Item 1. Description of Business.
Corporate Structure
Correctional Services Corporation (the "Company") was incorporated in Delaware on October 28, 1993 to acquire all of the outstanding capital stock of a number of affiliated corporations engaged in the operation of corrections and detention facilities. All references to the Company include the Company and all wholly-owned subsidiaries on a consolidated basis.
Description
The Company is a leading developer and manager of privatized correctional and detention facilities in the United States. Through its three divisions, Adult, Juvenile and Community Corrections, the Company provides a diverse range of services to local, state, and federal governmental correctional agencies. The Company currently has agreements to operate 26 correctional and detention facilities in New York, Florida, Arizona, Texas, New Mexico, Washington, Mississippi and Puerto Rico, with a total of 4,641 beds. The Company is also aggressively pursuing other privatized correctional projects both at the request for proposal ("RFP") stage and the pre-RFP development stage.
The Company manages both secure and non-secure facilities. The Company's secure facilities include a detention and processing center for illegal aliens, adult prisons, adult jails, intermediate sanction facilities, juvenile detention and treatment facilities, driving while intoxicated ("DWI") facilities, and military-style boot camps for juvenile offenders. Its non-secure facilities include residential programs, such as community correctional facilities for federal and state offenders serving the last six months of their sentences, and non-residential supervision programs.
In addition to providing fundamental residential services for adult and juvenile offender, the Company has developed a broad range of programs intended to reduce recidivism, including basic and special education, substance abuse treatment and counseling, vocational training, life skills training, and behavioral modification counseling. The management services offered by the Company range from project consulting to the design, development and management of new correctional and detention facilities and the redesign, renovation and management of older facilities. The Company believes its proven ability to manage the full spectrum of correctional facilities and its wide variety of programs and services will increase its marketing opportunities.
Operational Divisions
The Company has organized its operations into three divisions: Adult, Juvenile and Community Corrections.
Adult. The Adult Division operates 9 secure facilities located in Seattle, Washington; Houston, Texas; Del Valle (Travis), Texas; Pearsall (Frio County), Texas; Mansfield (Tarrant County), Texas; Florence and Phoenix, Arizona; Grenada, Mississippi; and Gallup (McKinley County), New Mexico, with a total of 2,495 beds. In addition to providing housing for adult inmates, the Company provides a variety of rehabilitation and educational services. The Company also provides health care, transportation, food services and work and recreational programs for adult inmates.
Juvenile. The Juvenile Division operates 8 facilities and has contracts to operate 5 additional facilities in Eagle Lake (Colorado County), Texas; (Bayamon Detention and Treatment Centers), Puerto Rico; Salinas, Puerto Rico and Okaloosa, Florida. The current facilities are located in Bartow, Polk City, and Pahokee, Florida; Canadian (Hemphill), Texas; Mansfield (Tarrant County), Texas; Rockdale (Milam County), Texas; Killeen (Bell County), Texas and Medical Lake (Spokane), Washington. The facilities house convicted youths aged 12 to 20, and represent a total of 1,692 beds under contract. The Company manages secure and non-secure juvenile offender facilities for low, medium, and high risk youths in highly structured programs, including military-style boot camps, wilderness programs, secure education and training centers, and detention facilities. The Company believes these programs, by instilling the qualities of self-respect, respect for others and their property, personal responsibility and family values, can help reduce the recidivism rate of its program participants.
Community Corrections. The Community Corrections Division operates four facilities, located in Ft. Worth, Texas; and Brooklyn, Manhattan and the Bronx, New York with a total of 454 beds. These are non-secure residential facilities for adult male and female offenders transitioning from institutional to independent living. Offenders are eligible for these programs based upon the type of offense committed and behavior while incarcerated in prison. If qualified, offenders may generally spend the last six months of their sentence in a community corrections program, whose mission is to reduce the likelihood of an inmate committing an offense after release by assisting in the reunification process with family and the community. Normally, in order to remain in the program, offenders must be employed, participate in substance abuse programs, submit to frequent random drug testing, and pay a predetermined percentage of their earnings to the government to offset the cost of the program. The Company supervises these activities and also provides life skills training, case management, home confinement supervision and family reunification programs at these facilities. The Company believes that community correctional facilities help reduce recidivism, result in prison beds being available for more violent offenders and, in appropriate cases, represent cost-effective alternatives to prisons.
Marketing and Business Development
The Company engages in extensive marketing and business development on a national basis and markets selected projects in the international arena. Marketing efforts are spearheaded by the Company's business development team in conjunction with the CEO and outside consultants.
The Company's business development department is responsible for marketing the full range of services to clients. Marketing responsibilities include identifying new clients, preparing and delivering formal presentations and identifying strategic partners.
The Company receives frequent inquiries from or on behalf of governmental agencies. Upon receiving such an inquiry, the Company determines whether there is an existing or future need for the Company's services, whether the legal and political climate is conducive to correctional operations and whether or not the project is viable.
Contract Award Process
Most governmental procurement and purchasing activities are controlled by procurement regulations take the form of RFPs, and to date most of the Company's new business results from responding to these requests. Interested parties submit proposals in response to an RFP within a time period of 15 to 120 days from the time the RFP is issued. A typical RFP requires a bidder to provide detailed information, including the services to be provided by the bidder, the bidder's experience and qualifications and the price at which the bidder is willing to provide the services. From time to time, the Company engage independent consultants to assist in responding to the RFPs. Approximately six to eighteen months is generally required from the issuance of the RFP to the contract award.
Before responding to an RFP, the Company researches and evaluates, among other factors: (i) the current size and growth projections of the available correctional and detention population; (ii) whether or not a minimum capacity level is guaranteed; (iii) the willingness of the contracting authority to allow the Company to house populations of similar classification within the proposed facility for other governmental agencies; and (iv) the willingness of the contracting authority to allow the Company to make adjustments in operating activities, such as work force reductions in the event the actual population is less than the contracted capacity.
Under the RFP, the bidder may be required to design and construct a new facility or to redesign and renovate an existing facility at its own cost. In such event, the Company's ability to obtain the contract award is dependent upon its ability to obtain the necessary financing or fund such costs internally.
In addition to issuing formal RFPs, governmental agencies may use a procedure known as Purchase of Services or Requests for Qualification ("RFQ"). In the case of an RFQ, the requesting agency selects a firm it believes is most qualified to provide the necessary services and then negotiates the terms of the contract, including the price at which the services are to be provided.
Strategic Acquisitions
Historically, the Company's growth has been generated internally, primarily through the competitive bid process. However, the Company continues to evaluate strategic acquisitions, particularly where an acquisition would enhance the Company's capabilities or add to the services it offers in the correctional services industry. Acquisitions include companies with one or more contracts as well as individual facilities with government agencies.
Market
Through the United States, there is a growing trend toward privatization of corrections and detention functions as governments of all types have faced continuing pressure to control costs and improve the quality of services. Further, as a result of the number of crimes committed each year the correspond- ing number of arrests, incarceration costs generally grow faster than many other parts of budget items. In an attempt to address these pressures, governmental agencies responsible for correctional and detention facilities are increasingly privatizing facilities.
Numerous studies have proven there is a general shortage of beds available in detention and treatment facilities. That fact, coupled with the high rate of recidivism and the public demand for longer sentences, has resulted in over- crowding in these facilities and an increasingly viable market.
In addition, numerous courts and other governmental entities in the United States have mandated that additional services offered to inmates be expanded and living conditions be improved. Many governments do not have the readily available resources to make the changes necessary to meet such mandates.
According to the United State Department of Justice Office and Juvenile Justice Delinquency Prevention, "Juvenile Offenders and Victims: 1996 Update of Violence" and "Juvenile Arrests 1995", in 1996 there were 2.7 million arrests of persons under 18, up 67% from 1986. One-fourth of juvenile arrests in 1995 were of females - a steady increase since 1991. By the year 2010, juvenile arrests for violent crime are expected to more than double.
In the international sector, the demand for privately managed facilities is increasing due to fiscal pressures, overcrowding, increasing recidivism and an overall desire to deliver augmented services while minimizing their cost impact.
Competition
The Company competes on the basis of cost, quality and range of services offered, its experience in managing facilities, the reputation of its personnel and its ability to design, finance and construct new facilities. Some of the Company's competitors have greater resources than the Company. The Company also competes in some markets with local companies that may have a better understanding of local conditions and a better ability to gain political and public acceptance. In addition, the Company's Community Corrections and Juvenile Divisions compete with governmental and not-for-profit entities. The Company's main competitors include Wackenhut Corrections Corporation, Cornell Corrections, Corrections Corporation of America and Youth Services International.
Recent Events
CSC Management de Puerto Rico, Inc. In July, 1997 the Company formed CSC Management de Puerto Rico, Inc., a Puerto Rican corporation, to pursue the operation and management of facilities in the Commonwealth of Puerto Rico. Later in the year, the Company was awarded three contracts for the design, construction, operation and management of juvenile treatment and detention facilities in Bayamon and Salinas, Puerto Rico.
Correctional Services Corporation (UK), Ltd. In February, 1998 the Company formed Correctional Services Corporation (UK) Ltd., a British company, to pursue correctional projects in the United Kingdom. The Company intends to build relationships with international joint venture partners to maximize its capabilities abroad.
Bayamon and Salinas, Puerto Rico. In February 1998, the Company signed contracts with the Juvenile Institutions Administration of the Commonwealth of Puerto Rico to operate two Juvenile Treatment Centers and one Juvenile Detention Center. The Salinas Treatment Center has a 100 bed capacity and will be designed, built, owned and operated by CSC. It is estimated that the costs of construction will be $11,000,000. It is expected to become fully operational in the first quarter of 1999. The Bayamon Treatment Center has a
141 bed capacity and is currently undergoing renovation. Until the renovations are complete, which is anticipated to be the first quarter of 1999, the facility will operate at a reduced capacity. The Company will assume operation of the facility in the second quarter of 1998. The Bayamon Detention Center has a 120 bed capacity and will begin accepting residents in the second quarter of 1998. Each of the three contracts has a base period of 5 years with one 5 year renewal option. Once completed and fully operational these facilities are expected to contribute approximately $15 million in revenue on an annualized basis.
New York State Community Corrections Programs. Due to substantially reduced occupancy rates and the lack of a long-term contract with New York State, the Company had previously determined it would wind down the operation of its New York State Community Corrections Program.
In the second quarter of 1997, the Company closed its Manhattan location and placed all remaining residents in its Brooklyn location. Throughout the year, the Company continued its effort to ascertain the likelihood of increased population and a long-term contract. In the third quarter of 1997, the Company understood the State would be issuing a formal Request for Proposal (RFP) relating to its Community Corrections Programs. In addition, the State indicated to the Company that the population rates would improve. At that time the Company decided to re-open its Manhattan location and to prepare to bid on the pending RFP. In February of 1998, the Company was awarded contracts to operate two Community Corrections Programs in its Manhattan location for a total capacity of 130.
Although the Company has recently signed contracts to operate these two programs, the State has given no minimum occupancy guarantee and did not increase the per diem rate. It is the Company's belief that the populations in New York will continue to fluctuate and the New York operations will not produce income for the Company. The Company believes that the remaining. balance of the accrued closure costs reserves at December 31, 1997 is adequate to offset the estimated losses associated with this contract. From a financial point of view, the Company's decision to operate these programs is based on its desire to offset the fixed obligations of the Company pertaining to the lease of the buildings. These obligations will continue regardless of whether or not the Company actually operates a program.
Fort Worth Community Corrections Program. Due to substantially reduced occupancy levels at its Fort Worth Community Corrections Program, the Company began winding down the operations of the Program in the first quarter of 1997. Subsequently, the Company was asked by the Texas Department of Criminal Justice (TDCJ) to leave a portion of the facility open until an alternative site could be located.
In August of 1997, the Company signed an amendment to its contract with TDCJ which significantly lowered the expected population of the facility in addition to increasing the per diem rate to $33.00 from $29.95. The Company has continued to run the Program at the reduced levels pending the locating of an alternate site. Although the facility is expected to generate a loss, the Company believes that the remaining balance of the accrued closure costs reserves at December 31, 1997 is adequate to offset the estimated losses associated with this contract. From a financial viewpoint, the Company's decision to continue to operate the facility is based on its desire to offset the fixed obligations of the Company pertaining to the building. These obligations will continue regardless of whether or not the Company actually operates the Program.
Facilities
The Company operates both pre-disposition and post-disposition secure and non-secure correctional and detention facilities and non-secure community correctional facilities for federal, state and local correctional agencies. Pre-disposition secure detention facilities provide secure residential detention for individuals awaiting trial and/or the outcome of judicial proceedings, and for aliens awaiting deportation or the disposition of deportation hearings. Post-disposition secure facilities provide secure incarceration for individuals who have been found guilty of a crime by a court of law. The Company operates four types of post-disposition facilities: secure prisons, intermediate sanction facilities, military-style boot camps, and secure treatment and training facilities. Secure prisons and intermediate sanction facilities provide secure correctional services for individuals who have been found guilty of one or more offenses. Offenders placed in intermediate sanction facilities are typically persons who have committed a technical violation of their parole conditions, but whose offense history or current offense does not warrant incarceration in a prison. Both types of facilities offer vocational training, substance abuse treatment and offense specific treatment. Boot camps provide intensely structured and regimented residential correctional services which emphasize disciplined activities modeled after the training principles of military boot camps and stress physical challenges, fitness, discipline and personal appearance. Secure treatment and training facilities provide numerous services designed to reduce recidivism including: educational and vocational training, life skills, anger control management, and substance abuse counseling and treatment.
The Company also operates non-secure residential and non-residential community corrections programs. Non-secure residential facilities, known as half-way houses, provide residential correctional services for offenders in need of less supervision and monitoring than are provided in a secure environment. Offenders in community corrections facilities are typically allowed to leave the facility to work in the immediate community and/or participate in community-based educational and vocational training programs during daytime hours. Generally, persons in community correctional facilities are serving the last six months of their sentence. Non-residential programs permit the offender to reside at home or in some other approved setting under supervision and monitoring by the Company. Supervision may take the form of either requiring the offender to report to a correctional facility a specified number of times each week and/or having Company employees monitor the offender on a case management basis at his/her work site and home.
The following information is provided with respect to the facilities for which the Company has management contracts:
Facility Management Contracts
The Company is compensated on the basis of the population in each of its facilities on a fixed basis. Contracts usually either provide fixed per diem rates and some have a minimum revenue guarantee. Invoices are sent on a monthly basis. Occupancy rates for facilities tend to be low when first opened or when expansions are first available. However, after a facility gets beyond the start-up period (typically 3 months), the occupancy rate tends to stabilize.
The Company's contracts generally require the Company to operate each facility in accordance with all applicable laws, rules and regulations. Furthermore, the Company is required by its contracts to maintain certain levels of insurance coverage for general liability, workers' compensation, vehicle liability and property loss or damage. The Company is also required to indemnify the contracting agencies for claims and costs arising out of the Company's operations and in certain cases, to maintain performance bonds.
As is standard in the industry, the Company's contracts are short term in nature, generally ranging from one to three years and contain multiple renewal options. Most facility contracts also generally contain clauses which allow the governmental agency to terminate a contract without cause. The Company's contracts are generally subject to legislative appropriation of funds. To date, none of the Company's contracts have been terminated though any of these methods.
Operating Procedures
The Company is responsible for the overall operation of each facility under its management, including staff recruitment, general administration of the facility, security of inmates and employees, supervision of the offenders and facility maintenance. The Company, either directly or through subcontractors, also provides health care (including medical, dental and psychiatric services) and food service. Certain facilities also offer special rehabilitation and educational programs, such as academic or vocational education, job and life skills training, counseling, substance abuse programs, and work and recreational programs.
The Company's contracts generally require the Company to operate each facility in accordance with all applicable local, state and federal laws, rules and regulations, and the standards and guidelines of the American Correctional Association. The ACA standards, designed to safeguard the life, health and safety of offenders and personnel, describe specific objectives with respect to administration, personnel and staff training, security, medical and health care, food service, inmate supervision and physical plant requirements. The Company believes the benefits of operating its facilities in accordance with ACA standards include improved management, better defense against lawsuits by offenders alleging violations of civil rights, a more humane environment for personnel and offenders and measurable criteria for upgrading programs, personnel and the physical plant on a continuous basis. The Company's Seattle INS Detention Center and Tarrant County Community Correctional Facility are fully accredited by the ACA and certain other facilities currently are being reviewed for accreditation. The Company's goal is to obtain and maintain ACA accreditation for all of its facilities. Richard P. Staley, the Company's Senior Vice President and director, is a member of the ACA and a certified ACA standards auditor for jail and detention facilities. James Irving, the Company's Vice President for Juvenile Justice, is a past Chairman of the ACA Standards Committee and a certified ACA standard auditor for jail and detention facilities.
Facility Design and Construction
In addition to its facility management services, the Company also consults with various governmental entities to design and construct new correctional and detention facilities and renovate older facilities to provide enhances services to the population. The Company manages all of the facilities it has designed and constructed or redesigned and renovated.
Pursuant to the Company's design, build and manage contracts, it is responsible for overall project development and completion. Typically, the Company develops the conceptual design for a project, then hires architects, engineers and construction companies to complete the development. When designing a particular facility, the Company utilized, with appropriate modifications, prototype designs the Company has used in developing other projects. Management of the Company believes that the use of such prototype designs allows it to reduce cost overruns and construction delays.
Facilities Under Construction
Construction is nearly complete on the 65 bed juvenile facility in Okaloosa, Florida. The facility is scheduled to open in April, 1998.
Renovations are underway in the 141 bed juvenile treatment facility in Bayamon, Puerto Rico. The Company is expected to accept its first residents in this facility June, 1998.
Construction will begin on a 100 bed juvenile detention center in Salinas, Puerto Rico. The facility will house minimum to medium risk inmates ages 12 to 17 and is expected to be completed in the first quarter of 1999.
Employees
At March 13, 1998, the Company had approximately 1,730 full-time employees, consisting of clerical and administrative personnel, security personnel, food service personnel and facility administrators. The Company believes its relationship with its employees is good.
Each of the Company's facilities is managed as a separate entity by an experienced facility administrator. Other facility personnel include administrative, security, medical, food service, counseling, classification and educational and vocational training personnel. The Company conducts background screening checks and drug testing on potential facility employees. Some of the services rendered at certain facilities, such as medical services and education or training, are provided by third-party contractors.
Employee Training
All jurisdictions require corrections officers to complete a specified amount of training prior to employment. In most cases, Company employees must undergo at least 160 hours of training before being allowed to work in a position that will bring them in contact with offenders or detainees. This training consists of approximately 40 hours relating to Company policies, operational procedures and management philosophy, and 120 hours relating to legal issues, rights of offenders and detainees, techniques of communication and supervision, improvement of interpersonal skills and job training relating to the specific tasks to be held. Each Company employee having contact with offenders receives a minimum of 40 hours of additional training each year, and each management employee receives a minimum of 24 hours of training each year.
Insurance
Each management contract with a governmental agency requires the Company to maintain certain levels of insurance coverage for general liability, workers' compensation, vehicle liability and property loss or damage and to indemnify the contracting agency for claims and costs arising out of the Company's operations. The Company maintains general liability insurance in the amount of $5,000,000 and two umbrella policies in the amount of $5,000,000 and $20,000,000, respectively, for itself and each of its subsidiaries. There can be no assurance that the aggregate amount and kinds of the Company's insurance are adequate to cover all risks it may incur or that insurance will be available in the future. In addition, the Company is unable to secure insurance for some unique business risks including, but not limited to, riot and civil commotion or the acts of an escaped offender.
Regulations
The industry in which the Company operates is subject to federal, state and local regulations which are administered by a variety of regulatory authorities. Generally, providers of correctional services must comply with a variety of applicable federal, state and local regulations, including education, health care and safety regulations. Management contracts frequently include extensive reporting requirements. In addition, many federal , state and local governments are required to follow competitive bidding procedures before awarding a contract. Certain jurisdictions may also require the successful bidder to award subcontracts on a competitive bid basis and to subcontract to varying degrees with businesses owned by women or minorities.
Litigation
The nature of the Company's business results in numerous claims or litigation against the Company for damages arising from the conduct of its employees or others. Under the rules of the Securities and Exchange Commission, the Company is obligated to disclose lawsuits which involve a claim for damages in excess of 10% of its current assets notwithstanding the Company's belief as to the merit of the lawsuit and the existence of adequate insurance coverage.
In May 1993, a former employee of the Company filed suit in the United States District Court, Southern District of New York, claiming he was intentionally assaulted by employees of the Company and claiming $5,000,000 in damages on each of six causes of action. In January 1996, a lawsuit was filed with the Supreme Court of New York, County of Kings, by a former employee alleging sexual harassment and discrimination, physical assault, rape and negligent screening of employees and claiming damages of $4,000,000 plus attorney fees. The Company is awaiting court rulings in both of these cases which are expected to result in dismissals of these actions by mid-1998.
In March 1996, former inmates at one of the Company's facilities filed suit in the Supreme Court of the State of New York, County of Bronx on behalf of themselves and others similarly situated, alleging personal injuries and property damage purportedly caused by negligence and intentional acts of the Company and claiming $500,000,000 each for compensatory and punitive damages, which suit was transferred to the United States District Court, Southern District of New York, in April 1996. In July 1996, seven detainees at one of the Company's facilities (and certain of their spouses) filed suit in the Superior Court of New Jersey, County of Union, seeking $10,000,000 each in damages arising from alleged mistreatment of the detainees, which suit was transferred to the United States District Court, District of New Jersey, in August 1996. In July 1997, former detainees of the Company's Elizabeth, New Jersey facility filed suit in the United States District Court for the District of New Jersey. The suit claims violation of civil rights, personal injury and property damage allegedly caused by the negligent and intentional acts of the Company. No monetary damages have been stated. Through stipulation, all these actions will now be heard in the United States District Court for the District of New Jersey. This will streamline the discovery process, minimize costs and avoid inconsistent rulings.
The Company believes the claims made in each of the foregoing actions to be without merit and will vigorously defend such actions. The Company further believes the outcome of these actions and all other current legal proceedings to which it is a party will not have a material adverse effect upon its results of operations, financial condition or liquidity. However, there is an inherent risk in any litigation and a decision adverse to the Company could be rendered.
Risks Associated with Company's Business
Safe Harbour Statement Under The Private Securities Litigation Reform Act Of 1995
This document contains forward-looking statements involving various risks and uncertainties. Actual results could differ materially from those projected due to factors which may include population fluctuations, acquisition risks, market conditions, government funding and availability of financing. These and other risk factors are outlined in the reports filed by the Company with the Securities and Exchange Commission.
Internal Expansion. The Company's growth is generally dependent upon its ability to obtain contracts to develop and manage new correctional and detention facilities. The rate of such development depends on a number of factors, including crime rates and sentencing patterns in various jurisdictions and the Company's ability to integrate new facilities into its management structure. Certain jurisdictions recently have required the successful bidders to make a significant capital investment in connection with the financing of a particular project, a trend which will require the Company to have sufficient capital resources in order to compete effectively.
Acquisitions. The Company intends to grow through internal expansion and through selective acquisitions of both companies and individual facilities. There can be no assurance that the Company will be able to identify, acquire or profitably manage acquired operations or that operations acquired will be profitable or achieve levels of profitability that justify the related investment. Acquisitions involve a number of special risks, including possible adverse short-term effects on the Company's operating results, diversion of management's attention from existing business, dependence on retaining, hiring and training key personnel, risks associated with unanticipated problems or legal liabilities, and amortization of acquired intangible assets, any of which could have a material adverse effect on the Company's financial condition, results of operations and liquidity.
Resistance to Privatization of Correctional and Detention Facilities. Management of correctional and detention facilities by private entities is a relatively new concept and has not achieved complete acceptance by either governments or the public. The movement toward privatization of correctional and detention facilities has also encountered resistance from certain groups, such as labor unions, local sheriff's departments, and groups that believe that correctional and detention facility operations should only be conducted by governmental agencies. In addition, changes in the dominant political party in any market in which the Company operates could result in significant changes to the previous acceptance of privatization in such market. Further, some sectors of the federal government and some state and local governments are not legally permitted to delegate their traditional management responsibilities for correctional and detention facilities to private companies.
Contracts Subject to Governmental Funding. The Company's facility management contracts are subject to either annual or bi-annual governmental appropriations. A failure by a governmental agency to receive such appropriations could result in termination of the contract by such agency or a reduction of the management fee payable to the Company. In addition, even if funds are appropriated, delays in payments may occur which could have a material adverse effect on the Company's financial condition, results of operations and liquidity. See "Business - Facility Management Contracts."
Uncertain Occupancy Levels. The Company is dependent upon the governmental agency with which it has a management contract to provide inmates for, and maintain the occupancy level of, the managed facility. A substantial portion of the Company's revenues is generated under facility management contracts that specify a net rate per day per inmate ("per diem rate"), with no minimum guaranteed occupancy levels, while most of the Company's facilities cost structures are relatively fixed. Under such a per diem rate structure, a decrease in occupancy levels may have a material adverse effect on the Company's financial condition, results of operations and liquidity. See "Business Facility Management Contracts" and "Business-Recent Events."
Speculative Projects. The Company makes capital expenditures on personnel, fixtures, facilities and equipment for facilities where no contracts have yet been awarded. If contracts do not materialize, the initial outlay may be lost.
In some cases, the Company may decide to construct and own a facility without a contract award when it believes there is significant shortage of beds and a strong likelihood it will be awarded a contract; however, there can be no assurance that any contract will, in fact, be awarded. Further, there can be no assurance that the Company will be able to obtain contracts to construct and/or manage new facilities or retain existing contracts upon their expiration.
Regulation. The industry in which the Company operates is subject to a variety of federal, state and local regulations, including education, health care and safety regulations, which are administered by various regulatory authorities. The Company's contracts typically include extensive reporting requirements, and supervision and on-site monitoring by representatives of the contracting governmental agencies. Corrections officers customarily are required to meet certain training standards and, in some instances, facility personnel are required to be licensed and subject to background investigation. Certain jurisdictions also require the Company to award subcontracts on a competitive basis or to subcontract with businesses owned by members of minority groups. The failure to comply with any applicable laws, rules or regulations and the loss of any required license could have a material adverse effect on the Company's financial condition, results of operations and liquidity. Further, current and future operations of the Company may be subject to additional regulation as a result of new statues and regulations or changes in the manner in which existing statutes and regulations are or may be interpreted or applied, which could have a material adverse effect on the Company's financial condition, results of operations and liquidity.
Dependence on Senior Management. The success of the Company's operations will depend upon the continued services of its executive management, including James F. Slattery, Chairman and Chief Executive Officer, Ira Cotler, Executive Vice President and Chief Financial Officer, and Michael Garretson, Executive Vice President and Chief Operating Officer. The loss of two or more of the Company's senior management could have an adverse effect on the Company's business and financing. The Company has an employment agreement with all three executive officers.
Volatility of Market Price. From time to time, there may be volatility in the market price for the Company's Common Stock. Operating results of the Company or of other private prison operators, economic conditions, natural disasters or incidents at competitor's facilities could cause the market price
of the Company's stock to fluctuate. In addition, in recent years the stock market has experienced extreme price and volume fluctuations resulting in a significant effect on the market prices of the securities issued by many companies for reasons unrelated to their operating performance.
Item 2.
Item 2. Description of Property.
Brooklyn, New York Lease
The Company leases this building, located at 988 Myrtle Avenue, Brooklyn, New York, from Myrtle Avenue Family Center, Inc. ("MAFC") pursuant to a lease which commenced January 1, 1994 and expires December 31, 1998. The lease establishes a monthly rental of $40,000 and contains three five-year renewal options. The monthly rental for the first option period, which runs from January 1, 1999 through December 31, 2003, is $40,000. The monthly rental for the second option period, which runs from January 1, 2004 through December 31, 2008, is $45,000, and the monthly rental for the third option period, which runs from January 1, 2009 through December 31, 2013, is $50,000. In addition, the Company pays taxes, insurance, repairs and maintenance on the building. MAFC is a corporation owned by Esther Horn (27.5%), James F. Slattery (8%) and Aaron Speisman (27.5%), significant stockholders of the Company. The terms of the lease were not negotiated at arms length due to their relationship with both the Company and MAFC.
Bronx, New York Lease
The Company leases a building located at 2534 Creston Avenue, Bronx, New York from Creston Realty Associates, L.P. ("CRA"), which is owned 10% by Esther Horn, a significant stockholder of the Company.. The lease term is two years commencing October 1, 1996 and has three additional one year option periods. The Company also pays a base rent of $180,000 per year which will escalate five percent per year for each of the three year options if they are exercised. The Company pays taxes, insurance, repairs and maintenance on this building which will be used to house a community correctional center. The terms of this lease were not negotiated at arms length due to the relationship between the Company, Ms. Horn and CRA. However, pursuant to the terms of a Board of Directors resolution adopted in connection with the Company's initial public offering, all transactions between the Company and any of its officers, directors or affiliates (except for wholly-owned subsidiaries) must be approved by a majority of the unaffiliated members of the Board of Directors and be on terms no less favorable to the Company than could be obtained from unaffiliated third parties and be in connection with bona fide business purposes of the Company.
Manhattan, New York Lease
The Company subleases the building located at 12-16 East 31st Street, New York, New York as well as an annex located at 11 East 30th Street, New York, New York from LeMarquis Operating Corp. ("LMOC"). The Company currently utilizes approximately fifty percent of the building for the LeMarquis Correctional Center and for the New York Community Correctional Program. LMOC is a corporation owned 25% by Ms. Horn and 8% by Mr. Slattery. LMOC leases this building from an unaffiliated party at a current base monthly rental of approximately $15,456 (the "Base Rent"), plus taxes and other charges in the approximate current amount of $17,346 for a total monthly rental of approximately $32,802. The Company has the right to use as much of the building as it requires for its business subject to the rights of certain residential
subtenants to remain in the building. These rights include the right to housing at a predetermined rental for an indefinite period of time pursuant to New York State rent stabilization laws.
The Company pays rent of $18,000 per month above the rent paid by LMOC to the building's owner for a total monthly rent of approximately $50,802. The Company has, to date, invested $690,000 in leasehold improvements. The Company will not receive any credit, in terms of a reduction in rent or otherwise, for these improvements. The initial term of the Company's sublease expired April 30, 1995 and is in its first renewal period which expires April 30, 2000. The sublease contains two additional five-year renewal options beginning May 1, 2000. The monthly rent above the rent paid by LMOC to the building's owner will increase to $22,000 per month during the second renewal term beginning May 1, 2000 and to $26,000 per month during the third renewal term beginning May 1, 2005.
Fort Worth, Texas Lease
The Company leases the facility located at 600 North Henderson Street, Fort Worth, Texas from an unaffiliated party at a monthly rental of $10,200 for the period May 16, 1994 through May 15, 1996; $10,400 for the period May 16, 1996 through May 15, 1997; $10,815.20 for the period May 16, 1997 through May 15, 1998; and $11,252.97 for the period May 16, 1998 through April 15, 1999. The lease for these premises commenced May 16, 1994 and expires April 15, 1999. The lease contains three renewal options. The term of the first renewal option is for three years and the second and third renewal options are for two years. The Company's rent is to increase four percent per annum during each year of the renewal term.
Frio County, Texas Lease
The Company leases the facility at 410 S. Cedar in Pearsall, Texas from the County for the period ending December 1, 2009. The Company has prepaid twelve years of rent equaling $4,750,760. The lease may be extended for one additional five year period at a price to be negotiated by the parties.
Executive Office Leases
The Company leases approximately 6,400 square feet of executive office space located at 1819 Main Street, Sarasota, Florida from an unaffiliated party at a base monthly rental of $8,278 for the period October 1, 1995 through September 30, 1996; $8,812 for the period October 1, 1996 through September 30, 1997; $9,346 for the period October 1, 1997 through September 30, 1998; $9,880 for the period October 1, 1998 through September 30, 1999; $10,415 for the period October 1, 1999 through September 30, 2000. The lease does not contain any renewal options. On March 1, 1997 the Company entered into a lease amendment for approximately 1,399 square feet in its existing executive offices. The lease amendment calls for an additional base rental of $1,924 with annual increases of approximately $100 per month on each October 1st until the expiration of the lease amendment on September 30, 2000.
The Company also leases an office at 276 Fifth Avenue, New York, New York from an unaffiliated party at a monthly rental of $2,231. The lease for these premises, which commenced November 1, 1993, expires October 31, 1998.
Item 3.
Item 3. Legal Proceedings.
Information with respect to this item is incorporated herein by reference to Item 1 "Business-Litigation."
Item 4.
Item 4. Submission of Matters to a Vote of Stockholders.
None.
PART II
Item 5.
Item 5. Market for Common Equity and Related Stockholder Material
Item 6.
Item 6. Management's Discussion and Analysis or Plan of Operation.
	The Company's primary source of revenue is generated from the management of correctional and detention facilities under federal, state and local governmental agency contracts. The majority of the Companies contracts are based on a daily rate per offender, some of which have guaranteed minimum payments; others provide for fixed monthly payments irrespective of the number of offenders housed.
	The Company typically pays all facility operating expenses, except rent in the case of certain government-provided facilities. The Company's primary expenses are categorized as either operating or general and administrative. Operating expenses consist of payroll (corporate and facility employee salaries, wages and fringe benefits, and payroll taxes) and resident expenses which include food, medical services, supplies and clothing. General and administrative expenses consist of rent, utilities, insurance, professional fees, travel and lodging and depreciation and amortization.
	The Company usually incurs development costs, which may range from $50,000 to $200,000, in responding to a governmental agency RFP. Such costs include planning and developing the project, preparing the bid proposal, travel and legal expenses and consulting fees. If management believes the recovery of such costs is probable, the costs are deferred until the anticipated contract has been awarded, at which time the deferred costs are amortized on a straight- line basis over the term of the contract (including option periods not to exceed five years). Development costs of unsuccessful or abandoned bids are expensed. The time period from incurring initial development costs on a project to the commencement of operations ranges from six to eighteen months.
	After a contract has been awarded, the Company incurs start-up costs from the date of the award until commencement of operations. Start-up costs include recruitment, training and travel of personnel and certain legal costs, and are capitalized until operations commence, at which time such costs are amortized on a straight-line basis over the term of the contract (including option periods not to exceed five years). Revenues generated during this initial period under per diem contracts increase as the offender population increases.
In anticipation of the millennium, management has completed a corporate program which has prepared all Company computer systems and applications for the year 2000. No incremental infrastructure costs have been, or will be, incurred as a result of these enhancements.
Results of Operations
Year ended December 31, 1997 Compared to Year ended December 31, 1996
	Revenue increased 90.3% from $31,501,658 for the year ended December 31, 1996 to $59,936,101 for the year ended December 31, 1997. The increase in revenue from 1996 to 1997 was primarily attributable to the opening of seven new facilities during 1997 (Bronx, New York, Polk, Florida and Pahokee, Florida in January 1997; Frio County, Texas in March 1997; Milam County, Texas in June 1997; Gallup, New Mexico in July 1997; and Florence, Arizona in October 1997). In addition, the Company experienced increased occupancy levels in certain facilities and generated a full year of revenue in the Bell County, Texas and Phoenix, Arizona facilities that were opened only a partial year in 1996. Compensated mandays was 1,115,000 in 1997 and 641,000 in 1996.
	Operating expenses increased 98.2% from $21,928,329 for the year ended December 31, 1996 to $43,472,402 for the year ended December 31, 1997 primarily due to increases in payroll and related payroll taxes and benefits related to the opening of the new facilities. As a percentage of revenues, operating expenses increased from 69.6% in 1996 to 72.5% in 1997. The increase in operating expenses as a percentage of revenues can be attributed to lower operating margins on the Company's community corrections programs, the opening of new facilities and an increase in corporate staff to support the Company's expanded operations.
	General and administrative expenses increased 37.0% from $8,655,628 for the year ended December 31, 1996 to $11,859,399 for the year ended December 31, 1997. The increase in general and administrative expenses was primarily attributable to the opening of new facilities. As a percentage of revenues, general and administrative expenses decreased to 19.8% in 1997 from 27.5% in 1996. The decrease in general and administrative expenses as a percentage of revenue is a result of the increase in revenues and the Company's efforts in controlling fixed costs.
At December 31, 1996 the Company wrote-off $3,329,000 for its Fort Worth, Texas and New York State Community Corrections programs. The Company wrote-off
fixed assets, development and start-up costs and other costs associated with the closure of each program.
	The operating loss for the year ended December 31, 1996 of $2,411,299 was attributable principally to the above mentioned facilities closure costs.
	Interest income, net of interest expense, was $444,077 for the year ended December 31, 1997 compared to interest expense, net of interest income, of $481,728 for the year ended December 31, 1996, a net change of $925,805. This increase resulted from utilizing a portion of the net proceeds received from the September 1996 public offering of common stock to repay bank indebtedness which reduced interest expense, and from investing the balance of the net proceeds in cash equivalents which increased interest income. Also, interest expense was reduced by interest capitalized on facilities under construction. During 1996, interest of $103,576 was capitalized on the Phoenix facility construction and during 1997, $371,500 was capitalized on the construction of the Florence, Arizona facility.
	For the year ended December 31, 1997 the Company recognized a provision for income taxes of $2,022,853. For the year ended December 31, 1996 the Company recognized an income tax benefit of $1,025,000 principally from the utilization of operating losses. The effective tax rate was 35.4% in 1996 and 40.1% in 1997.
	As a result of the foregoing factors, the Company had a net loss of $1,868,027 or $0.32 per share for the year ended December 31, 1996 compared to net income of $3,025,524 or $0.39 per share for the year ended December 31, 1997.
Year ended December 31, 1996 Compared to Year ended December 31, 1995
	Revenue increased slightly from $31,490,026 for the year ended December 31, 1995 to $31,501,658 for the year ended December 31, 1996. A full year's revenues in 1996 generated by the Canadian, Texas facility which began operations in April, 1995 and the Bartow, Florida facility which began operations in July 1995, as well as revenues generated by the Phoenix, Arizona facility which began operation in April 1996, were offset by the loss in revenues stemming principally from the discontinuance of the Company's operations at its Elizabeth, New Jersey INS facility on June 18, 1995 and lower occupancy rates at the Company's Fort Worth and Houston, Texas and New York State Community Corrections facilities.
	Operating expenses increased 11.1% from $19,731,797 for the year ended December 31, 1995 to $21,928,329 for the year ended December 31, 1996 primarily due to increases in payroll which increased $1,839,967 or 15.1%. These changes resulted primarily from the opening of the facilities noted above, and the addition of management personnel in the corporate office. As a percentage of revenues, operating expenses increased from 62.7% for the year ended December 31, 1995 to 69.6% for the year ended December 31, 1996.
	General and administrative expenses decreased 12.9% from $9,938,344 for the year ended December 31, 1995 to $8,655,628 for the year ended December 31, 1996. The decline in general and administrative expenses was primarily attributable to the closure of the Elizabeth, New Jersey INS facility in June 1995. As a percentage of revenues, general and administrative expenses were 31.6% and 27.5% for the years ended December 31, 1995 and 1996 respectively. In addition, at December 31, 1995 and 1996, the Company wrote-off $3,909,700 and $3,329,000 respectively in facility closure costs for its Elizabeth, New Jersey INS
facility (1995) and for its Fort Worth, Texas and New York State Community Corrections programs (1996). In each year, the Company wrote-off fixed assets, development and start-up costs and other costs associated with the closure of each program.
	The operating losses for the 1995 and 1996 years of $2,089,815 and $2,411,299 respectively are attributable principally to the above mentioned facility closure costs.
	Interest expense, net of interest income, decreased 31.1% from $699,576 for the year ended December 31, 1995 to $481,728 for the year ended December 31, 1996 This decrease resulted primarily from utilizing a portion of the net proceeds received from the September 1996 public offering of common stock to repay bank indebtedness which reduced interest expense, and from investing the balance of the net proceeds in cash equivalents which increased interest income.
	The income tax benefits of $1,050,000 and $1,025,000 respectively for the years 1995 and 1996 result principally from the utilization of operating losses sustained in each year. The effective tax rate was 37.6% in 1995 and 35.4% in 1996.
	As a result of the foregoing factors, the Company had a net loss of $1,739,391 or $0.38 per share for the year ended December 31, 1995 compared to a net loss of $1,868,027 or $0.32 per share for the year ended December 31, 1996.
Liquidity and Capital Resources
	The Company has financed its operations through public and private sales of securities, cash generated from operations and borrowings from banks. The Company had working capital at December 31, 1997 of $6,691,704 compared $23,560,360 at December 31, 1996. The Company's current ratio decreased from 5.83 to 1 at December 31, 1996 to 1.58 to 1 at December 31, 1997. The decrease is principally attributable to the funding of the construction of the Florence, Arizona facility, startup costs relating to the Company's new facilities and the inclusion of the subordinated notes due in July 1998 as a current liability at December 31, 1997. The Company's long-term debt to stockholders' equity ratio was 0.7% at December 31, 1997 as compared to 9.8% at December 31, 1996.
	Net cash provided by operating activities was $3,352,504 for the year ended December 31, 1997 as compared to $ 1,022,759 for the year ended December 31, 1996. The change was attributed primarily to increases in net income, depreciation and amortization, and accounts payable partially offset by an increase in accounts receivable. Net cash of $16,119,117 was used in investing activities during the year ended December 31, 1997 as a result of the capital xpenditures associated with the construction of the Florence, Arizona facility and start-up costs relating to the opening of new facilities.
Net cash of $2,949,532 was used in financing activities in the year ended December 31, 1997 as compared to $25,738,273 provided by financing activities in the year ended December 31, 1996. During 1997 $4,750,760 was used to prepay a 12 year lease for the Frio County facility and was partially offset by $1,248,800 (net of imputed interest) installment payments received from the sale of equipment and leasehold improvements. The principal source of funds provided by financing activities for the year ended December 31, 1996 was the public offering of Common Stock (see below).
Financing
	On September 12, 1996 the Company completed a public offering of 2,450,000 shares of Common Stock at $13.625 per share. Of the 2,450,000 shares of Common Stock offered, 2,070,000 were sold by the Company and 380,000 shares by certain stockholders. The Company did not receive any proceeds from the shares sold by the stockholders. The net proceeds received by the Company after deducting applicable issuance costs and expenses aggregated $25,938,514. The net proceeds were used to repay short-term and long-term bank indebtedness in the amount of $7,198,468, and to finance construction, start-up and related costs of two Florida facilities, the Florence, Arizona Facility and other facilities and for general corporate purposes, including the financing of working capital needs. Also, in October, 1996 pursuant to the underwriters' over-allotment option, the Company sold an additional 367,500 shares of Common Stock, which aggregated an additional $4,569,542 in net proceeds.
	Effective December 31, 1995, the Company entered into an $11,000,000 Revolving Credit and Term Loan Agreement (the "Loan Agreement") with NationsBank, N.A. ("NationsBank"). Pursuant to the terms of the Loan Agreement, the Company may borrow up to the lesser of $6,000,000 or 85.0% of the Company's eligible accounts receivable (none outstanding at December 31, 1997). Loan proceeds are to be used for working capital, including deferred development and start-up costs in connection with new or existing facilities. Interest on the revolving credit loan is computed, at the Company's option, at either NationsBank prime rate plus 0.75% or the London International Bank rate plus 3.35%. On January 14, 1998 the Company extended the term of the revolving credit portion of its loan agreement until April 3, 1998. The Company is currently in negotiations with NationsBank for a new and expanded credit and lease agreement.
	The Company has granted NationsBank the first priority security interest in all of its assets. The Company is required to pay NationsBank 0.25% of the average unused portion of the revolving credit loan.
	During the year ended December 31, 1995, the Company completed a private placement of 5,676.6 units at $1,000 per unit, each unit consisting of (i) a ten percent (10.0%) subordinated promissory note due July 1, 1998, in the principal amount of $1,000, and (ii) four year warrants to purchase 154 shares of Common Stock at $7.75 per share. The Company received gross proceeds of $5,676,600 from the sale of the units of which $365,000 was attributed to the value of the warrants.
	During such period, the Company also completed the private placement of 496,807 shares of Common Stock at $7.75 per share, receiving gross proceeds of $3,850,254. Approximately $8,500,000 of the proceeds of the two placements was used to finance costs associated with the Company's Phoenix, Arizona facility and the balance for expenses related to the private placements and for working capital.
	The Company received $185,388 and $426,890 from the exercise of stock options and warrants during the years ended December 31, 1997 and 1996 respectively.
	The Company anticipates making cash investments in the acquisition and construction of new facilities and the expansion of existing facilities. In addition, the Company expects to use its cash to finance startup costs in connection with new contracts. The Company believes that its cash, cash flow
from operations, and amounts available under its anticipated credit and lease agreement will be sufficient to meet its capital requirements for the foreseeable future. However, the Company is continuing to evaluate opportunities, which could require significant outlays of cash. If such opportunities are pursued the Company would require additional financing resources. Management believes these additional resources may be available through alternative financing methods.
Item 7.
Item 7. The information required by this Item is contained on Pages through hereof.
Item 8.
Item 8. None.
PART III
Item 9.
Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act
Executive Officers and Directors
company, and had held several management positions with the Sheraton Hotel Corporation.
Michael C. Garretson joined the Company in August 1994 as its Vice President of Business Development. In October 1995, he became the Director of Planning and Economic Development for the City of Jacksonville, Florida and served in such position until rejoining the Company in January 1996, during which period he also acted as a consultant to the Company. Mr. Garretson was elected Executive Vice President and Chief Operating Officer in March 1996. From September 1993 to August 1994, Mr. Garretson was Senior Vice President of Wackenhut Corrections Corp., a developer and manager of privatized correctional and detention facilities, and from August 1990 to August 1993 was Director of Area Development for Euro Disney S.C.A., the operator of a European theme park.
Aaron Speisman co-founded the Company in October 1987 and has been its Executive Vice President, Secretary and a director since the Company's inception. From October 1987 to March 1994, Mr. Speisman also served as Chief Financial Officer of the Company. Since June 1, 1996, Mr. Speisman has been employed by the Company on a part-time basis.
Ira M. Cotler was elected Chief Financial Officer in January, 1998. He was elected the Company's Executive Vice President-Finance in March 1996. Prior to joining the Company, from June 1989 to February 1996, Mr. Cotler was employed by Janney Montgomery Scott Inc., an investment banking firm, serving in several capacities, most recently as Vice President of Corporate Finance.
Richard P. Staley has served as the Company's Senior Vice President of Operations since November 1988 and as a director since May 1994. From 1984 to 1987, Mr. Staley was the Evaluation and Compliance Director for Corrections Corporation of America and from 1953 to 1983, held various positions with the United States Department of Justice, Immigration and Naturalization Service. Mr. Staley is a certified American Correctional Association standards auditor for jail and detention facilities.
Melvin T. Stith was elected a director of the Company in November 1994. Since July 1991, Mr. Stith has been Dean of the Florida State University College of Business. From December 1989 to July 1991, Mr. Stith was Chairman of the Marketing Department of the Florida State University College of Business where he was also a Professor. Mr. Stith is also a director of Sprint and United Telephone of Florida.
Raymond S. Evans was elected a director in May 1994. For more than the past five years, Mr. Evans has been a partner of the law firm of Ruskin, Moscou, Evans & Faltischek, P.C.
Stuart M. Gerson was elected a director in June 1994. Since March 1993, Mr. Gerson has been a partner of the law firm of Epstein Becker & Green, P.C. From January 1993 to March 1993, he was acting Attorney General of the United States. From January 1989 to January 1993, Mr. Gerson was the Assistant U.S. Attorney General for the Civil Division of the Department of Justice.
Shimmie Horn was elected a director of the Company in June 1996. Mr. Horn, received a B.A. degree in Economics from Yeshiva College in 1993, and graduated from the Benjamin Cardozo School of Law in 1996. He is the son of the late Morris Horn, the former Chairman and a founder of the Company.
Item 10.
Item 10. Executive Compensation
The following table sets forth a summary of the compensation earned in 1995, 1996 and 1997 by the Company's Chief Executive Officer and by each other executive officer whose compensation exceeded $100,000 in 1997:
The following table sets forth information concerning stock options granted executive officers named in the Summary Compensation Table:
Option Grants in 1997: None
Employment Agreements
The Company has entered into an employment agreement with Mr. Slattery which expires February 9, 1999 and provides for minimum annual compensation of $189,000, cost of living increases, use of an automobile, reimbursement of business expenses, health insurance, related benefits and a bonus equal to 5% of pre-tax profits in excess of $1,000,000, such bonus not to exceed $200,000. As of June 1, 1996, Mr. Speisman is employed under an agreement which provides for Mr. Speisman's employment on a part-time basis at an annual salary of $35,000.
The Company has entered into an employment agreement with Mr. Garretson which expires January 20, 1999 and provides for compensation of $115,000, annual salary increases, automobile allowances, reimbursement of business expenses, health or disability insurance, related benefits, a bonus equal to 3% of pre-tax profits in excess of $1,000,000, such bonus not to exceed $75,000, and the grant to purchase 100,000 shares of Common Stock.
The Company's current employment agreement with Mr. Cotler was extended in July, 1997 and has a term of three years with automatic annual renewal provisions. Mr. Cotler receives $135,000, annual salary increases, automobile allowances and a bonus equal to 3% of pre-tax profits in excess of $1,000,000, such bonus not to exceed $75,000.
In October 1989, a subsidiary of the Company, entered into an employment agreement with William Banks. Under this agreement, Mr. Banks was responsible for developing and implementing community relations projects on behalf of the Company and for acting as a liaison between the Company and local community and civic groups who may have concerns about Company's facilities being established in their communities, and with government officials throughout the State of New York. As compensation, Mr. Banks received 3% of the gross revenue from all Federal Bureau of Prisons, state and local correctional agency contracts within the State of New York with a guaranteed minimum monthly income of $4,500. In December 1993, Mr. Banks agreed to become a consultant to the Company upon the same terms and conditions in order to accurately reflect the level and nature of the services he provided. In 1996 and 1997, Mr. Banks earned approximately $296,000 and $239,000 respectively.
Stock Options
1993 Stock Option Plan
Under the 1993 Stock Option Plan (the "1993 Plan") 500,000 shares of Common Stock are reserved for issuance upon exercise of options designated as either (i) incentive stock options ("ISOs") under the Internal Revenue Code of 1986, as amended (the "Code") or (ii) non-qualified options. Under the 1993 Plan, ISOs may be granted to employees and officers of the Company and non-qualified options may be granted to consultants, directors (whether or not they are employees), employees or officers of the Company.
The 1993 Plan is administered by the Company's Stock Option Committee which determines the persons to whom options will be granted, the number of shares to be covered by each option, whether the options granted are intended to be ISO's, the rate of exercise of each option, the option purchase price per share, the manner of exercise, the form of payment upon exercise, and whether restrictions such as repurchase rights are to be imposed on the shares following exercise. Options granted under the 1993 Plan expire five years after the date of grant and may not be granted at a price less than the fair market value of the Common Stock on the date of grant (or 110% of fair market value in the case of persons holding 10% or more of the voting stock of the Company). The aggregate fair market value of shares for which ISOs granted to any employee are exercisable for the first time by such employee during any calendar year (under all stock option plans of the Company and any related corporation) may not exceed $100,000. No options may be granted under the 1993 Plan after October 2003; however, options granted under the 1993 Plan prior thereto may extend beyond that date. Options granted under the 1993 Plan are not transferable during an optionee's lifetime but are transferable at death by will or by the laws of descent and distribution.
During fiscal 1995 and 1996, options to purchase 54,375 and 50,700 shares, respectively, were granted under the 1993 Plan at exercise prices ranging from $4.76 to $20.63 per share. In 1997, options to purchase 155,500 shares were granted under the 1993 Plan at exercise prices ranging from $8.75 to $17.88 per share.
Item 11.
Item 11. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth certain information as of March 13, 1998, based on information obtained from the persons named below, with respect to the beneficial ownership of shares of the Company's Common Stock by (i) each person known by the Company to beneficially own more than 5% of the outstanding shares of Common Stock, (ii) each executive officer and director of the Company, and (iii) all officers and directors of the Company as a group:
Item 12.
Item 12. Certain Relationships and Related Transactions
The Company subleases a building located at 12-16 East 31st Street, New York, New York from LeMarquis Operating Corp. ("LMOC"), a corporation owned 25% by Ester Horn and 8% by James F. Slattery. The Company currently utilizes approximately fifty percent of the building for the Manhattan Community Corrections and the New York Community Corrections programs. LMOC leases this building from an unaffiliated party at a current base monthly rental of approximately $16,074 (the "Base Rent"), plus taxes, currently approximately $14,000, and water and sewer charges, currently approximately $3,500, for a total monthly rental of approximately $33,000. The Company has the right to use as much of the building as it requires for its business subject to the rights of certain residential subtenants to remain in the building. These rights include the right to housing at a predetermined rental for an indefinite period of time pursuant to New York State rent stabilization laws.
As a result of the lease negotiations, under a sublease dated as of January 1, 1994, since May 1, 1995, the Company has paid rent of $18,000 per month above the rent paid by LMOC to the building's owner for a total monthly rent of approximately $51,420. The Company has, to date, invested $739,000 in leasehold improvements and will not receive any credit, in terms of a reduction in rent or otherwise, for these improvements. The terms of this sublease were not negotiated at arm's length due to the relationship of Mrs. Horn and Mr. Slattery with both the Company and LMOC. The negotiation of the sublease, including the renewal terms, was requested by the Representative of the Underwriters of the Company's February 2, 1994 initial public offering to substantially track the renewal terms of the Company's management contract. The negotiations were not subject to the board resolution, adopted subsequent to the negotiations, relating to affiliated transactions, although the terms were approved by all of the directors. The initial term of the Company's sublease expired April 30, 1995, and is currently in its first renewal term expiring April 30, 2000. The sublease contains two additional successive five-year renewal options beginning May 1, 2000. The monthly rent above the rent paid by LMOC to the building's owner will increase to $22,000 per month during the second renewal term beginning May 1, 2000 and to $26,000 per month during the third renewal term beginning May 1, 2005. The Company paid $40,000 to LMOC for the renewal options.
These renewal options were separately negotiated between the Board of Directors of the Company and LMOC. Mr. Slattery participated in such negotiations. Mrs. Horn and Mr. Slattery will receive their proportionate shares of rents received by LMOC under the terms of this sublease.
Previously, residential and commercial tenants of this building paid rent to LeMarquis Enterprise Corp. ("Enterprises"), a company owned 30% by Mrs. Horn, 28% by Mr. Slattery and 25% by Mr. Speisman, and Enterprises paid all expenses of operating the residential and commercial portions of the building as well as a portion of the overall expenses of the building. As of February 1994, however, all of the building's revenues, including rent from the residential and commercial tenants are now received and expenses paid by the Company. The revenue from this portion of the building was approximately $193,000 in 1996 and $184,000 in 1997. The Company anticipates that operating the portion of the building occupied by residential and commercial tenants will result in a net expense to the Company of approximately $6,500 per month. Due to New York rent stabilization laws, the Company is unable to increase the rent paid by the residential tenants in this building in response to increased rent or expenses incurred by the Company.
The Company leases the entire building located at 988 Myrtle Avenue, Brooklyn, New York from Myrtle Avenue Family Center, Inc. ("MAFC") pursuant to a lease which commenced January 1, 1994 and expires December 31, 1998. The lease establishes a monthly rental of $40,000 and contains three five-year renewal options. The monthly rental for the first option period, which runs from January 1, 1999 through December 31, 2003, is $40,000. The monthly rental for the second option period, which runs from January 1, 2004 through December 31, 2008, is $45,000, and the monthly rental for the third option period, which runs from January 1, 2009 through December 31, 2013, is $50,000. In addition, the Company pays taxes, insurance, repairs and maintenance on this building. MAFC is a corporation owned by Mrs. Horn (27.5%) and Messrs. Slattery (8%) and Speisman (27.5%). The terms of the lease were not negotiated at arm's length due to their relationship with MAFC and the Company. Messrs. Slattery and Speisman participated in such negotiations.
The Company leases a building located at 2534 Creston Avenue, Bronx, New York from Creston Realty Associates, L.P. ("CRA"), the corporation owned 10% by Ester Horn. The lease term is two years commencing October 1, 1996 and has three additional one year option periods. The Company also pays a base rent of $180,000 per year which will escalate five percent per year for each of the three year options if they are exercised. The Company pays taxes, insurance, repairs and maintenance on this building which will be used to house a community correctional center. The terms of this lease were not negotiated at arms length due to the relationship between the Company, Ms. Horn and CRA.
Pursuant to the terms of a Board of Directors resolution adopted in connection with the Company's initial public offering, all transactions between the Company and any of its officers, directors or affiliates (except for wholly-owned subsidiaries) must be approved by a majority of the unaffiliated members of the Board of Directors and be on terms no less favorable to the Company than could be obtained from unaffiliated third parties and be in connection with bona fide business purposes of the Company. In the event the Company makes a loan to an individual affiliate (other than a short-term advance for travel, business expense, relocation or similar ordinary operating expenditure), such loan must be approved by a majority of the unaffiliated directors
ITEM 13.
ITEM 13. EXHIBITS AND REPORTS
(a) Exhibits
*2.1 Stock Transfer Agreements between the Company and the stock- holders of each of Esmor Management, Inc., Esmor (Brooklyn), Inc., Esmor Manhattan, Inc., Esmor (Seattle), Inc., Esmor New Jersey, Inc., Esmor Texas, Inc. and Esmor Houston, Inc.
*3.1 Certificate of Incorporation dated October 28, 1993
##3.1.1 Copy of Certificate of Amendment of Certificate of Incorporation of Esmor Correctional Services, Inc. dated July 29, 1996
*3.2 By-Laws
*4.2 Form of Underwriter's Warrant between the Company and Janney Montgomery Scott Inc.
*10.1 Stock Option Plan
*10.5 Employment Agreement between the Company and James F. Slattery
*10.6 Employment Agreement between the Company and Aaron Speisman
##10.6.1 Modification to the Employment Agreement between the Company and Aaron Speisman, dated June 13, 1996
#10.8.3 Exercise of third option of the contract for operation of a facility in New York, New York for women through June 30, 1995
*10.9 Contract between the Company and the U.S. Department of Justice, Federal Bureau of Prisons for operation of a facility in Brooklyn, New York, dated November 13, 1990
*10.9.1 Letter dated September 23, 1993 from the U.S. Department of Justice, Federal Bureau expressing its intent to exercise the third option year of the contract
*10.9.2 Exercise of third option year of the contract for operation of a facility in Brooklyn, New York
#10.9.3 Extension of contract for operation of a facility in Brooklyn, New York through March 31, 1995
*10.10 Bridge Contract between the Company and the U.S. Department of Justice, Immigration and Naturalization Service for operation of the Seattle Processing Center, dated September 28, 1993
##10.10.1 Contract Amendment between the Company and the U.S. Immigration and Naturalization service for operation of the Seattle Processing Center, dated October 1, 1996
*10.11 Contract between the Company and the Judicial District Community Supervision and Corrections Department of Tarrant County, dated September 1,
#10.11.1 Renewal and Amendment of Agreement between the Company and the Judicial District Community Supervision and Corrections Department of Tarrant County, dated October 5, 1994
**10.11.2 Contract between the Company and the Judicial District Community Supervision and Corrections Department of Tarrant County, dated September 26, 1995 for the operation of the Tarrant County Community Corrections Facility
*10.12 Contract between the Company and the New York State Department of Corrections, dated July 17, 1992
**10.12.1 Extension of Contract between the Company and the New York State Department of Corrections
*10.13 Contract between the Company and the Texas Department of Criminal Justice, Pardons and Paroles Division
#10.13.1 Extension to the contract between the Company and the Texas Department of Criminal Justice, Pardons and Paroles Division for operation of the South Texas Intermediate Sanction Facility
**10.13.2 Contract between the Company and the Texas Department of Criminal Justice for operation of the South Texas Intermediate Sanction Facility
*10.14 Contract between the Company and the U.S. Immigration and Naturalization Service for operation of the New Jersey Processing Center, dated August 13, 1993
**10.14.1 Contract between the Company and the U.S. Immigration and Naturalization Service extending the period which the INS has to exercise its renewal option under its contract for the operation of the New Jersey Processing Center
*10.15 Agreement between the Company and William Banks, dated October 31, 1989
*10.15.1 Letter dated December 9, 1993 from William Banks to the Company
*10.16 Form of Sub-Lease between the Company and LeMarquis Operating Corporation
*10.17 Form of Lease between the Company and Myrtle Avenue Family Center, Inc.
*10.18 Lease between the Company and T. NY (USA)
#10.19 Contract by and between Esmor Canadian, Inc. and the Board of Trustees for the Hemphill County Juvenile Detention Center for operation of the Hemphill County Juvenile Detention Center
#10.20 Contract between Esmor Fort Worth, Inc. and the Texas Department of Criminal Justice, Pardons and Paroles Division for the Fort Worth Community
10.20.1 Addendum One to the Contract between Esmor Fort Worth, Inc. and the Texas Department of Criminal Justice, Pardons and Paroles Division for the Fort Worth Community
10.20.2 Amendment Two to the Contract between Esmor Fort Worth, Inc. and the Texas Department of Criminal Justice, Pardons and Paroles Division for the Fort Worth Community dated April 1, 1997
10.20.3 Amendment Three to the Contract between Esmor Fort Worth, Inc. and the Texas Department of Criminal Justice, Pardons and Paroles Division for the Fort Worth Community dated September 1, 1997
#10.21 Contract dated September 1, 1994 by the Community Supervision and Corrections Department of Travis County, Texas for the Travis County Substance Abuse Treatment Facility
**10.21.1 Contract dated October 1, 1995 by the Community Supervision and Corrections Department of Travis County, Texas for the Travis County Substance Abuse Treatment Facility
++10.21.2 Amendment to the Contract and the Company for the Operation and Management of the Travis County Substance Abuse Treatment facility
#10.22 Contract between the Company and the U.S. Department of Justice, Immigration and Naturalization Service for operation of the Seattle Processing Center, effective August 1, 1994
**10.22.1 Exercise of second option of the contract for operation of the Seattle Processing Center #10.23 Lease between Esmor Fort Worth, Inc. and Region Enterprises, Inc.
#10.23 Lease between Esmor Fort Worth, Inc. and Region Enterprises, Inc.
#10.24 Revolving Credit and Term Loan Agreement with Marine Midland Bank dated as of July 28, 1994
10.24.1 Renewal of the Revolving Line of Credit Note dated January 15,
**10.25 1994 Non-Employee Director Stock Option Plan
**10.26 Loan and Security Agreement with NationsBank, N.A. (South) dated as of December 31, 1995
10.26.1 Intentionally blank
10.26.2 Deed of Trust Modification Agreement dated January 14, 1998
10.26.3 Third Amendment to Loan Agreement dated January 5, 1998
10.26.4 Fourth Amendment to Loan Agreement dated January 14, 1998
**10.27 Lease between the Company and Zell/Merrill Lynch Real Estate Opportunity Partners Limited Partnership dated as of June 30, 1995
##10.27.1 Amendment to the Lease Agreement between the Company and Zell Merrill Lynch Real Estate Opportunity Partners Limited Partnership dated November 15, 1996
**10.28 Lease between the Company and Gayton Crossing dated as of May 26,
**10.29 Contract between the Company and the State of Florida, Correctional Privatization Commission dated October 6, 1995 for operation of the Pahokee Youth Facility
**10.30 Contract between the Company and the State of Florida, Correctional Privatization Commission dated October 6, 1995 for operation of the Polk City Youth Facility
**10.31 Contract between the Company and the State of Arizona, Department of Corrections for operation of the Arizona DWI Facility in Phoenix, Arizona dated July 1995
10.31.1 Amendment Number One to the contract between the Company and the State of Arizona, Department of Corrections for the operation of the Arizona DWI Facility in Phoenix, Arizona dated April 1997
10.31.2 Amendment Number Two to the contract between the Company and the State of Arizona, Department of Corrections for the operation of the Arizona DWI Facility in Phoenix, Arizona dated December 1997
**10.32 Contract between the Company and the State of Florida, Department of Juvenile Justice for operation of the Bartow Youth Facility
**10.33 Contract, effective as of December 22, 1995, between the Company and Johnson County, Texas for the Johnson County Juvenile Detention Center
**10.34 Asset Purchase Agreement dated as of December 15, 1995 between the Company and Corrections Corporation of America
**10.35 Construction Contract dated as of December 28, 1995 between the Company and Bison Industries, Inc. for construction of the Pahokee (Florida) Youth Facility
**10.36 Design and Construction Contract dated as of December 1, 1995 by and between the Company, the Florida Correctional Finance Corporation and the State of Florida, Correctional Privatization Commission for the design and construction of the Polk City (Florida) Youth Facility
**10.37 Contract dated July 1, 1995, between the Company and the U.S. Department of Justice, Federal Bureau of Prisons for operation of a facility in New York, New York
**10.38 Contract between the Company and the U.S. Department of Justice, Federal Bureau of Prisons for operation of a facility in Brooklyn, New York
10.39 (Intentionally blank)
##10.40 Contract between the Company and the U.S. Bureau of Prisons for operation of the Bronx Community Corrections Center, dated October, 1, 1996
##10.41 Contract between the Company and the State of Arizona for operation of the DWI Secure Prison in Phoenix, Arizona dated January 1997
##10.42 Contract between the Company and McKinley County New Mexico for operation of the McKinley County, New Mexico Adult Detention Facility, dated October 3, 1996
##10.43 Contract between the Company and Colorado County, Texas for the operation of the Colorado County, Texas Juvenile Residential Facility
##10.44 Lease Agreement between the Company and Creston Realty Associates, L.P., dated October 1, 1996
*10.45 Lease between the Company and Elberon Development Company
##10.45.1 Assignment of Lease between the Company and Elberon Development Company
##10.46 Contract between the Company and Bell County Texas for operation of the Bell County Juvenile Residential Facility
##10.47 Employment Agreement between the Company and Ira M. Cotler, dated January 21, 1996
+10.47.1 Amended Employment Agreement between the Company and Ira M. Cotler dated July 9, 1997
##10.48 Employment Agreement between the Company and Michael C. Garretson, dated January 21, 1996
+10.49 Contract between the Company and Okaloosa County, Florida for the Design, Build and Operation of a Moderate Risk Residential Program and a High Risk Residential Program dated June 13, 1997
+10.49.1 Amendment to Contract between the Company and Okaloosa County, Florida for the Design, Build and Operation of a Moderate Risk Residential Program and a High Risk Residential Program dated June 16, 1997
++10.50 Contract between the Company and Grenada County, Mississippi for the Operation and Management of a 200 bed jail dated September 1, 1997
++10.50.1 Lease Agreement between the Company and Grenada County dated September 1, 1997
++10.51 Asset Purchase Agreement between the Company and Dove Development Corporation, Consolidate Financial Resources/Crystal City, Inc., dated August 27, 1997
++10.51.1 First Amendment to Asset Purchase Agreement between the Company and Dove Development Corporation, Consolidate Financial Resources/Crystal City, Inc., dated August 27, 1997
++10.52 Contract between the Company and McKinley County, New Mexico for the Operation and Management of the McKinley County Adult Detention Facility in Gallup, New Mexico, executed August 21, 1997
++10.53 Contract between the Company and the Martin Hall Juvenile Facility Board dated October 15, 1997 for the Operation and Management of the Martin Hall Juvenile Detention Center in Medical Lake, Washington
10.54 Lease Agreement between the Company and Frio County dated November 26, 1997
10.55 Contract between CSC Management de Puerto Rico and the Juvenile Institutions Administration of the Commonwealth of Puerto Rico dated December 22, 1997 for the operation and management of a secure residential treatment program for youths at the Salinas facility in Puerto Rico
10.56 Contract between the Company and the Juvenile Institutions Administration dated February 6, 1998 for operation of the Metropolitan Juvenile Detention Center in Puerto Rico
10.57 Contract between the Company and the Juvenile Institutions Administration dated February 6, 1998 for operation of the Metropolitan Juvenile Treatment Center in Puerto Rico
10.58 Contract between the Company and the New York State Department of Corrections for Community Reintegration Services dated March 1, 1998
10.59 Resolution from the City Council of the City of Eagle Lake, Texas to the Company to construct and operate a 1,000 bed prison facility in Eagle Lake, Colorado County, Texas dated July 22, 1997
**21.1 List of Significant Subsidiaries
21.2 Amended List of Subsidiaries
27. Financial Data Schedule
- ------------------------
* Incorporated by reference to the Company's Registration Statement on Form SB-2 (File No. 33-71314-NY).
# Incorporated by reference to the Company's Annual Report on Form-10-KSB for the year ended December 31, 1994.
** Incorporated by reference to the initial filing of the Company's Annual Report on Form 10-KSB for the year ended December 31, 1995.
## Incorporated by reference to the Company's Annual Report on Form-10-KSB for the year ended December 31, 1996.
+ Incorporated by reference to the Company's filings on Form 10-Q for June 30, 1997.
++ Incorporated by reference to the Company's filings on Form 10-Q for September 30, 1997.
(b) Reports on Form 8-K
The Company did not file any reports on Form 8-K in fiscal 1997.
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
CORRECTIONAL SERVICES CORPORATION Registrant
By: /s/James F. Slattery, President --------------------------------- James F. Slattery, President
Dated: March 30, 1998
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date
/s/James F. Slattery President (Principal Executive Officer) March 30, 1998 - -------------------- and Director James. F. Slattery
/s/Aaron Speisman Vice President, Secretary and Director March 30, 1998 - -------------------- Aaron Speisman
/s/Ira C. Cotler Chief Financial Officer (Principal March 30, 1998 - -------------------- Financial Officer) Ira C. Cotler
/s/Raymond S. Evans Director March 30, 1998 - -------------------- Raymond S. Evans
/s/Stuart Gerson Director March 30, 1998 - -------------------- Stuart Gerson
/s/Melvin Stith Director March 30, 1998 - -------------------- Melvin Stith
/s/Shimmie Horn Director March 30, 1998 - -------------------- Shimmie Horn
/s/Richard Staley Vice President and Director March 30, 1998 - -------------------- Richard Staley
CONSOLIDATED FINANCIAL STATEMENTS AND REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES
December 31, 1997, 1996 and 1995
C O N T E N T S
Page
Report of Independent Certified Public Accountants
Consolidated Balance Sheets as of December 31, 1997 and 1996
Consolidated Statements of Operations for the years ended December 31, 1997, 1996 and 1995
Consolidated Statement of Stockholders' Equity for the years ended December 31, 1997, 1996 and 1995
Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995 -6
Notes to Consolidated Financial Statements -30
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors Correctional Services Corporation
We have audited the accompanying consolidated balance sheets of Correctional Services Corporation and Subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Correctional Services Corporation and Subsidiaries as of December 31, 1997 and 1996, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles.
GRANT THORNTON LLP
Tampa, Florida March 11, 1998
CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Correctional Services Corporation and Subsidiaries operate and manage detention and correctional facilities for federal, state and local government agencies. On August 1, 1996, the Company's Certificate of Incorporation was amended which changed the name of the Company to Correctional Services Corporation and increased the number of authorized shares of Common Stock from 10,000,000 to 30,000,000 shares.
1. Principles of Consolidation
The consolidated financial statements as of December 31, 1996 include the accounts of Correctional Services Corporation and its wholly-owned subsidiaries, Esmor, Inc., Correctional Services Management, Inc., Esmor Brooklyn, Inc., Esmor Seattle, Inc., Esmor Manhattan, Inc., Esmor Mansfield, Inc., Esmor Houston, Inc., Esmor New Jersey, Inc., Esmor Ft. Worth, Inc., Esmor Canadian, Inc. and Esmor Travis, Inc. (collectively the "Company" or the " companies"). As of December 31, 1996 all of the aforementioned subsidiaries (except Esmor, Inc. and Esmor New Jersey, Inc.) were merged into the parent company. An additional corporation, CSC Management de Puerto Rico, Inc., was added to the Company's consolidated group as of July 1, 1997. All significant intercompany balances and transactions have been eliminated.
2. Use of Estimates in Consolidated Financial Statements
In preparing consolidated financial statements in conformity with generally accepted accounting principles, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. For discussion of the realization of Receivable from Sale of Equipment and Leasehold Improvements and costs pertaining to New York and Fort Worth closures, see Note L.
3. Revenue Recognition
Revenue is recognized at the time the service is provided. Revenues are principally derived from contracts with federal, state and local government agencies.
4. Cash and Cash Equivalents
The Company considers all highly liquid debt instruments purchased with original maturities of three months or less to be cash equivalents.
	Restricted cash of $60,626 at December 31, 1997 represents a major maintenance and repair reserve fund established by the Company as required by contracts in Polk and Pahokee, Florida.
CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (Continued)
5. Building, Equipment and Leasehold Improvements
Building, equipment and leasehold improvements are carried at cost. Depreciation of buildings is computed using the straight-line method over twenty and thirty year periods. Depreciation of equipment is computed using the straight-line method over a five-year period. Leasehold improvements are being amortized over the shorter of the life of the asset or the applicable lease term (ranging from five to twenty years).
6. Capitalized Interest
In accordance with Statement of Financial Accounting Standards No. 34 Capitalization of Interest Costs the Company capitalizes interest on facilities during construction. During 1997 the Company capitalized interest of $371,500 related to the construction of the Florence, Arizona facility. During 1996 interest of $103,576 was capitalized relating to the construction of the Phoenix, Arizona facility.
7. Deferred Development and Start-up Costs
Deferred development costs consist of costs that can be directly associated with a specific anticipated contract and, if the recoverability from that contract is probable, they are deferred until the anticipated contract has been awarded. At the commencement of operations of the facility, the deferred development costs are amortized over the life of the contract (including option periods) as development expense but not to exceed five years. Costs of unsuccessful or abandoned contracts are charged to expense when their recovery is not considered probable. Facility start-up costs, which include costs of initial employee training, travel and other direct expenses are incurred (after a contract is awarded) in connection with the opening of new facilities. These costs are capitalized and amortized on a straight-line basis over the term (including option periods) of the contracts not to exceed five years.
In April 1997, the American Institute of Certified Public Accountants issued a proposed accounting standard on "Accounting for the Costs of Start-up Activities." If adopted in 1998, the standard would require the Company to expense start-up and deferred development costs as incurred. In addition, the standard may require that all previously capitalized start-up costs be expensed and reported as a cumulative effect of a change in accounting principle at the time of the adoption. As of December 31, 1997, unamortized startup costs and deferred development were $8,043,380.
8. Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of
On January 1, 1996, the Company adopted Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long- Lived Assets and for Long- Lived Assets to
CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (Continued)
be Disposed Of ("SFAS No. 121"). The standards for SFAS No. 121 require that the Company recognize and measure impairment losses of long-lived assets and certain identifiable intangibles and to value long-lived assets to be disposed of. The primary objectives under SFAS No. 121 are to (a) recognize an impairment loss of an asset whenever events or changes in circumstances indicate that its carrying amount may not be recoverable or (b) if planning to dispose of long-lived assets or certain identifiable intangibles, such assets have been reflected in the Company's consolidated financial statements at the net asset value less cost to sell. The effect, adoption and application of SFAS No. 121 was not considered material to the consolidated financial statements in 1997 and 1996.
9. Income Taxes
The Company utilizes an asset and liability approach for financial accounting and reporting for income taxes. The primary objectives of accounting for income taxes are to (a) recognize the amount of tax payable for the current year and (b) recognize the amount of deferred tax liability or asset based on management's assessment of the tax consequences of events that have been reflected in the Company's consolidated financial statements.
10. Earnings Per Share
In 1997, the Company adopted Statement of Financial Accounting Standards No. 128, Earnings per Share ("SFAS No. 128"). The standard requires the disclosure of basic and diluted earnings per share for periods ending after December 15, 1997 and restatement of prior periods to conform with the new disclosure format. The computation under SFAS No. 128 differs from the primary and fully diluted earnings per share computed under APB Opinion No. 15 primarily in the manner in which potential common stock is treated. Basic earnings per share is computed by dividing net income by the weighted-average number of common shares outstanding. In the computation of diluted earnings per share, the weighted-average number of common shares outstanding is adjusted for the effect of all potential common stock and the average share price for the period is used in all cases when applying the treasury stock method to potentially dilutive outstanding options. The 1996 and 1995 earnings per share amounts presented herein have been restated to reflect the adoption of SFAS No. 128.
11. Stock Based Compensation
In October 1995, the Financial Accounting Standards Board issued SFAS No. 123, Accounting for Stock-Based Compensation ("SFAS No. 123"). With respect to stock options granted to employees, SFAS No. 123 permits companies to continue using the accounting method promulgated by the Accounting Principles Board Opinion No. 25 ("APB No. 25"), Accounting for Stock Issued to Employees, to measure compensation or to adopt the fair value based method prescribed by SFAS No. 123. Management has not adopted SFAS No. 123's accounting recognition provisions related to stock options granted to employees and
CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (Continued)
accordingly, will continue following APB No. 25's accounting provisions. All other requirements of SFAS No. 123 were implemented on January 1, 1996.
12. New Accounting Pronouncements
SFAS No. 130 Reporting Comprehensive Income is effective for fiscal years beginning after December 15, 1997. This statement establishes standards for reporting and display of comprehensive income and its components in a full set of general purpose financial statements. The requirements of this statement include: (a) classifying items of other comprehensive income by their nature in a financial statement and (b) displaying the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of the balance sheet. The Company plans to adopt SFAS No. 130 for the year ending December 31, 1998 and expects no material impact to the Company's financial statement presentation.
SFAS No. 131 Disclosures about Segments of an Enterprise and Related Information is effective for fiscal years beginning after December 15, 1997. This statement supercedes SFAS No. 14 Financing Reporting for Segments of a Business Enterprise and amends SFAS No. 94 Consolidation of All Majority-Owned Subsidiaries. This statement requires annual financial statements to disclose information about products and services, geographic areas and major customers based on a management approach, along with interim reports. The management approach requires disclosing financial and descriptive information about an enterprise's reportable operating segments based on reporting information the way management organizes the segments for making decisions and assessing performance. It also eliminates the requirement to disclose additional information about subsidiaries that were not consolidated. The Company plans to adopt SFAS No. 131 for the year ending December 31, 1998 impacting only the Company's disclosure information and not its results of operations.
13. Reclassifications
Certain reclassifications have been made to the 1996 and 1995 balances to conform to the 1997 presentation.
CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE B - CONTRACTUAL AGREEMENTS WITH GOVERNMENT AGENCIES
The Company currently operates nineteen secure and non-secure corrections or detention programs in the states of Arizona, Florida, New Mexico, Mississippi, New York, Texas and Washington for Federal, state and local government agencies exclusive of two programs which are expected to wind down in 1998 and for which a write-down has been provided for the year ended December 31, 1996 (see Note L). The Company's secure facilities include a detention and processing center for illegal aliens, intermediate sanction facilities for parole violators and a shock incarceration facility, which is a military style "boot camp" for youthful offenders. Non-secure facilities include residential programs such as community correction facilities for federal and state offenders serving the last six months of their sentences and non-residential programs such as home confinement supervision.
The Company is compensated on the basis of the number of offenders held in each of its facilities. The Company's contracts may provide for fixed per diem rates or monthly fixed rates. Some contracts also provide for minimum guarantees.
The terms of each contract vary and can be from one to five years. Contracts for more than one year have renewal options which either are exercisable on mutual agreement between the Company and the government agency or are exercisable by the government agency alone.
CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE C - FAIR VALUE OF FINANCIAL INSTRUMENTS
For the Company, financial instruments consist principally of cash and cash equivalents, subordinated promissory notes and long-term debt.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
1. Cash and Cash Equivalents
The carrying amount reasonably approximates fair value because of the short maturity of those instruments.
2. Subordinated Promissory Notes and Long-Term Debt
The fair value of the Company's subordinated promissory notes and long-term debt is estimated based upon the quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of the same remaining maturities. As of December 31, 1997 and 1996 the estimated fair values of the subordinated promissory notes and long-term debt approximated their carrying values.
3. Receivable from Sale of Equipment and Leasehold Improvements
The carrying value of the receivable from sale of equipment and leasehold improvements at December 31, 1997 and 1996 is $2,259,082 and $3,507,882, respectively. The Company believes the fair value of the receivable from sale of equipment and leasehold improvements is not practicable to estimate (See Note L-1(b)).
CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE D - PREPAID EXPENSES AND OTHER CURRENT ASSETS
Prepaid expenses and other current assets consist of the following:
December 31, 1997 1996 ---------- ----------
Prepaid insurance $ 153,875 $ 214,231 Prepaid real estate taxes 133,110 165,061 Prepaid and refundable income taxes 87,501 819,199 Prepaid rent - current portion 383,333 - Other 206,757 803,482 --------- ---------
$ 964,576 $2,001,973 --------- --------- --------- ---------
NOTE E - BUILDING, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Building, equipment and leasehold improvements, at cost, consist of the following:
December 31, 1997 1996 ---------- ----------
Buildings and land $21,125,911 $10,072,687 Equipment 3,464,003 2,221,427 Leasehold improvements 998,502 645,341 ---------- ---------- 25,588,416 12,939,455
Less accumulated depreciation (1,871,244) (899,306) ---------- ---------- $23,717,172 $12,040,149 ---------- ---------- ---------- ----------
Depreciation expense for the years ended December 31, 1997, 1996 and 1995 was approximately $972,000, $640,000 and $1,040,000, respectively.
CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE F - OTHER ASSETS
Deferred development and start-up costs are comprised of the following:
December 31, 1997 1996 ---------- ----------
Development costs $4,343,247 $3,158,242 Start-up costs 5,301,229 3,079,272 --------- ---------
9,644,476 6,237,514
Less accumulated amortization (1,601,096) (419,555) --------- ---------
$8,043,380 $5,817,959 --------- --------- --------- ---------
The December 31, 1997 and 1996 balance of $8,043,380 and $5,817,959 includes development costs of approximately $1,005,500 and $306,300, respectively, related to unawarded contracts. Deferred development at December 31, 1997 and 1996, includes $637,500 paid to Colorado County, Texas for the Company's contractual commitment to finance 25% of the facility's construction cost. Colorado County, Texas is obligated to fund the balance.
Other assets consist of the following:
December 31, 1997 1996 ---------- ----------
Deferred refinancing costs, net $ 193,330 $ 344,167 Deposits 355,160 106,820 Deferred lease option costs 18,656 26,660 Prepaid rent - net of current portion 4,335,482 - Other 30,699 7,510 --------- ---------
$4,933,327 $ 485,157 --------- --------- --------- ---------
During the year, the Company entered into a prepaid lease agreement with a facility located in Frio, Texas. The term of the lease is for twelve years and began in December 1997. The current portion of the lease payments are included in prepaid expenses (Note D) and the long-term portion is included above in other assets.
CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE G - ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities consist of the following:
December 31, 1997 1996 ---------- ----------
Accounts payable $1,906,454 $1,900,867 Accrued expenses 2,610,299 1,193,348 Payroll and related taxes 1,523,475 691,540 Construction costs (including retainage) 499,250 10,950 Income taxes - 116,333 Other 16,843 - Accrued closure costs of Fort Worth and New York Community Corrections 982,741 960,504 --------- ---------
$7,539,062 $4,873,542 --------- --------- --------- ---------
NOTE H - DEBT
Long-term debt consists of the following:
December 31, 1997 1996 ---------- ----------
Mortgage payable due in semi-annual installments of $17,083 which includes principal plus interest at 10% per annum due in full October 2006 $323,291 $ - Less current portion (1,800) - ------- -------
$321,491 $ - ------- -------
Effective December 31, 1995, the Company and NationsBank, N.A. entered into a loan and security agreement totaling $11.0 million. The agreement consists of $5 million term loan at a fixed rate of 8.92%, which refinanced previous debt with another bank, and a $6 million revolving line of credit for working capital purposes. On September 17, 1996, the outstanding balances of both the term loan ($4,333,360) and the revolving line ($2,865,108) were repaid in full with interest from the net proceeds raised from the public offering (see Note K). Borrowings under the revolver are based, at the Company's option, on .75% over the bank's prime rate or the London International Bank Rate (LIBOR) plus 3.35%. After September 30, 1996 the interest rate charged under either method is based on the Company's financial performance as specified in the agreement. Further, the Company is required to pay an annual commitment fee of .25% of the average unused portion of the facility. The Company may prepay any borrowings without interest or penalty. The Company's subsidiaries have guaranteed the Company's obligation under the agreement. The Company has granted the
CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE H - DEBT - (Continued)
bank a first priority security interest in all of its assets. The lending agreement contains certain financial covenants including debt service coverage ratio and senior liabilities to tangible net worth and subordinated debt ratio. The agreement precludes the payment of dividends and stock repurchase or redemptions prior to December 31, 1996. Thereafter, such dividends, purchase or redemptions is limited to 10% of the Company's net earnings after taxes provided that the Company is in compliance with the above-noted financial covenants. The Company was in compliance with all financial covenants as of December 31, 1997. There were no bank borrowings at December 31, 1997 and 1996.
On January 14, 1998 the Company extended the term of the revolving credit portion of its loan agreement until April 3, 1998. The Company is currently in negotiations with NationsBank for a new and expanded credit and lease agreement.
Through a series of transactions that closed in July, August and September 1995, the Company issued 5,676.6 units at $1,000 per unit, in a private placement of its securities ("1995 Private Placement"). Each unit consists of (i) a 10% subordinated promissory note due July 1, 1998 in the principal amount of $1,000, interest payable quarterly and (ii) a four year warrant to purchase 154 shares of Common Stock at $7.75 per share. The Company received proceeds of $5,676,600 in connection with the 1995 Private Placement and recorded the market value of the warrants, $365,000, as promissory note discount amortized over three years. The net proceeds from such issuance were used to purchase and renovate the Phoenix, Arizona facility.
At December 31, 1997, aggregate maturities of long-term debt were as follows:
Year ending December 31, ----------------------- 1998 $ 1,800 1999 2,000 2000 2,300 2001 2,500 2002 2,800 Thereafter 311,891 ------- TOTAL $323,291 ------- -------
CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE I - RENTAL AGREEMENTS
The Company has operating leases for certain of its facilities and certain machinery and equipment which expire at various dates through 2002. Substantially all the facility leases provide for payment by the Company of all property taxes and insurance.
Future minimum rental commitments under non-cancelable leases as of December 31, 1997, are as follows:
Related Total Companies ---------- ----------
Year ending December 31,
1998 $2,500,000 $1,232,000 1999 1,818,000 642,000 2000 1,158,000 222,000 2001 756,000 - 2002 543,000 - Thereafter 2,739,000 - --------- ---------
$9,514,000 $2,096,000 --------- --------- --------- ---------
The Company leases one facility from a related party under a sublease arrangement, which expires April 30, 2000. The Company has a five-year option to renew this sublease arrangement. Residential and commercial tenants occupy a portion of this building and annex.
The Company leases a second facility from a related party. The lease commenced January 1, 1994 and expires December 31, 1998. Thereafter, the Company has three successive five-year options to renew. In addition to the base rent, the Company pays taxes, insurance, repairs and maintenance on this facility.
The Company leases a third facility from a related party. The lease commenced October 1, 1996 and expires September 30, 1998. Thereafter, the Company has three successive one-year options to renew. In addition to the base rent, the Company pays taxes, insurance, repairs and maintenance on this facility.
Rental expense for the years ended December 31, 1997, 1996 and 1995 aggregated $1,439,000, $1,549,000 and $1,632,000, respectively, and is included in general and administrative expenses. Rent expenses for the year ended December 31, 1997 is net of $539,000 related to rental costs incurred at the Company's Fort Worth and New York facilities that was written off against accrued closure costs. (See Note L) Rent to related companies aggregated $1,260,000, $1,090,000 and $1,038,000 for the years ended December 31, 1997, 1996 and 1995, respectively.
CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE J - INCOME TAXES
The income tax expense (benefit) consists of the following:
Years Ended December 31, ----------------------- 1997 1996 1995 ---------- ---------- ----------
Current: Federal $ 242,853 $ (695,000) $ (42,000) State and local 160,000 45,000 112,000
Deferred: Federal, state and local 1,620,000 (375,000) (1,120,000) --------- --------- ---------
$2,022,853 $(1,025,000) $(1,050,000) --------- --------- --------- --------- --------- ---------
The following is a reconciliation of the federal income tax rate and the effective tax rate as a percentage of pre-tax income:
Years Ended December 31, ----------------------- 1997 1996 1995 ---------- ---------- ----------
Statutory federal rate 34.0% (34.0)% (34.0)% State taxes, net of federal tax benefit 5.0 1.4 5.0 Non-deductible items 0.9 1.5 1.2 Other 0.2 (4.3) (9.8) ---- ---- ----
40.1% (35.4)% (37.6)% ---- ---- ---- ---- ---- ----
CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE J - INCOME TAXES - (Continued)
Deferred income taxes reflect the tax effected impact of temporary differences between the amounts of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws and regulations. The components of the Company's deferred tax assets (liabilities) are summarized as follows:
December 31, 1997 1996 ---------- ----------
Facility closure costs $ 678,000 $ 969,000 Vacation accrual 129,000 70,000 Development costs (1,021,000) 111,000 Accrued expenses 392,000 33,000 Depreciation ( 373,000) - Net operating loss carryforward - 242,000 Alternative minimum tax credit 70,000 70,000 --------- --------- ( 125,000) 1,495,000 Valuation allowance - - --------- ---------
$( 125,000) $1,495,000 --------- --------- --------- ---------
The Company, after considering its pattern of profitability, excluding the New Jersey, Ft. Worth, and NYCC facility closure charges, and its anticipated future taxable income, believes it is more likely than not that the deferred tax assets will be realized.
NOTE K - STOCKHOLDERS' EQUITY
On March 8, 1995, the Company's Board of Directors authorized a five-for-four stock split in the form of a 25% stock dividend payable on April 5, 1995 to stockholders of record on March 23, 1995. All references in the financial statements to average number of shares outstanding, per share amounts and stock option data for prior periods presented have been restated to reflect the five-for-four stock split.
During September 1995, the Company completed the private placement of 496,807 shares of Common Stock at $7.75 per share. The Company received gross proceeds of $3,850,254 and incurred issuance costs of $380,556. The net proceeds were used for its Phoenix, Arizona facility.
In connection with the 1995 Private Placement, warrants issued with units totaled 874,198, which are exercisable at $7.75 per share. During the years ended December 31, 1997 and 1996, 10,800 and 216,703 of such warrants were exercised simultaneously with the tendering of subordinated notes. At December 31, 1997 and 1996, warrants outstanding totaled 646,695 and 657,495, respectively. (See Note H).
CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE K - STOCKHOLDERS' EQUITY - (Continued)
On February 2, 1994, the Company completed a public offering of 833,333 shares of Common Stock. The net proceeds received by the Company after deducting applicable issuance costs and expenses aggregated $4,105,020. In connection with the public offering, the Company sold to the representative of the underwriters, for a nominal sum, warrants to purchase from the Company 109,375 shares of Common Stock. The warrants are exercisable for a period of four years commencing February 2, 1995 at an exercise price of 107% of the initial public offering price ($4.76), increasing to 114% of the initial public offering price on February 2, 1996, 121% of the initial public offering price on February 2, 1997 and 128% of the initial public offering price on February 2, 1998. During the year ended December 31, 1997, 7,100 and 16,500 of such warrants were exercised at an exercise price of $5.43 and $5.77 per share, respectively. During the year ended December 31, 1996, 30,000 of such warrants were exercised at an exercise price of $5.43 per share.
On September 12, 1996, the Company completed a public offering of 2,070,000 shares of Common Stock at $13.625 per share. The net proceeds of the public offering after deducting applicable issuance costs and expenses aggregated approximately $25,790,000. In October, 1996, pursuant to the underwriters' over-allotment option, the Company sold an additional 367,500 shares of Common Stock at $13.625 per share. The net proceeds received from the exercise of the over-allotment option aggregated approximately $4,716,000. The net proceeds of the public offering and the over-allotment option were used to repay bank loans of $7,198,468 (See Note H) and are being used for construction, start-up and related costs of the Florence, Arizona and Eagle Lake, Texas facilities and for start-up costs of the Polk and Pahokee, Florida facilities and for general corporate purposes.
CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE L - COMMITMENTS AND CONTINGENCIES
1(a). Fort Worth and New York Closures
During the fourth quarter of 1996, due to substantially reduced occupancy levels and operating losses being sustained at two of the Company's community-based halfway houses, the Company decided to discontinue the operations of two programs (one in Fort Worth, Texas and the other in New York, New York). As a result, the Company accrued certain expenses at December 31, 1996, and has written down certain assets related to each program.
In Fort Worth, the Company notified the contracting agency (Texas Department of Criminal Justice) that the entire facility will be closed. In addition, all incremental closure related costs, from April 1, 1997 until the expiration of the facility's operating lease in May, 1999, have been charged to operations at December 31, 1996. Such expenses include the write-off of fixed assets, deferred development and start-up costs, and a provision for rent expense, real estate taxes, insurance and closure costs. The Company began winding down the operations of the Program in the first quarter of 1997. Subsequently, the Company was asked by the Texas Department of Criminal Justice (TDCJ) to leave a portion of the facility open until an alternative site could be located.
In August of 1997, the Company signed an amendment to its contract with TDCJ which significantly lowered the expected population of the Facility in addition to increasing the per diem rate to $ 33.00 from $29.95. The Company has continued to run the Program at the reduced levels pending the locating of an alternate site. The Company operated this facility at a loss in 1997 and estimates that it will continue to incur a loss in the future based on the terms of the amended contract with TDCJ. The Company believes that the remaining balance of the accrued closure costs reserved at December 31, 1997 is adequate to offset the estimated losses associated with this contract. The Company's decision to continue to operate the Facility is based on its desire to offset the fixed obligations of the Company pertaining to the building. These obligations will continue regardless of whether or not the Company actually operates the Program.
At the Company's Brooklyn and Manhattan, New York facilities, the Company has written-off a portion of fixed assets and expenses during the year ended December 31, 1996 related to the program it manages for the New York State Department of Corrections. Such expenses include rents and related costs of operating each facility, real estate taxes, insurance and closure costs from April 1, 1997 through the expiration of the facilities' operating leases on December 31, 1998 and April 30, 2000, respectively. Costs and expenses associated with the Company's ongoing programs in New York with the Federal Bureau of Prisons have not been written down except for certain costs anticipated at the Manhattan facility resulting from the closure of the New York program. In the second quarter of 1997, the Company closed its Manhattan location and placed all of its remaining residents in its Brooklyn location. Throughout the year, the Company continued its efforts to ascertain the likelihood
CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE L - COMMITMENTS AND CONTINGENCIES - (Continued)
1(a).	Fort Worth and New York Closures
of increased population and a long-term contract. In the third quarter of 1997, the Company understood the State would be issuing a formal Request for Proposal (RFP) relating to its Community Corrections Programs. In addition, the State indicated to the Company that the population rates would improve. At that time the Company decided to re-open its Manhattan location and to prepare to bid on the pending RFP. In February of 1998, the Company was awarded contracts to operate two Community Corrections Programs in its Manhattan location for a total capacity of 130.
Although the Company has recently signed contracts to operate these two programs, the State has given no minimum occupancy guarantee and did not increase the per diem rate. It is the Company's belief that the populations in New York will continue to fluctuate and the New York operations will not produce income for the Company. The Company believes that the remaining balance of the accrued closure costs related to these operations at December 31, 1997 is adequate to offset the estimated losses associated with these programs. The Company's decision to operate these programs is based on its desire to offset the fixed obligations of the Company pertaining to the lease of the buildings. These obligations will continue regardless of whether or not the Company actually operates a program.
The December 31, 1996 write-down of $3,329,000 represents actual charges to operations incurred for each program at December 31, 1996 and the present value of those expenses subsequent to April 1, 1997, attributable to the closure of each program which total $3,600,000 discounted using an interest rate of 9% per annum.
The composition of the writedown at December 31, 1996 is as follows:
Fixed assets, net $ 564,050 Deferred development and start-up costs, net 98,446 Accrued closure costs 2,566,504 Closure related costs incurred in 1996 100,000 --------- $3,329,000 --------- ---------
Accrued closure costs are as follows:
December 31, 1997 1996 ---------- ----------
Accrued closure costs $1,737,741 $2,566,504 Less current portion 982,741 960,504 --------- --------- Long-term portion of accrued closure costs $ 755,000 $1,606,000 --------- --------- --------- ---------
CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE L - COMMITMENTS AND CONTINGENCIES - (Continued)
1(a). Fort Worth and New York Closures
For each of the aforementioned programs, the operating losses incurred until the facilities are closed will be reflected in the financial statements applicable to those periods.
1(b). New Jersey Facility Closure
Due to a disturbance at the Company's Elizabeth, New Jersey facility on June 18, 1995, the facility was closed and the INS moved all detainees located therein to other facilities. On December 15, 1995, the Company and a publicly-traded company (the "Buyer"), which also operates and manages detention and correctional facilities, entered into an asset purchase agreement pursuant to which the Buyer purchased the equipment, inventory and supplies, contract rights and records, leasehold and land improvements of the Company's New Jersey facility for $6,223,000. The purchase price is payable in non-interest bearing monthly installments of $123,000 (through August 1999) effective January 1997, the month the Buyer commenced operations of the facility. If the INS re-awards the contract to the Buyer, the unpaid balance is payable in monthly non-interest bearing installments of $123,000 beginning in the first month of the re-award term and the Company will record as income the unpaid balance. On June 13, 1996 the Company, the Buyer and the INS executed a novation agreement whereby the Buyer became the successor-in-interest to the contract with the INS. In addition, the Company's lease for the New Jersey facility was assigned to the Buyer. The Company has no continuing obligation with respect to the Elizabeth, New Jersey facility.
The receivable from sale of the equipment and leasehold improvements reflected in the balance sheet at December 31, 1997 and December 31, 1996, represents the present value of the consideration to be received through August 1999 of $2,259,082 and $3,507,882, respectively, ($4,428,000 discounted using an interest rate of 11.5% per annum) reduced by the estimated closing costs (legal and consulting) and the facility's estimated carrying costs through December 31, 1996. The statement of operations for 1995 reflects a provision, "New Jersey facility closure costs," of $3,909,700 which represents $416,201 from the write-off of deferred development costs related to the facility and $3,493,499 resulting from the adjustment of the carrying value of the related assets discussed above. During the year ended December 31, 1996 the entire reserve established at December 31, 1995 for carrying and closing costs was reduced by approximately $300,000 of payments for rent and other carrying and closing costs.
CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE L - COMMITMENTS AND CONTINGENCIES - Continued
2. Legal Matters
In May 1993, a former employee of the Company filed suit in the United States District Court, Southern District of New York, claiming he was intentionally assaulted by employees of the Company and claiming $5,000,000 in damages on each of six causes of action. In January 1996, a lawsuit was filed with the Supreme Court of New York, County of Kings, by a former employee alleging sexual harassment and discrimination, physical assault, rape and negligent screening of employees and claiming damages of $4,000,000 plus attorney fees. The Company is awaiting court rulings in both of these cases which are expected to result in dismissals of these actions during 1998.
In March 1996, former inmates at one of the Company's facilities filed suit in the Supreme Court of the State of New York, County of Bronx on behalf of themselves and others similarly situated, alleging personal injuries and property damage purportedly caused by negligence and intentional acts of the Company and claiming $500,000,000 each for compensatory and punitive damages, which suit was transferred to the United States District Court, Southern District of New York, in April 1996. In July 1996, seven detainees at one of the Company's facilities (and certain of their spouses) filed suit in the Superior Court of New Jersey, County of Union, seeking $10,000,000 each in damages arising from alleged mistreatment of the detainees, which suit was transferred to the United States District Court, District of New Jersey, in August 1996. In July 1997, former detainees of the Company's Elizabeth, New Jersey facility filed suit in the United States District Court for the District of New Jersey. The suit claims violation of civil rights, personal injury and property damage allegedly caused by the negligent and intentional acts of the Company. No monetary damages have been stated. Through stipulation, all these actions will now be heard in the United States District Court for the District of New Jersey. This will streamline the discovery process, minimize costs and avoid inconsistent rulings.
The Company believes the claims made in each of the foregoing actions to be without merit and will vigorously defend such actions. The Company further believes the outcome of these actions and all other current legal proceedings to which it is a party will not have a material adverse effect upon its results of operations, financial condition or liquidity.
3. Contracts
Renewal of government contracts (Note B) is subject to, among other things, appropriations of funds by the various levels of government involved (Federal, state or local). Also, several contracts contain provisions whereby the Company may be subject to audit by the government agencies involved. These contracts also generally contain "termination for the convenience of the government" and "stop work order" clauses which generally allow the government to terminate a contract without cause. In the event one of the Company's larger contracts is terminated, it may have a material adverse effect on the Company's operations.
CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE L - COMMITMENTS AND CONTINGENCIES - (Continued)
4. Officers' Compensation
Effective February 9, 1994, the President entered into a five-year employment agreement with the Company that provides annual compensation of $189,000, annual cost of living increases and an annual bonus of five percent of pre-tax earnings greater than $1,000,000, not to exceed $200,000.
In January 1996, the Company entered into three-year employment agreements with its Chief Operating Officer and Executive Vice President- Finance, which provide annual compensation of $115,000 and $129,000, respectively, and a bonus equal to 3% of pre-tax profits in excess of $1,000,000 not to exceed $75,000 and $75,000, respectively. Pursuant to the terms of the employment agreement, each executive was granted an option to purchase 100,000 shares of Common Stock. The option was granted at the fair market value of the stock on the date of grant, which was $8.875 per share. The options are exercisable as follows: one-third on the date of grant, one-third one year from the date of grant and the remaining one-third two years from the date of grant.
5. Concentrations of Credit Risk
Approximately 97.8%, 98.0% and 96.6% of the Company's revenues for the years ended December 31, 1997, 1996 and 1995, respectively, relate to amounts earned from Federal, state and local contracts. The Company's contracts in 1997, 1996 and 1995 with government agencies where revenues exceeded 10% of the Company's total consolidated revenues were with the U. S. Bureau of Prisons, the INS, the New York State Department of Corrections, the Texas Department of Criminal Justice, and the Arizona Department of Corrections (1997 and 1996 only).
6. Fiduciary Funds
The Company has acted as a fiduciary disbursing agent on behalf of a governmental entity whereby certain governmental entity funds are maintained in a separate bank account. These funds have been paid to the general contractor, which constructed the government owned facilities. The Company is responsible for managing the construction process. The Company has no legal rights to the funds nor the constructed facility, and accordingly, such funds do not appear in the accompanying financial statements.
7. Construction Commitments
The Company has various construction contracts related to ongoing projects totaling approximately $1,439,000 as of December 31, 1997.
CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE L - COMMITMENTS AND CONTINGENCIES - (Continued)
8. Letter of Credit
In connection with the Company's workmen's compensation insurance coverage requirements, the Company has obtained a $258,000 Letter of Credit from its bank in favor of the insurance carrier.
NOTE M - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per share in accordance with SFAS No. 128:
Years Ended December 31, ----------------------- 1997 1996 1995 ---------- ---------- ----------
Numerator: Net income (loss) $3,025,524 $(1,868,027) $(1,739,391) --------- --------- --------- --------- --------- ---------
Denominator: Basic earnings per share: Weighted average shares outstanding 7,675,220 5,781,853 4,552,707
Effect of dilutive securities - stock options and warrants 442,702 - - --------- --------- ---------
Denominator for diluted earnings per share 8,117,922 5,781,853 4,552,707 --------- --------- --------- --------- --------- ---------
Net income (loss) per common share - basic $0.39 $(0.32) $(0.38) ---- ---- ---- ---- ---- ----
Net income (loss) per common share - diluted $0.37 $(0.32) $(0.38) ---- ---- ---- ---- ---- ----
The effect of dilutive securities for 1996 and 1995 were not included in the calculation of diluted net loss per common share as the effect would have been anti-dilutive.
NOTE N - STOCK OPTIONS
In October 1993, the Company adopted a stock option plan (the "Stock Option Plan"). This plan provides for the granting of both: (i) incentive stock options to employees and/or officers of the Company and (ii) non-qualified options to consultants, directors, employees or officers of the Company. The total number of shares that may be sold pursuant to options granted under the stock option plan is 500,000. The Company, in June 1994, adopted a Non-employee Directors Stock Option Plan, which provides for the grant of non-qualified options to purchase up to 196,875 shares of the Company's Common Stock.
CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE N - STOCK OPTIONS - (Continued)
Options granted under both plans may not be granted at a price less than the fair market value of the Common Stock on the date of grant (or 110% of fair market value in the case of persons holding 10% or more of the voting stock of the Company). Options granted under the Stock Option Plan will expire not more than five years from the date of grant.
In 1996, the Company granted 215,000 options to two key employees and a director of the Company. The exercise price of the options is equal to the fair market value of the Common Stock at the date of the grant. These options vest over a two-year period and expire five years from the date of grant.
The Company has adopted only the disclosure provisions of SFAS No. 123. It applies APB No. 25 and related interpretations in accounting for its plans and does not recognize compensation expense for its stock based compensation plans other than for restricted stock. If the Company had elected to recognize compensation expense based upon the fair value at the grant date for awards under these plans consistent with the methodology prescribed by SFAS No. 123, the Company's net income (loss) per share would be adjusted to the pro forma amounts indicated below:
Years Ended December 31, ----------------------- 1997 1996 1995 --------- --------- --------- Net income (loss) As reported $3,025,524 $(1,868,027) $(1,739,391) Pro forma (unaudited) 2,215,352 $(2,716,910) $(1,972,438)
Income (loss) per common share - basic As reported $ 0.39 $ (0.32) $ (0.38) Pro forma $ 0.29 $ (0.47) $ (0.43)
Income (loss) per common share - diluted As reported $ 0.37 $ (0.32) $ (0.38) Pro forma (unaudited) $ 0.27 $ (0.47) $ (0.43)
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 these options was estimated at the date of grant using Black-Scholes option-pricing model with the following weighted-average assumptions for the years ended December 31, 1997, 1996 and 1995.
Years Ended December 31, ----------------------- 1997 1996 1995 --------- --------- ---------
Volatility 70% 72% 72% Risk free rate 6.00% 5.64% 6.38% Expected life 3 years 3.32 years 4 years
CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE N - STOCK OPTIONS - (Continued)
The weighted average fair value of options granted during 1997, 1996 and 1995 for which the exercise price equals the market price on the grant date was $5.65, $5.71 and $8.81, respectively, and the weighted average exercise prices were $11.32, $10.56 and $15.04, respectively. The weighted average fair value and weighted average exercise price of options granted in 1995 for which the exercise price exceeded the market price on the grant date were $10.50 and 20.63, respectively.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially effect the fair value estimate, in management's opinion the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
Stock option activity during 1997, 1996 and 1995 is summarized below:
Weighted-Average Options Exercise Price ------- ----------------
Balance, January 1, 1995 290,313 $ 6.19 Granted 81,875 15.73 Exercised (7,000) 4.76 Canceled - - ------- ----- Balance, December 31, 1995 365,188 8.35 Granted 293,700 10.56 Exercised (64,888) 6.37 Canceled (43,750) 12.67 ------- ----- Balance, December 31, 1996 550,250 9.40 Granted 170,750 11.32 Exercised (2,625) 4.76 Canceled (21,950) 16.01 ------- ----- Balance, December 31, 1997 696,425 9.75 ------- ----- ------- -----
CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE N - STOCK OPTIONS - (Continued)
The following table summarizes information concerning currently outstanding and exercisable stock options at December 31, 1997:
Weighted-Average Remaining Range of Number Contractual Life Weighted-Average Exercise Prices Outstanding (Years) Exercise Price --------------- ----------- ---------------- ---------------- $ 4 - 8 202,050 1.35 $6.06 8 - 12 312,625 3.35 9.31 12 - 18 146,750 4.17 13.75 18 - 21 35,000 2.46 19.29 ------- 696,425 ------- -------
Range of Number Weighted-Average Exercise Prices Exercisable Exercise Price --------------- ----------- ---------------- $ 4 - 8 202,050 $ 6.06 8 - 12 240,375 9.08 12 - 18 51,750 16.50 18 - 21 35,000 19.29
NOTE O - EMPLOYEE BENEFIT PLANS
On July 1, 1996, the Company adopted a contributory retirement plan under Section 401(k) of the Internal Revenue Code, for the benefit of all employees meeting certain minimum service requirements. Eligible employees can contribute up to 15% of their salary but not in excess of $9,500 in 1997 and 1996. The Company's contribution under the plan amounts to 20% of the employees' contribution. In 1997 and 1996, the Company contributed $62,000 and $15,886, respectively, to the plan.
NOTE P - SELF INSURANCE
During 1996, the Company decided to self-insure for workers' compensation insurance. The Company has obtained an aggregate excess policy, which limits the Company's exposure to a maximum of $600,000 and $400,000 as of December 31, 1997 and 1996, respectively. The estimated insurance liability totaling $451,000 and $120,000 on December 31, 1997 and 1996, respectively is based upon review by the Company and an independent insurance broker of claims filed and claims incurred but not reported.
On October 1, 1997 the Company entered into a group health plan subject to a self-insured retention. The Company's maximum annual self-insured retention per employee is $1,687, which includes
CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE P - SELF INSURANCE - (Continued)
fixed costs of $418 and claims costs $1,269. The fixed costs include the loss limit charges. The fixed costs are reduced by 5% upon reaching a threshold of 750 participating employees and by another 5% upon a reaching a threshold of 1,000 participating employees. At December 31, 1997 the plan had 878 participants and medical insurance liability of $179,000. This liability represents the maximum claim exposure under the plan less actual payments made during 1997. In addition, the Company is subject to a maximum terminal liability of $168 per participating employee and an administrative charge of $27 per participating employee in the event of termination. Since termination is not anticipated, no terminal accruals were made at December 31, 1997.
NOTE Q - SUBSEQUENT EVENTS
In February, 1998 the Company formed Correctional Services Corporation (UK) Ltd., a British company, to pursue correctional projects in the United Kingdom. The Company intends to build relationships with international joint venture partners to maximize its capabilities abroad.
In February, 1998 the Company signed contracts with the Juvenile Institutions Administration of the Commonwealth of Puerto Rico to operate two Juvenile Treatment Centers and one Juvenile Detention Center. The Salinas Treatment Center has a 100 bed capacity and will be designed, built, owned and operated by CSC. It is estimated that the costs of construction will be $11,000,000. It is expected to become fully operational in the first quarter of 1999. The Bayamon Treatment Center has a 141 bed capacity and is currently undergoing renovation. Until the renovations are complete, which is anticipated to be the first quarter of 1999, the facility will operate at a reduced capacity. The Company will assume operation of the facility in the second quarter of 1998. The Bayamon Detention Center has a 120 bed capacity and will begin accepting residents in the second quarter of 1998. Each of the three contracts has a base period of 5 years with one 5 year renewal option. Once completed and fully operational these facilities are expected to contribute approximately $15 million in revenue on an annualized basis.