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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 June 30, 2003
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 July 31, 2003, 4,895,002 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)
June 30, December 31,
2003 2002
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 444,000 $ 1,250,000
Certificates of deposit 1,800,000 1,800,000
Accounts receivable, net 3,112,000 2,768,000
Prepaid expenses and other 505,000 287,000
---------- ----------
Total current assets $ 5,861,000 $ 6,105,000
Property and equipment, net 30,858,000 30,041,000
Intangible assets 3,623,000 3,770,000
---------- ----------
Total assets $ 40,342,000 $ 39,916,000
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable, accrued liabilities and other $ 637,000 $ 624,000
Accrued payroll 477,000 571,000
Accrued income tax 134,000 265,000
Current maturities of long-term debt 2,962,000 3,515,000
---------- ---------
Total current liabilities $ 4,210,000 $ 4,975,000
Long-term debt, less current maturities 21,098,000 20,545,000
Convertible debentures 3,850,000 3,850,000
Deferred income taxes 288,000 232,000
Redeemable common stock, $.001 par value
1,622,448 shares issued and outstanding 2,522,000 3,176,000
Stockholders' equity:
Common stock: Par value $.001; 24,000,000 shares
authorized; 4,895,002 shares issued and
outstanding, less 1,622,448 shares subject
to repurchase 3,000 3,000
Preferred stock; par value $.001; 1,000,000
shares authorized; none issued --- ---
Paid-in capital 8,562,000 7,908,000
Accumulated deficit (191,000) (773,000)
---------- ----------
Total liabilities and stockholders' equity $ 40,342,000 $ 39,916,000
=========== ===========
The accompanying notes are an integral part of these consolidated
financial statements.
Page 1
AVALON CORRECTIONAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
----------- ----------- ------------ ------------
Revenues $ 6,112,000 $ 6,744,000 $ 12,282,000 $ 13,369,000
----------- ----------- ------------ ------------
Costs and expenses
Direct operating $ 4,321,000 $ 4,649,000 $ 8,700,000 $ 9,117,000
General and administrative 425,000 565,000 783,000 1,077,000
Depreciation and amortization 370,000 494,000 727,000 989,000
Interest expense 594,000 641,000 1,183,000 1,295,000
----------- ----------- ------------ ------------
Net income from operations
before income tax expense $ 402,000 $ 395,000 $ 889,000 $ 891,000
Income tax expense 114,000 90,000 306,000 225,000
----------- ----------- ------------ ------------
Net income $ 288,000 $ 305,000 $ 583,000 $ 666,000
=========== =========== ============ ============
Net income per share, basic $ 0.06 $ 0.06 $ 0.12 $ 0.14
=========== ============ ============ ============
Net income per share, diluted $ 0.05 $ 0.06 $ 0.11 $ 0.12
=========== ============ ============ ============
The accompanying notes are an integral part of these consolidated
financial statements.
Page 2
AVALON CORRECTIONAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(Unaudited)
For the six months ended
June 30,
2003 2002
---------- -----------
OPERATING ACTIVITIES:
Net income $ 583,000 $ 666,000
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 727,000 989,000
Amortization of debt issue costs 123,000 163,000
Loss on sale of property 14,000 ---
Changes in operating assets and liabilities:
Decrease (increase) in:
Accounts receivable (344,000) 195,000
Prepaid expenses and other (218,000) (318,000)
Increase (decrease) in:
Accounts payable, accrued liabilities,
and other 13,000 (419,000)
Accrued payroll (94,000) (62,000)
Accrued income tax (131,000) (45,000)
Deferred income taxes 56,000 ---
---------- ----------
Net cash provided by operations $ 729,000 $ 1,169,000
---------- ----------
INVESTING ACTIVITIES:
Capital expenditures $ (1,534,000) $ (393,000)
---------- ----------
Net cash used in investing activities $ (1,534,000) $ (393,000)
------------ -----------
FINANCING ACTIVITIES:
Proceeds from borrowing $ 15,258,000 $ 14,004,000
Repayment of borrowing (15,259,000) 15,171,000)
Proceeds from warrant and option exercise --- 74,000
------------ ------------
Net cash used in financing activities $ (1,000) $ (1,093,000)
------------ ------------
NET DECREASE IN CASH AND CASH EQUIVALENTS $ (806,000) $ (317,000)
CASH AND CASH EQUIVALENTS, BEGINNING OF 1,250,000 2,389,000
PERIOD
------------ -------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 444,000 $ 2,072,000
============ =============
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 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 consolidated financial statements
and notes should be read in conjunction with the December 31, 2002 Form 10-KSB
filing. The results of operations for the three months and the six months ended
June 30, 2003, are not necessarily indicative of the results that may be
expected for the entire year ended December 31, 2003.
The consolidated balance sheet as of June 30, 2003, the statements of
operations for the three months and six months ended June 30, 2003 and 2002 and
the statements of cash flows for the six months ended June 30, 2003 and 2002 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.
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.
Stock-Based Compensation -
The Company has a stock-based compensation plan. The Company accounts for
this plan under the recognition and measurement principles of Accounting
Principles Board 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 Financial
Accounting Standards Board Statement No. 123, Accounting for Stock-Based
Compensation, to stock-based employee compensation.
Three months ended June 30, Six months ended June 30,
--------------------------- -------------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Net income, as reported $ 288,000 $ 305,000 $ 583,000 $ 666,000
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for all
awards, net of related tax effects 26,000 57,000 52,000 115,000
----------- ---------- ---------- ----------
Pro forma net income $ 262,000 $ 248,000 $ 531,000 $ 551,000
=========== ========== ========== ==========
Earnings per share:
Basic - as reported $0.06 $0.06 $0.12 $0.14
Basic - pro forma 0.05 0.05 0.11 0.11
Diluted - as reported 0.05 0.06 0.11 0.12
Diluted - pro forma 0.05 0.05 0.10 0.11
Page 4
NOTE 2. LONG-TERM DEBT
Long-term debt consists of the following:
June 30, December 31,
2003 2002
------------- -------------
Revolving line of credit with finance company, collateralized
by accounts receivable, with interest at 1.0% over prime
(effective rate of 4.8% at June 30, 2003); due Feb 2005 $ 827,000 $ 1,423,000
Notes payable to banks, collateralized by transportation
equipment, due in installments through March 2012
with interest ranging from 2.9% to 10.4%. 772,000 641,000
Notes payable to banks and finance companies, collateralized by
land, buildings and improvements due in monthly and quarterly
installments through February 2005 with interest ranging from
3.9% to 11.0% 12,284,000 11,794,000
Note payable to an investment company, uncollateralized
with interest at 12.5%, payable quarterly, due in four quarterly
installments beginning in 2005, including original issue premium 10,177,000 10,202,000
--------------- ------------
$ 24,060,000 $ 24,060,000
Less - current maturities 2,962,000 3,515,000
-------------- ------------
$ 21,098,000 $ 20,545,000
=============== ============
The Company completed a $15,000,000 private placement of debt and equity
with an investment company on September 16, 1998. Pursuant to the terms of the
agreement, the Company tendered an unsecured subordinated note with a face value
of $10,000,000 bearing interest of 12.5% with interest payable in quarterly
installments until December 31, 2005, when the first of four quarterly principal
installments is due. The Company also tendered 1,622,448 shares of redeemable
common stock to the investment company. These shares are subject to repurchase
by the Company under certain circumstances, or beginning September 16, 2003 at
the holders option, at the then current average traded price of the stock. The
Company is accreting the difference between the carrying value and the estimated
redemption price of the stock by periodic charges / credits to additional
paid-in capital.
The Company obtained an independent fair value appraisal of the debt and
equity instruments reflecting a fair value allocation of the debt of $10,365,000
and the fair value allocation of the redeemable common stock of $4,635,000. The
original issue premium of $365,000 is being accreted as a reduction of interest
expense over the term of the debt instrument. Debt issue costs of $1,654,000
(including $266,000 representing the fair value of warrants issued to financial
advisors) have been allocated to the debt and redeemable common stock based upon
their fair values. Costs of $511,000 allocated to the redeemable common stock
reduced its original book value to $4,124,000. Costs of $1,143,000 allocated to
the debt instrument are included in other assets and are being amortized to
interest expense over the life of the debt instrument using the effective
interest method.
Certain notes payable to finance and investment companies contain covenants
that require the Company, among other things, to maintain certain earnings and
debt coverage ratios and receive approval for certain capital expenditures as
defined in the agreements. The Company was in compliance with all debt covenants
at June 30, 2003.
Page 5
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 three 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 623,632
shares of Class A common stock at exercise prices ranging from $1.32 to $4.25
per share. Options providing for the issuance of 543,158 shares were exercisable
at June 30, 2003.
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.
The Company holds a 15% equity interest in an assisted living center and
has guaranteed debt related to the building of the investee. Debt payments are
made by the investee semi-annually and range in amounts from $45,000 to $90,000
by the time of the final payment on May 1, 2016. The outstanding debt balance
was $1,665,000 at June 30, 2003, was contingent and was not recognized in the
Company's consolidated financial statements. 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 proceeds from the
sale of the living center would exceed the existing debt. The Company believes
the consolidation of this entity may be required under FIN 46, effective in the
third quarter of the current year (see note 6). Total assets of the assisted
living center totaled $1,851,000 as of June 30, 2003, and losses for the six
months ending June 30, 2003 equaled $45,000.
The Oklahoma Office of Juvenile Affairs (OJA), 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 July 31, 2003, the facility remains vacant while
other sources of offenders are being sought. This was the first time the Company
had not had a multi-year contract extension renewed. The contract is the only
one the Company had with OJA. The Union City facility is a marketable facility
and the Company is actively seeking a replacement population.
Page 6
NOTE 5. EARNINGS PER SHARE
The following table sets forth the computation of earnings per share and
earnings per share assuming dilution.
Three months ended Six months ended
June 30, June 30,
2003 2002 2003 2002
--------- --------- --------- ---------
Numerator:
Net income - basic $ 288,000 $ 305,000 $ 583,000 $ 666,000
Effect of dilutive securities:
- interest reduction on assumed debenture
conversions, net of income tax 43,000 72,000 87,000 144,000
--------- --------- ---------- ---------
Numerator for earnings per share, diluted $ 331,000 $ 377,000 $ 670,000 $ 810,000
========= ========= ========== =========
Denominator for earnings per share:
Weighted average shares outstanding - basic 4,895,002 4,888,598 4,895,002 4,868,380
Effect of dilutive securities:
- debenture conversions 1,283,333 1,283,333 1,283,333 1,283,333
- stock options 5,186 118,445 299 107,810
- stock warrants --- 277,311 --- 262,987
------------ --------- ---------- ---------
Denominator for earnings per share, diluted 6,183,521 6,567,686 6,178,634 6,522,510
============ ========= ========== =========
Income per share, basic $ 0.06 $ 0.06 $ 0.12 $ 0.14
============ ========= ========== =========
Income per share, diluted $ 0.05 $ 0.06 $ 0.11 $ 0.12
============ ========= ========== =========
Outstanding options and warrants of 1,300,432 for the three months ended
June 30, 2003, 243,539 for the three months ended June 30, 2002, 1,413,632 for
the six months ended June 30, 2003, and 243,539 for the six months ended June
30, 2002, have been excluded from the above calculations as they would be
anti-dilutive. The average exercise prices of the excluded, anti-dilutive
options and warrants were $1.75 for the three months ended June 30, 2003, and
$1.71 for the six months ended June 30, 2003. For both the three and six months
ended June 30, 2002, the prices were $3.52.
NOTE 6. RECENTLY ADOPTED ACCOUNTING STANDARDS
In January 2003, the FASB issued Interpretation No.46, Consolidation of
Variable Interest Entities (FIN 46). Subject to certain criteria defined in the
Interpretation, FIN 46 will require consolidation by business enterprises of
variable interest entities if the enterprise has a variable interest that will
absorb the majority of the entity's expected losses, receives a majority of its
expected returns, or both. The provisions of FIN 46 are effective immediately
for interests acquired in variable interest entities after January 31, 2003, and
at the beginning of the first interim or annual period beginning after June 15,
2003, for interests acquired in variable interest entities before February 1,
2003, (for the Company in the third quarter of 2003). The Company is in the
process of determining what impact, if any, the adoption of the provisions of
FIN 46 will have upon its financial condition or results of operations. Certain
transitional disclosures required by FIN 46 in all financial statements
initially issued after January 31, 2003, have been included in note 4.
In May 2003, the FASB issued Statement 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity.
Statement 150 changes the classification in the statement of financial position
of certain common financial instruments from either equity or mezzanine
presentation to liabilities and requires an issuer of those financial statements
to recognize changes in fair value or redemption amount, as applicable, in
earnings. Statement 150 is effective for the first interim period beginning
after June 15, 2003 (for the Company in the third quarter of 2003). The Company
is currently in the process of determining the impact that adoption of the
provisions of Statement 150 will have on its financial condition and results of
operations.
Page 7
AVALON CORRECTIONAL SERVICES, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This document contains statements that are not historical but are
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These
include statements regarding the expectations, beliefs, intentions or strategies
for the future. The Company intends that all forward-looking statements be
subject to the safe-harbor provisions of the Private Securities Litigation
Reform Act of 1995. These forward-looking statements reflect the Company's views
as of the date they are made with respect to future events and financial
performance, but are subject to many uncertainties and risks which could cause
the actual results of the Company to differ materially from any future results
expressed or implied by such forward-looking statements. Examples of such
uncertainties and risks include, but are not limited to: fluctuations in
occupancy levels and labor costs; the ability to secure both new contracts and
the renewal of existing contracts; the availability and cost of financing to
redeem common shares and to expand the Company's business; and public resistance
to privatization. Additional risk factors include those discussed in periodic
reports filed by the Company from time to time. The Company does not undertake
any obligation to update any forward- looking statements.
Liquidity and Capital Resources -
The Company's business strategy is to focus on the private 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 June 30, 2003 was $1,651,000 representing a current
ratio of 1.39:1.00, compared to working capital of $1,130,000 and a current
ratio of 1.23:1.00 at December 31, 2002. Capital expenditures have been
$1,534,000 in 2003, compared to $393,000 in 2002. The 2003 capital expenditures
include the expansion of the Phoenix Center to 208 beds, completed in June of
2003. The 2002 capital expenditures include normal, operating purchases of
vehicles, equipment, and building improvements.
The Company had approximately $4,469,000 of cash, short-term investments,
and revolving credit available for new projects at June 30, 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 has a senior credit facility with Fleet Capital Corporation
consisting of a $13,500,000 term loan and a revolving line of credit equal to
the lesser of $3 million or 80% of eligible accounts receivable. As of June 30,
2003, the balance of the term loan equaled $11,744,000 and the outstanding
revolving line equaled $827,000.
Results of Operations -
Three Months Ended June 30, 2003 Compared to the Three Months Ended June
30, 2002.
The Company's revenues decreased by 9% to $6,112,000 for the three months
ended June 30, 2003 from $6,744,000 for the three months ended June 30, 2002.
The decrease in net revenues was a result of the expiration of the Union City
Juvenile Center contract in December 2002. The Union City revenues were $971,000
for the three months ended June 30, 2002. This reduction was partially offset by
increased revenues of $339,000 from the Company's adult facilities.
Earnings before interest, taxes, depreciation and amortization for the
three months ended June 30, 2003 were $1,366,000 compared to $1,530,000 for the
three months ended June 30, 2002. The decrease in earnings before interest,
taxes, depreciation and amortization was a result of the expiration of the Union
City Juvenile Center contract. In December 2002 earnings before interest, taxes,
depreciation and amortization can be reconciled to earnings before taxes by
adding interest and depreciation and amortization expenses to net income before
taxes.
Page 8
Income before taxes increased 2% for the three months ended June 30, 2003
to $402,000 compared to $395,000 for the three months ended June 30, 2002. The
increase in income before taxes was accomplished by increasing revenues at the
adult facilities and the implementation of significant cost reduction by the
Company.
The Company's net income was $288,000 for the three months ended June 30,
2003 and $305,000 for the three months ended June 30, 2002. The decrease of
$17,000 in net income was a result of a $24,000 increase in the tax provision
for the three months ended June 30, 2003. The Company recorded a tax provision
of $114,000 for the three months ended June 30, 2003, compared to a provision of
$90,000 for the three months ended June 30, 2002. The lower effective rate in
2002 was due to the utilization of tax loss carry forwards.
The Company's earnings per share were $.06 basic and $.05 diluted for the
three months ended June 30, 2003 and $.06 basic and diluted for the three months
ended June 30, 2002.
Corporate. General and administrative expenses decreased 25% to $425,000
for the three months ended June 30, 2003, from $565,000 for the three months
ended June 30, 2002. The decrease was a result of significant cost- containment
efforts, particularly in the areas of personnel, travel and marketing, that were
undertaken in light of the expiration of the Union City Juvenile Center
contract. Interest expense decreased $47,000 for the three months ended June 30,
2003 versus the second quarter of 2002 as a result of lower interest rates.
Depreciation and amortization expenses decreased $124,000 as several assets were
fully depreciated during 2002.
Six Months Ended June 30, 2003 Compared to the Six Months Ended June 30, 2002.
The Company's revenues decreased $1,087,000 to $12,282,000 for the six
months ended June 30, 2003 compared to $13,369,000 for the six months ended June
30, 2002. The decreased revenues were a result of the expiration of the Union
City Juvenile Center contract in December 2002. The Union City revenues were
$1,942,000 for the six months ended June 30, 2002. This reduction was partially
offset by increased revenues of $855,000 from the Company's adult facilities.
Earnings before interest, taxes, depreciation and amortization were
$2,799,000 for the six months ended June 30, 2003 compared to $3,175,000 for the
six months ended June 30, 2002. The decrease in earnings before interest, taxes,
depreciation and amortization was a result of the expiration of the Union City
Juvenile Center contract. Earnings before interest, taxes, depreciation and
amortization can be reconciled to earnings before taxes by adding interest and
depreciation and amortization expenses to net income before taxes.
Income before taxes declined $2,000 to $889,000 for the six months ended
June 30, 2003 from $891,000 for the six months ended June 30, 2002.
The Company's net income was $583,000 for the six months ended June 30,
2003 compared to $666,000 for the six months ended June 30, 2002. The decrease
of $83,000 in net income was a result of a $81,000 increase in the tax
provision for the six months ended June 30, 2003. The Company recorded a tax
provision of $306,000 for the six months ended June 30, 2003, compared to a
provision of $225,000 for the six months ended June 30, 2002. The lower
effective rate in 2002 was due to the utilization of tax loss carry forwards.
The Company's earnings per share were $.12 basic and $.11 diluted for the
six months ended June 30, 2003, compared to $.14 basic and $.12 diluted for the
six months ended June 30, 2002.
Corporate. General and administrative expenses decreased to $783,000 for
the six months ended June 30, 2003 compared to $1,077,000 for the six months
ended June 30, 2002. The decrease was a result of significant cost-containment
efforts, particularly in the areas of personnel, travel and marketing. Interest
expense decreased $112,000 for the six months ended June 30, 2003 compared to
the six months ended June 30, 2002, as a result of lower interest rates.
Depreciation and amortization expenses decreased $262,000 as several assets were
fully depreciated during 2002.
Page 9
Critical Accounting Policies -
Intangible assets. Three of Avalon's facilities - the Avalon Correctional
Center, The Villa at Greeley and the Phoenix Center have intangible assets on
their books representing the value allocated to the operating contracts at the
time of their acquisition. Through December 31, 2001, these intangible assets
were being amortized over a twenty-year period. Financial Accounting Standards
Board SFAS 142 requires that intangible assets, whose useful lives are estimated
to be indefinite, can no longer be amortized. Avalon's intangible assets have
indefinite lives inasmuch as they relate to contracts that are renewable at
minimal costs, are routinely renewed and are expected to be renewed for the
foreseeable future. If the intangible assets are shown to be impaired in some
future period, they are required to be written down to their fair value in the
period when the impairment is ascertained. The Company's intangible assets with
indefinite lives total $2,856,000 at June 30, 2003. Any impairments recorded
would have an adverse effect on earnings, possibly materially, in the period the
impairment is determined. During 2002, independent appraisals were obtained on
the related properties. The value on each property was higher than the carrying
value of the underlying intangible and tangible assets, so no impairment has
been found to exist. Intangible assets with indefinite lives are tested for
impairment annually.
Equity valuation. 1,622,448 shares of the Company's stock (approximately
one-third of the issued and outstanding shares) have a put attached which can be
exercised beginning in September 2003. This put is redeemable under certain
circumstances at the holder's option and requires the Company to purchase the
stock at the market value. The stock is recorded on the Company's books at an
estimated redemption value and is updated quarterly. The stock was recorded at
its estimated fair value and is being accreted to the estimated value at the
redemption date. This accretion will become more volatile as the redemption date
draws nearer, and will ultimately track the price of the stock. This change in
stock value is offset by an equal change to Paid-in Capital. The Company is
currently evaluating the impact, if any, that FASB 150 will have on the
financial condition and results of operations.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
At June 30, 2003, approximately half of the Company's long-term debt was
subject to variable interest rates ($12,600,000 of debt outstanding to Fleet
Capital Corporation). The detrimental effect of a hypothetical 100 basis point
increase in interest rates would be to reduce income before provision for income
taxes by approximately $60,000 for the six months ended June 30, 2003.
Item 4. Controls and Procedures
The Company's chief executive officer and its vice president of finance
have evaluated the effectiveness of the Company's disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14(c) and 15d-14(c)) as of a
date within 90 days of the filing date (the "Evaluation Date") of this quarterly
report, and have concluded that as of the Evaluation Date, the Company's
disclosure controls and procedures were adequate, effective, and ensure that
material information relating to the Company and its consolidated subsidiaries
would be made known to them timely by others within those entities.
There were no significant changes in the Company's internal controls or in
other factors that could significantly affect the Company's disclosure controls
and procedures subsequent to the Evaluation Date, nor were there any significant
deficiencies or material weaknesses in such disclosure controls and procedures
requiring corrective actions. As a result, no corrective actions were taken.
Page 10
AVALON CORRECTIONAL SERVICES, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
Item 1. Legal Proceedings - None.
Item 2. Changes in Securities - None.
Item 3. Defaults Upon Senior Securities - None.
Item 4. Submission of Matters to a Vote of Security Holders -
May 21, 2003 Annual Meeting
Director Elected -
Votes for Mark S. Cooley - 4,799,907 Votes withheld - 18,300
Directors Continued - Robert O. McDonald
Donald E. Smith
Charles W. Thomas
James P. Wilson
Proposal: To ratify the selection of Grant Thornton, LLP as the
Company's independent publicAccountants and auditors for
the fiscal year ending December 31, 2003
Votes for - 4,619,382 Votes against - 179,725 Abstain
- 19,100
Item 5. Other Information - None.
Item 6. Exhibits and reports on Form 8-K - None.
The following exhibits are filed as a part of this Quarterly Report on Form
10-Q:
99.1 Certification of Donald E. Smith, Chief Executive Officer,
pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification of Lloyd Lovely, Vice President of Finance, pursuant
to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
Page 11
AVALON CORRECTIONAL SERVICES, INC. AND SUBSIDIARIES
SIGNATURES
In accordance with the requirement of the Exchange Act, the registrant has
caused this report to be signed on its behalf by the undersigned thereunto duly
authorized.
Date: July 31, 2003 AVALON CORRECTIONAL SERVICES, INC.
By: s/ Donald E. Smith
Donald E. Smith, Chief Executive Officer
By: s/ Lloyd Lovely
Lloyd Lovely, Vice President of Finance
Page 12
CERTIFICATIONS
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 an procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6 The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
July 31, 2003
/s/ Donald E. Smith
Donald E. Smith
Chief Executive Officer
I, Lloyd Lovely, certify that:
1. I have reviewed this quarterly report on Form 10-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-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
audit committee of registrant's board of directors (or persons performing
the equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
July 31, 2003
/s/ Lloyd Lovely
Lloyd Lovely
Vice President of Finance
Exhibit 99.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Avalon Correctional Services, Inc.
(the "Company") on Form 10-Q for the period ended June 30, 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 result of operations of the Company.
/s/ Donald E. Smith
Donald E. Smith
Chief Executive Officer
July 31, 2003
Exhibit 99.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Avalon Correctional Services, Inc.
(the "Company") on Form 10-Q for the period ended June 30, 2003, as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), I,
Lloyd Lovely, Vice President of Finance of the Company, certify, pursuant to 18
U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley
Act of 2002, that to the best of my knowledge:
(1) The Report fully complies with the requirements of section 13 (a) or 15 (d)
of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and result of operations of the Company.
/s/ Lloyd Lovely
Lloyd Lovely
Vice President of Finance
July 31, 2003