<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-SB
GENERAL FORM FOR REGISTRATION OF SECURITIES
OF SMALL BUSINESS ISSUERS UNDER SECTION 12(b)
OR 12(g) OF THE SECURITIES ACT OF 1934
CORRECTIONAL SYSTEMS, INC.
- --------------------------------------------------------------------------------
(Name of Small Business Issuer in Its Charter)
CALIFORNIA 33-0607766
- ----------------------------------------- ------------------------------
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification No.)
6910 "A" MIRAMAR ROAD, SAN DIEGO, CA 92121
- ----------------------------------------- ------------------------------
(Address of Principal Executive Offices) (Zip Code)
(619) 566-9816
- --------------------------------------------------------------------------------
(Registrant's Telephone Number, Including Area Code)
Securities to be registered pursuant to Section 12(b) of the Act:
Title of Each Class Name Of Each Exchange On Which
To Be So Registered Each Class Is To Be Registered
------------------- ------------------------------
- --------------------------------- ------------------------------------
- --------------------------------- ------------------------------------
Securities to be registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $0.001 PAR VALUE PER SHARE
- --------------------------------------------------------------------------------
(Title of Class)
<PAGE>
PART I
ITEM 1. DESCRIPTION OF BUSINESS.
Correctional Systems, Inc. and its subsidiaries, Sentencing Concepts, Inc.
and Reality House, Inc. (collectively, the "Company" or "CSI"), provide
management services to federal, state and local jails and community correctional
facilities and offer non-imprisonment alternatives such as electronic home
monitoring, counseling and educational programs, community service, offender
intervention and treatment, and comprehensive drug and alcohol testing. We
formed the Company in 1994 and acquired our subsidiaries in 1998.
On October 4, 1999, the shareholders of the Company approved by written
consent a re-incorporation of the Company into Delaware. Of the 3,644,400 shares
of common stock of the Company outstanding, holders of 1,978,849, or 54.3% of
the total outstanding shares voted for the re-incorporation.
A. CSI'S INSTITUTIONAL DIVISION
Our institutional division operates nine City or County jail facilities and
three Bureau of Prisons community correctional centers.
CITY JAILS
We have entered into agreements with nine cities or counties to manage and
operate their city or county jail. With the exception of one of the agreements,
each provides for payment to Correctional Systems of an amount based upon
operating expenses incurred and a management fee based on a percentage of the
operating expenses. One agreement provides for payment to Correctional Systems
of an amount based upon operating expenses incurred and the sharing of revenues
over and above the operating expenses.
JAIL POPULATION. The population of these jails are arrestees, self-pay
inmates, sentenced county work furlough inmates and sentenced federal inmates
serving short-term sentences. A facility that qualifies to handle arrestees
prior to arraignment (for not more than 96 hours) is a "Type I Facility." A
facility that qualifies to handle both arrestees prior to arraignment as well as
sentenced inmates is a "Type II Facility."
CSI SERVICES. Services provided in a CSI jail facility generally include
booking, processing, holding and programming. Other services may include,
depending upon the contract:
- Work Furlough. Inmates are allowed to leave the facility to work,
attend court-related programs and return to the facility.
- Electronic Monitoring. Inmates have an electronic monitoring device
attached at the jail facility.
- Detoxification. Arrestees under the influence are place in detox cells
up to the time prescribed by law.
- Revenue-Generation via Self-Pay and Contract Inmates. The City may
enter into intergovernmental agreements to house inmates from other
jurisdictions for a fee. With
<PAGE>
the approval of the court, some inmates choose to pay to serve their
sentence in City jails rather than at a County jail.
CURRENT OPERATIONS. Correctional Systems currently operates the following
nine jails:
1) The Seal Beach, California, City Jail. The Seal Beach Jail agreement has
been in effect since May 1, 1994. It is renewable each year for one-year
terms until April 2004. This Type II Facility also houses self-pay inmates,
work furlough inmates, Bureau of Prison inmates and arrestees from
surrounding cities. The Seal Beach Jail was awarded accreditation by the
American Correctional Association in August 1996.
2) The Baldwin Park, California, City Jail. The Baldwin Park City Jail
agreement has been in effect since March 1, 1996. Its term was three years
and is renewable for one-year terms. The agreement was renewed in February
1999.
3) The Montebello, California, City Jail. The Montebello City agreement has
been in effect since March 1996. It was a two-year agreement and is
renewable each year. It was renewed in January 1998 and 1999. This Type II
Facility also houses short-term city or county inmates and United States
Marshals Service inmates.
4) The Alhambra, California, City Jail. The City of Alhambra agreement has
been in effect since April 29, 1997. Its term is three years and is
renewable for two additional one-year terms. Correctional Systems also
manages Alhambra's contract to house detainees from the Immigration and
Naturalization Service.
5) The Downey, California, City Jail. The City of Downey agreement has been in
effect since May 1998 and is for a term of three years. The agreement is
renewable for two one-year terms.
6) The Bell, California, City Jail. The Bell City agreement has been in effect
since October 1998 and is for a term of three years. The agreement is
renewable for an additional three-year term.
7) The Hawthorne, California, City Jail. The City of Hawthorne agreement was
approved by the City Council on October 12, 1998. Correctional Systems
assumed complete responsibility for the Jail on November 1, 1998. The
agreement's three-year term is renewable for two one-year terms.
8) The Whittier, California, City Jail. The City of Whittier agreement was
approved by the City Council in September 1999. CSI is transitioning into
complete responsibility for the jail and expects to be fully responsible
for the facility by the end of November 1999. The agreement's three-year
term is renewable for additional three-year terms unless canceled by the
City or the Company.
9) The Lincoln County, New Mexico, County Jail. Correctional Systems entered
into a memorandum of understanding with Lincoln County, New Mexico to
provide a Jail Commander to manage their 55 bed jail as of January 5, 1998,
and to provide the County Commissioners with an evaluation of their jail.
This initial agreement had been extended five times. The present agreement
with Lincoln County is a short-term agreement from July 1999 through
December 1999, with an option to renew through June 30, 2000.
2
<PAGE>
U.S. BUREAU OF PRISON CONTRACTS
Correctional Systems operates three U.S. Bureau of Prisons community
correctional center halfway houses in Brownsville, Austin and Edinburg, Texas.
The community correctional centers ("CCC") are half-way houses that house
inmates under authority of Bureau of Prisons who are within 18 months of being
released from prison. CCCs provide transitional housing for inmates still under
federal custody and guides them through a process of vocational evaluation,
obtaining and maintaining steady employment, alcohol and other drug counseling
and testing, life skills development, anger management and family reunification.
REALITY HOUSE, BROWNSVILLE, TEXAS. Correctional Systems acquired Reality
House, Inc., a wholly-owned subsidiary, in August 1998. Reality House has been
in operation for twenty-five years and has a capacity to house 54 inmates.
MID-VALLEY HOUSE, MCALLEN, TEXAS. In August 1998, the Federal Bureau of
Prisons awarded a Community Correctional Center contract to Correctional
Systems. Mid-Valley House is capable of housing 60 inmates and has been
operational since December, 1998.
MCCABE CENTER, AUSTIN, TEXAS. Correctional Systems, Inc. acquired McCabe
Comprehensive Sanctions Center in July 1999. McCabe Center has been in operation
for the past twenty-two years. With a capacity to house 55 inmates, McCabe
Center also provides services to the U.S. Pretrial Service, the U.S. Probation
Department and the Texas Department of Corrections.
B. CSI'S ALTERNATIVE SENTENCING DIVISION
The Company's wholly-owned subsidiary, Sentencing Concepts, provides
alternatives to imprisonment for low-risk offenders. Sentencing Concepts'
programs combine punishment options and offender supervision with education and
counseling and utilize a combination of measures such as home detention via
electronic monitoring, rehabilitative counseling and education programs,
offender supervision and substance abuse testing.
Sentencing Concepts was established in 1994 and has California offices in
Anaheim, Lake Forrest, Stockton, San Luis Obispo and Santa Barbara. There are
currently more than 1,000 offenders per week receiving counseling, drug testing,
electronic monitoring or other Sentencing Concepts services. Sentencing Concepts
provides monitoring programs by contract or certification to the following
counties:
a) San Luis Obispo County, California;
b) Santa Barbara County, California;
c) Orange County, California;
d) San Joaquin County, California;
e) Contra Costa County, California;
f) Placer County, California; and
g) Lyon County, Nevada.
3
<PAGE>
In addition, Sentencing Concepts is under contract or purchase order to
provide PharmCheck-TM- Drugs of Abuse Patch to over 30 Drug Courts nationwide
and to over 75 county agencies and health care providers.
SENTENCING CONCEPTS' SERVICES
- 24-hour electronic monitoring. Sentencing Concepts provides 24-hour
monitoring services by utilizing advanced electronic monitoring
equipment, such as ankle transmitters and receiving units, to monitor
individuals through a central station.
- Scheduled compliance monitoring. This program is designed to allow
offenders to perform only certain daily activities such as employment,
school, etc. The program includes the use of a tamperproof digital
electro-optical monitoring device that is worn by an offender like a
wristwatch.
- The Shield Program. The Shield Program is specifically designed for
use in cases of domestic violence or battery, and allows for the
effective monitoring of compliance with court imposed restraining
orders.
- Monitored community service. The goal of this program is to provide
the Court with a means of utilizing community service as a sentencing
option for low risk and first-time offenders.
- Video in-home breathalyzer. This program combines a Department of
Transportation approved breath analysis testing unit with an installed
video monitor which allows for the random testing of an offender's
breath alcohol level combined with visual verification.
- Voice track monitoring. The Voice Track-Registered Trademark-
system is a computer-based voice verification device, which utilizes
telephone transmission.
- Day reporting center. The Day Reporting Center is an alternative to
custody for low risk offenders. Offenders are required to attend
regular counseling and education sessions and must submit to random
drug and alcohol testing as required by the Court.
- Chemical dependency treatment program. Sentencing Concepts offers a
State of California certified outpatient treatment program designed
specifically for individuals who have acknowledged a drug and/or
alcohol dependency problem.
- Substance abuse counseling and education. This class is designed for
the individual who is in the early stages of drug use.
- Anger management program. This program focuses on those involved with
non-domestic (i.e. physical fights between employees in a work
environment) problems relating to anger control or management.
- Batterer's treatment program. This program was designed to meet the
1996 State of California legislation that mandates attendance in a
52-week course for any person CHARGED or convicted of a domestic
battering offense.
- Drug and alcohol testing. Sentencing Concepts performs random drug and
alcohol testing of its clients. The offender pays for the tests. In
addition to the standard test by urinalysis, Sentencing Concepts is a
national distributor of the PharmCheck-TM- Drugs of Abuse Patch that
detects the use of illicit drugs.
4
<PAGE>
C. PRIVATE CORRECTIONAL INDUSTRY
OFFENDER MANAGEMENT INDUSTRY. Offender management describes the broad range
of activities related to maintaining a large group of arrested and convicted
people (adults and juveniles) during incarceration, probation and parole. It
includes prison management, jail management, inmate health care, food service,
education and training, and security monitoring. The industry has three
segments: adult secure corrections, juvenile corrections and community
corrections (work release, prerelease programs and alternative sentencing
practices such as electronic monitoring and counseling services in lieu of
incarceration).
The U.S. public expenditures on offender management are believed to exceed
$40 billion dollars annually. The U.S. adult secure prison population exceeded
1.8 million in 1998, according to a recent Bureau of Justice Statistics report.
In addition, the state prison population grew 4.1% to 1.06 million; federal
prison population grew 6.4% to 99,000; and the local jail population increased
9.4% to 567,000, according to the report. Significantly, local jails are now at
97% of capacity, up from 92% in 1996. With both federal and state prisons
operating 15% to 25% above design capacity, space is at a premium. Furthermore,
over the last ten years there has been an increase in the tendency of
politicians to demand that offenders serve more actual jail time. With prison
populations increasing and public agencies strapped for funds to build new
facilities, private companies have been moving to either manage adult and
juvenile facilities or to provide some form of alternative sentencing programs
for low risk, first-time offenders.
In addition to increasing demand for traditional correctional services,
there also appears to be a great demand for alternative sentencing practices.
According to a draft report of an Orange County, California, task force on jail
overcrowding, jail facilities should be saved for dangerous offenders, and low
risk offenders should be placed in some form of electronic monitoring or
counseling program (Los Angeles Times). The report suggests the following
alternatives:
- Greater use of electronic monitoring and house arrest
- Expansion of the County Drug Court
- Use of private jail facilities
- More work furlough and community service programs
COMPETITION. We face competition in two areas: Corrections Competition and
Alternative Sentencing Competition.
CORRECTIONAL COMPETITION
PRIVATE PRISONS: We believe there are currently approximately twelve major
private corrections firms providing correctional services to Government
Agencies. The largest of the publicly-held companies are Corrections Corporation
of America and Wackenhut Corporation who, combined, have captured the largest
share of the industry. The other large publicly-held companies include Cornell
Corrections and Correctional Services. Management Training Company (MTC) and
CiviGenics are the large privately-held companies that provide correctional
services. The following is a short list of the largest publicly-held and
privately-held companies with which CSI competes:
5
<PAGE>
- Cornell Corrections (CRN)
- Wackenhut Corporation (WAK)
- Corrections Corporation of America (PZN)
- Community Correctional Services (CSCQ)
- CiviGenics - A Private Company
- Community Corrections Corporation - A Private Company
COMMUNITY PRE-RELEASE CENTERS: With respect to the community pre-release
centers, there are a variety of competitors in both the non-profit and
for-profit arenas. These include The Salvation Army and Volunteers of America
and many other smaller non-profit organizations, and Cornell Corrections,
Community Corrections, Inc. and Behavioral Systems, Southwest, Inc., among
others, on the for-profit side. Typical Government contracts for pre-release
services are granted for two years with three one-year options.
SMALL CITY JAIL: In the small city jail market in California there appears
to be only one major competitor to Correctional Systems and that is the
Wackenhut Security Division. Other firms that have been known to bid on the
small jail business outside of California include G.W. Associates.
ALTERNATIVE SENTENCE COMPETITION
The Alternative Sentence industry includes electronic monitoring, drug and
alcohol counseling and testing and other related counseling services as referred
by the criminal courts. Sentencing Concepts combines the use of electronic
monitoring and counseling or case management services.
We are aware of only one electronic monitoring company that is
publicly-held (BI, Inc.); we believe that other electronic monitoring companies
are small, private companies or subsidiaries of larger companies, including
several security alarm companies. Sentencing Concepts leases equipment and
services as needed from several different vendors. Below is a short list of the
major companies with whom SCI competes:
- BI, Incorporated (BIAC)
- Sentinel Monitoring - A Private Company
- GSSC - A Private Company
- LCA - A Private Company
- EMS - A Private Company
- CSSS, Inc. - A Private Company
CORRECTIONAL SYSTEMS' POSITION IN THE INDUSTRY. There are approximately
twelve management firms that are presently operating secure, 24-hour, adult
correctional facilities. Correctional Systems is one of the smallest of these
twelve firms.
GOVERNMENT APPROVAL. For our jail projects, there is no outside
governmental approval required in order for the Company to provide its services
other than normal contract approval and the oversight of the governmental entity
with which we are contracting. CSI's halfway house projects (CCC's) do require
some outside governmental approval in order for us to operate, such as zoning
approval, fire and health department clearances. Several of the Alternative
Sentencing
6
<PAGE>
options are required to meet strict criteria. All equipment and programs
utilized by the Company meet or exceed the established criteria and have been
approved for use by the appropriate governmental agency.
GOVERNMENTAL REGULATIONS. Certain states either do not allow privatization
of correctional facilities or limit the type of facilities that can be
privatized. For example, the State of California prohibits county correctional
facilities from privatizing, but allows for all other jurisdictions to
privatize.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
COMPARISON OF RESULTS FOR THE NINE MONTH PERIOD ENDED SEPTEMBER 30, 1998 TO
SEPTEMBER 30, 1999
REVENUE. The Company continued to expand and added 1 city jail and
acquired 1 U.S. Bureau of Prisons community correction center during the
first 9 months of 1999. This internal expansion along with the acquisition of
the community correction center completed in the third quarter of 1999 and 9
full months of operations related to 1998 acquisitions caused revenue to
increase $3,351,692 or 201% from the same period last year.
OPERATING EXPENSES. Total operating expenses increased $3,256,968 to
$4,903,119 or 198% for the 9 months ended as compared to the same period last
year as a result of increased expense associated with the increase in
revenues.
TAXES. The Company recorded an income tax provision for the 9 months ended
September 30, 1999 of $18,339, which differs from the statutory rate largely as
a result of the use of net operating loss carryovers.
COMPARISON OF RESULTS FOR THE YEAR ENDED DECEMBER 31, 1997 TO THE YEAR ENDED
DECEMBER 31, 1998
REVENUE. Total revenue increased $1,953,178, or 186%, for 1998 to
$3,004,984, as compared to 1997. This is primarily due to the Company's
expansion of 4 city jails which contributed $854,546 to the increased
revenue, the addition of 2 community correction centers, which contributed
$442,342 to the increased revenue and the acquisition of a sentencing
alternative company, which contributed $649,725 to the increased revenue.
SALARIES AND WAGES. Salaries and wages increased $653,119, or 101% for 1998
to $1,301,493, as compared to 1997. The city jails contributed $294,988 to the
increase, the community correction facilities contributed $148,207 to the
increase and alternative sentencing contributed $209,924 to the increase.
OTHER OPERATING EXPENSES. Other operating expenses, which consist
primarily of food, medical and dental and appreciation, increased $773,511,
or 304%, in 1998 to $1,027,772, as compared to 1997. This was primarily due
to the city jails contributing $419,769 to the increase, the community
correction facilities contributing $108,821 to the increase and alternative
sentencing contributing $236,016 to the increase.
GROSS PROFITS. Gross profits increased $526,548, or 353% in 1998 to
$675,719, as compared to 1997, due to the expansion of our correctional
facilities management and addition of the sentencing alternative company.
7
<PAGE>
GENERAL AND ADMINISTRATIVE. General and administrative costs as a
percentage of revenue decreased to 23% for 1998 as compared to 59% for 1997,
primarily as a result of increase in revenues without the addition of
significant expense.
LIQUIDITY AND CAPITAL RESOURCES:
Net cash used in operations decreased to $(276,074) from $(436,220) for
1998 as compared to the same period in 1997 or 37%. This was primarily due to
the reduction in net loss for 1998 to $(28,408) as compared to $(460,587) for
same period in 1997 or 94%. This was offset by an increase in accounts
receivable of $221,404, due to the Company's growth, and a decrease in accounts
payable and other accrued liabilities of $(300,821), due to the additional funds
paid to creditors.
As part of its expansion policy, the Company acquired Reality House, Inc.
for approximately $1.4 million and Sentencing Concepts, Inc. for common stock
issued by the Company valued at $575,000. As part of the Sentencing Concepts
transaction $500,000 of additional funds were invested in Sentencing Concepts to
fund future expansion, additionally $100,000 was loaned to the previous owners
of Sentencing Concepts.
Resources for these acquisitions were made possible by an infusion of
equity capital in the form of preferred stock by First Analysis Securities
Corporation in an amount of approximately $2.1 million.
On July 29, 1999 the Company acquired, from a not-for profit corporation in
Texas, a building and a contract with the Bureau of Prisons that funds the
operations of the property as a community corrections facility. The total
purchase price of $1,050,000 was financed by 2 loans secured by real property.
Principal and interest payments for the loans are $5,432 at 8% and $12,800 at
9.288%. The loans run through 2011 and 2006, respectively.
Our working capital requirements have increased due to our growth. We
believe cash flows from operations will be sufficient to enable us to meet
our working capital requirements for the next 12 months. However, in order to
implement future growth plans, future equity financing will be required.
Based on total assets and annual revenues, we are significantly smaller
than many of our competitors. These competitors include large privately-held and
publicly-held companies that have substantially greater financial, marketing and
other resources than we do. These companies offer services and operate in the
markets in which we compete. The services offered by these companies in some
cases are similar to the services that we offer. We expect that competition will
increase substantially as a result of industry consolidations and alliances, as
well as the emergence of new competitors. There can be no assurance that we will
be able to compete successfully with existing or new competitors or that
competitive pressures faced by us will not materially and adversely affect our
business, operating results and financial condition.
We anticipate that we will need to undertake private placements or a
public offering of our securities at a future date, depending upon market
conditions, in order to obtain sufficient capital for us to implement our
intended growth plan. No assurance can be given that we will be successful in
raising additional investment capital in the future, or that if we are
successful, that the financial resources obtained will be sufficient for us
to successfully carry out our intended growth plan.
YEAR 2000.
We use many computer systems and related software that process dates using
two digits to define specific years. These systems may not be able to
distinguish the year 2000 from the year 1900, resulting in system failures or
miscalculations that may disrupt operations and other activities. Since
mid-1998, we have identified those systems that are not Year 2000 compliant and
have made software modifications to ensure compliance. These modifications have
not materially adversely affected our results of operations or financial
position. We have also conducted limited surveys of our major city, county,
state and federal government customers and found that those contacted are aware
of the Year 2000 problem and their own remediation requirements. However, we
have no means of assuring that their suppliers and customers will be Year 2000
compliant, and their inability to complete required remediations in a timely
manner could have an adverse effect on us.
8
<PAGE>
FORWARD LOOKING STATEMENTS
Statements in this section regarding our anticipated capital expenditures,
Year 2000 compliance and anticipated performance in future periods constitute
forward looking statements within the meaning of the Securities Exchange Act of
1934. These statements are subject to certain risks and uncertainties that could
cause actual amounts to differ materially from those projected. We believe these
forward looking statements are reasonable; however, undue reliance should not be
placed on such forward looking statements, which are based on current
expectations.
With respect to anticipated capital expenditures, we have made certain
assumptions regarding, among other things, maintenance of existing facilities
and equipment, availability and desirability of new, technologically advanced
equipment, installation and start up times, cost estimates and continued
availability of financial resources. The estimated amount of capital
expenditures is subject to certain risks, including, among other things, the
risk that unexpected capital expenditures will be required and unexpected
costs and expenses will be incurred.
With respect to Year 2000 compliance, we have performed certain
assessments to identify remediation needs of our computer systems and related
software and contacted customers to assess the impact of the Year 2000
problem on their operations. Our expectations regarding the impact of the
Year 2000 problem and our estimate of the costs to achieve Year 2000
compliance are subject to certain risks, including, among other things, the
risk that the assessments have not identified all required system
modifications, system modifications can not be completed in a timely manner,
unexpected costs and expenses will be incurred in connection with system
modifications, and major customers will not successfully achieve Year 2000
compliance in a timely manner. Further, statements regarding our performance
in future periods are subject to the specific risks identified above, as well
as to risks relating to, among other things, the competitive nature of the
corrections industry industry in general, pressures on prices due to
competitive and economic conditions, deterioration of relationships with, or
loss of, significant correctional facilities, technological advancements,
employee relations, continued availability of financial resources,
difficulties integrating acquired businesses and possible changes in
governmental policies affecting our industry.
9
<PAGE>
ITEM 3. DESCRIPTION OF PROPERTY.
The following chart lists the principal locations and size of the Company's
facilities and indicates whether the property is owned or leased and, if leased,
the lease expiration.
<TABLE>
<CAPTION>
LEASED OR OWNED
LOCATION USE SIZE LEASE EXPIRATION
<S> <C> <C> <C>
San Diego, CA Corporate and 1,200 sq. ft. Leased (Expires 06/03/2000)
Administration
Los Alamitos, CA Regional and 1,100 sq.ft. Leased (Expires 12/31/2001)
Accounting
Anaheim Administrative and 3,000 sq. ft. Leased (Expires 12/31/2000)
Program Monitoring
Lake Forrest Program Monitoring 849 sq.ft. Leased (Expires 09/30/2000)
Stockton Program Monitoring 4,000 sq.ft. Leased (Expires 10/14/2001)
San Luis Obispo Program Monitoring 715 sq. ft. Month-to-Month Lease
Santa Barbara Program Monitoring 624 sq. ft. Leased (Expires 12/31/2000)
Edinburg, Texas Community 6,400 sq.ft. Leased (Expires 12/16/2008)
Corrections Center
Brownsville, Texas Community 8,338 sq.ft. Owned
Corrections Center
Austin, Texas Community 18,000 sq. ft Owned
Corrections Center
</TABLE>
10
<PAGE>
The Company owns the real property and buildings located in Brownsville,
Texas, and Austin, Texas, at which it operates its Community Correctional
Centers for the Federal Bureau of Prisons. The real property and building in
Brownsville, Texas, is subject to a real estate lien note in the principal
amount of $788,400 which matures on March 15, 2006. The note is secured by the
real property, building and other personal property. The real property and
building in Austin, Texas, is subject to a promissory note in the principal
amount of $500,000 which matures on July 29, 2011. The note is secured by the
real property, building and other personal property.
The Company leases corporate and administrative offices in San Diego, Los
Alamitos, Anaheim, Lake Forrest, Stockton, San Luis Obispo and Santa Barbara. As
of December 31, 1998, its minimum future lease payment commitment for the next
five years under operating leases of office space, facilities and equipment is
as follows: 1999 - $208,613; 2000 - $199,328; 2001 - $140,599; 2002 - $135,535;
and 2003 - $135,850.
11
<PAGE>
ITEM 4. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth certain information regarding the beneficial
ownership of shares of common stock and Preferred Stock as of October 4, 1999
for (i) each director and director nominee of the Company; (ii) each executive
officer; (iii) each person known to the Company to be the beneficial owner of
more than 5% of the outstanding shares; and (iv) all directors and executive
officers as a group. Except pursuant to applicable community property laws or as
otherwise indicated, each shareholder has sole voting and investment power with
respect to the shares beneficially owned.
<TABLE>
<CAPTION>
TYPE OF VOTING NUMBER OF % VOTING
NAME AND ADDRESS OF OWNER SECURITY SHARES SECURITIES
------------------------- -------- ------ ----------
<S> <C> <C> <C>
William L. Garrison
7341 Clear Haven
Dallas, TX 75248 common stock 760,500 (1) 10.9%
John Forren
6910-A Miramar Road
Suite 200
San Diego, CA 92121 0 (1) 0%
Gary Maynard
2001 Priestley Ave.
North Base, Building 605
Norman, OK 73072 0 0%
Daniel J. Verwiel
1815 E. Center Street
Suite 201
Anaheim, CA 92805 common stock 493,579 (1) 7.0%
Patricia Verwiel
1815 E. Center Street
Suite 201
Anaheim, CA 92805 common stock 523,580 (1) 7.5%
Estate of Lawrence G. Grossman
209 Camaro Way
San Marcos, TX 78666 common stock 760,500 (1) 10.9%
James R. Macdonald
233 S. Wacker Drive
Suite 9500
Chicago, IL 60606 A Preferred 30,303 0.4%
Apex Funds (2) A Preferred 884,351 12.6%
IEPEF Funds (3) A Preferred 1,632,657 23.3%
The Productivity Fund III, L.P. A Preferred 816,325 11.6%
Officers and Directors as a Group Common and
(12 persons) A Preferred 2,588,462 36.9%
Total Outstanding (1) common stock 3,644,400 (1) 52.0%
A Preferred 3,363,636 48.0%
Voting Securities 7,008,036 (1) 100.0%
</TABLE>
1) DOES NOT INCLUDE COMMON STOCK ISSUABLE UPON EXERCISE OF OUTSTANDING OPTIONS
(SEE OPTION TABLE. BELOW), EXCEPT COMMON STOCK THAT THE LISTED BENEFICIAL OWNER
HAS THE RIGHT TO ACQUIRE WITHIN SIXTY DAYS, FROM OPTIONS, WARRANTS, RIGHTS,
CONVERSION PRIVILEGE OR SIMILAR OBLIGATIONS.
2) INCLUDES 841,438 SHARES HELD BY APEX FUND III, L.P. AND 42,913 SHARES HELD
BY APEX STRATEGIC PARTNERS, LLC.
3) INCLUDES 1,306,126 SHARES HELD BY INFRA STRUCTURE AND ENVIRONMENTAL PRIVATE
EQUITY FUND III, L.P. AND 326,531 SHARES HELD BY ENVIRONMENTAL & INFORMATION
TECHNOLOGY PRIVATE EQUITY FUND III.
12
<PAGE>
ITEM 5. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS.
EXECUTIVE OFFICERS AND DIRECTORS
The executive officers and directors of the Company, their ages as of March 30,
1999 and their positions are set forth below.
<TABLE>
<CAPTION>
HELD OFFICE
NAME AGE POSITION SINCE
---- --- -------- -----------
<S> <C> <C> <C>
William L. Garrison 58 Chairman of the Board, Director 1998
John R. Forren 45 President, Chief Executive Officer, Director 1996
R. Andrew Gately 49 Chief Financial Officer 1998
Daniel J. Verwiel 37 Chief Executive Officer (SCI), Director 1998
Charles Turnbo 56 Vice President, Mid-West Regional Administrator 1996
Martin Rickler 54 Vice President, Planning & Research 1996
David S. Crouse 61 Vice President, Facility Activation 1994
Western Regional Administrator 1997
Gary Maynard 56 Director 1998
James Macdonald 42 Director 1998
</TABLE>
WILLIAM L. GARRISON. Mr. Garrison joined Correctional Systems after over 25
years of employment with the Federal Bureau of Prisons. He served as an
Assistant Regional Director of the South Central Region of the Federal Bureau of
Prisons (September 1982 through April 1985); Warden at five different prisons of
the Federal Bureau of Prisons (April 1976 to September 1982; May 1985 through
October 1988); Director of a Federal Bureau of Prisons Staff Training Center;
Correctional Programs Administrator, Case Management Supervisor and a
Correctional Officer. After leaving the Federal Bureau of Prisons, he served as
the administrator of a privately-owned prison (October 1988 through May 1989);
auditor for the American Correctional Association (1989 until the present); a
self-employed corrections consultant (October 1989 through January 1990);
Director of Operations for Detention Services, Inc. (January 1990 through
November 1990); and a self-employed corrections consultant (December 1990
through July 1993).
JOHN R. FORREN, MHA. Mr. Forren has 18 years experience in the private
corrections industry. As Vice President and Chief Operating Officer of two other
large private correctional service providers, Eclectic Communications, Inc. and
Cornell Corrections, he has "started-up" more than 15 facilities, many of them a
first for the corrections field. Mr. Forren has worked closely with such
contracting agencies as: California Department of Corrections, North Carolina
Department of Corrections, U.S. Marshal Service, Federal Bureau of Prisons, U.S.
Department Of Justice, Immigrations and Naturalization Service, Virginia
Department of Corrections and the State of North Carolina. Mr. Forren holds a
Bachelor of Science and a Master of Hospital Administration degree from the
University of LaVerne.
R. ANDREW GATELY. Mr. Gately's fiscal expertise is deeply rooted in the
financial supervision and oversight of public companies with annual revenues
from $20 million through $100 million. As Vice President and Controller of
Maxicare Health Plans, Mr. Gately was responsible for all corporate accounting,
SEC reporting and fiscal management for the company's $1 Billion in annual
revenue. As a Partner in R. Andrew Gately & Co, Mr. Gately now specializes in
financial management and audits for small publicly traded companies and devotes
fifty percent of his time to Correctional Systems, Inc. as Chief Financial
Officer.
13
<PAGE>
DANIEL J. VERWIEL. Mr. Verwiel manages the operations and development of
Sentencing Concepts. Mr. Verwiel has experience in administering contracts with
public agencies and working with state and federal legislators on the
development of legislature and prison alternatives. Prior to the formation of
Sentencing Concepts, he was a program manager for TRW (1982-1994). Mr. Verwiel
received his Bachelor of Science degree from the University of Arizona and a
Master of Business Administration degree from the University of Southern
California.
CHARLES A. TURNBO. As South Central Regional Director for the Federal
Bureau of Prisons, Mr. Turnbo was responsible for 20,000 inmates and 4,000 staff
in the states of Tennessee, Arkansas, Louisiana, Texas, Oklahoma and New Mexico.
He also served as Northeast Regional Director for the BOP. He has also been a
BOP Warden at two prisons; an Associate Warden at the FCI in Lompoc, CA, and an
instructor at the Federal Prison Staff Training Center in Dallas, Texas. Turnbo
began his 20+ year career with the BOP as the Chief of Classification and Parole
at the FCI in Seagoville, Texas. An adjunct college professor of Criminal
Justice at several different colleges, Mr. Turnbo also has a Masters Degree in
Social Work.
MARTIN RICKLER, PH.D. Dr. Rickler has devoted over 20 years to the
development of innovative programs in the areas of criminal justice, alcohol &
drug abuse treatment, and health care. Dr. Rickler was part of the team that
implemented the first privately-operated state prison in California; the first
private federal juvenile prison in the U.S.; the first psychiatric halfway house
for developmentally disabled Cuban aliens under federal detention; and the first
California Department of Corrections Return To Custody Facility. As a Programs
Designer and consultant, Dr. Rickler has created innovative treatment programs
that have garnered over $100 million in renewable government and foundation
awards. In addition to five years of counseling experience, Dr. Rickler has also
served on the faculty of the University of California, Antioch University and
the Pacifica Graduate Institute. Dr. Rickler was presented a lifetime
achievement award in 1988 by the Governor of California and the California State
Alcohol Advisory Board for his work in the substance abuse field. Dr. Rickler is
a consultant to the State of California Alcohol and Drug Programs and serves
Correctional Systems, Inc. as Vice President of Planning and Research.
DAVID S. CROUSE. As a third generation corrections professional, Mr. Crouse
brings 36 years of professional correctional experience to his current duties
Correctional Systems' Vice President of Facility Activation and Western Regional
Administrator. In his 27 years at the BOP, Mr. Crouse served as a Correctional
Treatment Specialist at a 1,000-bed jail facility that he managed from design,
through start-up and into operation; Manager of an 86-bed Youth Corrections Act
Unit; Shift Supervisor; and, Transportation Supervisor. In addition to his
extensive corrections management experience, Mr. Crouse has training and
experience in correctional counseling and has been responsible for establishing
programs utilizing a variety of treatment modalities.
CARMINE R. LANZA--DIRECTOR OF LAW ENFORCEMENT LIAISON. Mr. Lanza joined
Correctional Systems, Inc. as Director of Law Enforcement Liaison upon
retirement from a very successful 27 year law enforcement career. He served in
the ranks of Patrol Officer, Detective, Sergeant, Lieutenant, Captain and Chief
of Police. Chief Lanza headed a police department of 100 full-time employees and
managed an annual budget in excess of $8 million dollars. During Chief Lanza's 8
years as Police Chief, he brought many innovative programs to Baldwin Park,
California, including Community-Oriented Policing in which he became a
nationally recognized expert. Chief Lanza's duties at Correctional Systems
include networking with local, county, state and federal
14
<PAGE>
public safety organizations and working with these organizations and
Correctional Systems staff to develop and implement new project proposals.
GARY D. MAYNARD. Mr. Maynard received a Bachelor of Arts degree in 1966
from East Central State College in Oklahoma, a Master of Science degree in 1968
from Oklahoma State University at Stillwater and a Doctorate degree in
Counseling Psychology in 1973 from Oklahoma University at Norman. He commenced
service in the Oklahoma Army National Guard even before graduation and continued
this service until retirement at the rank of Brigadier General in 1995. His
service included positions of Adjutant General, Oklahoma Military Department
(June 1992 to June 1995) and Cabinet Secretary for Veterans Affairs for the
State of Oklahoma (July 1993 to January 1995). During his studies towards his
Masters degree, he was employed as a Rehabilitation Counselor (1968 to 1970) and
during his continuing studies toward his Doctorate degree, he was employed as a
Psychologist at the El Reno, Oklahoma, Federal Reformatory. Starting in 1973 and
concurrently with his service in the Oklahoma Army National Guard, he was
employed with the Oklahoma and Arkansas Department of Corrections as follows:
Chief Counselor, Lexington, Oklahoma, Regional Treatment Center (1973 to 1974);
Supervisor, Planning and Research. Oklahoma Department of Corrections (1974 to
1975); Deputy Warden, Oklahoma State Penitentiary (1975 to 1977); Assistant
Director, Arkansas Department of Corrections, Pine Bluff, Arkansas (1977 to
1980); Warden, Joseph Harp Correctional Center, Lexington, Oklahoma (May 1980 to
May 1982); Deputy Director of Institutions, Western Division, Oklahoma
Department of Corrections (May 1982 to July 1985); Warden, Oklahoma State
Penitentiary (July 1985 to July 1987); Associate Director, Oklahoma Department
of Corrections (July 1987 to December 1987); Director, Oklahoma Department of
Corrections (December 1987 to June 1992); and Director, Southwestern Region,
Oklahoma Department of Corrections (June 1995 to May 1997). Following retirement
from the Oklahoma Army National Guard, Mr. Maynard served as a consultant to the
University of Oklahoma Department of Juvenile Affairs (May 1997 to August 1997).
Mr. Maynard has been serving as the Director, Corrections and Public Safety
Programs, College of Continuing Education, University of Oklahoma since August
1997.
JAMES R. MACDONALD. Mr. Macdonald is employed by First Analysis
Corporation, an investment research firm which manages several venture capital
partnerships. He specializes in business services and outsourcing investments
with special focus on the offender management industry. He joined First Analysis
in 1997. From 1983 to 1997, he held a variety of general management and
marketing positions with Nalco Chemical Company. From 1980 to 1983, he was
employed by Ecolab, Inc. He received an MBA from Harvard Business School in 1980
and a Bachelor of Science degree in Civil Engineering from Cornell University in
1978.
15
<PAGE>
ITEM 6. EXECUTIVE COMPENSATION.
The following table sets forth the cash compensation, as well as
certain other compensation paid or accrued, by the Company to the Company's
President and Chief Executive Officer, John R. Forren, and the Company's Vice
President of Planning and Research, Dr. Martin Rickler, for the period from
January 1, 1997 to December 31, 1999. No other executive officer had a total
annual salary and bonus equal to or in excess of $100,000 during the reported
periods.
MANAGEMENT COMPENSATION
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
Annual Compensation Long-Term Compensation
- -----------------------------------------------------------------------------------------------------------------------------------
Awards Payouts
- -----------------------------------------------------------------------------------------------------------------------------------
Restricted Securities
Name and Stock Underlying LTIP All Other
Principal Salary Bonus Other Annual Award(s) Options/ Payouts Compensation
Position Year ($) ($) Compensation ($) ($) SARs (#) ($) ($)
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
John Forren 1999 100,000 -- -- -- -- -- --
- -----------------------------------------------------------------------------------------------------------------------------------
President and Chief 1998 78,125 -- -- -- -- -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Executive Officer 1997 46,875 -- -- -- -- -- --
- -----------------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------------
Martin Rickler 1999 100,000 -- -- -- -- -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Vice-President, Planning 1998 78,125 -- -- -- -- -- --
- -----------------------------------------------------------------------------------------------------------------------------------
and Research 1997 64,375 -- -- -- -- -- --
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
OPTIONS/SAR GRANTS IN LAST FISCAL YEAR (Individual Grants)
The following table lists stock options (whether or not in tandem with
SARs) and freestanding SARs (including options and SARs that subsequently have
been transferred) made during the last completed fiscal year to each of the
named executive officers.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
Number of Securities Percent of Total
Underlying Options/ Options/SARs
SARs Granted Granted to Employees Exercise of Base Expiration
Name # in Fiscal Year Price ($/Sh) Date
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
John Forren 100,000 16% 0.94 3/16/08
- ---------------------------------------------------------------------------------------------------------------------
Martin Rickler 100,000 16% 0.94 3/16/08
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
16
<PAGE>
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Number of
Unexercised Value of
Securities Unexercised
Underlying In-The-Money
Options/SARs At Option/SARs At
Shares Acquired FY-End (#) FY-End ($)
on Exercise Value Realized Exercisable/ Exercisable/
Name (#) ($) Unexercisable Unexercisable
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
John Forren -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------
Martin Rickler -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
DIRECTOR COMPENSATION
As of June 17, 1999, Mr. Garrison, Chairman of the Board of Directors,
receives the compensation listed below:
- Salary of $60,000 per year;
- Expense reimbursement related to business activities;
- $2,500 bonus for each project with profit contribution of
$30,000-$50,000; and
- $5,000 bonus for each completed community corrections acquisition or
new project with $200,000 to $400,000 profit contribution won with
substantive input from Mr. Garrison.
In addition to serving as Chairman of the Board of Directors, Mr. Garrison
acts as Regional Administrator for the current Texas projects and performs
development duties for the company.
EMPLOYMENT AGREEMENTS
MR. FORREN AND DR. RICKLER. Both Mr. Forren and Dr. Rickler have five year
employment agreements. The agreements, effective from September 15, 1996 through
September 14, 2001, provide that Mr. Forren shall serve at no position lower
than President and Chief of Operations, and that Dr. Rickler will serve at no
position lower than Vice President of Planning and Research. The agreements
provide further:
1. BASE SALARY. The first year of employment Mr. Forren received $25,000
and Dr. Rickler received $60,000 plus a signing bonus of $5,000. The
second year both Mr. Forren and Dr. Rickler received $75,000 and both
are to receive $100,000 base salary each year thereafter.
2. EXECUTIVE BENEFITS. Standard executive health, sick leave and holiday
benefits were granted, including 30 days vacation leave annually.
3. PLACE OF EMPLOYMENT: SAN DIEGO, CALIFORNIA. It was agreed that both
Mr. Forren and Dr. Rickler would be employed within the Greater San
Diego area.
4. CONSTRUCTIVE TERMINATION. Except for standard malfeasance and such,
any termination of Mr. Forren and Dr. Rickler will be deemed a
"constructive termination" and will immediately grant the terminated
party all stock options due for the entire contract as well as one
year of the current base salary.
17
<PAGE>
VERWIELS. Daniel Verwiel and Patricia Verwiel each have entered into
employment agreements with Sentencing Concepts providing for an initial annual
salary of $75,000 each, with any increase to be approved by the compensation
committees of the Boards of Sentencing Concepts and Correctional Systems. The
Verwiel's employment agreements also contain covenants not to compete that
extend for two years following any termination of employment and confidentiality
and non-disclosure provisions.
In addition, the Employment Agreement for Daniel Verwiel provides for (i) a
bonus of $10,950, provided Mr. Verwiel was employed by Sentencing Concepts,
Correctional Systems or its subsidiary through July 31, 1999; (ii) a two (2)
year nonstatutory stock option covering up to 30,000 shares of Correctional
Systems common stock (the "Longevity Options"); and (iii) a bonus in an amount
equal to certain tax liabilities that Daniel Verwiel may incur as a result of
exercising any Longevity Options.
Each Employment Agreement also provides for the grant of (i) a 5 year
nonstatutory stock option covering 300,000 shares of Correctional Systems common
stock (the "Employment Options"); (ii) a 2 year nonstatutory stock option
covering up to 100,000 shares of Correctional Systems common stock (the
"Earn-Out Options"); (iii) a bonus in an amount equal to certain tax liabilities
that the Verwiels may incur as a result of exercising any Earn-Out Options; and
(iv) a loan in an amount necessary for the exercise of the Earn-Out Options.
The Earn-Out Option agreements grant to the Verwiels non-qualified options
to acquire up to an aggregate of 200,000 shares of Correctional Systems common
stock (100,000 shares per person) at an exercise price equal to $0.20 per share.
The Earn-Out Options vest as follows and shall be exercisable at any time after
they vest until August 1, 2000.
(i) if the Earn-Out Period Profit is equal to or greater than $50,000,
options to acquire an aggregate of 100,000 shares of Correctional
Systems common stock vest (50,000 shares for each person); and
(ii) if the Earn-Out Period Profit exceeds $50,000, then for each Dollar in
excess of $50,000, options to acquire 4 additional shares of
Correctional Systems common stock vest (2 shares for each Dollar for
each person) up to the maximum 200,000 shares. The Earn-Out Options,
however, automatically vest if there is a change in control during the
Earn-Our Period.
The Longevity Option agreement will grant to Daniel Verwiel non-qualified
options to acquire 30,000 shares of Correctional Systems common stock at an
exercise price of $0.20 per share (the "Longevity Options") exercisable on or
after July 31, 1999, provided he is still employed by Sentencing Concepts at
that time until August 1, 2000.
The Employment Option agreements will grant to the Verwiels non-qualified
options to acquire up to an additional 600,000 shares of Correctional Systems
common stock (300,000 per person).
The Employment Options vest as follows and are exercisable at any time
after they vest until the fifth anniversary of the grant:
18
<PAGE>
(i) If each is, and has at all times prior to January 1, 2002, been
employed by Correctional Systems and/or Sentencing Concepts, then
options to acquire an aggregate of 50,000 shares of Correctional
Systems common stock (25,000 Employment Options for each person) vest
on January 1, 2002;
(ii) If each is, and has at all times prior to January 1, 2003, been
employed by Correctional Systems and/or Sentencing Concepts, then
options to acquire an additional 50,000 shares of Correctional Systems
common stock (25,000 Employment Options for each person) vest on
January 1, 2003; and
ITEM 7. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
ESCROW AGREEMENT
Pursuant to the Sentencing Concepts Merger Agreement, the Company deposited
into escrow 270,000 shares of Correctional Systems common stock (the "Escrowed
Shares"), consisting of the following: 70,000 shares issuable to Daniel Verwiel
to provide incentive for Mr. Verwiel to remain in the employ of Correctional
Systems or Sentencing Concepts (the "Longevity Shares"); 100,000 shares issuable
to Patricia and Daniel Verwiel as security for the Verwiels' indemnity
obligations under the Sentencing Concepts Merger Agreement (the "Indemnification
Shares"); and 100,000 shares issuable to Patricia and Daniel Verwiel as security
for the repayment of loans by Correctional Systems to the Verwiels (described
below) contemplated by the Sentencing Concepts Merger Agreement (the "Pledged
Shares").
The Escrow Agreement provides for the release of the Escrowed Shares to the
Verwiels and/or the cancellation of such shares as follows:
Longevity Shares (70,000 shares):
(1) July 31, 1999. On July 31, 1999, 20,000 of the Longevity Shares
were released to Mr. Verwiel.
(2) July 31, 2000. If Mr. Verwiel is still employed by Sentencing
Concepts or Correctional Systems on July 31, 2000, then 50,000 of
the Longevity Shares shall be released to Mr. Verwiel. If his
employment is terminated on or before July 31, 2000, he forfeits
any right to the remaining Longevity Shares;
(3) Change of Control. If a Change of Control, as defined in the
Sentencing Concepts Merger Agreement, notwithstanding the
foregoing, any remaining Longevity Shares shall be released to
Mr. Verwiel. A "Change of Control" includes, among other
transactions, certain mergers of Correctional Systems with
another corporation or entity and any certain sales of
substantially all of the assets of Correctional Systems.
Indemnification Shares (100,000 shares):
Pursuant to the Sentencing Concepts Merger Agreement, the Verwiels
will jointly and severally indemnify the Company against damages that arise
arise out of any breach of or failure by Sentencing Concepts or any
Sentencing Concepts shareholder to perform any
19
<PAGE>
of their obligations under the Sentencing Concepts Merger Agreement. As
security for these indemnities by the Verwiels, 50,000 shares of the
Correctional Systems common stock to be issued and delivered to each of
Daniel Verwiel and Patricia Verwiel pursuant to the Sentencing Concepts
Merger Agreement, an aggregate of 100,000 shares (the "Indemnification
Shares"), shall be placed in escrow and are subject to forfeiture and
cancellation pursuant to escrow agreement described above. If no claims
under the indemnity (described below) provided by the Verwiels to
Correctional Systems have been made on or before the first anniversary of
the closing date of the Sentencing Concepts Merger Agreement, all of the
Indemnification Shares will be released from the Escrow on such date and
shall be delivered to Daniel and Patricia Verwiel (50,000 shares each). If
a claim or claims are made under the indemnities before such first
anniversary date, then the Indemnification Shares shall remain in and
subject to the Escrow Agreement until such time as the amount of such
claims made and the indemnification obligations of the Verwiels with
respect thereto have been finally determined. Once a determination is made,
a number of Indemnification Shares shall be canceled to satisfy the
indemnity obligation.
Pledged Shares (100,000 shares):
Upon repayment in full of all amounts outstanding under loans to the
Verwiels (described below) contemplated by the Sentencing Concepts Merger
Agreement, all of the Pledged Shares will be released from the Escrow on
such date and shall be delivered to Daniel and Patricia Verwiel (50,000
shares each).
LOANS
Pursuant to the Sentencing Concepts Merger Agreement, Correctional
Systems loaned to Patricia Verwiel an amount equal to $50,000 pursuant to the
terms of full recourse promissory note and security agreement. On August 18,
1998, Correctional Systems loaned Daniel Verwiel $50,000 pursuant to a
promissory note and security agreement. The promissory notes (i) bear
interest at the rate of seven percent (7%) per annum or the rate necessary to
avoid imputed interest under the Internal Revenue Code of 1986, as amended,
whichever rate is higher, (ii) provide that interest and principal shall be
due and payable on the fifth anniversary of the issuance of such notes and
(iii) are secured by a pledge of an aggregate of 100,000 shares of the
Correctional Systems common stock to be issued to Patricia and Daniel Verwiel
(50,000 shares each) pursuant to the Sentencing Concepts Merger Agreement
(the "Pledged Shares").
20
<PAGE>
STOCKHOLDERS' AGREEMENT AND REGISTRATION RIGHTS AGREEMENT
Pursuant to the Sentencing Concepts Merger Agreement, the Verwiels became a
party to a Stockholders' Agreement and a Registration Rights Agreement, each by
and among Correctional Systems and certain of its shareholders, which agreements
constitute a portion of the Series A Preferred Agreements and set forth certain
restrictions on transfer of any of the Correctional Systems securities or
options issued to the Verwiels pursuant to the Sentencing Concepts Merger
Agreement and certain registration rights of the parties thereto. (See,
Description of Securities of Correctional Systems).
ITEM 8. DESCRIPTION OF SECURITIES.
The authorized capital stock of Correctional Systems currently consists of
Forty Million (40,000,000) shares of common stock, $0.001 par value per share,
and Ten Million (10,000,000) shares of Preferred Stock, $0.001 par value. As of
the date of this Registration Statement, 3,644,400 shares of Correctional
Systems common stock and 3,363,636 shares of Series A Preferred Stock ("Series A
Preferred") were issued and outstanding.
COMMON STOCK
VOTING RIGHTS. Holders of common stock are entitled to one vote per share
on all matters submitted to a vote of the shareholders. Shares of common stock
do not have cumulative voting rights, which means that the holders of a majority
of the shareholder votes eligible to vote and voting for the election of the
Board of Directors can elect all members of the Board of Directors.
DIVIDEND RIGHTS. Holders of record of shares of common stock are entitled
to receive dividends when and if declared by the Board of Directors out of funds
of Correctional Systems legally available therefor.
LIQUIDATION RIGHTS. Upon any liquidation, dissolution or winding up of
Correctional Systems, holders of shares of common stock are entitled to receive
pro rata all of the assets of Correctional Systems available for distribution to
shareholders after distributions are made to the holders of Correctional Systems
Preferred Stock.
PREEMPTIVE RIGHTS. Holders of common stock do not have any preemptive
rights to subscribe for or to purchase any stock, obligations or other
securities of Correctional Systems.
SERIES A PREFERRED STOCK
PREFERENCE AND RANKING. The preferences of each share of Series A Preferred
with respect to dividend payments and distributions of the Correctional Systems'
assets upon voluntary or involuntary liquidation, dissolution or winding up of
the Correctional Systems is equal to the preferences of every other share of
Series A Preferred from time to time outstanding in every respect. The Series A
Preferred ranks prior to the Correctional Systems common stock as to the payment
of dividends and the distribution of assets upon voluntary or involuntary
liquidation, dissolution or winding up of the Correctional Systems.
21
<PAGE>
VOTING RIGHTS. Each holder of Series A Preferred shall be entitled to cast
the number of votes per share thereof as equals the number of votes which could
be cast by the holders of the number of shares of common stock into which such
share of Series A Preferred are then convertible. The holders of shares of
Common and Series A Preferred shall vote together and not as separate classes or
series.
DIVIDENDS. If any dividend or other distribution payable in cash or other
property is declared on the common stock, each holder of Series A Preferred on
the record date for such dividend or distribution shall be entitled to receive
on the date of payment or distribution of such dividend or other distribution
the same cash or other property which such holder would have received on such
record date if such holder were the holder of record of the number of shares of
Common into which the shares of Series A Preferred then held by such holder are
then convertible.
CONVERSION. Subject to certain exceptions, any holder of Series A Preferred
shall have the right (an "Optional Conversion Right") at any time to convert all
or any portion of the Series A Preferred held by such holder into an equal
number of shares of common stock, subject to certain adjustments (the
"Conversion Price").
Immediately prior to the closing of any of the following events, all of the
shares of Series A Preferred then outstanding shall be converted (a "Mandatory
Conversion"), without any further action on the part of the Correctional Systems
or the holders of such Series A Preferred into the number of shares of common
stock into which the Series A Preferred would be convertible under the Optional
Conversion Right at the time of the Mandatory Conversion: (a) the consummation
of a qualified public offering or (b) (i) the common stock trading at or above
Three Hundred Fifty Percent (350%) of the Conversion Price for Twenty (20)
consecutive trading days with a minimum trading volume of Thirty Thousand
(30,000) shares per day (on a current basis, as adjusted for stock dividends,
stock splits, etc.) and (ii) Correctional Systems has completed a single sale to
the public of common stock pursuant to an effective registration statement under
the Securities Act under which the gross proceeds to the Correctional Systems of
the common stock actually sold to the public by the Correctional Systems in such
sale is at least Twenty Million Dollars ($20,000,000).
The number of shares of common stock issuable upon conversion of Series A
Preferred shall be subject to adjustment from time to time upon the happening of
certain events, including, a subdivision or combination of outstanding common
stock; certain dividends and distributions; reclassification, consolidation or
merger; and issuance of additional shares of common stock.
If at any time Correctional Systems issues additional shares of common
stock, or securities convertible into common stock, for a consideration per
share of common stock less than the Conversion Price in effect at the time of
such issuance, then the Conversion Price in effect immediately prior to the
issuance of such additional shares of common stock shall be reduced to a price
per share equal to the consideration per share received for the additional
shares of common stock.
RESTRICTED ACTS. As long as any shares of Series A Preferred are
outstanding, Correctional Systems shall not, with certain exceptions, without
the affirmative vote or written consent of the holders of at least a majority of
then outstanding Series A Preferred: (a) authorize, create or issue any shares
of any additional shares of common stock or securities convertible into common
stock; (b) issue any instrument or security exercisable for or convertible into
shares of Series A Preferred,
22
<PAGE>
or issue shares of Series A Preferred other than the first 3,363,636 shares
issued; (c) enter into, or permit any Subsidiary to enter into, any agreement,
indenture or other instrument which contains any provisions restricting the
payment of dividends on the Series A Preferred; (d) redeem, purchase or
otherwise acquire for value (or pay into or set aside for a sinking fund for
such purpose) any share or shares of Series A Preferred; (e) redeem, purchase or
otherwise acquire (or pay into or set aside for a sinking fund for such purpose)
any shares of common stock, provided, however, that this restriction shall not
apply to (i) the repurchase by resolution of the Board of shares of Common from
employees, officers, directors, consultants or other persons performing services
for the Correctional Systems or any Subsidiary pursuant to agreements under
which the Correctional Systems has the option to repurchase such shares upon the
occurrence of certain events, such as the termination of employment or (ii) the
cancellation of shares of Common subject to forfeiture; (f) merge Correctional
Systems with or into any other person or entity or other form of corporate
reorganization in which the Correctional Systems shall not be the continuing or
surviving entity (other than a reincorporation transaction) or sell all or the
majority of Correctional Systems' assets; (g) amend its Articles of
Incorporation or Bylaws; or (h) incur funded indebtedness, capitalized lease
obligations or guarantees of third party debt, in each case involving an amount
in excess of $3,000,000; (i) engage an investment bank, consultant, or other
advisor for the purpose of raising capital or refinancing securities or
indebtedness or for selling or merging Correctional Systems; (j) engage in any
transaction which could involve a conflict of interest or which involves
dealings between the Correctional Systems, insiders or affiliates; (k) declare
or pay any dividend other than pursuant to the terms of the Series A Preferred;
(l) enter into any agreement, commitment or plan of merger, reorganization or
consolidation that would result in the Correctional Systems acquiring any
business entity, or any division or segment of a business entity; or (m) file a
registration statement under the Securities Act.
LIQUIDATION RIGHTS. If Correctional Systems shall be voluntarily or
involuntarily liquidated, dissolved or wound up, the holders of the Series A
Preferred shall be entitled to receive, prior and in preferences to any
distribution to the holders of common stock, out of funds legally available for
distribution to the stockholders after payment of the debts and liabilities of
the Correctional Systems, an amount (the "Series A Liquidation Preference") per
share equal to the Series A issue price, together with an amount equal to all
accrued but unpaid dividends on the Series A Preferred. Upon distribution of the
Series A Liquidation Preference, all remaining assets of the Correctional
Systems shall be distributed to the holders of Common and Series A Preferred,
pro rata in accordance with the number of Common shares held by each of them,
assuming for such purpose that the Series A Preferred has been converted into
Common after making all adjustments provided for hereunder.
STOCKHOLDERS' AGREEMENT
RESTRICTIONS ON TRANSFER. The Stockholders' Agreement contains certain
restrictions on transfer of any of the Correctional Systems securities or
options issued to the Verwiels pursuant to the Sentencing Concepts Merger
Agreement or held by the parties thereto.
RIGHTS OF FIRST REFUSAL AND PARTICIPATION RIGHTS. The Stockholders'
Agreement contains rights of first refusal and take-along rights with respect to
proposed transfers and preemptive rights with respect to the issuance of
additional securities by Correctional Systems. The Stockholders' Agreement also
provides that if a party thereto is presented with an opportunity to purchase
securities from a stockholder that is not a party to the Stockholders'
Agreement, such party must
23
<PAGE>
share such purchase opportunity with the other parties to the Stockholders'
Agreement.
ELECTION OF DIRECTORS. The Stockholders' Agreement contains a voting
agreement providing that the parties thereto will take all action necessary to
insure that the number of directors of Correctional Systems shall not exceed six
and that the composition of the Board is as follows: (i) one of the directors is
to be designated by the holders of a majority of the common stock held by
parties to the Stockholders Agreement, provided that such nominee is not a
member of management or any employee of Correctional Systems; (ii) one of the
directors is to be designated by the holders of the Series A Preferred; and
(iii) the composition of the Board of any subsidiary of Correctional Systems
shall be the same as the Board of Correctional Systems.
ADDITIONAL APPROVALS. The Stockholders' Agreement provides that the
following actions require the prior approval of the Director designated by the
holders of the Series A Preferred:
(i) increasing the cash compensation of any executive by more than Five
Percent (5%) per year;
(ii) granting any stock options or entering into any phantom option
plans;
(iii) terminating or replacing any of the four most senior executives;
(iv) increasing the number of the directors composing the Board;
(v) causing Correctional Systems or any Subsidiary to enter into any
business other than the business presently conducted; and
(vi) forming any Subsidiary or causing it to issue any debt or equity
securities.
MANDATORY SALE. The Stockholder's Agreement provides that if Correctional
Systems has not been sold, merged with a public company or has not been the
subject of a Qualified Public Offering (as defined in the Stockholders'
Agreement) by July 21, 2003, or if Correctional Systems fails to report a profit
in any calendar year beginning with the calendar year ending December 31, 1999,
then the parties thereto will upon the request of the holders of Series A
Preferred take such action as is necessary or appropriate to cause Correctional
Systems or its outstanding securities to be sold within in six (6) months after
delivery of the sale request.
REGISTRATION RIGHTS AGREEMENT
The Registration Rights Agreement provides the holders of Series A
Preferred with two long-form demand registration rights and unlimited short-form
and piggyback registration rights. The Registration Rights Agreement also
provides certain members of management that are parties to the Registration
Rights Agreement with piggyback registration rights. Correctional Systems is
obligated to pay all expenses, other than discounts and commissions, associated
with the exercise of the Series A Preferred holders' demand registration rights.
The Registration Rights Agreement also provides that the holders of Series A
Preferred shall designate the underwriter to be used in connection with any
demand registration.
24
<PAGE>
PART II
ITEM 1. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Until October 21, 1999, our common stock was published on the National
Association of Securities Dealers' OTC Bulletin Board ("OTCBB") under the
symbol "CRXS." The OTCBB is a quotation service that displays real-time
quotes, last-sale prices, and volume information in domestic and certain
foreign securities. Although the OTCBB is operated by the National
Association of Securities Dealers ("NASD"), it is unlike Nasdaq-Registered
Trademark- or other listed markets where individual companies apply for
listing and must meet and maintain strict listing standards; instead,
individual brokerage firms or Market Makers initiate quotations for specific
securities on the OTCBB.
In 1999, the U.S. Securities and Exchange Commission ("SEC") approved
amendments to the NASD's OTC Bulletin Board eligibility rules. The amendments
require a company with securities quoted on the OTCBB to make periodic filings
with the SEC. Prior to the eligibility rule amendments, there was no requirement
for a company quoted on the OTCBB to make publicly available reports with the
SEC or other regulator. In order to make periodic filings with the SEC, a
company must register its class of securities with the SEC under the Securities
Exchange Act of 1934 (the "1934 Act").
On November ___, 1999, the OTCBB removed the Company's symbol from the
OTCBB, as the Company had not yet registered its common stock under the 1934
Act. Until the Company becomes eligible for quotation on the OTCBB, its
securities will be traded through the "Pink Sheets," which is a paper medium
published daily but not widely disseminated.
The following market quotations for the Company's common stock were
obtained from the OTC Bulletin Board. The quotations reflect inter-dealer
prices, without retail mark-up, mark-down or commission and may not represent
actual transactions. See "No Assurance of Public Market; Possible Volatility of
Market Price of common stock."
<TABLE>
<CAPTION>
HIGH LOW
1999 ---- ----
----
<S> <C> <C>
Third Quarter 0.9375 0.5625
Second Quarter 0.9375 0.3125
First Quarter 0.8125 0.3125
1998
----
Fourth Quarter 1.03125 0.28125
</TABLE>
The approximate number of security holders is 75. The Board of Directors
has never declared any dividends and does not expect to do so in the foreseeable
future.
The Company has authorized an employee stock option plan pursuant to which
it may issue options to acquire up to 1,500,000 shares of common stock. There
are presently outstanding nonstatutory options to acquire 1,431,800 shares of
common stock. Of these options outstanding, all except 256,450 are fully vested.
The unvested options vest from time to time until January 2003, at which time
all presently outstanding options will be vested.
25
<PAGE>
There are also outstanding 3,363,636 shares of Series A Preferred Stock
that are convertible on a share for share basis into common stock of the
Company.
Of the 3,644,400 shares of common stock outstanding, all except 270,000 may
be sold pursuant to Rule 144 of the Securities Act of 1933, as amended.
The sale of a significant number of the foregoing shares may cause
substantial fluctuations in the market price of our common stock. Moreover,
sales of substantial amounts of our common stock (including shares issuable upon
exercise of options) in the public market could materially and adversely affect
the market price of our common stock.
NO ASSURANCE OF PUBLIC MARKET; POSSIBLE VOLATILITY OF MARKET PRICE OF COMMON
STOCK.
Although we intend to have our common stock published on the OTCBB, there
can be no assurance that a regular trading market for our common stock will
develop. The OTCBB is an unorganized, inter-dealer, over-the-counter market
which provides significantly less liquidity than a national securities exchange
or the Nasdaq Stock Market, and quotes for securities included in the OTCBB are
not listed in the financial sections of newspapers as they are for securities
listed on a national securities exchange and the Nasdaq Stock Market. Therefore,
prices for securities traded solely on the OTCBB may be difficult to obtain and
our stockholders may be unable to resell our common stock at or near their
original offering price or at any price.
RISKS RELATING TO LOW-PRICED STOCKS; POSSIBLE ADVERSE EFFECTS OF "PENNY STOCK"
RULES ON LIQUIDITY FOR OUR COMMON STOCK.
The Securities and Exchange Commission (the "Commission") has adopted
regulations which generally define "penny stock" to be any equity security that
is not traded on a national securities exchange or the Nasdaq Stock Market and
that has a market price of less than $5.00 per share or an exercise price of
less than $5.00 per share, subject to certain exceptions. If our common stock is
included in the OTCBB and is trading at less than $5.00 per share at any time,
trading in our common stock will be subject to the requirements of "penny stock"
regulations.
These regulations require, among other things, prior to any penny stock
transaction, the delivery of a disclosure schedule explaining the penny stock
market and the associated risks, and which impose various sales practice
requirements on broker-dealers who sell penny stocks to persons other than
established customers and accredited investors (generally institutions or
individual investors with assets in excess of $1,000,000 or an individual annual
income exceeding $200,000 or, together with the investor's spouse, a joint
income of $300,000). For these types of transactions, the broker-dealer must
make a special suitability determination for the purchaser and have received the
purchaser's written consent to the transaction prior to sale. The broker-dealer
must also disclose the commission payable to both the broker-dealer and the
registered representative, current quotations for the securities and, if the
broker-dealer is the sole market-maker, the broker-dealer must disclose this
fact and the broker-dealer's presumed control over the market.
These additional regulations imposed upon broker-dealers that trade "penny
stocks" may discourage broker-dealers from effecting transactions in our
securities, which could severely limit
26
<PAGE>
the market price and liquidity of such securities and the ability of holders of
our common stock to sell their securities in the secondary market.
ITEM 2. LEGAL PROCEEDINGS.
In July, 1999, Sentencing Concepts was named as a co-defendant in the case
of Dinwiddie vs. PharmChem in the Fresno County Superior Court, case No.
C98908669-5. The plaintiff in the lawsuit alleges that a drug patch that was
used to test her drug abuse caused an allergic reaction that resulted in a scar
to her upper arm. As the distributor of the patch to the Fresno County Drug
Court, Sentencing Concepts was named in the lawsuit. We believe the outcome of
the lawsuit will not result in a material adverse effect on our financial
position or results of operation.
ITEM 3. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS.
Not applicable.
ITEM 4. RECENT SALES OF UNREGISTERED SECURITIES.
On September 1, 1998, the Company acquired 100 percent of the common stock
of Sentencing Concepts, Inc. in exchange for 1,150,000 shares of the Company's
common stock. In addition, 600,000 options were granted to the previous owners
of Sentencing Concepts with the following vesting requirements: 50,000 options
will vest upon their continued employment with the Company, through January 1,
2002 and 50,000 options will vest upon their continued employment with the
Company, through January 1, 2003. The remaining 500,000 options shall vest,
based upon pre-determined profitability levels of Sentencing Concepts,
subsequent to the acquisition. The exercise price of these 600,000 options is
$0.83.
December 1, 1997, the Company issued 10,000 shares of its common stock to
an individual in exchange for services performed.
The sales and issuances of securities described above were deemed to be
exempt from registration under the Securities Act by virtue of Section 4(2) or
Regulation D promulgated under the Securities Act.
ITEM 5. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Pursuant to the General Corporation Law of the State of California, under
most circumstances Correctional Systems' officers and directors may not be held
liable to Correctional Systems or its shareholders for errors in judgment or
other acts or omissions in the conduct of Correctional Systems' business unless
such errors in judgment, acts or omissions constitute fraud, gross negligence or
malfeasance.
27
<PAGE>
PART F/S
<TABLE>
<CAPTION>
PAGE
-------
<S> <C>
Report of Independent Public Accountants.................................. F - 2
Consolidated Balance Sheet as of December 31, 1998........................ F - 3
Consolidated Statements of Operations for
the Years Ended December 31, 1998 and 1997.............................. F - 4
Consolidated Statements of Shareholders'
Equity for the Years Ended December 31, 1998 and 1997................... F - 5
Consolidated Statements of Cash Flows for
the Years Ended December 31, 1998 and 1997.............................. F - 6
Notes to Consolidated Financial Statements................................ F - 8
Unaudited Consolidated Balance Sheet as
of September 30, 1999................................................... F - 16
Unaudited Consolidated and Subsidiaries Statement of
Income for the Nine-Months Ended September 30, 1999..................... F - 17
Unaudited Consolidated Statement of Cash
Flows for the Nine-Months Ended September 30, 1999...................... F - 18
</TABLE>
<PAGE>
PART III
Item 1. Index to Exhibits.
2.1 Certificate of Incorporation*
2.2 By-laws*
6(c) Incentive Stock Plan*
Item 2. Description of Exhibits.
2.1 Certificate of Incorporation*
2.2 By-laws*
6(c) Incentive Stock Plan*
*To be filed by amendment.
<PAGE>
SIGNATURES
In accordance with Section 12 of the Securities Exchange Act of 1934, the
registrant caused this reorganization statement to be signed on its behalf by
the undersigned, thereunto duly authorized.
CORRECTIONAL SYSTEMS, INC.
a California Corporation
Date: November 22, 1999
/s/ John R. Forren
--------------------------
By: John R. Forren
Its: President, Chief Executive Officer
and Director
<PAGE>
CORRECTIONAL SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 1998 AND FOR THE
YEARS ENDED DECEMBER 31, 1998 AND 1997
TOGETHER WITH REPORT OF INDEPENDENT
PUBLIC ACCOUNTANTS
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Correctional Systems, Inc.:
We have audited the accompanying consolidated balance sheet of CORRECTIONAL
SYSTEMS, INC. (a California corporation) and subsidiaries as of December 31,
1998, and the related consolidated statements of operations, shareholders'
equity and cash flows for each of the two years in the period ended December 31,
1998. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Correctional
Systems, Inc. and subsidiaries as of December 31, 1998, and the results of their
operations and their cash flows for each of the two years in the period ended
December 31, 1998 in conformity with generally accepted accounting principles.
/s/ ARTHUR ANDERSEN LLP
San Diego, California
July 29, 1999
F-2
<PAGE>
CORRECTIONAL SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
AS OF DECEMBER 31, 1998
ASSETS
<TABLE>
<S> <C>
Cash $ 489,096
Accounts receivable 513,128
-----------
Total current assets 1,002,224
-----------
Property and equipment:
Land 78,000
Building 262,000
Furniture and equipment 116,449
Less: accumulated depreciation (32,145)
-----------
Total property and equipment 424,304
-----------
Related party notes and interest receivable 103,333
Goodwill, net of accumulated amortization of $25,565 1,467,611
Other intangibles, net of accumulated amortization of $6,818 603,182
Deposits and other assets 15,970
-----------
$ 3,616,624
===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable $ 201,220
Accrued earn-out and bonus 228,200
Line of credit 40,887
Accrued payroll and taxes 101,265
Notes payable 106,776
Deferred revenue and other liabilities 107,223
-----------
Total current liabilities 785,571
-----------
Commitments and Contingencies (Note 7)
Shareholders' equity:
Preferred stock, $.001 par value, 10,000,000 shares authorized, 3,363,636
issued and outstanding 3,364
Common stock, $.001 par value, 40,000,000
shares authorized, 3,644,400 shares issued and outstanding 3,644
Additional paid-in capital 3,618,462
Accumulated deficit (794,417)
-----------
2,831,053
-----------
$ 3,616,624
===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE>
CORRECTIONAL SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Revenues $ 3,004,984 $ 1,051,806
Salaries and wages 1,301,493 648,374
Other operating expenses 1,027,772 254,261
----------- -----------
Total operating expenses 2,329,265 902,635
----------- -----------
Gross profit 675,719 149,171
General and administrative expenses 704,111 620,249
----------- -----------
Loss from operations (28,392) (471,078)
Other income (expense):
Interest income and expense, net 2,377 -
Other income (expense) (2,393) 10,491
----------- -----------
Total other income (expense) (16) 10,491
----------- -----------
Net loss $ (28,408) $ (460,587)
=========== ===========
Basic and diluted net loss per share $ (0.01) $ (0.19)
=========== ===========
Weighted average common shares outstanding 2,877,733 2,485,234
=========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
CORRECTIONAL SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
PREFERRED COMMON
------------------------- -------------------------
SHARES AMOUNT SHARES AMOUNT
---------- ------ -------- --------
<S> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1996 - $ - 2,484,400 $ 2,484
Issuance of common stock, net of offering costs of $1,000 - - 10,000 10
Forgiveness of board member liability - - - -
Net loss - - - -
----------- ----------- ----------- -----------
BALANCE AT DECEMBER 31, 1997 - - 2,494,400 2,494
Issuance of common stock, net of offering costs of $56,355 - - 1,150,000 1,150
Issuance of preferred stock, net of offering costs of $52,395 3,363,636 3,364 - -
Net loss - - - -
----------- ----------- ----------- -----------
BALANCE AT DECEMBER 31, 1998 3,363,636 $ 3,364 3,644,400 $ 3,644
=========== =========== =========== ===========
<CAPTION>
ADDITIONAL
PAID-IN ACCUMULATED
CAPITAL DEFICIT TOTAL
---------- --------- -------
<S> <C> <C> <C>
BALANCE AT DECEMBER 31, 1996 $ 913,736 $ (305,422) $ 610,798
Issuance of common stock, net of offering costs of $1,000 8,990 - 9,000
Forgiveness of board member liability 14,000 - 14,000
Net loss - (460,587) (460,587)
----------- ----------- -----------
BALANCE AT DECEMBER 31, 1997 936,726 (766,009) 173,211
Issuance of common stock, net of offering costs of $56,355 517,495 - 518,645
Issuance of preferred stock, net of offering costs of $52,395 2,164,241 - 2,167,605
Net loss - (28,408) (28,408)
----------- ----------- -----------
BALANCE AT DECEMBER 31, 1998 $ 3,618,462 $ (794,417) $ 2,831,053
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE>
CORRECTIONAL SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (28,408) $ (460,587)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 50,685 6,416
Loss on disposal of property and equipment - 842
Increase in accounts receivable (221,404) (97,085)
Decrease(increase) in other assets (4,326) 4,643
Increase(decrease) in accounts payable and accrued liabilities (300,821) 109,551
Increase in accrued earn-out and bonus 228,200 -
----------- -----------
Net cash used in operating activities (276,074) (436,220)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Payments for acquired companies, net of cash acquired (1,377,456) -
Costs incurred in connection with issuance of common stock (56,355) -
Purchase of furniture and equipment (30,889) -
Payments received from related parties 30,000 -
Loans to related parties (100,000) (30,000)
----------- -----------
Net cash used in investing activities (1,534,700) (30,000)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of preferred stock, net 2,167,605 -
Proceeds from issuance of common stock, net - 9,000
Borrowings on line of credit 14,525 123,950
Payments on line of credit - (97,588)
Payments on notes payable (6,959) -
----------- -----------
Net cash provided by financing activities 2,175,171 35,362
----------- -----------
INCREASE(DECREASE) IN CASH 364,397 (430,858)
CASH, beginning of year 124,699 555,557
----------- -----------
CASH, end of year $ 489,096 $ 124,699
=========== ===========
</TABLE>
(continued)
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE>
CORRECTIONAL SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(continued)
<TABLE>
<CAPTION>
1998 1997
--------- ---------
<S> <C> <C>
SUPPLEMENTAL DISCLOSURE OF NON-CASH
INVESTING ACTIVITES:
Acquisition of Sentencing Concepts, Inc.:
Accounts receivable $ 36,907 $ -
Furniture and equipment 14,164 -
Other assets 11,020 -
Accounts payable (550,428) -
Notes payable (113,735) -
--------- ---------
$(602,072) $ -
========= =========
SUPPLEMENTAL DISCLOSURE OF NON-CASH
FINANCING ACTIVITY:
Forgiveness of board member liability $ - $ 14,000
========= =========
Interest paid $ 7,058 $ 1,797
========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
<PAGE>
CORRECTIONAL SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
1. DESCRIPTION OF BUSINESS AND RISK FACTORS
Description of Business
Correctional Systems, Inc. and subsidiaries ("CSI" individually or the
"Company" collectively) was incorporated in the state of California on
March 31, 1994. CSI operates correctional facilities on behalf of cities
and counties under the terms of multi-year contracts with local
governmental agencies. The population of the correctional facilities
typically consists of arrestees, self-pay inmates, sentenced county work
furlough inmates, sentenced federal inmates serving short-term sentences
and individuals requiring detoxification. As a result of an acquisition in
1998 (see Note 3), the Company also operates a community correction
facility known as Reality House, Inc. (RHI). RHI primarily provides work
furlough programs and counseling, funded by the Bureau of Prisons. The
Company's subsidiary, Sentencing Concepts, Inc. (SCI), also acquired in
1998 (see Note 3), provides non-imprisonment alternatives to individuals
who would have otherwise been subject to standard judicial punishment. The
services include electronic home monitoring; drug, alcohol, and anger
management counseling; and drug use testing. The Company has contracts
with various municipal judicial systems to provide these services.
Risk Factors
Based on total assets and annual revenues, the Company is significantly
smaller than many of its competitors. These competitors include large
privately-held and publicly-held companies that have substantially greater
financial, marketing and other resources than the Company. These companies
offer services and operate in the markets in which the Company competes.
The services offered by these companies in some cases are similar to the
services that the Company offers. The Company expects that competition
will increase substantially as a result of industry consolidations and
alliances, as well as the emergence of new competitors. There can be no
assurance that the Company will be able to compete successfully with
existing or new competitors or that competitive pressures faced by the
Company will not materially and adversely affect its business, operating
results and financial condition.
The Company has grown internally, by procuring agreements to operate
correctional facilities, and externally, by acquiring existing operators
of correctional facilities. The Company intends to continue its
development and growth in this manner. Its ability to manage this
development and intended growth will depend on the efforts of its key
management and employees. The Company plans to use incentives, including
competitive compensation and stock plans, to retain well-qualified
employees and attract new employees to accommodate any expansion. There
can be no assurance, however, that the Company will be able to retain and
attract personnel with the requisite capabilities and experience. The
F-8
<PAGE>
loss of one or more current key management personnel could also materially
adversely affect the Company.
The Company anticipates that it will need to undertake private placements
or a public offering of its securities at a future date, depending upon
market conditions, in order to obtain sufficient capital to implement its
intended growth plan. No assurance can be given that it will be successful
in raising additional investment capital in the future, or that if it is
successful, that the financial resources obtained will be sufficient to
successfully carry out the Company's intended growth plan.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CONSOLIDATION
The consolidated financial statements include the accounts of CSI and its
wholly-owned subsidiaries, SCI and RHI. All significant intercompany
accounts and transactions have been eliminated.
CASH
Cash includes cash in readily available checking and money market
accounts.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and depreciated over the
estimated useful lives of the assets using the straight-line method as
follows:
Building 40 years
Furniture and equipment 3 to 5 years
GOODWILL AND INTANGIBLES
Goodwill is amortized over a period not to exceed 20 years. Other
intangibles, which represent certain operating rights, are amortized over
a period not to exceed 30 years.
LONG-LIVED ASSETS
The Company accounts for long-lived assets in accordance with Statement
of Accounting Standards No. 121, "Accounting for the Impairment of
Long-Lived Assets" ("SFAS No. 121"). SFAS No. 121 requires that
long-lived assets and certain identifiable intangibles to be held by an
entity be reviewed for possible impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not
be fully recoverable. The Company periodically re-evaluates the
original assumptions and rationale utilized in the establishment of the
carrying value and estimated lives of its long-lived assets. The
criteria used for these evaluations include management's estimate of
the asset's continuing ability to generate income from operations and
positive cash flow in future periods as well as the strategic
significance of any intangible asset in carrying out the Company's
business objectives.
REVENUE RECOGNITION
Revenue is generally recognized as services are provided under the
provisions of contracts entered into with governmental agencies, either at
a fixed monthly rate or at a net rate per day per inmate. During 1998 and
1997, the Company received reimbursements for certain costs incurred
F-9
<PAGE>
in the amount of $1,195,799 and $549,334, respectively. These amounts are
included in revenue.
Under contracts entered into by SCI, the Company must provide services to
all clients referred by the judicial process, regardless of the client's
ability to pay. Further, the contracts allow for SCI to charge its clients
fees based on a prearranged sliding fee schedule. SCI contracts do not
guarantee a specified level of revenue nor do they provide for
reimbursement for losses relating to servicing clients who are unable to
pay. As a result, portions of SCI's clients receive services for nominal
or for no fees. Accordingly, losses for services provided are recognized
when identified. Fees received in advance of services are recorded as
deferred revenue until services are rendered. Deferred revenues in the
amount of $71,512 are included in deferred revenue and other liabilities
as of December 31, 1998.
NET LOSS PER SHARE
Basic and diluted net loss per share for the years ended December 31, 1998
and 1997 have been computed using the weighted average number of
shares of common stock outstanding during the period pursuant to Statement
of Financial Accounting Standards No. 128, "Earnings Per Share." The
weighted average number of shares does not include the dilutive
effect of any stock options, as the effect would be antidilutive.
INCOME TAXES
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards No. 109 ("SFAS No. 109"), "Accounting for
Income Taxes." Under SFAS No. 109, deferred tax assets and liabilities
reflect the future tax consequences of the difference between the
financial reporting and tax basis of assets and liabilities using current
enacted tax rates. Due to the issuance of preferred stock to First
Analysis Securities Corporation (see Note 4), Federal tax law limits the
utilization of the net operating losses incurred prior to this event.
Therefore, the use of the net operating loss carryforward has been limited
to $6,400. Subsequent to this event, the Company incurred $45,000 of
additional net operating losses during 1998, which are not limited. The
Company's combined net operating losses expire in 2018. At December 31,
1998, the only significant deferred tax assets and liabilities is the
asset related to the net operating loss carryforward. Due to uncertainty
of future realization, the Company has recorded a full valuation allowance
against this deferred tax asset.
STOCK BASED COMPENSATION
In January 1996, the Company adopted Statement of Financial Accounting
Standards No. 123 ("SFAS No. 123"), "Accounting for Stock-Based
Compensation." SFAS No. 123 requires that the Company either recognize
compensation expense for grants of stock, stock options, and other equity
instruments to employees based on new fair value accounting rules or elect
the disclosure only provisions of SFAS No. 123, under which the pro forma
net income and earnings per share using the fair value method is
disclosed. The Company has elected the disclosure only requirement (see
Note 6).
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reported period. Actual results could differ from those
estimates.
F-10
<PAGE>
NEW ACCOUNTING STANDARDS
In 1997, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 131 ("SFAS No. 131"), "Disclosure
About Segments Of An Enterprise and Related Information". SFAS No. 131
requires that public business enterprises report financial and descriptive
information about its reportable segments. Operating segments are
components of an enterprise about which separate financial information is
available that is evaluated regularly by the chief operating
decision-maker in deciding how to allocate resources and in assessing
performance. The Company operates in one segment (privatized correctional
services).
In 1997, the FASB issued Statement of Financial Accounting Standards No.
130 ("SFAS No. 130"), "Reporting Comprehensive Income." This statement is
effective for fiscal years beginning after December 15, 1997. This
statement requires that all items that are required to be recognized under
accounting standards as components of comprehensive income be reported in
a financial statement that is displayed with the same prominence as other
financial statements. During the periods presented, the Company had no
items required to be disclosed as components of comprehensive income.
3. ACQUISITIONS AND PRO FORMA INFORMATION
On August 1, 1998, the Company acquired 100 percent of the common stock of
RHI and the separately owned building in which RHI operates, in exchange
for approximately $1,411,508 in cash. The excess cost over the fair market
value of the net tangible assets acquired was allocated to goodwill in the
amount of $335,176 and to other intangibles in the amount of $610,000,
which represents a special use permit issued to the property that allows
RHI to operate as a community corrections facility.
On September 1, 1998 the Company acquired 100 percent of the common stock
of SCI in exchange for 1,150,000 shares of the Company's common stock, of
which 270,000 was placed in escrow as security and will be released to the
previous principals of SCI one year after the closing date, assuming that
there are no unresolved issues, if any. In addition, 600,000 options
were granted to the previous owners of SCI with the following vesting
requirements: 50,000 options will vest upon their continued employment
with the Company, through January 1, 2002 and 50,000 options will vest
upon their continued employment with the Company, through January 1, 2003.
The remaining 500,000 options shall vest, based upon pre-determined
profitability levels of SCI, subsequent to the acquisition. The exercise
price of these 600,000 options is the mean between the average
bid and average ask price for the ten trading days prior to September 1,
1998, or approximately $0.83.
As a part of this acquisition, the Company entered into employment
agreements with the previous owners of SCI through August 2000. The
agreements provide an additional 230,000 options of which 200,000 will
vest, based upon profitability levels that SCI must attain after the
acquisition, and 30,000 that will vest upon continued employment through
July 31, 1999. These options have an exercise price of $0.20 per share. If
required, the Company will fund the exercise of these options by the
previous owners.
The acquisition of SCI was accounted for under the purchase method of
accounting. The transaction generated $1,158,000 in goodwill, which
represents the fair market value of the CSI stock issued to the former
owners of SCI, less the fair market value of the tangible net assets
F-11
<PAGE>
received by CSI. This goodwill is being amortized over 20 years using the
straight-line method.
On a pro forma basis, had the SCI and the RHI acquisitions taken place on
January 1, 1998, and January 1, 1997, respectively, the Company would have
recorded revenue, net loss, and basic and diluted net loss per share as
follows:
<TABLE>
<CAPTION>
PRO FORMA (UNAUDITED)
---------------------
YEAR ENDED DECEMBER 31
----------------------
1998 1997
----------- -----------
<S> <C> <C>
Revenue $ 4,826,489 $ 3,450,486
Net loss $ (163,633) $ (615,745)
Basic and diluted net loss per share $ (0.05) $ (0.09)
</TABLE>
4. EQUITY FINANCING
On July 31, 1998, the Company entered into a stock purchase agreement with
First Analysis Securities Corporation (FASC). Under the agreement, FASC
purchased 3,363,636 shares of preferred stock for $2,220,000. The
agreement specifies that $500,000 of the $2,200,000 be spent directly by
SCI to fund expansion. The Company incurred $52,395 in costs, which are
netted against the proceeds in the statement of shareholders' equity.
The FASC shares must be converted, in total or in part, into common stock
at any time upon a "conversion event" as defined by the agreement. The
number of shares of common stock issuable upon conversion of the preferred
stock and the conversion price shall be adjusted from time to time, based
upon "certain events" as defined by the agreement. Additionally, if at any
time the Company issues additional shares of common stock, or securities
convertible into common stock, for a consideration per share of common
stock less than the conversion price in effect at the time of such
issuance, then the conversion price in effect immediately prior to the
issuance of such additional shares of common stock shall be reduced to a
price per share equal to the consideration per share received for the
additional shares of common stock.
The preferred stock has voting rights equal to the number of shares of
common stock issuable upon conversion. As long as the preferred stock is
outstanding, the Company is restricted from certain acts, as defined by
the agreement. If the Company is voluntarily or involuntarily liquidated,
the preferred stockholders shall be entitled to receive, prior to
distributions to any holder of common stock, a per share amount equal to
the preferred stock original issue price in addition to all accrued but
unpaid preferred dividends, if any (the "Series A Liquidation
Preference"). Upon distribution of the Series A Liquidation Preference,
the remaining assets would be distributed to common and preferred
stockholders on a pro rata basis.
5. RELATED PARTY NOTES AND INTEREST RECEIVABLE
As of December 31, 1998, related party notes receivable consisted of two
$50,000 loans (plus accrued interest at 7 percent) due from officers (the
President and Chief Operating Officer) of SCI. The loans are secured by
CSI common stock owned by the officers. Principal and interest are due on
July 31, 2003.
6. EMPLOYEE STOCK OPTION PLAN
The Company has reserved 1,500,000 shares of common stock for future
issuance under an employee stock option plan. Options are generally
granted at fair market value at the date of grant, expire ten years after
the date of grant and fully vest within four years of the date of grant.
F-12
<PAGE>
The following table summarizes stock option plan activity for the years
ended December 31, 1998 and 1997:
<TABLE>
<CAPTION>
Weighted Average
Options Exercise Price
------- --------------
<S> <C> <C>
Outstanding, December 31, 1996 1,110,625 $0.60
Granted 4,000 $1.00
---------
Outstanding, December 31, 1997 1,114,625 $0.60
Granted 634,350 $0.64
Forfeited (317,175) $0.60
---------
Outstanding, December 31, 1998 1,431,800 $0.62
=========
Exercisable, December 31, 1998 256,450 $0.20 - $1.80
=========
</TABLE>
As permitted, the Company has adopted the disclosure only provisions of
SFAS No. 123. Accordingly, no compensation expense has been recognized for
options granted. Had compensation expense been determined based on the
fair value at date of grant for the 1998 and 1997 awards consistent with
the provisions of SFAS No. 123, the Company's net loss would have been
increased to the pro forma amount as follows:
<TABLE>
<CAPTION>
1998 1997
--------- ---------
<S> <C> <C>
Net loss - as reported $ (28,408) $(460,587)
Net loss - pro forma $ (43,551) $(465,285)
Net loss per basic and diluted share $ (0.02) $ (0.19)
</TABLE>
The fair value of each option grant was estimated on the date of grant
using the Black-Scholes option-pricing model and using the following
weighted average assumptions for grants in 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
------- -------
<S> <C> <C>
Risk-free interest rate 5.74% 6.00%
Expected lives 10 Years 10 Years
Expected volatility 115.06% 87.41%
Expected dividend yield 0.00% 0.00%
</TABLE>
7. COMMITMENTS AND CONTINGENCIES
The Company leases certain office space, facilities, and equipment under
operating lease agreements. The Company is obligated to make future
minimum lease payments as of December 31, 1998 as follows:
<TABLE>
<S> <C>
1999 $ 208,613
2000 199,328
2001 140,599
2002 135,535
2003 135,850
Thereafter 593,100
----------
Total $1,413,025
==========
</TABLE>
Total rent expense for 1998 and 1997 was $48,054 and $11,873,
respectively.
The Company is involved in various legal matters in the ordinary course of
its business activities. In the opinion of management, the outcome of such
matters is not expected to have a material adverse impact on the Company's
financial position or results of operations.
F-13
<PAGE>
8. LINE OF CREDIT
During 1998 and 1997, the Company had a line of credit with a bank, which
provided for borrowings of up to $50,000 at an annual interest rate of 11
percent. The line of credit was fully repaid on April 28, 1999 with the
account subsequently being closed on May 28, 1999.
9. NOTES PAYABLE
The Company had an unsecured note payable due to the former owner of RHI
in the amount of $100,000 bearing interest at 8 percent per annum, due May
20, 1999. Interest only payments were made monthly in the amount
of $667. Principal and interest were paid in full on June 4,
1999. Additionally, the Company has a loan secured by a vehicle in the
amount of $6,776, due August 11, 2000. Principal and interest payments are
made monthly in the amount of $357.
10. SUBSEQUENT EVENTS
On July 29, 1999, the Company acquired a building, certain equipment and
intangibles in exchange for the issuance of $1,025,000 in notes payable
and $25,000 in cash. Similar to RHI, this facility provides work furlough
programs and counseling services funded under contract with the Bureau of
Prisons. The notes payable are secured by real property, with one loan in
the amount of $500,000 and principal and interest payments of $5,412
through July 2011 at 8 percent interest per annum, and the other loan in
the amount of $525,000 with principal and interest payments of $12,800
through 2006 at 9.29 percent interest per annum.
11. QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
Quarter Ended
----------------------------------------------------------------
03/31/98 06/30/98 09/30/98 12/31/98
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenue $ 381,849 $ 466,686 $ 818,359 $ 1,338,090
Operating expenses and other 397,369 499,044 749,738 1,387,241
----------- ----------- ----------- -----------
Net income (loss) $ (15,520) $ (32,358) $ 68,621 $ (49,151)
=========== =========== =========== ===========
Basic and diluted net
income (loss) per share $ (.01) $ (.01) $ .02 $ (.01)
=========== =========== =========== ===========
weighted average common
shares outstanding 2,494,400 2,494,400 2,877,733 3,644,400
=========== =========== =========== ===========
</TABLE>
<TABLE>
<CAPTION>
Quarter Ended
----------------------------------------------------------------
03/31/97 06/30/97 09/30/97 12/31/97
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenue $ 213,305 $ 278,428 $ 309,685 $ 250,388
Operating expenses and other 319,200 389,656 401,899 401,638
----------- ----------- ----------- -----------
Net loss $ (105,895) $ (111,228) $ (92,214) $ (151,250)
=========== =========== =========== ===========
Basic and diluted net loss per share $ (.04) $ (.05) $ (.04) $ (.06)
=========== =========== =========== ===========
Weighted average common
shares outstanding 2,484,400 2,484,400 2,484,400 2,487,733
=========== =========== =========== ===========
</TABLE>
F-14
<PAGE>
CORRECTIONAL SYSTEMS, INC.
AND SUBSIDIARIES
UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS AS OF SEPTEMBER 30, 1999
AND FOR THE NINE MONTH PERIOD ENDED
SEPTEMBER 30, 1999
F-15
<PAGE>
CORRECTIONAL SYSTEMS, INC.
CONSOLIDATED CONDENSED AND SUBSIDIARIES
BALANCE SHEET
SEPTEMBER 30, 1999
UNAUDITED
<TABLE>
<S> <C>
ASSETS
CASH $ 304,841
ACCOUNTS RECEIVABLES 812,583
INVENTORY 6,546
-----------
TOTAL CURRENT ASSETS 1,123,970
-----------
PROPERTY & EQUIPMENT - NET 1,544,214
GOODWILL - NET 1,410,961
INTANGIBLES - NET 590,905
NOTES REC LONG TERM RELATED PARTY AND OTHER 176,224
-----------
TOTAL ASSETS $ 4,846,274
-----------
-----------
LIABILITIES & EQUITY
ACCOUNTS PAYABLE $ 136,828
ACCRUED AND OTHER LIABILITIES 510,050
NOTES PAYABLE CURRENT 116,818
-----------
CURRENT LIABILITIES 763,696
-----------
NOTE PAYABLE LONGTERM 1,145,394
DEFERRED TAX LIABILITY 9,004
COMMITMENT AND CONTINGENCIES
SHAREHOLDERS' EQUITY
PREFERRED STOCK - PAR 3,364
CAPITAL STOCK - PAR 3,644
PAID IN-CAPITAL 3,618,461
RETAINED EARNINGS (DEFICIT) (697,289)
-----------
TOTAL SHAREHOLDERS' EQUITY 2,928,180
-----------
-----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 4,846,274
-----------
-----------
</TABLE>
F-16
<PAGE>
CORRECTIONAL SYSTEMS, INC.
CONSOLIDATED AND SUBSIDIARIES STATEMENT OF INCOME
FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 1999
UNAUDITED
<TABLE>
<CAPTION>
<S> <C>
REVENUES $ 5,018,586
SALARIES AND WAGES 2,102,241
OTHER OPERATING EXPENSES 1,645,130
-----------
GROSS PROFIT 1,271,215
-----------
GENERAL AND ADMINISTRATIVE EXPENSE 1,125,762
-----------
INCOME FROM OPERATIONS 145,453
-----------
INTEREST EXPENSE (42,401)
INTEREST INCOME 14,543
OTHER EXPENSE (2,128)
-----------
INCOME BEFORE PROVISION FOR TAXES 115,467
-----------
INCOME TAX PROVISION (18,339)
-----------
NET INCOME $ 97,128
-----------
-----------
BASIC EARNINGS PER SHARE $ 0.03
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING BASIC 3,644,400
DILUTED EARNINGS PER SHARE $ 0.01
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING DILUTED 7,149,574
</TABLE>
F-17
<PAGE>
CORRECTIONAL SYSTEMS, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 1999
UNAUDITED
<TABLE>
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
NET INCOME $ 97,128
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH
USED IN OPERATIONS:
DEPRECIATION AND AMORTIZATION 118,818
INCREASE IN ACCOUNTS RECEIVABLE (299,455)
INCREASE IN INVENTORY (6,546)
INCREASE IN OTHER ASSETS (57,921)
DECREASE IN ACCOUNTS PAYABLE (64,393)
INCREASE IN ACCRUED LIABILITIES 24,142
INCREASE INCOME TAXES PAYABLE 18,339
-----------
NET CASH USED IN OPERATING ACTIVITIES (169,888)
-----------
CASH FLOWS FROM INVESTING ACTIVITIES:
PURCHASE OF PROPERTY AND EQUIPMENT (1,169,803)
-----------
NET CASH USED IN INVESTING ACTIVITIES (1,169,803)
-----------
CASH FLOWS FROM FINANCING ACTIVITIES:
PROCEEDS FROM NOTES PAYABLE NET 1,155,436
-----------
NET CASH PROVIDED BY INVESTING ACTIVITIES 1,155,436
-----------
DECREASE IN CASH (184,255)
CASH, BEGINNING OF PERIOD 489,096
-----------
CASH, END OF PERIOD $ 304,841
-----------
-----------
</TABLE>
F-18
