximately $576,000 for the year ended 1998 and $672,000 for each of the years ended 1997 and 1996. Debt related to the capital leases was approximately $1,299,000 and $1,398,000 at December 31, 1998 and 1997, respectively.
The Company loaned its majority stockholder $5.0 million in 1993, payable in monthly principal installments of $62,500 plus interest at 9.0% at December 31, 1995, due November 1997. The Company distributed the loan to stockholder to the Company's stockholders effective June 30, 1996.
12. STOCK-BASED COMPENSATION PLANS
The Company sponsors the Kevco, Inc. 1995 Stock Option Plan and the Kevco, Inc. 1996 Stock Option Plan (the "Plans"), which are stock-based incentive compensation plans. The Company applies APB Opinion 25 and related standards in accounting for the Plans.
Under the Plans, the Company is authorized to issue up to 702,735 shares of common stock pursuant to "Awards" granted in the form of incentive stock options (intended to qualify under Section 422 of the Internal Revenue Code of 1986, as amended) and nonqualified stock options. Awards may be granted to selected employees and directors of the Company. During 1998, 1997 and 1996, the Company granted only nonqualified stock options under the Plans.
NONQUALIFIED STOCK OPTIONS
The Plans provide that the exercise price of any stock option will be determined by the board of directors on the date of grant. The stock options granted after November 1996 vest over 10 years. All options granted prior to November 1996 vested in November 1996, at the time of the initial public offering. The options have been granted at prices equal to the market value of the shares at the date of grant and expire not more than 7 and 10 years after the date of grant for the 1996 and 1995 plans, respectively. In accordance with APB 25, the Company has not recognized any compensation cost for these stock options granted during 1998, 1997 and 1996.
A summary of the status of the Company's stock options as of December 31, 1998, 1997 and 1996, and the changes during the year ended on those dates is presented below:
The fair value of each stock option granted is estimated on the date of grant using the minimum value method of option pricing with the following weighted-average assumptions for grants in 1998, 1997 and 1996, respectively: dividend yield of zero percent for all years; risk-free interest rates are different for each grant and range from 4.65% to 6.19%; the expected lives of 6.3 and 9.5 years, respectively, for the options under the Plans; and expected volatility of approximately 56.0% and 48.0% for options granted in 1998 and 1997, respectively. In determining the "minimum value," FASB Statement of Financial Standards No. 123, "Accounting for Stock-Based Compensation," ("FAS 123") does not require the volatility of the Company's common stock underlying the options to be calculated or considered for options granted in 1996 because the Company was not publicly-traded when the options were granted.
The following table summarizes information about stock options outstanding at December 31, 1998:
NET INCOME AND EARNINGS PER SHARE
Had the compensation cost for the Company's stock-based compensation plans been determined consistent with FAS 123, the Company's net income and earnings per share for 1998, 1997 and 1996 would approximate the pro forma amounts below (in thousands, except per share data):
The effects of applying FAS 123 in this pro forma disclosure are not indicative of future amounts. FAS 123 does not apply to awards prior to 1995, and the Company anticipates making awards in the future under its stock-based compensation plans.
13. SEGMENT REPORTING
In June 1997, the FASB issued Statement of Financial Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information," which the Company has adopted in the current year.
The Company identifies such segments based upon management responsibility within the United States. The Company operates in three business segments: Distribution, Manufacturing and Wood Products. The Distribution segment primarily distributes plumbing products, building products, electrical components and hardware supplies to the manufactured housing and recreational vehicle industries; the Manufacturing segment primarily manufactures and distributes thermoformed products, laminated wallboard products and plastic injection molded products primarily to the manufactured housing and recreational vehicle industries; and the Wood Products segment primarily manufactures roof trusses and lumber cut to customer specifications for use in manufactured homes. As a result of the Company's acquisition strategy, which has impacted all three segments, year-to-year comparisons may not be indicative of future results.
The Company measures segment performance based upon revenue and operating income results. The information in the Corporate/Other category consists primarily of intercompany eliminations of Manufacturing sales to Distribution and corporate operating expenses, and is utilized to reconcile to the consolidated results. Amounts are presented in thousands for each respective year.
(a) Consists primarily of intercompany eliminations of Manufacturing sales to Distribution.
(b) Consists primarily of corporate operating expenses.
POWER OF ATTORNEY
Each person whose signature appears below hereby constitutes and appoints jointly and severally, Jerry E. Kimmel, Richard S. Tucker and Ellis L. McKinley, Jr., and each one of them, his attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign any and all amendments to this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission.
S I G N A T U R E S
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
KEVCO, INC.
Date: April 13, 1999 By: /s/ Jerry E. Kimmel ------------------------------ Jerry E. Kimmel, Chairman, President and Chief Executive Officer
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON APRIL 13, 1999.
INDEX TO EXHIBITS