SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1997
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from__ to__
Commission File Number: 0-20307
AVALON COMMUNITY SERVICES, INC.
(Name of small business issuer in its charter)
Nevada 13-3592263
(State of Incorporation) (I.R.S. Employer I.D. Number)
13401 Railway Drive, Oklahoma City, Oklahoma 73114
(Address of Principal executive offices) (Zip Code)
Issuer's telephone number (405) 752-8802
Securities registered under Section 12 (b) of the Exchange Act: None
Securities registered under Section 12 (g) of the Exchange Act:
Shares of Class A Common Stock, par value $.001
-----------------------------------------------
(Title of class)
The issuer has (1) filed all reports required to be filed by Section 13 or 15
(d) of the Exchange Act during the past 12 months (or such shorter period as the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 day: Yes X No ___
Disclosure of delinquent filers in response to Item 405 of Regulation S-B is
not contained in this form, and no disclosure will be contained, to the best of
Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this form 10-KSB. [ X ]
Revenues for continuing operations for the year ended December 31, 1997 were
$5,878,000.
The aggregate market value of voting common stock held by non affiliates was
$8,206,240 on February 27, 1998, based on the average high and low prices of
such stock as reported by the National Association of Securities Dealers
Automated Quotations Systems ("NASDAQ") on that day. As of February 27, 1998,
2,984,380 shares of the issuer's common stock, par value $.001, were issued and
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Proxy Statements for the 1998 Annual Meeting of Shareholders
are incorporated by reference in Part III.6
Transitional Small Business Disclosure Format: Yes__ No X .
<PAGE>
TABLE OF CONTENTS
FORM 10-KSB ANNUAL REPORT
FOR THE YEAR ENDED DECEMBER 31, 1997
Item Page
- ---- ----
PART I
1. Description of Business 1
2. Description of Property 5
3. Legal Proceedings 6
4. Submission of Matters to a Vote of Security Holders 6
PART II
5. Market for Common Equity and Related
Stockholder Matters 6
6. Management's Discussion and Analysis of Financial
Condition and Results of Operations 7
7. Financial Statements 9
8. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure 28
PART III
9. Directors, Executive Officers, Promoters and Control
Persons; Compliance with Section 16 (a) of
the Exchange Act 28
10. Executive Compensation 29
11. Security Ownership of Certain Beneficial Owners
and Management 29
12. Certain Relationships and Related Transactions 29
13. Exhibits and Reports on Form 8-K 29
Signatures 32
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
PART I
------
ITEM 1. DESCRIPTION OF BUSINESS.
The Company -
Avalon Community Services, Inc., is a Nevada Corporation owning and operating
private correctional facilities. Avalon Community Services, Inc. and its wholly
owned subsidiaries ("Avalon" or the "Company") specialize in operating private
community correctional facilities and providing intensive correctional
programming. Avalon currently operates facilities and manages programs in
Oklahoma, Texas, Missouri, and Nebraska with plans to significantly expand into
additional states. Avalon's business strategy is designed to escalate Avalon
into a dominant role as a provider of community correctional services. Avalon's
development plan is to expand operations through new state and Federal contracts
and selective acquisitions to capitalize on the current rapid growth trends in
the private corrections industry.
The private correctional services industry has experienced significant growth
in recent years. During 1995 there were 3.8 million individuals on probation or
parole. This population is expected to increase to over 7 million by the year
2005. Annual correction industry growth rates have been approximately 7 to 8
percent per year. This growth rate exceeds the general population growth because
of increasing crime rates, higher conviction rates and longer prison sentences.
Avalon contracts with various government agencies to provide community
corrections services. Studies have documented a 10 to 30 percent savings to
government agencies as a result of utilizing private corrections providers to
build and operate correctional facilities. Avalon management believes its
background and abilities to build and operate community correctional facilities
and provide correctional programing position the Company for substantial future
growth in the corrections industry.
Avalon currently owns and operates 805 private community corrections beds. The
Company owns and operates three minimum-security correctional facilities (655
beds) in Oklahoma and one medium-security correctional facility (150 beds) in
Texas. Avalon believes it is the largest private provider of community
correctional services in Oklahoma. The Avalon facilities provide numerous
programs for offenders generally serving the last six months of their sentence.
Avalon provides contract agencies the basic services relating to the security,
detention and care of inmates, and a broad range of rehabilitative programs to
reduce recidivism. The provided programming includes substance abuse treatment
and counseling, vocational training, work release programs, basic educational
programs, job and life skill training, and reintegration services.
Avalon also provides intensive substance abuse treatment services to inmates
in six medium security correctional facilities in Nebraska and one medium
security correctional facility in Missouri. Intensive programming is an
essential part of community based corrections. Avalon has provided substance
abuse programs in facilities for over thirteen (13) years. Avalon's management
has been engaged in the business of providing private correctional services
since 1985.
Avalon's management made the decision to divest all non correctional services
at the end of 1996 to allow management to focus exclusively on private
corrections. Avalon is aggressively developing its private correctional
operations through selective acquisitions and responding to requests of
governmental agencies.
Avalon's corporate office is located at 13401 Railway Drive in Oklahoma City,
Oklahoma. Avalon's common stock is traded on the NASDAQ SmallCap Market with the
symbol "CITY".
Page 1
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
Facilities -
The following table summarizes certain information with respect to facilities
and programs managed by Avalon at March 3, 1998.
<TABLE>
<CAPTION>
Facility Name
And Location Company Role Capacity Facility / Program Type
- ---------------------------------- ---------------------------- ------------ -----------------------
<S> <C> <C> <C>
Carver Center, Complete Facility 250 Beds Community Security
Oklahoma City, OK Ownership and Corrections
Management
Avalon Correctional Center, Complete Facility 255 Beds Community Security
Tulsa, OK Ownership and Corrections
Management
Turley Correctional Center, Complete Facility 150 Beds Community Security
Tulsa, OK Ownership and Corrections
Management
El Paso Intermediate Complete Facility 150 Beds Medium Security
Sanction Facility, Ownership and Correctional Facility
El Paso, TX Management
Nebraska State Penitentiary, Program Management 30 Clients Substance Abuse
Lincoln, NE Treatment Services
The Lincoln Correctional Program Management 50 Clients Substance Abuse
Center, Lincoln, NE Treatment Services
The Omaha Correctional Program Management 25 Clients Substance Abuse
Center, Omaha, NE Treatment Services
The Nebraska Community Program Management 30 Clients Substance Abuse
Corrections Center, Treatment Services
Lincoln, NE
Community Correctional Program Management 45 Clients Substance Abuse
Center, Lincoln, NE Treatment Services
Community Correctional Program Management 30 Clients Substance Abuse
Center, Omaha, NE Treatment Services
Ozark Correctional Center, Program Management 650 Clients Substance Abuse
Jefferson City, MO Treatment Services
Avalon Corporate Office, Corporate Headquarters N/A Administrative
Oklahoma City, OK
</TABLE>
Page 2
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
Correctional Services -
Avalon owns and operates four correctional centers, Carver Center, Avalon
Correctional Center, Turley Correctional Center and El Paso Intermediate
Sanction Facility. The correctional centers provide complete correctional
administration, correctional officer staffing, housing, food services,
vocational assistance, transportation, and rehabilitation services. Avalon also
provides intensive substance abuse treatment services to inmates in six medium
security correctional facilities in Nebraska and one medium security
correctional facility in Missouri.
Oklahoma. Avalon's contracts with the Oklahoma Department of Corrections
extend through June 30, 1998. The contracts with the Oklahoma Department of
Corrections are bid every three years. The structure of the Oklahoma contracts
is based upon three one year contract periods. Avalon has contracted with the
State of Oklahoma pursuant to similar contracts since 1985. The State of
Oklahoma's performance under the contracts is subject to annual appropriation by
the legislature. Avalon also provides services pursuant to a Federal contract
obtained in connection with the acquisition of the Turley Correctional Center in
October 1997. The five year contract extends through April 30, 1999, including
renewal options.
Carver Center is a 250 bed minimum security correctional facility located in
Oklahoma City, Oklahoma. Carver Center has been expanded from its initial
capacity of 25 beds in 1985, to its current capacity of 250 beds to accommodate
the increasing needs of the Oklahoma Department of Corrections.
Avalon Correctional Center is a 255 bed minimum security correctional facility
located in Tulsa, Oklahoma. The Avalon Correctional Center was built by Avalon
and opened in July 1995.
Turley Correctional Center is a 150 bed minimum security correctional facility
located in Tulsa, Oklahoma. The Turley Correctional Center was purchased by
Avalon in October 1997. The Company is developing plans to construct a new
facility on this site and increase the facility's capacity to 180 beds. The
construction is scheduled for completion during the fourth quarter of 1998.
Carver Center, Avalon Correctional Center and Turley Correctional Center are
accredited by the American Correctional Association ("ACA") as Adult Community
Correctional Facilities. ACA accreditation or candidacy is required to contract
with the State of Oklahoma for correctional services. The ACA, a private
not-for-profit organization, was established to develop uniformity and industry
standards for the operation of correctional facilities and provision of inmate
care.
Texas. Avalon purchased the El Paso Intermediate Sanction Facility in El Paso,
Texas in August 1996. The facility has a capacity of 150 beds. The Company
signed a fifteen year contract to provide services in the facility for the West
Texas Community Supervision and Corrections Department in July 1996. Avalon also
signed a three year contract with the Texas Department of Criminal Justice in
November 1996, to provide services for up to 50 male parole and mandatory
supervision releases in the facility.
Nebraska. Avalon was awarded a contract in February 1996, with the State of
Nebraska Department of Correctional Services to provide substance abuse
treatment services. The Nebraska contract had an initial fifteen-month term with
two (2), one year renewal options. The contract is to provide substance abuse
treatment services in six prisons: the Nebraska State Penitentiary, the Lincoln
Correctional Center, the Omaha Correctional Center, the Nebraska Community
Corrections Center at Lincoln, the Community Correctional Center in Lincoln, and
the Community Correctional Center in Omaha. Avalon began providing the contract
services in March 1996.
Missouri. Avalon was awarded a four year contract in March 1997 with the
Missouri Department of Corrections. The contract is to provide substance abuse
services in the Ozark Correctional Center, a 650 bed medium security prison in
Fordland, Missouri. Avalon began providing services in the Ozark Correctional
Center on May 1, 1997.
Page 3
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
Avalon is evaluating additional correctional projects in several states.
Discontinued Operations-
Avalon previously provided mental health services and assisted living services
in Oklahoma and Colorado. Avalon's management made the decision to divest all
non correctional services at the end of 1996 to allow management to focus
exclusively on private corrections.
Competition -
Corrections. The trend in the United States toward privatization of government
services and functions has increased as governments have faced continuing
pressure to control costs and improve the quality of services. Governmental
agencies responsible for the operation of detention facilities are privatizing
facilities and contracting with private contractors for services in an attempt
to address these pressures. Fiscal pressures have forced some government
agencies to limit public services and seek more cost-effective means of
providing the remaining services. Many do not have the readily-available
resources to make the changes to meet such mandates and are utilizing the
services of private providers.
A combination of factors in many states (i.e., decreasing revenues, increasing
prison population, litigation arising from substandard prison conditions, and
overcrowding) has led to a revamping of the corrections' processes and a
reallocation of limited prison resources. Private correctional services provide
a substantial economic savings allowing the contracting governmental agency to
comply with legislative and judicial pressure to improve prison conditions.
Private operated correctional management companies are able to provide high
quality services at a lower cost. Private correctional facilities operating as
contractors for government agencies, pursuant to court order or otherwise, exist
in virtually every state. The private correctional services industry has
experienced rapid growth in recent years. The industry is very early in its life
cycle. Private companies manage approximately 5 percent of the beds in the U.S.
prison system.
The area of community corrections, like that of all other corrections sectors,
has experienced substantial growth over the past decade. Community corrections
includes providing services to individuals still in the correctional system and
individuals granted parole or sentenced to probation. Offenders are often placed
in a community corrections facility for the last six to twelve months of their
sentence. Offenders in a community corrections facility receive programming to
prepare them for re-entry into the community. The community corrections market
segment is estimated at $4 billion annually and includes approximately 5,000
providers.
Contracts for correctional services are awarded by government agencies and are
generally based upon competitive bidding and quality of services provided.
Avalon management believes the Company has several competitive advantages in
contracting for correctional services including: a) a thirteen-year history of
providing quality services to the Oklahoma Department of Corrections; b) a
geographic location allowing for lower administrative overhead charges when
bidding against competitors for regional contracts; c) accreditation by the
American Correctional Association since 1990 and certification as a drug and
alcohol provider since 1985; and d) a high quality and cost-effective corporate
infrastructure for management, marketing, financial management, financial
reporting, quality assurance, and providing support services.
Avalon has developed a broad range of programs designed to reduce recidivism,
including substance abuse treatment and counseling, vocational training, work
release programs, GED classes, job and life skills training, and reintegration
services in addition to providing fundamental residential services for adult
inmates. The management services offered by Avalon range from project consulting
for the design and development of new correctional facilities, to the complete
turnkey development of siting, designing, constructing, and operating
correctional facilities. Avalon management believes its experience and success
in owning and operating community correctional facilities and providing
programming will be the basis for the Company becoming the dominant company in
the community corrections industry.
Page 4
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
Avalon contracts with the State of Oklahoma to provide services at Carver
Center, Avalon Correctional Center and Turley Correctional Center. Avalon also
provides services pursuant to a contract with the Federal Bureau of Prisons at
Turley Correctional Center. Avalon contracts with West Texas Community
Supervision and Correctional Department and with the Texas Department of
Criminal Justice Parole Department to provide services in the El Paso
Intermediate Sanction Facility. Revenues generated from the Texas and Oklahoma
contracts during 1997 comprised approximately 83% of total revenues. Revenues
from contracts with the Oklahoma Department of Corrections represented 52% of
1997 revenues.
Insurance -
Avalon maintains insurance coverage for general liability, property and
contents, automobile physical damage and liability, workers' compensation, and
directors and officers. Avalon believes its existing insurance coverage is
adequate.
Regulations -
Avalon's correctional facilities in Oklahoma are accredited by the American
Correctional Association ("ACA"), an independent organization comprised of
professionals in the corrections industry. The ACA utilizes compliance audit
teams to rigorously examine all aspects of the Company's facilities and
operations. The Company recognizes the importance of maintaining high quality
management and operations at its facilities. Accreditation is generally granted
for a three-year period. Carver Center has been accredited since 1990 and is
currently accredited through 1999. Avalon Correctional Center was accredited in
1996 and is accredited through 1999. Turley Correctional Center was accredited
in 1997 and is accredited through 2000.
The corrections industry is subject to federal, state and local regulations
administered by a variety of regulatory authorities. The correctional services
offered by Avalon in various states are subject to regulations and oversight by
the various government agencies. Management believes its operations are
currently in compliance with all applicable laws and regulations affecting
Avalon's business.
Employees -
At March 2, 1998, Avalon had approximately 158 full-time employees, including,
directors and officers. Avalon has not experienced a work stoppage, and
management considers its employee relations to be good.
ITEM 2. DESCRIPTION OF PROPERTY.
Carver Center is a 250 bed minimum security correctional facility located in
Oklahoma City, Oklahoma. The facility is located on five acres of land and
includes five buildings. Avalon constructed a new 16,000 square foot dormitory
at Carver Center in the second quarter of 1995. The Carver Center facility
contains approximately 35,000 square feet of building space.
Avalon Correctional Center is a 255 bed minimum security correctional facility
located on approximately two acres of land in Tulsa, Oklahoma. The construction
of the approximately 36,000 square foot facility was completed and opened by the
Company in July, 1995.
Turley Correctional Center is a 150 bed minimum security correctional facility
located in Tulsa, Oklahoma. The facility is located on a thirty-five acre tract
of land and includes seven buildings. The Company is developing plans to
construct a new building on the Turley Correctional Center property in 1998. The
new building will replace six of the existing structures on the property and
increase the capacity of the facility to 180 beds. The Turley Correctional
Center was purchased in October 1997.
Page 5
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
El Paso Intermediate Sanction Facility is a 150 bed medium security
correctional facility located on seven acres of land in El Paso, Texas. The
facility was constructed as an intermediate sanction facility. The 36,000 square
foot facility was purchased by the Company in 1996.
Avalon owns a recently remodeled 60,000 square foot building located in Elk
City, Oklahoma. The building is zoned for the operation of a residential care
facility or an assisted living center. This building is under contract for sale
as of March 2, 1998.
Avalon Corporate Office is located in Oklahoma City, Oklahoma, in a commercial
building at 13401 Railway Drive, Oklahoma City, Oklahoma 73114. The building
contains approximately 21,000 square feet of warehouse space including
approximately 8,000 square feet of office space.
Substantially all property owned by Avalon is pledged as collateral on Company
debt. See Note 5 to the Consolidated Financial Statements.
ITEM 3. LEGAL PROCEEDINGS.
Avalon is a party to litigation arising in the normal course of business.
Management believes that the ultimate outcome of these matters will not have a
material effect on Avalon's financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of Avalon's stockholders during the
quarter ended December 31, 1997.
PART II
-------
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Avalon's common stock trades on the NASDAQ SmallCap Market with the symbol
"CITY". The following table reflects the range of high and low sales prices, as
reported by the National Quotation Bureau for each quarterly period during 1996
and 1997. The prices represent inter-dealer prices, without retail mark up, mark
down, or commission and may not represent actual transactions. Trading in
Avalon's common stock is limited and may not be an indication of the value of
the common stock.
Quarterly Period Ended High Low
------------------------------- -------------- -------------
March 31, 1996 2 1/2 2
June 30, 1996 7 5/8 2 1/2
September 30, 1996 5 7/8 4 1/8
December 31,1996 4 3/4 3 7/8
March 31, 1997 5 1/2 3 15/16
June 30, 1997 4 7/8 3 1/2
September 30, 1997 5 3 7/8
December 31, 1997 5 5/16 3 3/4
Avalon had approximately 830 holders of record of its common stock as of March
11, 1998. No dividends were declared during 1996 and 1997. Avalon's Board of
Directors presently intends to retain all earnings in the foreseeable future for
use in Avalon's business. Payment of dividends on the Common Stock is restricted
by certain credit facilities.
The average high and low price for the Common Stock, as reported on the NASDAQ
SmallCap Market System was $4.25 per share on February 27, 1998.
Page 6
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
Liquidity and Capital Resources -
The Company's business strategy is to focus on the private corrections
industry, expanding its operations into additional states through new Federal
and state contracts and selective acquisitions. This strategy was implemented in
the fourth quarter of 1996. Since the fourth quarter of 1996, all non
correctional operations have been discontinued and all related assets have been
sold or are under letters of intent or contract to sell. Losses associated with
discontinued operations and disposal of the related assets in 1997 are reflected
as losses from discontinued operations in the Statement of Operations. The
Company expects the 1998 earnings to include only correctional facility
operations.
Working capital at December 31, 1997 was $875,000 representing a current ratio
of 1.47. Warrants and options were exercised in 1997 generating net new capital
of $146,000, used primarily for operating needs. Capital expenditures were $2.3
million in 1997, compared to $171,000 in 1996. The significant expenditures
during 1997 were the purchase of the Turley Correctional Center in Tulsa,
Oklahoma, and investment in equipment. Proceeds from asset dispositions of
$196,000 were primarily a result of the sale of assets associated with
discontinued operations. Proceeds from asset dispositions were used to retire
debt.
The Company issued $4.15 million of convertible subordinated debentures in
1997 through a private placement. The debentures bear interest at 7.5% per annum
and mature in 2007. The debentures can be converted into the Company's Class A
common stock at $3.00 per share at any time prior to their maturity. The
debentures proceeds were utilized to complete an acquisition and provide capital
for new contracts and acquisitions. The Company acquired the Turley Correctional
Center in Tulsa, Oklahoma in October 1997. The purchase price of approximately
$1.4 million was funded with debenture proceeds.
The Company's revolving bank line of credit is currently $500,000. Long-term
debt borrowed during 1997 totaled $2.5 million primarily consisting of
refinancing the Avalon Correctional Center in Tulsa, Oklahoma. The refinancing
resulted in reducing the interest rate from 10% to 8.95% on the $1.6 million
mortgage. Additional financing was utilized to fund equipment purchases.
The Company has cash reserves of $1.96 million and cash flow from operations
to meet its current cash requirements. The Company expects current contracts to
generate sufficient income to increase cash reserves, while minimizing income
taxes through the utilization of tax loss carryforwards. Additional sources of
funding may be required on a project funding basis. The Company is currently
negotiating with financial institutions to obtain a line of credit to fund
future growth. The Company is also evaluating equity sources of financing. The
Company may receive equity from the exercise of stock options, warrants, or
conversion of debentures in 1998.
Results of Operations -
Year Ended December 31, 1997 Compared to the Year Ended December 31, 1996-
Total revenues from continuing operations increased by 77% to $5.9 million in
1997 from $3.3 million in 1996. The increase was a result of the acquisition of
the Turley Correctional Facility in Tulsa, Oklahoma, a contract award to provide
substance abuse counseling in Fordland, Missouri, a new contract award to
provide services to the Texas Department of Criminal Justice in El Paso, Texas,
and a full year of operations under a contract with the West Texas Community
Supervision and Corrections Department at the El Paso Intermediate Sanction
Facility acquired by the Company in August 1996.
Page 7
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
Revenues in 1997 were enhanced by the following: the Turley Correctional
Facility provided $353,000 of revenues; the Fordland, Missouri substance abuse
counseling contract provided $514,000 of revenues; the Texas Department of
Criminal Justice contract provided $427,000 of revenues; the West Texas
Community Supervision and Corrections Department contract increased revenues by
$733,000 due to a full year of operations in 1997; and the Avalon Correctional
Facility in Tulsa, OK, increased revenues by $556,000 due to increased inmate
census.
The Company's net loss from continuing operations was $1,853,000 in 1997
compared to $60,000 in 1996. The 1997 loss included a non cash charge of
$1,819,000 resulting from a discount on the convertible debentures issued in
September 1997. Excluding the effect of the $1,819,000 discount on convertible
debentures in 1997, the loss from continuing operations was $34,000.
The Company incurred a net loss in 1997 of $2,581,000 or $.88 per share, as
compared to a net loss in 1996 of $1,034,000 or $.38 per share. The majority
(98.7%) of the loss in 1997 resulted from the accounting treatment of a discount
from issuance of convertible debentures of $1,819,000, a non cash expense, and a
loss of $728,000 from discontinued operations. The discount on the convertible
debentures was the result of the market value of the Company's common stock
exceeding the conversion price of the debentures at the date the debentures were
issued. The debenture discount was accounted for by a charge to expense and
credit to paid in capital, resulting in no change of liabilities, cash or net
equity.
Corrections. Operating income, before interest, depreciation, and income
taxes, increased approximately 67% in 1997 to $1,175,000 compared to $705,000
for 1996. The substantial increase in operating income was a result of the
Company's focus on private corrections and obtaining new contracts and acquiring
additional facilities. The average daily inmate census increased to 425 in 1997
from 268 in 1996, an increase of 59%. The census increase was a result of the
acquisition of the Turley Correctional Facility in Tulsa, Oklahoma, a new
contract award to provide services to the Texas Department of Criminal Justice
in El Paso, Texas, and a full year of operations under a contract with the West
Texas Community Supervision and Corrections Department at the El Paso
Intermediate Sanction Facility acquired by the Company in August, 1996.
Direct operating expenses increased by 89% in 1997 over 1996, primarily as a
result of the full operations in 1997 of the El Paso Intermediate Sanction
Facility, the contract award for substance abuse counseling services at
Fordland, Missouri, and the acquisition of the Turley Correctional Center in
Tulsa, Oklahoma. The profit margin decreased slightly to 37% in 1997 from 41% in
1996. This was primarily due to lower profit margins generated from substance
abuse counseling services in prisons in Nebraska and Missouri. Substance abuse
programs profit margins are typically lower than margins generated by
residential correctional facilities.
Discontinued Operations. The Company made the decision to discontinue all non
correctional operations in the fourth quarter of 1996. The Company's strategy is
to focus on opportunities in the corrections industry. The net loss from
discontinued operations was $649,000, net of income tax allocations, for 1996.
Revenues from discontinued operations were $50,000 and $493,000, in 1997 and
1996 respectively. The losses on the disposal of assets related to discontinued
operations were $728,000 and $325,000, in 1997 and 1996, respectively.
Corporate. General and administrative expenses increased in 1997 by 53% to
$990,000 from $646,000. The majority of this increase was a result of the
overhead reimbursement received from discontinued operations in 1996. The gross
overhead reimbursement received by the Company from discontinued operations in
1996 was $398,000. The Company incurred minimal additional costs in 1997
associated with additional staffing, increased legal and professional expenses,
and an increase in promotional costs. These additional costs resulted from the
Company's focus on corrections and implementing a strategy for growth through
new contracts and acquisitions.
The increase in interest expense of $330,700 in 1997 resulted from interest on
the convertible debentures and a full year interest on indebtedness assumed in
1996 with the acquisition of the El Paso Intermediate Sanction Facility.
Depreciation and amortization expense have increased commensurate with the
growth of the correctional operations.
Page 8
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
ITEM 7. FINANCIAL STATEMENTS.
Index to Financial Statements:
Page
Report of Independent Certified Public Accountants 10
Consolidated Balance Sheets 11
Consolidated Statements of Operations 12
Consolidated Statements of Stockholders' Equity 13
Consolidated Statements of Cash Flow 14
Notes to Consolidated Financial Statements 16
Page 9
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors of
Avalon Community Services, Inc.
We have audited the accompanying consolidated balance sheets of Avalon Community
Services, Inc. and subsidiaries (the "Company") as of December 31, 1997 and
1996, and the related consolidated statements of operations, stockholders'
equity, and cash flows for the years then ended. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits 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 consolidated financial position of the
Company as of December 31, 1997 and 1996, and the consolidated results of their
operations and their cash flows for the years then ended in conformity with
generally accepted accounting principles.
GRANT THORNTON, LLP
Oklahoma City, Oklahoma
February 27, 1998 (except for Note 16, as to which the date is March 3, 1998)
Page 10
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
1997 1996
----------- ----------
ASSETS
Current assets:
Cash and cash equivalents $ 1,458,000 $ 313,000
Short term certificate of deposit 500,000 ---
Accounts receivable, net of allowance for
doubtful accounts of $8,000 and $5,000, respectively 673,000 401,000
Current maturities of notes receivable 16,000 ---
Due from affiliates --- 120,000
Prepaid expenses and other 107,000 311,000
- ------------------------------------------------------- ----------- ----------
Total current assets 2,754,000 1,145,000
- ------------------------------------------------------- ----------- ----------
Property and equipment, net 9,212,000 8,312,000
Notes receivable, net of current maturities 318,000 ---
Other assets 1,111,000 66,000
- ------------------------------------------------------- ----------- ----------
Total assets $13,395,000 $9,523,000
======================================================= =========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable, accrued liabilities and other $ 1,030,000 $ 448,000
Current maturities of long-term debt 849,000 519,000
- ------------------------------------------------------- ----------- ----------
Total current liabilities 1,879,000 967,000
- ------------------------------------------------------- ----------- ----------
Long-term debt, less current maturities 5,129,000 5,861,000
Convertible debentures 4,150,000 ---
Commitments and contingencies --- ---
Stockholders' equity:
Common stock:
Class A - par value $.001; 20,000,000 shares
authorized; 2,982,170 and 2,927,135 shares issued
and outstanding in 1997 and 1996, respectively 3,000 3,000
Class B - no par 4,000,000 shares authorized; none
and 3,410,000 shares issued and outstanding
in 1997 and 1996, respectively --- ---
Preferred stock; par value $.001; 1,000,000
shares authorized; none issued --- ---
Paid-In capital 6,189,000 4,066,000
Accumulated deficit (3,955,000) (1,374,000)
- ------------------------------------------------------- ----------- ----------
Total stockholders' equity 2,237,000 2,695,000
- ------------------------------------------------------- ----------- ----------
Total liabilities and stockholders' equity $13,395,000 $9,523,000
======================================================= =========== ==========
These accompanying notes are an integral part of these consolidated financial
statements.
Page 11
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31,
1997 1996
------------ ------------
Revenues $ 5,878,000 $ 3,313,000
Costs and expenses
Direct operating 3,713,000 1,962,000
General and administrative 990,000 646,000
Depreciation and amortization expense 460,000 307,000
Discount on convertible debentures 1,819,000 ---
Interest expense 749,000 419,000
- ----------------------------------------------- ------------ ------------
Loss from continuing operations
before income tax expense (1,853,000) (21,000)
Income tax expense --- 39,000
- ----------------------------------------------- ------------ ------------
Loss from continuing operations (1,853,000) (60,000)
- ----------------------------------------------- ------------ ------------
Discontinued operations:
Loss on operations, net of income tax
benefit of $0 in 1997 and 1996 --- (649,000)
Loss on disposal, net of income tax benefit of
$0 in 1997 and $120,000 in 1996 (728,000) (325,000)
- ----------------------------------------------- ------------ ------------
Loss from discontinued operations (728,000) (974,000)
- ----------------------------------------------- ------------ ------------
Net loss $(2,581,000) $(1,034,000)
=============================================== ============ ============
Basic and diluted loss per share:
Continuing operations $ (0.63) $ (0.02)
Discontinued operations (0.25) (0.36)
- ----------------------------------------------- ------------ ------------
Net loss per share: $ (0.88) $ (0.38)
=============================================== ============ ============
Weighted average number of common
shares outstanding, basic and diluted 2,935,369 2,745,879
=============================================== ============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
Page 12
<PAGE>
<TABLE>
<CAPTION>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Common Stock
--------------------------------- Total
Class A Class A Class B Paid-In Accumulated Stockholders'
Shares Amount Shares Capital Deficit Equity
---------- ------- ------------ ------------ ------------ --------------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1996 2,496,905 $ 3,000 1,210,000 $ 2,678,000 (340,000) $ 2,341,000
Net loss --- --- --- --- (1,034,000) (1,034,000)
Stock options exercised 3,230 --- --- 5,000 --- 5,000
Class B shares issued --- --- 2,200,000 --- --- ---
Stock and warrants issued for
purchase of El Paso Facility 50,000 --- --- 200,000 --- 200,000
Warrants exercised, net of
issuance costs 377,000 --- --- 1,183,000 --- 1,183,000
---------- ------- ------------ ------------ ------------ --------------
Balance, December 31, 1996 2,927,135 $ 3,000 3,410,000 $ 4,066,000 $(1,374,000) $ 2,695,000
Net loss --- --- --- --- (2,581,000) (2,581,000)
Stock options exercised 22,035 --- --- 36,000 --- 36,000
Class B shares retired --- --- (3,410,000) --- --- ---
Issuance of warrants --- --- --- 158,000 --- 158,000
Discount on issuance of
convertible debentures --- --- --- 1,819,000 --- 1,819,000
Warrants exercised, net of
issuance costs 33,000 --- --- 110,000 --- 110,000
---------- ------- ------------ ------------ ------------ --------------
Balance, December 31, 1997 2,982,170 $ 3,000 --- $ 6,189,000 $(3,955,000) $ 2,237,000
========== ======= ============ ============ ============ ==============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
Page 13
<PAGE>
<TABLE>
<CAPTION>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
Year ended December 31,
1997 1996
--------------- ------------
OPERATING ACTIVITIES:
<S> <C> <C>
Net loss $(2,581,000) $(1,034,000)
Adjustments to reconcile net loss to
net cash provided by (used for) operating activities
Depreciation and amortization 460,000 382,000
Discount on convertible debentures 1,819,000 ---
Deferred income taxes --- (89,000)
Loss on sale of property 71,000 14,000
Write down of property 59,000 318,000
Changes in operating assets and liabilities:
Decrease (increase) in -
Accounts receivable (331,000) (118,000)
Due to / from affiliates 120,000 (11,000)
Prepaid expenses and other assets 40,000 (129,000)
Increase (decrease) in accounts payable and other 609,000 (27,000)
- --------------------------------------------------------------- --------------- -------------
Net cash provided by (used in) operations 266,000 (694,000)
- --------------------------------------------------------------- --------------- -------------
INVESTING ACTIVITIES:
Purchase of short term investments (500,000) ---
Capital expenditures (941,000) (172,000)
Payment for purchase of business (1,400,000) (200,000)
Funding of note receivable (25,000) ---
Proceeds from payments on notes receivable 1,000 ---
Proceeds from disposition of property 45,000 46,000
Proceeds from disposition of discontinued operations 151,000 ---
- --------------------------------------------------------------- --------------- ------------
Net cash used in investing activities (2,669,000) (326,000)
- --------------------------------------------------------------- --------------- ------------
FINANCING ACTIVITIES:
Proceeds from convertible debenture issue 4,150,000 ---
Proceeds from borrowing 5,210,000 3,445,000
Repayment of borrowing (5,612,000) (3,451,000)
Proceeds from warrant and option exercise 146,000 1,324,000
Payments of warrant & debenture issue costs (346,000) (106,000)
- --------------------------------------------------------------- ---------------- ------------
Net cash provided by financing activities 3,548,000 1,212,000
- --------------------------------------------------------------- ---------------- ------------
Net Increase in Cash
And Cash Equivalents $ 1,145,000 $ 192,000
- --------------------------------------------------------------- ---------------- ------------
Cash and Cash Equivalents,
Beginning of Period $ 313,000 $ 121,000
- --------------------------------------------------------------- ---------------- ------------
Cash and Cash Equivalents
End of Period $ 1,458,000 $ 313,000
=============================================================== ================ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
Page 14
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
Year ended December 31,
1997 1996
--------------- ------------
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the year for:
Interest $ 668,000 $ 482,000
Income Taxes --- 4,000
The Company sold assets associated with the discontinued operations in July
1997. The Company accepted a $310,000 note receivable as partial proceeds from
the sale.
The Company acquired property and equipment of $3,681,000, assumed debt of
$2,974,000 and liabilities of $307,000, and issued common stock and stock
purchase warrants with a fair value of $200,000 with the acquisition of a
correctional facility in August 1996.
The Company applied $29,000 of deferred warrant costs against the proceeds
received upon the exercise of certain stock purchase warrants during 1996.
The accompanying notes are an integral part of these consolidated financial
statements.
Page 15
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED 1997 AND 1996
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- ---------------------------------------------------
Nature of Business -
Avalon Community Services, Inc. ("the Company" or "Avalon") is an Oklahoma
based corporation specializing in operating private correctional facilities and
providing intensive correctional programming. The Company currently operates in
Oklahoma, Texas, Missouri, and Nebraska with plans to significantly expand into
additional states. The Company owns and operates four community correctional
facilities and provides substance abuse services in seven additional
correctional facilities.
Principles of Consolidation -
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries after elimination of all material intercompany
balances and transactions.
Use of Estimates -
The preparation of the consolidated financial statements requires the use of
management's estimates and assumptions in determining the carrying values of
certain assets and liabilities and disclosures of contingent assets and
liabilities at the date of the consolidated financial statements and the
reported amounts for certain revenues and expenses during the reporting period.
Actual results could differ from those estimated.
Cash and Cash Equivalents -
The Company considers all highly liquid investments with original maturities
of three months or less when purchased and money market funds to be cash
equivalents.
Concentrations of Credit Risk -
Financial instruments potentially subjecting the Company to concentrations of
credit risk consist principally of temporary cash investments, accounts
receivable and notes receivable. The Company places its temporary cash
investments with high credit quality financial institutions and money market
funds and limits the amount of credit exposure to any one institution or fund.
However, the Company had a significant portion of its cash equivalents in one
money market fund and the short term certificate of deposit at one financial
institution at December 31, 1997. Concentrations of credit risk with respect to
accounts receivable are limited due to the fact that a significant portion of
the Company's receivables are from state governments. The Company maintains an
allowance for doubtful accounts for potential credit losses. Actual bad debt
expenses have not been material. Credit risk on a note receivable is partially
mitigated by the collateralization of the note by second lien on real estate.
Property and Equipment -
Property and equipment are recorded at cost. Expenditures for major additions
and improvements are capitalized, while minor replacements, maintenance and
repairs are charged to expense as incurred. When property and equipment is
retired or otherwise disposed of, the cost and related accumulated depreciation
are removed from the accounts and any resulting gain or loss is reflected in
current operations. Depreciation is provided using the straight-line method over
the following estimated useful lives:
Buildings and Improvements 40 Years
Furniture and Equipment 5 to 7 Years
Transportation Equipment 3 to 15 Years
Page 16
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED 1997 AND 1996
Impairment losses are recorded on long-lived assets when indicators of
impairment are present and the undiscounted cash flows estimated to be generated
by those assets are less than the assets' carrying amounts. When required,
impairment losses are recognized based upon the estimated fair value of the
asset
Income Taxes -
Deferred income taxes are recognized for the tax consequences in future years
of differences between the tax bases of assets and liabilities and their
financial reporting amounts at each year-end based on enacted tax laws and
statutory tax rates applicable to the period in which the differences are
expected to affect taxable income. Valuation allowances are established when
necessary to reduce deferred tax assets to the amount expected to be realized.
Income tax expense is the tax payable for the period and the change during the
period in deferred tax assets and liabilities.
Revenue Recognition -
The Company recognizes revenues as services are provided. Revenues are earned
based upon the number of inmates on a per diem basis at the Company's
correctional facilities. Revenues are earned on a monthly contract basis for
substance abuse treatment services. All correctional and substance abuse
revenues are received monthly from various governmental agencies.
Deferred Development Costs -
Deferred development costs consist of costs that can be directly associated
with an anticipated contract and, if the recoverability from that contract is
probable, they are deferred until the anticipated contract has been awarded. The
development costs are deferred until the commencement of operations of the
facility or contract period and amortized over the anticipated life of the
contract (including option and renewal periods). Costs of unsuccessful or
abandoned contracts are charged to expense when their recovery is not considered
probable. Facility costs are incurred (after a contract is awarded) in
connection with the opening of new facilities under the contract. These costs,
which are required under the contract, to the extent recoverable, are
capitalized from the date of award until commencement of operations, at which
time they are amortized on a straight-line basis over the term (including option
periods) ranging from one to five year periods of the government contracts.
Net Loss Per Common Share -
Basic loss per share has been computed on the basis of weighted average shares
outstanding during each period. Diluted loss per share is the same as basic loss
per share because assumed exercise of options and warrants (see note 7) would be
anti-dilutive.
Page 17
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED 1997 AND 1996
NOTE 2. PROPERTY AND EQUIPMENT
- -------------------------------
The elements of property and equipment and related accumulated depreciation as
of December 31, 1997 and 1996 are as follows:
Accumulated
Cost Depreciation
-------------------------------------
December 31, 1997:
Land $ 1,092,000 $ ---
Buildings and Improvements 7,544,000 513,000
Furniture and Equipment 784,000 424,000
Transportation Equipment 883,000 154,000
------------- --------------
$ 10,303,000 $ 1,091,000
============= ==============
December 31, 1996:
Land $ 619,000 $ ---
Buildings and Improvements 7,591,000 384,000
Furniture and Equipment 717,000 320,000
Transportation Equipment 156,000 67,000
------------- --------------
$ 9,083,000 $ 771,000
============= ==============
The Company changed its' estimate of the useful lives of buildings and
improvements from 25 to 40 years during 1996. The change resulted in a decrease
in net loss, net of income tax expense of $28,000, for 1996 of approximately
$55,000 or $.02 per share
NOTE 3. ACCOUNTS PAYABLE, ACCRUED LIABILITIES AND OTHER
- --------------------------------------------------------
The elements of accounts payable, accrued liabilities and other as of December
31, 1997 and 1996 are as follows:
1997 1996
---------------------------------
Trade accounts payable $ 303,000 $ 80,000
Accrued interest payable 140,000 36,000
Accrued salary and benefits 115,000 89,000
Discontinued operations liabilities 157,000 12,000
Other accrued liabilities 315,000 231,000
------------ -----------
$ 1,030,000 $ 448,000
============ ===========
Page 18
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED 1997 AND 1996
NOTE 4. CORRECTIONAL CONTRACTS
- -------------------------------
The Company contracts with various governmental agencies to provide
correctional services. The contracts generally specify for the Company to
provide correctional services including complete residential services and
programming in the Company's facilities ("Residential Services") or specified
correctional programming services in the governmental agency's facilities
("Programming Services"). Compensation paid to the Company for Residential
Services is generally based on a per person, per day basis. Compensation paid to
the Company for Programming Services is generally based upon the units of
service provided. Revenues generated from Residential Services during 1997 and
1996 comprised 91% and 88%, respectively, of total Company revenues. Contract
revenues from the Oklahoma Department of Corrections represented 52% and 58% of
total Company revenues in 1997 and 1996, respectively.
The Company has a fifteen (15) year Residential Services contract with West
Texas Community Supervision and Corrections Department and a four year
Residential Services contract with the Texas Department of Criminal Justice
Parole Department to provide correctional services in El Paso, Texas. The
Company's current Residential Services contracts with the Oklahoma Department of
Corrections extend through June 30, 1998. The Company has two Programming
Services contracts with the Nebraska Department of Correctional Services with
terms extending through September 30, 1999, including renewal options. The
Company has a Programming Services contract with the State of Missouri extending
through June 30, 1998, with renewal options extending to June 30, 2000.
NOTE 5. LONG-TERM DEBT
- -----------------------
Long-term debt consists of the following:
December 31,
1997 1996
--------------------------
Revolving bank line of credit $ 167,000 $ 38,000
Notes payable to banks, collateralized by
equipment due in installments through
July 1999 with interest from 7.99% to 8.5% 89,000 137,000
Notes payable to banks, collateralized
by transportation equipment, due in
installments through March 2012
with interest ranging from 7.99% to 9.49%. 621,000 71,000
Notes payable to banks, collateralized
by land, buildings and improvements
due in installments through June 2012
with interest ranging from 8.5% to 11% 4,941,000 5,584,000
Note payable to an individual, uncollateralized,
with interest at 8.5%, due in full April 1998 160,000 ---
Note payable to corporation collateralized by
buildings, with interest at 8.5%
with principal due in full January 1998 --- 550,000
----------- -----------
5,978,000 6,380,000
Less - current maturities 849,000 519,000
----------- -----------
$ 5,129,000 $ 5,861,000
=========== ===========
Page 19
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED 1997 AND 1996
The aggregate maturities of long-term debt for each of the next five years are
as follows: 1998: $849,000; 1999: $926,000; 2000: $765,000; 2001: $506,000;
2002: $ 540,000; thereafter: $2,392,000. Substantially all notes payable and
long-term debt has been personally guaranteed by the Company's CEO.
The revolving bank line of credit provides for aggregate maximum borrowings of
$500,000 and bears interest at 1% over national prime, (effective rates of 9.5%
and 9.2%, at December 31, 1997 and 1996, respectively) The line of credit is
collateralized by the Company's Federal and state contract revenues. Payment of
dividends is restricted by terms of the Company's revolving credit facility. The
revolving bank line of credit matures April 5, 1998.
NOTE 6. CONVERTIBLE DEBENTURES
- -------------------------------
The Company completed a private placement of $4,150,000 of convertible
debentures on September 12, 1997. The debentures bear interest at 7.5% and
mature on September 12, 2007. The debentures may be redeemed by the Company at
any time after May, 2001 at 106.5% of principal, declining to 100% at maturity.
The debentures are convertible into common stock immediately after issuance at
$3.00 per share.
The difference between the conversion price of the debentures and the fair
value of the Company's common stock as evidenced by the quoted market price of
the common stock multiplied by the number of shares into which the debentures
are convertible at the date of issue has been recorded as a discount on debt.
This discount is to be amortized from the period of issuance to the date that
the security is first convertible. This discount was immediately charged to
current year earnings, since the debentures are immediately convertible after
issuance. The recognition of this charge did not affect cash flow, the Company's
assets or liabilities, or total stockholder's equity. The discount charge did
impact current year operations and accumulated deficit, offset by an increase to
paid in capital. The discount charge of $1,819,000 is reflected in the statement
of operations.
NOTE 7. STOCKHOLDERS' EQUITY
- -----------------------------
The Company has outstanding 275,100 Class B stock purchase warrants providing
for the purchase of the Company's Class A common stock at a price of $6.00 per
share. The warrants may be exercised at any time until their expiration at March
26, 1999. The warrants may be redeemed by the Company at any time for $.01 per
share, with the exception of certain warrants relating to 1,600 shares of common
stock.
Page 20
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED 1997 AND 1996
The Company completed a private placement of 1,000,000 shares of its common
stock and 1,000,000 Class C stock purchase warrants in August 1994. The
placement provided for 100,000 shares of common stock and 100,000 Class C stock
purchase warrants reserved for underwriters. The Company issued an additional
165,000 Class C stock purchase warrants in 1996. Twenty five thousand additional
Class C stock purchase warrants were issued in 1997. The Company recognized
$10,000 of cost based upon the difference in the exercise price of the Class C
warrants and the current market price of the common stock on the date of
issuance. The Company has issued 410,000 shares of common stock upon the
exercise of the Class C stock purchase warrants through December 31, 1997. The
Company currently has 880,000 Class C stock purchase warrants outstanding,
including the 100,000 warrants reserved for underwriters.
The Class C stock purchase warrants provide for the purchase of the Company's
Class A common stock at any time until their expiration at December 30, 1999.
Anti-dilution provisions of the warrant agreement have reduced the exercise
price from $3.50 to $3.33 per share as of December 31, 1997. The warrants were
issued in connection with a 1994 offering, therefore the reduction of exercise
price from anti-dilution provisions had no effect on the Company's financial
statements. The warrants may be redeemed by the Company upon certain events, for
$.01 per share.
The Company issued Class D Warrants in August 1996, to purchase 200,000 shares
of Common Stock in connection with the acquisition of the El Paso Intermediate
Sanction Facility. The warrants were issued along with 50,000 shares of common
stock. The Company valued the warrants and the stock at $200,000 and recorded
this amount as part of the purchase price of the asset, with a corresponding
credit to paid in capital. This valuation was based upon the market price of the
stock at the date of issuance and the fair value of the assets received. The
Class D stock purchase warrants provide for the purchase of the Company's Class
A common stock at a price of $5.125 per share at any time until their expiration
at August 2, 2001. The warrants may be redeemed by the Company upon certain
events for $.01 per share.
The Company issued Class E Warrants to purchase 79,000 shares of Common Stock
in September 1997, in connection with the private placement of Convertible
Debentures. The Company recognized $148,000 of cost based upon the difference in
the exercise price of the Class E warrants and the current market price of the
common stock on the date of issuance. This cost was recorded as debenture issue
costs and is classified in other assets on the balance sheet. The debenture
issue cost will be amortized to expense over the term of the convertible
debentures. The Class E stock purchase warrants provide for the purchase of the
Company's Class A common stock at a price of $3.00 per share at any time until
their expiration at September 12, 2002. The warrants may be redeemed by the
Company upon certain events for $.01 per share.
The Company issued 3,900,000 shares of Class B common stock from 1995 to 1997
in connection with the CEO's personal guarantee of debt. Class B shares are
voting rights only, are non-transferable and have no liquidation or dividend
rights. The Company canceled all Class B common stock on August 25, 1997,
pursuant to a Change of Control Agreement between the Company and the Company's
CEO. The Company has no Class B shares outstanding and has no plans to reissue
these shares.
A 1994 agreement provided for the issuance of 750,000 common stock purchase
warrants to purchase Class A common stock at $1.50 per share for each dollar of
Company debt guaranteed by the Company's CEO. The warrants will have a five year
term from the date of issuance. Management believes that the warrants had no
economic value when granted, and accordingly, no amount has been assigned to
such warrants in the financial statements.
Page 21
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED 1997 AND 1996
NOTE 8. STOCK OPTION PLAN
- --------------------------
The Company adopted a stock option plan (the "Plan") providing for the
issuance of 250,000 shares of Class A common stock pursuant to both incentive
stock options, intended to qualify under Section 422 of the Internal Revenue
Code, and options that do not qualify as incentive stock options
("non-statutory"). The Option Plan was registered with the Securities and
Exchange Commission in November 1995. The purpose of the Plan is to provide
continuing incentives to the Company's officers, key employees, and members of
the Board of Directors. The options generally vest over a four or five-year
period with a ten year expiration period. On December 1, 1996, the Company
amended its stock option plan, increasing the number of shares available under
the Plan to 600,000. Non-statutory options have been granted providing for the
issuance of 477,330 shares of Class A common stock at exercise prices ranging
from $1.50 to $4.00 per share. Options providing for the issuance of 83,850
shares were exercisable at December 31, 1997.
The Company uses the intrinsic value method to account for its stock option
plan in which compensation is recognized only when the fair value of each option
exceeds its exercise price at the date of grant. Accordingly, no compensation
cost has been recognized for the options issued. Had compensation cost been
determined based on the fair value of the options at the grant dates, the
Company's net loss and basic loss per share would have been increased to the pro
forma amounts indicated below.
1997 1996
------------- -------------
Net loss
As reported $ (2,581,000) $ (1,034,000)
Pro forma (2,880,000) (1,375,000)
Loss per share
As reported $ (0.88) $ (0.38)
Pro forma (0.98) (0.50)
These pro forma amounts may not be representative of future disclosures
because they do not take into effect pro forma compensation expense related to
grants made before 1995. The fair value of each grant is estimated on the date
of grant using the Black-Scholes options-pricing model with the following
weighted-average assumptions used for grants in 1997 and 1996, respectively: no
expected dividends; expected volatility of 85% and 96%; risk-free interest rate
of 5.8% and 5.7%; and expected lives of ten years.
The Black-Scholes options valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
Page 22
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED 1997 AND 1996
A summary of the status of the Company's stock option plan as of December 31,
1997 and 1996, and changes during the years ending on those dates is presented
below.
<TABLE>
<CAPTION>
1997 1996
--------------------------- ---------------------------
Weighted Weighted
average average
Shares exercise price Shares exercise price
---------- -------------- ---------- --------------
<S> <C> <C> <C> <C>
Outstanding at beginning of year 469,770 $ 2.93 229,900 $ 1.71
Granted 71,400 3.80 259,600 3.93
Exercised (22,035) 1.63 (3,230) 1.62
Forfeited (41,805) 3.02 (16,500) 1.78
---------- -------------- ---------- --------------
Outstanding at end of year 477,330 3.11 469,770 2.93
Options exercisable at year end 83,850 1.71 57,005 1.63
Weighted average fair value of
options granted during the year $ 3.00 $ 3.70
============== ==============
</TABLE>
The following table summarizes information about fixed-price stock options
outstanding at December 31, 1997:
<TABLE>
<CAPTION>
Options outstanding Options exercisable
---------------------------------------------- ------------------------
Weighted Weighted Weighted
Number average average Number average
outstanding at remaining exercise exercisable exercise
12/31/97 contractual life price at 12/31/97 price
-------------- ---------------- -------- ----------- ---------
<S> <C> <C> <C> <C> <C>
Range of exercise prices
$1.50 to $2.25 177,330 7.20 $ 1.70 82,600 $ 1.68
$3.26 to $4.00 300,000 8.63 3.95 1,250 3.80
-------------- ---------------- -------- ----------- ---------
$1.50 to $4.00 477,330 83,850
============== ===========
</TABLE>
NOTE 9. ACQUISITIONS
- ---------------------
The Company acquired the Turley Correctional Facility in Tulsa, Oklahoma on
October 2, 1997. The Turley Correctional Facility is a 150 bed adult residential
community corrections facility located on approximately thirty-five acres of
real estate. The acquisition was accounted for under the purchase method of
accounting. The purchase price was approximately $1,400,000 and included
approximately $445,000 attributable to specific intangible items. These costs
are included in other assets and are being amortized on a straight line method
over three to twenty years. Revenues and expenses generated from the facility
subsequent to October 1, 1997, are included in 1997 operations. Pro forma
financial information for the acquisition is not presented because historical
Page 23
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED 1997 AND 1996
financial information of the acquired operations is not available. A subsidiary
of the Company, Southern Corrections Systems, Inc., has assumed the annual
contracts with the Oklahoma Department of Corrections. The Company is in the
final stages of completing the necessary requirements to assume the contract
with the Federal Bureau of Prisons.
The Company acquired the El Paso Intermediate Sanction Facility in El Paso,
Texas from Secure Corrections, Inc. in August, 1996. The facility is 150 bed,
36,000 square foot medium security correctional facility on approximately seven
acres of real estate. The purchase price was approximately $3,681,000 including
the assumption of certain liabilities. A subsidiary of the Company, Southern
Corrections Systems, Inc., entered into a fifteen (15) year contract to provide
services in the facility for the West Texas Community Supervision and
Corrections Department.
NOTE 10. DISCONTINUED OPERATIONS
- ---------------------------------
The Company discontinued all non correctional operations in the fourth quarter
of 1996. Revenues from discontinued operations for the years ended 1997 and 1996
were $50,000 and $493,000, with a net discontinued loss from operations, net of
income tax benefit, of $649,000 for 1996. The Company estimated a loss on the
disposal of all non correctional operations of $325,000 (net of income tax
benefit of $120,000) in 1996. This included a provision of approximately $48,000
for expected operating losses during the phase out period beginning during the
fourth quarter of 1996. All such expected losses were incurred in 1996. Actual
operating losses incurred during 1997 and expected operating losses through the
estimated disposal date of approximately $535,000, and an additional loss on
disposal of approximately $193,000 were estimated in 1997. Accordingly, 1997
includes an additional loss of $728,000. Approximately $541,000 of these losses
were recorded in the fourth quarter of 1997.
The remaining assets at December 31, 1997, consist of one building and an
investment in one assisted living center. The Company has executed letters of
intent for their sale and management believes such sales will be concluded in
the quarter ended June 30, 1998.
The net assets and liabilities of the discontinued operations included as
accounts payable, accrued liabilities and other in the accompanying consolidated
balance sheet, are as follows:
December 31,
1997 1996
---------- ---------
Assets
Property and equipment, net $ 298,000 $ 328,000
Liabilities
Accounts payable and accrued liabilities (157,000) (25,000)
Note payable (298,000) (315,000)
---------- ----------
Net liabilities of discontinued operations $(157,000) $ (12,000)
========== ==========
Page 24
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED 1997 AND 1996
NOTE 11. FAIR VALUE OF FINANCIAL INSTRUMENTS
- ---------------------------------------------
The carrying values of cash, cash equivalents, and short term certificates of
deposit approximate their fair values, due to the short term nature and
stability of market interest rates in 1997. The notes receivable approximate
fair value since the notes receivable were negotiated in proximity to December
31, 1997. The fair values of the Company's debt maturing within one year, the
revolving credit facility and other long-term debt approximate the carrying
values, due to variable interest rates, the stability of market interest rates
in 1997, and the fact that rates on the debt approximate the Company's
incremental borrowing rate. The convertible debentures approximate fair value
since the convertible debentures were issued in proximity to December 31, 1997.
All the Company's financial instruments are held for purposes other than
trading.
NOTE 12. INCOME TAX
- --------------------
The components of the provision for (benefit from) income taxes for the years
ended December 31, 1997 and 1996 from continuing operations were as follows:
Federal State Total
------- ------- -------
1997 -
Current $ --- $ --- $ ---
Deferred --- --- ---
------- ------- -------
$ --- $ --- $ ---
======= ======= =======
1996 -
Current $ 7,000 $ 1,000 $ 8,000
Deferred 26,000 5,000 31,000
------- ------- -------
$33,000 $ 6,000 $39,000
======= ======= =======
The difference between the tax basis of assets and liabilities and their
financial reporting amounts that give rise to significant portions of deferred
income tax assets and liabilities are: assets - net operating loss
carryforwards, excess tax basis in property and equipment, and nondeductible
accruals and allowances; liabilities - accelerated tax depreciation. The Company
has approximately $1,133,000 of net operating loss carry forwards at December
31, 1997, expiring through 2012.
The following is a reconciliation of the provision for (benefit from) income
taxes from continuing operations computed by applying the Federal statutory rate
of 34% and the effective income tax rate for the years ended December 31, 1997
and 1996:
Page 25
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED 1997 AND 1996
December 31,
1997 1996
----------- -----------
Provision for (benefit from) income taxes
at statutory rate $ (630,000) $ (7,000)
Nondeductible expenses 624,000 3,000
State income taxes (73,000) 6,000
Change in valuation allowance 68,000 13,000
Change in prior year estimate 11,000 24,000
------------ -----------
Total provision for (benefit from) income taxes $ --- $ 39,000
============ ===========
Deferred tax assets and liabilities are as follows:
Deferred tax assets
Net operating loss carry forward $ 453,000 $ 314,000
Property & equipment 144,000 120,000
Shareholder contributed property 46,000 46,000
Nondeductible accruals and allowances 214,000 9,000
Other 1,000 1,000
------------ -----------
858,000 490,000
Less: Valuation allowance (637,000) (353,000)
------------ -----------
Deferred tax assets 221,000 137,000
------------ ----------
Deferred tax liabilities:
Property and equipment (155,000) (71,000)
------------ -----------
Deferred tax liabilities (155,000) (71,000)
------------ -----------
Net deferred tax asset $ 66,000 $ 66,000
============ ===========
The valuation allowance on tax assets increased $284,000 in 1997 and $312,000
in 1996, including $68,000 and $13,000 related to continuing operations in 1997
and 1996, respectively. The tax effects of approximately $618,000 of
nondeductible expenses relate to the allocation of proceeds from convertible
debentures (see Note 6) charged to operations in 1997.
NOTE 13. RELATED PARTY TRANSACTIONS
- ------------------------------------
The Company's initial operations were formed by acquiring existing operations
from the Company's CEO in 1992 and 1993. Certain existing agreements related to
providing management, administrative and accounting services and leases of
buildings were continued, resulting in related party transactions.
The Company charged $398,000 to affiliated entities controlled by the CEO for
management, administrative, and accounting services in 1996. Such amount has
been reflected as a reduction of general and administrative expenses in the
Consolidated Statement of Operations.
Page 26
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED 1997 AND 1996
The balance due from affiliates at December 31, 1996, resulted from charges
for administrative and accounting services, as well as net cash advances made.
The outstanding balance related to residential care operations was included in
discontinued operations in 1996.
The Company managed the operations of a residential care operation and leased
a building to an affiliated entity in 1996. The Company also leased equipment
from an affiliated entity in 1996. The leases resulted in net lease expense of
$4,000 in 1996.
The Company issued 3,900,000 shares of Class B common stock to the Company's
CEO from 1995 to 1997, pursuant to a 1994 debt guarantee agreement for his
personal guarantee of debt. The Company canceled all Class B common stock in
August 1997, pursuant to a Change of Control Agreement between the Company and
the Company's CEO.
The Company entered into agreements with affiliated entities in 1995 and 1996
to develop and manage two assisted living centers. The Company received a 15%
equity interest in each assisted living center and funded start up costs of
approximately $357,000 for these centers in 1996. The Company sold one facility
in 1997 and plans to sell its remaining interest in one facility during 1998.
The Company guaranteed the debt of both facilities in 1996 and continues to
guarantee the debt of one of the facilities at December 31, 1997. The
outstanding balance of the guaranteed debt was $2,012,000 at December 31, 1997.
NOTE 14. COMMITMENTS AND CONTINGENCIES
- ---------------------------------------
Total lease expense was $57,000 and $118,000 for 1997 and 1996 under all
operating leases. The future minimum lease payments are as follows: 1998 -
$42,000, 1999 - $13,000, 2000 - $7,000 , 2001 - $6,000, and 2002 - $2,000.
The Company executed three-year employment agreements with the Company's CEO
and President in 1997. The agreements provide for compensation at a base rate
and increases to be determined on an annual basis by the Board of Directors. The
agreements also contain provisions for severance pay and disability payments, as
well as non-compete agreements preventing them from engaging in a business
deemed similar to that of the Company.
NOTE 15. LITIGATION
- --------------------
The Company is a party to litigation arising in the normal course of business.
Management believes that the ultimate outcome of these matters will not have a
material effect on the Company's financial condition or results of operations.
NOTE 16. SUBSEQUENT EVENTS
- ---------------------------
The Company was awarded a five year contract in March 1998 with the Oklahoma
Office of Juvenile Affairs. The contract is to provide services for 80 youthful
delinquent male offenders ages 13 to 19. The Company will design, build and
operate a new medium security facility to provide for housing, education,
program and recreation areas for these offenders. The contract is expected to
generate annual revenues of approximately $3,600,000 beginning in the fourth
quarter of 1998. The contract is expected to generate revenues of $18,800,000
over a five year period. The Company will complete the construction of the
facility and commence operations under this contract in December 1998.
Page 27
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
The Company dismissed Coopers & Lybrand, L.L.P., the Registrant's independent
auditors, on February 25, 1997, and appointed the accounting firm of Grant
Thornton, LLP as independent accountants for fiscal year ended 1996. The
dismissal and appointment were approved by the Board of Directors of the
Company. During the two most recent fiscal years and the three interim periods
subsequent to December 31, 1995, and through the date of dismissal, there have
been no disagreements with Coopers & Lybrand, L.L.P. on any matter of accounting
principles or practices, financial statement disclosure or auditing scope or
procedure or any reportable event.
The reports on the financial statements of the Company rendered by Coopers &
Lybrand, L.L.P. did not contain an adverse opinion or disclaimer of opinion or
qualification or modification as to uncertainty, the scope of audit performed,
or accounting principles. The Company had not consulted with Grant Thornton, LLP
prior to their appointment with respect to any matters of accounting principles
or practices, financial statement disclosure, auditing scope or procedure or any
disagreement with the Company. There have been no disagreements with Grant
Thornton, L.L.P. on any matter of accounting principles or practices, financial
statement disclosure or auditing scope or procedure or any reportable event.
PART III
- --------
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
MANAGEMENT -
Name Age Position(s) with the Company
---- --- ----------------------------
Donald E. Smith ............... 45 Chief Executive Officer, Director
Jerry M. Sunderland ........... 61 President, Director
Gary D. Parsons............... 54 Vice President of Operations
Randall J. Wood .............. 40 Corporate Secretary
Tiffany Wright................. 30 Public Information Officer
Paul D. Voss ................. 30 Vice President of Finance
Robert O. McDonald ............ 59 Director
Mark S. Cooley ............... 40 Director
Directors and Officers of the Company -
The following is a brief description of the business experience during the
past five years of each of the above-name persons:
Donald E. Smith is the founder of the Company's corrections operations and has
served as the Chief Executive Officer of Avalon and its subsidiaries since their
inception. Mr. Smith has owned, managed and developed a number of private
corporations since 1985 to provide private corrections, residential care, mental
health care, and other related services. Mr. Smith received a Bachelor of
Science degree in 1974 from Northwestern State College. Mr. Smith was employed
by Arthur Andersen & Co. for seven years prior to founding the Company.
Jerry M. Sunderland has served as President of Avalon since June, 1995. Mr.
Sunderland served as an Correctional Administrator for the Company and
affiliates since 1988. Mr. Sunderland also serves as a Director of Avalon's and
its subsidiaries. Mr. Sunderland was employed by the Oklahoma Department or
Corrections for sixteen years including ten years as warden of maximum security
prison. Mr. Sunderland also served as an agent for the Oklahoma State Bureau of
Investigation for twelve years. Mr. Sunderland has a Bachelors degree in
Sociology and a Masters degree in Corrections.
Page 28
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
Gary D. Parsons was appointed as Vice President of Operations in December
1997. Mr. Parsons has over 24 years of experience in developing and operating
quality programs and facilities for adult offenders. Mr. Parsons was employed by
the Oklahoma Department of Corrections for twenty four years. Mr. Parsons is
responsible for Avalon's correctional operations, including recruitment and
training of personnel, maintaining accreditation by the American Correctional
Association, and compliance with contractual requirements. Mr. Parsons received
a Bachelors degree in Business Administration and a Masters degree in Business
Administration from the University of Central Oklahoma.
Randall J. Wood serves as Corporate Secretary and General Counsel for the
Company. Prior to joining the Company in 1996, Mr. Wood's practice was focused
primarily in the field of real property and commercial litigation. Mr. Wood
practiced with the firm of Stack & Barnes, P.C. for ten years, and was with the
firm of Hammons, Vaught & Conner prior to joining the Company. Mr. Wood is a
member of the Oklahoma Bar Association and is authorized in Oklahoma Federal
Courts and the Tenth Circuit Court of Appeals. Mr. Wood is responsible for the
duties of the Corporate Secretary, management of legal matters, and compliance
with government regulations for the Company and its subsidiaries. Mr. Wood
received his law degree from the University of Oklahoma in 1983.
Tiffany Wright serves as Public Information Officer and assistant Corporate
Secretary for the Company. Ms. Wright served for four years as marketing manager
for Eagle Picher Industries, a New York Stock Exchange listed company, prior to
joining Avalon in 1994. Ms. Wright has developed and is responsible for
directing the Company's public relations department and implementing marketing
strategies. Ms. Wright is the primary contact for the Company's shareholders and
investors. Ms. Wright received a Bachelors Degree in Business Administration,
Marketing and Management from Missouri Southern State College.
Paul D. Voss was appointed Vice President of Finance in January, 1998. Mr.
Voss was Controller at Magic Circle Energy from 1994 to 1996. Mr. Voss was a
senior auditor for Grant Thornton for five years and more recently an accounting
manager for Finley & Cook, P.L.L.C. Mr. Voss received a degree in Business
Administration from the Angelo State University in 1989, holds CPA licenses in
Oklahoma and Texas and is a member of both the American Institute of CPAs and
the Oklahoma Society of CPAs.
Robert O. McDonald was appointed as a Director of Avalon in October, 1994. Mr.
McDonald is Chairman of the Board of Directors of Capital West Securities and
its parent holding company, Affinity Holding Corp. Mr. McDonald started his
investment career in 1961 with Allen and Company and left in 1967 to form
McDonald Bennahum and Co., which later joined with Ladenburg Thalmann and Co.
where Mr. McDonald was a Senior Partner. Mr. McDonald joined Planet Oil Mineral
Corporation in 1971 and became president in 1973. From 1975 until 1993, Mr.
McDonald was affiliated with Stifel Nicolaus & Company and headed its municipal
syndicated effort. Mr. McDonald received a Bachelor's Degree in Finance from the
University of Oklahoma in 1960. He also served as an Officer in the United
States Army and Army Reserve.
Mark S. Cooley was appointed as a Director of Avalon in January 1998, subject
to shareholder approval at the 1998 annual meeting. Mr. Cooley is a Principal of
Cooley & Company and Pro Trust Equity Partners. Mr. Cooley was with Citicorp and
Chemical Bank for twelve years in their Corporate Finance Divisions in New York
and Denver. Mr. Cooley received his Bachelors degree in Economics from DePauw
University and an MBA in Finance from Indiana University.
ITEMS 10, 11 and 12.
The information required by these Items has been incorporated by Reference
from the Company's definitive proxy statement which will be filed with the
Commission not later than 120 days after December 31, 1997.
Page 29
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
3. i Articles of Incorporation (1)
ii Bylaws (1)
iii Articles of Amendment to Registrant's Articles of
Incorporation (2)
iv Amendment to Registrant's Articles of Incorporation dated
December 31, 1995
v Unanimous Consent of Board of Directors authorizing extension
of expiration dates of Class "B" Redeemable Warrants (3)
vi Certificate of Corporate Resolutions, dated December 13,
1993, regarding authorization of Class B Common Stock and
Amendment to Articles (5)
4. i Form of Stock Certificate (1)
ii Form of Class "B" Redeemable Warrant (1)
iii Form of Class "B" Warrant Agreement (1)
iv Form of Class "C" Redeemable Warrant (6)
v Form of Class "C" Warrant Agreement (6)
vi Form of Class "D" Redeemable Warrant (7)
vii Form of Class "D" Warrant Agreement (7)
viii Form of Class "E" Warrant Agreement (10)
ix Form of Convertible Debenture Agreement (10)
10. i Contract between Southern Correction Systems, Inc. and the
Oklahoma Department of Corrections for halfway house services
for the year ended June 30, 1998 (6)
ii Contract between Southern Corrections Systems, Inc. and the
Oklahoma Department of Corrections for public works inmates
for the year ended June 30, 1998 (6)
iii Contract between Southern Corrections Systems, Inc. and the
Oklahoma Department of Corrections for halfway house services
for the year ended June 30, 1998. (6)
iv Stock Option Plan adopted by Board of Directors on August 16,
1994 (6)
v Placement Agent Agreement dated May 15, 1994, between
Registrant and Westminster Securities Corporation (6)
vi Acquisition Agreement dated August 2, 1996 between
Registrant, Kensington Capital Plc, and RECOR, Inc. (7)
vii Change of Control Agreement between Donald E. Smith and
Avalon Community Services, Inc. dated August 25, 1997. (7)
viii Employement Agreement with Donald E. Smith dated August 8,
1997. (7)
ix Employment Agreement with Jerry M. Sunderland dated August 8,
1997 (7)
x Letter of Acceptance and Notice of Award dated February 24,
1997 to Avalon Community Services, Inc. from the Missouri
Department of Corrections. (7)
xi Commercial Contract to Buy and Sell Real Estate dated October
2, 1997 between Avalon Community Services, Inc. and Freedom
Ranch, Inc. (9)
xii Notice of Award dated March 3, 1998 to Southern Corrections
Systems, Inc. from the Oklahoma Office of Juvenile Affairs.
(11)
16. i Letter re: Change in Certified Accountant (8)
21. i Subsidiaries of Registrant (5)
(b) Reports on Form 8-K.
i Form 8-K dated October 17, 1997 re: Acquisition of Assets
from Freedom Ranch, Inc.
ii Form 8-K dated March 19, 1998 re: Award from the Oklahoma
Office of Juvenile Affairs.
Footnotes:
1) Incorporated herein by reference to the Registrant's
Registration Statement on Form S-18 dated March 26, 1991.
2) Incorporated herein by reference to the Registrant's
Post-Effective Amendment No. 1 to Registration Statement on
Form S-18 dated August 3, 1992.
Page 30
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
3) Incorporated herein by reference to the Registrant's
Post-Effective Amendment No. 2 to Registration Statement on
Form S-18 dated October 26, 1992.
4) Incorporated herein by reference to the Registrant's Form 8-K
dated January 13, 1994.
5) Incorporated herein by reference to the Registrant's Form
10-KSB for the fiscal year ended December 31, 1993 and dated
March 24, 1994.
6) Incorporated herein by reference to the Registrant's
Registration Statement on Form SB-2 dated September 13, 1995
and amended.
7) Incorporated herein by reference to the Registrant's
Registration Statement on Form S-2 Amendment No. 1, dated
April 16, 1996 and amended.
8) Incorporated herein by reference to the Registrant's Form 8-K
dated March 4, 1997.
9) Incorporated herein by reference to the Registrant's Form 8-K
dated October 17, 1997.
10) Incorporated herein by reference to the Registrant's Form S-2
dated December 22, 1997.
11) Incorporated herein by reference to the Registrant's Form 8-K
dated March 19, 1998.
Page 31
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
AVALON COMMUNITY SERVICES, INC.
By: s\ Donald E. Smith
------------------------------------
Donald E. Smith
Chief Executive Officer and Director
Dated: March 26, 1998
In accordance with the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.
By: s\ Donald E. Smith
- ------------------------------------
Donald E. Smith
Chief Executive Officer and Director Dated: March 26, 1998
By: s\ Jerry M. Sunderland
- ------------------------------------
Jerry M. Sunderland
President and Director Dated: March 26, 1998
By: s\ Robert O. McDonald
- ------------------------------------
Robert O. McDonald
Director Dated: March 26, 1998
By: s\ Paul Voss
- ------------------------------------
Paul Voss
Vice President of Finance Dated: March 26, 1998
Page 32
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<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 1,458,000
<SECURITIES> 500,000
<RECEIVABLES> 697,000
<ALLOWANCES> 8,000
<INVENTORY> 0
<CURRENT-ASSETS> 2,754,000
<PP&E> 10,303,000
<DEPRECIATION> 1,091,000
<TOTAL-ASSETS> 13,395,000
<CURRENT-LIABILITIES> 1,879,000
<BONDS> 9,279,000
0
0
<COMMON> 3,000
<OTHER-SE> 2,234,000
<TOTAL-LIABILITY-AND-EQUITY> 13,395,000
<SALES> 0
<TOTAL-REVENUES> 5,878,000
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<INTEREST-EXPENSE> 749,000
<INCOME-PRETAX> (1,853,000)
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<INCOME-CONTINUING> (1,853,000)
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