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 September 30, 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 October 31, 2002, 4,895,002 shares of the issuer's Class A common
stock, par value $.001, were ssued and outstanding.
Transitional Small Business Disclosure Format: Yes ___; No X .
PART I - FINANCIAL INFORMATION
AVALON CORRECTIONAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, December 31,
2002 2001
--------------- --- -------------
ASSETS
Current assets:
Cash and cash equivalents $ 1,022,000 $ 2,389,000
Certificates of deposit 1,500,000 ---
Related party receivables 16,000 161,000
Accounts receivable, net 3,007,000 2,611,000
Prepaid expenses and other 426,000 239,000
--------------- --- ---------------
Total current assets $ 5,971,000 $ 5,400,000
Property and equipment, net 29,946,000 30,414,000
Other assets 3,940,000 4,273,000
--------------- --- ---------------
Total assets $ 39,857,000 $ 40,087,000
=============== === ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable, accrued liabilities
and other
Current maturities of $ 1,552,000 $ 2,170,000
long-term debt 3,387,000 2,545,000
-------------- --- ---------------
Total current liabilities $ 4,939,000 $ 4,715,000
Long-term debt, less current maturities 21,128,000 22,547,000
Convertible debentures 3,850,000 3,850,000
Redeemable common stock, $.001 par value
1,622,448 shares issued and outstanding 3,461,000 3,470,000
Stockholders' equity:
Common stock: Par value $.001; 24,000,000
authorized; 4,895,002 and 4,847,624
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 7,624,000 7,536,000
Accumulated deficit (1,148,000) (2,034,000)
-------------- --- ---------------
Total liabilities and stockholders'
equity $ 39,857,000 $ 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 Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
---------------- ---------------- --------------- ---------------
Revenues $ 6,878,000 $ 6,359,000 $ 20,247,000 $ 18,623,000
---------------- ---------------- --------------- ---------------
Costs and expenses
Direct operating $ 4,891,000 $ 4,211,000 $ 14,008,000 $ 12,736,000
General and administrative 470,000 527,000 1,547,000 1,277,000
Depreciation and amortization 510,000 508,000 1,499,000 1,367,000
Interest expense 644,000 718,000 1,939,000 2,298,000
---------------- ---------------- --------------- ---------------
Net income from operations
before income tax expense $ 363,000 $ 395,000 $ 1,254,000 $ 945,000
Income tax expense 143,000 --- 368,000 ---
---------------- ---------------- --------------- ---------------
Net income $ 220,000 $ 395,000 $ 886,000 $ 945,000
================ ================ =============== ===============
Basic income per share:
Net income per share, basic $ 0.04 $ 0.08 $ 0.18 $ 0.20
================ ================ =============== =============
Weighted average number of common and
common equivalent shares outstanding, basic 4,894,628 4,838,520 4,876,664 4,794,737
================ ================ =============== =============
Diluted income per share:
Net income per share, diluted $ 0.04 $ 0.07 $ 0.16 $ 0.19
================ ================ =============== =============
Weighted average number of common and
common equivalent shares outstanding,
diluted 6,416,256 6,445,786 6,489,795 6,277,861
================ ================ =============== =============
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 nine months ended September 30,
2002 2001
---------------------------------------
OPERATING ACTIVITIES:
Net income $ 886,000 $ 945,000
Adjustments to reconcile net income to
net cash provided by operating activities
Depreciation and amortization 1,499,000 815,000
Amortization of debt issue costs 247,000 422,000
Changes in operating assets and liabilities
Decrease (increase) in -
Accounts receivable (251,000) 1,166,000
Prepaid expenses and other (480,000) (65,000)
Increase (decrease) in accounts payable,
accrued liabilities and other (618,000) 27,000
-------------------------
Net cash provided by operating activities $ 1,283,000 $ 3,310,000
-------------------------
INVESTING ACTIVITIES:
Capital expenditures $ (653,000) $(1,002,000)
Purchase of certificates of deposit $ (1,500,000) ---
----------------------------
Net cash used in investing activities $ (2,153,000) $(1,002,000)
----------------------------
FINANCING ACTIVITIES:
Proceeds from borrowings $ 21,303,000 $ 19,933,000
Repayment of borrowings (21,879,000) (21,941,000)
Proceeds from warrant and option exercise 79,000 127,000
----------------------------
Net cash used in financing activities (497,000) $ (1,881,000)
----------------------------
NET INCREASE (DECREASE) IN CASH $ (1,367,000) $ 427,000
CASH, BEGINNING OF PERIOD 2,389,000 726,000
----------------------------
CASH, END OF PERIOD $ 1,022,000 $ 1,153,000
============================
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 facilities. 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 four programs in leased facilities: a 352-bed
intermediate sanction unit in Tulsa, Oklahoma; a 35-bed community corrections
facility in Denver, Colorado; a 48 bed juvenile substance abuse treatment
facility in San Angelo, Texas; and a day reporting center in Northglen,
Colorado. The Colorado community corrections programs also provide
non-residential services to approximately 175 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 September
30, 2002 and December 31, 2001 was $21,000 and $27,000, respectively.
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:
Page 4
Buildings and improvements 10 to 40 Years
Furniture and equipment 5 to 10 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 related 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 period 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 and state income tax effects.
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. 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 September 30, 2002, the statements of
operations for the three months and nine months ended September 30, 2002 and
2001, and the statements of cash flows for the nine months ended September 30,
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 accounting principles generally accepted in the United States and should be
read in conjunction with the December 31, 2001 Form 10-KSB filing. The results
of operations for the three months and nine months ended September 30, 2002, are
not necessarily indicative of the results that may be expected for the entire
year ended December 31, 2002.
Subsequent Event -
On October 10, 2002, the board of directors of the Oklahoma Office of
Juvenile Affairs (OJA) voted to not renew their contract with Avalon for 80 beds
at the Company's Union City facility. The vote was a cost-cutting move as a part
of the board's state mandate to reduce expenditures from its budget in the
current fiscal year. The contract is scheduled to cease on December 2, 2002. The
OJA contract contributed approximately $3,800,000 to the Company's annual
revenues for the year ended December 31, 2001. The OJA contract was the primary
source of revenue for the Union City facility. The Company is currently
evaluating other sources of offenders for the facility.
Page 5
NOTE 2. LONG-TERM DEBT
Long-term debt consists of the following:
September 30, December 31,
2002 2001
---------------- ---------------
Revolving line of credit with finance company, collateralized
by accounts receivable, with interest at 0.75% over prime
(effective rate of 5.5% at September 30, 2002); due Feb 2005. $ 1,358,000 $ 495,000
Notes payable to banks, collateralized by transportation
equipment, due in installments through March 2012
with interest ranging from 0.00% to 10.85%. 680,000 699,000
Notes payable to banks and finance companies, collateralized by
land, buildings, and improvements due in installments through
February 2005 with interest ranging from 4.31% to 11.00%. 12,261,000 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 10,216,000 10,254,000
---------------- ---------------
$ 24,515,000 $ 25,092,000
Less - current maturities $ (3,387,000) $ (2,545,000)
---------------- ---------------
$ 21,128,000 $ 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 was classified in other assets on the balance sheet. The debenture
issue cost was amortized to expense over the term of the convertible debentures.
The Class E stock purchase warrants provided for the purchase of the Company's
common stock at a price of $3.00 per share until they expired on September 12,
2002.
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 provided for the purchase of the Company's common stock at any
time until their expiration on September 16, 2002. The exercise price of the
warrants was $3.75 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
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 508,032 shares of Class A common stock at
exercise prices ranging from $1.50 to $4.25 per share. Options providing for the
issuance of 442,558 shares were exercisable at September 30, 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
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 Nine months ended
September 30, September 30,
2002 2001 2002 2001
------------ ------------ ------------ ------------
Numerator:
Net income - basic $ 220,000 $ 395,000 $ 886,000 $ 945,000
Effect of dilutive securities:
- interest reduction on assumed debenture
conversions, less 40% effective tax rate 43,000 72,000 130,000 217,000
------------ ------------ ------------ ------------
Numerator for earnings per share, diluted $ 263,000 $ 467,000 $ 1,016,000 $ 1,162,000
============ ============ ============ ============
Denominator for earnings per share:
Weighted average shares outstanding - basic 4,894,628 4,838,520 4,876,664 4,794,737
Effect of dilutive securities:
- debenture conversions 1,283,333 1,283,333 1,283,333 1,283,333
- stock options 56,477 97,189 91,162 46,228
- stock warrants 181,818 226,744 238,636 153,563
------------ ------------ ------------ ------------
Denominator for earnings per share, diluted 6,416,256 6,445,786 6,489,795 6,277,861
============ ============ ============ ============
Income per share, basic $ 0.04 $ 0.08 $ 0.18 $ 0.20
============ ============ ============ ============
Income per share, diluted $ 0.04 $ 0.07 $ 0.16 $ 0.19
============ ============ ============ ============
Outstanding options and warrants of 104,700 for the three months and nine
months ended September 30, 2002, respectively, and 282,539 for the three months
and nine months ended September 30, 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, Goodwill and Intangible Assets, as if
the statement had been adopted for all prior periods presented. The amortization
expense and net income of the Company for the presented periods follow:
Three months ended Nine months ended
September 30, September 30,
2002 2001 2002 2001
----------- ---------- ---------- -----------
Reported net income $ 305,000 $ 395,000 $ 666,000 $ 945,000
Add back: Intangible assets amortization --- 56,000 --- 169,000
----------- ---------- ---------- -----------
Adjusted net income $ 305,000 $ 451,000 $ 666,000 $ 1,114,000
=========== ========== ========== ===========
Basic earnings per share:
Reported net income $ .04 $ .08 $ .18 $ .20
Intangible assets amortization --- .01 --- .04
----------- ---------- ---------- -----------
Adjusted net income $ .04 $ .09 $ .18 $ .24
=========== ========== ========== ===========
Diluted earnings per share:
Reported net income $ .04 $ .07 $ .16 $ .19
Intangible assets amortization --- .01 --- .03
----------- ---------- ---------- -----------
Adjusted net income $ .04 $ .08 $ .16 $ .22
=========== ========== ========== ===========
9. COMMITMENTS AND CONTINGENCIES
The Board of Director's voted to terminate the Company's deferred
compensation plan on August 29, 2002. The plan was fully accrued and the
termination will have no effect on income.
10. RECENTLY ADOPTED ACCOUNTING STANDARDS
In July 2002, the FASB issued SFAS No. 146 "Accounting for Costs Associated
with Exit or Disposal Activities", (SFAS 146). SFAS 146 addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies EITF Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (Including Certain
Costs Incurred in a Restructing)". SFAS 146 requires that a liability for a cost
associated with an exit or disposal activity be recognized when the liability is
incurred, rather than at the date of the entity's commitment to an exit plan.
This statement is effective for exit and disposal activities that are initiated
after December 31, 2002. Since adoption of this SFAS is prospective, the Company
does not believe that the implementation of this SFAS will have a material
impact on its financial statements.
Page 9
AVALON CORRECTIONAL SERVICES, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This document contains statements that are not historical but are
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These
include statements regarding the expectations, beliefs, intentions, or
strategies for the future. The Company intends that all forward-looking
statements be subject to the safe-harbor provisions of the Private Securities
Litigation Reform Act of 1995. These forward-looking statements reflect the
Company's views as of the date they are made with respect to future events and
financial performance, but are subject to many uncertainties and risks which
could cause the actual results of the Company to differ materially from any
future results expressed or implied by such forward-looking statements. Examples
of such uncertainties and risks include, but are not limited to: fluctuations in
occupancy levels and labor costs; the ability to secure both new contracts and
the renewal of existing contracts; the availability and cost of financing to
redeem common shares and to expand the Company's business; and public resistance
to privatization. Additional risk factors include those discussed in reports
filed by the Company from time to time on Forms 10-KSB, 10-QSB, and 8-K. The
Company does not undertake any obligation to update any forward-looking
statements.
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 $38 million of new
capital and credit facilities since September 1997.
The Company had approximately $3.5 million of cash, short-term investments,
and revolving credit available for new projects at September 30, 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.
The Company obtained an $18 million senior credit facility with Fleet
Capital Corporation in February 1999. The credit facility with Fleet Capital
Corporation was amended in December 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 for working
capital. While this amount is adequate for the foreseeable future, additional
Company growth or a slowdown in revenue collections may require additional
working capital. The Fleet loan facility contains financial covenants that
require the Company to maintain certain earnings levels, limit capital
expenditures, and maintain ratios relating to fixed charges, liabilities to
tangible net worth, and total indebtedness. The total amount due to Fleet at the
end of the quarter was $12,732,000. The credit facility matures in February
2005.
On October 10, 2002, the board of director's of the Oklahoma Office of
Juvenile Affairs (OJA) voted to not renew their contract with Avalon for 80 beds
at the Company's Union City facility. The vote was a cost-cutting move as a part
of the board's state mandate to reduce expenditures from its budget in the
current fiscal year. The contract is now scheduled to cease on December 2, 2002.
The OJA contract contributed approximately $3,800,000 to the Company's annual
revenues for the year ended December 31, 2001. The OJA contract was the primary
source of revenue for the Union City facility. The Company is currently
evaluating other sources of offenders for the facility.
Results of Operations -
Three Months Ended September 30, 2002 Compared to the Three Months Ended
September 30, 2001.
The Company's revenues increased by 8% to $6,878,000 million for the three
months ended September 30, 2002 from $6,359,000 for the three months ended
September 30, 2001. The increased revenues were a result of increased offender
census, the acquisition of the Austin Treatment Center in December 2001, and the
expansion of the Phoenix Center in Colorado in February 2002. Earnings before
interest, taxes, depreciation, and amortization for the three months ended
September 30, 2002 were $1,517,000 compared to $1,621,000 for the three months
ended September 30, 2001. The new Riverside Intermediate Sanction Unit, which is
still ramping up to operating capacity, recognized losses of approximately
$116,000 during the three months ended September 30,2002.
Page 10
The Company's net income was $220,000 for the three months ended September
30, 2002 and $395,000 for the three months ended September 30, 2001. The Company
began recording a provision for income taxes in 2002 and recorded a provision of
$143,000 for the three months ended September 30, 2002. A provision for income
taxes was not recorded for the three months ended September 30, 2001, due to the
utilization of tax loss carryforwards. Net income before income taxes was
$363,000 for the three months ended September 30, 2002 and $395,000 for the
three months ended September 30, 2001. The earnings per share were $.04 basic
and $.04 diluted for the three months ended September 30, 2002 and were $.08
basic and $.07 diluted for the three months ended September 30, 2001.
Corporate. General and administrative expenses decreased to $470,000 for
the three months ended September 30, 2002, from $527,000 for the three months
ended September 30, 2001. Interest expense decreased $74,000 for the three
months ended September 30, 2002 over the third quarter of 2001as a result of
lower interest rates and a reduction in long term debt. Depreciation and
amortization expenses were virtually identical to the same quarter last year.
Nine Months Ended September 30, 2002 Compared to the Nine Months Ended September
30, 2001.
The Company's revenues increased $1,624,000 to $20,247,000 for the nine
months ended September 30, 2002 compared to $18,623,000 for the nine months
ended September 30, 2001. The increased revenues were a result of overall
increased offender census, the acquisition of the Austin Transitional Center in
December 2001, and the expansion of the Phoenix Center in Colorado in February
2002. Earnings before interest, taxes, depreciation, and amortization increased
2% for the nine months ended September 30, 2002 to $4,692,000 compared to
$4,610,000 for the nine months ended September 30, 2001. The Company recognized
losses of $305,000 on the new Riverside Intermediate Sanction Unit during the
nine months ended September 30, 2002. The census at this facility increased
substantially during September and Riverside is now expected to show a profit
from this point forward.
The Company began recording a provision for income taxes in 2002 with a
provision of $368,000 for the nine months ended September 30, 2002. A provision
for income taxes was not recorded for the nine months ended September 30, 2001,
due to the utilization of tax loss carryforwards. Net income before income taxes
was $1,254,000 for the nine months ended September 30, 2002 and $945,000 for the
three months ended September 30, 2001.
The Company's net income was $886,000 for the nine months ended September
30, 2002 compared to $945,000 for the nine months ended September 30, 2001. The
Company's earnings per share were $.18 basic and $.16 diluted for the nine
months ended September 30, 2002 compared to $.20 basic and $.19 diluted for the
nine months ended September 30, 2001.
Corporate. General and administrative expenses increased to $1,547,000 for
the nine months ended September 30, 2002 compared to $1,277,000 for the nine
months ended September 30, 2001. General and administrative expenses increased
primarily due to increased legal, travel, and staffing costs for the Company's
new operations and acquisitions. Interest expense decreased $359,000 for the
nine months ended September 30, 2002 over the nine months ended September 30,
2001, as a result of lower interest rates and a reduction in long term debt.
Depreciation and amortization 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 affect 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 has experienced reductions in
revenues as a consequence of contracting agencies reducing the bed utilization
in the Company's facilities. A reserve cannot be established to estimate future
downturns.
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. Through December 31, 2001, these intangible assets
were being amortized over a twenty-year period. Financial Accounting Standards
Board SFAS 142 requires that intangible assets, whose useful lives are estimated
to be indefinite, can no longer be amortized. Avalon's intangible assets have
indefinite lives inasmuch as they relate to contracts that are renewable at
minimal costs, are routinely renewed, and are expected to be renewed. If the
intangible assets are shown to be impaired in some future period, they are
required to be written down to their fair value in the period when the
impairment
Page 11
is ascertained. The Company's intangible assets with indefinite lives total
$2,856,000 at September 30, 2002. Any impairments recorded would have an adverse
effect on earnings, possibly materially, in the period the impairment is
determined. During 2002, independent appraisals were obtained on the related
properties. The value on each property was higher than the carrying value of the
underlying intangible and tangible assets, so no impairment has been found to
exist. Iintangible assets with indefinite lives will be tested for impairment
annually.
Equity valuation. 1,622,448 shares of the Company's stock (approximately
one-third) have a put attached which can be exercised 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. The
stock was recorded at its estimated fair value and is being accreted to the
estimated value at the redemption date. This accretion 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.
Item 3. Controls and Procedures
The Company's chief executive officer and its vice president of finance
have evaluated the effectiveness of the Company's disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14(c) and 15d-14(c) as of a
date within 90 days of the filing date (the "Evaluation Date") of this quarterly
report, and have concluded that as of the Evaluation Date, the Company's
disclosure controls and procedures were adequate, effective, and ensure that
material information relating to the Company and its consolidated subsidiaries
would be made known to them timely by others within those entities.
There were no significant changes in the Company's internal controls or in
other factors that could significantly affect the Company's disclosure controls
and procedures subsequent to the Evaluation Date, nor were there any significant
deficiencies or material weaknesses in such disclosure controls and procedures
requiring corrective actions. As a result, no corrective actions were taken.
Page 12
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 and reports on Form 8-K - None.
The following exhibits are filed as a part of this Quarterly Report on Form
10-QSB:
99.1 Certification of Donald E. Smith, Chief Executive Officer,
pursuant to 18.U.S.C. Section 1350 as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification of Lloyd Lovely, Vice President of Finance, pursuant
to 18.U.S.C. Section 1350 as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
Page 13
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: November 1, 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 14
CERTIFICATIONS
I, Donald E. Smith, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of Avalon Correctional
Services, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in thiS quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
November 1, 2002
/s/ Donald E. Smith
Donald E. Smith
Chief Executive Officer
I, Lloyd Lovely, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of Avalon Correctional
Services, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there ere significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
November 1, 2002
/s/ Lloyd Lovely
Lloyd Lovely
Vice President of Finance
Exhibit 99.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Avalon Correctional Services, Inc.
(the "Company") on Form 10-QSB for the period ended September 30, 2002 as filed
with the Securities and Exchange Commission on the date hereof (the "Report"),
I, Donald E. Smith, Chief Executive Officer of the Company, certify, pursuant to
18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley
Act of 2002, that to the best of my knowledge:
(1) The Report fully complies with the requirements of section 13 (a) or 15
(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and result of operations of the Company.
/s/ Donald E. Smith
Donald E. Smith
Chief Executive Officer
November 1, 2002
Exhibit 99.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Avalon Correctional Services, Inc.
(the "Company") on Form 10-QSB for the period ended September 30, 2002, as filed
with the Securities and Exchange Commission on the date hereof (the "Report"),
I, Lloyd Lovely, Vice President of Finance of the Company, certify, pursuant to
18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley
Act of 2002, that to the best of my knowledge:
(1) The Report fully complies with the requirements of section 13 (a) or 15
(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and result of operations of the Company.
/s/ Lloyd Lovely
Lloyd Lovely
Vice President of Finance
November 1, 2002