SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 or 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2001
Commission File Number: 0-20307
AVALON CORRECTIONAL SERVICES, INC.
(Exact name of small business issuer as
specified in its charter)
Nevada 13-3592263
(State of Incorporation) (I.R.S. Employer I.D. Number)
13401 Railway Drive, Oklahoma City, Oklahoma 73114
(Address of principal executive offices)
(405) 752-8802
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15 (d) of the Exchange Act during the past 12 months (or such shorter
period as the registrant was required to file such reports), and (2) been
subject to such filing requirements for the past 90 days:
Yes X No ___
As of July 27, 2001, 4,822,924 shares of the issuer's Class A common stock, par
value $.001, were issued and outstanding.
Transitional Small Business Disclosure Format: Yes ___; No X .
PART I - FINANCIAL INFORMATION
AVALON CORRECTIONAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2001 2000
__________________________________
ASSETS
Current assets:
Cash and cash equivalents $ 1,426,000 $ 726,000
Related party receivables 328,000 317,000
Accounts receivable, net 2,277,000 3,719,000
Prepaid expenses and other 278,000 160,000
__________________________________
Total current assets 4,309,000 4,924,000
Property and equipment, net 29,307,000 29,673,000
Other assets 4,734,000 4,858,000
__________________________________
Total assets $ 38,350,000 $ 39,455,000
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable, accrued liabilities 1,632,000 $ 1,477,000
and other
Current maturities of long-term
debt 1,872,000 2,992,000
_________________________________
Total current liabilities 3,504,000 4,469,000
Long-term debt, less current maturities 22,838,000 23,614,000
Convertible debentures 3,850,000 3,850,000
Redeemable Common Stock, $.001 par value
1,622,448 shares issued and outstanding 3,515,000 3,593,000
Stockholders' equity:
Common stock: Par value $.001; 20,000,000 shares
authorized; 4,822,924 and 4,765,630 shares
issued and outstanding, less 1,622,448
shares subject to repurchase. 3,000 3,000
Preferred stock; par value $.001; 1,000,000
shares authorized; none issued ___ ___
Paid-In capital 7,450,000 7,285,000
Accumulated deficit (2,810,000) (3,359,000)
__________________________________
Total liabilities and stockholders'
equity 38,350,000 $ 39,455,000
__________________________________
The accompanying notes are an integral part of these consolidated financial
statements.
Page 1
AVALON CORRECTIONAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
2001 2000 2001 2000
______________________________________________
Revenues $6,315,000 $5,417,000 $12,264,000 $10,665,000
______________________________________________
Costs and expenses
Direct operating $4,482,000 $3,511,000 $8,525,000 7,028,000
General and administrative 308,000 470,000 750,000 863,000
Depreciation and amortization 464,000 337,000 859,000 671,000
Interest expense 756,000 870,000 1,580,000 1,659,000
______________________________________________
Income from continuing operations
before income tax expense $306,000 $ 229,000 $550,000 $444,000
Income tax expense --- --- --- ---
______________________________________________
Net income $ 306,000 $ 229,000 $ 550,000 $ 444,000
______________________________________________
Basic income per share:
Net income per share, basic $ 0.06 $ 0.05 $ 0.11 $0.09
______________________________________________
Weighted average number of common
and common equivalent shares
outstanding 4,779,260 4,743,652 4,772,483 4,729,641
______________________________________________
Diluted income per share:
Net income per share, diluted $ 0.06 $ 0.05 $ 0.11 $0.09
______________________________________________
Weighted average number of common
and common equivalent shares
outstanding, diluted 5,097,166 4,821,962 4,920,664 4,799,038
______________________________________________
The accompanying notes are an integral part of these consolidated financial
statements.
Page 2
AVALON CORRECTIONAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(Unaudited)
For the six months ended June 30,
2001 2000
___________________________________
OPERATING ACTIVITIES:
Net income $ 550,000 $ 444,000
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation expense 577,000 671,000
Change in Other assets 124,000 176,000
Changes in operating assets
and liabilities:
Decrease (increase) in -
Accounts receivable 1,433,000 (61,000)
Prepaid expenses and other (118,000) 277,000
Increase in accounts payable,
accrued liabilities and other 155,000 183,000
___________________________________
Net cash provided by operating activities $ 2,721,000 $ 1,690,000
___________________________________
INVESTING ACTIVITIES:
Capital expenditures $ (214,000) $ (1,172,000)
Proceeds from payments on notes receivable ___ 28,000
___________________________________
Net cash used in investing activities $ (214,000) $ (1,144,000)
___________________________________
FINANCING ACTIVITIES:
Proceeds from borrowings 13,337,000 11,367,000
Repayment of borrowings (15,231,000) (11,928,000)
Proceeds from warrant and option exercise 87,000 67,000
___________________________________
Net cash used in financing activities $ (1,807,000) $ (494,000)
___________________________________
NET INCREASE IN CASH $ 700,000 $ 52,000
CASH, BEGINNING OF PERIOD 726,000 601,000
___________________________________
CASH, END OF PERIOD $ 1,426,000 $ 653,000
___________________________________
The accompanying notes are an integral part of these consolidated financial
statements.
Page 3
AVALON CORRECTIONAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business -
Avalon Correctional Services, Inc. ("Avalon" or the "Company") (formerly
Avalon Community Services, Inc.) is an owner and operator of private community
correctional services. Avalon specializes in privatized community correctional
facilities and intensive correctional programming. Avalon is currently operating
in Oklahoma, Texas and Colorado with plans to significantly expand into
additional states. Avalon's business strategy is designed to elevate the Company
into a dominant provider of community correctional services by expanding its
operations through new state and Federal contracts and selective acquisitions.
Avalon owns a 248-bed minimum security facility in Oklahoma City, Oklahoma; a
266-bed minimum security facility in Tulsa, Oklahoma; a 168-bed adult minimum
security facility in Tulsa, Oklahoma; a 150-bed medium security facility in El
Paso, Texas; a 300-bed medium security facility in El Paso, Texas; a 160-bed
medium security juvenile facility in Union City, Oklahoma; a 115-bed minimum
security facility in Henderson, Colorado; and a 300-bed minimum security
multi-use facility in Greeley, Colorado. Avalon also operates a 37-bed minimum
security facility in Denver, Colorado, and a day reporting center in Northglen,
Colorado. The Colorado community corrections programs also provide
non-residential services to approximately 520 offenders in the State of
Colorado.
Principles of Consolidation -
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries after elimination of all material intercompany
balances and transactions.
Use of Estimates -
The preparation of the consolidated financial statements requires the use
of management's estimates and assumptions in determining the carrying values of
certain assets and liabilities and disclosures of contingent assets and
liabilities at the date of the consolidated financial statements and the
reported amounts for certain revenues and expenses during the reporting period.
Actual results could differ from those estimated.
Cash and Cash Equivalents -
The Company considers all highly liquid investments with original
maturities of three months or less when purchased and money market funds to be
cash equivalents.
Concentrations of Credit Risk -
Financial instruments potentially subjecting the Company to concentrations
of credit risk consist principally of temporary cash investments, accounts
receivable and notes receivable. The Company places its temporary cash
investments with high credit quality financial institutions and money market
funds and limits the amount of credit exposure to any one institution or fund.
Concentrations of credit risk with respect to accounts receivable are limited
due to the fact that a significant portion of the Company's receivables are from
state governments. The Company maintains an allowance for doubtful accounts for
potential credit losses. Actual bad debt expenses have not been material.
Page 4
Property and Equipment -
Property and equipment are recorded at cost. Expenditures for major
additions and improvements are capitalized, while minor replacements,
maintenance and repairs are charged to expense as incurred. When property and
equipment are retired or otherwise disposed of, the cost and related accumulated
depreciation are removed from the accounts and any resulting gain or loss is
reflected in current operations. Depreciation is provided using the
straight-line method over the following estimated useful lives:
Buildings and Improvements 40 Years
Furniture and Equipment 5 to 7 Years
Transportation Equipment 3 to 15 Years
Impairment losses are recorded on long-lived assets when indicators of
impairment are present and the undiscounted cash flows estimated to be generated
by those assets are less than the assets' carrying amounts. Impairment losses
are recognized based upon the estimated fair value of the asset when required.
Income Taxes -
Deferred income taxes are recognized for the tax consequences in future
years of differences between the tax bases of assets and liabilities and their
financial reporting amounts at each year-end based on enacted tax laws and
statutory tax rates applicable to the period in which the differences are
expected to affect taxable income. Valuation allowances are established when
necessary to reduce deferred tax assets to the amount expected to be realized.
Income tax expense is the tax payable for the period and the change during the
period in deferred tax assets and liabilities.
Revenue Recognition -
The Company recognizes revenues as services are provided. Revenues are
earned based upon the number of inmates on a per diem basis at the Company's
correctional facilities. Correctional revenues are received monthly from various
governmental agencies.
Development Costs -
The Company expenses development and new facility opening costs as incurred.
Net Income Per Common Share -
Basic net income per share has been computed on the basis of weighted
average shares outstanding during each period. Diluted income per share has been
computed based on the assumption that all dilutive options, warrants, and
convertible instruments are exercised.
Interim Financial Statements -
The consolidated balance sheet as of June 30, 2001 and the statements of
operations and cash flows for the three months and six months ended June 30,
2001 and 2000 are unaudited and, in the opinion of management, reflect all
adjustments that are necessary for a fair presentation of the financial position
as of such date and the results of operations and cash flows for the period then
ended. All such adjustments are of a normal and recurring nature.
The financial statements included herein have been prepared in conformity
with generally accepted accounting principles and should be read in conjunction
with the December 31, 2000 Form 10-KSB filing. Footnote disclosures which would
substantially duplicate the disclosure contained in the most recent annual
report on Form 10-KSB have been condensed or omitted. The results of operations
for the three months and six months ended June 30, 2001, are not necessarily
indicative of the results that may be expected for the entire year ended
December 31, 2001.
Page 5
NOTE 2. LONG-TERM DEBT
Long-term debt consists of the following:
June 30, December 31,
2001 2000
___________________________
Revolving bank line of credit, collateralized by
accouts receivable, with interest at 1% over $ 71,000 $ 1,070,000
prime (effective rate of 7.00% at June 30, 2001;
due February 2003).
Notes payable to banks, collateralized by
transportation equipment, due in installments
through March 2012 with interest ranging from
4.90% to 9.49%. 767,000 806,000
Notes payable to banks, collateralized by land,
buildings, and improvements due in installments
through June 2012 with interest ranging from
6.56% to 11.00%. 13,600,000 14,441,000
Note payable to an investment company,
uncollateralized with interest at 12.5%, due in
four installments beginning in 2005, including
original issue premium 10,272,000 10,289,000
__________________________
$24,710,000 $26,606,000
Less - current maturities $ 1,872,000 $ 2,992,000
__________________________
$22,838,000 $23,614,000
__________________________
The Company completed a $15,000,000 private placement of debt and equity
with an investment company on September 16, 1998. Pursuant to the terms of the
agreement, the Company tendered an unsecured subordinated note with a face value
of $10,000,000 bearing interest of 12.5% with interest payable in quarterly
installments until December 31, 2005, when the first of four quarterly principal
installments is due. The Company also tendered 1,622,448 shares of redeemable
common stock to the investment company. These shares are subject to repurchase
by the Company under certain circumstances, or beginning September 16, 2003 at
the holders option, at the then current average traded price of the stock. The
Company is accreting the difference between the carrying value and the estimated
redemption price of the stock by periodic charges / credits to additional
paid-in capital. The financial covenants require the Company, among other
things, to maintain certain earnings and debt coverage ratios.
The Company obtained an independent fair value appraisal of the debt and
equity instruments reflecting a fair value allocation of the debt of $10,365,000
and the fair value allocation of the redeemable common stock of $4,635,000. The
original issue premium of $365,000 is being accreted as a reduction of interest
expense over the term of the debt instrument. Debt issue costs of $1,654,000
(including $266,000 representing the fair value of warrants issued to financial
advisors) have been allocated to the debt and redeemable common stock based upon
their fair values. Costs of $511,000 allocated to the redeemable common stock
reduced its original book value to $4,124,000. Costs of $1,143,000 allocated to
the debt instrument are included in other assets and are being amortized to
interest expense over the life of the debt instrument using the effective
interest method.
Page 6
NOTE 3. CONVERTIBLE DEBENTURES
The Company completed a private placement of $4,150,000 of convertible
debentures on September 12, 1997. The convertible debentures bear interest at
7.5% and mature on September 12, 2007. The convertible debentures may be
redeemed by the Company at any time after May, 2000 at 106.5% of principal,
declining to 100% at maturity. The convertible debentures are convertible into
common stock at $3.00 per share at any time until their maturity. The
convertible debenture holders signed agreements to subordinate the debentures to
the $10,000,000 face value note issued on September 16, 1998. The Company
redeemed $300,000 of convertible debentures at face value in September 1998.
NOTE 4. STOCKHOLDERS' EQUITY
The Company issued 200,000 Class D stock purchase warrants in August 1996,
in connection with the acquisition of the El Paso Intermediate Sanction
Facility. The Class D stock purchase warrants provide for the purchase of the
Company's common stock at any time until their expiration at August 2, 2001. The
exercise price of the class D warrants is $4.20 per share as of the end of the
quarter. The warrants may be redeemed by the Company upon certain events for
$.01 per share.
The Company issued Class E Warrants to purchase 79,000 shares of Common
Stock in September 1997, in connection with the private placement of Convertible
Debentures. The Company recognized $148,000 of cost based upon the difference in
the exercise price of the Class E warrants and the current market price of the
common stock on the date of issuance. This cost was recorded as debenture issue
costs and is classified in other assets on the balance sheet. The debenture
issue cost is amortized to expense over the term of the convertible debentures.
The Class E stock purchase warrants provide for the purchase of the Company's
common stock at a price of $3.00 per share at any time until their expiration at
September 12, 2002. The warrants may be redeemed by the Company upon certain
events for $.01 per share.
The Company issued 200,539 stock purchase warrants to financial advisors in
September 1998, in connection with the $15,000,000 private placement. The stock
purchase warrants provide for the purchase of the Company's common stock at any
time until their expiration at September 2002. The exercise price of the
warrants is $3.75 per share as of the end of the quarter. The warrants may be
redeemed by the Company upon certain events for $.01 per share. The fair value
of the warrants was allocated between the proceeds the debt and equity issues as
debt issue cost and a reduction in redeemable common stock.
A 1994 agreement provided for the issuance of an option to issue 750,000
common stock purchase warrants to purchase common stock at $1.50 per share for
each dollar of Company debt guaranteed by the Company's CEO. The warrants have a
five year term from the date of issuance, March 9, 2001.
NOTE 5. STOCK OPTION PLAN
The Company adopted a stock option plan (the "Plan") providing for the
issuance of 250,000 shares of Class A common stock pursuant to both incentive
stock options, intended to qualify under Section 422 of the Internal Revenue
Code, and options that do not qualify as incentive stock options
("non-statutory"). The Option Plan was registered with the Securities and
Exchange Commission in November 1995. The purpose of the Plan is to provide
continuing incentives to the Company's officers, key employees, and members of
the Board of Directors.
The options generally vest within five years and have a ten year expiration
period. The Company amended its stock option plan on December 1, 1996,
increasing the number of shares available under the Plan to 600,000.
Non-statutory options have been granted providing for the issuance of 489,760
shares of Class A common stock at exercise prices ranging from $1.50 to $4.25
per share. Options providing for the issuance of 386,740 shares were exercisable
at June 30, 2001.
NOTE 6. LITIGATION
The Company is a party to litigation arising in the normal course of
business. Management believes that the ultimate outcome of these matters will
not have a material effect on the Company's financial condition or results of
operations.
Page 7
NOTE 7. EARNINGS PER SHARE
The following table sets forth the computation of income per share and
income per share assuming dilution.
Three months ended Six months ended
June 30, June 30,
2001 2000 2001 2000
___________________________________________
Numerator
Net income $ 306,000 $ 229,000 $ 550,000 $ 444,000
___________________________________________
Denominator for earnings per share
Weighted average shares
outstanding-basic 4,779,260 4,743,652 4,772,482 4,729,641
Effect of dilutive securities
- stock options 317,906 78,310 148,182 78,310
_____________________________________________
Denominator for earnings per 5,097,166 4,821,962 4,920,664 4,799,038
share assuming dilution _____________________________________________
Income per share, basic $ 0.06 $ 0.05 $ 0.11 $ 0.09
_____________________________________________
Income per share assuming
dilution $ 0.06 $ 0.05 $ 0.11 $ 0.09
_____________________________________________
Page 8
AVALON CORRECTIONAL SERVICES, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Liquidity and Capital Resources -
The Company's business strategy is to focus on the private corrections
industry, expanding its operations into additional states through new Federal
and state contracts and selective acquisitions. The successful implementation of
the Company's growth plan has created the need for additional capital and
financing. The Company has been successful in securing $37 million of new
capital and credit facilities since September 1997.
The Company had approximately $2.6 million of cash and revolving credit
available for new projects at June 30, 2001. The Company believes it has
adequate cash reserves and cash flow from operations to meet its current cash
requirements. The Company expects current contracts to generate sufficient
income to increase cash reserves, while minimizing income taxes through the
utilization of tax loss carryforwards.
The Company secured an $18 million senior credit facility with Fleet
Capital Corporation in February 1999. The credit facility with Fleet Capital
Corporation was amended in December of 1999 to provide for a credit facility
consisting of a $13.5 million term loan and a revolving line of credit equal to
the lesser of $3 million or 80% of eligible accounts receivable.
Cash flows for the first half of the year are significantly better than the
first six months of the previous year primarily due to increased collections of
accounts receivable. These collections had slowed at the end of the year 2000,
thereby inflating the collections for the first two months of the current year,
when receivables returned to normal levels.
Results of Operations -
Three Months Ended June 30, 2001 Compared to the Three Months Ended June
30, 2000.
Total revenues increased by 17% to $6.32 million for the three months ended
June 30, 2001 from $5.42 million for the three months ended June 30, 2000. The
increase was a result of overall higher inmate populations.
The Company had net income for the three months ended June 30, 2001 of
$306,000 or $.06 basic and diluted income per share, as compared to net income
for the three months ended June 30, 2000 of $229,000 or $.05 basic and diluted
earnings per share. The Company's significant improvement was the result of
overall higher inmate populations.
Earnings before interest, taxes, depreciation, and amortization (EBITDA)
increased 6% for the three months ended June 30, 2001 to $1,526,000 compared to
$1,436,000 for the three months ended June 30, 2000.
Corporate. General and administrative expenses were $308,000 for the three
months ended June 30, 2001, compared to $470,000 for the three months ended June
30, 2000. These expenses are 4.9 % of revenues in the second quarter of 2001 and
8.7% of revenues for the second quarter of 2000. The decrease in interest
expense of $114,000 for the three months ended June 30, 2001 over the second
quarter of 2000 resulted from significantly lower interest rates and slightly
less outstanding debt. Depreciation and amortization expense have increased
commensurate with the growth of the correctional operations.
Six Months Ended June 30, 2001 Compared to the Six Months Ended June 30, 2000.
Revenues for the first two quarters of 2001 increased 15% to $12.3 million
compared to $10.7 million for the same period in 2000. The Company had net
income for the six months ended June 30, 2001 of $550,000 or $.11 basic and
diluted income per share, as compared to net income for the six months ended
June 30, 2000 of $444,000 or $.09 basic and diluted income per share. The
Company's improvement was the result of the aforementioned higher inmate
populations.
Page 9
Earnings before interest, taxes, depreciation, and amortization (EBITDA)
increased 8% for the six months ended June 30, 2001 to $2,989,000 compared to
$2,774,000 for the six months ended June 30, 2000.
Corporate. General and administrative expenses were $750,000 for the six
months ended June 30, 2001 compared to $863,000 for the six months ended June
30, 2000. These expenses are 6.1% of revenues for the six months ended June 30,
2001 compared to 8.1% of revenues for the six months ended June 30, 2000.
Depreciation and amortization have increased commensurate with the growth of the
correctional operations. Interest expense declined significantly due to rate
decreases from the primary lender.
Page 10
AVALON CORRECTIONAL SERVICES, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
Item 1. Legal Proceedings - None.
Item 2. Changes in Securities - None.
Item 3. Defaults Upon Senior Securities - None.
Item 4. Submission of Matters to a Vote of Security Holders -
May 23, 2001 Annual Meeting
Directors Elected -- Robert O. McDonald and Charles W. Thomas
Votes for -- 4,602,638 Votes against -- 8,530
Directors Continued Donald E. Smith
Jim Wilson
Mark S. Cooley
Proposal: To ratify the selection of Grant Thornton, LLP as the
Company's independent public countants and auditors for the fiscal
year ending December 31, 2001
Votes for -- 4,362,926 Votes against -- 248,242
Item 5. Other Information - None.
Item 6. Exhibits and reports on Form 8-K
Page 11
AVALON CORRECTIONAL SERVICES, INC. AND SUBSIDIARIES
SIGNATURES
In accordance with the requirement of the Exchange Act, the registrant has
caused this report to be signed on its behalf by the undersigned thereunto duly
authorized.
Date: July 27, 2001 AVALON CORRECTIONAL SERVICES, INC.
s//Donald E. Smith
By:________________________________________
Donald E. Smith, Chief Executive Officer
s// Lloyd Lovely
By:________________________________________
Lloyd Lovely, Vice President of Finance
Page 12