AVALON CORRECTIONAL SERVICES, INC
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 0-20307
AVALON CORRECTIONAL SERVICES, INC.
(Exact Name of registrant 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 and zip code of principal executive office)
Issuer's telephone number, including area code (405) 752-8802
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered under Section 12 (g) of the Act:
Shares of Class A Common Stock, par value $.001
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days: Yes X No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes ___ No X
The aggregate market value of voting common stock held by non-affiliates
was approximately $3,185,000 on June 30, 2003, based on the average bid and
asked prices of such stock as reported by the National Association of Securities
Dealers Automated Quotations Systems ("NASDAQ") on that day.
As of April 9, 2004, 4,896,196 shares of the issuer's common stock, par
value $.001, were issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Proxy Statement for the 2004 Annual Meeting of Shareholders
are incorporated by reference in Part III, Items 11, 12, 13 and 14.
Page 1
AVALON CORRECTIONAL SERVICES, INC.
INDEX TO ANNUAL
REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2003
Page
----
PART I
1. Business ..........................................................3
2. Property..............................................................9
3. Legal Proceedings....................................................10
4. Submission of Matters to a Vote of Security Holders.................10
PART II
5. Market for Registrant's Common Equity and Related
Stockholder Matters...........................................11
6. Selected Financial Data..............................................11
7. Management's Discussion and Analysis of Financial Condition and
Results of Operation..........................................12
7A. Quantitative and Qualitative Disclosures About Market Risk...........15
8. Financial Statements and Supplementary Data..........................16
9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure......................................36
9A. Controls and Procedures.............................................36
PART III
10. Directors and Executive Officers of the Registrant...................36
11. Executive Compensation...............................................39
12. Security Ownership of Certain Beneficial Owners and Management and
Management and Related Stockholder Matters......................39
13. Certain Relationships and Related Transactions.......................39
14. Principal Accounting Fees and Services...............................39
PART IV
15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K....39
Signatures..........................................................41
Certifications......................................................42
Page 2
AVALON CORRECTIONAL SERVICES, INC.
PART I
ITEM 1. BUSINESS
The Company
Avalon Correctional Services, Inc., is an owner and operator of private
community correctional facilities. Avalon Correctional Services, Inc. and its
wholly owned subsidiaries ("Avalon" or the "Company") specialize in operating
private community correctional facilities and providing alternative correctional
programming. Avalon currently operates facilities and manages programs 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 role as a provider of community correctional services. Avalon's
development plan is to expand operations through new state and federal contracts
and selective acquisitions. Avalon has been providing private community
correctional services since 1985. Avalon contracts with various governmental
agencies to provide community corrections operations and services.
The management and rehabilitation of inmate populations are of utmost
concern to cities, counties, states and a variety of federal agencies throughout
the country. Increasingly, government is partnering with private companies to
assist them with their correctional needs. Avalon management believes its
background and ability to build and operate community correctional facilities
and provide correctional programming, positions the Company for substantial
growth in the corrections industry.
The Challenges for Corrections
Overcrowded conditions in prisons and jails result in unsafe management
conditions and often lead to earlier than planned releases by courts and judges.
Inmates in overcrowded conditions typically receive little or no rehabilitative
programs, resulting in higher recidivism rates.
High recidivism rates impact the lifetime cost of incarceration. An inmate
who returns to prison after release not only wastes the initial investment that
was made, but greatly adds to the lifetime cost of incarceration.
Skyrocketing costs of correctional budgets can place a financial drain on
other governmental priorities such as education and healthcare. Government
officials' wrestle with limited time and capital resources as they try to
address all of their constituents' needs.
The Sentencing Project, a group that promotes alternatives to prison, said
state and federal policies continue to drive up incarceration rates despite
sharp drops in violent crime rates since 1994.
"The relentless increases in prison and jail populations can best be
explained as the legacy of an entrenched infrastructure of punishment that has
been embedded in the criminal justice system over the last 30 years," said
Malcolm Young, the group's executive director.
Prisons and jails held one out of every 142 U.S. residents. The prison and
jail population, long the world's largest, has almost doubled since 1990.
The utilization of beds in private secure and community correctional
facilities helps reduce the overcrowded conditions and thus improves the overall
operations in publicly operated prison and jail systems. More specifically
targeted towards reducing the rate of reentry or recidivism rate is community
corrections. The term "community corrections" is one that is often confusing. In
the broadest sense, it is the supervision or treatment of criminal offenders in
non-secure residential settings. In states with Community Corrections Acts, the
term refers to specific programs that are based and operated in local
communities. Community based corrections programs broaden the range of criminal
sanctions available to the justice system and manage populations that would
otherwise be placed in secure settings.
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AVALON CORRECTIONAL SERVICES, INC.
Appropriations for Community Corrections, more specifically for the State
of Colorado, have seen gradual increases since the Colorado Community
Corrections program started in 1974. From the first appropriations in 1976,
funding increased to $1.7 million in FY 1979-80. Five years later $5.8 million
was appropriated and funding for the most current year (FY02) was $39.7 million.
Despite these increases, the funding has not kept pace with the demand for beds
and needs for resources to provide quality community corrections services.
Judges have backlogs of offenders eligible for placements in community beds.
Avalon's particular areas of growth will come in four of the following
areas:
1. The trend in corrections is toward utilizing community-based
sentencing rather than secure facilities. Community-based
sentencing relies to a significant degree on community
corrections facilities, which are Avalon's primary focus.
2. Acquisitions of existing community corrections companies continue
to be attractive and available.
3. Federal and State requests for proposals should continue to offer
opportunities for expansion due to the ongoing shortage of beds
the Federal Bureau of Prisons and county jails are experiencing.
4. The increasing number of offenders incarcerated, the decline in
states' revenues and the decrease in funds available to pay to
house offenders are creating economic pressure to utilize the
least restrictive and most cost effective form of incarceration
available. Community corrections programs are the least
restrictive and most cost effective form of incarceration.
Inmates serving the last 6 to 12 months of their incarceration in
a community correctional facility report a lower recidivism rate
than those released directly from secure facilities into society.
Avalon currently owns and operates 2,300 private community corrections
beds. The Company owns and operates three community correctional facilities, a
160-bed correctional center and one intermediate sanction unit in Oklahoma; two
medium-security facilities and one community correctional facility in Texas; and
four community correctional facilities in Colorado. Avalon is the largest
private provider of community correctional services in Oklahoma. The Avalon
facilities provide numerous alternative programs for offenders generally serving
the last six months of their sentence. Avalon provides contract agencies a
complete range of services relating to the security, detention and care of
offenders, and a broad range of rehabilitative programs to reduce recidivism.
Programming is an essential part of community-based corrections. Avalon has
provided substance abuse programs for over 18 years. The provided programming
includes substance abuse treatment and counseling, vocational training, work
release programs, basic educational programs, job and life skill training, and
reintegration services. The Colorado community corrections programs also provide
non-residential services to approximately 210 offenders in the State of
Colorado. Avalon's private pay program, operated from the Company's community
correctional facilities, has a growing population of clients referred by local
judicial systems as an alternative to secure incarceration.
Avalon's corporate office is located at 13401 Railway Drive in Oklahoma
City, Oklahoma 73114. Avalon's common stock is traded on the NASDAQ
Small-Cap Market with the symbol "CITY".
Facilities
The following table summarizes certain information with respect to
facilities and programs managed by Avalon.
Facility Name
And Location Capacity Facility/Program Type
- --------------- --------- ----------------------
Carver Center, 300 beds Community Corrections
Oklahoma City, Oklahoma Facility
Avalon Correctional Center, 320 Beds Community Corrections
Tulsa, Oklahoma Facility
Turley Correctional Center, 150 Beds Community Corrections
Tulsa, Oklahoma Facility
Page 4
AVALON CORRECTIONAL SERVICES, INC.
El Paso Intermediate 150 Beds Medium Security
Sanction Facility Correctional Facility
El Paso, Texas Correctional Facility
Union City Correctional Center, 160 Beds Medium Security
Union City, Oklahoma Correctional Facility
El Paso Multi-Purpose Facility, 324 Beds Medium Security
El Paso, Texas Correctional Facility
Phoenix Center, 207 Beds Community Corrections
Henderson, Colorado Facility
The Villa at Greeley, 307 Beds Community Corrections
Greeley, Colorado Facility
The Loft House, 35 Beds Community Corrections
Denver, Colorado Facility
Community Sentencing Center, N/A Day Reporting Center,
Northglenn, Colorado Community Corrections
Facility
Riverside Intermediate Sanction 352 Beds Intermediate Sanctions
Tulsa, Oklahoma Unit, Community
Corrections
Austin Transitional Center, 180 Beds Community Corrections
Del Valle, Texas Facility
Emerald Square, 60 Beds Assisted Living Center
Oklahoma City, Oklahoma
Avalon Corporate Office, N/A Administration
Oklahoma City, Oklahoma
Community Correctional Services
Avalon owns and operates nine community based correctional centers, Carver
Center, Avalon Correctional Center, Turley Correctional Center, Union City
Correctional Center, El Paso Intermediate Sanction Facility, El Paso
Multi-Purpose Facility, Austin Transitional Center, Phoenix Center and The Villa
at Greeley. The Company also operates community corrections programs in three
leased facilities; the Loft House, a community corrections program; the
Community Sentencing Center, a day reporting center; and the Riverside
Intermediate Sanction Unit, a multi-use corrections program. The community
corrections centers provide complete correctional administration, correctional
officer staffing, housing, food services, vocational assistance, transportation,
and rehabilitation services.
Oklahoma Avalon's contracts with the Oklahoma Department of Corrections
extend through June 30, 2004 and are generally renewed every three years. The
structure of the Oklahoma contracts is based upon three one-year contract
periods. Avalon has contracted with the State of Oklahoma pursuant to similar
contracts since 1985. The State of Oklahoma's performance under the contracts is
subject to annual appropriation by the legislature. Avalon also provides
services pursuant to a Federal contract obtained in 1997. The five-year Federal
contract was renewed in 1999 and extends through 2004.
Carver Center is a 300-bed community corrections facility located in
Oklahoma City, Oklahoma. Carver Center has been expanded from its initial
capacity of 50 beds in 1985, to its current capacity of 300 beds to accommodate
the increasing needs of the Oklahoma Department of Corrections. Carver center
was sited, designed, and constructed by Avalon.
Avalon Correctional Center is a 320-bed community corrections facility
located in Tulsa, Oklahoma. The facility has been expanded from its initial
capacity of 255 beds to its current capacity of 320 beds to accommodate the
increasing needs of the Oklahoma Department of Corrections. The Avalon
Correctional Center was sited, designed, and constructed by Avalon and opened in
July 1995.
Page 5
AVALON CORRECTIONAL SERVICES, INC.
Turley Correctional Center is a 150-bed community corrections facility
located in Tulsa, Oklahoma. Avalon acquired the Turley Correctional Center in
October 1997. A new 150-bed correctional facility was constructed on the 35-acre
grounds at the Turley Correctional Center in May of 2000.
Union City Correctional Center is a 160-bed medium security correctional
facility located in Union City, Oklahoma. The Union City Correctional Center was
sited, designed, and constructed by the Company for use as a Juvenile Center.
Construction of the Union City Correctional Center was completed and the Center
began receiving offenders in February 1999. The Center has a licensed capacity
of 160 beds. The Oklahoma Office of Juvenile Affairs, in a cost-cutting move,
did not exercise the option for the final year of a five-year contract providing
for the care of 80 juveniles at the facility. The contract expired on December
2, 2002 and the building is currently used as an overflow facility for the
Carver Center. See Note 11 to the consolidated financial statements for
discussion of pending sale of this facility.
Riverside Intermediate Sanction Unit was opened in December 2001. The
facility is leased from the Tulsa County Criminal Justice Authority for a period
of up to twenty years. The facility is utilized to provide substance abuse
programming and community corrections programs for various jurisdictions.
Accreditation of Facilities and Quality Performance
Avalon maintains an internal quality assurance program and the results of
this program are readily available to current and prospective customers.
Independent accreditation by various oversight and regulatory organizations is
designed to show that a facility meets nationally accepted professional
standards for quality of operation, facility design, management, and
maintenance. Accrediting entities include the American Correctional Association
(ACA) for the adult secure and community corrections sectors, as well as the
Department of Mental Health, Department of Public Welfare, Department of Health
and Department of Fire and Safety.
The Avalon facilities are managed in accordance with the guidelines of the
American Correctional Association. Carver Center, Avalon Correctional Center and
Turley Correctional Center are accredited by the American Correctional
Association ("ACA") as Adult Community Correctional Facilities. ACA
accreditation or candidacy is required to contract with the State of Oklahoma
for correctional services. The ACA, a private not-for-profit organization, was
established to develop uniformity and industry standards for the operation of
correctional facilities and provision of inmate care. Accreditation involves an
extensive audit and compliance procedure, and is generally granted for a
three-year period. The current accreditation for Carver Center expires in 2005.
Avalon Correctional Center was initially accredited in 1996 and is accredited
through 2005. Turley Correctional Center was initially accredited in October
2000 and is accredited through October 2006. The Riverside Intermediate Sanction
Unit will apply for ACA accreditation in 2004.
Texas Avalon acquired the El Paso Intermediate Sanction Facility in El
Paso, Texas in August 1996. The facility has a capacity of 150-beds. The Company
entered into a fifteen-year contract to provide services in the facility for the
West Texas Community Supervision and Corrections Department in July 1996.
The Company was awarded a contract in June 1998 with the Texas Department
of Criminal Justice to provide 250 multi-purpose beds in El Paso, Texas. A new
324-bed facility was constructed adjacent to the existing El Paso Facility in
1999 to accommodate this new contract. The El Paso Multi-Purpose Facility was
completed and became operational in the second quarter of 1999.
Avalon acquired the Austin Transitional Center in December 2001. The
community corrections facility has a capacity of 180 offenders and contracts
with the Texas Department of Criminal Justice for community corrections
services. The facility consists of thirteen modular buildings owned by Avalon
and located on leased land. The land is leased for a period of five years with a
renewal option of five years.
Avalon contracted with Tom Green County in Texas to operate the Roy K. Robb
facility, a post-adjudication juvenile substance abuse facility in September
2002. The Company cancelled the contract in March 2003.
Page 6
AVALON CORRECTIONAL SERVICES, INC.
Colorado The Company acquired a management contract in May 1999 to operate
the Adams Community Corrections Program in Northglenn, Colorado. The Program
provides residential and non-residential services in three locations: The
Phoenix Center, a 107-bed residential center in Henderson, Colorado; The Loft
House, a 35-bed residential program in Denver, Colorado and the Community
Sentencing Center, a day reporting center in Northglenn, Colorado. The Company
completed the expansion of the Phoenix Center from 107 beds to 207 beds in 2003.
The Program provides services pursuant to contracts with various state, federal,
and local agencies.
The Company acquired The Villa at Greeley in June 1999. The Villa owns and
operates a 307-bed multi-purpose facility and provides residential and
non-residential offender services and an assisted living program in Greeley,
Colorado. The Villa contracts with various state, federal, and local agencies.
Assisted Living Center
The Company holds a 15% equity interest in an assisted living center
located in Oklahoma and has an investment of $0 at December 31, 2003. The
Company guaranteed facility debt related to the building of the investment and
has pledged $1,600,000 in certificates of deposit for such guarantee. The
Company has operated the facility since it was constructed in 1997.
Competition
While generally funded by state corrections agencies, community
correctional services are operated in large part by a fractured array of private
organizations. The Salvation Army, Volunteers of America charities, and
approximately several thousand individual operations nationally claim a
significant share of the community corrections market.
Community Corrections was founded more than 150 years ago. The 1980's saw
tremendous growth in community corrections' populations, from about 1.4 million
persons at the start of the decade to 3.2 million by 1990, a more than 130%
increase. This increase was larger than that experienced by either prisons or
jails over the same period. In 2000, approximately two-thirds of the adults
under correctional supervision were on parole or on probation. In 2001, an
estimated 585,000 offenders were released into the community with a need for
transitional services such as community corrections. Since supervising an
offender on parole costs about one-tenth the cost of incarcerating an inmate,
the attractiveness of this solution is apparent.
Virtually every national study and commission beginning with the
President's Commission on Law Enforcement and Administration of Justice (1967)
up to the President's National Drug Control Strategy (1990) has recommended
expanding community corrections. The National Advisory Commission on Criminal
Justice Standards and Goals referred to community corrections as the justice
system's "brightest hope." Public opinion polls also show wide support for
community-based sentencing for nonviolent offenders.
President George W. Bush in his State of the Union Address (January 2004)
said this, "In the past, we've worked together to bring mentors to children of
prisoners and provide treatment for the addicted, and help for the homeless.
Tonight I ask you to consider another group of Americans in need of help. This
year (2004), some 600,000 inmates will be released from prison back into
society. We know from long experience that if they can't find work or a home or
help, they are more likely to commit crimes and return to prison. So tonight, I
propose a four-year, $300 million Prisoner Re-Entry Initiative to expand job
training and placement services, to provide transitional housing, and to help
newly released prisoners get mentoring, including from faith-based groups.
America is the land of second chance and when the gates of the prison open, the
path ahead should lead to a better life."
Private Corrections Management
The U.S. prison population surpasses 2 million, according to reports issued
by the United States Department of Justice, Bureau of Justice Statistics (the
"BJS"). The number of adult offenders housed in federal and state prison
facilities and in local jails increased from 744,208 at year-end 1985 to
2,033,331 at year end. Industry reports indicate that adult offenders convicted
of violent crimes generally serve only one-third of their sentence with the
majority of them being repeat offenders. Accordingly, there is a public demand
for longer prison sentences, as well as prison terms for juvenile offenders,
resulting in even more overcrowding in United States correctional and detention
facilities. Finally, numerous courts and other government entities in the United
States have mandated that additional services offered to offenders be expanded
in the community and that more rehabilitation programs are offered to offenders
qualifying for community corrections placement.
Page 7
AVALON CORRECTIONAL SERVICES, INC.
At least 95% of all state prisoners will be released from prison at some
point. Nearly 80% will be released to parole or to community supervision
programs. A BJS recidivism study of 272,111 persons released from prisons in 15
states in 1994 estimated 67.5% were rearrested for a felony or serious
misdemeanor within 3 years, 46.9% were reconvicted, and 25.4% were re-sentenced
to prison for a new crime. The 272,111 offenders discharged in 1994 had
accumulated 4.1 million arrest charges before their most recent imprisonment and
another 744,000 charges within 3 years of release.
If recent incarceration rates remain unchanged, an estimated 1 of every 15
persons (6.6%) will serve time in a prison during their lifetime.
Contracts for correctional services are awarded by government agencies and
are generally based upon competitive bidding and quality of services provided.
Avalon management believes the Company has several competitive advantages in
contracting for community correctional services including: a) a nineteen-year
history of providing quality services to the Oklahoma Department of Corrections;
b) a geographic location allowing for lower administrative overhead charges when
bidding against competitors for regional contracts; c) accreditation by the
American Correctional Association since 1990 and certification as a drug and
alcohol treatment services provider since 1985; and d) a high quality and
cost-effective corporate infrastructure for management, marketing, financial
management, financial reporting, quality assurance, and support services.
Avalon has developed a broad range of programs designed to reduce
recidivism, including substance abuse treatment and counseling, vocational
training, work release programs, GED classes, job and life skills training, and
reintegration services in addition to providing fundamental residential services
for adult inmates. The management services offered by Avalon range from the
design and development of new correctional facilities, to the complete turnkey
development including, siting, designing, constructing, and operating of
community correctional facilities. Avalon management believes its experience and
success in owning and operating community correctional facilities and providing
successful programming will be the basis for becoming the dominant company in
the community corrections industry. Avalon is the only publicly traded company
focused solely on the community corrections segment of the corrections industry.
For the year ended December 31, 2003, approximately 31% of the Company's
revenue was derived from contracts with the Oklahoma governmental agencies
relating to the Company's adult community correctional facilities in Oklahoma
City ("Carver Center"), Tulsa ("Avalon Correctional Center" and "Riverside
ISF"), and Turley ("Turley Correctional Center"). Approximately 24% of the
Company's revenue was derived from contracts with Colorado governmental
agencies. Approximately 27% of the Company's revenue was derived from contracts
with Texas governmental agencies, relating to the Company's correctional
facilities in El Paso and Austin, Texas. Approximately 8% of the Company's
revenue was derived from collections directly from individual offenders.
Community Corrections programs enhance opportunities to apply restorative
justice principles by making non violent offenders personally responsible to
their community for their criminal offenses while providing opportunities to be
locally rehabilitated. Community Corrections provides significant relief to the
ever-increasing adult correctional system and offers a savings to U.S. citizens.
Insurance
Avalon maintains insurance coverage for general liability, property and
contents, automobile physical damage and liability, workers' compensation, and
directors and officers. Avalon believes its existing insurance coverage is
adequate.
Regulations
Avalon maintains an internal quality assurance program and the results of
this program are readily available to current and prospective customers.
Independent accreditation by various oversight and regulatory organizations is
designed to show that a facility meets nationally accepted professional
standards for quality of operation, facility design, management, and
maintenance. Accrediting entities include the American Correctional Association
(ACA) for the adult secure and community corrections sectors, as well as the
Department of Mental Health, Department of Public Welfare, Department of Health
and Department of Fire and Safety.
Page 8
AVALON CORRECTIONAL SERVICES, INC.
The Avalon facilities are managed in accordance with the guidelines of the
American Correctional Association. Carver Center, Avalon Correctional Center and
Turley Correctional Center are accredited by the American Correctional
Association ("ACA") as Adult Community Correctional Facilities. ACA
accreditation or candidacy is required to contract with the State of Oklahoma
for correctional services. The ACA, a private not-for-profit organization, was
established to develop uniformity and industry standards for the operation of
correctional facilities and provision of inmate care. Accreditation involves an
extensive audit and compliance procedure, and is generally granted for a
three-year period.
The corrections industry is subject to federal, state and local regulations
administered by a variety of regulatory authorities. The correctional services
offered by Avalon in various states are subject to regulations and oversight by
the various government agencies. Management believes its operations are
currently in compliance with all applicable laws and regulations affecting
Avalon's business.
Employees
At April 9, 2004, Avalon had approximately 430 full-time employees,
including directors and officers. Avalon has not experienced a work stoppage,
and management considers its employee relations to be good.
ITEM 2. PROPERTY
Carver Center is a 300-bed community corrections facility located in
Oklahoma City, Oklahoma. The facility is located on five acres of land and
includes five buildings. Avalon constructed a new 16,000 square foot dormitory
at Carver Center in the second quarter of 1995. The Carver Center facility
contains approximately 35,000 square feet of building space. Carver Center was
sited, designed, and constructed by the Company.
Avalon Correctional Center is a 320-bed community corrections facility
located on approximately two acres of land in Tulsa, Oklahoma. The construction
of the approximately 36,000 square foot facility was completed and opened by the
Company in July 1995. The Avalon Correctional Center was sited, designed, and
constructed by the Company.
Turley Correctional Center is a 150-bed community corrections facility
located in Tulsa, Oklahoma. The facility is located on a thirty-five acre tract
of land and includes two buildings. The Company acquired the Turley Correctional
Center in October 1997. A new 26,000 square foot correctional facility was
sited, designed and constructed by the Company and opened in May 2000 on the
grounds at the Turley Correctional Center.
El Paso Intermediate Sanction Facility is a 150-bed medium security
correctional facility located on seven acres of land in El Paso, Texas. The
facility was constructed as an intermediate sanction facility. The Company
acquired the 36,000 square foot facility in 1996.
Union City Correctional Center is a 160-bed medium security correctional
facility located on 20 acres of land in Union City, Oklahoma. Construction of
the 45,000 square foot facility was completed and the Center began receiving
offenders in February 1999. The Union City Correctional Center was sited,
designed, and constructed by the Company.
El Paso Multi-Purpose Facility is a 324-bed medium security correctional
facility on seven acres of land acquired in 1998 in El Paso, Texas. Construction
of the 54,000 square foot facility was completed in 1999. The El Paso
Multi-Purpose Facility was sited, designed, and constructed by the Company.
The Phoenix Center is a 207-bed community corrections facility located in
Northglenn, Colorado. The 29,757 square foot facility is located on
approximately 2.2 acres of land. The Company completed the expansion of the
Phoenix Center from 107 beds to 207 beds in 2003. The Company acquired the
Phoenix Center in 1999.
Page 9
AVALON CORRECTIONAL SERVICES, INC.
The Villa at Greeley is a 307-bed multi-use correctional facility located
in Greeley, Colorado. The 101,000 square foot facility is located on
approximately four acres of land. The Company acquired the Villa at Greeley in
1999.
The Loft House is a 35-bed community corrections facility located in
Denver, Colorado. The Company leases the Loft House location.
Community Sentencing Center is a day reporting correctional program in
Northglenn, Colorado. The Center is leased and contains approximately 3,500
square feet.
Riverside Intermediate Sanction Unit is a 352-bed facility leased from the
Tulsa County Criminal Justice Authority. The initial lease term ends in June
2007, with three five-year options for extension. The facility was extensively
renovated by the Company and opened in December 2001.
Austin Transitional Center is a 180-bed community corrections facility
located in Del Valle, Texas, a suburb of Austin. The facility consists of
thirteen modular buildings owned by Avalon and located on leased land. The land
is leased for a period of five years with a renewal option of five years. The
Company acquired the Austin Transitional Center in December 2001.
Emerald Square is a 60-bed assisted living center facility located in
Oklahoma City, Oklahoma. The facility was built in 1996 and consists of 55
living units plus common areas, offices, kitchen and dining areas, all in one
building, located on 14 acres of land.
Avalon Corporate Office is located in Oklahoma City, Oklahoma, in a
commercial building at 13401 Railway Drive, Oklahoma City, Oklahoma 73114. The
Company owned building contains approximately 21,000 square feet of warehouse
space including approximately 13,000 square feet of office space.
Substantially all property owned by Avalon is pledged as collateral on the
Company's credit facilities. See Note 7 to the Consolidated Financial
Statements.
ITEM 3. LEGAL PROCEEDINGS
Avalon 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 Avalon's financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
Page 10
AVALON CORRECTIONAL SERVICES, INC.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Avalon's common stock trades on the NASDAQ Small-Cap Market with the symbol
"CITY". The following table reflects the range of high and low sales prices, as
reported by the National Quotation Bureau for each quarterly period during 2003
and 2002. The prices represent inter-dealer prices, without retail mark up, mark
down, or commission and may not represent actual transactions. Trading in
Avalon's common stock is limited and may not be an indication of the value of
the common stock.
Quarterly Period Ended High Low
---------------------- ----- ----
December 31, 2003 $2.06 $1.37
September 30, 2003 $1.55 $1.27
June 30, 2003 $1.55 $1.25
March 31, 2003 $1.50 $1.17
December 31, 2002 $1.87 $1.20
September 30, 2002 $2.30 $1.80
June 30, 2002 $2.55 $2.26
March 31, 2002 $2.45 $2.05
The average high and low price for the Common Stock, as reported on the
NASDAQ Small-Cap Market System was $2.38 per share on April 8, 2004.
Avalon had approximately 138 holders of record of its common stock as of
April 9, 2004. The Company did not declare any dividends during 2003 or 2002.
Avalon's Board of Directors presently intends to retain all earnings in the
foreseeable future for use in Avalon's business. Payment of dividends on the
Common Stock is restricted by certain credit facilities.
Equity Compensation Plans
The following table provides information with respect to the Company's
equity compensation plans as of December 31, 2003.
Number of securities
remaining available for
Number of securities future insurance under
to be issued upon weighted average equity compensation
exercise of exercise price of plans (excluding
outside options, outstanding options, securities reflected
warrants and rights warrants and rights in column (a)
------------------- ------------------- -------------
Plan Category (a) (b) (c)
--- --- ---
Equity compensation plans
approved by security holders (1) 692,660 $1.69 7,340
(1) These stock options have been issued pursuant to the Company's Stock Option
Plan which has been approved by security holders.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data as of and for the years ended
December 31, 1999 through 2003 has been derived from the Company's consolidated
financial statements. The following data should be read in conjunction with the
Company's consolidated financial statements, the related notes thereto, and
"Management's
Page 11
AVALON CORRECTIONAL SERVICES, INC
Discussion and Analysis of Financial Condition and Results of Operations."
For the Years Ended December 31,
-----------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Statement of Operations:
Revenues $25,260,000 $27,456,000 $25,147,000 $22,922,000 $16,803,000
=========== =========== =========== =========== ===========
Expenses $23,475,000 $25,788,000 $23,822,000 $21,959,000 $16,685,000
=========== =========== =========== =========== ===========
Operating Income $ 1,785,000 $ 1,668,000 $ 1,325,000 $ 963,000 $ 118,000
=========== =========== =========== =========== ===========
Net Income $ 1,174,000 $ 1,121,000 $ 1,325,000 $ 963,000 $ 83,000
=========== =========== =========== =========== ===========
Basic income per share $ 0.24 $ 0.23 $ 0.28 $ 0.20 $ 0.02
=========== =========== =========== =========== ===========
Diluted income per share $ 0.22 $ 0.20 $ 0.25 $ 0.20 $ 0.02
=========== =========== ========== =========== ===========
December 31,
-------------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Balance Sheet Data:
Total assets $39,701,000 $39,691,000 $40,087,000 $39,455,000 $38,440,000
Total liabilities $28,350,000 $29,517,000 $31,112,000 $31,933,000 $31,949,000
Stockholders' equity $ 8,723,000 $ 6,998,000 $ 5,505,000 $ 3,929,000 $ 2,367,000
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN 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-K, 10-Q and 8-K. The Company
does not undertake any obligation to update any forward-looking statements.
Overview
Avalon Correctional Services, Inc., is an owner and operator of private
community correctional facilities containing approximately 2,300 beds. Avalon
Correctional Services, Inc. and its wholly owned subsidiaries specialize in
operating private community correctional facilities and providing alternative
correctional programming. Avalon currently operates facilities and manages
programs in Oklahoma, Texas, and Colorado, with plans to significantly expand
into additional states. Avalon's business strategy is designed to elevate the
Page 12
AVALON CORRECTIONAL SERVICES, INC
Company into a dominant role as a provider of community correctional services.
Avalon's development plan is to expand operations through new state and federal
contracts and selective acquisitions. Avalon has been providing private
community correctional services since 1985. Avalon contracts with various
governmental agencies to provide community corrections operations and services.
The management and rehabilitation of inmate populations are of utmost concern to
cities, counties, states and a variety of federal agencies throughout the
country. Increasingly, government is partnering with private companies to assist
them with their correctional needs. Management of the Company closely monitors
the operations and assesses the residential and nonresidential census data. For
further information, see Results of Operations.
Results of Operations
Year Ended December 31, 2003 Compared to the Year Ended December 31, 2002
Total revenues decreased by 8% to $25,260,000 in 2003 from $27,456,000 in
2002. The net decrease in revenues was primarily a result of the closure of the
Union City Facility in December 2002. The Union City contract with the Oklahoma
Office of Juvenile Affairs expired on December 2, 2002. The Union City facility
contributed revenues of $3,575,000 in 2002 and $3,819,000 in 2001. The Company's
net income before taxes increased 7% to $1,785,000 in 2003 compared to
$1,668,000 in 2002.
Operating income before interest, depreciation and amortization and income
taxes decreased 9% to $5,955,000 in 2003 from $6,518,000 in 2002. The average
daily residential offender census increased by 3% to 1,744 in 2003 from 1,693 in
2002. The average daily non-residential offender census was 260 in 2003 compared
to 224 in 2002. The residential census increase was a result of increased
offender census in the Company's existing facilities and the expansion of the
Phoenix Center in June 2003. These increases were offset by the loss of the
Union City contract that expired on December 2, 2002. The Oklahoma Office of
Juvenile Affairs did not exercise the option for the final year of a five-year
contract for this facility. The Union City facility contributed operating income
before interest, depreciation and amortization and income taxes of $1,195,000 in
2002 (prior to allocation of corporate overhead). The data to reconcile the
Company's net income of $1,174,000 to operating income of $5,955,000 is as
follows. Add back to net income the amounts of $611,000 for income tax expense,
$2,287,000 for interest expense and $1,883,000 for depreciation and amortization
expense.
The Company entered into an asset purchase agreement to sell the Union City
facility in February 2004. The sale is subject to certain customary conditions
as well as the Buyer's ability to obtain financing, receive appropriate
licenses, certifications, permits, zoning and a contract for a client population
for the facility. The asset purchase agreement is scheduled to close on or
before June 25, 2004. The asset purchase agreement is expected to result in
proceeds in excess of the carrying value of the Union City facility. Should the
contract not close or be extended, the Company will review the carrying value of
the facility and determine if an impairment of the carrying value will be
required during the second quarter of 2004.
Direct operating expenses decreased by 7% in 2003 compared to 2002. The
decrease was a result of the closure of the Union City Facility in December
2002. The Company also incurred start up costs of approximately $357,000
associated with the Riverside Intermediate Sanction Unit and Roy K. Robb
facility during 2002.
General and administrative expenses decreased by 14% in 2003. The decrease
was a result of significant cost containment efforts. General and administrative
expenses equaled approximately 7% of revenues in 2003 and 2002. Depreciation and
amortization expense was $1,883,000 for 2003 compared to $2,256,000 for 2002, a
decrease of 17%. The decrease was a result of several assets being fully
depreciated during 2002. The amortization of intangible contract costs was
$225,000 in 2003 and 2002. Interest expense decreased by $307,000 in 2003 as a
result of lower interest rates and lower borrowing levels.
The Company's effective tax rate for 2003 was 34.2% compared to 32.8%
for 2002. The Company's income tax expense was $611,000 in 2003, an increase
of $64,000 over the income tax expense of $547,000 for 2002, the year in
which the Company fully utilized its remaining tax loss carryforwards. Net
income for 2003 was $1,174,000, compared to $1,121,000 for 2002.
Page 13
AVALON CORRECTIONAL SERVICES, INC
Year Ended December 31, 2002 Compared to the Year Ended December 31, 2001
Total revenues increased by 9% to $27,456,000 in 2002 from $25,147,000 in
2001. The net increase in revenues was primarily a result of increased offender
census, the opening of the Riverside Intermediate Sanction Unit in December
2001, the acquisition of the Austin Transitional Center in December 2001 and the
addition of Roy K. Robb contract in September 2002. The Company's net income
before taxes increased 26% to $1,668,000 in 2002 compared to $1,325,000 in 2001.
Operating income before interest, depreciation and amortization, and income
taxes increased 5% to $6,518,000 in 2002 from $6,199,000 in 2001. The average
daily residential offender census increased by 14% to 1,693 in 2002 from 1,486
in 2001. The average daily non-residential offender census was 224 in 2002
compared to 243 in 2001. The residential census increase was a result of
increased offender census in the Company's existing facilities, the opening of
the Riverside Intermediate Sanction Unit in December 2001 and the acquisition of
the Austin Transitional Center in December 2001. The Union City contract with
the Oklahoma Office of Juvenile Affairs expired on December 2, 2002. The Union
City facility contributed revenues of $3,575,000 in 2002 and $3,819,000 in 2001.
The Union City facility contributed operating income before interest,
depreciation and amortization and income taxes of $1,195,000 in 2002 and
$1,047,000 in 2001 (prior to allocation of corporate overhead). The data to
reconcile the Company's net income of $1,121,000 to operating income of
$6,518,000 is as follows. Add back to net income the amounts of $547,000 for
income tax expense, $2,594,000 for interest expense and $2,256,000 for
depreciation and amortization expense.
Direct operating expenses increased by 10% in 2002 compared to 2001. The
increase was a result of additional costs associated with increased offender
census in the Company's existing facilities, the opening of the Riverside
Intermediate Sanction Unit in December 2001 and the addition of the Austin
Transitional Center in December 2001. The Company incurred start up costs of
approximately $357,000 associated with the Riverside Intermediate Sanction Unit
and Roy K. Robb facility during 2002.
General and administrative expenses increased by 11% in 2002. The increase
was a result of additional costs associated with the increase in overall
offender census and additional staffing for the new facilities opened and
acquired in 2001. General and administrative expenses equaled approximately 7%
of revenues in 2002 and 2001. Depreciation and amortization expense was
$2,256,000 for 2002 compared to $1,881,000 for 2001, an increase of 20%. The
increase was a result of the additional expenses associated with the addition of
the Riverside and Austin facilities. Interest expense decreased by $399,000 in
2002 as a result of lower interest rates and lower borrowing levels.
The Company fully utilized its remaining tax loss carryforwards in 2002 and
recorded income tax expense of $547,000. The Company did not incur income tax
expense in 2001. Net income for 2002 was $1,121,000, compared to $1,325,000 for
2001.
Liquidity and Capital Resources
The Company's business strategy is to focus on the private community
corrections industry, expanding its operations in existing and additional states
through new Federal and state contracts and selective acquisitions. The
successful implementation of the Company's growth plan will create the need for
additional capital and financing.
Working capital at December 31, 2003 was $1,683,000 representing a current
ratio of 1.42:1.00, compared to working capital of $1,130,000 and a current
ratio of 1.23:1.00 at December 31, 2002. Capital expenditures were $2,587,000 in
2003, $1,206,000 in 2002 and $2,179,000 in 2001. The 2003 capital expenditures
include renovations and expansion of the Carver Center to increase capacity,
expansion of the Phoenix Center to increase capacity to 207 beds, and other
normal operating purchases of vehicles, equipment and building improvements. The
2002 capital expenditures include renovations to the Carver Center, expansion of
the Phoenix Center, and other normal operating purchases of vehicles, equipment,
and building improvements. The 2001 capital expenditures include expansion and
new furniture to increase the capacity of Carver Center from 250 beds to 300
beds, expansion and new furniture to increase the capacity of Avalon
Correctional Center from 255 beds to 320 beds in the third quarter of 2001,
renovation of the Riverside Intermediate Sanction Unit in November 2001,
expansion of office space at the Central Office in June 2001, the acquisition of
the Austin Transitional Center in December 2001, expansion of the Phoenix Center
in December 2001, and other normal operating purchases of vehicles, equipment
and building improvements. Operations provided $3,749,000 in cash flow in 2003,
$2,760,000 in 2002 and $5,135,000 in 2001.
Page 14
AVALON CORRECTIONAL SERVICES, INC
The Company had approximately $2,600,000 of cash and revolving credit
available for new projects at December 31, 2003. 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 balances. The Company is exploring various financing
options in anticipation of future debt maturities and future expansion
opportunities. See Note 7 to consolidated financial statements.
Contractual Obligations
Future payments due on the Company's contractual obligations as of December 31,
2003 are as follows:
Payments due by period
------------------------------------------------------------------
Total 2004 2005-2006 2007-2008 thereafter
----- ---- --------- --------- ----------
Long term debt $22,335,000 $2,030,000 $19,963,000 $ 65,000 $ 277,000
Convertible debentures 3,850,000 - - 3,850,000 -
Carver expansion 400,000 400,000 - - -
Operating leases 781,000 329,000 340,000 112,000 -
-----------------------------------------------------------------
Total $27,366,000 $2,759,000 $20,303,000 $4,027,000 $ 277,000
=================================================================
The Company sold 1,622,448 shares of redeemable common stock to an
investment company on September 16, 1998. The 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. No
shares have been tendered by the holder as of December 31, 2003.
Critical Accounting Policies
The consolidated financial statements are prepared in conformity with
accounting principles generally accepted in the United States. As such, the
Company is required to make certain estimates, judgments and assumptions that it
believes are reasonable based upon the information available. These estimates
and assumptions affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenue and
expenses during the reporting period. A summary of the significant accounting
policies is described in Note 1 to the audited financial statements.
New Accounting Pronouncements
See Notes 1 and 3 to the Consolidated Financial Statements for discussion
of new accounting pronouncements and the accounting change for new
pronouncements.
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk Exposure
The primary market risk exposures affecting the Company are changes in
interest rates. The Company is exposed to market risk related to the senior bank
credit facility. The interest on the senior credit facility is subject to
fluctuations in interest rates. Assuming an immediate increase or decrease of
100 basis points in interest rates, the interest expense for the years ended
December 31, 2003, 2002 and 2001 would have been increased or decreased by
approximately $110,000, $130,000 and $140,000, respectively.
The Company may from time to time, invest its cash in a variety of
short-term financial instruments. These instruments generally consist of highly
liquid investments. While these investments are subject to interest rate risk
and could decline in value if market interest rates increase, a hypothetical 100
basis point increase or decrease in market interest rates would not materially
affect the value of these instruments.
Page 15
AVALON CORRECTIONAL SERVICES, INC
ITEM 8. FINANCIAL STATEMENTS
Index to Financial Statements:
Page
----
Report of Independent Certified Public Accountants 17
Consolidated Balance Sheets 18
Consolidated Statements of Operations 19
Consolidated Statements of Stockholders' Equity 20
Consolidated Statements of Cash Flow 21
Notes to Consolidated Financial Statements 23
Page 16
AVALON CORRECTIONAL SERVICES, INC
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors of
Avalon Correctional Services, Inc.
We have audited the accompanying consolidated balance sheets of Avalon
Correctional Services, Inc. and subsidiaries (the "Company") as of December 31,
2003 and 2002, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 2003. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company as of
December 31, 2003 and 2002, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2003 in
conformity with accounting principles generally accepted in the United States of
America.
GRANT THORNTON LLP
Oklahoma City, Oklahoma
February 9, 2004
Page 17
AVALON CORRECTIONAL SERVICES, INC
CONSOLIDATED BALANCE SHEETS
December 31,
-----------------------------
2003 2002
---------- ----------
ASSETS
Current assets:
Cash and cash equivalents $ 1,015,000 $ 1,250,000
Certificates of deposit (pledged in 2003) 1,600,000 1,800,000
Accounts receivable, net 2,662,000 2,768,000
Prepaid expenses and other 426,000 287,000
------- -------
Total current assets $ 5,703,000 $ 6,105,000
Property and equipment, net 30,636,000 30,041,000
Intangible assets, net 2,395,000 2,620,000
Other assets 967,000 925,000
------- -------
Total assets $ 39,701,000 $39,691,000
============ ===========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Accounts payable, accrued liabilities and
other $ 1,990,000 $ 1,460,000
Current maturities of long-term debt 2,030,000 3,515,000
--------- ---------
Total current liabilities $ 4,020,000 $ 4,975,000
Long-term debt, less current maturities 20,305,000 20,545,000
Convertible debentures 3,850,000 3,850,000
Deferred income taxes 175,000 147,000
Redeemable common stock, $.001 par value
1,622,448 shares issued and outstanding in
2003 and 2002 2,628,000 3,176,000
Stockholders' equity:
Common stock - par value $.001; 24,000,000
shares authorized;
4,896,954 and 4,895,002 shares issued
and outstanding in 2003 and 2002,
respectively, less 1,622,448 shares
subject to repurchase in 2003 and 2002 3,000 3,000
Preferred stock; par value $.001; 1,000,000
shares authorized; none issued --- ---
Paid-in capital 8,459,000 7,908,000
Retained earnings (deficit) 261,000 (913,000)
------- ---------
Total liabilities and stockholders' equity $39,701,000 $39,691,000
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
Page 18
AVALON CORRECTIONAL SERVICES, INC
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended December 31,
2003 2002 2001
---- ---- ----
Revenues $25,260,000 $27,456,000 $25,147,000
----------- ---------- -----------
Costs and expenses
Direct operating $17,592,000 $18,938,000 $17,147,000
General and administrative 1,713,000 2,000,000 1,801,000
Depreciation and amortization expense 1,883,000 2,256,000 1,881,000
Interest expense 2,287,000 2,594,000 2,993,000
--------- --------- ---------
Net income before income tax expense $1,785,000 $1,668,000 $1,325,000
Income tax expense 611,000 547,000 ---
--------- --------- ----------
Net income $ 1,174,000 $1,121,000 $1,325,000
========== ========= =========
Basic income per share: $ 0.24 $ 0.23 $ 0.28
========== ========= =========
Diluted income per share: $ 0.22 $ 0.20 $ 0.25
========== ========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
Page 19
AVALON CORRECTIONAL SERVICES, INC
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<s> <c> <c> <c> <c> <c>
Common Retained Total
Common Stock Paid-In Earnings Stockholders'
Stock Shares Amount Capital (Deficit) Equity
------------ ------ ------- --------- ------------
Balance, January 1, 2001 4,765,630 $ 3,000 $7,285,000 $(3,359,000) $3,929,000
Net income --- --- --- 1,325,000 1,325,000
Stock options exercised 81,994 --- 128,000 --- 128,000
Accretion of redeemable stock --- --- 123,000 --- 123,000
--------- ------ ------- -------- -------
Balance, December 31, 2001 4,847,624 3,000 7,536,000 $(2,034,000) $5,505,000
Net income --- --- --- 1,121,000 1,121,000
Stock options exercised 47,378 --- 78,000 --- 78,000
Accretion of redeemable stock --- --- 294,000 --- 294,000
---------- ------ -------- ----------- ----------
Balance, December 31, 2002 4,895,002 $ 3,000 $7,908,000 $ (913,000) $6,998,000
Net income --- --- --- 1,174,000 1,174,000
Stock options exercised 1,952 --- 3,000 --- 3,000
Accretion of redeemable stock --- --- 548,000 --- 548,000
========= ======= ======= ========= =========
Balance, December 31, 2003 4,896,954 $ 3,000 $8,459,000 $ 261,000 $8,723,000
========= ======= ========= ========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
Page 20
AVALON CORRECTIONAL SERVICES, INC
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31,
-------------------------------------------
2003 2002 2001
--------------- ------------ ------------
OPERATING ACTIVITIES:
Net income $ 1,174,000 $1,121,000 $ 1,325,000
Adjustments to reconcile net income to
Net cash provided by operating
activities:
Depreciation and amortization 1,883,000 2,256,000 1,881,000
Amortization of debt issue costs 234,000 363,000 254,000
(Gain) loss on sale of property (11,000) 11,000 32,000
Changes in operating assets and
liabilities
Decrease (increase) in
Accounts receivable 106,000 4,000 986,000
Prepaid expenses and other assets (139,000) (376,000) (36,000)
Increase (decrease) in accounts
payable and other 502,000 (619,000) 693,000
------- --------- -------
Net cash provided by operations 3,749,000 $ 2,760,000 $ 5,135,000
--------- ----------- -----------
INVESTING ACTIVITIES:
Capital expenditures $(2,587,000) $(1,206,000) $(2,179,000)
Acquisition of business --- --- (71,000)
Purchases of certificates of deposit --- (1,800,000) ---
Sales of certificates of deposit 200,000
Proceeds from disposition of property 120,000 61,000 164,000
------ ------ -------
Net cash used in investing $(2,267,000) $(2,945,000) $(2,086,000)
------------ ------------ ------------
FINANCING ACTIVITIES:
Proceeds from borrowing $27,299,000 $28,479,000 $27,330,000
Repayment of borrowing (29,019,000) (29,511,000) (28,844,000)
Proceeds from stock option exercises 3,000 78,000 128,000
----- ------ -------
Net cash used in financing
activities $(1,717,000) $ (954,000) $(1,386,000)
------------ ----------- ------------
Net increase (decrease) in cash
and cash equivalents $ (235,000) $(1,139,000) $ 1,663,000
Cash and cash equivalents,
beginning of period 1,250,000 2,389,000 726,000
--------- --------- -------
Cash and cash equivalents
end of period $ 1,015,000 $ 1,250,000 $ 2,389,000
=========== =========== ===========
The accompanying notes are an integral part of these consolidated financial
statements
Page 21
AVALON CORRECTIONAL SERVICES, INC
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the year for: 2003 2002 2001
---------- ----------- -----------
Interest $ 2,146,000 $ 2,269,000 $ 2,735,000
=========== =========== ===========
Income taxes $ 337,000 $ 279,000 $ ---
=========== =========== ===========
The accompanying notes are an integral part of these consolidated financial
statements
Page 22
AVALON CORRECTIONAL SERVICES, INC
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
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 160-bed medium
security correctional facility in Union City, Oklahoma; a 150-bed medium
security facility in El Paso, Texas; a 324-bed medium security facility in El
Paso, Texas; a 180-bed community corrections facility on leased land in Del
Valle, Texas; a 207-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 35-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 210 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.
Accounts Receivable
Accounts receivable consists of amounts due from various governmental
agencies under contractual agreement for correctional services in the Company's
facilities. Receivables are recorded at the estimate of amounts due based upon
the terms of the related agreements.
Management periodically assesses the Company's accounts receivable and
establishes an allowance for estimated uncollectible amounts based on historical
write-offs. Accounts determined to be uncollectible are charged to operations
when that determination is made.
Concentrations of Credit Risk
Financial instruments potentially subjecting the Company to concentrations
of credit risk consist principally of temporary cash investments, certificates
of deposits and accounts receivable. The Company places its temporary cash
investments and certificates of deposit 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 December 31, 2003 and 2002 is $11,000 and $5,000,
respectively.
Page 23
AVALON CORRECTIONAL SERVICES, INC
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 10 to 40 Years
Furniture and Equipment 5 to 10 Years
Transportation Equipment 2 to 15 Years
The Company follows the provisions of Statement of Financial Accounting
Standards (SFAS) No. 144, Accounting for the Impairment or Disposal of
Long-lived Assets in determining impairment losses on long-term assets.
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.
SFAS No. 142, Goodwill and Other Intangible Assets, requires that goodwill
and intangible assets with indefinite useful lives be tested annually for
impairment. SFAS No. 142 also requires that intangible assets with finite useful
lives be amortized and be evaluated for impairment in accordance with SFAS No.
144. In addition, the Statement eliminates the requirement to amortize goodwill
or intangible assets with indefinite useful lives (Note 3).
Equity Method Investments
Investments in unconsolidated subsidiaries, jointly owned companies, and
other investees in which the Company has a 20% to 50% interest or otherwise
exercises significant influence are carried at cost, adjusted for the Company's
proportionate share of their undistributed earnings or losses. See Note 16 to
consolidated financial statements.
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.
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.
Page 24
AVALON CORRECTIONAL SERVICES, INC
Stock Based Compensation
The Company uses the intrinsic value method in accordance with APB 25 to
account for its stock option plan in which compensation is recognized only when
the exercise price of each option is less than the market value of the
underlying common stock at the date of grant. Accordingly, no compensation cost
has been recognized for the options issued as all options granted have exercise
prices equal to market value at the date of grant. Had compensation cost been
determined based on the fair value of the options at the grant dates in
accordance with SFAS 123, the Company's net income and net income per share
would have been decreased to the pro forma amounts indicated below.
2003 2002 2001
---------- ----------- --------
Net income
As reported $ 1,174,000 $ 1,121,000 $ 1,325,000
Deduct: stock based compensation
expense determined under fair
value method, net of tax effects (111,000) (190,000) (277,000)
--------- --------- ---------
Pro forma $ 1,063,000 $ 931,000 $ 1,048,000
----------- ------- -----------
Basic income per share
As reported $ 0.24 $ 0.23 $ 0.28
--------- -------- ---------
Pro forma $ 0.22 $ 0.19 $ 0.22
--------- -------- ----------
Diluted income per share
As reported $ 0.22 $ 0.20 $ 0.25
---------- --------- ----------
Pro forma $ 0.17 $ 0.14 0.21
--------- -------- ----------
The fair value of each grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions used:
2003 2002 2001
---- ---- ----
Dividends - - -
Expected volatility 37.5% 35.0% 67.0%
Risk free interest rate 2.7% 3.1% 5.1%
Expected life (years) 10 10 10
The Black-Scholes options valuation model was developed for use in
estimating the fair value of traded options with no vesting restrictions and
which are fully transferable. Option valuation models require the input of
highly subjective assumptions including the expected stock price volatility. The
Company's employee stock options have characteristics significantly different
from those of traded options, and changes in the subjective input assumptions
can materially affect the fair value estimate. It is management's opinion that
the existing models do not provide a reliable measure of the fair value of its
employee stock options because the model assumes the security being measured is
widely traded and liquid. The Company's stock does not have a significant
trading volume and is illiquid.
Recently Issued Accounting Pronouncements -
In January 2003, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities"
(VIEs), which is an interpretation of Accounting Research Bulletin (ARB) No. 51,
"Consolidated Financial Statements." FIN 46, as revised by FIN 46(R), addresses
the application of ARB No. 51 to VIEs, and generally would require that assets,
liabilities and results of the activity of a VIE be consolidated into the
financial statements of the enterprise that is considered the primary
beneficiary. This interpretation applies immediately to VIEs created after
January 31, 2003, and to VIEs in which a company obtains an interest after that
date. The Company had not created or obtained an interest in any VIEs in 2003.
In addition, the interpretation becomes applicable on December 31, 2003 for
special purpose entities (SPEs) created prior to February 1, 2003. As of
December 31, 2003, the Company had no SPEs for which it was considered the
primary beneficiary. For non-SPEs in which a company holds a variable interest
that it acquired before February 1, 2003, the FASB has postponed the date on
which the interpretation will become applicable to March 31, 2004.
Page 25
AVALON CORRECTIONAL SERVICES, INC
The Company has identified one non-consolidated entity (Emerald Square) as
a VIE where the Company is considered the primary beneficiary (see Note 16). In
accordance with the provisions of FIN 46, as revised, the Company will be
required to consolidate this VIE as of March 31, 2004. The Company does not
expect the consolidation of this VIE to have a material effect on the
consolidated results of operations or financial position.
In December 2003, the Staff of the Securities and Exchange Commission (SEC)
issued Staff Accounting Bulletin (SAB) No. 104, "Revenue Recognition," which
supersedes SAB No. 101. The primary purpose of SAB No. 104 is to rescind
accounting guidance contained in SAB No. 101 and the SEC's "Revenue Recognition
in Financial Statements Frequently Asked Questions and Answers" (the FAQ)
related to multiple element revenue arrangements. The Company does not expect
the issuance of SAB No. 104 to significantly impact its current revenue
recognition policies.
NOTE 2. PROPERTY AND EQUIPMENT
The elements of property and equipment and related accumulated depreciation
as of December 31, 2003 and 2002 are as follows:
2003 2002
---------- -----------
Land $ 3,143,000 $ 3,143,000
Buildings and Improvements 29,766,000 28,121,000
Construction in Progress 119,000 329,000
Furniture and Equipment 2,757,000 2,662,000
Transportation Equipment 1,524,000 1,567,000
--------- ---------
$37,309,000 $ 35,822,000
Accumulated Depreciation (6,673,000) (5,781,000)
----------- -----------
$30,636,000 $ 30,041,000
========== ============
NOTE 3. INTANGIBLE ASSETS
Upon original implementation of Statement of Financial Accounting Standards
("SFAS") No. 142, the Company determined that intangible assets related to the
value of contracts previously acquired in business combinations had an
indefinite life, and therefore were not amortized. After communication with the
SEC staff resulting in a reevaluation of the life of contract intangibles, the
Company decided to restate the consolidated financial statements as of and for
the year ended December 31, 2002, to amortize contract intangibles over a
fifteen-year life (the life assigned prior to the implementation of SFAS No. 142
on January 1, 2002). Intangible assets originally determined to have indefinite
lives totaled $2,631,000 at December 31, 2002. The effect of the restatement
reduced total assets from $39,916,000, as originally reported at December 31,
2002, to $39,691,000, reduced total liabilities from $29,602,000 to $29,517,000
(due to income tax effects) and therefore reduced stockholders' equity from
$7,138,000 to $6,998,000. The restatement also reduced net income from
$1,261,000, or $0.22 per diluted share, to $1,121,000, or $0.20 per diluted
share.
Accumulated amortization expense on intangible assets was $960,378 and
$734,937 for the years ended December 31, 2003 and 2002, respectively.
Page 26
AVALON CORRECTIONAL SERVICES, INC
NOTE 4. OTHER ASSETS
Other assets consist of the following at December 31:
2003 2002
----------- --------------
Debt issue costs, net $ 704,000 $ 713,000
Other 263,000 212,000
------------ ------------
$ 967,000 $ 925,000
============ ============
NOTE 5. ACCOUNTS PAYABLE, ACCRUED LIABILITIES AND OTHER
The elements of accounts payable, accrued liabilities and other as of
December 31, 2003 and 2002 are as follows:
2003 2002
------------ ------------
Trade accounts payable $ 329,000 $ 158,000
Accrued interest payable 121,000 141,000
Accrued taxes 752,000 427,000
Accrued salary and benefits 717,000 660,000
Other accrued liabilities 71,000 74,000
--------- ---------
$1,990,000 $1,460,000
NOTE 6. CORRECTIONAL CONTRACTS
The Company contracts with various governmental agencies to provide
correctional services. The contracts generally specify for the Company to
provide correctional services including complete residential services and
programming in the Company's facilities ("Residential Services"). Compensation
paid to the Company for Residential Services is generally based on a per person,
per day basis. Contract revenues from contracts exceeding 10% of total Company
revenue for the years ending December 31, are as follows:
2003 2002 2001
---------- --------- ----------
Governmental Agency A 31% 24% 27%
Governmental Agency B 27% 24% 24%
Governmental Agency C 0% 13% 15%
Governmental Agency D 24% 24% 18%
The Company's current Residential Services contracts with the Oklahoma
Department of Corrections extend through June 30, 2004. The Company has a
fifteen-year Residential Services contract with West Texas Community Supervision
and Corrections Department extending through August 31, 2011. The Company has a
Residential Services contract and a Halfway House Services Contract with the
Texas Department of Criminal Justice Parole Department to provide correctional
services in El Paso, Texas through August 2005, with two additional two-year
option periods. The Texas Department of Criminal Justice issued a new contract
for Halfway House Services at the Austin Transitional Center that extends
through August of 2005, with two option periods of two years each. The Company's
contract with the Oklahoma Office of Juvenile Affairs expired in December 2002.
The Company's current contracts with the Colorado Department of Corrections
extend through June 30, 2008.
Page 27
AVALON CORRECTIONAL SERVICES, INC
NOTE 7. LONG-TERM DEBT AND REDEEMABLE COMMON STOCK
Long-term debt consists of the following:
December 31,
------------------------
2003 2002
--------- --------
Senior credit facility:
revolvoing line of credit $ 40,000 $ 1,423,000
term loan 11,034,000 11,024,000
Notes payable to banks and finance companies,
collaterized by transportation equipment, due
in stallments through March 2012 with interest
ranging from 209% to 11.0% 1,110,000 1,411,000
Note payable to an investment company,
uncollateralized;
interest at 12.5% payable quarterly; principal
due in four quarterly installments beginning
December 31, 2005; includes unaccreted
original issue premium 10,151,000 10,202,000
---------- ----------
$ 22,335,000 $ 24,060,000
Less - current maturities 2,030,000 3,515,000
---------- ----------
$ 20,305,000 $ 20,545,000
========== ===========
The aggregate maturities of long-term debt for each of the next five years
are as follows: 2004: $2,030,000; 2005: $12,353,000; 2006: $7,610,000; 2007:
$32,000; 2008: $33,000 and $277,000 thereafter.
The Company has a senior credit facility collateralized by certain assets
of the Company with Fleet Capital consisting of a term loan and a revolving line
of credit equal to the lesser of $3,000,000 or 80% of eligible accounts
receivable. At December 31, 2003, the outstanding balances were $11,034,000 on
the term loan and $40,000 under the revolving line of credit. The term loan
requires principal payments in the amount of $355,000 plus interest on the first
day of each calendar quarter. The remaining principal outstanding, together with
any and all other amounts due, shall be due and payable on February 25, 2005.
The interest rate on the senior credit facility is comprised of a base rate
margin and LIBOR margin, which varies in relation to the senior debt to EBITDA
ratio. At December 31, 2003, the rate was approximately 4.75% on the senior
credit facility. The senior credit facility contains certain covenant
requirements that the Company must maintain. The covenants are based on a
trailing twelve month period and are comprised of a required fixed coverage
ratio; a liabilities to tangible net worth ratio; a maximum ratio of
indebtedness to EBITDA; a required minimum EBITDA and a limit on certain capital
expenditures. The Company was in compliance with all debt covenants at December
31, 2003.
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 records adjustments to the estimated redemption price of the stock by
periodic charges / credits to additional paid-in capital.
Page 28
AVALON CORRECTIONAL SERVICES, INC
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. Certain of the Company's indebtedness is personally
guaranteed by the Chief Executive Officer as a requirement of the lenders. The
Company was in compliance with all debt covenants at December 31, 2003.
NOTE 8. 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%, payable semi-annually, 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 9. 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 the 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 expired in September 2002.
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 10. 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, and
further amended its plan on May 21, 2003, increasing the number of shares
available to 700,000. Non-statutory options have been granted providing for
the issuance of 692,660 shares of Class A common stock at exercise prices
ranging from $1.32 to $4.25 per share. Options providing for the issuance of
561,887 shares were exercisable at December 31, 2003.
Page 29
AVALON CORRECTIONAL SERVICES, INC
A summary of the status of the Company's stock option plan as of December
31, 2003, 2002 and 2001, and changes during the years ending on those dates is
presented below.
2003 2002 2001
Weighted Weighted Weighted
Average Average Average
Shares Exercise Shares Exercise Shares Exercise
------ -------- ------ -------- ------ --------
Outstanding at
beginning of year 505,832 $ 1.83 461,060 $ 1.69 479,610 $ 1.69
Granted 216,110 1.37 104,500 2.31 96,700 1.70
Exercised (1,952) 1.70 (47,378) 1.65 (81,994) 1.56
Forfeited (27,330) 1.73 (12,350) 1.88 (33,256) 1.70
-------- -------- --------
Outstanding at end
of year 692,660 1.69 505,832 1.83 461,060 1.69
======== ======== =======
Options exercisable
at year end 561,887 1.73 441,490 1.79 380,028 1.71
======== ======== =======
Weighted average fair
of Options granted ----------- ----------- -----------
during the year $ 1.37 $ 1.24 $ 1.37
=========== =========== ===========
The following table summarizes information about fixed-price stock options
outstanding at December 31, 2003.
Options Outstanding Options Exercisable
------------------- -------------------
Weighted
Average Weighted Weighted
Number Remaining Average Number Average
Outstanding Contractual Exercise Exercisable Exercise
at 12/31/03 Life (years) Price at 12/31/03 Price
----------- ------------ ----- ----------- -----
Range of exercise
price
$1.50 to $2.25 594,460 6.98 $ 1.58 482,048 $ 1.63
$2.26 to $3.39 96,200 8.19 $ 2.32 77,839 $ 2.33
$3.40 to $4.25 2,000 4.13 $ 4.00 2,000 $ 4.00
------- -------
$1.50 to $4.25 692,660 561,887
======= =======
NOTE 11. ACQUISITIONS AND CONTRACTS
On September 1, 2002, the Company began managing the Roy K. Robb facility
in San Angelo, Texas. The operation of the 40-bed facility was governed by a
contract with Tom Green County in Texas. Roy K. Robb is a post-adjudication
juvenile substance abuse facility contracting with surrounding counties to house
and rehabilitate youth. The contract to operate the facility extended for five
years, contained an option to extend for another five years, and allowed a
120-day notice of termination. After giving appropriate notice to Tom Green
County, the Company opted to terminate its contract and ceased operation of the
facility on March 31, 2003.
The Company acquired the assets and operations of the Austin Transitional
Center in Del Valle, Texas in December 2001. The Center was acquired from an
entity owned by an officer of the Company. The Center was acquired by the entity
upon approval of a Texas bankruptcy court. The terms of the acquisition to the
Company were identical to the terms of the acquiring entity. The Austin
Transitional Center is a community corrections center contracting with the Texas
Department of Criminal Justice. The facility consists of thirteen modular
buildings located on leased land. The land is leased from a third party for a
period of five years with a renewal option of five years. The acquisition price
was approximately $71,000 and included the assumption of a contract, with the
Texas Department of Criminal Justice, that originally extended to August 2003.
The Texas Department of Criminal Justice issued a new contract award for Halfway
House services at the Austin Transitional Center extending through August 2005,
with two option periods of two years each. The financial results of the
operation were included in the Company's financial statements beginning in
December 2001.
Page 30
AVALON CORRECTIONAL SERVICES, INC
The Company signed a contract with the Tulsa County Criminal Justice
Authority in April 2001 to lease the Riverside Intermediate Sanction Unit in
Tulsa. The costs to renovate the building were paid jointly by the Authority and
the Company. The Company's share of the renovation costs was approximately
$1,000,000. Approximately $900,000 of the costs was financed with the Company's
senior lender. The cost of the renovations is being amortized over the
twenty-year term of the lease. Renovation was completed in December 2001 and the
facility began receiving offenders in December 2001.
The Oklahoma Office of Juvenile Affairs, in a cost-cutting move, did not
exercise the option for the final year of a five-year contract providing for the
care of 80 juveniles at the Union City Juvenile Center. The contract expired on
December 2, 2002 and as of March 2004, the facility's only use is as an overflow
center for weekend clients assigned to the Carver Center. This is the first time
the Company has not had a multi-year contract extension renewed. The contract is
the only one the Company had with this agency. The Company at December 31, 2003
was actively seeking a permanent replacement population. The Company entered
into an asset purchase agreement to sell the Union City facility in February
2004. The sale is subject to certain customary conditions as well as the Buyer's
ability to obtain financing, receive appropriate licenses, certifications,
permits, zoning and a contract for a client population for the facility. The
asset purchase agreement is scheduled to close on or before June 25, 2004. The
asset purchase agreement is expected to result in proceeds in excess of the
carrying value of the Union City facility. Should the contract not close or be
extended, the Company will review the carrying value of the facility and
determine if an impairment of the carrying value will be required during the
second quarter of 2004.
NOTE 12. EARNINGS PER SHARE
The following table sets forth the computation of earnings per share
and earnings per share assuming dilution for the years ended December 31:
2003 2002 2001
---------- ------------- ------------
Numerator
Net income-basic $ 1,174,000 $ 1,121,000 $ 1,325,000
Effect of dilutive securities,
net of income tax:
- interest reduction on assumed
debenture conversions 173,000 173,000 289,000
------- ------- -------
Numerator for earnings per share
assuming dilution $ 1,347,000 $ 1,294,000 $ 1,614,000
=========== =========== ===========
Denominator for earnings per share:
Weighted average shares
outstanding-basic 4,896,196 4,891,942 4,808,067
Effect of dilutive securities:
-debenture conversions 1,283,333 1,283,333 1,283,333
-stock options 8,093 68,149 62,919
-stock warrants --- 201,220 178,288
--------- -------- --------
Denominator for earning per share
assuming dilution 6,187,622 6,444,644 6,332,607
========== ========= =========
Earnings per share, bsic $ 0.24 $ 0.23 $ 0.28
========== ========= =========
Earnings per share assuming dilution $ 0.22 $ 0.20 $ 0.25
========== ========= =========
Outstanding options and warrants of 477,850, 103,500 and 203,539 for the
periods ended December 31, 2003, 2002 and 2001, respectively, have been excluded
from the above calculations as they would be anti-dilutive. The weighted average
price of the anti-dilutive options and warrants were $1.84, $2.26 and $3.76 for
the periods ended December 31, 2003, 2002 and 2001, respectively.
Page 31
AVALON CORRECTIONAL SERVICES, INC
NOTE 13. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts and estimated fair values of the Company's financial
instruments, none of which were held for trading purposes, were as follows:
For the Years Ended December 31,
-----------------------------------------------------
2003 2002
------------------------------- -------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------------ ------------ --------- ----------
Financial Assets
Cash and cash equivalents $ 1,015,000 $ 1,015,000 $ 1,250,000 $ 1,250,000
=========== =========== =========== =========
Certficates of Deposit 1,600,000 1,600,000 1,800,000 1,800,000
=========== =========== =========== =========
Financial liabilities
Variable rate debt $ 11,372,000 $ 11,372,000 $ 12,448,000 $ 12,448,000
=========== =========== =========== ===========
Fixed rate debt $ 10,963,000 $ 12,345,000 $ 11,612,000 $ 13,070,000
=========== =========== =========== ===========
Convertible debentures $ 3,850,000 $ 4,430,000 $ 3,850,000 $ 4,430,000
=========== =========== =========== ===========
Redeemable common stock $ 2,628,000 $ 2,628,000 $ 3,176,000 $ 2,369,000
=========== ========== =========== ===========
The fair values presented represent management's best estimates and may not
be substantiated by comparisons to independent markets and, in many cases, could
not be realized in immediate settlement of the instruments. Certain financial
instruments and all non-financial instruments are not required to be disclosed;
therefore, the aggregate fair value amounts presented do not purport to
represent the underlying fair value of the Company.
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to estimate
that value.
Cash and Cash Equivalents - The carrying amounts reported in the
accompanying consolidated balance sheets for cash and cash equivalents
approximate fair value due to the highly liquid nature of the instruments.
Certificates of Deposit - The carrying amounts reported in the accompanying
consolidated balance sheets for certificates of deposit approximate fair value
due to the liquid nature of the instruments.
Variable Rate Debt - The carrying value of variable rate debt approximates
fair value due to the variable rate nature of the instruments.
Fixed Rate Debt - Fair values of fixed rate debt were calculated using
interest rates in effect as of each year end with the other terms of the debt
unchanged.
Convertible Debentures - Fair value of convertible debentures was
calculated using interest rates in effect as of each year-end with the other
terms unchanged.
Redeemable Common Stock - Fair value of redeemable common stock is
calculated assuming exercise of the purchase option under the terms of the stock
purchase agreement at December 31, 2003 and 2002.
Page 32
AVALON CORRECTIONAL SERVICES, INC
NOTE 14. INCOME TAX
Income tax expense consists of the following for the years ended
December 31:
2003 2002 2001
----------- ---------- ---------
Current:
Federal $ 535,000 $ 357,000 $ ---
State 62,000 41,000 ---
--------- --------- ----------
597,000 398,000 ---
Deferred:
Federal 12,000 132,000 ---
State 2,000 17,000 ---
---------- --------- ----------
14 ,000 149,000 ---
---------- --------- ----------
Total $ 611,000 $ 547,000 $ ---
========== ========== ===========
The following is a reconciliation of the provision for (benefit from)income
taxes from continuing operations computed by applying the Federal statutory
rate of 34% and the effective income tax rate for the years ended December 31:
2003 2002 2001
--------- -------- ---------
Provision for income taxes at $ 607,000 $ 567,000 $ 451,000
State income taxes, net of 31,000 67,000 ---
Nondeductible expenses 11,000 19,000 14,000
Change in valuation allowance 0 (73,000) (523,000)
Change in prior year estimate (38,000) (33,000) 58,000
--------- -------- ---------
Total provision for income $ 611,000 $ 547,000 $ ---
=========================================================================
Deferred tax assets and
liabilities are as follows
at December 31:
2003 2002
--------- -----------
Deferred tax assets related to:
Investee losses $ 343,000 $ 344,000
Accruals and allowances 78,000 64,000
--------- ----------
421,000 408,000
Less: Valuation allowance --- ---
--------- ----------
Deferred tax assets 421,000 408,000
Deferred tax liabilities related
Property and equipment (518,000) (491,000)
---------- ----------
Net deferred tax asset $ (97,000) $ (83,000)
========== ==========
Page 33
AVALON CORRECTIONAL SERVICES, INC
The Company's deferred tax assets and liabilities are included in the
accompanying consolidated balance sheets at December 31, 2003 and 2002 as
follows.
December 31,
----------------------------
2003 2002
------------ --------------
Deferred income taxes (included in other
assets) $ 78,000 $ 64,000
Deferred income taxes (non-current liability) (175,000) (147,000)
--------- ---------
Net deferred tax asset (liability) $(97,000) $ (83,000)
======== =========
The valuation allowance on tax assets decreased $73,000 in 2002 and
$523,000 in 2001. The decrease in valuation allowance in 2002 and 2001 was
primarily due to the utilization of net operating loss carry forwards.
NOTE 15. RELATED PARTY TRANSACTIONS
The Company occasionally utilizes previously owned transportation equipment
for use in its operations. The lenders providing financing for this equipment
require the debt to be secured by the personal guarantee of the Company's Chief
Executive Officer. In these situations the Company has leased certain vehicles
from an entity controlled by the Chief Executive Officer. The Company made
payments pursuant to such leases of $53,000, $64,000 and $33,000 during 2003,
2002 and 2001, respectively.
The Company executed an agreement to manage the operations of an entity
owned by an affiliate in November 2000. Fees received under this agreement
totaled $0, $180,000 and $548,000 for the years ended December 31, 2003, 2002
and 2001, respectively.
Certain of the Company's indebtedness is personally guaranteed by the Chief
Executive Officer as a requirement of the lenders.
NOTE 16. COMMITMENTS AND CONTINGENCIES
Total lease expense was $458,000, $220,000 and $109,000 for 2003, 2002 and
2001, respectively, under all operating leases. The future minimum lease
payments are as follows: 2004 - $329,000, 2005 - $183,000, 2006 - $157,000, 2007
- - $105,000, 2008 - $7,000.
The Company holds a 15% equity interest in an assisted living center and
has guaranteed debt related to the building of the investee and has pledged
$1,600,000 in certificates of deposit for the guarantee. The Company has
recognized losses of the investee and has reduced its carrying value in the
investment to zero. The outstanding debt balances were approximately $1,600,000
and $1,700,000 at December 31, 2003 and 2002, respectively. The Company would
have the right to sell the living center as a going concern and use any
proceeds, after payment of debts, to recover amounts owed to it by the living
center in the event of default of the debt payments. The Company expects that
the appraised value of the living center will exceed the existing debt. The
Company believes the consolidation of this entity will be required under FIN 46,
as revised by FIN 46 (R) at March 31, 2004 (see Note 1) and if after
consolidation, the Company would sell the asset for less than the carrying value
at that time, the Company could be required to recognize a loss on the
disposition of the asset. Total assets of the assisted living center totaled
approximately $1,600,000 as of December 31, 2003 and losses for the year ended
December 31, 2003 equaled $110,000.
The Company executed a three-year employment agreement with the Company's
CEO in 1997. The agreement provides for compensation at a base rate and
increases to be determined on an annual basis by the Board of Directors. The
agreement also contains provisions for severance pay and disability payments, as
well as a non-compete agreement preventing the CEO from engaging in a business
deemed similar to that of the Company. The Board of Directors extended this
agreement for three additional years in December 2001. The Company terminated
its deferred compensation plan for key executives in 2002.
Page 34
AVALON CORRECTIONAL SERVICES, INC
NOTE 17. 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.
The Company was awarded a judgment in late 2003 in the amount of
approximately $356,000 including prejudgment interest and attorney fees and
expenses. This judgment was awarded to the Company on a contract claim.
According to Oklahoma Statutes, the payment for such judgment is to be paid in
one-third installments annually, subject to the tax levy becoming final (which
occurred in the fourth quarter) and pursuant to the collection thereof. The
Company recorded a receivable of approximately $356,000 included as additional
revenues in 2003 related to this judgment.
NOTE 18. SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Selected quarterly financial data for each of the quarters in the years
ended December 31, 2003 and 2002 is as follows:
First Second Third Fourth Totals
----------- --------- --------- --------- -----------
2003
- ---------------------------
Total revenues $ 6,170,000 $ 6,112,00 $ 6,346,00 $ 6,632,000 $ 25,260,000
========== ========= ========= ========== ===========
Net income $ 260.000 $ 252,000 $ 311,000 $ 351,000 $ 1,174,000
========== ========= ========= ========== ===========
Earnings per common share - basic $ .05 $ .05 $ .06 $ .08 $ .24
========== ========= ======== ========= ==========
Earnings per common share - diluted $ .05 $ .05 $ .06 $ .06 $ .22
========== ========= ========= ========== ===========
2002
- ---------------------------
Total revenues $ 6,625,00 $ 6,744,00 $ 6,878,000 $ 7,209,000 $ 27,456,000
========= ========= ========== ========== ===========
Net income $ 326,000 $ 269,000 $ 185,000 $ 341,000 $ 1,121,000
========= ========= ========== ========== ===========
Earnings per common share - $ .07 $ .06 $ .04 $ .06 $ .23
========= ========= ========== ========= ===========
Earnings per common share - $ .06 $ .05 $ .04 $ .05 $ .20
========= ========= ========= ========= ===========
Page 35
AVALON CORRECTIONAL SERVICES, INC
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
The Company's Principal Executive Officer and Principal Financial Officer
have reviewed and evaluated the effectiveness of the Company's disclosure
controls and procedures (as defined in Exchange Act Rule 240.13a-15(e)) as of
the end of the period covered by this report. Based on that evaluation, the
Principal Executive Officer and the Principal Financial Officer have concluded
that the Company's current disclosure controls and procedures are effective to
ensure that information required to be disclosed by the Company in reports it
files or submits under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission's rules and forms. There was no change in the Company's internal
controls that occurred during the fourth quarter of the period covered by this
report that has materially affected, or is reasonably likely to affect, the
Company's internal controls over financial reporting.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
MANAGEMENT -
Name Age Position(s) with the Company
Donald E. Smith ..............51 Chief Executive Officer and Director
James L. Saffle ..............51 President
Patrick Sullivan .............37 Vice President of Texas Operations
Thomas M. Sullivan ...........45 Vice President of Colorado Operations
Randall J. Wood ..............45 Corporate Secretary, Vice President,
and Counsel
Tiffany Smith ................36 Vice President of Corporate
Communications
David Grose... ...............51 Vice President of Finance
Eric Gray ....................47 Vice President and Counsel
Robert O. McDonald ...........65 Director
Mark S. Cooley ...............46 Director
James P. Wilson ..............45 Director
Charles W. Thomas ............60 Director
Directors and Officers of the Company -
The following is a brief description of the business experience of each of
the above-named persons:
Donald E. Smith is the Chairman, Founder, and Chief Executive Officer of
Avalon Correctional Services and its subsidiaries. Mr. Smith has served as CEO
since the inception of the Company. Mr. Smith has owned, managed and developed a
number of private corporations since 1985 to provide private corrections, health
care and other related services. Mr. Smith has a Bachelor of Science degree in
Accounting with minors in Economics and Business Administration from
Northwestern State College. Mr. Smith was employed by Arthur Andersen & Co. for
seven years prior to founding the Company.
James L. Saffle is President of the Company and its subsidiaries. Mr.
Saffle oversees the Company's operating facilities throughout three states.
Prior to joining the Company in 2001, Mr. Saffle retired as Director of the
Oklahoma Department of Corrections, where he was instrumental in leading the
department through a period of tremendous growth and change. His distinguished
career with the Oklahoma Department of Corrections began as a Corrections
Officer and progressed through the positions of sergeant, lieutenant, training
and safety officer, chief of security, deputy warden, and warden. He further
served the Oklahoma Department of Corrections in the capacities of Southeastern
Regional Director and Interim Director and ultimately was appointed as Director
of the Oklahoma Department of Corrections by the Oklahoma Board of Corrections.
Mr. Saffle holds a Bachelor of Science in Criminal Justice and Psychology, and a
Masters of Science degree in Human Resources.
Page 36
AVALON CORRECTIONAL SERVICES, INC
Patrick Sullivan is Vice President of Texas Operations and has over fifteen
years of experience in the field of criminal justice and security operations.
His expertise is in staff management, facility operations, risk management, and
rehabilitative programs. He currently has administrative responsibility and
oversight for the Company's Texas intermediate sanction secure and non-secure
correctional facilities. Before joining Avalon, Mr. Sullivan was Vice President
of Facility Operations, Unit Director for a multi-use secure facility,
Operations Director, and Life Skills Coordinator for the Texson Management
Group, Inc. Prior to Texson, he held positions as Captain at the Kyle Unit,
Assistant Shift Supervisor, and Correctional Officer for the Wackenhut
Corrections Corporation. He attended Sam Houston University in Huntsville,
Texas, and San Antonio College.
Thomas M. Sullivan is Vice President of Colorado Operations. Mr. Sullivan
is a 24 year veteran of law enforcement and corrections, having worked at the
Montana State Prison, at the Alpha Center as Community Corrections provider, and
in Denver as a Parole Officer and Parole Supervisor. He is a nationally
recognized speaker on gangs and has co-authored a research book on the Racist
Asatru Religion. Mr. Sullivan continues to be the Colorado State Coordinator for
the National Major Gang Task Force. He is a veteran of the US Navy, and received
his bachelor's degree from the University of Hawaii. Mr. Sullivan was the 1994
Division of Adult Parole "Employee of the Year", received the Colorado STING
"Gang Officer of the Year" in 2002, and was the recipient of the Colorado
Association of Robbery Investigators "Lifetime Achievement" award in 2002.
Randall J. Wood joined Avalon in 1995 and serves as Corporate Secretary and
Counsel for the Company. Prior to joining the Company, Mr. Wood's practice was
focused primarily in the field of real property and commercial litigation. Mr.
Wood practiced with the firm of Stack & Barnes, P.C. for ten years, and was with
the firm of Hammons, Vaught, & Conner prior to joining the Company. Mr. Wood is
a member of the Oklahoma Bar Association and is authorized to practice in
Oklahoma Federal Courts and the Tenth Circuit Court of Appeals. Mr. Wood is
responsible for the duties of the Corporate Secretary, management of legal
matters, and compliance with government regulations for the Company and its
subsidiaries. Mr. Wood received his law degree from the University of Oklahoma
in 1983.
Tiffany Smith joined the Company in 1994 as the Public Information Officer
and was promoted to Assistant Corporate Secretary for the Company in 1997 and to
Vice President of Corporate Communications in 1999. Ms. Smith served for four
years as marketing manager for Eagle Picher Industries, a New York Stock
Exchange listed company, prior to joining Avalon. Ms. Smith has developed and is
responsible for directing the Company's Corporate Communications and Public
Relations department. Ms. Smith also developed and oversees Avalon's private-pay
program in Oklahoma. She is also responsible for responding to government
requests for proposals in Oklahoma, Colorado, and Texas. Ms. Smith is the
Company's primary contact for the Company's shareholders and investors. Ms.
Smith received a Bachelors Degree in Business Administration, Marketing and
Management from Missouri Southern State College. Ms. Smith is the spouse of
Donald Smith, Chief Executive Officer.
David Grose was appointed Vice President of Finance in January 2004. Mr.
Grose has overall responsibility for administration of the financial reporting
functions for the Company and subsidiaries. Mr. Grose is also responsible for
administration of the Company's human resources department, and other
administrative functions including GAAP and SEC compliance. Prior to joining
Avalon, he was Chief Financial Officer with Oxley Petroleum Company, formerly an
oil and gas exploration and development company, Vice President and Chief
Financial Officer for Amerivision Communications, a telecommunications company,
Vice President and Chief Financial Officer of Bayard Drilling Technologies,
formerly a publicly traded oil and gas drilling company and Director, Vice
President and Chief Financial Officer of Alexander Energy Corporation, formerly
a publicly traded oil and gas exploration and development company. Mr. Grose
graduated from Oklahoma State University with a Bachelor of Arts Degree in
Political Science and from the University of Central Oklahoma with a Masters
Degree in Business Administration.
Eric Gray joined Avalon as a Vice President in June 1999. Mr. Gray serves
as Corporate Counsel for the Company and is responsible for various
administrative functions. Mr. Gray's responsibilities include pending litigation
matters, contract review and State law compliance issues. Mr. Gray is also
responsible for administering and directing the Company's activities regarding
implementation of the Oklahoma Community Sentencing Act and the Oklahoma
mandated prison transition legislation. Before joining Avalon, he was Managing
Director and President of his law firm, Gray and Goresen, P.C., an associate and
shareholder/director of Edwards, Roberts & Propester, P.C., and an associate
with Kirk and Chaney. He graduated from the University of Pittsburgh with a
Bachelor of Arts degree. He holds his Juris Doctorate from Oklahoma City
University.
Page 37
AVALON CORRECTIONAL SERVICES, INC
Robert O. McDonald was appointed as a Director of Avalon in October 1994.
Mr. McDonald is Chairman of the Board of Directors of Capital West Securities
and its parent holding company, Affinity Holding Corp. Mr. McDonald started his
investment career in 1961 with Allen and Company and left in 1967 to form
McDonald Bennahum and Co., which later joined with Ladenburg Thalmann and Co.
where Mr. McDonald was a Senior Partner. Mr. McDonald joined Planet Oil Mineral
Corporation in 1971 and became president in 1973. From 1975 until 1993, Mr.
McDonald was affiliated with Stifel Nicolaus & Company and headed its municipal
syndicated effort. Mr. McDonald received a Bachelors Degree in Finance from the
University of Oklahoma in 1960. He also served as an Officer in the United
States Army and Army Reserve.
Mark S. Cooley was appointed as a Director of Avalon in January 1998. Mr.
Cooley is a Principal of Cooley & Company and Pro Trust Equity Partners. Mr.
Cooley was with Citicorp and Chemical Bank for twelve years in their Corporate
Finance Divisions in New York and Denver. Mr. Cooley received his Bachelors
degree in Economics from DePauw University and an MBA in Finance from Indiana
University.
James P. Wilson was appointed as a Director-elect of Avalon in September
1998, and was elected as a Director by shareholders at the 1999 annual meeting.
Mr. Wilson is a managing partner in the investment firm of Rice, Sangalis, Toole
& Wilson. Prior to founding Rice, Sangalis, Toole & Wilson, Mr. Wilson was a
vice president with First Texas Merchant Banking Group, and was also an audit
manager with Arthur Young & Co. Mr. Wilson received a BBA degree from Texas A&M
University, and is a Certified Public Accountant.
Charles W. Thomas, Ph.D. was appointed as a Director-elect of Avalon in
December 2000 and was elected as a Director by the shareholders at the 2001
annual meeting. Dr. Thomas received his B.S. degree from McMurry University in
1966 and his M.A. and Ph.D. degrees from the University of Kentucky in,
respectively, 1969 and 1971. After serving on the faculty of Virginia
Commonwealth University, the College of William and Mary, and Bowling Green
State University, he became a Professor of Criminology at the University of
Florida in 1980. He retired from his academic position in 1999 but continues to
publish the results of his on-going research on the economic, legal, and public
policy aspects of privatization. From 1997-2000, Dr. Thomas was a member of the
board of directors of Prison Realty Trust. Dr. Thomas is now Vice President for
Quality Assurance at ConnecGov, Inc., a privately held corporation that
specializes in computer-based training and distance learning.
Corporate Governance Items
Audit Committee Financial Expert
The information required by this Item is herein incorporated by reference
from the Company's Proxy Statement for the Annual Meeting of Shareholders
scheduled for May 19, 2004, which Proxy Statement is to be filed within 120 days
after December 31, 2003.
Audit Committee Composition and Independence
The information required by this Item is herein incorporated by reference
from the Company's Proxy Statement for the Annual Meeting of Shareholders
scheduled for May 19, 2004, which Proxy Statement is to be filed within 120 days
after December 31, 2003.
Code of Ethics for Chief Executive Officer and Senior Financial Officers
The Company has adopted a Code of Ethics for the Chief Executive Officer
and the Senior Financial Officers, violations of which should be reported to the
Audit Committee. The Code of Ethics is included within the Company's Proxy
Statement to be filed within 120 days of December 31, 2003, and is incorporated
herein by reference. Any amendment to or waiver of the application of the Code
of Ethics for the Chief Executive Officer and Senior Financial Officers will be
promptly disclosed on the Company's web site at www.avaloncorrections.com. The
information contained on or connected to the Company's Internet website is not
incorporated by reference into this Form 10-K and should not be considered part
of this or any other report that the Company files with or furnishes to the SEC.
Page 38
AVALON CORRECTIONAL SERVICES, INC
ITEMS 11, 12, 13 and 14.
The information required by these Items has been incorporated by Reference
from the Company's definitive proxy statement, which will be filed with the
Commission not later than 120 days after December 31, 2003.
ITEM 15. EXHIBITS AND REPORTS ON FORM 8-K.
3. i Articles of Incorporation (1)
ii Bylaws (1)
iii Articles of Amendment to Registrant's Articles of
Incorporation (2)
iv Amendment to Registrant's Articles of Incorporation dated
December 31, 1995
v Certificate of Corporate Resolutions, dated December 13, 1993,
regarding authorization of Class B Common Stock and
Amendment to Articles (3)
4. i Form of Stock Certificate (1)
ii Form of Convertible Debenture Agreement (6)
10. i Stock Option Plan adopted by Board of Directors on August
16, 1994 (4)
ii Change of Control Agreement between Donald E. Smith and
Avalon Community Services, Inc. dated August 25, 1997. (5)
iii Employment Agreement with Donald E. Smith dated August 8,
1997.(5)
iv Agreement dated June 1, 1998 between Southern Corrections
Systems, Inc. and the Texas Department of Criminal Justice.
(7)
v Financing agreement between Avalon Community Services,
Inc., and Fleet Capital Corporation dated February 25,
1999. (8)
vi Amended and Restated Loan and Security Agreement between
Avalon Correctional Services, Inc., et al., and Fleet
Capital Corporation, dated December 9, 1999. (10)
vii Agreement dated September 16, 1998, between Avalon
Community Services, Inc., and RSTW Partners III. (9)
21. i Subsidiaries of Registrant. The Registrant's wholly owned
subsidiary, Southern Corrections Systems, Inc., is the sole
member of The Villa at Greeley, L.L.C., a Colorado limited
liability company. Southern Corrections Systems, Inc., is
the sole voting member of Adams Community Corrections
Program, Inc., a Colorado nonprofit corporation.
31.1 CEO Certification required under Section 302 of Sarbanes-Oxley Act
of 2002.
31.2 CFO Certification required under Section 302 of Sarbanes-Oxley Act
of 2002.
32.1 CEO Certifications required under Section 906 of Sarbanes-Oxley Act
of 2002.
32.2 CFO Certifications required under Section 906 of Sarbanes-Oxley Act
of 2002.
(b) Reports on Form 8-K - none
Footnotes:
1) Incorporated herein by reference to the Registrant's Registration
Statement on Form S-18 dated March 26, 1991.
2) Incorporated herein by reference to the Registrant's Post
Effective Amendment No. 1 to Registration Statement on Form S-18
dated August 3, 1992.
3) Incorporated herein by reference to the Registrant's Form 10-KSB
for the fiscal year ended December 31, 1993 and dated March 24,
1994.
4) Incorporated herein by reference to the Registrant's Registration
Statement on Form SB-2 dated September 13, 1995 and amended.
Page 39
AVALON CORRECTIONAL SERVICES, INC
5) Incorporated herein by reference to the Registrant's Registration
Statement on Form S-2 Amendment No. 1 dated April 16, 1996 and
amended.
6) Incorporated herein by reference to the Registrant's Form S-2
dated December 22, 1997.
7) Incorporated herein by reference to the Registrant's Registration
Statement on Form S-2 dated September 14, 1998.
8) Incorporated by reference to the Registrant's Form 8-K dated
March 10, 1999.
9) Incorporated by reference to the Registrant's Form 8-K dated
October 1, 1998.
10) Incorporated by reference to the Registrant's Registration
Statement on Form S-2 dated March 24, 2000
Page 40
AVALON CORRECTIONAL SERVICES, INC
SIGNATURES.
In accordance with Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned, there unto duly authorized.
AVALON CORRECTIONAL SERVICES, INC.
By: s\ Donald E.Smith
Donald E. Smith
Chief Executive Officer and Director
Dated: April 9, 2004
In accordance with the Securities Exchange Act of 1934, this report has
been signed below by the following persons on behalf of the Registrant and in
the capacities and on the dates indicated.
By: s\ Donald E. Smith
Donald E. Smith
Chief Executive Officer and Director Dated: April 9, 2004
By: s\ Robert O. McDonald
Robert O. McDonald
Director Dated: April 9, 2004
By: s\ Mark S. Cooley
Mark S. Cooley
Director Dated: April 9, 2004
By: s\ James P. Wilson
James P. Wilson
Director Dated: April 9, 2004
By: s\ Charles W. Thomas, Ph.D.
Charles W. Thomas
Director Dated: April 9, 2004
By: s\ David Grose
David Grose
Vice President of Finance Dated: April 9, 2004
Page 41
AVALON CORRECTIONAL SERVICES, INC
ANNUAL CERTIFICATION
Exhibit 31.1
I, Donald E. Smith, Chief Executive Officer, certify that:
(1) I have reviewed this annual report on Form 10-K of Avalon Correctional
Services, Inc.;
(2) Based on my knowledge, this 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 report;
(3) Based on my knowledge, the financial
statements, and other financial information included in this 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 report;
(4) The registrant's other certifying officer and
I are responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for
the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed undeR our supervision
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
report is being prepared;
(b Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
(5) The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting,
to the registrant's auditors and the audit committee of the registrant's
board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: April 9, 2004 /s/ Donald E. Smith
Donald E. Smith
Chief Executive Officer
Page 42
AVALON CORRECTIONAL SERVICES, INC
ANNUAL CERTIFICATION
Exhibit 31.2
I, David Grose, Vice President of Finance, certify that:
(1) I have reviewed this annual eport on Form 10-K of Avalon Correctional
Services, Inc.;
(2) Based on my knowledge, this 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 report;
(3) Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects
the financial condition, results of operation an cash flows of the
registrant as of, and for, the periods presented in this report;
(4) The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision,
to ensure tha 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
report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
th case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5) The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit c ommittee of the registrant's
board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or
operation of interna control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: April 9, 2004 /s/ David Grose
David Grose
Vice President of Finance
Page 43
AVALON CORRECTIONAL SERVICES, INC
Exhibit 32.1
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 Annual Report of Avalon Correctional Services, Inc.
(the "Company") on Form 10-K for the period ended December 31, 2003, 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 results
of operations of the Company.
/s/ Donald E. Smith
Donald E. Smith
Chief Executive Officer
April 9, 2004
Page 44
AVALON CORRECTIONAL SERVICES, INC
Exhibit 32.2
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 Annual Report of Avalon Correctional Services, Inc.
(the "Company") on Form 10-K for the period ended December 31, 2003, as filed
with the Securities and Exchange Commission on the date hereof (the
"Report"), I, David Grose, Vice President of Finance, 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 results
of operations of the Company.
/s/ David Grose
David Grose
Vice President of Finance
April 9, 2004
Page 45