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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 March 31, 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 ______
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes ___ No X
As of May 11, 2004, 4,896,954 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)
March 31, December 31,
2004 2003
------------------ ------------------
ASSETS
Current assets:
Cash and cash equivalents $ 808,000 $ 1,015,000
Certificates of deposit (pledged) 1,600,000 1,600,000
Accounts receivable, net 3,233,000 2,662,000
Prepaid expenses and other 443,000 426,000
------------------ ------------------
Total current assets $ 6,084,000 $ 5,703,000
Assets held for sale 5,900,000 -
Property and equipment, net 26,420,000 30,636,000
Intangible assets, net 2,339,000 2,395,000
Other assets 940,000 967,000
------------------ ------------------
Total assets $ 41,683,000 $ 39,701,000
================== ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable, accrued liabilities and other $ 1,693,000 $ 1,990,000
Current maturities of long-term debt 13,613,000 2,030,000
------------------ ------------------
Total current liabilities $ 15,306,000 $ 4,020,000
Long-term debt, less current maturities 10,653,000 20,305,000
Convertible debentures 3,850,000 3,850,000
Deferred income taxes 162,000 175,000
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; 4,896,954 shares issued and
outstanding, less 1,622,448 shares subject
to repurchase 3,000 3,000
Preferred stock; par value $.001; 1,000,000
shares authorized; none issued - -
Paid-in capital 7,826,000 8,459,000
Retained earnings 622,000 261,000
------------------ ------------------
Total liabilities and stockholders' equity $ 41,683,000 $ 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 March 31,
2004 2003
--------------- -----------------
Revenues $ 6,433,000 $ 6,170,000
-------------- -----------------
Costs and expenses
Direct operating $ 4,453,000 $ 4,275,000
General and administrative 397,000 358,000
Depreciation and amortization 398,000 413,000
Interest expense 569,000 589,000
--------------- -----------------
Net income from continuing operations before income tax expense 616,000 $ 535,000
Income tax expense 211,000 171,000
--------------- -----------------
Net income from continuing operations $ 405,000 $ 364,000
Discontinued operations (43,000) (104,000)
--------------- -----------------
Net income $ 362,000 $ 260,000
=============== =================
Net income (loss) per share, basic;
continuing operations $ 0.08 $ 0.07
=============== =================
discontinued operations $ (0.01) $ (0.02)
=============== =================
total $ 0.07 $ 0.05
=============== =================
Net income (loss) per share, diluted;
continuing operations $ 0.07 $ 0.07
=============== =================
discontinued operations $ (0.01) $ (0.02)
=============== =================
total $ 0.06 $ 0.05
=============== =================
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)
Three months ended March, 31
-----------------------------------------
2004 2003
------------------- ------------------
OPERATING ACTIVITIES:
Net income $ 362,000 $ 260,000
Adjustments to reconcile net income to
net cash provided by (used in) operating activities:
Depreciation and amortization 413,000 413,000
Amortization of debt issue costs 82,000 74,000
Gain on sale of property - (2,000)
Changes in operating assets and liabilities:
Increase in:
Accounts receivable (571,000) (532,000)
Prepaid expenses and other (17,000) (209,000)
Increase (decrease) in accounts payable,
accrued liabilities and other (297,000) 14,000
------------------- ------------------
Net cash provided by (used in) operations $ (28,000) $ 18,000
------------------- ------------------
INVESTING ACTIVITIES:
Capital expenditures $ (398,000) $ (851,000)
Proceeds from disposition of property - 7,000
------------------- ------------------
Net cash used in investing activities $ (398,000) $ (844,000)
------------------- ------------------
FINANCING ACTIVITIES:
Proceeds from borrowing $ 7,472,000 $ 7,712,000
Repayment of borrowing (7,253,000) (7,696,000)
------------------- ------------------
Net cash provided by financing activities $ 219,000 $ 16,000
------------------- ------------------
NET DECREASE IN CASH AND CASH EQUIVALENTS $ (207,000) $ (810,000)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 1,015,000 1,250,000
PERIOD
------------------- ------------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 808,000 $ 440,000
=================== ==================
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 ended
March 31, 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 March 31, 2004, the statements of
operations for the three months ended March 31, 2004 and 2003 and the statements
of cash flows for the three months ended March 31, 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 March 31,
----------------------------
2004 2003
---------- ----------
Net income, as reported $ 362,000 $ 260,000
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects 45,000 13,000
---------- ----------
Pro forma net income $ 317,000 $ 247,000
========== ==========
Earnings per share:
Basic - as reported $ 0.07 $ 0.05
========== ==========
Basic - pro forma $ 0.06 $ 0.05
========== ==========
Diluted - as reported $ 0.06 $ 0.05
========== ==========
Diluted - pro forma $ 0.05 $ 0.04
========== ==========
Page 4
NOTE 2. LONG-TERM DEBT
Long-term debt consists of the following:
March 31, December 31,
2004 2003
---------------- ------------
Senior credit facility:
revolving line of credit $ 896,000 $ 40,000
term loan 10,679,000 11,034,000
Notes payable to banks and finance companies, collateralized by
transportation equipment, due in installments through March 2012
with interest ranging from 2.9% to 11.0% 954,000 1,110,000
Assisted living center debt 1,600,000 -
Notes payable to an investment company, uncollateralized;
interest at 14.5%, payable quarterly; principal due in four quarterly
installments beginning December 31, 2005; includes unaccreted
original issue premium 10,137,000 10,151,000
------------- -------------
24,266,000 22,335,000
Less - current maturities 13,613,000 2,030,000
------------- -------------
$ 10,653,000 $ 20,305,000
============= =============
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 March 31, 2004, the outstanding balances were $10,679,000 on the
term loan and $896,000 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 March 31, 2004, the rate was approximately 4.75% on the senior credit
facility. At March 31, 2004, the outstanding debt under the senior credit
facility was classified as current. The Company and the senior debt holder are
negotiating an extension of the current maturity date. 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 March 31, 2004.
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% (amended to 14.5% during the first
quarter of 2004) 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
Page 5
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.
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 March 31, 2004.
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 689,060
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 March 31, 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.
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
March 31,
2004 2003
------------ ------------
Numerator:
Net income - basic $ 362,000 $ 260,000
Effect of dilutive securities, net of income tax:
- interest reduction on assumed debenture conversions 43,000 43,000
------------ ------------
Numerator for earnings per share, diluted $ 405,000 $ 303,000
============ ============
Denominator for earnings per share:
Weighted average shares outstanding - basic 4,896,954 4,895,002
Effect of dilutive securities:
- debenture conversions 1,283,333 1,283,333
- stock options 70,454 -
- stock warrants 203,883 -
------------ ------------
Denominator for earnings per share, diluted 6,454,624 6,178,335
============ ============
Income per share, basic $ 0.07 $ 0.05
============ ============
Income per share, diluted $ 0.06 $ 0.05
============ ============
Outstanding options and warrants of 1,030,119 for the three months ended
March 31, 2004, and 1,330,932 for the three months ended March 31, 2003, have
been excluded from the above calculations as they would be anti- dilutive.
NOTE 6. 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 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 postponed the date on which
the interpretation become applicable to March 31, 2004.
The Company has identified one non-consolidated entity as a VIE where the
Company is considered the primary beneficiary (see Note 7). 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.
Page 7
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 7. 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 expected appraised value of the
assisted living center. The Company anticipates a sale of the Union City
facility will result in proceeds in excess of the carrying value of the Union
City facility.
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 $1,900,000 at March 31, 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 6) 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 $1,600,000 as of March 31, 2004 and
losses for the three months ended March 31, 2004 equaled $10,000. The assisted
living center is for sale and the Company has classified the asset as held for
sale and has recorded the operations of the assisted living center as
discontinued operations.
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 31, 2004, the facility's only use is as an
overflow center for weekend clients assigned to the Carver Center. This was the
first time the Company did not have a multi-year contract extension renewed. The
contract is the only one the Company had with this agency. The Board approved
a plan of disposition and an agreement to sell the Union City facility during
the first quarter of 2004.The Company has classified the Union City facility
as held for sale and has recorded the operations of the facility as discontinued
operations. The Company's asset purchase agreement to sell the Union City
facility was scheduled to close on or before June 25, 2004. The potential buyer
has notified the Company that a population is not available for the facility at
this time. The Company is in discussions with several parties expressing an
interest in a transaction for a purchase or lease of the Union City facility;
however 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 Union City facility and determined
an impairment of the carrying value is not warranted at this time.
The following is the revenue, net income (loss) and assets of the Union City
facility and the assisted living center:
Three months ended March 31,
------------------------------------------------
2004 2003 2004 2003
Assisted Living Center Union City Facility
Revenue $ 179,000 $ - $ - $ -
Net income (loss) $ (10,000) $ - $ (33,000) $ (104,000)
Assets held for sale - property
and equipment, net $1,600,000 $ - $4,300,000 $ -
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 March 31, 2004 Compared to the Three Months Ended March 31,
2003.
Total revenues increased by 4% to $6,433,000 in 2004 from $6,170,000 in
2003. The net increase in revenues was primarily a result of an increase in the
Company's offender census during the three months ended March 31, 2004. The
Company's net income from continuing operations before taxes increased 15% to
$616,000 during the first quarter of 2004 compared to $535,000 during the first
quarter of 2003.
Operating income before interest, depreciation and amortization,
discontinued operations and income taxes increased 3% to $1,583,000 for the
first quarter of 2004 from $1,537,000 for the first quarter of 2003. The average
daily residential offender census increased by 10% to 1,888 for the first
quarter of 2004 from 1,710 for the first quarter of 2003. The average daily
non-residential offender census was 317 for the first quarter of 2004 compared
to 342 for the first quarter of 2003. The data to reconcile the Company's net
income from continuing operations before tax for the first quarter of 2004 of
$616,000 to operating income of $1,583,000 is as follows. Add back to net income
from continuing operations before tax the amounts of $569,000 for interest
expense and $398,000 for depreciation and amortization expense. The data to
reconcile the Company's net income from continuing operations before tax for the
first quarter of 2003 of $535,000 to operating income of $1,537,000 is as
follows. Add back to net income from continuing operations before tax the
amounts of $589,000 for interest expense and $413,000 for depreciation and
amortization expense.
Direct operating expenses increased by 4% in the first quarter of 2004
compared to the first quarter of 2003. The increase was a result of the
additional expenses associated with the increase in the Company's offender
census during the quarter ended March 31, 2004.
Page 9
General and administrative expenses increased by 11% during the first
quarter of 2004 compared to the first quarter of 2003. This resulted primarily
from increases in insurance, advertising and marketing expenses. General and
administrative expenses equaled approximately 6% of revenues during the first
quarter of 2004 and 2003. Depreciation and amortization expense remained fairly
constant at $398,000 and $413,000 respectively, for the first quarter of 2004
and 2003. The amortization of intangible contract costs was $56,000 for the
first quarter of 2004 and 2003. Interest expense decreased by $20,000 for the
first quarter of 2004, as compared to the first quarter of 2003 as a result of
lower interest rates.
The Company's income tax expense was $211,000 for the first quarter of
2004, an increase of $40,000 over the income tax expense of $171,000 for the
first quarter of 2003. Net income from continuing operations increased $41,000
or 11% to $405,000 compared to $364,000 for the first quarter of 2003. Net
income after discontinued operations increased $102,000 or 39% in the first
quarter of 2004 to $362,000, as compared to $260,000 for the first 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 7).
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 deficit at March 31, 2004 was $9,222,000,
compared to working capital of $1,683,00 and a current ratio of 1.42:1.00 at
March 31, 2003. The working capital deficit at March 31, 2004 results from the
Company's senior debt facility, in the amount of $11,575,000, being classified
as a current liability. The senior debt facility has a maturity date of February
25, 2005 and the Company and the senior debt holder are negotiating an extension
of the current maturity date. Capital expenditures for the first quarter of 2004
were $398,000, compared to $851,000 for the first quarter of 2003. The first
quarter 2004 capital expenditures include normal, operating purchases of
vehicles, equipment and an expansion of Carver Center to 406 beds from 300 beds.
The first quarter 2003 capital expenditures included the expansion of the
Phoenix Center to 207 beds, completed in the summer of 2003.
The Company had approximately $4,400,000 (including $1,600,000 of pledged
certificates of deposit) of cash, short-term investments, and revolving credit
available for new projects at March 31, 2004. The Company believes it has
adequate cash reserves and cash flow from operations to meet its current cash
requirements (excluding payment of the senior credit facility due February 25,
2005). 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 mentioned
above, the senior credit facility outstanding debt matures February 25, 2005 and
the Company and the senior debt holder are negotiating to extend the maturity
date. If these negotiations are unsuccessful, the Company will have to seek
alternative sources of financing.
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 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 three months
ended March 31, 2004 and 2003 would have been increased or decreased by
approximately $28,000 and $29,000, respectively.
Page 10
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 Vice President of Finance
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 Vice President of Finance 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 - None.
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 Rule 13a-14 (a)/15d-14(a), as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Vice President of Finance of Avalon Correctional
Services, Inc., pursuant to Rule 13a-14(a)/15d-14(a), as adopted 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 Vice President of Finance 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.
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AVALON CORRECTIONAL SERVICES, INC. AND SUBSIDIARIES
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: May 11, 2004 AVALON CORRECTIONAL SERVICES, INC.
By: s/ Donald E. Smith
Donald E. Smith, Chief Executive Officer
By: s/ David Grose
----------------------------------------
David Grose, Vice President of Finance
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 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 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's board of
directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design or
operation of internal controls over financial reporting, to the
registrant's auditors and the audit committee of registrant's board
of directors (or persons performing the equivalent functions):
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
May 11, 2004
/s/ Donald E. Smith
Donald E. Smith
Chief Executive Officer
Exhibit 31.2
CERTIFICATION
I, David Grose, 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 significan 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.
May 11, 2004
/s/ David Grose
David Grose
Vice President of Finance
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 Quarterly Report of Avalon Correctional Services,
Inc. (the "Company") on Form 10-Q for the period ended March 31, 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
May 11, 2004
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 Quarterly Report of Avalon Correctional Services,
Inc. (the "Company") on Form 10-Q for the period ended March 31, 2004, as filed
with the Securities and Exchange Commission on the date hereof (the "Report"),
I, David Grose, 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 requirement 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/ David Grose
David Grose
Vice President of Finance
May 11, 2004