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 March 31, 2002
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 April 30, 2002, 4,891,301 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)
March 31, December 31,
2002 2001
------------- --- ---------------
ASSETS
Current assets:
Cash and cash equivalents $ 1,537,000 $ 2,389,000
Related party receivables 110,000 161,000
Accounts receivable, net 2,951,000 2,611,000
Prepaid expenses and other $343,000 239,000
------------- --- ---------------
Total current assets $ 4,941,000 $ 5,400,000
Property and equipment, net 30,199,000 30,414,000
Other assets 4,165,000 4,273,000
------------- --- ---------------
Total assets $ 39,305,000 $ 40,087,000
============= === ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable, accrued liabilities
and other $ 1,601,000 $ 2,170,000
Current maturities of long-term debt 2,347,000 2,545,000
------------- --- ---------------
Total current liabilities $ 3,948,000 $ 4,715,000
Long-term debt, less current maturities 22,141,000 22,547,000
Convertible debentures 3,850,000 3,850,000
Redeemable common stock, $.001 par value
1,622,448 shares issued and outstanding 3,532,000 3,470,000
Stockholders' equity:
Common stock: par value $.001; 24,000,000
shares authorized; 4,866,886 and
4,847,624 shares issued and
outstanding in 2002 and 2001,
respectively, less 1,622,448 shares
subject to repurchase in 2002 and 2001 3,000 3,000
Preferred stock; par value $.001; 1,000,000
shares authorized; none issued --- ---
Paid-In capital 7,505,000 7,536,000
Accumulated deficit (1,674,000) (2,034,000)
------------- --- ---------------
Total liabilities and stockholders'
equity $ 39,305,000 $ 40,087,000
============= === ===============
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
March 31,
2002 2001
------------ --------------
Revenues $ 6,625,000 $ 5,949,000
------------ --------------
Costs and expenses
Direct operating 4,468,000 4,043,000
General and administrative 512,000 442,000
Depreciation and amortization 495,000 395,000
Interest expense 654,000 825,000
------------ --------------
Income from operations
before income tax expense $ 496,000 $ 244,000
Income tax expense 135,000 ---
------------ --------------
Net income $ 361,000 $ 244,000
============ ==============
Basic income per share:
Net income per share, basic $ 0.07 $ 0.05
============ ==============
Weighted average number of common and
common equivalent shares outstanding, basic 4,847,938 4,765,630
============ ==============
Diluted income per share:
Net income per share, diluted $ 0.07 $ 0.05
============ ==============
Weighted average number of common and
common equivalent shares outstanding,
diluted 6,485,099 4,765,630
============ ==============
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 three months ended March 31,
2002 2001
--------------- -- ----------------
OPERATING ACTIVITIES:
Net income $ 361,000 $ 244,000
Adjustments to reconcile net income to
net cash provided by operating activities
Depreciation 495,000 303,000
Amortization of debt issue costs 79,000 139,000
Changes in operating assets and liabilities
Decrease (increase) in -
Accounts receivable (289,000) 1,351,000
Prepaid expenses and other (219,000) (56,000)
Decrease in accounts payable,
accrued liabilities and other (569,000) (451,000)
--------------- -- ----------------
Net cash provided by (used for)
operating activities (142,000) $ 1,530,000
--------------- -- ----------------
INVESTING ACTIVITIES:
Capital Expenditures $ (137,000) $ (39,000)
--------------- -- ----------------
Net cash used in investing activities $ (137,000) $ (39,000)
--------------- -- ----------------
FINANCING ACTIVITIES:
Proceeds from borrowings $ 7,092,000 $ 6,849,000
Repayment of borrowings (7,696,000) (8,123,000)
Proceeds from option exercise 31,000 ---
--------------- -- ----------------
Net cash used for financing activities $ (573,000) $ (1,274,000)
--------------- -- ----------------
NET INCREASE (DECREASE) IN CASH $ (852,000) $ 217,000
CASH, BEGINNING OF PERIOD 2,389,000 726,000
--------------- -- ----------------
CASH, END OF PERIOD $ 1,537,000 $ 943,000
=============== == ================
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") is an owner
and operator of private community correctional services. Avalon specializes in
privatized community correctional facilities and 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 300-bed community
corrections facility in Oklahoma City, Oklahoma; a 320-bed community corrections
facility in Tulsa, Oklahoma; a 150-bed community corrections 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 180- bed community corrections facility
on leased land in Del Valle, Texas; a 160-bed medium security juvenile facility
in Union City, Oklahoma; a 139-bed community corrections facility in Henderson,
Colorado; and a 307-bed multi-use community corrections facility in Greeley,
Colorado. Avalon also operates three programs in leased facilities: a 352- bed
intermediate sanction unit in Tulsa, Oklahoma; a 36-bed community corrections
facility in Denver, Colorado; and a day reporting center in Northglenn,
Colorado. The Colorado community corrections programs also provide
non-residential services to approximately 385 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 estimates.
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 is from
government agencies. The Company maintains an allowance for doubtful accounts
for potential credit losses. The allowance for doubtful accounts at each March
31, 2002 and December 31, 2001 was $27,000.
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 is 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 10 to 40 Years
Furniture and Equipment 5 to 7 Years
Transportation Equipment 2 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 by
management 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. The Company's
effective rate differs from the statutory rate of thirty-four percent due to the
utilization of net operating loss carryforwards.
Revenue Recognition -
The Company recognizes revenues as services are provided. Revenues are
generally earned based upon the number of offenders on a per diem basis at the
Company's correctional facilities. All 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 and warrants are
exercised using the treasury stock method. The dilutive effect of convertible
obligations is determined using the if-converted method.
Interim Financial Statements -
The consolidated balance sheet as of March 31, 2002 and the statements of
operations and cash flows for the three months ended March 31, 2002 and 2001 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, 2001 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 ended March 31, 2002, are not necessarily indicative of the
results that may be expected for the entire year ended December 31, 2002.
Page 5
NOTE 2. LONG-TERM DEBT
Long-term debt consists of the following:
March 31, December 31,
2002 2001
----------- -----------
Revolving line of credit with finance company,
collateralized by accounts receivable, with
interest at 1% over prime (effective rate of 5.0%
at March 31, 2002); due Feb. 2003 $ 369,000 $ 495,000
transportation equipment, due in installments
through October 2019 with interest ranging
from 1.90% to 10.85%. 691,000 699,000
Notes payable to banks and finance companies,
collateralized by land, buildings, and
improvements due in installments through
through February 2005 with interest ranging
from 4.40% to 11% 13,186,000 13,644,000
Note payable to an investment company,
uncollateralized with interest at 12.5%,
due in four installments beginning
in 2005, including original issue premium 10,242,000 10,254,000
----------- -----------
$24,488,000 $25,092,000
Less - current maturities (2,347,000) $(2,545,000)
----------- -----------
$22,141,000 $22,547,000
=========== ===========
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 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.
Certain notes payable to finance and investment companies contain covenants
that require the Company, among other things, to maintain certain earnings and
debt coverage ratios and receive approval for certain capital expenditures as
defined in the agreements.
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 Company may redeem the convertible
debentures 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.
NOTE 4. STOCKHOLDERS' EQUITY
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 September 12, 2002.
The Company may redeem the warrants 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 Company may redeem
the warrants 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, respectively.
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 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 505,798 shares of Class A common stock at
exercise prices ranging from $1.50 to $4.25 per share. Options providing for the
issuance of 418,280 shares were exercisable at March 31, 2002.
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
7. EARNINGS PER SHARE
The following table sets forth the computation of income per share and
income per share assuming dilution.
Three months ended
March 31,
2002 2001
--------- ---------
Numerator:
Net income - basic $ 361,000 $ 244,000
Effect of dilutive securities:
- interest reduction on assumed debenture
conversions 72,000 ---
--------- ---------
Numerator for earnings per share diluted $ 433,000 $ 244,000
========= =========
Denominator for earnings per share:
Weighted average shares outstanding - basic 4,847,938 4,765,630
Effect of dilutive securities:
- debenture conversions 1,283,333 ---
- stock options 104,904 ---
- stock warrants 248,924 ---
--------- ---------
Denominator for earnings per share diluted 6,485,099 4,765,630
========= =========
Income per share, basic $ 0.07 $ 0.05
========= =========
Income per share, diluted $ 0.07 $ 0.05
========= =========
Outstanding options and warrants of 268,039 and 939,419 for the periods
ended March 31, 2002 and 2001, respectively, have been excluded from the above
calculations as they would be anti-dilutive.
Page 8
8. INTANGIBLE ASSETS - ADOPTION OF STATEMENT 142
The following table presents the effects of Statement of Financial
Accounting Standards (SFAS) Number 142 as if the statement has been adopted for
all prior presented periods. The amortization expense and net income of Avalon
Correctional Services for the presented periods follow:
Three months ended
March 31,
2002 2001
--------- ---------
Reported net income $ 361,000 $ 244,000
Add back: Intangible assets amortization --- 56,000
--------- ---------
Adjusted net income $ 361,000 300,000
========= =========
Basic earnings per share:
Reported net income $ .07 .05
Intangible assets amortization --- .01
--------- ---------
Adjusted net income $ .07 .06
========= =========
Diluted earnings per share:
Reported net income $ .07 .05
Intangible assets amortization --- .01
--------- ---------
Adjusted net income $ .07 .06
========= =========
page 9
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 $3.5 million of cash and revolving credit
available for new projects at March 31, 2002. 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. The credit
facility matures in February 2003 and the Company is currently completing the
documentation for renewal of the credit facility for an additional two year
period.
Results of Operations -
Three Months Ended March 31, 2002 Compared to the Three Months Ended March 31,
2001.
Total revenues increased by 11% to $6.63 million for the three months ended
March 31, 2002 from $5.95 million for the three months ended March 31, 2001. The
increase was a result of overall increased offender census, the opening of the
Riverside Intermediate Sanction Unit in December 2001, and the acquisition of
the Austin Transitional Center in December 2001.
The Company had net income for the three months ended March 31, 2002 of
$305,000 or $.06 basic and diluted income per share, as compared to net income
for the three months ended March 31, 2001 of $244,000 or $.05 basic and diluted
earnings per share. The Company's significant improvement was the result of
overall higher offender populations.
Earnings before interest, taxes, depreciation, and amortization (EBITDA)
increased 12% for the three months ended March 31, 2002 to $1,645,000 compared
to $1,464,000 for the three months ended March 31, 2001.
Corporate. General and administrative expenses increased to $512,000 for
the three months ended March 31, 2002 from $442,000 for the three months ended
March 31, 2001. General and administrative expenses represented 7.7 % of
revenues in the first quarter of 2002 and 7.4% of revenues for the first quarter
of 2001. General and administrative expenses increased primarily due to
increased staffing for the Company's new contracts and acquisitions. The
decrease in interest expense of $171,000 for the three months ended March 31,
2002 over the first quarter of 2001 resulted from lower interest rates.
Depreciation and amortization expenses have increased commensurate with the
growth of the correctional operations.
Critical Accounting Policies -
Revenues. Many states and other governmental agencies are experiencing
budgetary pressures that could effect future revenues of the Company as a result
of the current economic downturn. Governmental agencies may look first at
reducing payments to outside contracting companies to maintain the level of
expenditures at the government agency, rather than looking for the most
cost-effective services available. The Company could experience reductions in
revenues as a consequence of contracting agencies reducing the bed utilization
in the Company's facilities. The Companies current and future accounts
receivable are not impaired by any potential reduction and accordingly, a
reserve cannot be established to offset future downturns.
Page 10
Liquidity. Avalon's loan facility with Fleet Capital Corporation is
scheduled to expire in February, 2003. The Company has received an offer from
Fleet Capital Corporation to extend the loan for an additional two years. The
documentation of this renewal is not complete at this time, however the Company
believes the renewal will be completed in the near future. The Company believes
it can find a suitable replacement credit facility on comparable terms should
for any reason the Fleet Capital Corporation agreement not be completed. The
Company would have insufficient cash reserves to meet this obligation should the
Fleet Capital Corporation agreement not be completed and an acceptable
alternative lending arrangement not be secured. The total amount due to Fleet at
the end of the quarter was $12,459,000.
Intangible assets. Three of Avalon's facilities - the Avalon Correctional
Center, The Villa at Greeley, and the Phoenix Center - have intangible assets on
their books representing the value allocated to the operating contracts at the
time of their acquisition. These intangible assets are being amortized over a
twenty-year period. Financial Accounting Standards Board SFAS 142 requires that
assets such as these with life spans estimated to be indefinite, can no longer
be amortized. If the intangible assets are shown to be impaired in some future
period, they will have to be written down to their new value, all in the period
where the impairment is ascertained. The Company's intangible assets total
$1,800,000 at the end of the quarter. A complete write-down of the balance would
most likely eliminate all profit for that year, although the liquidity of the
Company would not be affected. An impairment results in a non-cash charge to
earnings but does not affect cash flows.
Equity valuation. 1,622,448 shares of the Company's stock (approximately
one-third) have a put attached which becomes active in 2003. This put is
redeemable under certain circumstances at the holder's option and requires the
Company to purchase the stock at the market value. The stock is recorded on the
Company's books at an estimated redemption value and is updated quarterly. This
estimated price will become more volatile as the redemption date draws nearer,
and will ultimately track the price of the stock. This change in stock value is
offset by an equal change to Paid-in Capital, and could possibly hinder the
Company's ability to market its stock.
Page 11
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 - None.
Item 5. Other Information - None.
Item 6. Exhibits - None
Page 12
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: May 3, 2002 AVALON CORRECTIONAL SERVICES, INC.
By: s//Donald E. Smith
----------------------------------------
Donald E. Smith, Chief Executive Officer
By: S//Lloyd Lovely
----------------------------------------
Lloyd Lovely, Vice President of Finance
Page 13