UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 or 15 (D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2004
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 of principal executive offices)
(405) 752-8802
(Issuer's telephone number)
Indicate by check mark whether the registrant issuer (1) 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 ______
As of November 9, 2004, 4,967,579 shares of the issuer's Class A common
stock, par value $.001, were issued and outstanding.
PART I - FINANCIAL INFORMATION
AVALON CORRECTIONAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September December
2004 2003
----------- --------------
ASSETS
Current assets:
Cash and cash equivalents $ 1,700,000 $ 1,015,000
Certificates of Deposit (pledged) 900,000 1,600,000
Accounts receivable, net 3,753,000 2,662,000
Prepaid expenses and other 408,000 426,000
Restricted cash - current 285,000 -
____________ ____________
Total current $ 7,046,000 $ 5,703,000
Assets held for sale 5,900,000 -
Property and equipment, net 26,145,000 30,636,000
Intangible assets, net 2,228,000 2,395,000
Other assets 2,174,000 967,000
Restricted cash - long term 1,010,000 -
_____________ ____________
Total assets $ 44,503,000 $ 39,701,000
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable, accrued liabilities $ 2,164,000 $ 1,990,000
Current maturities of long-term debt 1,693,000 2,030,000
_____________ ____________
Total current liabilities $ 3,857,000 $ 4,020,000
Long-term debt, less current maturities 24,465,000 20,305,000
Convertible debentures 3,850,000 3,850,000
Deferred income taxes 155,000 175,000
Redeemable common stock, $.001 par value
1,622,448 shares issued and outstanding 3,261,000 2,628,000
Stockholders' equity:
Common stock:Par value $.001; 24,000,000
shares authorized; 4,929,789
outstanding, less 1,622,448 shares
subject to repurchase 3,000 3,000
Preferred stock; par value $.001;
1,000,000 shares authorized;
none issued - -
Paid-in capital 7,878,000 8,459,000
Retained Earnings 1,034,000 261,000
=========== ==========
Total liabilities and
stockholder's equity $44,503,000 $39,701,000
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
Page 1
AVALON CORRECTIONAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
__________ __________ ___________ __________
Revenues $6,888,000 $6,346,000 $20,151,000 $18,628,000
__________ __________ ___________ __________
Costs and expenses
Direct operating 4,830,000 4,440,000 13,702,000 13,042,000
General and
administrative 465,000 384,000 1,440,000 1,214,000
Depreciation and
amortization 429,000 543,000 1,344,000 1,299,000
Early Retirement
of Debt 439,000 - 439,000 -
Interest expense 444,000 339,000 1,661,000 1,522,000
__________ _________ __________ __________
Income from continuing
operations before
income tax
expense $ 281,000 $640,000 $1,565,000 $1,551,000
Income tax expense 99,000 198,000 586,000 558,000
__________ ________ __________ __________
Income from continuing
operations $ 182,000 $ 442,000 $979,000 $ 993,000
Discontinued operations,
net of income taxes (158,000) (131,000) (206,000) (170,000)
__________ _________ __________ ___________
Net income $ 24,000 $ 311,000 $ 773,000 $ 823,000
========== ========= ========== ===========
Net income (loss) per
share, basic
Continuing operations $ 0.03 $ 0.09 $ 0.20 $ 0.20
========== ========= ========= ===========
Discontinued operations $ (0.03) $ (0.03) $ (0.04) $ (0.03)
========== ========= ========= ===========
Total $ - $ 0.06 $ 0.16 $ 0.17
========== ========= ========= ===========
Net income (loss) per
share diluted
Continuing operations $ 0.03 $ 0.09 $ 0.19 $ 0.20
========== ========= ========= ===========
Discontinued operations $ (0.03) $ (0.03) $ (0.04) $ (0.03)
========== ========= ========= ===========
Total $ - $ 0.06 $ 0.15 $ 0.17
========== ========= ========= ===========
The accompanying notes are an integral part of these consolidated financial
statements.
Page 2
AVALON CORRECTIONAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(Unaudited)
For the nine months ended September 30,
2004 2003
___________ ___________
OPERATING ACTIVITIES:
Net income $ 773,000 $ 823,000
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 1,344,000 1,299,000
Amortization of debt issue costs 218,000 200,000
Early retirement of debt (non-cash) 313,000 -
Loss (gain) on sale of property (13,000) 14,000
Changes in operating assets and
liabilities:
Decrease (increase) in:
Accounts receivable (1,091,000) (603,000)
Prepaid expenses and other (1,141,000) (148,000)
Restricted cash - current (285,000) -
Increase (decrease) in:
Accounts payable, accrued liabilities, 154,000 107,000
and other ___________ __________
Net cash provided by operating activities $ 272,000 $ 1,692,000
___________ __________
INVESTING ACTIVITIES:
Capital expenditures (883,000) (2,017,000)
Proceeds from the disposition of property 35,000 67,000
____________ ___________
Net cash used in investing activities $ (848,000) $(1,950,000)
____________ ____________
FINANCING ACTIVITIES:
Proceeds from borrowings 46,127,000 21,758,000
Repayment of borrowings (43,908,000) (21,893,000)
Reserved cash due to Bonds (1,010,000) -
Proceeds from warrant and option exercise 52,000 4,000
____________ ____________
Net cash provided by (used in) $ 1,261,000 $ (131,000)
financing activities ____________ ____________
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 685,000 (389,000)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 1,015,000 1,250,000
____________ ____________
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 1,700,000 $ 861,000
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
Page 3
AVALON CORRECTIONAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1. BASIS OF PRESENTATION
Interim Financial Statements -
The unaudited consolidated financial statements included herein have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission. Accordingly, certain disclosures normally included in financial
statements prepared in conformity with accounting principles generally accepted
in the United States of America have been omitted. The accompanying unaudited
consolidated financial statements and notes should be read in conjunction with
the Company's audited financial statements for the year ended December 31, 2003
and the notes thereto contained in the Company's Form 10-K filing for the year
ended December 31, 2003. The results of operations for the three months and nine
months ended September 30, 2004, are not necessarily indicative of the results
that may be expected for the entire year ended December 31, 2004.
The consolidated balance sheet as of September 30, 2004, the statements of
operations for the three and nine months ended September 30, 2004 and 2003 and
the statements of cash flows for the nine months ended September 30, 2004 and
2003 are unaudited and, in the opinion of management, reflect all adjustments
that are necessary for a fair presentation of the financial position as of such
date and the results of operations and cash flows for the periods then ended.
All such adjustments are of a normal and recurring nature.
Stock-Based Compensation -
The Company has a stock-based compensation plan. The Company accounts for
this plan under the recognition and measurement principles of APB Opinion No.
25, Accounting for Stock Issued to Employees, and related Interpretations. No
stock-based employee compensation cost is reflected in net income, as all
options granted under this plan had an exercise price equal to the market value
of the underlying common stock on the date of grant. The following table
illustrates the effect on net income and earnings per share if the Company had
applied the fair value recognition provisions of FASB Statement No. 123,
Accounting for Stock-Based Compensation, to stock-based employee compensation.
Three months ended September 30, Nine months ended September 30,
---------------------------------------------------------------------
2004 2003 2004 2003
--------------------------------- --------------------------------
Net income, as reported $ 24,000 $ 311,000 $ 773,000 $ 823,000
Deduct: Total stock-based
employee compensation expense
determined under fair value based
method for all awards, net of
related tax effects 10,000 22,000 29,000 66,000
----------- ----------- ---------- ------------
Pro forma net income $ 14,000 $ 289,000 $ 744,000 $ 757,000
=========== =========== ========== ============
Earnings per share:
Basic - as reported $ - $ 0.06 $ 0.16 $ 0.17
============ =========== ========== ===========
Basic - pro forma $ - $ 0.05 $ 0.15 $ 0.15
============ =========== ========== ===========
Diluted - as reported $ - $ 0.06 $ 0.15 $ 0.17
============ =========== ========== ===========
Diluted - pro forma $ - $ 0.05 $ 0.14 $ 0.15
============ =========== ========== ===========
Page 4
NOTE 2. LONG-TERM DEBT
Long-term debt consists of the following:
September 30, December 31,
2004 2003
------------- ------------
Senior credit facility:
revolving line of credit $ - $ 40,000
term loan 4,500,000 11,034,000
Notes payable to banks and finance companies,
collateralized by transportation equipment,
due in installments through March 2012
with interest ranging from 4.85% to 8.75% 858,000 1,110,000
Note payable secured by certificate of deposit 900,000 -
Note payable to an investment company,
uncollateralized; includes unaccreted
original issue premium - 10,151,000
Note payable from Bond proceeds 19,900,000 -
------------- -----------
$26,158,000 $ 22,335,000
Less - current maturities 1,693,000 2,030,000
------------- -----------
$24,465,000 $ 20,305,000
============= ============
On July 15, 2004, Adams County, Colorado issued $19,900,000 of bonds ("the
Bonds") and loaned the proceeds to a subsidiary of the Company. The Bonds were
issued at par, bear interest at rates ranging from 8.375% to 10.25% and mature
on various dates between August 1, 2011 and August 1, 2024. The Bonds contain
certain covenant requirements that the Company must maintain. The Company was in
compliance with all covenants at September 30, 2004.
On September 28, 2004, the Company entered into a credit agreement with
Bank of America, N.A. The new credit facility consists of a term loan in the
amount of $4,500,000 and a revolving line of credit in the amount of $1,000,000.
Both portions of the credit facility bear interest at the 30 day LIBOR rate plus
2.5%. At September 30, 2004, the interest rate was approximately 4.4%. The
credit facility contains certain covenant requirements that the Company must
maintain. The Company was in compliance with all debt covenants at September 30,
2004.
At December 31, 2003, the Company had 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. The interest rate on the senior credit
facility was comprised of a base rate margin and LIBOR margin, which varied in
relation to the senior debt to EBITDA ratio. At December 31, 2003, the rate was
approximately 4.75% on the senior credit facility. As of September 30, 2004, the
senior credit facility with Fleet Capital has been repaid in full.
Page 5
Included in long-term debt on December 31, 2003, was the remaining portion
of a $15,000,000 private placement of debt and equity with an investment
company, which occurred 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 at 14.5%. The Company also tendered 1,622,448
shares of redeemable common stock to the investment company. These shares are
subject to repurchase by the Company under certain circumstances, or beginning
September 16, 2003, at the holders option, at the then current average traded
price of the stock. The Company is accreting the difference between the carrying
value and the estimated redemption price of the stock by periodic charges /
credits to additional paid-in capital. The Company obtained an independent fair
value appraisal of the equity instrument reflecting a fair value allocation of
the redeemable common stock of $4,635,000.
NOTE 3. 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 646,560
shares of Class A common stock at exercise prices ranging from $1.32 to $4.25
per share. Options providing for the issuance of 576,956 shares were exercisable
at September 30, 2004.
NOTE 4. LITIGATION AND CONTINGENCIES
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.
NOTE 5. RESTRICTED CASH
The Company is required to hold cash in reserve in four trust accounts
applicable to the Bonds; (i) a debt service reserve fund, in the amount of
$995,000 at September 30, 2004, (ii) a major maintenance reserve fund, in the
amount of $15,000 at September 30, 2004, (iii) a bond fund, which includes a
principal account, in the amount of $50,000 at September 30, 2004, and (iv) a
revenue fund in the amount of $235,000 at September 30, 2004. Funds (i) and (ii)
are classified as long term restricted cash, and funds (iii) and (iv) are
classified as current restricted cash.
Page 6
NOTE 6. EARNINGS PER SHARE
The following table sets forth the computation of earnings per share and
earnings per share assuming dilution.
Three months ended Nine months ended
September 30, September 30,
2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------------
Numerator:
Net income - basic $ 24,000 $ 311,000 $ 773,000 $ 823,000
Numerator for earnings per share, diluted $ 24,000 $ 311,000 $ 773,000 $ 823,000
========== ========== =========== ===========
Denominator for earnings per share:
Weighted average shares outstanding - basic 4,929,789 4,896,615 4,911,977 4,895,545
Effect of dilutive securities:
- stock options 123,852 7,799 145,811 2,364
- stock warrants 201,220 - 229,167 -
Denominator for earnings per share, diluted $ 5,254,861 $ 4,904,414 $ 5,286,955 $4,897,909
=========== =========== =========== ==========
Earnings per share, basic $ - $ 0.06 $ 0.16 $ 0.17
=========== =========== =========== ==========
Earnings per share, diluted $ - $ 0.06 $ 0.15 $ 0.17
=========== =========== =========== ==========
Number of outstanding convertible debentures,
warrants and options excluded from the above
calculations as they would be anti-dilutive 1,434,833 2,581,113 1,434,833 2,581,113
NOTE 7. RECENTLY ADOPTED ACCOUNTING STANDARDS
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 became 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 postponed the date on which
the interpretation became applicable to March 31, 2004.
The Company identified one non-consolidated entity as a VIE where the
Company is considered the primary beneficiary (see Note 8). In accordance with
the provisions of FIN 46, as revised, the Company has consolidated this VIE as
of January 1, 2004. Consolidation of this VIE did not 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 issuance of SAB No. 104
did not significantly impact the Company's current revenue recognition policies.
Page 7
NOTE 8. ASSETS HELD FOR SALE AND DISPOSITION
Assets held for sale are valued on an asset-by-asset basis at the lower of
the carrying amount or fair value, less costs to sell, and consist of property
and equipment. In estimating fair value, management considered the pending
status of the Union City facility and the appraised value of the assisted living
center. The Company anticipates a sale of the Union City facility will result in
proceeds in excess of its carrying value.
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
$900,000 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 $900,000
and $1,665,000 at September 30, 2004 and 2003, respectively. The Company would
have the right to sell the assisted living center as a going concern and use any
proceeds, after payment of debts, to recover amounts owed to it by the assisted
living center in the event of default of the debt payments. The appraised value
of the assisted living center exceeds the carrying value and the existing debt.
The Company has consolidated this entity under FIN 46, as revised by FIN 46 (R)
as of January 1, 2004 (see Note 7) and if the Company would sell the asset for
less than the carrying value, the Company could be required at that time to
recognize a loss on the disposition of the asset. Total assets of the assisted
living center totaled approximately $1,617,000 as of September 30, 2004. Gains
for the nine months ended September 30, 2004 equaled $50,000, and gains for the
three months ended September 30, 2004 equaled $25,000. The assisted living
center is for sale and the Company has classified the asset as held for sale and
has recorded its operations as discontinued operations.
The Company owns a facility in Union City, Oklahoma utilized until December
2, 2002 for a contract with the Oklahoma Office of Juvenile Affairs. The
facility is currently utilized as an overflow center for weekend clients
assigned to the Carver Center. The Company has classified the facility as held
for sale and has recorded the operations of the facility as discontinued
operations. The Company is in discussions with several parties expressing an
interest in a transaction for a purchase or lease of the facility. In the event
these potential transactions are not successful, an impairment of the carrying
value may be required at a future date. The Company has reviewed the carrying
value of the facility and determined an impairment of the carrying value is not
warranted at this time.
Following is the revenue and net income (loss) of the Union City facility
and the assisted living center:
Three months ended September 30,
2004 2003 2004 2003
----------------------------------------------------
Assisted Living Center Union City Facility
---------------------- --------------------
Revenue $ 183,000 - - -
Pretax net income (loss) 25,000 - (90,000) (52,000)
Nine months ended September 30,
2004 2003 2004 2003
---------------------------------------------------
Assisted Living Center Union City Facility
------------------------- --------------------
Revenue $ 543,000 - - -
Pretax net income (loss) 50,000 - (153,000) (170,000)
Certain reclassifications of prior periods' amounts have been made to
interest, depreciation expense, and discontinued operations to conform with the
current period presentation.
Page 8
AVALON CORRECTIONAL SERVICES, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
This document contains statements that are not historical but are
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These
include statements regarding the expectations, beliefs, intentions or strategies
for the future. The Company intends that all forward-looking statements be
subject to the safe-harbor provisions of the Private Securities Litigation
Reform Act of 1995. These forward-looking statements reflect the Company's views
as of the date they are made with respect to future events and financial
performance, but are subject to many uncertainties and risks which could cause
the actual results of the Company to differ materially from any future results
expressed or implied by such forward-looking statements. Examples of such
uncertainties and risks include, but are not limited to: fluctuations in
occupancy levels and labor costs; the ability to secure both new contracts and
the renewal of existing contracts; the availability and cost of financing to
redeem common shares and to expand the Company's business; public resistance to
privatization and the sale of the Union City facility and the assisted living
center for an amount in excess of the carrying value of the assets. Additional
risk factors include those discussed in periodic reports filed by the Company
from time to time. 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 2,600 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
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 -
Three Months Ended September 30, 2004 Compared to the Three Months Ended
September 30, 2003.
The Company's revenues increased by 9% to $6,888,000 for the three months
ended September 30, 2004 from $6,346,000 for the three months ended September
30, 2003. The increase in net revenues was primarily a result of an increase in
the Company's offender census during the three months ended September 30, 2004.
The Company's income from continuing operations before taxes decreased 56% to
$281,000 during the third quarter of 2004 compared to $640,000 during the third
quarter of 2003. The decrease was primarily a result of early retirement of
debt, in the third quarter of 2004, in the amount of $439,000.
Operating income before interest, depreciation and amortization,
discontinued operations, early retirement of debt and income taxes increased 5%
to $1,593,000 for the third quarter of 2004 from $1,522,000 for the third
quarter of 2003. The average daily residential offender census increased by 11%
to 1,967 for the third quarter of 2004 from 1,780 for the third quarter of 2003.
The average daily non-residential offender census was 350 for the third quarter
of 2004 compared to 274 for the third quarter of 2003. The data to reconcile the
Company's income from continuing operations before tax for the third quarter of
2004 of $281,000 to operating income of $1,593,000 is as follows. Add back to
income from continuing operations before tax the amounts of $444,000 for
interest expense, $439,000 for early retirement of debt and $429,000 for
depreciation and amortization expense. The information necessary to reconcile
the Company's income from continuing operations before tax for the third quarter
of 2003 of $640,000 to operating income of $1,522,000 is as follows. Add back to
income from continuing operations before tax the amounts of $339,000 for
interest expense and $543,000 for depreciation and amortization expense.
Page 9
AVALON CORRECTIONAL SERVICES, INC. AND SUBSIDIARIES
Direct operating expenses increased by 9% to $4,830,000 for the three
months ended September 30, 2004 from $4,440,000 for the three months ended
September 30, 2003. General and administrative expenses increased by 21% during
the third quarter of 2004 compared to the third quarter of 2003. This resulted
primarily from increases in accounting and professional fees. Direct operating
and general and administrative expenses remained fairly constant at
approximately 70% and 7% of revenues, respectively, during the third quarter of
2004 and 2003.
Depreciation and amortization expense decreased by 21% to $429,000 for the
third quarter 2004 from $543,000 for the third quarter 2003. The decrease was a
result of the Company's classification change of the Union City facility to held
for sale, in 2004. The amortization of intangible contract costs was $65,000 for
the third quarter of 2004 and $56,000 for the third quarter of 2003. Interest
expense increased by $100,000 for the third quarter of 2004, as compared to the
third quarter of 2003 as a result of higher interest rates and additional
indebtedness.
The Company's income tax expense was $99,000 for the third quarter of 2004,
a decrease of $99,000 over the income tax expense of $198,000 for the third
quarter of 2003. Income from continuing operations decreased $260,000 or 59% to
$182,000 compared to $442,000 for the third quarter of 2003. Net income after
discontinued operations decreased $287,000 or 92% in the third quarter of 2004
to $24,000, as compared to $311,000 for the third quarter of 2003.
The assisted living center and the Union City facility are for sale and the
Company has classified the assets as held for sale and has recorded the related
operations as discontinued operations (see Note 8).
Nine Months Ended September 30, 2004 Compared to the Nine Months Ended
September 30, 2003.
The Company's revenues increased $1,523,000 to $20,151,000 for the nine
months ended September 30, 2004 compared to $18,628,000 for the nine months
ended September 30, 2003. The increased revenues were a result of an increase in
the company's offender census during the nine months ended September 30, 2004.
Operating income before interest, depreciation and amortization,
discontinued operations, early retirement of debt and income taxes was
$5,009,000 for the nine months ended September 30, 2004 compared to $4,372,000
for the nine months ended September 30, 2003. The increase in earnings before
interest, taxes, depreciation and amortization, early retirement of debt and
discontinued operations was a result of the increase in average daily
residential offender census of 9% to 1,938 for the nine months ended September
30, 2004 from 1,778 for the nine months ended September 30, 2003 and an increase
in the average daily non-residential offender census of 17% to 325 for the nine
months ended September 30, 2004 from 277 for the nine months ended September 30,
2003. Operating income before interest, depreciation and amortization,
discontinued operations, early retirement of debt and income taxes can be
reconciled to income from continuing operations before taxes by adding interest,
early retirement of debt and depreciation and amortization expenses to income
before taxes.
Income from continuing operations before taxes remained fairly constant at
$1,565,000 and $1,551,000, respectively, for the nine months ended September 30,
2004 and 2003.
The Company recorded a tax provision of $586,000 for the nine months ended
September 30, 2004, compared to a provision of $558,000 for the nine months
ended September 30, 2003. Net income after discontinued operations decreased
$50,000 or 6% in the nine months ended September 30, 2004 to $773,000, as
compared to $823,000 for the nine months ended September 30, 2003.
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.
The Company's working capital at September 30, 2004 was $3,188,000, with a
current ratio of 1.83:1.00 compared to working capital of $1,707,00 and a
current ratio of 1.36:1.00 at September 30, 2003.
Page 10
Capital expenditures for the first nine months of 2004 were $1,085,000,
compared to $2,017,000 for the first nine months of 2003. The first nine months
of 2004 capital expenditures include normal, operating purchases of vehicles and
equipment. The Company also expanded Carver Center to 406 beds from 300. The
first half 2003 capital expenditures included the expansion of the Phoenix
Center to 207 beds, completed in the summer of 2003.
The Company had approximately $3,835,000 (including a $900,000 pledged
certificate of deposit) of cash, short-term investments, and revolving credit
available for new projects at September 30, 2004. 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.
Item 3. 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 bank credit
facility. The interest on the 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 nine months ended September 30,
2004 and 2003 would have been increased or decreased by approximately $66,000.
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
Item 4. Controls and Procedures
The Company's Chief Executive Officer and its Chief Financial Officer have
evaluated the effectiveness of the Company's disclosure controls and procedures
(as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)), as of the end of the
period covered by this report. Based upon that evaluation, the Chief Executive
Officer and Chief Financial Officer concluded that the Company's disclosure
controls and procedures are effective in timely alerting them to material
information relating to the Company that is required to be included in periodic
SEC filings. There have not been any changes in the Company's internal control
over financial reporting (as defined in Exchange Act Rules 13a-15 (f) and
15d-15(f)) during the fiscal quarter to which this report relates that have
materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
Page 11
AVALON CORRECTIONAL SERVICES, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
Item 1. Legal Proceedings - None.
Item 2. Changes in Securities - None.
Item 3. Defaults Upon Senior Securities - None.
Item 4. Submission of Matters to a Vote of Security Holders - None
Item 5. Other Information - None.
Item 6. Exhibits and reports on Form 8-K -
The Company filed a current report on Form 8-K, dated July 16, 2004,
reporting on "Item 5. Other Events" the completion of the Bond financing
transaction (see Part I, Note 2) and a current report on Form 8-K, dated
September 28, 2004, reporting on "Item 7.01. Regulation FD Disclosure" the
credit facility with Bank of America, N.A. (see Part I, Note 2).
The following exhibits are filed as a part of this Quarterly Report on Form
10-Q:
31.1 Certification of the Chief Executive Officer of Avalon Correctional
Services, Inc., pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
31.2 Certification of the Chief Financial Officer of Avalon Correctional
Services, Inc., pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
32.1 Certification of the Chief Executive Officer of Avalon Correctional
Services, Inc., pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of the Chief Financial Officer of Avalon Correctional
Services, Inc., pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Page 12
AVALON CORRECTIONAL SERVICES, INC. AND SUBSIDIARIES
SIGNATURES
In accordance with the requirement of the Exchange Act, the registrant has
caused this report to be signed on its behalf by the undersigned thereunto duly
authorized.
Date: November 10, 2004 AVALON CORRECTIONAL SERVICES, INC.
By: s/ Donald E. Smith
___________________________________________
Donald E. Smith, Chief Executive Officer
By: s/ Michael C. Bradley
___________________________________________
Michael C. Bradley, Chief Financial Officer
Page 13
Exhibit 31.1
CERTIFICATION
I, Donald E. Smith, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Avalon Correctional
Services, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-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 make known to
us by others within those entities, particularly during the period in
which this annual report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusion 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 changes 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 officers 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 registrant' board of
directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weakness in the design or
operation of internal controls 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
over financial reporting.
November 10, 2004
/s/ Donald E. Smith
Donald E. Smith
Chief Executive Officer
Exhibit 31.2
CERTIFICATION
I, Michael C. Bradley, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Avalon Correctional
Services, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-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 make known to
us by others within those entities, particularly during the period in
which this annual report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusion 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 changes 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 officers 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 registrant' board of
directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weakness in the design or
operation of internal controls 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
over financial reporting.
November 10, 2004
/s/ Michael C. Bradley
Michael C. Bradley
Chief Financial Officer
Exhibit 31.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Avalon Correctional Services, Inc.
(the "Company") on Form 10-Q for the period ended September 30, 2004 as filed
with the Securities and Exchange Commission on the date hereof (the "Report"),
I, Donald E. Smith, Chief Executive Officer of the Company, certify, pursuant to
18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley
Act of 2002, that to the best of my knowledge:
(1) The Report fully complies with the requirements of section 13 (a) or 15 (d)
of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and result of operations of the Company.
/s/ Donald E. Smith
Donald E. Smith
Chief Executive Officer
November 10, 2004
Exhibit 31.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Avalon Correctional Services, Inc.
(the "Company") on Form 10-Q for the period ended September 30, 2004, as filed
with the Securities and Exchange Commission on the date hereof (the "Report"),
I, Michael C. Bradley, Chief Financial Officer of the Company, certify, pursuant
to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the
Sarbanes-Oxley Act of 2002, that to the best of my knowledge:
(1) The Report fully complies with the requirements of section 13 (a) or 15 (d)
of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and result of operations of the Company.
/s/ Michael C. Bradley
Michael C. Bradley
Chief Financial Officer
November 10 2004