ITEM 1. BUSINESS
GENERAL
American Homestar Corporation ("American Homestar" or the "Company") is one of the fastest growing vertically integrated manufactured housing companies in the United States, with operations in manufacturing, retailing, financing and insurance. The Company currently operates 11 manufacturing facilities in seven states and sells homes through its dedicated distribution channels, which include 86 Company-owned retail sales centers and 41 franchised retail sales centers, and through more than 300 independent retail locations in 28 states. The Company's operations are strategically located in the Southwest, Southeast, Deep South, Rocky Mountain and Pacific Northwest regions of the United States, which represent many of the largest markets for manufactured housing. The Company provides financing to its retail customers through its affiliate, 21st Century Mortgage Corporation ("21st Century"), and also provides insurance products to its retail customers.
The cornerstone of American Homestar's strategy is the vertical integration of its operations, which includes the combination of manufacturing, retailing, financing and insuring of its products. Vertical integration allows the Company to increase its profit margins on the manufacture and sale of its products, and provides the ability to realize additional sources of income from financing the sales of and insuring the Company's products. Management believes that vertical integration allows the Company to better control the quality, design, manufacture and distribution of its homes, more effectively plan its inventory requirements, better coordinate the servicing of its products and promptly respond to changes in retail demand. An important element of the Company's vertical integration strategy is to maximize the percentage of new homes sold through the Company's dedicated distribution channels that are manufactured by the Company. This percentage for Company-owned retail sales centers (the "internalization rate") has increased from 38% in fiscal 1994 to 84% in fiscal 1998.
American Homestar has realized significant growth in its operations and profitability since its initial public offering in July 1994. Since that time, the Company has grown from three manufacturing facilities to 11, and from 25 Company-owned retail sales centers to 86. Revenues have increased from $119 million in fiscal 1994 to $514 million in fiscal 1998, representing a compounded annual growth rate ("CAGR") of 45%, while diluted earnings per share have increased from $0.45 to $0.98 during the same period, representing a CAGR of 22%. During the same period, shipments increased from 2,228 homes to 10,723 homes, representing a CAGR of 55%.
STRATEGY
The Company's primary strategic objectives are to maintain high growth in profitability and to generate superior long-term returns by leveraging the benefits of vertical integration and increasing its market share. In order to achieve these objectives, the Company is pursuing the following initiatives:
o EXPAND DEDICATED RETAIL DISTRIBUTION
The Company intends to expand its dedicated distribution channels in order to increase its market share. The Company plans to open or acquire 30 to 40 retail sales centers in each of the next two years and to expand its franchise program through conversion of existing independent retail sales centers, joint ventures and construction of new retail sales centers. During fiscal 1998, the Company increased its Company-owned retail sales centers from 54 to 86, which included the acquisition of 25 retail sales centers. Since initiating its national, branded franchise program in 1997, the Company has entered into franchise agreements covering 41 retail sales centers. In addition to increasing market share by expanding the number of Company-owned and franchised retail sales centers, management believes that it can increase the sales volumes of these locations by continuing to implement the Company's successful merchandising, advertising and sales training programs. The Company is presently focusing its retail distribution growth in the Deep South, Southeast and Pacific Northwest where the Company has already established manufacturing capacity to support a larger dedicated distribution network.
o INCREASE MANUFACTURING CAPACITY IN TANDEM WITH RETAIL EXPANSION
Each American Homestar manufacturing facility has a focused product mission, producing homes targeted to a specific price range. This specialization maximizes production efficiency and improves the economies of scale derived from significant production volumes in a single facility. The Company clusters its manufacturing facilities within a region in order to supply a wide range of homes to each market that it serves. As the Company's dedicated retail distribution increases in existing markets, capacity in existing plants will be expanded in order to take advantage of manufacturing efficiencies and economies of scale and to provide the full product offering of American Homestar to its retail sales centers and franchisees. The Company also intends to expand its manufacturing capacity as overall demand increases for its products and as strategic acquisition opportunities arise.
o GROW FINANCING OPERATIONS
American Homestar believes that the ability to offer retail financing through 21st Century is an important element of its growth strategy and vertical integration plan. By financing a significant portion of the homes sold through the Company's retail sales centers, 21st Century provides additional, recurring income from home sales. Furthermore, management believes that 21st Century provides the Company with a more reliable and responsive source of financing for customers purchasing homes through its dedicated distribution channels. The Company's insurance products also represent an opportunity for additional sources of recurring income from home sales.
o PURSUE STRATEGIC ACQUISITIONS
American Homestar has grown significantly through both internal expansion and strategic acquisitions of manufacturing facilities and retail sales centers. Since its initial public offering in 1994, the Company has acquired eight manufacturing facilities and has added 60 Company-owned retail sales centers, 36 through acquisitions. These acquisitions have expanded the Company's operations into the Southeast, Deep South, Rocky Mountain and Pacific Northwest regions and allowed the Company to implement its vertical integration strategy in these new markets. Given that the manufactured housing industry remains highly fragmented, particularly in retailing, the Company believes there are opportunities to enter new regions and further strengthen its existing markets through strategic acquisitions. Management believes that acquisitions will provide the Company with further opportunity to continue to increase its market share and leverage the benefits it derives from vertical integration.
INDUSTRY
A manufactured home is a single-family residence that is constructed in a controlled factory environment and transported to a home site. Total retail sales of new manufactured homes in the United States were approximately $14.5 billion in 1997. From 1991 through 1997, the manufactured housing industry experienced a significant increase in the number of homes sold. Factory shipments increased from approximately 171,000 homes in 1991 to approximately 354,000 homes in 1997. Manufactured housing has also significantly increased its share of the new home market. In 1997, manufactured homes accounted for approximately one-fourth of all new single-family homes completed, up from approximately one-sixth in 1991. Because of the lower cost of construction for manufactured homes compared to site-built homes, manufactured housing has historically served as one of the most affordable alternatives for the home buyer. The average retail price of a new manufactured home in 1997 was $29.09 per square foot, as compared to $64.70 per square foot for a new site-built home, excluding land costs. In recent years, demand has shifted toward larger, multi-section homes, which accounted for more than one-half of the manufactured homes produced in 1997.
Manufactured homes have traditionally been an attractive means for home buyers to overcome obstacles or large down payments and high monthly mortgage payments. Financing has become readily available to qualified manufactured home buyers from a variety of lenders. A number of these lenders have established securitization programs for consumer loans. Both the Federal Housing Administration's and the Department of Veterans Affairs' guaranteed loan programs permit loans for the purchase of manufactured housing. In addition, the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation accept manufactured housing mortgage loans and allow these mortgage loans to be pooled with traditional real estate mortgage loans. Also, manufactured homes may be financed as secured personal property loans in instances where the buyer does not own the land upon which the home will be sited.
RETAIL DISTRIBUTION
The Company retails its products through dedicated distribution channels, which include Company-owned retail sales centers and franchisees, and through independent retailers. The following table sets forth for the periods indicated certain data for shipments of homes manufactured by the Company, the number of Company-owned retail sales centers and the number of independent retail sales centers, including franchisees:
Dedicated Distribution. The Company employs a distinct merchandising and selling strategy in its dedicated distribution channels. At each Company-owned retail sales center a broad selection of fully furnished and professionally decorated model homes is displayed in a landscaped setting. The Company's professional sales staff receives extensive training on all of the Company's products and services, and is able to provide its customers with superior service. The Company also provides merchandising support and uses regional print, radio and television advertising to promote customer awareness and enhance its quality image.
In fiscal 1998, 55% of the Company's retail sales were multi-section homes and its average new home retail sales price was $48,154, compared to the industry average of $42,252. Since the beginning of fiscal 1994, the Company has increased the number of Company-owned retail sales centers from 21 to 86 as of May 31, 1998. The Company plans to open or acquire 30 to 40 retail sales centers each year over the next two years.
The following table sets forth for the periods indicated certain information relating to homes sold by Company-owned retail sales centers:
The Company has increased the percentage of new homes sold by Company-owned retail sales centers that are manufactured by the Company from 38% in fiscal 1994 to 84% in fiscal 1998. As the Company's manufacturing facilities continue to increase their production, the Company expects this percentage to increase. In addition to selling homes manufactured by the Company, most Company-owned retail sales centers sell homes manufactured by other companies as well as previously-owned manufactured homes.
The Company initiated its Oak Creek Village national, branded franchise program in September 1997 to accelerate distribution of the Company's products by converting existing independent retail sales centers and by encouraging entrepreneurs with considerable industry or business experience to open new retail sales centers as franchisees. Since the program's inception, the Company has entered into franchise arrangements covering 41 retail sales centers. The Company believes that its franchise program offers an attractive alternative for independent retailers. The benefits of a strategic
alliance with the Company for a franchisee include (i) a protected territory for specific products; (ii) access to the Company's manufacturing, retailing and financing expertise; (iii) minimal personal investment in the retail sales center; and (iv) the potential to open additional retail sales centers.
The Company enters into a franchise agreement ("Franchise Agreement") generally when an independent retailer chooses to convert to franchise status or when a franchisee secures a location. The Franchise Agreement provides for a term of five years with one five-year renewal option. Under conditions of the Franchise Agreement, the franchisee is required to purchase all product through the Company or through Company-approved suppliers. The Company has the right to terminate any Franchise Agreement under specified circumstances, including a franchisee's failure to adhere to the Company's standards. The current Franchise Agreement contains a right of first refusal for the Company to purchase the franchise.
In order to assist an independent retailer in the conversion to an Oak Creek Village, the Company may finance improvements to the franchisee's retail sales center. In such cases the lease is controlled by the Company and the costs of such improvements are added to the lease payment. The franchisee is required to finance its own inventory, but the Company may assist its franchisees in accessing floor plan financing at attractive rates. All franchisees are required to operate their Oak Creek Villages in compliance with applicable Company policies, standards and specifications. The Company monitors each franchisee's operations and results and assists the franchisee in order to optimize its performance.
The Company believes that the success of a retail sales center is dependent on the professionalism and knowledge of its managerial and sales staff, and therefore, has developed an extensive training program covering many facets of the Company's operations, products and services. Retail management and management trainees are expected to attend a series of formal training sessions covering a variety of sales and administrative topics. Management training provides employees with a complete review of the production process as well as a comprehensive understanding of the Company's retailing strategy and sales approach. Additionally, each new sales representative is required to attend a comprehensive four-day basic sales training course offered at least quarterly in each region. Sales representative training provides in-depth instruction in sales techniques and education on the Company's products and services. The training program is also available to the Company's franchisees. The Company has a full-time, dedicated training staff which travels to sales centers to provide on-site, one-on-one supplementary training. The Company believes that its general approach to marketing, the appearance of its sales locations and the professionalism of its sales management and staff are among its most distinguishing features in the marketplace.
Independent Retailers. The independent retailer network is an important part of the Company's sales and distribution strategy and is especially important in new regional markets in which the Company has no existing Company-owned retail sales centers. The Company believes its relations with its independent retailers are excellent. Except for franchise agreements with its franchisees, the Company has no written agreements with its independent retailers and the relationship may be terminated at any time by either party. The Company generally does not provide inventory financing arrangements for independent retailer purchases, nor does it consign homes. However, as is customary in the industry, lenders financing independent retailers require that the Company execute contingent repurchase agreements, which provide that, in the event of a retailer's default under the retailer's inventory financing arrangements, the Company will repurchase homes for the amount remaining unpaid to the lender, excluding interest and repossession costs. During the last three fiscal years, the Company has incurred no significant losses resulting from these contingent obligations. As of May 31, 1998, the Company's contingent repurchase liability was approximately $80.9 million.
MANUFACTURING
The Company manufactures a broad selection of homes ranging from traditional, lower-priced homes to distinctive, higher-priced homes, which retail from $16,500 to $124,600, excluding land costs. By providing such a broad selection, the Company believes it can meet the financial and aesthetic requirements of the full range of retail buyers. Additionally, the Company believes it offers high quality homes that incorporate more innovative architectural designs and features than are typically offered by its competitors. Over the past few years, as the demand for multi-section homes has increased, the Company has significantly increased its production of multi-section homes to 69% of total homes manufactured for fiscal 1998 from 50% in fiscal 1994.
The Company's manufacturing facilities generally operate on a one shift per day, five day per week basis. At May 31, 1998, the Company's facilities had the capacity to produce 109 floors per day, and its production rate was 86 floors per day (capacity figures are estimates of management). A floor is a single section home or one section of a multi-section home. The following table sets forth the total homes and floors manufactured by the Company for the periods indicated:
The principal materials used in the construction of the Company's homes include lumber and lumber products, gypsum wallboard, steel, aluminum, fiberglass, carpet, vinyl, fasteners, appliances, electrical items, windows and doors. Generally, materials are readily available and are purchased by the Company from numerous sources. The Company believes that the materials used in the manufacture of its homes are readily available at competitive prices from a wide variety of suppliers. Accordingly, the Company does not believe that the loss of any single supplier would have a material adverse effect on its business. The Company's direct or variable costs of operations can be significantly affected by the availability and pricing of raw materials.
The Company generally builds a home only after a specific order has been received and financing arrangements for payment have been made. In accordance with industry practice, dealers can cancel orders prior to the commencement of production without penalty, and accordingly, the Company does not consider its backlog of orders to be firm orders. Because of the seasonality of the market for manufactured homes, the level of backlog at any time is not necessarily indicative of the expected level of future orders. The Company's backlog, as well as level of new orders, generally declines during the winter months of December through February.
FINANCING
In 1995, the Company formed 21st Century together with Clayton Homes, Inc. ("Clayton") and three former executive officers of Clayton. Clayton is a leader in manufactured home financing through its finance subsidiary, Vanderbilt Mortgage and Finance, Inc. American Homestar, Clayton and the management of 21st Century own 50%, 25% and 25%, respectively, of 21st Century, and the Company has an option to purchase the stock owned by Clayton and the management of 21st Century under certain conditions after September 15, 2000. 21st Century provides retail sales financing through the Company's dedicated distribution channels and is the primary lender for all Company-owned retail sales centers. 21st Century is also adding to its growing loan portfolio through direct marketing efforts to capture re-finance business and by offering private label financing through joint ventures with other manufactured housing producers and retailers. Financing through 21st Century extends the profits of a home sale through a recurring income stream received over the life of loans originated. As of May 31, 1998, 21st Century's loan servicing portfolio was approximately $371 million and for the year ended May 31, 1998, 21st Century had loan originations of approximately $225 million.
INSURANCE
Through its wholly-owned subsidiary, Western Insurance Agency, Inc. ("Western"), the Company offers to its retail customers a variety of insurance products, including property/casualty insurance, credit life insurance and extended service contracts. The Company acts as agent and earns commissions from insurance written for purchasers of its manufactured homes. In addition, the Company's wholly-owned subsidiary, Lifestar Reinsurance, Ltd., reinsures credit life policies placed by Western. Through reinsurance, the Company also earns underwriting fees and investment income. The Company's reinsurance operations are managed by American Bankers Life Assurance Company of Florida pursuant to a management contract.
ACQUISITIONS
During the fourth quarter of fiscal 1998, the Company announced that it entered into definitive agreements for two strategic acquisitions which will allow the Company to further implement its vertical integration strategy and expand its presence in its Southeast region:
Effective July 1, 1998, the Company acquired First Value Homes, Inc. ("First Value"), a retailer based in Gastonia, North Carolina, which specializes in selling modular homes through its two environmentally displayed modular home superstore locations. First Value has developed and implemented a comprehensive marketing and sales system which provides the customer with one-stop shopping for site selection, site preparation, home installation and mortgage financing. First Value is a customer of R-Anell (as defined below), but also sells homes supplied by other manufacturers. In 1997, First Value generated revenues of $24 million.
On May 28, 1998, the Company agreed to acquire R-Anell Custom Homes, Inc. and its related manufacturing operations ("R-Anell"). R-Anell produces distinctive lines of high-quality, upscale manufactured homes and modular homes which are marketed under the R-Anell and Gold Medal brand names through a network of approximately 90 independent retailers located primarily in North Carolina, South Carolina and Virginia. R-Anell operates two plants in Denver, North Carolina that generated $57 million in revenue in 1997 and a new plant in Cherryville, North Carolina which is currently in its startup phase. The Cherryville facility is a state-of-the-art plant opened in October 1997 and is one of the largest manufactured housing production facilities in the United States. The transaction is expected to close in the second quarter of fiscal 1999. The closing of this transaction is subject to satisfaction of certain conditions and there can be no assurance that the transaction will be consummated.
Additionally, during fiscal 1997 and fiscal 1998, the Company made a number of strategic acquisitions, the most significant of which are as follows:
o In September 1996, the Company exercised its option to acquire Guerdon Holdings, Inc. ("Guerdon") after managing Guerdon's operations under a management agreement since March 1996. Guerdon produces manufactured homes in four facilities located in Oregon, Idaho, Nebraska and Mississippi, and sells its homes to over 150 independent retailers located in 17 states in the Pacific Northwest, Rocky Mountain and Deep South regions of the United States.
o In September 1996, the Company acquired Heartland Homes, Inc. ("Heartland"), a single plant manufacturer of low- to medium-priced homes in North Carolina. Concurrent with the Heartland acquisition, the Company also purchased the assets of Manu-Fac Homes, Inc. ("Manu-Fac"), a contractually affiliated group of 15 independent retailers, which have since become franchisees of the Company.
o In June 1997, the Company acquired Brilliant Holding Corporation and its subsidiaries ("Brilliant"), a manufacturer of single- and multi-section homes with three plants in Alabama. Brilliant sells its homes to nearly 200 independent retailers located in 14 states.
o In June 1997, the Company acquired N.C. Mobile Home Corporation ("N.C. Homes"), which operates 12 retail sales centers in North Carolina and one retail sales center in Virginia.
o In January 1998, the Company acquired Davis Homes, Inc. ("Davis Homes"), which operates three retail centers in Alabama.
While the Company's historical primary market area has been the Southwest, particularly Texas and the surrounding states, the Company's recent expansion has given it a national presence with operations now encompassing the Southwest, Southeast, Deep South, Rocky Mountain and Pacific Northwest regions of the United States. Assuming the completion of the R-Anell acquisition, the Company will operate 15 manufacturing plants, retail through 86 Company-owned retail sales centers and 41 retail franchise locations and serve over 300 independent retail locations in 28 states.
TRANSPORTATION
Roadmasters Transport Company, Inc. ("Roadmasters"), a 51% owned subsidiary, and Brilliant Carriers, Inc. ("Carriers"), a wholly-owned subsidiary, provide manufactured housing transportation services and are the primary transporters of manufactured homes from the Company's manufacturing facilities. Roadmasters and Carriers lease their equipment from independent owner-operators, which allows them to cover a large geographic area without a significant investment in equipment. The Company believes that its controlling ownership interests in Roadmasters and Carriers provide it with the ability to better control the delivery of homes to its retail sales centers and to independent retailers, especially during peak sales and delivery periods, as well as to profit from each home shipment.
SIGNIFICANT SUPPLIERS
In fiscal 1996, fiscal 1997 and fiscal 1998, Redman Homes, Inc. ("Redman") supplied approximately 26%, 18% and 10%, respectively, of the homes sold by Company-owned retail sales centers. The Company's supply relationship with Redman is terminable at will by either party. While the Company believes that it can replace any independent manufacturer by substituting its own products and the products of other manufacturers, any such loss could have an adverse effect on the Company's results of operations.
COMPETITION
The manufactured housing industry is highly competitive and the capital requirements for entry are relatively small. Manufactured homes compete with new and existing site-built homes, apartments, townhouses and condominiums. Competition exists at both the manufacturing and retail levels and is based primarily on price, product features, reputation for service and quality, location, depth of field inventory, sales promotions, merchandising and terms and availability of dealer and retail customer financing.
GOVERNMENT REGULATION
The Company's manufactured homes are subject to a number of federal, state and local laws and codes. Construction of manufactured homes is governed by the National Manufactured Home Construction and Safety Standards Act of 1974 ("MHCSS Act") and the regulations issued by the Department of Housing and Urban Development ("HUD") thereunder, establishing comprehensive national construction standards. These regulations cover all aspects of manufactured home construction, including structural integrity, fire safety, wind loads, thermal protection and ventilation. The Company's manufacturing facilities and the plans and specifications of its manufactured homes have been approved by a HUD-designated inspection agency. The Company's homes are regularly checked by an independent, HUD-approved inspector for compliance during construction. Failure to comply with applicable HUD regulations could expose the Company to a wide variety of sanctions, including mandated closings of Company manufacturing facilities. The Company believes its manufactured homes meet or surpass all present HUD requirements.
Manufactured, modular and site-built homes are all typically built with particle board, paneling and other products that contain various formaldehyde resins. HUD regulates the allowable concentration of formaldehyde in certain products used in manufactured homes and requires warnings to purchasers concerning formaldehyde-associated risks. Certain components of manufactured homes are subject to regulation by the Consumer Products Safety Commission ("CPSC"), which is empowered to ban the use of component materials believed to be hazardous to health and to require the manufacturer to repair defects in components of its homes. The CPSC, the Environmental Protection Agency and other governmental agencies currently are re-evaluating the allowable standards for formaldehyde emissions. The Company
currently uses materials in its manufactured homes that meet the current HUD standards for formaldehyde emissions and believes that it otherwise complies with HUD and other applicable government regulations in this regard.
The Company's operations are also subject to the provisions of the Texas Manufactured Housing Act, the Consumer Credit Act and the Truth-in-Lending Act, as well as local zoning and housing regulations. A number of states require manufactured home producers and retailers to post bonds to ensure the satisfaction of consumer warranty claims. A number of states have adopted procedures governing the installation of manufactured homes. Utility connections are subject to state and local regulation and must be complied with by the dealer or other person installing the home. The operations of Roadmasters and Western are subject to regulation by various federal, state and local authorities.
A variety of laws affect the financing of manufactured homes by the Company. The Truth-in-Lending Act and Regulation Z promulgated thereunder require written disclosure of information relating to such financing, including the amount of the annual percentage rate and financing charge. The Fair Credit Act also requires certain disclosures to potential customers concerning credit information used as a basis to deny credit. The Federal Equal Credit Opportunity Act and Regulation B promulgated thereunder prohibit discrimination against any credit applicant based on certain specified grounds. The Federal Trade Commission has adopted or proposed various trade regulation rules dealing with unfair credit and collection practices and the preservation on consumers' claims and defenses. The Federal Trade Commission regulations also require disclosure of a manufactured home's insulation specification. Installment sales contracts eligible for inclusion in the Government National Mortgage Association Program are subject to the credit underwriting requirements of the Federal Housing Administration. A variety of state laws also regulate the form of installment sales contracts and the allowable charges pursuant to installment sales contracts. The sale of insurance products by the Company is subject to various state insurance laws and regulations, which govern allowable charges and other insurance products.
The Company is also subject to the provisions of the Fair Debt Collection Practices Act, which regulates the manner in which the Company collects payments on installment sale contracts, and the Magnuson-Moss Warranty-Federal Trade Commission Improvement Act, which regulates the descriptions of warranties on products. The Company's collection activities and warranties are also subject to state laws and regulations.
The transportation of manufactured homes on highways is subject to regulation by various federal, state and local authorities. Such regulations may prescribe size and road use limitations and impose lower than normal speed limits and various other requirements. Manufactured homes are also subject to local zoning and housing regulations.
The Company's operations are also subject to federal, state and local laws and regulations relating to the generation, storage, handling, emission, transportation and discharge of materials into the environment. The Company is not aware of any pending litigation to which it is a party or claims that may result in significant contingent liabilities related to environmental pollution or asbestos. In addition, the Company does not believe it will be required under existing environmental laws and enforcement policies to expend amounts that will have a material adverse effect on its results or operations or financial condition.
A significant portion of the Company's manufacturing labor force includes persons who are not U.S. citizens, and the Company is subject to the regulations of the Immigration and Naturalization Service ("INS"). The Company adheres to the procedures required for the prevention of the hiring of illegal aliens, but, nonetheless, the Company has from time to time experienced losses of a portion of its labor force due to INS investigative operations, which losses have temporarily decreased production at the affected manufacturing facilities.
In general, legislation is proposed from time to time that, if enacted, would significantly affect the regulatory climate for manufactured and modular homes. At present, it is not possible to predict what, if any, changes or legislation may be adopted or the effect any such changes or legislation may have on the Company or the manufactured housing industry as a whole.
EMPLOYEES
As of May 31, 1998, the Company employed 3,803 persons. The Company does not have any collective bargaining agreements and has not experienced any work stoppages as a result of labor disputes. The Company considers it employee relations to be good.
A significant portion of the total compensation of management of the Company is derived from incentive bonuses based on the operating income of the operating unit for which such management is responsible, as well as the attainment of margin goals. Many of the Company's managers are also shareholders and all are eligible to participate in the Company's 1994 Amended and Restated Stock Compensation Plan.
ITEM 2.
ITEM 2. PROPERTIES
At May 31, 1998, the Company operated 11 manufacturing facilities, 86 retail sales centers and had two administrative offices. Fifty-two of the retail sales centers and both administrative offices are leased. The Company's retail sales centers consist of tracts of land, ranging from 2.5 to 7.0 acres, on which manufactured homes are displayed, each with a sales office containing approximately 2,000 square feet of office space. The Company's retail sales centers are located in 14 states as follows: Alabama (7), Arkansas (1), Colorado (4), Idaho (1), Louisiana (5), Mississippi (1), New Mexico (5), North Carolina (11), Oklahoma (3), Tennessee (1), Texas (44), Utah (1), Virginia (1) and Washington (1). The Company believes that all facilities are adequately maintained and suitable for their present use.
The Company owns all of its manufacturing facilities and substantially all of its manufacturing equipment, fixtures, furniture and office equipment. The following table sets forth certain information with respect to the Company's manufacturing facilities:
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in routine litigation arising in the ordinary course of business. In the opinion of the Company, such matters will not have a material adverse effect on the financial condition or the results of operations of the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On June 18, 1998, at a special meeting, the shareholders of the Company, an amendment to the Company's Restated Articles of Incorporation increasing the number of authorized shares of the Company's common stock from 20,000,000 to 50,000,000 was approved. The voting was as follows:
For.............................. 12,407,028 Against.......................... 3,180,286 Abstained........................ 1,263
MANAGEMENT
The information in this section entitled "Management" in the American Homestar 1998 Proxy Statement is incorporated herein by reference in response to this item.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
The Company's common stock is quoted on the Nasdaq National Market under the symbol "HSTR." The following table sets forth, for the periods indicated, the high and low sales price per share of the Company's common stock as reported on the Nasdaq National Market. The following share prices have been adjusted to reflect the 5-for-4 stock splits effected on January 18, 1996 and February 7, 1997 and the three-for-two stock split effected October 31, 1997.
As of August 7, 1998, there were 170 record holders of the Company's common stock. On August 7, 1998, the reported last sale price of the Company's common stock as reported by the Nasdaq National Market was $19.00 per share.
DIVIDEND POLICY
The Company has not paid any dividends on the common stock since it became a public reporting company. The Company does not anticipate paying cash dividends on the common stock in the foreseeable future and intends to continue its present policy of retaining earnings for reinvestment in the operations of the Company. The terms of certain indebtedness of the Company restrict its ability to pay dividends or make distributions.
RECENT SALES OF UNREGISTERED SECURITIES
On June 10, 1997, Brilliant was acquired by the Company and 711,149 shares of the Company's common stock and options to purchase 38,852 shares of the Company's common stock were issued in exchange for all of Brilliant's outstanding common stock and options. See Note 3 of the Notes to the Company's Consolidated Financial Statements included herein.
On June 16, 1997, the Company acquired the assets and liabilities of NC Homes for cash, a note payable and 176,472 shares of the Company's common stock. See Note 3 of the Notes to the Company's Consolidated Financial Statements included herein.
On January 6, 1998, the Company acquired the assets and liabilities of Davis Homes, Inc. for cash, a note payable and 61,158 shares of the Company's common stock. See Note 3 of the Notes to the Company's Consolidated Financial Statements included herein.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data include the accounts of American Homestar and Brilliant. Brilliant was acquired by the Company effective June 1997, and the acquisition was accounted for as a pooling of interests. Accordingly, the Company's Consolidated Financial Statements have been restated for all periods prior to the acquisition to combine the previously separate entities. See Notes 1 and 3 of the Notes to the Company's Consolidated Financial Statements included herein. The financial information set forth under Statement of Operations Data and Balance Sheet Data for each of the five fiscal years ended May 31, 1998 was derived from the Company's audited Consolidated Financial Statements. The Consolidated Financial Statements as of May 31, 1997 and 1998, and for each of the years in the three-year period ended May 31, 1998, are included elsewhere herein. The selected financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and related Notes thereto included in Item 8 of this Form 10-K.
See following page for Footnotes to Selected Financial Data.
FOOTNOTES TO SELECTED FINANCIAL DATA
(1) Acquisition costs are non-recurring transaction costs related to the Brilliant acquisition. Such costs reduced diluted earnings per share by $0.11 for fiscal 1998. (2) Extraordinary losses on early extinguishment of debt in fiscal 1997 and 1998. (3) The earnings per share data presented herein comply with Statement of Financial Accounting Standards No. 128, which was required to be applied on a retroactive basis commencing with the Company's third quarter of fiscal 1998, and give retroactive effect to the changes in capital structure. See Notes 1 and 9 of Notes to the Company's Consolidated Financial Statements included herein.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Form 10-K contains certain forward-looking statements and information relating to the Company that are based on the beliefs of the Company's management as well as assumptions made by and information currently available to the Company's management. When used in this document, the words "anticipate," "believe," "estimate," "should," and "expect" and similar expressions as they relate to the Company or management of the Company are intended to identify forward-looking statements. Such statements reflect the current views of the Company with respect to future events and are subject to certain risks, uncertainties and assumptions, including the risk factors described in the Company's most recently filed registration statement. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated or expected. The Company does not intend to update these forward-looking statements.
GENERAL
American Homestar is one of the fastest growing vertically integrated manufactured housing companies in the United States with operations in manufacturing, retailing, financing and insurance.
In fiscal 1993, in response to growing demand for manufactured homes, the Company began developing its expansion and vertical integration plan by opening nine new retail sales centers and entering into a new venture (the "Homestar Venture") with Oak Creek Homes, Inc. ("Oak Creek"), a long-time supplier, to start-up and operate two manufacturing facilities. The costs associated with the start-up of two new manufacturing facilities and the new retail sales centers had an adverse effect on the Company's operating results in the second half of fiscal 1993 and in the first half of fiscal 1994. By October 1993, both manufacturing facilities had become profitable.
Effective August 31, 1993, a combination was consummated with the shareholders of Oak Creek exchanging their shares of Oak Creek common stock for shares of the Company's common stock (the "Combination"). In connection with the Combination, all of the retail sales management personnel and manufacturing management personnel exchanged their shares of common stock in the Company's subsidiaries for shares of the Company's common stock.
In September 1995, the Company formed 21st Century to originate, finance, sell and service manufactured housing sales contracts from the Company and third parties. 21st Century is managed by two former executive officers of Clayton and its finance subsidiary, Vanderbilt Mortgage and Finance, Inc. The Company, Clayton and management of 21st Century own 50%, 25% and 25%, respectively, of the equity capital of 21st Century. 21st Century commenced operation in October 1995. The Company accounts for its investment in 21st Century using the equity method of accounting, showing its proportionate share of 21st Century's earnings or losses as "earnings or loss in affiliate."
In September 1996, the Company exercised its option to acquire Guerdon after managing Guerdon's operations under a management agreement since March 1996. Guerdon produces manufactured homes in four facilities located in Oregon, Idaho, Nebraska and Mississippi, and sells its homes to over 150 independent retailers located in 17 states in the Pacific Northwest Rocky Mountain and South Central regions of the United States.
In September 1996, the Company acquired Heartland, a single plant manufacturer of low-to medium-priced homes in North Carolina. Concurrent with the Heartland acquisition, the Company also purchased the assets of Manu-Fac Homes Inc. ("Manu-Fac"), a contractually affiliated group of 15 independent retailers, which have since become franchisees of the Company.
In June 1997, the Company acquired Brilliant, which operates three manufacturing plants in Northern Alabama. Also in June 1997, the Company acquired N.C. Homes, which operates twelve retail sales centers in North Carolina and one in Virginia. In January 1998, the Company acquired Davis Homes, which operates three retail sales centers in Alabama.
VERTICAL INTEGRATION AND INTERNALIZATION
The Company's growth strategy is based on an increasing degree of vertical integration over time. Vertical integration allows the Company to increase its profit margins on the manufacture and sale of its products, and provides the ability to realize additional sources of income from financing the sales and insuring the Company's products.
Several elements of the Company's growth strategy center on increasing the rate of "internalization" of its retail sales (i.e. the proportion of new homes sold by Company-owned retail sales centers that are also manufactured by the Company). This strategy enables the Company to earn both a manufacturing profit and a retailing profit on those home sales; however, only retail sales revenue is recognized. Accordingly, increasing the internalization rate (without otherwise affecting the Company's level of manufacturing and retailing activity) has the effect of increasing gross margins and reducing reported revenues; however, aggregate gross profit (in dollars) is not materially affected by changes in the internalization rate.
Another key element of the Company's growth strategy is to increase the degree of retail penetration of its financial services. As insurance product penetration increases, both reported revenues and earnings should increase without a corresponding increase in retail sales activity. Similarly, as 21st Century finances more of the Company's retail sales, the Company's earnings should increase without a corresponding increase in retail sales activity.
RESULTS OF OPERATIONS
The Company's acquisition of Brilliant in June 1997 was accounted for as a pooling of interests. Accordingly, all applicable periods have been restated to combine the previously separate entities. See Note 3 of the Notes to the Company's Consolidated Financial Statements included herein.
The following table summarizes certain key sales statistics for the Company for the periods indicated:
(1) The internalization rate is the proportion of new homes sold by Company-owned retail sales centers that are manufactured by the Company.
The following table summarizes the Company's historical operating results, expressed as a percentage of total revenues, for the periods indicated:
Year ended May 31, 1998 compared to year ended May 31, 1997
Net Sales. Net sales of manufactured homes were $481.9 million in fiscal year ended May 31, 1998, compared to $383.1 million in fiscal 1997. Sales from the Heartland and Guerdon manufacturing operations were $108.4 million and $72.6 million in fiscal years 1998 and 1997, respectively. Excluding the Heartland and Guerdon operations, net sales increased to $373.5 million in fiscal year 1998, compared to $310.6 million in fiscal year 1997. The increase was primarily the result of a 19% increase in the number of new and previously-owned homes sold at retail as well as a 5% increase in the average selling price of new homes. A decline in the average number of new homes sold per retail sales center from 93 in fiscal 1997 to 69 in fiscal 1998 was primarily attributable to retail management changes necessitated by the restructuring of the Company's retail operations and average new homes sold from the recently acquired operations of NC Homes being significantly lower than the average historically generated by the Company's retail locations in Texas and the surrounding states. The Company added 32 new Company-owned retail sales centers in fiscal 1998, 12 of which were NC Homes retail sales centers.
Other Revenues. Transportation revenues in fiscal 1998 were $10.4 million, a decrease of 24% from $13.6 million in fiscal 1997. This decrease was primarily due to increased competition among manufactured home transporters, particularly in Texas and surrounding states. Transportation is not a key growth area of the Company and has over time represented a declining proportion of total revenues and operating income. Other revenues increased to $21.6 million in fiscal year 1998, compared to $12.7 million in fiscal 1997. Normal recurring revenues from insurance operations increased to $8.6 million in fiscal 1998, compared to $5.3 million in fiscal 1997. Other revenues also included $6.2 million in earned physical damage insurance premiums which for the first time were ceded to the Company's insurance subsidiary under a new reinsurance contract.
Cost of Sales. Cost of manufactured homes sold was $343.5 million, or 71.3% of net sales, in fiscal 1998, as compared to $279.3 million, or 72.9% of net sales in fiscal 1997. Cost of sales attributable to Heartland and Guerdon in fiscal 1998 and 1997 were $109.4 million and $60.1 million, respectively. Excluding the Heartland and Guerdon operations, cost of sales increased to $234.1 million, or 62.6% of net sales in fiscal 1998, compared to $211.7 million, or 68.1% of net sales in fiscal 1997. The increase in cost of sales was primarily due to higher sales volume. The decrease in cost of sales, expressed as a percentage of net sales, was primarily the result of an increase in the internalization rate from 74% in fiscal 1997 to 84% in fiscal 1998. Cost of sales attributable to transportation operations in fiscal 1998 were $8.4 million, or 80.9% of transportation revenues, a decrease of 25% from $11.2 million, or 82.3% of transportation revenues in fiscal 1997.
Selling, General and Administrative Expenses. Selling, general and administrative expenses in fiscal 1998, were $121.4 million, or 23.6% of total revenues, as compared to $87.8 million, or 21.4% of total revenues in fiscal 1997. The increase in selling, general and administrative expenses is attributable to increased sales, manufacturing and insurance activities as well as an increase in fixed costs and expenses associated with new retail sales centers and expanded manufacturing capacity. Selling, general and administrative expenses also included $5.9 million in claims and expenses related to the $6.2 million in earned premiums under the previously described new reinsurance contract.
Acquisition Costs. During fiscal 1998, the Company incurred $2.4 million in costs related to the Brilliant acquisition. These acquisition related costs primarily consisted of transaction costs and severance and termination agreements with two former officers of Brilliant.
Interest Expense. Interest expense increased 29% to $7.4 million in fiscal 1998, from $5.7 million in fiscal 1997. This increase was primarily attributable to increased borrowings associated with the Company's private placement of 8.32% senior unsecured notes totaling $61 million in July 1997, and increased gross borrowings under its floor plan credit facility to support a higher level of inventory due to the addition of new retail sales centers.
Income Taxes. The income tax provision, as a percentage of income before income taxes, minority interest, earnings in affiliate and extraordinary items, was 43.8% and 39.4% for fiscal years 1998 and 1997 respectively. The increase was primarily the result of nondeductible acquisition costs related to the Brilliant acquisition as well as nondeductible goodwill related to the acquisitions of Guerdon and NC Homes.
Extraordinary Loss. In connection with the private placement of $61 million of 8.32% senior unsecured notes in July 1997, the Company repaid existing secured bank debt of approximately $31 million. Consequently, the Company recorded an extraordinary loss of $634,000 (net of income tax benefit) which represented the write-off of unamortized debt issue costs as well as a prepayment penalty associated with the early repayment of the bank debt.
Year Ended May 31, 1997 Compared to Year Ended May 31, 1996
Net Sales. Net sales of manufactured homes were $383.1 million in fiscal 1997, an increase of 40% from $274.1 million in fiscal 1996. Sales from the Heartland and Guerdon manufacturing operations, acquired in fiscal 1997, were $72.6 million in fiscal 1997. On a basis comparable to fiscal 1996, net sales increased 13% to $310.5 million. This increase was primarily the result of an 18% increase in the number of new and previously-owned homes sold at retail as well as a 6% increase in the average selling price of new homes. The decline in the average new homes sold per retail sales center from 99 in fiscal 1996 to 93 in fiscal 1997 was attributable to unusually wet weather conditions during the fiscal 1997 winter and spring in the South and Southwest regions of the United States, which delayed the opening of several Company-owned retail sales centers from the Company's third quarter to the fourth quarter, as well as an increase in the number of retailers operating in Texas and surrounding states. However, average sales revenue in fiscal 1997 per retail sales center remained level with fiscal 1996 as the Company increased the percentage of multi-section homes sold in fiscal 1997 to 54% from 51% in fiscal 1996.
Other Revenues. Transportation revenues for fiscal 1997 were $13.6 million, an increase of 14% from $11.9 million in fiscal 1996. This increase was primarily due to an increase in transportation activity in response to generally higher demand for transportation services. Other revenues increased 20% to $12.7 million in fiscal 1997 compared to $10.5 million in fiscal 1996. This increase was primarily due to an increase in insurance commissions and premiums generated by the Company's insurance operations as well as revenue associated with the Company's franchising operations acquired in connection with the purchase of Manu-Fac in September 1996.
Cost of Sales. Cost of manufactured homes sold was $279.3 million, or 72.9% of net sales, in fiscal 1997, as compared to $199.0 million, or 72.6% of net sales, in fiscal 1996. Cost of manufactured homes attributable to the Heartland and Guerdon manufacturing operations for fiscal 1997 were $60.1 million. On a basis comparable to fiscal 1996, cost of manufactured homes increased 10% to $219.2 million, or 70.6% of net sales. The decrease in cost of manufactured homes, expressed as percentage of net sales, was the result of an increase in the internalization rate from 60% in fiscal 1996 to 74% in fiscal 1997 as well as increased operating efficiencies at the Company's three Texas manufacturing facilities. Cost of sales attributable to transportation operations for fiscal 1997 was $11.2 million (82.3% of transportation revenues), an increase of 13% from $9.9 million (83.2% of transportation revenues) in fiscal 1996. This increase was due to increased business activity.
Selling, General and Administrative Expenses. Selling, general and administrative expenses in fiscal 1997 were $87.8 million, or 21.4% of total revenues, compared to $66.2 million, or 22.3% of total revenues, in fiscal 1996. Selling, general and administrative expenses attributable to the Heartland and Guerdon manufacturing operations were $9.6 million in fiscal 1997. On a basis comparable to fiscal 1996, selling, general and administrative expenses were $78.2 million, or 23.2% of total revenues in fiscal 1997. The increase in selling, general and administrative expenses was attributable to increased sales, manufacturing, transportation and insurance activities as well as an increase in fixed costs and expenses associated with new Company-owned retail sales centers and expanded manufacturing capacity. The increase in selling, general and administrative expenses, expressed as a percentage of total revenues on a comparable basis, was the result of an increase in the internalization rate from 60% in fiscal 1996 to 74% in fiscal 1997. This increase was partially offset by a decrease in warranty expenses, expressed as a percentage of total revenues.
Interest Expense. Interest expense increased 40% to $5.7 million in fiscal 1997 from $4.1 million in fiscal 1996. The increase was due to increased borrowings of $25 million under a credit facility established with Bank One, Texas N.A., which was used to fund the Company's growth strategy as well as fund its acquisition of Guerdon, and an increase in floor plan debt used to support higher levels of inventory due to the opening of new retail sales centers.
Income Taxes. The income tax provision, as a percentage of income before income taxes, minority interest, earnings in affiliate and extraordinary items, was 39.4% and 39.9% for fiscal years 1997 and 1996, respectively.
Extraordinary Loss. In November 1996, the Company repaid existing secured bank debt of approximately $3.5 million. Consequently, the Company recorded an extraordinary loss of $347,000 (net of income tax benefit), which represented the write-off of unamortized debt issue costs as well as a prepayment penalty associated with the early repayment of the bank debt.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $8.1 million, $3.0 million and $17.3 million in fiscal 1996, 1997 and 1998, respectively. Substantial increases in inventory and other working capital items required to open Company-owned retail sales centers account for most of the operating cash requirements in these periods. In addition, cash was used in these periods to purchase inventory and fund working capital requirements for five new manufacturing facilities acquired in fiscal 1997. Although the Company acquired three new plants and opened or acquired thirty-two new Company-owned retail sales centers in fiscal 1998, additional inventory requirements were largely offset by a significant reduction in prevailing inventory levels at Company-owned retail sales centers.
An important part of the Company's growth strategy is to continue to expand the number of Company-owned retail sales centers and increase its manufacturing capacity to supply a growing number of Company-owned retail sales centers and franchises. Management estimates the capital required to open a new retail sales center is approximately $1.0 million to $1.25 million, primarily for inventory and working capital. Subject to continued increases in demand, the Company may incur additional capital expenditures to further increase its manufacturing capacity. The Company currently plans to open or acquire 30 to 40 retail sales centers each year for the next two years and, in connection therewith, to use cash to purchase inventory and operating assets and for working capital purposes. Management expects increased cash generated by the Company's retail sales centers and manufacturing operations to substantially fund the working capital required to open new retail sales centers.
The Company had capital expenditures of $6.8 million, $10.6 million and $14.7 million in fiscal 1996, 1997 and 1998, respectively. These expenditures were principally used to fund additions to manufacturing capacity and to purchase land, land improvements and buildings for new Company-owned retail sales centers.
Management anticipates that its capital requirements for fiscal 1999 will consist of approximately $15 million of working capital needs and capital expenditures associated with its current operations. The $15 million does not include any acquisition spending.
At May 31, 1998, the Company had a $125 million floor plan credit facility with Associates Housing Finance, LLC (the "Associates"). The facility, similar to a revolving credit facility, bears interest at a rate of prime less 0.50% (8.0% at May 31, 1998) and is used to finance the purchase of inventory of new homes at its retail sales centers. The Company is able to purchase participations in the floor plan credit facility, effectively reducing its net borrowings under the facility. These participations earn interest at a rate of prime less 0.75% (7.75% at May 31, 1998, with such interest income reported as a reduction of total interest expense) and are immediately available to the Company in cash as the Company redeems them. At May 31, 1998, the Company had net borrowings of $43.5 million (gross borrowings of $84.6 million less participations of $41.1 million).
On July 15, 1997, the Company completed a private placement of $61.0 million of 8.32% senior unsecured notes (the "Senior Notes"). Scheduled payments of the Senior Notes begin in July 2002 and continue annually until paid in full in July 2007. The Company used the net proceeds to repay approximately $31 million in existing bank debt. The remainder of the proceeds were used to temporarily reduce borrowings under the Company's floor plan credit facility.
Management believes that the Company's current cash resources, available floor plan credit facility and cash provided from operations will be sufficient to satisfy internal working capital and capital expenditure requirements for the next two fiscal years. Management also plans to pursue acquisition opportunities in the future. Financing for such acquisitions may be provided by cash from operations and from external sources. In July 1998, the Company reached an agreement with several of its existing senior unsecured note holders to issue an additional $51 million in new senior
unsecured notes with an average rate of 7.24% and which mature in 2008. The notes will require semi-annual interest payments and equal annual principal reductions beginning in 2004. Proceeds from the notes will be used to fund pending acquisitions with the remainder used for general corporate purposes. Subject to certain conditions, closing is planned for early September 1998.
INFLATION AND SEASONALITY
Inflation in recent years has been modest and has primarily affected the Company's manufacturing costs in the areas of labor, manufacturing overhead and raw materials other than lumber. The price of lumber is affected more by the imbalances between supply and demand than by inflation. Historically, the Company believes it has been able to minimize the effects of inflation by increasing the selling prices of its products, improving its manufacturing efficiency and increasing its employee productivity. In addition, the Company's business is seasonal, with weakest demand typically occurring during the Company's third fiscal quarter (December through February) and the strongest demand typically occurring during the Company's last fiscal quarter (March through May). Over the history of the Company's operations, management has not observed any correlation between interest rate fluctuations and increases or decreases in sales based solely on such fluctuations.
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 1 to the Notes to the Company's Consolidated Financial Statements included herein.
IMPACT OF YEAR 2000
Date sensitive computer applications that currently record years in two-digit, rather than four-digit, format may be unable to properly categorize and process dates occurring after December 31, 1999 (the "Year 2000" problem). The Company is currently upgrading its software programs and operating systems at a cost of approximately $2.3 million and believes that these new programs and systems will not be subject to the Year 2000 problem. The Company intends to complete the upgrade by early 1999. If Year 2000 related failures were to occur in the Company's computer and information systems, however, the Company could incur significant, unanticipated liabilities, expenses and possible disruption of its business. Additionally, risk of business disruption exists if Year 2000 related failures occur among the Company's lenders, suppliers, transporters and others upon which the Company relies, but over which the Company has no control.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is listed under Item 14 (a) and begins at page hereof.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information concerning the directors and executive officers 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 on October 8, 1998 (the "Proxy Statement") under the heading "Election of Directors," which information is incorporated herein by reference. The information concerning disclosure of delinquent Form 3, 4 or 5 filers is set forth in the Proxy Statement under the heading "Section 16 Requirements," 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 "Executive Compensation," which information is incorporated herein by reference. Information contained in the Proxy Statement under the caption "Executive Compensation - Report of the Board of Directors on Executive
Compensation and - Stock Performance Chart" is incorporated by reference herein.
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 certain relationships and related transactions is set forth in the Proxy Statement under the heading "Certain Transactions," 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) FINANCIAL STATEMENTS
Report of Independent Public Accountants
Report of Independent Public Accountants
Consolidated Balance Sheets as of May 31, 1997 and 1998
Consolidated Statements of Operations for the years ended May 31, 1996, 1997 and 1998
Consolidated Statements of Shareholders' Equity for the years ended May 31, 1996, 1997 and 1998
Consolidated Statements of Cash Flows for the years ended May 31, 1996, 1997 and 1998
Notes to the Consolidated Financial Statements
(2) SUPPLEMENTARY SCHEDULE TO FINANCIAL STATEMENTS
Schedule II - Valuation and Qualifying Accounts
(3) EXHIBITS
The exhibits filed as part of this report are listed under "Exhibits" at subsection (c) of Item 14
(b) REPORTS ON FORM 8-K
No report on Form 8-K was filed on behalf of the Company during the last quarter of the Company's 1998 fiscal year
(c) EXHIBITS
SIGNATURES
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.
AMERICAN HOMESTAR CORPORATION
Date: August 28, 1998 By: /s/ Laurence A. Dawson, Jr., President --------------------------------------- Laurence A. Dawson, Jr., President
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 the dates indicated.
Signature Title Date --------- ----- ----
/s/ FINIS F. TEETER Chairman of the Board and August 28, 1998 --------------------------- Co-Chief Executive Officer Finis F. Teeter (Principal Executive Officer)
/s/ LAURENCE A. DAWSON, JR. President, Co-Chief Executive August 28, 1998 --------------------------- Officer and Director Laurence A. Dawson, Jr. (Principal Executive Officer)
/s/ CRAIG A. REYNOLDS Executive Vice President, August 28, 1998 --------------------------- Chief Financial Officer, Craig A. Reynolds Secretary and Director (Principal Financial and Accounting Officer)
/s/ CHARLES N. CARNEY, JR. Executive Vice President August 28, 1998 --------------------------- and Director Charles N. Carney, Jr.
/s/ JACKIE H. HOLLAND Vice President, Treasurer August 28, 1998 --------------------------- and Director Jackie H. Holland
/s/ RONALD E. MCCASLIN Executive Vice President August 28, 1998 --------------------------- and Director Ronald E. McCaslin
/s/ WILLIAM O. HUNT Director August 28, 1998 --------------------------- William O. Hunt
/s/ JACK L. McDONALD Director August 28, 1998 --------------------------- Jack L. McDonald
/s/ DALE V. KESLER Director August 28, 1998 --------------------------- Dale V. Kesler
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Independent Auditors' Report
The Board of Directors American Homestar Corporation:
We have audited the consolidated financial statements of American Homestar Corporation and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also audited the financial statement schedule as listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits. We did not audit the consolidated financial statements of Brilliant Holding Corporation (see Note 1 of Notes to Consolidated Financial Statements), included in the Company's consolidated financial statements for fiscal 1996 and 1997, which statements reflect total assets constituting 8% of the consolidated total at May 31, 1997, and total revenues constituting 22% and 17% of the consolidated totals for the years ended May 31, 1996 and 1997, respectively. These consolidated financial statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Brilliant Holding Corporation, is based solely on the report of the other auditors.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of the other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of American Homestar Corporation and subsidiaries as of May 31, 1997 and 1998, and the results of their operations and their cash flows for each of the years in the three-year period ended May 31, 1998, in conformity with generally accepted accounting principles. Also, in our opinion, based on our audits and the report of the other auditors, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
/s/ KPMG PEAT MARWICK LLP
Houston, Texas June 25, 1998
Independent Auditors' Report
To Brilliant Holding Corporation:
We have audited the consolidated balance sheets of Brilliant Holding Corporation and subsidiaries as of December 31, 1995 and 1996, and the related consolidated statements of income, stockholders' equity, and cash flows for the years then ended (not presented separately herein). 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 in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Brilliant Holding Corporation and subsidiaries as of December 31, 1995 and 1996, and the results of their operations and their cash flows for the years then ended, in conformity with generally accepted accounting principles.
/s/ Deloitte & Touche LLP
Birmingham, Alabama April 11, 1997 (June 5, 1997 as to the Note 12)
AMERICAN HOMESTAR CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
See accompanying notes to consolidated financial statements.
AMERICAN HOMESTAR CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
See accompanying notes to consolidated financial statements.
AMERICAN HOMESTAR CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
See accompanying notes to consolidated financial statements.
AMERICAN HOMESTAR CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to consolidated financial statements.
AMERICAN HOMESTAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION AND GENERAL
The consolidated financial statements include the accounts of American Homestar Corporation and its majority-owned subsidiaries (the "Company"). All significant intercompany balances and transactions have been eliminated in consolidation.
On June 10, 1997, the Company completed the acquisition of Brilliant Holding Corporation ("Brilliant"). This transaction was accounted for as a pooling of interests; accordingly, the accompanying consolidated financial statements have been restated to include the results of Brilliant for all periods presented.
The Company owns 50% of the outstanding common stock of 21st Century Mortgage Corporation ("21st Century") which is accounted for under the equity method of accounting.
NATURE OF OPERATIONS
The Company is a vertically integrated manufactured housing company. As of May 31, 1998, the Company manufactured a wide variety of manufactured homes from its eleven manufacturing facilities which are sold through 86 Company-owned retail sales centers in Texas, North Carolina, Alabama, Louisiana, New Mexico, Oklahoma, Colorado, Idaho, Mississippi, Tennessee, Utah, Virginia, Arkansas and Washington as well as a network of retail franchisees and independent dealers. In addition, the Company offers installment financing to purchasers of manufactured homes from its retail sales centers. The Company also offers retail customers, through both its Company-owned retail sales centers and certain independent retailers, a variety of insurance products, including property casualty insurance, credit life insurance and extended warranty coverage.
ACCOUNTING 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 date of the financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates.
REVENUE RECOGNITION
Retail sales are recognized when cash payment is received, or in the case of credit sales (which represent the majority of the Company's retail sales), when a down payment is received and the Company and the customer enter into an installment sales contract. The Company manufactures its homes based on dealer orders; sales to independent dealers are recognized as revenue when title transfers to the buyer, which is the date of shipment. Almost all the Company's sales to dealers are financed through the dealer's floor plan financing arrangements. Dealers are not permitted to cancel purchases without penalty once the manufacturing process commences.
The Company also maintains used manufactured home inventory owned by outside parties for which the Company receives a sales commission when sold to consumers.
Premiums from credit life insurance policies reinsured by the Company's credit life subsidiary, Lifestar Reinsurance, Ltd. ("Lifestar"), are recognized as revenue over the life of the policy term. Premiums are ceded to Lifestar on an earned basis.
INVENTORIES
Newly manufactured homes are valued at the lower of cost or market, using the specific identification method. Used manufactured homes are valued at estimated wholesale prices, not in excess of net realizable value.
Raw materials are valued at the lower of cost or market, using the first-in, first-out method.
AMERICAN HOMESTAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are carried at cost. Depreciation on property, plant and equipment is provided by the straight-line method over the estimated useful lives of the related assets. Leasehold improvements are amortized using the straight-line method over the useful lives of the improvements or lease periods, whichever is shorter.
GOODWILL
Goodwill, which represents the excess of purchase price over the fair value of net assets acquired, is amortized on a straight-line basis over periods ranging from 10 to 40 years. The Company assesses the recoverability of goodwill by determining whether the amortization of the goodwill balance over the remaining useful life can be recovered through undiscounted future operating cash flows of the acquired operations.
INCOME TAXES
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which such temporary differences are expected be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that included the enactment date.
RESERVES FOR FUTURE LOSSES ON CREDIT SALES
The Company makes a current provision for estimated future losses on credit retail sales where the Company retains risk in the event of customer nonpayment of installment sales contracts. Typically, the Company's period of exposure to loss does not exceed three installment payments (60 days) on an individual contract. The amounts provided for estimated future losses on credit sales are determined based on the Company's historical loss experience after giving consideration to current economic conditions. In assessing current loss experience and economic conditions, management may adjust the reserve for losses on credit sales related to prior years' installment sales contracts. All adjustments are recognized currently.
ACCRUED WARRANTY AND SERVICE COSTS
The Company makes a current provision for future service costs associated with homes sold and for manufacturing defects for a period of one year from the date of sale of the home. The estimated cost of these items is accrued at the time of sale and is reflected in selling, general and administrative expenses in the consolidated statements of operations. For the years ended May 31, 1996, 1997 and 1998, warranty and service costs were $9,228,000, $11,400,000 and $18,009,000, respectively.
RESERVES FOR CONTINGENT REPURCHASE AGREEMENTS
Reserves for contingent repurchase agreements are established for losses based on the Company's historical loss experience, and actual losses are charged to the reserve when incurred. Management, in assessing the loss experience, adjusts the reserves through periodic provisions. The Company has not incurred losses related to contingent repurchases for the years ended May 31, 1996, 1997 and 1998.
AMERICAN HOMESTAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
EARNINGS PER SHARE
Statement of Financial Accounting Standards No. 128 "Earnings per Share", specifies new measurement, presentation and disclosure requirements for earnings per share and is required to be applied retroactively upon initial adoption. The Company has adopted SFAS No. 128 effective with the release of February 28, 1998 earnings data, and accordingly, has restated herein all previously reported earnings per share data after giving retroactive effect to the changes in capital structure discussed in Note 9. Basic earnings per share is based on the weighted average shares outstanding without any dilutive effects considered. Diluted earnings per share reflects dilution from all contingently issuable shares from outstanding options. A reconciliation of such earnings per share for the years ended May 31, 1996, 1997 and 1998 is as follows:
FINANCIAL INSTRUMENTS
Fair value estimates are made at discrete points in time based on relevant market information. These estimates may be subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. The Company believes that the carrying amounts of its current assets, current liabilities and long-term debt approximate the fair value of such items.
CASH EQUIVALENTS
Cash equivalents consist of short-term investments with an original maturity of three months or less, money market accounts and cash in transit from financial institutions. Cash in transit from financial institutions presents no risk to the Company regarding collectibility and is collected within 90 days. In addition, the Company has never experienced a loss because of a failure to collect amounts due from these financial institutions. Approximately 95% and 86% of the cash in transit from financial institutions balance at May 31, 1997 and 1998, respectively, is due from three lenders, of which 67% and 51%, respectively, is due from the Company's mortgage affiliate, 21st Century.
AMERICAN HOMESTAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130") was issued, which establishes standards for reporting and display of comprehensive income and its components. The components of comprehensive income refer to revenues, expenses, gains and losses that are excluded from net income under current accounting standards, including foreign currency translation items, minimum pension liability adjustments and unrealized gains and losses on certain investments in debt and equity securities. SFAS 130 requires that all items that are recognized under accounting standards as components of comprehensive income be reported in a financial statement displayed in equal prominence with other financial statements and the total of other comprehensive income for a period is required to be transferred to a component of equity that is separately displayed in a statement of financial position at the end of an accounting period. SFAS 130 is effective for fiscal years beginning after December 15, 1997. Management believes adoption of SFAS 130 for fiscal year 1999 will not have a significant impact on the consolidated financial statements of the Company.
In June 1997, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131") was issued. SFAS 131 establishes standards for disclosures about segments of an enterprise and related information. SFAS 131 establishes standards for reporting information about operating segments in annual financial statements and requires the reporting of selected information about operating segments in interim financial reports issued to stockholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. SFAS 131 is effective for fiscal years beginning after December 15, 1997. Management believes adoption of SFAS 131 for fiscal year 1999 will not affect the results of operations or financial position but will affect the disclosure of segment information.
In March 1998, the AICPA issued Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" (SOP 98-1), establishing accounting standards for such costs, as defined therein. Accordingly, certain costs of computer software developed or obtained for internal use should be capitalized and amortized over the estimated useful life of the software. SOP 98-1 is effective for fiscal years beginning after December 15, 1998 and should be adopted as of the beginning of the fiscal year. Management believes adoption of SOP 98-1 for fiscal year 2000 will not have a significant impact on consolidated financial statements of the Company.
In April 1998, the AICPA issued Statement of Position 98-5, "Reporting on the Costs of Start-Up Activities" (SOP 98-5), establishing accounting standards for costs of start-up activities, including organizational costs. Accordingly, such costs that were carried as an asset prior to the adoption of SOP 98-5 will be written off on the cumulative effect line in the statement of operations as of the beginning of the year adopted. SOP 98-5 is effective for fiscal years beginning after December 15, 1998. Management believes the adoption of SOP 98-5 in fiscal year 2000 will not have a significant impact on the consolidated financial statements of the Company.
RECLASSIFICATIONS
Certain prior years' amounts have been reclassified to conform to classifications used in 1998.
(2) PUBLIC OFFERING
On April 2, 1996, the Company completed a public offering of 3,234,375 shares of common stock at $9.07 per share (adjusted for the 5-for-4 stock split and the 3-for-2 stock split discussed in Note 9). Of the shares offered, 2,006,250 shares were sold by the Company and 1,228,125 shares were sold by certain shareholders of the Company. Net proceeds of $17,120,000 (before offering expenses) from the offering were used by the Company to fund its growth strategy.
AMERICAN HOMESTAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(3) ACQUISITIONS
On September 3, 1996, the Company acquired all of the common stock of Heartland Homes, Inc. ("Heartland") and certain operating assets of Manu-Fac Homes, Inc. ("Manu-Fac") for a combination of cash and notes totaling $8.5 million. Heartland is a single-plant manufactured housing producer in Henderson, North Carolina. Heartland markets its homes through 65 independent retailers in North Carolina and three surrounding states. Manu-Fac was a contractually affiliated group of independent retailers throughout North Carolina, operating under the CHOICENTER or WESTWOOD Homes trade names. In connection with the acquisition of such assets of Manu-Fac, these retailers became franchisees of Associated Retailers Group, Inc., a wholly-owned subsidiary of the Company, and continue to operate under the CHOICENTER or WESTWOOD trade names. The results of the acquired operations of Heartland and Manu-Fac have been included with those of the Company from the date of acquisition. The excess purchase price over the estimated fair value of net assets acquired as of the acquisition date of $6.2 million has been recorded as goodwill and is being amortized over 25 years. The estimated fair value of assets acquired and liabilities assumed in these acquisitions is summarized as follows:
On September 24, 1996, the Company completed the acquisition of Guerdon Holdings, Inc. and its subsidiary, Guerdon Homes, Inc. (collectively "Guerdon"). Guerdon produces manufactured homes in four facilities located in Oregon, Idaho, Nebraska and Mississippi, and sells its homes through approximately 150 independent retailers located primarily in the Pacific Northwest, Rocky Mountain, and South Central regions of the United States. The results of the acquired operations of Guerdon have been included with those of the Company from the date of the acquisition. The excess purchase price over the estimated fair value of the net assets acquired as of the acquisition date of $23.9 million has been recorded as goodwill and is being amortized over 40 years. The estimated fair value of assets acquired and liabilities assumed in this acquisition is summarized as follows:
AMERICAN HOMESTAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Unaudited pro forma results of operations of the Company for the years ended May 31, 1996 and 1997, assuming the Guerdon, Heartland and Manu-Fac acquisitions had been consummated at June 1, 1995, is summarized as follows:
On June 10, 1997, Brilliant was acquired by the Company, and 711,149 shares of the Company's common stock and options to purchase 38,852 shares of the Company's common stock were issued in exchange for all of Brilliant's outstanding common stock and options. This transaction was accounted for as a pooling of interests. Prior to the acquisition, Brilliant used a fiscal year ending on December 31. The restated consolidated financial statements for the years ended May 31, 1996 and 1997 combine the Company's consolidated financial statements for the years ended May 31, 1996 and 1997 with Brilliant's consolidated financial statements for the years ended December 31, 1995 and 1996, respectively. Due to the different fiscal year ends, retained earnings includes an adjustment to record Brilliant's net loss for the five months ended May 31, 1997, which will not be included in the restated consolidated financial statements for any fiscal period.
A summary of Brilliant's results of operations for the five months ended May 31, 1997 follows:
A reconciliation of revenues and net income of the combined entities as restated for the years ended May 31, 1996 and 1997 follows:
Adjustments to eliminate intercompany profit and conform Brilliant's method of accounting for inventory and
AMERICAN HOMESTAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
accrued warranty costs with that of the Company reduced net income for each of the years ended May 31, 1996 and 1997 by $117,000 and $450,000, respectively. Included in Brilliant's fiscal 1996 net income is an extraordinary loss of $347,000, net of income tax benefit.
On June 16, 1997, the Company completed the acquisition of N.C. Mobile Home Corporation (NC Homes), which operates 12 retail centers in North Carolina and one in Virginia. The results of the acquired operations of NC Homes have been included with those of the Company from the date of the acquisition. The excess purchase price over the estimated fair value of the net assets acquired as of the acquisition date of $3.6 million has been recorded as goodwill and is being amortized over 25 years. The fair value of assets acquired and liabilities assumed is summarized as follows:
On January 6, 1998, the Company completed the acquisition of Davis Homes, Inc. which operates three retail centers in Alabama. The results of the acquired operations of Davis Homes, Inc. have been included with those of the Company from the date of the acquisition. The excess purchase price over the estimated fair value of the net assets acquired as of the acquisition date of $2.1 million has been recorded as goodwill and is being amortized over 25 years. The estimated fair value of assets acquired and liabilities assumed is summarized as follows:
AMERICAN HOMESTAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The pro forma effects related to the NC Homes and Davis Homes, Inc. acquisitions are not significant.
(4) INVENTORIES
A summary of inventories follows:
Substantially all the Company's new and used manufactured homes were pledged as collateral against its floor plan credit facility (see note 6).
(5) PROPERTY, PLANT AND EQUIPMENT
A summary of property, plant and equipment follows:
AMERICAN HOMESTAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(6) NOTES AND FLOOR PLAN PAYABLE
The Company has a $125 million floor plan credit facility with Associates Housing Finance, LLC. ("Associates") to finance a major portion of its manufactured home inventory until such inventory is sold and contract proceeds are received. Amounts outstanding under the credit facility bear interest at prime less 0.50% (8.0% at May 31, 1998) with the Company's participations in the credit facility earning interest at prime less 0.75% (7.75% at May 31, 1998). The floor plan debt is secured by substantially all of the Company's manufactured home inventory and cash in transit from financial institutions. The Company may increase or decrease the participation at any time and may require Associates to re-purchase all of its participation.
Amounts due under the floor plan credit facility follows:
AMERICAN HOMESTAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A summary of notes payable follows:
AMERICAN HOMESTAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The aggregate maturities of notes payable for each of the five years subsequent to May 31, 1998 follow:
On July 15, 1997, the Company completed the private placement of $61 million of 8.32% senior unsecured notes with an average life of 7.5 years and a final maturity in July 2007. The Company used the net proceeds from this debt to repay approximately $25 million in existing secured bank indebtedness and approximately $6 million in secured debt of Brilliant. Consequently, the Company recorded an extraordinary loss of $634,000 (net of income tax benefit), which represents the write-off of unamortized debt issue costs as well as a prepayment penalty associated with the early repayment of the bank debt.
(7) INCOME TAXES
The provision for income taxes related to operations in the consolidated statements of operations is summarized below:
The Company files a consolidated return for federal tax purposes; accordingly, taxes at statutory rates are computed based on earnings before minority interests. The provision for income taxes related to operations varied from the amount computed by applying the U.S. federal statutory rate as a result of the following:
AMERICAN HOMESTAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are presented below:
Management of the Company considers it more likely than not that all the deferred tax assets will be realized due to sufficient taxable income in future years.
(8) INVESTMENT IN AFFILIATED COMPANIES
In September 1995, the Company invested $2.5 million to provide one-half of the initial capitalization of 21st Century, a newly formed mortgage company which commenced operations in October 1995 and provides retail financing to manufactured home buyers. 21st Century is 50% owned by the Company with the remaining 50% ownership divided equally between 21st Century's management and Clayton Homes, Inc. ("Clayton"). The Company has an option to purchase the stock owned by Clayton and the management of 21st Century after September 15, 2000. Summary financial information for 21st Century, derived from its audited financial statements, for the years ended May 31, 1997 and 1998 follows:
AMERICAN HOMESTAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(9) SHAREHOLDERS' EQUITY
On December 15, 1995, the Company effected a 5-for-4 stock split effective immediately for shareholders of record on January 5, 1996 and payable on January 18, 1996.
On January 10, 1997, the Company effected a 5-for-4 stock split effective immediately for shareholders of record on January 24, 1997 and payable on February 7, 1997.
On October 6, 1997, the Company effected a 3-for-2 stock split effective immediately for shareholders of record on October 17, 1997 and payable on October 31, 1997.
The consolidated financial statements, including all references to the number of shares of common stock and all per share information, have been adjusted to reflect the common stock splits.
During 1993, the Company and its principal shareholders sold common stock to certain employees at amounts less than fair value through the issuance of notes receivable. The fair value was determined by an independent appraisal. Compensation expense resulting from the sale of these shares was $60,000, $23,000 and $0 for the years ended May 31, 1996, 1997 and 1998, respectively.
A summary of common stock sold by the Company and its principal shareholders during the year ended May 31, 1994 follow:
(10) STOCK COMPENSATION PLAN
During 1994, the Company adopted the 1994 Stock Compensation Plan (the "Plan") whereby employees, independent directors and advisors are eligible to receive awards under the Plan. The Plan is administered by a committee of the Board of Directors (the "Committee"). An aggregate of 2,250,000 shares of common stock has been authorized and reserved for issuance under the Plan pursuant to the exercise of options or grant of restricted stock awards.
Restricted stock awards will give the recipient the right to receive a specified amount of shares of common stock contingent upon remaining a Company employee for a specified period, as determined by the Committee.
Options will become immediately exercisable and all restrictions will immediately lapse with respect to any award of restricted stock in the event of a change or threatened change in control of the Company and in the event of certain mergers and reorganizations of the Company. The options will expire no later than ten years after the date of grant. The exercise price for incentive stock options under the Plan may not be less than the fair value of the common stock on the date of grant. The exercise price for non-qualified options granted under the Plan will be at the discretion of the Committee.
AMERICAN HOMESTAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Option activity for the Company's 1994 Stock Compensation Plan follows:
A summary of the Company's 1994 Stock Compensation Plan at May 31, 1998 follows:
During fiscal 1997, the Company granted each co-chief executive officer a non-qualified stock option to purchase 140,625 shares of the Company's common stock at $9.07 per share, the then fair market value of the Company's common stock, under a Non-Qualified Stock Option Agreement (the "Option Agreements"). Each option is exercisable after November 15, 2005 and terminates on November 15, 2006. However, each option may be exercisable earlier according to the following schedule:
46,875 shares If the Company's market capitalization equals or exceeds $300 million at any time on or prior to November 15, 2000 which was exceeded during fiscal 1998.
46,875 shares If the Company's market capitalization equals or exceeds $400 million at any time on or prior to November 15, 2000 which was exceeded during fiscal 1998.
46,875 shares If the Company's market capitalization equals or exceeds $500 million at any time on or prior to November 15, 2000.
AMERICAN HOMESTAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As permitted under Statement of Financial Accounting Standards No. 123 "Accounting for Stock-Based Compensation" ("SFAS 123"), the Company accounts for stock based compensation in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"). Accordingly, no compensation cost has been recognized in fiscal 1996, 1997 and 1998 related to stock option grants. Had compensation cost been determined on the basis of SFAS 123, net income and earnings per share would have been as follows:
The fair value of each common stock option grant is estimated on the date of the grant using the Black Scholes option-pricing model with the following assumptions used for grants from all plans in fiscal 1996, 1997 and 1998:
(11) EMPLOYMENT AGREEMENTS
The Company entered into employment agreements, effective October 1, 1996, with the co-chief executive officers of the Company. Each agreement specifies a base salary of $235,000 per year plus an annual bonus of 2.25% of the Company's after-tax consolidated net income. Pursuant to these agreements, each co-chief executive officer was granted a stock option to purchase 93,750 shares of common stock pursuant to the Company's 1994 Stock Compensation Plan (see note 10). In addition, each co-chief executive officer was granted a Non-Qualified Stock Option to purchase 140,625 shares of common stock at $9.07, the fair value of the Company's common stock on the date of grant, under the Option Agreements (see note 10).
(12) RELATED PARTY BALANCES AND TRANSACTIONS
MOAMCO Properties, Inc. (MOAMCO), an entity owned by the Company's Chairman and Co-Chief Executive Officer, and Byway Partners, Ltd. ("Byways") a limited partnership in which the Company's President and Co-Chief Executive Officer is a limited partner and a family member is the general partner leased to the Company two facilities used in the manufacturing operations ("the Lancaster Facility" and "the Burleson Facility"). The amount paid to MOAMCO and Byways during the year ended May 31, 1996 was $12,500. During the year May 31, 1996, the Company exercised its option to purchase the Lancaster Facility and the Burleson Facility for $1,450,000 and $1,500,000, respectively. The purchase price was based on independent appraisals and ratified by the Company's Board of Directors.
AMERICAN HOMESTAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MOAMCO also owns and leases to the Company, under operating leases, land, improvements and buildings related to three sales centers. During the years ended May 31, 1996, 1997 and 1998, the Company paid MOAMCO approximately $144,000, $78,000 and $78,000 respectively, for these operating leases (see note 13). 21st Century pays the Company a fee based on the interest rate charged on the installment contracts and the loan volume received from each retail center. During the years ended May 31, 1996, 1997 and 1998, 21st Century paid the Company $6,000, $500,000 and $1,300,000, respectively.
(13) COMMITMENTS AND CONTINGENCIES
REPURCHASE AGREEMENTS
The Company has entered into repurchase agreements with various financial institutions and other credit sources pursuant to which the Company has agreed, under certain circumstances, to repurchase manufactured homes sold to independent dealers in the event of a default by a dealer on its obligation to such credit sources. Under the terms of such repurchase agreements, the Company agrees to repurchase manufactured homes at declining prices over the periods of the agreements (which generally range from 12 to 15 months). As of May 31, 1998 and 1997, the Company was at risk to repurchase approximately $80.9 million and $59.1 million, respectively, of manufactured homes.
LEGAL MATTERS
The Company is involved in various legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company's financial condition or results of operations.
SAVINGS PLAN
During 1992, the Company adopted the American Homestar Corporation 401(k) Retirement Plan (the "Savings Plan") whereby all employees of the Company are eligible to participate in the Savings Plan who have completed one year of service and have reached the age of twenty and one-half. The Savings Plan is administered by a Plan Administrator appointed by the Company. Eligible employees may contribute a portion of their annual compensation up to the legal maximum established by the Internal Revenue Service for each plan year. The Company's matching contributions are at the discretion of the Company and may be made up to a maximum of 3% each plan year. Employee contributions are immediately vested. Company contributions vest over the first six years of employment. Amounts contributed by the Company to the Savings Plan for the years ended May 31, 1996, 1997 and 1998 were $120,000, $185,000, and $263,000, respectively.
WORKERS COMPENSATION LIABILITY
The Company has rejected the insurance coverage provided by the Texas Workers' Compensation Act. While the Company maintains excess indemnity insurance, the Company's portion of self-insured retention is $250,000 per occurrence. Management, in assessing loss experience, adjusts the reserve through periodic provisions.
LEASES
The Company is obligated under various noncancelable operating lease agreements with varying monthly payments and varying expiration dates through 2004. Rental expense under operating leases for the years ended May 31, 1996, 1997 and 1998 were $1,509,000, $2,644,000, and $3,505,000, respectively.
AMERICAN HOMESTAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Aggregate annual rental payments, that include amounts due to related parties, on future lease commitments at May 31, 1998 were as follows:
(14) CONCENTRATIONS OF RISK
For the years ended May 31, 1996, 1997 and 1998, the Company had one producer that supplied 26%, 18% and 10%, respectively, of the new houses sold by Company-owned retail sales centers. The Company has a credit facility with one lender to finance the majority of its new home inventory. The loss of this lender could have a material adverse effect on the Company's operations. A majority of the Company-owned retail sales centers are located in Texas.
(15) SUPPLEMENTAL INFORMATION FOR STATEMENTS OF CASH FLOWS
The Company had the following non-cash investing and financing activities:
Supplemental disclosures of cash flow information are as follows:
AMERICAN HOMESTAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(16) BUSINESS SEGMENTS
The Company operates primarily in three business segments, retail sales, manufacturing of manufactured housing and financial services. The following table summarizes, for the periods indicated, the amounts of consolidated net revenues, operating income, identifiable assets, capital expenditures and depreciation and amortization attributable to these segments.
AMERICAN HOMESTAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Intersegment sales are primarily sales by the manufacturing segment to the retail segment and are transferred at market price. Earnings in affiliate in the consolidated statements of operations relate to the financial services segment.
(17) SUBSEQUENT EVENTS
Effective July 1, 1998, the Company completed the acquisition of First Value Homes, Inc. for a combination of cash and stock totaling $9 million. The final determination of the purchase price, which is subject to certain performance targets, will be made in the second quarter of fiscal 1999. The transaction will be accounted for as a purchase.
On May 28, 1998, the Company signed definitive agreements to acquire R-Anell Custom Homes, Inc. and its related manufacturing operations, Gold Medal Homes, Inc. and Gold Medal Homes of North Carolina, Inc. ("R-Anell"). The transactions, for a combination of cash and stock totaling $30 million, are expected to close in the second quarter of fiscal 1999 and will be accounted for as a purchase.
On June 18, 1998, at a special meeting, the Company's shareholders approved an increase in the number of authorized common shares from 20 million shares to 50 million shares.
(18) SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following presents a summary of the unaudited quarterly financial information for the years ended May 31, 1997 and 1998:
SCHEDULE II AMERICAN HOMESTAR CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS
(1) Amount represents acquired reserve for warranty and service costs.
INDEX TO EXHIBITS