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, 1998
[ ] 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, 1998
were $7,686,000.
The aggregate market value of voting common stock held by non
affiliates was $4,880,375 on March 5, 1999, 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 March 5,
1999, 4,668,138 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 1999 Annual Meeting of
Shareholders are incorporated by reference in Part III.6
Transitional Small Business Disclosure Format: Yes_ No X.
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
FORM 10-KSB ANNUAL REPORT
FOR THE YEAR ENDED DECEMBER 31, 1998
PART I
Item Page
- ---- ----
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 29
PART III
9. Directors, Executive Officers, Promoters and Control
Persons; Compliance with Section 16(a) of
the Exchange Act 29
10. Executive Compensation 31
11. Security Ownership of Certain Beneficial Owners
and Management 31
12. Certain Relationships and Related Transactions 31
13. Exhibits and Reports on Form 8-K 31
Signatures 34
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
PART I
ITEM 1. DESCRIPTION OF BUSINESS.
The Company -
Avalon Community Services, Inc., is an Oklahoma based 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 and Texas, with plans to significantly expand into
additional states. Avalon's business strategy is designed to grow the Company
into a dominant role as a provider of community correctional services. Avalon's
development plan is to expand operations through new state and Federal contracts
and selective acquisitions to capitalize on the current rapid growth trends in
the private correctional service industry.
The private correctional services industry growth continues to demand more
beds. As of the second quarter 1997, 1.73 million individuals were incarcerated
in this country's prisons and jails, an increase of 5.9% from the prior year.
The total prison and jail population has grown 6.0% annually during the last
five years. It is estimated that the weekly need for new corrections beds
remains between 1,500 and 2,000 beds. Avalon contracts with various governmental
agencies to provide community corrections operations and services. Studies have
documented a 10 to 30 percent savings to government agencies when utilizing
private corrections providers to build and operate correctional facilities.
Avalon management believes its background and abilities to build and operate
correctional facilities and provide correctional programming positions the
Company for substantial growth in the corrections industry. The number of adult
correctional beds operated by private managers has grown an astounding 2,200%
over the past 10 years. According to University of Florida data, approximately
107,000 beds were privately operated at year-end 1997, up from 85,000 at
year-end 1996. The number of privately operated corrections beds is projected to
triple over the next five years.
Avalon currently owns and operates 1,185 private corrections beds,
including 300 beds currently being constructed. The Company owns and operates
three minimum-security correctional facilities (655 beds) in Oklahoma, one
medium security juvenile facility (80 beds) in Oklahoma, one medium security
correctional facility (150 beds) in Texas, and an additional medium-security
correctional facility (300 beds) is currently being constructed 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'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 management made the decision to change the Company name to Avalon
Correctional Services, Inc., to reflect the Company's focus on the correctional
industry. This name change is subject to approval of the stockholders at the
annual meeting.
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 5, 1999.
<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 Sighting, Design, Corrections
Construction, Ownership,
and Management
Avalon Correctional Center, Complete Facility 255 Beds Community Security
Tulsa, OK Sighting, Design, Corrections
Construction, Ownership,
and Management
Turley Correctional Center, 1997 Acquisition 150 Beds Community Security
Tulsa, OK Complete Facility Corrections
Ownership and
Management
El Paso Intermediate 1996 Acquisition
Sanction Facility, Complete Facility 150 Beds Medium Security
El Paso, TX Ownership and Correctional Facility
Management
Union City Juvenile Center, Complete Facility 80 Beds Medium Security Juvenile
Union City, OK Sighting, Design, Facility
Construction, Ownership,
and Management
El Paso Multi Purpose Complete Facility 300 Beds Medium Security
Facility, Sighting, Design, Correctional Facility
El Paso, TX Construction, Ownership,
and Management
Avalon Corporate Office, Corporate Headquarters N/A Administrative
Oklahoma City, OK
</TABLE>
Correctional Services -
Avalon owns and operates six correctional centers, Carver Center, Avalon
Correctional Center, Turley Correctional Center, Union City Juvenile Center, El
Paso Intermediate Sanction Facility, and the El Paso Multi Purpose Facility
currently being constructed. The correctional centers provide complete
correctional administration, correctional officer staffing, housing, food
services, vocational assistance, transportation, and rehabilitation services.
Page 2
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
Oklahoma. Avalon's contracts with the Oklahoma Department of Corrections
extend through June 30, 1999. 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.
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 sighted,
designed, and constructed 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.
Union City Juvenile Center is an 80 bed medium security juvenile
correctional facility located in Union City, Oklahoma. The Union City Juvenile
Center was sighted, designed, and constructed by the Company. Construction of
the Union City Juvenile Center was completed and the Center began receiving
offenders in February 1999.
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.
The Company was awarded a contract in June 1998 with the Texas Department
of Criminal Justice to provide 250 multi-purpose beds in El Paso, Texas. A new
300 bed facility is being constructed adjacent to the existing El Paso Facility
and is expected to be completed and operational in the second quarter of 1999.
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. The remaining assets at December 31,
1998, consists of an investment in one assisted living center which was
reclassified as an asset held for sale in 1998. The Company has entertained
various offers to sell this investment, and management believes that the
facility will be sold in 1999.
Page 3
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
Competition -
Corrections. The trend in the United States toward privatization of
government services and functions continues to increase as governments have
faced continuing pressure to control costs and improve the quality of services.
Governmental agencies responsible for the operation of correctional facilities
are privatizing and contracting with private providers for services to address
these pressures.
A combination of factors in many states has led to a revamping of the
corrections' processes (i.e., decreasing revenues, increasing prison population,
litigation arising from substandard prison conditions, and substantial
overcrowding) in addition to 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. Privately operated correctional management
companies are able to provide high quality services at lower cost. Private
correctional facilities operating as contractors for government agencies,
pursuant to court order or otherwise, exist in virtually every state.
Avalon's primary focus is the area of community corrections. Comparable to
other corrections sectors, community corrections has experienced substantial
growth over the past decade. Community corrections provides 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. Community
corrections facilities enable offenders to remain employed and even upgrade
their job skills. The inmates also contribute to society by paying taxes, paying
court costs, paying victim restitution, and paying for a portion of the cost of
their incarceration. Community corrections facilities have the lowest
re-imprisonment rate among the various types of incarceration. Community
corrections facilities generate revenue for local communities, are more cost
effective than building additional jail cells, and help reduce the prison
overcrowding problem. 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 community correctional services including: a) a fourteen-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
successful programming will be the basis for becoming the dominant company in
the community corrections industry.
Avalon contracts with the State of Oklahoma to provide services at Carver
Center, Avalon Correctional Center, Turley Correctional Center and the Union
City Juvenile 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
contracts during 1998 comprised approximately 26% of total revenues. Revenues
from contracts with the Oklahoma Department of Corrections represented 49% of
1998 revenues.
Page 4
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
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 adult 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 application for accreditation of the
Union City Juvenile Center will be submitted during 1999.
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 February 23, 1999, Avalon had approximately 261 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. The Avalon Correctional Center was sighted,
designed, and constructed by the Company.
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 Turley Correctional Center
was purchased by the Company in October 1997.
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.
Union City Juvenile Center is an 80 bed medium security juvenile
correctional facility located on 20 acres of land in Union City, Oklahoma.
Construction of the 45,000 square foot facility was completed and the Center
began receiving offenders in February 1999. The Union City Juvenile Center was
sighted, designed, and constructed by the Company.
Page 5
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
El Paso Multi Purpose Facility is a 300 bed medium security correctional
facility being constructed on seven acres of land purchased in 1998 in El Paso,
Texas. The 54,000 square foot facility is scheduled for completion in the second
quarter of 1999.
Avalon Corporate Office is located in Oklahoma City, Oklahoma, in a
commercial building at 13401 Railway Drive, Oklahoma City, Oklahoma 73114. The
Company owned 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 the
Company's credit facilities. See Note 6 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, 1998.
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 1998
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, 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
March 31, 1998 4 3/4 3 7/8
June 30, 1998 4 11/16 3 7/8
September 30, 1998 4 1/4 3 1/4
December 31, 1998 4 2 3/4
Avalon had approximately 830 holders of record of its common stock as of
March 5, 1999. No dividends were declared during 1998 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 $2.50 per share on March 5, 1999.
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. The successful implementation of
the Company's growth plan has created the need for additional capital and
financing. The Company has been successful in securing $37 million of new
capital and credit facilities since September 1997.
Working capital at December 31, 1998 was $8,643,000 representing a current
ratio of 3.04:1, compared to working capital of $875,000 and a current ratio of
1.47:1 at December 31, 1997. The increase in working capital from December 31,
1997 is primarily due to the $15 million private placement completed September
16, 1998. Capital expenditures were $5.0 million in 1998, compared to $2.3
million in 1997. The capital expenditures consist primarily of construction
costs for the Union City Juvenile Center completed in February 1999, and the
construction of the El Paso Multi Purpose Facility scheduled for completion in
the second quarter of 1999.
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 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 had approximately $11.1 million of cash available for new
projects at December 31, 1998. The Company believes it has adequate cash
reserves and cash flow from operations to meet its current cash requirements.
The Company expects current contracts to generate sufficient income to increase
cash reserves, while minimizing income taxes through the utilization of tax loss
carryforwards. The Company secured an $18 million senior credit facility with
Fleet Capital Corporation in February 1999. The credit facility and available
cash balance will enable the Company to expand its operations through
acquisitions and development.
Since the fourth quarter of 1996, all non correctional operations have been
discontinued and all related assets have been sold or are being held for sale.
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. 1998 earnings include only correctional facility
operations, except for $91,000 recorded for losses on facilities held for sale.
Results of Operations -
Year Ended December 31, 1998 Compared to the Year Ended December 31, 1997-
Total revenues from continuing operations increased by 31% to $7.7 million
in 1998 from $5.9 million in 1997. The increase was a result of the a full years
operation at the Turley Correctional Facility in Tulsa, Oklahoma acquired in
October 1997, a new community transition program contract awarded in June 1998
at the Ozark Correctional Facility in Fordland, Missouri, and increased revenues
from the Company's El Paso operations.
The Company's net loss from continuing operations was $376,000 in 1998
compared to $1,853,000 in 1997. 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.
Page 7
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
The Company incurred a net loss in 1998 of $450,000 or $.13 per share, as
compared to a net loss in 1997 of $2,581,000 or $.88 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 23% in 1998 to $1,449,000 compared to $1,175,000
for 1997. The average daily inmate census increased to 496 in 1998 from 425 in
1997, an increase of 17%. The census increase was a result of a full year of
operation at the Turley Correctional Facility in Tulsa, Oklahoma, acquired in
October 1997.
Direct operating expenses increased by 27% in 1998 over 1997, primarily as
a result of the full operations in 1997 of the Turley Correctional Facility and
the contract award for a community transition program at Fordland, Missouri.
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. Revenues from
discontinued operations were $0 and $50,000, in 1998 and 1997 respectively. The
losses on the disposal of assets related to discontinued operations were $0 and
$728,000, in 1998 and 1997, respectively.
Corporate. General and administrative expenses increased in 1998 by 16% to
$1,091,000 from $943,000. The majority of this increase was related to increased
staffing.
The increase in interest expense of $475,000 in 1998 resulted from a full
year interest on the convertible debentures issued in September 1997, and
interest on the $10,000,000 subordinated note placed in September 1998.
The Company is aware of the risk of computer error in the year 2000. Such
errors could cause computers to recognize the year 2000 as 1900 and cause the
computer to fail in calculation or function. As a result, the Company has
reviewed its computer operations and has identified all computers and systems
that are not year 2000 compliant (y2k). The Company's primary exposure to y2k
problems is in its financial reporting area. The company has purchased and
ordered computer equipment and software to become fully y2k compliant. The cost
of this equipment, including testing and implementation to become y2k compliant
is expected to be approximately $15,000. The Company will test and implement the
new equipment and software before July 1, 1999.
Page 8
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
Page
ITEM 7. FINANCIAL STATEMENTS. ----
Index to Financial Statements:
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, 1998 and
1997, 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, 1998 and 1997, and the consolidated results of their
operations and their cash flows for the years then ended in conformity with
generally accepted accounting principles.
As discussed in Note 17 to the financial statements, during the year ending
December 31, 1998, the Company adopted the provisions of Statement of Position
98-5 " Reporting on Costs of Start Up Activities" which changed its method of
accounting for deferred development and new facility opening costs.
GRANT THORNTON, LLP
Oklahoma City, Oklahoma
February 19, 1999, except
for the second paragraph of
Note 6 and Note 18 as to
which date is February 25, 1999
Page 10
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
1998 1997
------------------------------------------
ASSETS
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 5,181,000 $ 1,458,000
Investment in short term U.S. treasury bills 5,919,000 ---
Short term certificate of deposit --- 500,000
Accounts receivable, net 1,348,000 673,000
Current maturities of notes receivable 322,000 16,000
Prepaid expenses and other 100,000 107,000
------------------------------------------
Total current assets $ 12,870,000 $ 2,754,000
------------------------------------------
Property and equipment, net $ 13,644,000 $ 9,212,000
Notes receivable, net of current maturities --- 318,000
Other assets 2,251,000 1,111,000
------------------------------------------
Total assets $ 28,765,000 $ 13,395,000
==========================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable, accrued liabilities and other $ 2,026,000 $ 1,030,000
Current maturities of long-term debt 2,201,000 849,000
------------------------------------------
Total current liabilities $ 4,227,000 $ 1,879,000
------------------------------------------
Long-term debt, less current maturities $ 14,348,000 $ 5,129,000
------------------------------------------
Convertible debentures $ 3,850,000 $ 4,150,000
------------------------------------------
Redeemable Class A Common Stock, $.001 par value
1,622,448 shares issued and outstanding in 1998 $ 4,124,000 $ ---
------------------------------------------
Stockholders' equity:
Common Stock - par value $.001; 20,000,000 shares
authorized; 4,664,598 and 2,982,170 shares issued
and outstanding in 1998 and 1997, respectively,
less 1,662,448 and no shares subject to repurchase
in 1998 and 1997, respectively $ 3,000 $ 3,000
Preferred stock; par value $.001; 1,000,000
shares authorized; none issued --- ---
Paid-In capital 6,618,000 6,189,000
Accumulated deficit (4,405,000) (3,955,000)
------------------------------------------
Total stockholders' equity $ 2,216,000 $ 2,237,000
------------------------------------------
Total liabilities and stockholders' equity $ 28,765,000 $ 13,395,000
==========================================
</TABLE>
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
<TABLE>
<CAPTION>
Year Ended December 31,
1998 1997
---------------------------------------------
<S> <C> <C>
Revenues $ 7,686,000 $ 5,878,000
Costs and expenses:
Direct operating 4,692,000 3,698,000
General and administrative 1,091,000 943,000
Development costs 336,000 62,000
Losses from property held for sale 91,000 ---
Depreciation and amortization expense 628,000 460,000
Discount on convertible debentures --- 1,819,000
Interest expense 1,224,000 749,000
---------------------------------------------
Loss from continuing operations
before income tax expense $ (376,000) $ (1,853,000)
Income tax expense --- ---
---------------------------------------------
Loss from continuing operations $ (376,000) $ (1,853,000)
---------------------------------------------
Discontinued operations:
Loss on disposal, net of income tax benefit of
$0 and 1997 $ --- $ (728,000)
---------------------------------------------
Loss from discontinued operations $ --- $ (728,000)
---------------------------------------------
Net Loss before cumulative effect of
change in accounting principles $ (376,000) $ (2,581,000)
---------------------------------------------
Cumulative effect of change in
accounting principles $ (74,000) $ ---
---------------------------------------------
Net loss $ (450,000) $ (2,581,000)
=============================================
Basic and diluted loss per share:
Continuing operations $ (0.11) $ (0.63)
Discontinued operations --- (0.25)
Cumulative effect of change in
accounting principles (0.02) ---
---------------------------------------------
Net loss per share: $ (0.13) $ (0.88)
=============================================
Weighted average number of common
shares outstanding, basic and diluted 3,499,403 2,935,369
=============================================
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
Page 12
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
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, 1997 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
Net loss --- --- --- --- (450,000) (450,000)
Stock options exercised 17,480 --- --- 29,000 --- 29,000
Issuance of warrants --- --- --- 266,000 --- 266,000
Issuance of redeemable
common stock 1,622,448 --- --- --- --- ---
Warrants exercised, net of
issuance costs 42,500 --- --- 134,000 --- 134,000
------------------------------------------------------------------------------
Balance, December 31, 1998 4,664,598 $ 3,000 --- $ 6,618,000 $ (4,405,000) $ 2,216,000
==============================================================================
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
Page 13
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
<TABLE>
<CAPTION>
Year ended December 31,
1998 1997
----------------------------------------
OPERATING ACTIVITIES:
<S> <C> <C>
Net loss $ (450,000) $ (2,581,000)
Adjustments to reconcile net loss to
net cash provided by (used for) operating activities
Amortization of discount on investments (47,000) ---
Depreciation and amortization 628,000 460,000
Amortization of debt issue costs 55,000 ---
Discount on convertible debentures --- 1,819,000
Loss on sale of property 18,000 71,000
Write down of property 17,000 59,000
Cumulative effect of change in accounting principles 74,000 ---
Changes in operating assets and liabilities:
Decrease (increase) in -
Accounts receivable (675,000) (331,000)
Due to / from affiliates (97,000) 120,000
Prepaid expenses and other assets 7,000 40,000
Increase (decrease) in accounts payable and other (335,000) 609,000
----------------------------------------
Net cash provided by operations $ (805,000) $ 266,000
----------------------------------------
INVESTING ACTIVITIES:
Purchase of short term investments $ (5,872,000) $ (500,000)
Proceeds from maturity of certificate of deposit 500,000 ---
Capital expenditures (3,737,000) (941,000)
Payment for purchase of business --- (1,400,000)
Funding of note receivable (4,000) (25,000)
Proceeds from payments on notes receivable 16,000 1,000
Proceeds from disposition of property 16,000 45,000
Proceeds from disposition of discontinued operations 280,000 151,000
----------------------------------------
Net cash used in investing activities $ (8,801,000) $ (2,669,000)
----------------------------------------
</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
<TABLE>
<CAPTION>
Year ending December 31,
1998 1997
----------------------------------------
FINANCING ACTIVITIES:
<S> <C> <C>
Proceeds from convertible debenture issue $ --- $ 4,150,000
Proceeds from borrowing 16,515,000 5,210,000
Repayment of borrowing (6,532,000) (5,612,000)
Payment of debt issue costs (1,452,000) ---
Proceeds from warrant and option exercise 163,000 146,000
Payment of warrant & debenture issue costs --- (346,000)
Proceeds from issuance of Redeemable Common Stock 4,635,000 ---
----------------------------------------
Net cash provided by financing activities $ 13,329,000 $ 3,548,000
----------------------------------------
Net increase in cash
and cash equivalents $ 3,723,000 $ 1,145,000
----------------------------------------
Cash and cash equivalents,
beginning of period $ 1,458,000 $ 313,000
----------------------------------------
Cash and cash equivalents
end of period $ 5,181,000 $ 1,458,000
========================================
</TABLE>
<TABLE>
<CAPTION>
SUPPLEMENTAL CASH FLOW INFORMATION:
<S> <C> <C>
Cash paid during the year for:
Interest $ 1,286,000 $ 668,000
Income taxes --- ---
</TABLE>
Non cash investing and financing activities:
The Company has approximately $1,231,000 relating to construction costs,
and $100,000 relating to debt issue costs financed through accounts payable at
December 31, 1998. During 1998, the company issued warrants of approximately
$266,000 in exchange for financial advisory services.
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 1998 AND 1997
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 community correctional
facilities and providing intensive correctional programming. The Company
currently operates in Oklahoma and Texas with plans to significantly expand into
additional states. The Company owns and operates 1,185 private corrections beds
including 300 beds currently being constructed.
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.
Investments -
The Company accounts for certain investments in debt securities in the
following manner. Debt securities that the Company has a positive intent and
ability to hold to maturity are classified as held-to-maturity securities and
are reported at amortized cost. Debt securities that are bought and held
principally for the purpose of selling in the near term are classified as
trading securities and reported at fair value, with unrealized gains and losses
included in earnings. Debt securities not classified as either held-to-maturity
securities or trading securities are classified as available-for-sale securities
and reported at fair value, with unrealized gains and losses, net of tax
effects, excluded from earnings and reported in other comprehensive income. The
Company has classified its entire debt securities portfolio as held-to-maturity
securities.
Declines in the fair value of individual securities below cost or amortized
cost that are other than temporary result in write-downs included in earnings.
The specific identification method is followed in determining the cost of
securities sold.
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.
The Company had a significant portion of its cash equivalents in United States
treasury bills at December 31, 1998. 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. Approximately 75% and 44%
of total accounts receivable at December 31, 1998 and 1997, respectively, were
Page 16
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED 1998 AND 1997
due from the Oklahoma Department of Corrections. The Company maintains an
allowance for doubtful accounts for potential credit losses. The allowance for
doubtful accounts at December 31, 1998 and 1997 was $9,000 and $8,000,
respectively. Actual bad debt expenses have not been material. Credit risk on a
note receivable by the Company 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
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. Impairment losses
are recognized based upon the estimated fair value of the asset when required.
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 -
Prior to 1998, development costs that could be directly associated with an
anticipated contract were capitalized, and, if the recoverability from that
contract was probable, they were deferred until the anticipated contract had
been awarded. The development costs of sucessful proposals were deferred and
amortized over the anticipated life of the contract (including option and
renewal periods), while costs of unsuccessful or abandoned contracts were
charged to expense when their recovery was not considered probable. Facility
costs were incurred (after a contract is awarded) in connection with the opening
of new facilities under the contract, and were capitalized from the date of
award until commencement of operations and amortized on a straight-line basis
over the term of the contract. As of January 1, 1998, the Company, pursuant to
Statement of Position 98-5 "Reporting on the Costs of Start Up Activities",
expensed development and new facility opening costs.
Page 17
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED 1998 AND 1997
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 the assumed exercise of options and warrants (Note
9), the assumed redemption of 1,622,448 shares of common stock (Note 6), and the
conversion of debentures (Note 7), would be anti-dilutive.
Reclassifications-
Certain reclassifications have been made to the 1997 financial statements
to conform to the 1998 presentation.
NOTE 2. INVESTMENTS
The amortized cost of debt securities, together with thier estimated fair
value, are summarized as follows as of December 31, 1998.
<TABLE>
<CAPTION>
Cost / Gross Gross
Amortized Unrealized Unrealized Estimated
Type of Investment Cost Gains Losses Fair Value
- -------------------------- --------------- -------------- ---------------- ---------------
<S> <C> <C> <C> <C>
U.S. Treasury Bills $ 5,919,000 --- --- $ 5,919,000
</TABLE>
At December 31, 1998, the entire investment in U.S. treasury bills are due
within one year. The Company had no sale or maturities of investments during
1998 or 1997.
NOTE 3. PROPERTY AND EQUIPMENT
The elements of property and equipment and related accumulated depreciation
as of December 31, 1998 and 1997 are as follows:
Accumulated
Cost Depreciation
-------------------------------------
December 31, 1998:
Land $ 1,388,000 $ ---
Buildings and Improvements 7,586,000 758,000
Furniture and Equipment 933,000 533,000
Transportation Equipment 1,086,000 258,000
Construction in Progress 4,200,000 ---
------------- ------------
$ 15,193,000 $ 1,549,000
============= ============
Page 18
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED 1998 AND 1997
Accumulated
Cost Deprciation
-----------------------------------
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
============= ============
NOTE 4. ACCOUNTS PAYABLE, ACCRUED LIABILITIES AND OTHER
The elements of accounts payable, accrued liabilities and other as of
December 31, 1998 and 1997 are as follows:
1998 1997
-----------------------------------
Trade accounts payable $ 1,450,000 $ 303,000
Accrued interest payable 154,000 140,000
Accrued salary and benefits 168,000 115,000
Discontinued operations liabilities --- 157,000
Other accrued liabilities 254,000 315,000
------------ ------------
$ 2,026,000 $ 1,030,000
============ ============
NOTE 5. 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. Contract revenues from significant contracts as a percentage
of total Company revenue for the years ending December 31, are as follows:
1998 1997
----------- -----------
Oklahoma Department of Corrections 49% 52%
West Texas Community Supervision and Corrections 18% 31%
Missouri Department of Corrections 13% ---
Page 19
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED 1998 AND 1997
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 extending
through August 31, 2011 and August 31, 1999, respectively. The Company's current
Residential Services contracts with the Oklahoma Department of Corrections
extend through June 30, 1999. The Company has a Programming Services contract
with the State of Missouri extending through February 28, 1999.
NOTE 6. LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
December 31,
1998 1997
------------------------------
<S> <C> <C>
Revolving bank line of credit,
collateralized by accounts
receivable, with interest at
1% over prime (effective rate
of 9.25% at December 31, 1998);
due June 1999 $ 724,000 $ 167,000
Notes payable to banks, collateralized by
equipment due in installments through
July 1999 with interest at 7.99%. 2,000 89,000
Notes payable to banks, collateralized
by transportation equipment, due in
installments through March 2012
with interest ranging from 4.90% to 9.49%. 676,000 621,000
Notes payable to banks, collateralized
by land, buildings and improvements
due in installments due in installments
through June 2012 with interest
ranging from 8.95% to 11%. 4,631,000 4,941,000
Note payable to an individual, uncollateralized,
with interest at 8.5%, due in full April 1999. 160,000 160,000
Note payable to an investment company, unsecured
with interest at 12.5%, due in four installments
beginning in 2005, including original issue premium 10,356,000 ---
------------- -------------
$ 16,549,000 $ 5,978,000
Less - current maturities $ 2,201,000 $ 849,000
------------- -------------
$ 14,348,000 $ 5,129,000
============= =============
</TABLE>
Page 20
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED 1998 AND 1997
The Company completed a senior credit facility with Fleet Capital
Corporation on February 25, 1999. The Company utilized existing cash reserves in
February 1999 to retire $5,053,000 in existing indebtedness upon the completion
of the senior credit facility. The aggregate maturities of long-term debt for
each of the next five years after the retirement of indebtedness are as follows:
1999: $537,000; 2000: $404,000; 2001: $436,000; 2002: $468,000; 2003: $495,000
and $14,206,000 thereafter.
The Company completed a $15,000,000 private placement of debt and equity
with an investment company on September 16, 1998. Pursuant to the terms of the
agreement, the Company tendered an unsecured subordinated note with a face value
of $10,000,000 bearing interest of 12.5% with interest payable in quarterly
installments until December 31, 2005, when the first of four quarterly principal
installments are due. The Company also tendered 1,622,448 shares of redeemable
common stock to the investment company. These shares are subject to repurchase
by the Company, at the holders option, after five years from the date of
issuance at the fair value as defined in the agreement under certain
circumstances if the Company is unable to meet certain covenants required by the
agreement. The financial covenants require the Company, among other things, to
maintain certain earnings and debt coverage ratios.
The Company obtained an independent fair value appraisal of the debt and
equity instruments reflecting a fair value allocation of the debt of $10,365,000
and the fair value allocation of the redeemable common stock of $4,635,000. The
original issue premium of $365,000 will be accreted as a reduction of interest
expense over the term of the debt instrument. Debt issue costs of $1,654,000
(including $266,000 representing the fair value of warrants issued to financial
advisors) has been allocated to the debt and redeemable common stock based upon
their fair values. Costs of $511,000 allocated to the redeemable common stock
have reduced its book value to $4,124,000. Costs of $1,143,000 allocated to the
debt instrument are included in other assets and amortized to interest expense
over the life of the debt instrument using the effective interest method.
NOTE 7. CONVERTIBLE DEBENTURES
The Company completed a private placement of $4,150,000 of convertible
debentures on September 12, 1997. The convertible debentures bear interest at
7.5% and mature on September 12, 2007. The convertible debentures may be
redeemed by the Company at any time after May, 2001 at 106.5% of principal,
declining to 100% at maturity. The convertible debentures are convertible into
common stock at $3.00 per share at any time until their maturity. The
convertible debenture holders signed agreements to subordinate the debentures to
the $10,000,000 face value note issued on September 16, 1998. The Company
redeemed $300,000 of convertible debentures at face value in September 1998.
NOTE 8. STOCKHOLDERS' EQUITY
The Company has outstanding 275,100 Class B stock purchase warrants
providing for the purchase of the Company's 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.
The Company completed a private placement in August 1994, of 1,000,000
shares of common stock and 1,000,000 Class C stock purchase warrants and an
additional 100,000 shares of common stock and 100,000 Class C stock purchase
warrants were reserved for underwriters. The Company issued an additional 25,000
and 165,000 Class C stock purchase warrants, respectively, in 1997 and 1996. The
Company has issued 452,500 shares of common stock upon the exercise of the Class
C stock purchase warrants through December 31, 1998 and has a total of 837,500
Class C stock purchase warrants outstanding.
Page 21
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED 1998 AND 1997
The Class C stock purchase warrants provide for the purchase of the
Company's common stock at any time until their expiration at December 30, 1999.
The exercise price of the Class C stock purchase warrants is $3.19 per share as
of December 31, 1998. The warrants may be redeemed by the Company upon certain
events, for $.01 per share.
The Company issued 200,000 Class D stock purchase warrants in August 1996,
in connection with the acquisition of the El Paso Intermediate Sanction
Facility. The Class D stock purchase warrants provide for the purchase of the
Company's common stock at any time until their expiration at August 2, 2001. The
exercise price of the class D warrants is $4.20 per share as of December 31,
1998. 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 is amortized to expense over the term of the convertible debentures.
The Class E stock purchase warrants provide for the purchase of the Company's
common stock at a price of $3.00 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 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 and the certificate of
designation creating the stock on August 25, 1997, pursuant to a Change of
Control Agreement between the Company and the Company's CEO.
The Company issued 200,539 stock purchase warrants to financial advisors in
September 1998, in connection with the $15,000,000 private placement. The stock
purchase warrants provide for the purchase of the Company's common stock at any
time until their expiration in September 2002. The exercise price of the
warrants is $3.75 per share as of December 31,1998. The warrants may be redeemed
by the Company upon certain events for $.01 per share. The fair value of the
warrants was allocated between the proceeds the debt and equity issues as debt
issue cost and a reduction in redeemable common stock.
A 1994 agreement provided for the issuance of 750,000 common stock purchase
warrants to purchase 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.
NOTE 9. 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.
Page 22
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED 1998 AND 1997
The options generally vest over a four or five-year period with a ten year
expiration period. The Company amended its stock option plan on December 1,
1996, increasing the number of shares available under the Plan to 600,000.
Non-statutory options have been granted providing for the issuance of 492,900
shares of Class A common stock at exercise prices ranging from $1.50 to $4.25
per share. Options providing for the issuance of 216,690 shares were exercisable
at December 31, 1998.
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 per share would have been increased to the pro forma amounts
indicated below.
1998 1997
---------------- ----------------
Net loss
As reported $ (450,000) $ (2,581,000)
Pro forma (760,400) (2,880,000)
Loss per share, basic and diluted
As reported $ (0.13) $ (0.88)
Pro forma (0.22) (0.98)
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 1998 and 1997, respectively: no
expected dividends; expected volatility of 85% and 85%; riskfree interest rate
of 5.9% and 5.8%; and expected lives of ten years.
The Black-Scholes options valuation model was developed for use in
estimating the fair value of traded options with no vesting restrictions and
that are fully transferable. Option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. The
Company's employee stock options have characteristics significantly different
from those of traded options, and changes in the subjective input assumptions
can materially affect the fair value estimate. It is management's opinion that
the existing models do not necessarily provide a reliable single measure of the
fair value of its employee stock options.
A summary of the status of the Company's stock option plan as of December
31, 1998 and 1997, and changes during the years ending on those dates is
presented below.
Page 23
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
---------------------------------- ---------------------------------
Weighted Weighted
average average
Shares exercise price Shares exercise price
---------------- ----------------- --------------- ----------------
<S> <C> <C> <C> <C>
Outstanding at beginning of year 477,330 $ 3.11 469,770 $ 2.93
Granted 85,830 3.11 71,400 3.80
Exercised (17,480) 1.67 (22,035) 1.63
Forfeited (52,780) 2.95 (41,805) 3.02
---------- --------- ---------- ---------
Outstanding at end of year 492,900 3.18 477,330 3.11
Options exercisable at year end 216,690 2.64 83,850 1.71
---------- --------- ---------- ---------
Weighted average fair value of
options granted during the year $ 3.29 $ 3.00
========= =========
</TABLE>
The following table summarizes information about fixed-price stock options
outstanding at December 31, 1998:
<TABLE>
<CAPTION>
Options outstanding Options exercisable
-------------------------------------------------- -------------------------------
Weighted Weighted Weighted
Number average average Number average
outstanding at remaining exercise exercisable exercise
12/31/98 contractual life price at 12/31/98 price
---------------- ------------------ ------------- --------------- --------------
Range of exercise prices
<S> <C> <C> <C> <C> <C>
$1.50 to $2.25 164,400 6.63 $ 1.70 125,065 $ 1.69
$3.75 to $4.25 328,500 7.85 3.92 91,625 3.92
---------------- ------------------ ------------- --------------- --------------
$1.50 to $4.25 492,900 216,690
======= =======
</TABLE>
NOTE 10. ACQUISITIONS AND CONTRACT AWARDS
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. The intangible
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. A
subsidiary of the Company, Southern Corrections Systems, Inc., has assumed the
annual contracts with the Oklahoma Department of Corrections and the Federal
Bureau of Prisons.
Page 24
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED 1998 AND 1997
The following unaudited pro forma summary presents the consolidated results
of operations of the Company for the year ending December 31, 1997, as if the
business combination had occurred on January 1, 1997.
Revenues $ 6,886,000
Net Loss (2,592,000)
Loss per share, basic and diluted $ (0.88)
The above amounts are based upon certain assumptions and estimates which
the Company believes are reasonable. The pro forma results do not necessarily
represent results which would have occurred if the business combination had
taken place at the date and on the basis assumed above.
The Company was awarded a five year contract in March 1998 with the
Oklahoma Office of Juvenile Affairs. The contract is to sight, design, build,
and operate a facility to provide services for 80 youthful delinquent male
offenders ages 13 to 19. The contract is expected to generate monthly revenues
of approximately $300,000 beginning in the first quarter of 1999. The contract
is expected to generate revenues of $18,800,000 over a five year period. The
Company completed construction of the facility and commenced operations under
this contract in the first quarter of 1999.
The Company was awarded a new contract in July 1998 with the Texas
Department of Criminal Justice for an additional 200 adult male offenders. The
Company has sighted, designed, and begun construction of a new 300 bed secure
facility in El Paso, Texas. The contract is expected to generate monthly
revenues of approximately $200,000 beginning in the second quarter of 1999.
NOTE 11. DISCONTINUED OPERATIONS
The Company discontinued all non correctional operations in the fourth
quarter of 1996. Revenues from discontinued operations for 1997 were $50,000.
Operating losses from discontinued operations of $535,000 and a loss on disposal
of assets utilized in discontinued operations of $193,000 were incurred in 1997.
Approximately $541,000 of these losses were recorded in the fourth quarter of
1997.
The remaining assets at December 31, 1998, consist of an investment of
approximately $95,000 in one assisted living center. The Company has entertained
various offers and management believes that the facility will be sold in 1999.
The net assets and liabilities of the discontinued operations included as
accounts payable, accrued liabilities and other in the accompanying consolidated
balance sheet at December 31, 1997, are as follows:
Assets
Property and equipment, net $ 298,000
Liabilities
Accounts payable and accrued liabilities (157,000)
Note payable (298,000)
--------------
Net liabilities of discontinued operations $ (157,000)
==============
Page 25
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED 1998 AND 1997
NOTE 12. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying values of cash, cash equivalents, investments in U.S. treasury
bills and short term certificates of deposit approximate their fair values, due
to the short term nature and stability of market interest rates in 1998. 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 1998, and the
fact that rates on the debt approximate the Company's incremental borrowing
rate. The convertible debentures approximate fair value due to the stability of
market interest rates in 1998. All the Company's financial instruments are held
for purposes other than trading.
NOTE 13. INCOME TAX
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 carry
forwards, excess tax basis in property and equipment, and nondeductible accruals
and allowances; liabilities, accelerated tax depreciation. The Company has
approximately $2,646,000 of net operating loss carry forwards at December 31,
1998, expiring through 2013.
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, 1998 and 1997:
<TABLE>
<CAPTION>
December 31,
1998 1997
---------------- ---------------
<S> <C> <C>
Provision for (benefit from) income taxes
at statutory rate $ (128,000) $ (630,000)
Nondeductible expenses 9,000 624,000
State income taxes (18,000) (73,000)
Change in valuation allowance 118,000 68,000
Change in prior year estimate 19,000 11,000
--------------- ---------------
Total provision for (benefit from) income taxes $ --- $ ---
=============== ===============
Deferred tax assets and liabilities are as follows:
Deferred tax assets
Net operating loss carry forward $ 1,058,000 $ 453,000
Property & equipment --- 144,000
Shareholder contributed property --- 46,000
Nondeductible accruals and allowances 338,000 214,000
Other 1,000 1,000
--------------- ---------------
$ 1,397,000 $ 858,000
Less: Valuation allowance $ (1,058,000) $ (637,000)
--------------- ---------------
</TABLE>
Page 26
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED 1998 AND 1997
<TABLE>
<S> <C> <C>
Deferred tax assets $ 339,000 $ 221,000
---------------- ---------------
Deferred tax liabilities:
Property and equipment $ (273,000) $ (155,000)
---------------- ---------------
Deferred tax liabilities (273,000) (155,000)
---------------- ---------------
Net deferred tax asset $ 66,000 $ 66,000
================ ===============
</TABLE>
The valuation allowance on tax assets increased $421,000 in 1998 and
$284,000 in 1997, including $396,000 and $68,000 related to continuing
operations in 1998 and 1997, respectively. The tax effects of approximately
$618,000 of nondeductible expenses relate to the allocation of proceeds from
convertible debentures charged to operations in 1997. The increase in valuation
allowance for 1998 was a result of an increase in prior year operating losses of
$188,000 and increase in the historic tax basis of assets of $63,000
NOTE 14. RELATED PARTY TRANSACTIONS
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 1999.
Facility debt of $1,990,000 was guaranteed by the Company at December 31, 1998.
NOTE 15. COMMITMENTS AND CONTINGENCIES
Total lease expense was $58,000 and $57,000 for 1998 and 1997,
respectively, under all operating leases. The future minimum lease payments are
as follows: 1999 - $48,000, 2000 - $41,000, 2001 - $32,000 , 2002 - $14,000, and
2003 - $4,000.
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.
The Company entered into a construction contract with Oscar J. Boldt
Construction for construction of the Union City Juvenile Center in Union City,
Oklahoma. The total contract amount is $4,115,000 and the total amount paid to
the contractor as of December 31, 1998 is $2,055,000. Construction of the
facility was completed in the first quarter of 1999.
Page 27
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED 1998 AND 1997
The Company entered into a construction contract with C.F. Jordan
Commercial L.P. for construction of a 300 bed facility in El Paso, Texas. The
total contract amount is $3,960,000 and the amount paid to the contractor as of
December 31, 1998 is $298,000. Construction is expected to be completed in the
second quarter of 1999.
Effective September 1, 1998 the Company established a deferred compensation
plan for certain officers or key executives of the Company. The plan currently
has a monthly committment or $5,400.
Capitalized interest on construction projects totaled approximately $71,000
for the year ending December 31, 1998.
NOTE 16. 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 17. CHANGE IN ACCOUNTING PRINCIPLE
During the fourth quarter of 1998 the Company elected to adopt, for all of
1998 and future years, the provision of Statement of Position 98-5 "Reporting on
Costs of Start Up Activities". Development and new facility opening costs had
been deferred and amortized over the life of the contract prior to January 1,
1998. As a result of the adoption of the new pronouncement, deferred costs of
approximately $74,000 were charged to operations and reported as cumulative
effect of change in accounting principle, effective January 1, 1998. The effect
of the change in 1998 was to increase the net loss before the cumulative effect
of change in accounting Principles by approximately $207,000 or $0.06 per share.
Pursuant to the pronouncement, presentation of the pro forma effects of
retroactive application are not required.
NOTE 18. SUBSEQUENT EVENTS
The Company completed a senior credit facility with Fleet Capital
Corporation on February 25, 1999. The four year revolving credit facility will
be utilized to finance the expansion of the Company's business.
The credit facility provides for an $18 million senior revolving debt
facility secured by substantially all assets of the Company. The credit facility
is subject to a 1/2% unused line fee and interest on outstanding balances at
Prime plus .25% to .50% or LIBOR plus 2.0% to 3.0%. The maturity date of the
credit facility is February 25, 2003.
The Company has not needed to utilize the credit facility. Existing cash
reserves were utilized to retire debt that was collateralized by assets now
pledged pursuant to the credit facility. The Company expects to borrow amounts
under the facility in 1999 to finance new projects and acquisitions.
Page 28
<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. There have been no disagreements with Coopers & Lybrand, L.L.P. or
Grant Thornton LLP on any matter of accounting principles or practices,
financial statement disclosure or auditing scope or procedure or any reportable
event during the two most recent fiscal years and the three interim periods
subsequent to December 31, 1995, and through the date of dismissal.
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 ............... 46 Chief Executive Officer, Director
Jerry M. Sunderland ........... 62 President, Director
Gary D. Parsons............... 54 Senior Vice President of Operations
Tim West ...................... 50 Senior Vice President of Operations
Randall J. Wood .............. 40 Corporate Secretary
Tiffany Smith ................. 30 Vice President of Corporate
Communications
Paul D. Voss ................. 31 Vice President of Finance
Shawn Sunderland............... 35 Vice President of Business Development
Robert O. McDonald ............ 60 Director
Mark S. Cooley ............... 41 Director
James A. Wilson ............... 42 Director-elect
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 abovename 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, 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.
Page 29
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
Jerry M. Sunderland joined the Company in 1988 and has served as President
of Avalon since June 1995. Mr. Sunderland also serves as a Director of Avalon
and its subsidiaries. Mr. Sunderland has in excess of 38 years of experience in
developing and operating quality programs and facilities for adult offenders.
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.
Gary D. Parsons joined Avalon as Vice President of Operations in December
1997 and was promoted to Senior Vice President of Operations in February 1999.
Mr. Parsons has in excess of 25 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
jointly 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.
Tim West joined Avalon as Vice President of Operations in May 1998 and was
promoted to Senior Vice President of Operations in February 1999. Mr. West has
in excess of 25 years of experience designing, developing, and operating
correctional institutions. Mr. West is jointly 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. West has served in numerous
capacities in the Texas criminal justice system, most recently as the Senior
Warden at the Mark W. Stiles Unit in Huntsville, Texas. Mr. West also served as
the project director for the "Michael Prototype" in the Texas prison system. Mr.
West received a Bachelors and Masters Degree in Contemporary Corrections from
the Institute for Contemporary Corrections and the Behavioral Sciences at Sam
Houston University.
Randall J. Wood joined Avalon in 1995 and 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 Smith joined the Company in 1994 as the Public Information Officer
and was promoted to Assistant Corporate Secretary for the Company in 1997 and to
Vice President of Corporate Communications in 1999. Ms. Smith served for four
years as marketing manager for Eagle Picher Industries, a New York Stock
Exchange listed company, prior to joining Avalon. Ms. Smith has developed and is
responsible for directing the Company's corporate communications and public
relations department and implementing marketing strategies. Ms. Smith is the
primary contact for the Company's shareholders and investors. Ms. Smith received
a Bachelors Degree in Business Administration, Marketing and Management from
Missouri Southern State College. Ms. Smith is the spouse of Donald Smith, Chief
Exective Officer.
Paul D. Voss joined the Company as Vice President of Finance in January
1998. Mr. Voss is primarily responsible for financial reporting and corporate
administration for the Company. 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.
Shawn Sunderland joined the Company in 1997 and was promoted to Vice
President of Business Development in February 1999. Mr Sunderland has been
engaged in the corrections and law enforcement industry for more than 9 years.
Mr. Sunderland is responsible for project development including site
development, lease negotiation, proposal development, facility design, and
program implementation. Mr. Sunderland is the son of Jerry Sunderland,
President.
Page 30
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
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. 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.
James P. Wilson was appointed as a Director-elect of Avalon in September
1998, subject to shareholder approval at the 1999 annual meeting. Mr. Wilson is
a managing partner in the investment firm of Rice, Sangalis, Toole & Wilson.
Prior to founding Rice, Sangalis, Toole & Wilson, Mr. Wilson was a vice
president with First Texas Merchant Banking Group, and was also an audit manager
with Arthur Young & Co. Mr. Wilson received a BBA degree from Texas A&M
University, and is a Certified Public Accountant.
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, 1998.
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)
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, 1999 (13)
ii Contract between Southern Corrections Systems, Inc. and the
Page 31
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
Oklahoma Department of Corrections for public works inmates
for the year ended June 30, 1999 (13)
iii Contract between Southern Corrections Systems, Inc. and the
Oklahoma Department of Corrections for halfway house services
for the year ended June 30, 1999.(13)
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 Change of Control Agreement between Donald E. Smith and
Avalon Community Services, Inc. dated August 25, 1997. (7)
vii Employment Agreement with Donald E. Smith dated August 8,
1997. (7)
viii Employment Agreement with Jerry M. Sunderland dated August 8,
1997 (7)
ix Letter of Acceptance and Notice of Award dated February 24,
1997 to Avalon Community Services, Inc. from the Missouri
Department of Corrections. (7)
x Commercial Contract to Buy and Sell Real Estate dated
October 2, 1997 between Avalon Community Services, Inc.
and Freedom Ranch, Inc. (9)
xi Notice of Award dated March 3, 1998 to Southern Corrections
Systems, Inc. from the Oklahoma Office of Juvenile
Affairs.(11)
x Contract between Southern Corrections Systems, Inc. and the
Texas Department of Criminal Justice dated June 18, 1998. (13)
xi Financing agreement between Avalon Community Services, Inc.
and Rice, Salgalis, Toole and Wilson dated
September 16, 1998. (12)
xii Financing agreement between Avalon Community Services, Inc,
and Fleet Capital Corporation dated February 25, 1999. (14)
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.
iii Form 8-K dated October 1, 1998 re: Financing agreement with
Rice, Sangalis, Toole & Wilson.
ix For 8-K dated March 10, 1999 re; Financing agreement with
Fleet Capital Corporation.
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.
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.
Page 32
<PAGE>
AVALON COMMUNITY SERVICES, INC. AND SUBSIDIARIES
11) Incorporated herein by reference to the Registrant's Form 8-K
dated March 19, 1998.
12) Incorporated herein by reference to the Registrant's Form 8-K
dated October 1, 1998.
13) Incorporated herein by reference to the Registrant's Form S-2
dated December 2, 1998.
14) Incorporated herin by reference to the Registrant's 8-K dated
March 10, 1999.
Page 33
<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, 1999
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, 1999
By: s\ Jerry M. Sunderland
------------------------------
Jerry M. Sunderland
President and Director Dated: March 26, 1999
By: s\ Robert O. McDonald
------------------------------
Robert O. McDonald
Director Dated: March 26, 1999
By: s\ Mark S. Cooley
------------------------------
Mark S. Cooley
Director Dated: March 26, 1999
By: s\ Paul Voss
------------------------------
Paul Voss
Vice President of Finance Dated: March 26, 1999
Page 34
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<ARTICLE> 5
<MULTIPLIER> 1
<CURRENCY> U.S. Dollars
<S> <C>
<PERIOD-TYPE> Year
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1
<CASH> 5,181,000
<SECURITIES> 5,919,000
<RECEIVABLES> 1,357,000
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<DEPRECIATION> 1,549,000
<TOTAL-ASSETS> 28,765,000
<CURRENT-LIABILITIES> 4,227,000
<BONDS> 18,198,000
0
0
<COMMON> 3,000
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<INCOME-PRETAX> (376,000)
<INCOME-TAX> 0
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