AVALON CORRECTIONAL SERVICES, INC




                                UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549

                                  FORM 10-K

              [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                    OF THE SECURITIES EXCHANGE ACT OF 1934
                 For the Fiscal Year Ended December 31, 2003
                                      OR
            [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
                    OF THE SECURITIES EXCHANGE ACT OF 1934
                      For the transition period from to

                       Commission File Number: 0-20307

                      AVALON CORRECTIONAL SERVICES, INC.
            (Exact Name of registrant as specified in its charter)

                  Nevada                                      13-3592263
            (State of Incorporation)                 I.R.S. Employer I.D.Number)

              13401 Railway Drive, Oklahoma City, Oklahoma 73114
             (Address and zip code of principal executive office)

        Issuer's telephone number, including area code (405) 752-8802

       Securities registered pursuant to Section 12(b) of the Act: None

            Securities registered under Section 12 (g) of the Act:

               Shares of Class A Common Stock, par value $.001
                               (Title of class)

     Indicate  by check mark  whether the  registrant  (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the  Securities  Exchange Act of
1934  during  the  preceding  12 months  (or for such  shorter  period  that the
registrant was required to file such reports),  and (2) has been subject to such
filing requirements for the past 90 days: Yes X No ___

     Indicate by check mark if disclosure of delinquent  filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's  knowledge,  in definitive proxy or information  statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]

     Indicate by check mark whether the registrant is an  accelerated  filer (as
defined in Rule 12b-2 of the Act). Yes ___ No X

     The aggregate  market value of voting  common stock held by  non-affiliates
was  approximately  $3,185,000  on June 30,  2003,  based on the average bid and
asked prices of such stock as reported by the National Association of Securities
Dealers Automated Quotations Systems ("NASDAQ") on that day.

     As of April 9, 2004,  4,896,196  shares of the issuer's common stock,  par
value $.001, were issued and outstanding.

                      DOCUMENTS INCORPORATED BY REFERENCE:

     Portions of the Proxy Statement for the 2004 Annual Meeting of Shareholders
are incorporated by reference in Part III, Items 11, 12, 13 and 14.

                                     Page 1
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                       AVALON CORRECTIONAL SERVICES, INC.

                                 INDEX TO ANNUAL
                               REPORT ON FORM 10-K
                      FOR THE YEAR ENDED DECEMBER 31, 2003
                                                                         Page
                                                                         ----
PART I

1.   Business    ..........................................................3

2.   Property..............................................................9

3.   Legal Proceedings....................................................10

4.    Submission of Matters to a Vote of Security Holders.................10

PART II

5.   Market for Registrant's Common Equity and Related
            Stockholder Matters...........................................11

6.   Selected Financial Data..............................................11

7.   Management's Discussion and Analysis of Financial Condition and
            Results of Operation..........................................12

7A.  Quantitative and Qualitative Disclosures About Market Risk...........15

8.   Financial Statements and Supplementary Data..........................16

9.   Changes in and Disagreements With Accountants on Accounting
            and Financial Disclosure......................................36

9A.   Controls and Procedures.............................................36

PART III

10.  Directors and Executive Officers of the Registrant...................36

11.  Executive Compensation...............................................39

12.  Security Ownership of Certain Beneficial Owners and Management and
          Management and Related Stockholder Matters......................39

13.  Certain Relationships and Related Transactions.......................39

14.  Principal Accounting Fees and Services...............................39

PART IV

15.   Exhibits, Financial Statement Schedules, and Reports on Form 8-K....39

      Signatures..........................................................41

      Certifications......................................................42

                                     Page 2
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                       AVALON CORRECTIONAL SERVICES, INC.

                                     PART I

ITEM 1. BUSINESS

The Company

     Avalon  Correctional  Services,  Inc.,  is an owner and operator of private
community correctional  facilities.  Avalon Correctional Services,  Inc. and its
wholly owned  subsidiaries  ("Avalon" or the "Company")  specialize in operating
private community correctional facilities and providing alternative correctional
programming.  Avalon  currently  operates  facilities  and  manages  programs in
Oklahoma,   Texas,  and  Colorado,  with  plans  to  significantly  expand  into
additional states. Avalon's business strategy is designed to elevate the Company
into a dominant role as a provider of community correctional services.  Avalon's
development plan is to expand operations through new state and federal contracts
and  selective  acquisitions.   Avalon  has  been  providing  private  community
correctional  services since 1985.  Avalon  contracts with various  governmental
agencies to provide community corrections operations and services.

     The  management  and  rehabilitation  of inmate  populations  are of utmost
concern to cities, counties, states and a variety of federal agencies throughout
the country.  Increasingly,  government is partnering with private  companies to
assist  them with their  correctional  needs.  Avalon  management  believes  its
background and ability to build and operate  community  correctional  facilities
and provide  correctional  programming,  positions  the Company for  substantial
growth in the corrections industry.

The Challenges for Corrections

     Overcrowded  conditions  in prisons and jails  result in unsafe  management
conditions and often lead to earlier than planned releases by courts and judges.
Inmates in overcrowded  conditions typically receive little or no rehabilitative
programs, resulting in higher recidivism rates.

     High recidivism rates impact the lifetime cost of incarceration.  An inmate
who returns to prison after release not only wastes the initial  investment that
was made, but greatly adds to the lifetime cost of incarceration.

     Skyrocketing  costs of correctional  budgets can place a financial drain on
other  governmental  priorities  such as education  and  healthcare.  Government
officials'  wrestle  with  limited  time and  capital  resources  as they try to
address all of their constituents' needs.

     The Sentencing Project, a group that promotes  alternatives to prison, said
state and federal  policies  continue to drive up  incarceration  rates  despite
sharp drops in violent crime rates since 1994.

     "The  relentless  increases  in  prison  and jail  populations  can best be
explained as the legacy of an entrenched  infrastructure  of punishment that has
been  embedded in the  criminal  justice  system  over the last 30 years,"  said
Malcolm Young, the group's executive director.

     Prisons and jails held one out of every 142 U.S. residents.  The prison and
jail population, long the world's largest, has almost doubled since 1990.

     The  utilization  of beds in  private  secure  and  community  correctional
facilities helps reduce the overcrowded conditions and thus improves the overall
operations  in publicly  operated  prison and jail  systems.  More  specifically
targeted  towards  reducing the rate of reentry or recidivism  rate is community
corrections. The term "community corrections" is one that is often confusing. In
the broadest sense, it is the supervision or treatment of criminal  offenders in
non-secure  residential settings. In states with Community Corrections Acts, the
term  refers  to  specific  programs  that  are  based  and  operated  in  local
communities.  Community based corrections programs broaden the range of criminal
sanctions  available  to the justice  system and manage  populations  that would
otherwise be placed in secure settings.

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                       AVALON CORRECTIONAL SERVICES, INC.

     Appropriations for Community  Corrections,  more specifically for the State
of  Colorado,   have  seen  gradual  increases  since  the  Colorado   Community
Corrections  program  started in 1974.  From the first  appropriations  in 1976,
funding  increased to $1.7 million in FY 1979-80.  Five years later $5.8 million
was appropriated and funding for the most current year (FY02) was $39.7 million.
Despite these increases,  the funding has not kept pace with the demand for beds
and needs for  resources  to provide  quality  community  corrections  services.
Judges have backlogs of offenders eligible for placements in community beds.

     Avalon's  particular  areas of growth  will  come in four of the  following
areas:

          1.   The  trend in  corrections  is toward  utilizing  community-based
               sentencing   rather  than  secure   facilities.   Community-based
               sentencing   relies  to  a   significant   degree  on   community
               corrections facilities, which are Avalon's primary focus.

          2.   Acquisitions of existing community corrections companies continue
               to be attractive and available.

          3.   Federal and State requests for proposals should continue to offer
               opportunities  for expansion due to the ongoing  shortage of beds
               the Federal Bureau of Prisons and county jails are experiencing.

          4.   The increasing number of offenders  incarcerated,  the decline in
               states'  revenues and the  decrease in funds  available to pay to
               house  offenders  are creating  economic  pressure to utilize the
               least  restrictive and most cost effective form of  incarceration
               available.   Community   corrections   programs   are  the  least
               restrictive  and  most  cost  effective  form  of  incarceration.
               Inmates serving the last 6 to 12 months of their incarceration in
               a community  correctional facility report a lower recidivism rate
               than those released directly from secure facilities into society.

     Avalon  currently  owns and operates  2,300 private  community  corrections
beds. The Company owns and operates three community correctional  facilities,  a
160-bed correctional center and one intermediate sanction unit in Oklahoma;  two
medium-security facilities and one community correctional facility in Texas; and
four  community  correctional  facilities  in  Colorado.  Avalon is the  largest
private  provider of community  correctional  services in  Oklahoma.  The Avalon
facilities provide numerous alternative programs for offenders generally serving
the last six  months of their  sentence.  Avalon  provides  contract  agencies a
complete  range of services  relating  to the  security,  detention  and care of
offenders,  and a broad range of rehabilitative  programs to reduce  recidivism.
Programming  is an essential  part of  community-based  corrections.  Avalon has
provided  substance abuse programs for over 18 years.  The provided  programming
includes  substance abuse treatment and counseling,  vocational  training,  work
release programs,  basic educational programs,  job and life skill training, and
reintegration services. The Colorado community corrections programs also provide
non-residential  services  to  approximately  210  offenders  in  the  State  of
Colorado.  Avalon's private pay program,  operated from the Company's  community
correctional  facilities,  has a growing population of clients referred by local
judicial systems as an alternative to secure incarceration.

      Avalon's  corporate office is located at 13401 Railway Drive in Oklahoma
City,  Oklahoma  73114.   Avalon's  common  stock  is  traded  on  the  NASDAQ
Small-Cap Market with the symbol "CITY".

Facilities

      The  following  table  summarizes  certain  information  with  respect  to
facilities and programs managed by Avalon.

Facility Name
And Location                        Capacity             Facility/Program Type
---------------                     ---------            ----------------------

Carver Center,                       300 beds             Community Corrections
  Oklahoma City, Oklahoma                                 Facility
Avalon Correctional Center,          320 Beds             Community Corrections
  Tulsa, Oklahoma                                         Facility
Turley Correctional Center,          150 Beds             Community Corrections
  Tulsa, Oklahoma                                         Facility

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                       AVALON CORRECTIONAL SERVICES, INC.

El Paso Intermediate                 150 Beds             Medium Security
Sanction Facility                                         Correctional Facility
  El Paso, Texas                                          Correctional Facility
Union City Correctional Center,      160 Beds             Medium Security
  Union City, Oklahoma                                    Correctional Facility
El Paso Multi-Purpose Facility,      324 Beds             Medium Security
  El Paso, Texas                                          Correctional Facility
Phoenix Center,                      207 Beds             Community Corrections
  Henderson, Colorado                                     Facility
The Villa at Greeley,                307 Beds             Community Corrections
  Greeley, Colorado                                       Facility
The Loft House,                      35 Beds              Community Corrections
  Denver, Colorado                                        Facility
Community Sentencing Center,         N/A                  Day Reporting Center,
  Northglenn, Colorado                                    Community Corrections
                                                          Facility
Riverside Intermediate Sanction      352 Beds             Intermediate Sanctions
  Tulsa, Oklahoma                                         Unit, Community
                                                          Corrections
Austin Transitional Center,          180 Beds             Community Corrections
  Del Valle, Texas                                        Facility
Emerald Square,                      60 Beds              Assisted Living Center
  Oklahoma City, Oklahoma
Avalon Corporate Office,             N/A                  Administration
  Oklahoma City, Oklahoma

Community Correctional Services

     Avalon owns and operates nine community based correctional centers,  Carver
Center,  Avalon  Correctional  Center,  Turley Correctional  Center,  Union City
Correctional   Center,  El  Paso  Intermediate   Sanction   Facility,   El  Paso
Multi-Purpose Facility, Austin Transitional Center, Phoenix Center and The Villa
at Greeley.  The Company also operates community  corrections  programs in three
leased  facilities;  the  Loft  House,  a  community  corrections  program;  the
Community   Sentencing  Center,  a  day  reporting  center;  and  the  Riverside
Intermediate  Sanction  Unit, a multi-use  corrections  program.  The  community
corrections centers provide complete correctional  administration,  correctional
officer staffing, housing, food services, vocational assistance, transportation,
and rehabilitation services.

     Oklahoma  Avalon's  contracts  with the Oklahoma  Department of Corrections
extend  through June 30, 2004 and are generally  renewed every three years.  The
structure  of the  Oklahoma  contracts  is based  upon three  one-year  contract
periods.  Avalon has contracted  with the State of Oklahoma  pursuant to similar
contracts since 1985. The State of Oklahoma's performance under the contracts is
subject  to  annual  appropriation  by the  legislature.  Avalon  also  provides
services  pursuant to a Federal contract obtained in 1997. The five-year Federal
contract was renewed in 1999 and extends through 2004.

     Carver  Center is a  300-bed  community  corrections  facility  located  in
Oklahoma  City,  Oklahoma.  Carver  Center has been  expanded  from its  initial
capacity of 50 beds in 1985, to its current  capacity of 300 beds to accommodate
the increasing  needs of the Oklahoma  Department of Corrections.  Carver center
was sited, designed, and constructed by Avalon.

     Avalon  Correctional  Center is a 320-bed  community  corrections  facility
located in Tulsa,  Oklahoma.  The  facility has been  expanded  from its initial
capacity of 255 beds to its  current  capacity  of 320 beds to  accommodate  the
increasing  needs  of  the  Oklahoma  Department  of  Corrections.   The  Avalon
Correctional Center was sited, designed, and constructed by Avalon and opened in
July  1995.
                                     Page 5
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                       AVALON CORRECTIONAL SERVICES, INC.

     Turley  Correctional  Center is a 150-bed  community  corrections  facility
located in Tulsa,  Oklahoma.  Avalon acquired the Turley  Correctional Center in
October 1997. A new 150-bed correctional facility was constructed on the 35-acre
grounds at the Turley Correctional Center in May of 2000.

     Union City  Correctional  Center is a 160-bed medium security  correctional
facility located in Union City, Oklahoma. The Union City Correctional Center was
sited,  designed,  and constructed by the Company for use as a Juvenile  Center.
Construction of the Union City Correctional  Center was completed and the Center
began receiving  offenders in February 1999. The Center has a licensed  capacity
of 160 beds. The Oklahoma Office of Juvenile  Affairs,  in a cost-cutting  move,
did not exercise the option for the final year of a five-year contract providing
for the care of 80 juveniles at the facility.  The contract  expired on December
2, 2002 and the  building  is  currently  used as an overflow  facility  for the
Carver  Center.  See  Note  11 to  the  consolidated  financial  statements  for
discussion of pending sale of this facility.

     Riverside  Intermediate  Sanction  Unit was opened in  December  2001.  The
facility is leased from the Tulsa County Criminal Justice Authority for a period
of up to twenty  years.  The  facility is utilized  to provide  substance  abuse
programming and community corrections programs for various jurisdictions.

Accreditation of Facilities and Quality Performance

     Avalon maintains an internal quality  assurance  program and the results of
this  program  are  readily  available  to current  and  prospective  customers.
Independent  accreditation by various oversight and regulatory  organizations is
designed  to  show  that  a  facility  meets  nationally  accepted  professional
standards  for  quality  of  operation,   facility   design,   management,   and
maintenance.  Accrediting entities include the American Correctional Association
(ACA) for the adult secure and  community  corrections  sectors,  as well as the
Department of Mental Health, Department of Public Welfare,  Department of Health
and Department of Fire and Safety.

     The Avalon  facilities are managed in accordance with the guidelines of the
American Correctional Association. Carver Center, Avalon Correctional Center and
Turley  Correctional   Center  are  accredited  by  the  American   Correctional
Association   ("ACA")   as  Adult   Community   Correctional   Facilities.   ACA
accreditation  or candidacy  is required to contract  with the State of Oklahoma
for correctional services. The ACA, a private not-for-profit  organization,  was
established to develop  uniformity  and industry  standards for the operation of
correctional facilities and provision of inmate care.  Accreditation involves an
extensive  audit  and  compliance  procedure,  and is  generally  granted  for a
three-year period. The current  accreditation for Carver Center expires in 2005.
Avalon  Correctional  Center was initially  accredited in 1996 and is accredited
through 2005.  Turley  Correctional  Center was initially  accredited in October
2000 and is accredited through October 2006. The Riverside Intermediate Sanction
Unit will apply for ACA accreditation in 2004.

     Texas Avalon  acquired  the El Paso  Intermediate  Sanction  Facility in El
Paso, Texas in August 1996. The facility has a capacity of 150-beds. The Company
entered into a fifteen-year contract to provide services in the facility for the
West Texas Community Supervision and Corrections Department in July 1996.

     The Company  was awarded a contract in June 1998 with the Texas  Department
of Criminal Justice to provide 250  multi-purpose  beds in El Paso, Texas. A new
324-bed  facility was  constructed  adjacent to the existing El Paso Facility in
1999 to accommodate this new contract.  The El Paso  Multi-Purpose  Facility was
completed and became operational in the second quarter of 1999.

     Avalon  acquired  the Austin  Transitional  Center in  December  2001.  The
community  corrections  facility has a capacity of 180  offenders  and contracts
with  the  Texas  Department  of  Criminal  Justice  for  community  corrections
services.  The facility  consists of thirteen modular  buildings owned by Avalon
and located on leased land. The land is leased for a period of five years with a
renewal option of five years.

     Avalon contracted with Tom Green County in Texas to operate the Roy K. Robb
facility,  a  post-adjudication  juvenile  substance abuse facility in September
2002. The Company cancelled the contract in March 2003.

                                     Page 6
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                       AVALON CORRECTIONAL SERVICES, INC.

     Colorado The Company acquired a management  contract in May 1999 to operate
the Adams Community  Corrections  Program in Northglenn,  Colorado.  The Program
provides  residential  and  non-residential  services  in three  locations:  The
Phoenix Center, a 107-bed  residential center in Henderson,  Colorado;  The Loft
House,  a 35-bed  residential  program in  Denver,  Colorado  and the  Community
Sentencing Center, a day reporting center in Northglenn,  Colorado.  The Company
completed the expansion of the Phoenix Center from 107 beds to 207 beds in 2003.
The Program provides services pursuant to contracts with various state, federal,
and local agencies.

     The Company  acquired The Villa at Greeley in June 1999. The Villa owns and
operates  a  307-bed   multi-purpose   facility  and  provides  residential  and
non-residential  offender  services and an assisted  living  program in Greeley,
Colorado. The Villa contracts with various state, federal, and local agencies.

Assisted Living Center

     The  Company  holds a 15% equity  interest  in an  assisted  living  center
located in Oklahoma  and has an  investment  of $0 at  December  31,  2003.  The
Company  guaranteed  facility debt related to the building of the investment and
has  pledged  $1,600,000  in  certificates  of deposit for such  guarantee.  The
Company has operated the facility since it was constructed in 1997.

Competition

     While   generally   funded  by  state   corrections   agencies,   community
correctional services are operated in large part by a fractured array of private
organizations.   The  Salvation  Army,  Volunteers  of  America  charities,  and
approximately   several  thousand  individual   operations  nationally  claim  a
significant share of the community corrections market.

     Community  Corrections  was founded more than 150 years ago. The 1980's saw
tremendous growth in community corrections' populations,  from about 1.4 million
persons  at the start of the  decade to 3.2  million  by 1990,  a more than 130%
increase.  This increase was larger than that  experienced  by either prisons or
jails over the same  period.  In 2000,  approximately  two-thirds  of the adults
under  correctional  supervision  were on parole or on  probation.  In 2001,  an
estimated  585,000  offenders  were released into the community  with a need for
transitional  services  such as  community  corrections.  Since  supervising  an
offender on parole costs about  one-tenth the cost of  incarcerating  an inmate,
the attractiveness of this solution is apparent.

     Virtually   every  national   study  and  commission   beginning  with  the
President's  Commission on Law Enforcement and  Administration of Justice (1967)
up to the  President's  National Drug Control  Strategy  (1990) has  recommended
expanding  community  corrections.  The National Advisory Commission on Criminal
Justice  Standards and Goals  referred to community  corrections  as the justice
system's  "brightest  hope."  Public  opinion  polls also show wide  support for
community-based sentencing for nonviolent offenders.

     President  George W. Bush in his State of the Union Address  (January 2004)
said this, "In the past,  we've worked  together to bring mentors to children of
prisoners and provide  treatment  for the  addicted,  and help for the homeless.
Tonight I ask you to consider  another group of Americans in need of help.  This
year  (2004),  some  600,000  inmates  will be  released  from  prison back into
society.  We know from long experience that if they can't find work or a home or
help, they are more likely to commit crimes and return to prison. So tonight,  I
propose a four-year,  $300 million  Prisoner  Re-Entry  Initiative to expand job
training and placement services,  to provide  transitional  housing, and to help
newly released  prisoners get  mentoring,  including  from  faith-based  groups.
America is the land of second chance and when the gates of the prison open,  the
path ahead should lead to a better life."

Private Corrections Management

     The U.S. prison population surpasses 2 million, according to reports issued
by the United States  Department of Justice,  Bureau of Justice  Statistics (the
"BJS").  The  number of adult  offenders  housed  in  federal  and state  prison
facilities  and in local  jails  increased  from  744,208  at  year-end  1985 to
2,033,331 at year end. Industry reports indicate that adult offenders  convicted
of violent  crimes  generally  serve only  one-third of their  sentence with the
majority of them being repeat offenders.  Accordingly,  there is a public demand
for longer  prison  sentences,  as well as prison terms for juvenile  offenders,
resulting in even more overcrowding in United States  correctional and detention
facilities. Finally, numerous courts and other government entities in the United
States have mandated that additional  services  offered to offenders be expanded
in the community and that more rehabilitation  programs are offered to offenders
qualifying for community corrections placement.
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                       AVALON CORRECTIONAL SERVICES, INC.

     At least 95% of all state  prisoners  will be released  from prison at some
point.  Nearly  80% will be  released  to  parole  or to  community  supervision
programs.  A BJS recidivism study of 272,111 persons released from prisons in 15
states  in  1994  estimated  67.5%  were  rearrested  for a  felony  or  serious
misdemeanor within 3 years, 46.9% were reconvicted,  and 25.4% were re-sentenced
to  prison  for a new  crime.  The  272,111  offenders  discharged  in 1994  had
accumulated 4.1 million arrest charges before their most recent imprisonment and
another 744,000 charges within 3 years of release.

     If recent incarceration rates remain unchanged,  an estimated 1 of every 15
persons (6.6%) will serve time in a prison during their lifetime.

     Contracts for correctional  services are awarded by government agencies and
are generally based upon competitive  bidding and quality of services  provided.
Avalon  management  believes the Company has several  competitive  advantages in
contracting for community  correctional  services including:  a) a nineteen-year
history of providing quality services to the Oklahoma Department of Corrections;
b) a geographic location allowing for lower administrative overhead charges when
bidding against  competitors for regional  contracts;  c)  accreditation  by the
American  Correctional  Association  since 1990 and  certification as a drug and
alcohol  treatment  services  provider  since  1985;  and d) a high  quality and
cost-effective  corporate  infrastructure for management,  marketing,  financial
management, financial reporting, quality assurance, and support services.

     Avalon  has  developed  a  broad  range  of  programs  designed  to  reduce
recidivism,  including  substance  abuse  treatment and  counseling,  vocational
training,  work release programs, GED classes, job and life skills training, and
reintegration services in addition to providing fundamental residential services
for adult  inmates.  The  management  services  offered by Avalon range from the
design and development of new correctional  facilities,  to the complete turnkey
development  including,  siting,  designing,   constructing,  and  operating  of
community correctional facilities. Avalon management believes its experience and
success in owning and operating community correctional  facilities and providing
successful  programming  will be the basis for becoming the dominant  company in
the community corrections  industry.  Avalon is the only publicly traded company
focused solely on the community corrections segment of the corrections industry.

     For the year ended  December 31, 2003,  approximately  31% of the Company's
revenue was derived  from  contracts  with the  Oklahoma  governmental  agencies
relating to the Company's  adult community  correctional  facilities in Oklahoma
City ("Carver  Center"),  Tulsa  ("Avalon  Correctional  Center" and  "Riverside
ISF"),  and Turley  ("Turley  Correctional  Center").  Approximately  24% of the
Company's  revenue  was  derived  from  contracts  with  Colorado   governmental
agencies.  Approximately 27% of the Company's revenue was derived from contracts
with  Texas  governmental  agencies,  relating  to  the  Company's  correctional
facilities  in El Paso and  Austin,  Texas.  Approximately  8% of the  Company's
revenue was derived from collections directly from individual offenders.

     Community  Corrections programs enhance  opportunities to apply restorative
justice  principles by making non violent  offenders  personally  responsible to
their community for their criminal offenses while providing  opportunities to be
locally rehabilitated.  Community Corrections provides significant relief to the
ever-increasing adult correctional system and offers a savings to U.S. citizens.

Insurance

     Avalon maintains  insurance  coverage for general  liability,  property and
contents, automobile physical damage and liability,  workers' compensation,  and
directors  and  officers.  Avalon  believes its existing  insurance  coverage is
adequate.

Regulations

     Avalon maintains an internal quality  assurance  program and the results of
this  program  are  readily  available  to current  and  prospective  customers.
Independent  accreditation by various oversight and regulatory  organizations is
designed  to  show  that  a  facility  meets  nationally  accepted  professional
standards  for  quality  of  operation,   facility   design,   management,   and
maintenance.  Accrediting entities include the American Correctional Association
(ACA) for the adult secure and  community  corrections  sectors,  as well as the
Department of Mental Health, Department of Public Welfare,  Department of Health
and Department of Fire and Safety.
                                     Page 8
<PAGE>
                       AVALON CORRECTIONAL SERVICES, INC.


     The Avalon  facilities are managed in accordance with the guidelines of the
American Correctional Association. Carver Center, Avalon Correctional Center and
Turley  Correctional   Center  are  accredited  by  the  American   Correctional
Association   ("ACA")   as  Adult   Community   Correctional   Facilities.   ACA
accreditation  or candidacy  is required to contract  with the State of Oklahoma
for correctional services. The ACA, a private not-for-profit  organization,  was
established to develop  uniformity  and industry  standards for the operation of
correctional facilities and provision of inmate care.  Accreditation involves an
extensive  audit  and  compliance  procedure,  and is  generally  granted  for a
three-year period.

     The corrections industry is subject to federal, state and local regulations
administered by a variety of regulatory  authorities.  The correctional services
offered by Avalon in various states are subject to regulations  and oversight by
the  various  government  agencies.   Management  believes  its  operations  are
currently in  compliance  with all  applicable  laws and  regulations  affecting
Avalon's business.

Employees

     At April 9,  2004,  Avalon  had  approximately  430  full-time  employees,
including  directors and officers.  Avalon has not  experienced a work stoppage,
and management considers its employee relations to be good.

ITEM 2.  PROPERTY

     Carver  Center is a  300-bed  community  corrections  facility  located  in
Oklahoma  City,  Oklahoma.  The  facility  is  located on five acres of land and
includes five buildings.  Avalon  constructed a new 16,000 square foot dormitory
at Carver  Center in the second  quarter of 1995.  The  Carver  Center  facility
contains  approximately  35,000 square feet of building space. Carver Center was
sited, designed, and constructed by the Company.

     Avalon  Correctional  Center is a 320-bed  community  corrections  facility
located on approximately two acres of land in Tulsa,  Oklahoma. The construction
of the approximately 36,000 square foot facility was completed and opened by the
Company in July 1995. The Avalon  Correctional Center was sited,  designed,  and
constructed by the Company.

     Turley  Correctional  Center is a 150-bed  community  corrections  facility
located in Tulsa,  Oklahoma. The facility is located on a thirty-five acre tract
of land and includes two buildings. The Company acquired the Turley Correctional
Center in October  1997.  A new 26,000  square foot  correctional  facility  was
sited,  designed  and  constructed  by the Company and opened in May 2000 on the
grounds at the Turley Correctional Center.

     El  Paso  Intermediate  Sanction  Facility  is a  150-bed  medium  security
correctional  facility  located on seven  acres of land in El Paso,  Texas.  The
facility was  constructed  as an  intermediate  sanction  facility.  The Company
acquired the 36,000 square foot facility in 1996.

     Union City  Correctional  Center is a 160-bed medium security  correctional
facility  located on 20 acres of land in Union City,  Oklahoma.  Construction of
the 45,000 square foot  facility was  completed  and the Center began  receiving
offenders  in  February  1999.  The Union  City  Correctional  Center was sited,
designed, and constructed by the Company.

     El Paso  Multi-Purpose  Facility is a 324-bed medium security  correctional
facility on seven acres of land acquired in 1998 in El Paso, Texas. Construction
of the  54,000  square  foot  facility  was  completed  in  1999.  The  El  Paso
Multi-Purpose Facility was sited, designed, and constructed by the Company.

     The Phoenix Center is a 207-bed community  corrections  facility located in
Northglenn,   Colorado.   The  29,757   square  foot   facility  is  located  on
approximately  2.2 acres of land.  The Company  completed  the  expansion of the
Phoenix  Center  from 107 beds to 207 beds in 2003.  The  Company  acquired  the
Phoenix Center in 1999.
                                     Page 9
<PAGE>
                       AVALON CORRECTIONAL SERVICES, INC.

     The Villa at Greeley is a 307-bed multi-use  correctional  facility located
in  Greeley,   Colorado.   The  101,000  square  foot  facility  is  located  on
approximately  four acres of land. The Company  acquired the Villa at Greeley in
1999.

     The Loft  House is a  35-bed  community  corrections  facility  located  in
Denver, Colorado. The Company leases the Loft House location.

     Community  Sentencing  Center is a day  reporting  correctional  program in
Northglenn,  Colorado.  The Center is leased and  contains  approximately  3,500
square feet.

     Riverside  Intermediate Sanction Unit is a 352-bed facility leased from the
Tulsa County  Criminal  Justice  Authority.  The initial lease term ends in June
2007, with three five-year  options for extension.  The facility was extensively
renovated by the Company and opened in December 2001.

     Austin  Transitional  Center is a 180-bed  community  corrections  facility
located in Del  Valle,  Texas,  a suburb of Austin.  The  facility  consists  of
thirteen modular  buildings owned by Avalon and located on leased land. The land
is leased for a period of five years with a renewal  option of five  years.  The
Company acquired the Austin Transitional Center in December 2001.

     Emerald  Square is a 60-bed  assisted  living  center  facility  located in
Oklahoma  City,  Oklahoma.  The  facility  was built in 1996 and  consists of 55
living units plus common areas,  offices,  kitchen and dining areas,  all in one
building, located on 14 acres of land.

     Avalon  Corporate  Office is  located  in  Oklahoma  City,  Oklahoma,  in a
commercial  building at 13401 Railway Drive,  Oklahoma City, Oklahoma 73114. The
Company owned building  contains  approximately  21,000 square feet of warehouse
space including approximately 13,000 square feet of office space.

     Substantially  all property owned by Avalon is pledged as collateral on the
Company's  credit  facilities.   See  Note  7  to  the  Consolidated   Financial
Statements.

ITEM 3.  LEGAL PROCEEDINGS

     Avalon is a party to  litigation  arising in the normal course of business.
Management  believes that the ultimate  outcome of these matters will not have a
material effect on Avalon's financial condition or results of operations.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

      None.
                                    Page 10
<PAGE>
                       AVALON CORRECTIONAL SERVICES, INC.

                                   PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

     Avalon's common stock trades on the NASDAQ Small-Cap Market with the symbol
"CITY".  The following table reflects the range of high and low sales prices, as
reported by the National  Quotation Bureau for each quarterly period during 2003
and 2002. The prices represent inter-dealer prices, without retail mark up, mark
down,  or  commission  and may not  represent  actual  transactions.  Trading in
Avalon's  common stock is limited and may not be an  indication  of the value of
the common stock.

            Quarterly Period Ended              High              Low
            ----------------------              -----             ----

            December 31, 2003                   $2.06             $1.37
            September 30, 2003                  $1.55             $1.27
            June 30, 2003                       $1.55             $1.25
            March 31, 2003                      $1.50             $1.17
            December 31, 2002                   $1.87             $1.20
            September 30, 2002                  $2.30             $1.80
            June 30, 2002                       $2.55             $2.26
            March 31, 2002                      $2.45             $2.05

     The  average  high and low price for the Common  Stock,  as reported on the
NASDAQ Small-Cap Market System was $2.38 per share on April 8, 2004.

     Avalon had  approximately  138 holders of record of its common  stock as of
April 9, 2004.  The Company did not declare any dividends  during 2003 or 2002.
Avalon's  Board of  Directors  presently  intends to retain all  earnings in the
foreseeable  future for use in Avalon's  business.  Payment of  dividends on the
Common Stock is restricted by certain credit facilities.

Equity Compensation Plans

     The  following  table  provides  information  with respect to the Company's
equity compensation plans as of December 31, 2003.

<TABLE>
<CAPTION>
<S>                                   <C>                     <C>                  <C>
                                                                                       Number of securities
                                                                                     remaining available for
                                        Number of securities                         future insurance under
                                         to be issued upon      weighted average      equity compensation
                                            exercise of         exercise price of       plans (excluding
                                          outside options,     outstanding options,    securities reflected
                                         warrants and rights    warrants and rights        in column (a)
                                         -------------------    -------------------         -------------

      Plan Category                             (a)                   (b)                       (c)
                                                ---                   ---                       ---
Equity compensation plans
 approved by security holders (1)            692,660                $1.69                     7,340
</TABLE>

(1)  These stock options have been issued pursuant to the Company's Stock Option
     Plan which has been approved by security holders.

ITEM 6.  SELECTED FINANCIAL DATA

     The  following  selected  financial  data  as of and for  the  years  ended
December 31, 1999 through 2003 has been derived from the Company's  consolidated
financial statements.  The following data should be read in conjunction with the
Company's  consolidated  financial  statements,  the related notes thereto,  and
"Management's
                                    Page 11
<PAGE>
                       AVALON CORRECTIONAL SERVICES, INC

Discussion and Analysis of Financial Condition and Results of Operations."
<TABLE>
<CAPTION>

                                             For the Years Ended December 31,
                             -----------------------------------------------------------------
<S>                     <C>           <C>           <C>          <C>            <C>
                               2003          2002          2001           2000         1999
                               ----          ----          ----           ----         ----
Statement of Operations:

Revenues                    $25,260,000   $27,456,000   $25,147,000   $22,922,000   $16,803,000
                            ===========   ===========   ===========   ===========   ===========
Expenses                    $23,475,000   $25,788,000   $23,822,000   $21,959,000   $16,685,000
                            ===========   ===========   ===========   ===========   ===========
Operating Income            $ 1,785,000   $ 1,668,000   $ 1,325,000   $   963,000   $   118,000
                            ===========   ===========   ===========   ===========   ===========
Net Income                  $ 1,174,000   $ 1,121,000   $ 1,325,000   $   963,000   $    83,000
                            ===========   ===========   ===========   ===========   ===========
Basic income per share      $      0.24   $      0.23   $      0.28   $      0.20   $      0.02
                            ===========   ===========   ===========   ===========   ===========
Diluted income per share    $      0.22   $      0.20   $      0.25   $      0.20   $      0.02
                            ===========   ===========   ==========    ===========   ===========


                                                        December 31,
                            -------------------------------------------------------------------
                                2003          2002          2001         2000          1999
                                ----          ----          ----         ----          ----
 Balance Sheet Data:

Total assets                $39,701,000   $39,691,000   $40,087,000   $39,455,000   $38,440,000

Total liabilities           $28,350,000   $29,517,000   $31,112,000   $31,933,000   $31,949,000

Stockholders' equity        $ 8,723,000   $ 6,998,000   $ 5,505,000   $ 3,929,000   $ 2,367,000
</TABLE>

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS

     This  document  contains   statements  that  are  not  historical  but  are
forward-looking  statements  within the meaning of Section 27A of the Securities
Act of 1933 and  Section  21E of the  Securities  Exchange  Act of  1934.  These
include statements regarding the expectations, beliefs, intentions or strategies
for the future.  The Company  intends  that all  forward-looking  statements  be
subject to the  safe-harbor  provisions  of the  Private  Securities  Litigation
Reform Act of 1995. These forward-looking statements reflect the Company's views
as of the date  they are made  with  respect  to  future  events  and  financial
performance,  but are subject to many  uncertainties and risks which could cause
the actual results of the Company to differ  materially  from any future results
expressed  or  implied  by such  forward-looking  statements.  Examples  of such
uncertainties  and  risks  include,  but are not  limited  to:  fluctuations  in
occupancy  levels and labor costs;  the ability to secure both new contracts and
the renewal of existing  contracts;  the  availability  and cost of financing to
redeem common shares and to expand the Company's business; and public resistance
to  privatization.  Additional  risk factors  include those discussed in reports
filed by the Company from time to time on Forms 10-K,  10-Q and 8-K. The Company
does not undertake any obligation to update any forward-looking statements.

Overview

     Avalon  Correctional  Services,  Inc.,  is an owner and operator of private
community  correctional  facilities containing  approximately 2,300 beds. Avalon
Correctional  Services,  Inc. and its wholly owned  subsidiaries  specialize  in
operating private community  correctional  facilities and providing  alternative
correctional  programming.  Avalon  currently  operates  facilities  and manages
programs in Oklahoma,  Texas, and Colorado,  with plans to significantly  expand
into additional  states.  Avalon's  business strategy is designed to elevate the

                                    Page 12
<PAGE>
                       AVALON CORRECTIONAL SERVICES, INC

Company into a dominant role as a provider of community  correctional  services.
Avalon's  development plan is to expand operations through new state and federal
contracts  and  selective  acquisitions.   Avalon  has  been  providing  private
community  correctional  services  since 1985.  Avalon  contracts  with  various
governmental agencies to provide community corrections  operations and services.
The management and rehabilitation of inmate populations are of utmost concern to
cities,  counties,  states  and a variety  of federal  agencies  throughout  the
country. Increasingly, government is partnering with private companies to assist
them with their correctional  needs.  Management of the Company closely monitors
the operations and assesses the residential and nonresidential  census data. For
further information, see Results of Operations.

Results of Operations

Year Ended December 31, 2003 Compared to the Year Ended December 31, 2002

     Total revenues  decreased by 8% to $25,260,000 in 2003 from  $27,456,000 in
2002.  The net decrease in revenues was primarily a result of the closure of the
Union City Facility in December  2002. The Union City contract with the Oklahoma
Office of Juvenile  Affairs expired on December 2, 2002. The Union City facility
contributed revenues of $3,575,000 in 2002 and $3,819,000 in 2001. The Company's
net  income  before  taxes  increased  7% to  $1,785,000  in  2003  compared  to
$1,668,000 in 2002.

     Operating income before interest,  depreciation and amortization and income
taxes  decreased 9% to $5,955,000 in 2003 from  $6,518,000 in 2002.  The average
daily residential offender census increased by 3% to 1,744 in 2003 from 1,693 in
2002. The average daily non-residential offender census was 260 in 2003 compared
to 224 in 2002.  The  residential  census  increase  was a result  of  increased
offender  census in the Company's  existing  facilities and the expansion of the
Phoenix  Center in June 2003.  These  increases  were  offset by the loss of the
Union City  contract  that expired on December 2, 2002.  The Oklahoma  Office of
Juvenile  Affairs did not  exercise the option for the final year of a five-year
contract for this facility. The Union City facility contributed operating income
before interest, depreciation and amortization and income taxes of $1,195,000 in
2002 (prior to  allocation  of corporate  overhead).  The data to reconcile  the
Company's  net income of  $1,174,000  to operating  income of  $5,955,000  is as
follows.  Add back to net income the amounts of $611,000 for income tax expense,
$2,287,000 for interest expense and $1,883,000 for depreciation and amortization
expense.

     The Company entered into an asset purchase agreement to sell the Union City
facility in February 2004. The sale is subject to certain  customary  conditions
as  well  as the  Buyer's  ability  to  obtain  financing,  receive  appropriate
licenses, certifications, permits, zoning and a contract for a client population
for the  facility.  The asset  purchase  agreement  is  scheduled to close on or
before June 25,  2004.  The asset  purchase  agreement  is expected to result in
proceeds in excess of the carrying value of the Union City facility.  Should the
contract not close or be extended, the Company will review the carrying value of
the  facility  and  determine if an  impairment  of the  carrying  value will be
required during the second quarter of 2004.

     Direct  operating  expenses  decreased by 7% in 2003 compared to 2002.  The
decrease  was a result of the  closure of the Union City  Facility  in  December
2002.  The  Company  also  incurred  start up costs  of  approximately  $357,000
associated  with  the  Riverside  Intermediate  Sanction  Unit  and Roy K.  Robb
facility during 2002.

     General and administrative  expenses decreased by 14% in 2003. The decrease
was a result of significant cost containment efforts. General and administrative
expenses equaled approximately 7% of revenues in 2003 and 2002. Depreciation and
amortization  expense was $1,883,000 for 2003 compared to $2,256,000 for 2002, a
decrease  of 17%.  The  decrease  was a result of  several  assets  being  fully
depreciated  during 2002.  The  amortization  of intangible  contract  costs was
$225,000 in 2003 and 2002.  Interest expense  decreased by $307,000 in 2003 as a
result of lower interest rates and lower borrowing levels.

      The Company's  effective  tax rate for 2003 was 34.2%  compared to 32.8%
for 2002.  The Company's  income tax expense was $611,000 in 2003, an increase
of $64,000  over the income tax  expense  of  $547,000  for 2002,  the year in
which the Company fully  utilized its remaining  tax loss  carryforwards.  Net
income for 2003 was $1,174,000, compared to $1,121,000 for 2002.
                                    Page 13
<PAGE>
                       AVALON CORRECTIONAL SERVICES, INC

Year Ended December 31, 2002 Compared to the Year Ended December 31, 2001

     Total revenues  increased by 9% to $27,456,000 in 2002 from  $25,147,000 in
2001. The net increase in revenues was primarily a result of increased  offender
census,  the opening of the  Riverside  Intermediate  Sanction  Unit in December
2001, the acquisition of the Austin Transitional Center in December 2001 and the
addition of Roy K. Robb  contract in September  2002.  The  Company's net income
before taxes increased 26% to $1,668,000 in 2002 compared to $1,325,000 in 2001.

     Operating income before interest, depreciation and amortization, and income
taxes  increased 5% to $6,518,000 in 2002 from  $6,199,000 in 2001.  The average
daily  residential  offender census increased by 14% to 1,693 in 2002 from 1,486
in 2001.  The  average  daily  non-residential  offender  census was 224 in 2002
compared  to 243 in 2001.  The  residential  census  increase  was a  result  of
increased offender census in the Company's existing  facilities,  the opening of
the Riverside Intermediate Sanction Unit in December 2001 and the acquisition of
the Austin  Transitional  Center in December  2001. The Union City contract with
the Oklahoma  Office of Juvenile  Affairs expired on December 2, 2002. The Union
City facility contributed revenues of $3,575,000 in 2002 and $3,819,000 in 2001.
The  Union  City  facility   contributed   operating   income  before  interest,
depreciation  and  amortization  and  income  taxes  of  $1,195,000  in 2002 and
$1,047,000  in 2001 (prior to  allocation  of corporate  overhead).  The data to
reconcile  the  Company's  net  income  of  $1,121,000  to  operating  income of
$6,518,000  is as follows.  Add back to net income the  amounts of $547,000  for
income  tax  expense,   $2,594,000  for  interest  expense  and  $2,256,000  for
depreciation and amortization expense.

     Direct  operating  expenses  increased by 10% in 2002 compared to 2001. The
increase was a result of additional  costs  associated  with increased  offender
census in the  Company's  existing  facilities,  the  opening  of the  Riverside
Intermediate  Sanction  Unit in  December  2001 and the  addition  of the Austin
Transitional  Center in December  2001.  The Company  incurred start up costs of
approximately  $357,000 associated with the Riverside Intermediate Sanction Unit
and Roy K. Robb facility during 2002.

     General and administrative  expenses increased by 11% in 2002. The increase
was a result  of  additional  costs  associated  with the  increase  in  overall
offender  census  and  additional  staffing  for the new  facilities  opened and
acquired in 2001. General and administrative  expenses equaled  approximately 7%
of  revenues  in 2002  and  2001.  Depreciation  and  amortization  expense  was
$2,256,000  for 2002  compared to  $1,881,000  for 2001, an increase of 20%. The
increase was a result of the additional expenses associated with the addition of
the Riverside and Austin  facilities.  Interest expense decreased by $399,000 in
2002 as a result of lower interest rates and lower borrowing levels.

     The Company fully utilized its remaining tax loss carryforwards in 2002 and
recorded  income tax expense of  $547,000.  The Company did not incur income tax
expense in 2001. Net income for 2002 was $1,121,000,  compared to $1,325,000 for
2001.

Liquidity and Capital Resources

     The  Company's  business  strategy  is to  focus on the  private  community
corrections industry, expanding its operations in existing and additional states
through  new  Federal  and  state  contracts  and  selective  acquisitions.  The
successful  implementation of the Company's growth plan will create the need for
additional capital and financing.

     Working capital at December 31, 2003 was $1,683,000  representing a current
ratio of  1.42:1.00,  compared to working  capital of  $1,130,000  and a current
ratio of 1.23:1.00 at December 31, 2002. Capital expenditures were $2,587,000 in
2003,  $1,206,000 in 2002 and $2,179,000 in 2001. The 2003 capital  expenditures
include  renovations  and expansion of the Carver  Center to increase  capacity,
expansion  of the  Phoenix  Center to increase  capacity to 207 beds,  and other
normal operating purchases of vehicles, equipment and building improvements. The
2002 capital expenditures include renovations to the Carver Center, expansion of
the Phoenix Center, and other normal operating purchases of vehicles, equipment,
and building  improvements.  The 2001 capital expenditures include expansion and
new  furniture to increase  the  capacity of Carver  Center from 250 beds to 300
beds,   expansion   and  new  furniture  to  increase  the  capacity  of  Avalon
Correctional  Center  from 255 beds to 320 beds in the  third  quarter  of 2001,
renovation  of the  Riverside  Intermediate  Sanction  Unit  in  November  2001,
expansion of office space at the Central Office in June 2001, the acquisition of
the Austin Transitional Center in December 2001, expansion of the Phoenix Center
in December 2001, and other normal  operating  purchases of vehicles,  equipment
and building improvements.  Operations provided $3,749,000 in cash flow in 2003,
$2,760,000 in 2002 and $5,135,000 in 2001.
                                    Page 14
<PAGE>
                       AVALON CORRECTIONAL SERVICES, INC

      The Company had  approximately  $2,600,000 of cash and revolving  credit
available for new projects at December 31, 2003.  The Company  believes it has
adequate cash reserves and cash flow from  operations to meet its current cash
requirements.  The Company  expects current  contracts to generate  sufficient
income to increase cash balances.  The Company is exploring  various financing
options  in  anticipation  of future  debt  maturities  and  future  expansion
opportunities. See Note 7 to consolidated financial statements.

Contractual Obligations

Future payments due on the Company's contractual  obligations as of December 31,
2003 are as follows:
<TABLE>
<CAPTION>
                                               Payments due by period
<S>                     <C>             <C>           <C>           <C>            <C>
                         ------------------------------------------------------------------
                             Total         2004        2005-2006     2007-2008   thereafter
                             -----         ----        ---------     ---------   ----------
Long term debt            $22,335,000   $2,030,000   $19,963,000   $    65,000   $  277,000
Convertible debentures      3,850,000           -              -     3,850,000           -
Carver expansion              400,000      400,000             -             -           -
Operating leases              781,000      329,000       340,000       112,000           -
                          -----------------------------------------------------------------
Total                     $27,366,000   $2,759,000   $20,303,000    $4,027,000   $  277,000
                          =================================================================
</TABLE>

     The  Company  sold  1,622,448  shares  of  redeemable  common  stock  to an
investment  company on September 16, 1998.  The shares are subject to repurchase
by the Company under certain  circumstances,  or beginning September 16, 2003 at
the holders  option,  at the then current  average traded price of the stock. No
shares have been tendered by the holder as of December 31, 2003.

Critical Accounting Policies

     The  consolidated  financial  statements  are prepared in  conformity  with
accounting  principles  generally  accepted in the United  States.  As such, the
Company is required to make certain estimates, judgments and assumptions that it
believes are reasonable  based upon the information  available.  These estimates
and  assumptions  affect the reported  amounts of assets and  liabilities at the
date of the  financial  statements  and the  reported  amounts  of  revenue  and
expenses during the reporting  period.  A summary of the significant  accounting
policies is described in Note 1 to the audited financial statements.

New Accounting Pronouncements

     See Notes 1 and 3 to the Consolidated  Financial  Statements for discussion
of  new   accounting   pronouncements   and  the   accounting   change  for  new
pronouncements.

ITEM 7a.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk Exposure

     The primary  market  risk  exposures  affecting  the Company are changes in
interest rates. The Company is exposed to market risk related to the senior bank
credit  facility.  The  interest  on the senior  credit  facility  is subject to
fluctuations  in interest rates.  Assuming an immediate  increase or decrease of
100 basis points in interest  rates,  the  interest  expense for the years ended
December  31,  2003,  2002 and 2001 would have been  increased  or  decreased by
approximately $110,000, $130,000 and $140,000, respectively.

     The  Company  may  from  time to time,  invest  its  cash in a  variety  of
short-term financial instruments.  These instruments generally consist of highly
liquid  investments.  While these  investments are subject to interest rate risk
and could decline in value if market interest rates increase, a hypothetical 100
basis point  increase or decrease in market  interest rates would not materially
affect the value of these instruments.
                                    Page 15
<PAGE>
                       AVALON CORRECTIONAL SERVICES, INC

ITEM 8.  FINANCIAL STATEMENTS

Index to Financial Statements:
                                                                       Page
                                                                       ----
      Report of Independent Certified Public Accountants                17

      Consolidated Balance Sheets                                       18

      Consolidated Statements of Operations                             19

      Consolidated Statements of Stockholders' Equity                   20

      Consolidated Statements of Cash Flow                              21

      Notes to Consolidated Financial Statements                        23

                                     Page 16
<PAGE>
                       AVALON CORRECTIONAL SERVICES, INC


              REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

To the Board of Directors of
Avalon Correctional Services, Inc.

We  have  audited  the  accompanying   consolidated  balance  sheets  of  Avalon
Correctional Services,  Inc. and subsidiaries (the "Company") as of December 31,
2003  and  2002,  and  the  related   consolidated   statements  of  operations,
stockholders'  equity and cash  flows for each of the three  years in the period
ended  December  31,  2003.  These  consolidated  financial  statements  are the
responsibility of the Company's management.  Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the  United  States of  America.  Those  standards  require  that we plan and
perform the audit to obtain  reasonable  assurance  about  whether the financial
statements are free of material misstatement.  An audit includes examining, on a
test basis,  evidence  supporting  the amounts and  disclosures in the financial
statements.  An audit also includes assessing the accounting principles used and
significant  estimates  made by  management,  as well as evaluating  the overall
financial  statement  presentation.   We  believe  that  our  audits  provide  a
reasonable basis for our opinion.

In our opinion, the consolidated  financial statements referred to above present
fairly, in all material  respects,  the financial  position of the Company as of
December 31, 2003 and 2002,  and the results of their  operations and their cash
flows for each of the three  years in the  period  ended  December  31,  2003 in
conformity with accounting principles generally accepted in the United States of
America.



GRANT THORNTON LLP

Oklahoma City, Oklahoma
February 9, 2004

                                    Page 17
<PAGE>
                        AVALON CORRECTIONAL SERVICES, INC

                         CONSOLIDATED BALANCE SHEETS

                                                          December 31,
                                                -----------------------------
                                                       2003           2002
                                                    ----------     ----------
                     ASSETS
Current assets:

   Cash and cash equivalents                      $  1,015,000    $ 1,250,000

   Certificates of deposit (pledged in 2003)         1,600,000      1,800,000

   Accounts receivable, net                          2,662,000      2,768,000

   Prepaid expenses and other                          426,000        287,000
                                                       -------        -------
   Total current assets                           $  5,703,000    $ 6,105,000

Property and equipment, net                         30,636,000     30,041,000

Intangible assets, net                               2,395,000      2,620,000

Other assets                                           967,000        925,000
                                                       -------        -------

      Total assets                                $ 39,701,000    $39,691,000
                                                  ============    ===========
      LIABILITIES AND STOCKHOLDER'S EQUITY

Current liabilities:

   Accounts payable, accrued liabilities and
      other                                       $  1,990,000    $ 1,460,000

   Current maturities of long-term debt              2,030,000      3,515,000
                                                     ---------      ---------

      Total current liabilities                   $  4,020,000    $ 4,975,000

Long-term debt, less current maturities             20,305,000     20,545,000

Convertible debentures                               3,850,000      3,850,000

Deferred income taxes                                  175,000        147,000

Redeemable common stock, $.001 par value

   1,622,448 shares issued and outstanding in
       2003 and 2002                                 2,628,000      3,176,000

Stockholders' equity:

   Common stock - par value $.001; 24,000,000
      shares authorized;

         4,896,954 and 4,895,002 shares issued

         and outstanding in 2003 and 2002,

         respectively, less 1,622,448 shares

         subject to repurchase in 2003 and 2002          3,000          3,000

   Preferred stock; par value $.001; 1,000,000

         shares authorized; none issued                    ---            ---

   Paid-in capital                                   8,459,000      7,908,000

   Retained earnings (deficit)                         261,000      (913,000)
                                                       -------      ---------

    Total liabilities and stockholders' equity     $39,701,000    $39,691,000
                                                   ===========    ===========

 The accompanying notes are an integral part of these consolidated financial
                                 statements.

                                    Page 18
<PAGE>

                        AVALON CORRECTIONAL SERVICES, INC

                    CONSOLIDATED STATEMENTS OF OPERATIONS


                                               For the Years Ended December 31,
                                                2003         2002        2001
                                                ----         ----        ----

Revenues                                    $25,260,000 $27,456,000  $25,147,000
                                            -----------  ----------  -----------

Costs and expenses

   Direct operating                         $17,592,000 $18,938,000  $17,147,000

   General and administrative                1,713,000    2,000,000    1,801,000

   Depreciation and amortization expense     1,883,000    2,256,000    1,881,000

   Interest expense                          2,287,000    2,594,000    2,993,000
                                             ---------    ---------    ---------

Net income before income tax expense        $1,785,000   $1,668,000   $1,325,000

       Income tax expense                      611,000      547,000          ---
                                             ---------    ---------   ----------
Net income                                  $ 1,174,000  $1,121,000   $1,325,000
                                             ==========   =========    =========

Basic income per share:                     $      0.24  $     0.23   $     0.28
                                             ==========   =========    =========
Diluted income per share:                   $      0.22  $     0.20   $     0.25
                                             ==========   =========    =========

 The accompanying notes are an integral part of these consolidated financial
                                 statements.

                                    Page 19
<PAGE>
                        AVALON CORRECTIONAL SERVICES, INC

              CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>

                            <c>           <c>        <c>           <c>          <c>
                                               Common                   Retained       Total
                                  Common       Stock     Paid-In        Earnings    Stockholders'
                                Stock Shares   Amount    Capital        (Deficit)      Equity
                               ------------   ------    -------        ---------   ------------
Balance, January 1, 2001         4,765,630   $ 3,000    $7,285,000   $(3,359,000)   $3,929,000

Net income                             ---       ---           ---      1,325,000    1,325,000

Stock options exercised             81,994       ---       128,000            ---      128,000

Accretion of redeemable stock          ---       ---       123,000            ---      123,000
                                 ---------    ------       -------       --------      -------

Balance, December 31, 2001        4,847,624    3,000     7,536,000   $(2,034,000)   $5,505,000

Net income                             ---       ---          ---       1,121,000    1,121,000

Stock options exercised             47,378       ---       78,000             ---       78,000

Accretion of redeemable stock          ---       ---      294,000             ---      294,000
                                ----------   ------     --------      -----------   ----------
Balance, December 31, 2002       4,895,002   $ 3,000   $7,908,000     $  (913,000)  $6,998,000

Net income                             ---       ---          ---       1,174,000    1,174,000

Stock options exercised              1,952       ---        3,000             ---        3,000

Accretion of redeemable stock          ---       ---      548,000             ---      548,000
                                 =========    =======     =======       =========    =========
Balance, December 31, 2003       4,896,954    $ 3,000  $8,459,000      $  261,000   $8,723,000
                                 =========    =======   =========       =========    =========
</TABLE>

 The accompanying notes are an integral part of these consolidated financial
                                 statements.

                                    Page 20
<PAGE>
                       AVALON CORRECTIONAL SERVICES, INC

                    CONSOLIDATED STATEMENTS OF CASH FLOWS

                                          For the Years Ended December 31,
                                     -------------------------------------------
                                            2003          2002           2001
                                     ---------------  ------------  ------------
OPERATING ACTIVITIES:

Net income                              $ 1,174,000    $1,121,000    $ 1,325,000

Adjustments to reconcile net income to

   Net cash provided by operating
      activities:

      Depreciation and amortization       1,883,000     2,256,000      1,881,000

      Amortization of debt issue costs      234,000       363,000        254,000

(Gain) loss on sale of property            (11,000)        11,000         32,000

Changes in operating assets and

liabilities

   Decrease (increase) in

      Accounts receivable                   106,000         4,000        986,000

      Prepaid expenses and other assets   (139,000)     (376,000)       (36,000)

   Increase (decrease) in accounts

   payable and other                        502,000     (619,000)        693,000
                                            -------     ---------        -------

     Net cash provided by operations      3,749,000   $ 2,760,000    $ 5,135,000
                                          ---------   -----------    -----------
INVESTING ACTIVITIES:

Capital expenditures                    $(2,587,000)  $(1,206,000)  $(2,179,000)

Acquisition of business                         ---           ---       (71,000)

Purchases of certificates of deposit            ---    (1,800,000)           ---

Sales of certificates of deposit            200,000

Proceeds from disposition of property       120,000        61,000        164,000
                                             ------        ------        -------
    Net cash used in investing          $(2,267,000)  $(2,945,000)  $(2,086,000)
                                        ------------  ------------  ------------

FINANCING ACTIVITIES:

Proceeds from borrowing                $27,299,000     $28,479,000   $27,330,000

Repayment of borrowing                (29,019,000)    (29,511,000)  (28,844,000)

Proceeds from stock option exercises         3,000          78,000       128,000
                                             -----          ------       -------
    Net cash used in financing

    activities                        $(1,717,000)     $ (954,000)  $(1,386,000)
                                      ------------     -----------  ------------
Net increase (decrease) in cash

       and cash equivalents           $ (235,000)     $(1,139,000)   $ 1,663,000

Cash and cash equivalents,

   beginning of period                  1,250,000        2,389,000       726,000
                                        ---------        ---------       -------
 Cash and cash equivalents

   end of period                      $ 1,015,000      $ 1,250,000   $ 2,389,000
                                      ===========      ===========   ===========

 The accompanying notes are an integral part of these consolidated financial
                                  statements

                                    Page 21
<PAGE>
                        AVALON CORRECTIONAL SERVICES, INC

              CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

SUPPLEMENTAL CASH FLOW INFORMATION:

Cash paid during the year for:             2003          2002            2001
                                       ----------    -----------     -----------
     Interest                         $ 2,146,000    $ 2,269,000     $ 2,735,000
                                      ===========    ===========     ===========
     Income taxes                     $   337,000    $   279,000     $       ---
                                      ===========    ===========     ===========




 The accompanying notes are an integral part of these consolidated financial
                                  statements

                                    Page 22

<PAGE>

                       AVALON CORRECTIONAL SERVICES, INC

NOTE 1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Business

     Avalon Correctional Services,  Inc. ("Avalon" or the "Company") is an owner
and operator of private community correctional  services.  Avalon specializes in
privatized  community  correctional  facilities  and  correctional  programming.
Avalon is  currently  operating in  Oklahoma,  Texas and Colorado  with plans to
expand into additional states. Avalon's business strategy is designed to elevate
the Company  into a dominant  provider  of  community  correctional  services by
expanding its operations  through new state and Federal  contracts and selective
acquisitions.  Avalon owns a 300-bed community  corrections facility in Oklahoma
City, Oklahoma; a 320-bed community  corrections facility in Tulsa,  Oklahoma; a
150-bed  community  corrections  facility in Tulsa,  Oklahoma;  a 160-bed medium
security  correctional  facility  in Union  City,  Oklahoma;  a  150-bed  medium
security  facility in El Paso,  Texas; a 324-bed medium security  facility in El
Paso,  Texas;  a 180-bed  community  corrections  facility on leased land in Del
Valle, Texas; a 207-bed community  corrections facility in Henderson,  Colorado;
and a 307-bed multi-use  community  corrections  facility in Greeley,  Colorado.
Avalon also operates three programs in leased facilities: a 352-bed intermediate
sanction unit in Tulsa,  Oklahoma;  a 35-bed community  corrections  facility in
Denver,  Colorado;  and a day  reporting  center in  Northglenn,  Colorado.  The
Colorado community corrections programs also provide non-residential services to
approximately 210 offenders in the State of Colorado.

Principles of Consolidation

     The consolidated  financial  statements include the accounts of the Company
and its wholly-owned subsidiaries after elimination of all material intercompany
balances and transactions.

Use of Estimates

     The preparation of the consolidated  financial  statements requires the use
of management's  estimates and assumptions in determining the carrying values of
certain  assets  and  liabilities  and  disclosures  of  contingent  assets  and
liabilities  at the  date  of the  consolidated  financial  statements  and  the
reported amounts for certain revenues and expenses during the reporting  period.
Actual results could differ from those estimates.

Cash and Cash Equivalents

     The  Company   considers  all  highly  liquid   investments  with  original
maturities  of three months or less when  purchased and money market funds to be
cash equivalents.

Accounts Receivable

     Accounts  receivable  consists  of amounts  due from  various  governmental
agencies under contractual  agreement for correctional services in the Company's
facilities.  Receivables  are recorded at the estimate of amounts due based upon
the terms of the related agreements.

     Management  periodically  assesses the Company's  accounts  receivable  and
establishes an allowance for estimated uncollectible amounts based on historical
write-offs.  Accounts  determined to be uncollectible  are charged to operations
when that determination is made.

Concentrations of Credit Risk

     Financial instruments  potentially subjecting the Company to concentrations
of credit risk consist  principally of temporary cash investments,  certificates
of deposits and  accounts  receivable.  The Company  places its  temporary  cash
investments  and  certificates  of deposit  with high credit  quality  financial
institutions  and money market funds and limits the amount of credit exposure to
any one  institution  or fund.  Concentrations  of credit  risk with  respect to
accounts  receivable  are limited due to the fact that a significant  portion of
the Company's receivables is from government agencies.  The Company maintains an
allowance for doubtful  accounts for potential credit losses.  The allowance for
doubtful  accounts  at  December  31,  2003  and  2002 is  $11,000  and  $5,000,
respectively.

                                    Page 23
<PAGE>
                        AVALON CORRECTIONAL SERVICES, INC

Property and Equipment

     Property  and  equipment  are  recorded  at cost.  Expenditures  for  major
additions  and   improvements  are   capitalized,   while  minor   replacements,
maintenance  and repairs are charged to expense as incurred.  When  property and
equipment are retired or otherwise disposed of, the cost and related accumulated
depreciation  are removed from the accounts  and any  resulting  gain or loss is
reflected   in  current   operations.   Depreciation   is  provided   using  the
straight-line method over the following estimated useful lives:

                  Buildings and Improvements              10 to 40 Years
                  Furniture and Equipment                  5 to 10 Years
                  Transportation Equipment                 2 to 15 Years

     The Company  follows the  provisions  of Statement of Financial  Accounting
Standards  (SFAS)  No.  144,  Accounting  for  the  Impairment  or  Disposal  of
Long-lived  Assets  in  determining   impairment  losses  on  long-term  assets.
Impairment   losses  are  recorded  on  long-lived  assets  when  indicators  of
impairment are present and the undiscounted cash flows estimated to be generated
by those assets are less than the assets' carrying  amounts.  Impairment  losses
are recognized based upon the estimated fair value of the asset when required.

     SFAS No. 142, Goodwill and Other Intangible Assets,  requires that goodwill
and  intangible  assets with  indefinite  useful  lives be tested  annually  for
impairment. SFAS No. 142 also requires that intangible assets with finite useful
lives be amortized and be evaluated for  impairment in accordance  with SFAS No.
144. In addition,  the Statement eliminates the requirement to amortize goodwill
or intangible assets with indefinite useful lives (Note 3).

Equity Method Investments

     Investments in unconsolidated  subsidiaries,  jointly owned companies,  and
other  investees  in which the  Company has a 20% to 50%  interest or  otherwise
exercises  significant influence are carried at cost, adjusted for the Company's
proportionate  share of their  undistributed  earnings or losses. See Note 16 to
consolidated financial statements.

Income Taxes

     Deferred  income taxes are  recognized for the tax  consequences  in future
years of differences  between the tax bases of assets and  liabilities and their
financial  reporting  amounts at each  year-end  based on  enacted  tax laws and
statutory  tax rates  applicable  to the  period in which  the  differences  are
expected to affect  taxable  income.  Valuation  allowances  are  established by
management  when necessary to reduce  deferred tax assets to the amount expected
to be  realized.  Income tax  expense is the tax  payable for the period and the
change during the period in deferred tax assets and liabilities.

Revenue Recognition

     The Company  recognizes  revenues as services  are  provided.  Revenues are
generally  earned  based upon the number of offenders on a per diem basis at the
Company's  correctional  facilities.  All  correctional  revenues  are  received
monthly from various governmental agencies.

Development Costs

     The  Company  expenses  development  and  new  facility  opening  costs  as
incurred.

Net Income Per Common Share

     Basic  net  income  per share has been  computed  on the basis of  weighted
average shares outstanding during each period. Diluted income per share has been
computed  based on the  assumption  that all  dilutive  options and warrants are
exercised using the treasury stock method.

                                    Page 24

<PAGE>
                        AVALON CORRECTIONAL SERVICES, INC

Stock Based Compensation

     The Company uses the intrinsic  value method in  accordance  with APB 25 to
account for its stock option plan in which  compensation is recognized only when
the  exercise  price  of each  option  is less  than  the  market  value  of the
underlying common stock at the date of grant. Accordingly,  no compensation cost
has been  recognized for the options issued as all options granted have exercise
prices equal to market value at the date of grant.  Had  compensation  cost been
determined  based  on the  fair  value  of the  options  at the  grant  dates in
accordance  with SFAS 123,  the  Company's  net  income and net income per share
would have been decreased to the pro forma amounts indicated below.

                                             2003           2002          2001
                                          ----------     -----------    --------
      Net income

         As reported                       $ 1,174,000  $ 1,121,000  $ 1,325,000

         Deduct: stock based compensation
         expense determined under fair
         value method, net of tax effects    (111,000)    (190,000)    (277,000)
                                             ---------    ---------    ---------
         Pro forma                         $ 1,063,000  $  931,000   $ 1,048,000
                                            -----------    -------   -----------
      Basic income per share

         As reported                       $      0.24   $    0.23   $      0.28
                                             ---------    --------     ---------
         Pro forma                         $      0.22   $    0.19   $      0.22
                                             ---------    --------    ----------

      Diluted income per share

           As reported                     $      0.22   $    0.20   $      0.25
                                            ----------    ---------   ----------
           Pro forma                       $      0.17   $    0.14          0.21
                                             ---------    --------    ----------

     The fair value of each grant is  estimated  on the date of grant  using the
Black-Scholes   option-pricing   model  with  the   following   weighted-average
assumptions used:

                                              2003      2002        2001
                                              ----      ----        ----

               Dividends                         -         -           -

               Expected volatility           37.5%     35.0%       67.0%

               Risk free interest rate        2.7%      3.1%        5.1%

               Expected life (years)            10       10           10

     The  Black-Scholes  options  valuation  model  was  developed  for  use  in
estimating  the fair value of traded  options with no vesting  restrictions  and
which are fully  transferable.  Option  valuation  models  require  the input of
highly subjective assumptions including the expected stock price volatility. The
Company's employee stock options have  characteristics  significantly  different
from those of traded options,  and changes in the subjective  input  assumptions
can materially affect the fair value estimate.  It is management's  opinion that
the existing  models do not provide a reliable  measure of the fair value of its
employee stock options  because the model assumes the security being measured is
widely  traded and  liquid.  The  Company's  stock  does not have a  significant
trading volume and is illiquid.

Recently Issued Accounting Pronouncements -

     In January 2003,  the Financial  Accounting  Standards  Board (FASB) issued
Interpretation No. 46 ("FIN 46"),  "Consolidation of Variable Interest Entities"
(VIEs), which is an interpretation of Accounting Research Bulletin (ARB) No. 51,
"Consolidated  Financial Statements." FIN 46, as revised by FIN 46(R), addresses
the  application of ARB No. 51 to VIEs, and generally would require that assets,
liabilities  and  results  of the  activity  of a VIE be  consolidated  into the
financial   statements  of  the  enterprise   that  is  considered  the  primary
beneficiary.  This  interpretation  applies  immediately  to VIEs created  after
January 31, 2003, and to VIEs in which a company  obtains an interest after that
date.  The  Company had not created or obtained an interest in any VIEs in 2003.
In addition,  the  interpretation  becomes  applicable  on December 31, 2003 for
special  purpose  entities  (SPEs)  created  prior to  February  1, 2003.  As of
December  31,  2003,  the  Company had no SPEs for which it was  considered  the
primary  beneficiary.  For non-SPEs in which a company holds a variable interest
that it acquired  before  February 1, 2003,  the FASB has  postponed the date on
which the interpretation will become applicable to March 31, 2004.

                                    Page 25
<PAGE>

                        AVALON CORRECTIONAL SERVICES, INC

     The Company has identified one non-consolidated  entity (Emerald Square) as
a VIE where the Company is considered the primary  beneficiary (see Note 16). In
accordance  with the  provisions  of FIN 46, as  revised,  the  Company  will be
required to  consolidate  this VIE as of March 31,  2004.  The Company  does not
expect  the  consolidation  of  this  VIE  to  have  a  material  effect  on the
consolidated results of operations or financial position.

     In December 2003, the Staff of the Securities and Exchange Commission (SEC)
issued Staff Accounting  Bulletin (SAB) No. 104,  "Revenue  Recognition,"  which
supersedes  SAB No.  101.  The  primary  purpose  of SAB No.  104 is to  rescind
accounting guidance contained in SAB No. 101 and the SEC's "Revenue  Recognition
in Financial  Statements  Frequently  Asked  Questions  and  Answers"  (the FAQ)
related to multiple  element revenue  arrangements.  The Company does not expect
the  issuance  of SAB  No.  104 to  significantly  impact  its  current  revenue
recognition policies.

NOTE 2.  PROPERTY AND EQUIPMENT

     The elements of property and equipment and related accumulated depreciation
as of December 31, 2003 and 2002 are as follows:

                                                     2003            2002
                                                  ----------    -----------
      Land                                       $ 3,143,000   $  3,143,000

      Buildings and Improvements                  29,766,000     28,121,000

      Construction in Progress                       119,000        329,000

      Furniture and Equipment                      2,757,000      2,662,000

      Transportation Equipment                     1,524,000      1,567,000
                                                   ---------      ---------

                                                 $37,309,000  $  35,822,000

         Accumulated Depreciation                (6,673,000)    (5,781,000)
                                                 -----------    -----------
                                                 $30,636,000  $  30,041,000
                                                  ==========   ============

NOTE 3.  INTANGIBLE ASSETS

     Upon original implementation of Statement of Financial Accounting Standards
("SFAS") No. 142, the Company  determined that intangible  assets related to the
value  of  contracts  previously  acquired  in  business   combinations  had  an
indefinite life, and therefore were not amortized.  After communication with the
SEC staff resulting in a reevaluation of the life of contract  intangibles,  the
Company decided to restate the consolidated  financial  statements as of and for
the year ended  December  31,  2002,  to amortize  contract  intangibles  over a
fifteen-year life (the life assigned prior to the implementation of SFAS No. 142
on January 1, 2002).  Intangible assets originally determined to have indefinite
lives  totaled  $2,631,000 at December 31, 2002.  The effect of the  restatement
reduced total assets from  $39,916,000,  as originally  reported at December 31,
2002, to $39,691,000,  reduced total liabilities from $29,602,000 to $29,517,000
(due to income tax  effects) and  therefore  reduced  stockholders'  equity from
$7,138,000  to  $6,998,000.   The  restatement  also  reduced  net  income  from
$1,261,000,  or $0.22 per diluted  share,  to  $1,121,000,  or $0.20 per diluted
share.

     Accumulated  amortization  expense on  intangible  assets was  $960,378 and
$734,937 for the years ended December 31, 2003 and 2002, respectively.

                                    Page 26
<PAGE>
                        AVALON CORRECTIONAL SERVICES, INC


NOTE 4.  OTHER ASSETS

      Other assets consist of the following at December 31:

                                                      2003            2002
                                                  -----------    --------------

       Debt issue costs, net                    $     704,000      $    713,000

       Other                                          263,000           212,000
                                                 ------------       ------------

                                                $     967,000      $    925,000
                                                 ============       ============
NOTE 5.  ACCOUNTS PAYABLE, ACCRUED LIABILITIES AND OTHER

      The  elements  of  accounts  payable, accrued  liabilities and other as of
December 31, 2003 and 2002 are as follows:


                                                      2003              2002
                                                  ------------      ------------
     Trade accounts payable                       $  329,000          $  158,000

     Accrued interest payable                        121,000             141,000

     Accrued taxes                                   752,000             427,000

     Accrued salary and benefits                     717,000             660,000

     Other accrued liabilities                        71,000              74,000
                                                   ---------           ---------
                                                  $1,990,000          $1,460,000


NOTE 6.  CORRECTIONAL CONTRACTS

     The  Company  contracts  with  various  governmental  agencies  to  provide
correctional  services.  The  contracts  generally  specify  for the  Company to
provide  correctional  services  including  complete  residential  services  and
programming in the Company's facilities ("Residential  Services").  Compensation
paid to the Company for Residential Services is generally based on a per person,
per day basis.  Contract revenues from contracts  exceeding 10% of total Company
revenue for the years ending December 31, are as follows:

                                  2003           2002           2001
                               ----------     ---------     ----------
     Governmental Agency A         31%            24%            27%

     Governmental Agency B         27%            24%            24%

     Governmental Agency C          0%            13%            15%

     Governmental Agency D         24%            24%            18%


     The Company's  current  Residential  Services  contracts  with the Oklahoma
Department  of  Corrections  extend  through  June 30,  2004.  The Company has a
fifteen-year Residential Services contract with West Texas Community Supervision
and Corrections  Department extending through August 31, 2011. The Company has a
Residential  Services  contract and a Halfway House  Services  Contract with the
Texas Department of Criminal Justice Parole  Department to provide  correctional
services in El Paso,  Texas through August 2005,  with two  additional  two-year
option periods.  The Texas  Department of Criminal Justice issued a new contract
for Halfway  House  Services  at the Austin  Transitional  Center  that  extends
through August of 2005, with two option periods of two years each. The Company's
contract with the Oklahoma Office of Juvenile  Affairs expired in December 2002.
The Company's  current  contracts  with the Colorado  Department of  Corrections
extend through June 30, 2008.

                                    Page 27
<PAGE>

                        AVALON CORRECTIONAL SERVICES, INC

 NOTE 7. LONG-TERM DEBT AND REDEEMABLE COMMON STOCK

      Long-term debt consists of the following:

                                                              December 31,
                                                        ------------------------
                                                          2003            2002
                                                        ---------       --------
     Senior credit facility:

       revolvoing line of credit                     $     40,000   $  1,423,000

       term loan                                       11,034,000     11,024,000


     Notes payable to banks and finance companies,

       collaterized by transportation equipment, due

       in stallments through March 2012 with interest

       ranging from 209% to 11.0%                       1,110,000      1,411,000


     Note payable to an investment company,

       uncollateralized;

       interest at 12.5% payable quarterly; principal

       due in four quarterly installments beginning

       December 31, 2005; includes unaccreted

       original issue premium                          10,151,000     10,202,000
                                                       ----------     ----------
                                                     $ 22,335,000   $ 24,060,000

     Less - current maturities                          2,030,000      3,515,000
                                                       ----------     ----------
                                                     $ 20,305,000   $ 20,545,000
                                                       ==========    ===========

     The aggregate  maturities of long-term debt for each of the next five years
are as follows: 2004: $2,030,000;  2005:  $12,353,000;  2006: $7,610,000;  2007:
$32,000; 2008: $33,000 and $277,000 thereafter.

     The Company has a senior credit facility  collateralized  by certain assets
of the Company with Fleet Capital consisting of a term loan and a revolving line
of  credit  equal  to the  lesser  of  $3,000,000  or 80% of  eligible  accounts
receivable.  At December 31, 2003, the outstanding  balances were $11,034,000 on
the term loan and  $40,000  under the  revolving  line of credit.  The term loan
requires principal payments in the amount of $355,000 plus interest on the first
day of each calendar quarter. The remaining principal outstanding, together with
any and all other  amounts  due,  shall be due and payable on February 25, 2005.
The  interest  rate on the senior  credit  facility is  comprised of a base rate
margin and LIBOR  margin,  which varies in relation to the senior debt to EBITDA
ratio.  At December 31,  2003,  the rate was  approximately  4.75% on the senior
credit   facility.   The  senior  credit  facility   contains  certain  covenant
requirements  that the  Company  must  maintain.  The  covenants  are based on a
trailing  twelve month period and are  comprised  of a required  fixed  coverage
ratio;   a  liabilities  to  tangible  net  worth  ratio;  a  maximum  ratio  of
indebtedness to EBITDA; a required minimum EBITDA and a limit on certain capital
expenditures.  The Company was in compliance with all debt covenants at December
31, 2003.

     The Company  completed a $15,000,000  private  placement of debt and equity
with an investment  company on September 16, 1998.  Pursuant to the terms of the
agreement, the Company tendered an unsecured subordinated note with a face value
of  $10,000,000  bearing  interest of 12.5% with  interest  payable in quarterly
installments until December 31, 2005, when the first of four quarterly principal
installments  is due. The Company also tendered  1,622,448  shares of redeemable
common stock to the investment  company.  These shares are subject to repurchase
by the Company under certain  circumstances,  or beginning September 16, 2003 at
the holders option,  at the then current average traded price of the stock.  The
Company records  adjustments to the estimated  redemption  price of the stock by
periodic charges / credits to additional paid-in capital.

                                    Page 28
<PAGE>

                        AVALON CORRECTIONAL SERVICES, INC

     The Company  obtained an independent  fair value  appraisal of the debt and
equity instruments reflecting a fair value allocation of the debt of $10,365,000
and the fair value allocation of the redeemable common stock of $4,635,000.  The
original  issue premium of $365,000 is being accreted as a reduction of interest
expense  over the term of the debt  instrument.  Debt issue costs of  $1,654,000
(including $266,000  representing the fair value of warrants issued to financial
advisors) have been allocated to the debt and redeemable common stock based upon
their fair values.  Costs of $511,000  allocated to the redeemable  common stock
reduced its original book value to $4,124,000.  Costs of $1,143,000 allocated to
the debt  instrument  are  included in other  assets and are being  amortized to
interest  expense  over the  life of the debt  instrument  using  the  effective
interest method.

     Certain notes payable to finance and investment companies contain covenants
that require the Company,  among other things,  to maintain certain earnings and
debt coverage ratios and receive  approval for certain  capital  expenditures as
defined in the agreements.  Certain of the Company's  indebtedness is personally
guaranteed by the Chief Executive  Officer as a requirement of the lenders.  The
Company was in compliance with all debt covenants at December 31, 2003.

NOTE 8.  CONVERTIBLE DEBENTURES

     The Company  completed a private  placement of  $4,150,000  of  convertible
debentures on September 12, 1997. The  convertible  debentures  bear interest at
7.5%, payable  semi-annually,  and mature on September 12, 2007. The Company may
redeem  the  convertible  debentures  at any time  after  May 2000 at  106.5% of
principal,  declining  to 100%  at  maturity.  The  convertible  debentures  are
convertible  into  common  stock at $3.00  per  share  at any time  until  their
maturity. The convertible debenture holders signed agreements to subordinate the
debentures to the $10,000,000 face value note issued on September 16, 1998.

NOTE 9.  STOCKHOLDERS' EQUITY

     The Company  issued  Class E warrants to purchase  79,000  shares of Common
Stock in September 1997, in connection with the private placement of Convertible
Debentures. The Company recognized $148,000 of cost based upon the difference in
the exercise  price of the Class E warrants and the current  market price of the
common  stock on the date of the  issuance.  This cost was recorded as debenture
issue  costs and was  classified  in other  assets  on the  balance  sheet.  The
debenture  issue cost was amortized to expense over the term of the  convertible
debentures. The Class E stock purchase warrants expired in September 2002.

     A 1994  agreement  provided for the issuance of an option to issue  750,000
common stock purchase  warrants to purchase  common stock at $1.50 per share for
each dollar of Company debt guaranteed by the Company's CEO. The warrants have a
five-year term from the date of issuance, March 9, 2001.

NOTE 10.  STOCK OPTION PLAN

     The Company  adopted a stock  option plan (the  "Plan")  providing  for the
issuance of 250,000  shares of Class A common stock  pursuant to both  incentive
stock  options,  intended to qualify under  Section 422 of the Internal  Revenue
Code,   and  options   that  do  not   qualify  as   incentive   stock   options
("non-statutory").  The  Option  Plan was  registered  with the  Securities  and
Exchange  Commission  in  November  1995.  The purpose of the Plan is to provide
continuing  incentives to the Company's  officers,  key employees and members of
the Board of Directors.

      The  options  generally  vest  within  five  years  and have a  ten-year
expiration  period.  The  Company  amended  its  Plan  on  December  1,  1996,
increasing  the  number of shares  available  under the Plan to  600,000,  and
further  amended  its plan on May 21,  2003,  increasing  the number of shares
available to 700,000.  Non-statutory  options have been granted  providing for
the  issuance of 692,660  shares of Class A common  stock at  exercise  prices
ranging from $1.32 to $4.25 per share.  Options  providing for the issuance of
561,887 shares were exercisable at December 31, 2003.

                                    Page 29
<PAGE>
                        AVALON CORRECTIONAL SERVICES, INC

     A summary of the status of the  Company's  stock option plan as of December
31, 2003,  2002 and 2001,  and changes during the years ending on those dates is
presented below.


                               2003               2002               2001

                                  Weighted           Weighted           Weighted
                                  Average            Average            Average
                         Shares   Exercise  Shares   Exercise  Shares   Exercise
                         ------   --------  ------   --------  ------   --------

Outstanding at
  beginning of year     505,832   $   1.83  461,060  $   1.69  479,610   $  1.69

Granted                 216,110       1.37  104,500      2.31   96,700      1.70

Exercised               (1,952)       1.70  (47,378)     1.65  (81,994)     1.56

Forfeited              (27,330)       1.73  (12,350)     1.88  (33,256)     1.70
                       --------             --------           --------

Outstanding at end
  of  year              692,660       1.69   505,832     1.83  461,060      1.69
                       ========             ========           =======

Options exercisable
  at year end           561,887       1.73   441,490     1.79  380,028      1.71
                       ========             ========           =======

Weighted average fair
  of Options granted           -----------        -----------        -----------
  during the year              $      1.37        $      1.24        $      1.37
                               ===========        ===========        ===========

     The following table summarizes  information about fixed-price stock options
outstanding at December 31, 2003.


                          Options Outstanding             Options Exercisable
                          -------------------             -------------------
                                 Weighted
                                 Average       Weighted                 Weighted
                      Number     Remaining     Average    Number        Average
                    Outstanding  Contractual   Exercise   Exercisable   Exercise
                    at 12/31/03  Life (years)  Price      at 12/31/03   Price
                    -----------  ------------  -----      -----------   -----

Range of exercise
  price
$1.50 to $2.25        594,460          6.98    $  1.58        482,048    $  1.63
$2.26 to $3.39         96,200          8.19    $  2.32         77,839    $  2.33
$3.40 to $4.25          2,000          4.13    $  4.00          2,000    $  4.00
                      -------                                 -------
$1.50 to $4.25        692,660                                 561,887
                      =======                                 =======

NOTE 11.  ACQUISITIONS AND CONTRACTS

     On September 1, 2002,  the Company began  managing the Roy K. Robb facility
in San Angelo,  Texas.  The  operation of the 40-bed  facility was governed by a
contract  with Tom Green  County in  Texas.  Roy K. Robb is a  post-adjudication
juvenile substance abuse facility contracting with surrounding counties to house
and rehabilitate  youth. The contract to operate the facility  extended for five
years,  contained  an option to extend for  another  five  years,  and allowed a
120-day  notice of  termination.  After giving  appropriate  notice to Tom Green
County,  the Company opted to terminate its contract and ceased operation of the
facility on March 31, 2003.

     The Company  acquired the assets and operations of the Austin  Transitional
Center in Del Valle,  Texas in December  2001.  The Center was acquired  from an
entity owned by an officer of the Company. The Center was acquired by the entity
upon approval of a Texas  bankruptcy  court. The terms of the acquisition to the
Company  were  identical  to the  terms  of the  acquiring  entity.  The  Austin
Transitional Center is a community corrections center contracting with the Texas
Department  of Criminal  Justice.  The  facility  consists  of thirteen  modular
buildings  located on leased  land.  The land is leased from a third party for a
period of five years with a renewal option of five years. The acquisition  price
was  approximately  $71,000 and included the assumption of a contract,  with the
Texas Department of Criminal Justice,  that originally  extended to August 2003.
The Texas Department of Criminal Justice issued a new contract award for Halfway
House services at the Austin  Transitional Center extending through August 2005,
with two  option  periods  of two  years  each.  The  financial  results  of the
operation  were  included in the  Company's  financial  statements  beginning in
December 2001.

                                    Page 30
<PAGE>
                        AVALON CORRECTIONAL SERVICES, INC

     The  Company  signed a  contract  with the Tulsa  County  Criminal  Justice
Authority in April 2001 to lease the  Riverside  Intermediate  Sanction  Unit in
Tulsa. The costs to renovate the building were paid jointly by the Authority and
the Company.  The  Company's  share of the  renovation  costs was  approximately
$1,000,000.  Approximately $900,000 of the costs was financed with the Company's
senior  lender.  The  cost  of the  renovations  is  being  amortized  over  the
twenty-year term of the lease. Renovation was completed in December 2001 and the
facility began receiving offenders in December 2001.

     The Oklahoma Office of Juvenile  Affairs,  in a cost-cutting  move, did not
exercise the option for the final year of a five-year contract providing for the
care of 80 juveniles at the Union City Juvenile Center.  The contract expired on
December 2, 2002 and as of March 2004, the facility's only use is as an overflow
center for weekend clients assigned to the Carver Center. This is the first time
the Company has not had a multi-year contract extension renewed. The contract is
the only one the Company had with this agency.  The Company at December 31, 2003
was actively  seeking a permanent  replacement  population.  The Company entered
into an asset  purchase  agreement  to sell the Union City  facility in February
2004. The sale is subject to certain customary conditions as well as the Buyer's
ability  to obtain  financing,  receive  appropriate  licenses,  certifications,
permits,  zoning and a contract for a client  population  for the facility.  The
asset  purchase  agreement is scheduled to close on or before June 25, 2004. The
asset  purchase  agreement  is  expected  to result in proceeds in excess of the
carrying value of the Union City  facility.  Should the contract not close or be
extended,  the  Company  will  review the  carrying  value of the  facility  and
determine if an  impairment  of the carrying  value will be required  during the
second quarter of 2004.

NOTE 12.  EARNINGS PER SHARE

      The following table sets forth the computation of earnings per share
and earnings per share assuming dilution for the years ended December 31:

                                          2003           2002           2001
                                       ----------   -------------   ------------
Numerator

  Net income-basic                    $  1,174,000   $  1,121,000   $  1,325,000

    Effect of dilutive securities,
    net of income tax:

    - interest reduction on assumed
     debenture conversions                 173,000        173,000        289,000
                                           -------        -------        -------
Numerator for earnings per share
  assuming dilution                   $  1,347,000    $ 1,294,000   $  1,614,000
                                       ===========    ===========    ===========
Denominator for earnings per share:

  Weighted average shares
    outstanding-basic                    4,896,196      4,891,942      4,808,067

  Effect of dilutive securities:

   -debenture conversions                1,283,333      1,283,333      1,283,333

   -stock options                            8,093         68,149         62,919

   -stock warrants                             ---        201,220        178,288
                                         ---------       --------       --------
Denominator for earning per share
  assuming dilution                      6,187,622      6,444,644      6,332,607
                                        ==========      =========      =========
Earnings per share, bsic             $        0.24    $      0.23     $     0.28
                                        ==========      =========      =========
Earnings per share assuming dilution $        0.22    $      0.20     $     0.25
                                        ==========      =========      =========

     Outstanding  options and  warrants of 477,850,  103,500 and 203,539 for the
periods ended December 31, 2003, 2002 and 2001, respectively, have been excluded
from the above calculations as they would be anti-dilutive. The weighted average
price of the anti-dilutive  options and warrants were $1.84, $2.26 and $3.76 for
the periods ended December 31, 2003, 2002 and 2001, respectively.

                                    Page 31
<PAGE>
                        AVALON CORRECTIONAL SERVICES, INC

NOTE 13. FAIR VALUE OF FINANCIAL INSTRUMENTS

     The carrying  amounts and estimated fair values of the Company's  financial
instruments, none of which were held for trading purposes, were as follows:

<TABLE>
<CAPTION>
                                                    For the Years Ended December 31,
                                         -----------------------------------------------------
                                                        2003                  2002
                                         -------------------------------   -------------------
<S>                                   <C>            <C>            <C>          <C>
                                            Carrying      Estimated     Carrying    Estimated
                                            Amount        Fair Value    Amount      Fair Value
                                         ------------   ------------    ---------   ----------
  Financial Assets

    Cash and cash  equivalents          $  1,015,000  $  1,015,000  $  1,250,000  $  1,250,000
                                         ===========   ===========   ===========     =========
    Certficates of Deposit                 1,600,000     1,600,000     1,800,000     1,800,000
                                         ===========   ===========   ===========     =========
  Financial liabilities

    Variable rate debt                  $ 11,372,000  $ 11,372,000  $ 12,448,000  $ 12,448,000
                                         ===========   ===========   ===========   ===========
    Fixed rate debt                     $ 10,963,000  $ 12,345,000  $ 11,612,000  $ 13,070,000
                                         ===========   ===========   ===========   ===========
    Convertible debentures              $  3,850,000  $  4,430,000  $  3,850,000  $  4,430,000
                                         ===========   ===========   ===========   ===========
    Redeemable common stock             $  2,628,000  $  2,628,000  $  3,176,000  $  2,369,000
                                         ===========   ==========    ===========   ===========
</TABLE>

     The fair values presented represent management's best estimates and may not
be substantiated by comparisons to independent markets and, in many cases, could
not be realized in immediate  settlement of the instruments.  Certain  financial
instruments and all non-financial  instruments are not required to be disclosed;
therefore,  the  aggregate  fair  value  amounts  presented  do not  purport  to
represent the underlying fair value of the Company.

     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.

     Cash  and  Cash   Equivalents  -  The  carrying  amounts  reported  in  the
accompanying   consolidated   balance  sheets  for  cash  and  cash  equivalents
approximate fair value due to the highly liquid nature of the instruments.

     Certificates of Deposit - The carrying amounts reported in the accompanying
consolidated  balance sheets for certificates of deposit  approximate fair value
due to the liquid nature of the instruments.

     Variable Rate Debt - The carrying value of variable rate debt  approximates
fair value due to the variable rate nature of the instruments.

     Fixed  Rate Debt - Fair  values of fixed  rate debt were  calculated  using
interest  rates in effect  as of each year end with the other  terms of the debt
unchanged.

     Convertible   Debentures  -  Fair  value  of  convertible   debentures  was
calculated  using  interest  rates in effect as of each  year-end with the other
terms unchanged.

     Redeemable  Common  Stock  - Fair  value  of  redeemable  common  stock  is
calculated assuming exercise of the purchase option under the terms of the stock
purchase agreement at December 31, 2003 and 2002.

                                    Page 32
<PAGE>

                        AVALON CORRECTIONAL SERVICES, INC


NOTE 14.  INCOME TAX

      Income  tax  expense  consists  of the  following  for the  years  ended
December 31:


                                           2003          2002             2001
                                      -----------     ----------       ---------
              Current:

                 Federal               $  535,000     $  357,000     $       ---

                 State                     62,000         41,000             ---
                                        ---------      ---------      ----------
                                          597,000        398,000             ---
              Deferred:

                 Federal                   12,000        132,000             ---

                 State                      2,000         17,000            ---
                                       ----------      ---------      ----------
                                          14 ,000        149,000             ---
                                       ----------      ---------      ----------
                       Total          $   611,000    $   547,000    $        ---
                                       ==========     ==========     ===========

     The following is a reconciliation of the provision for (benefit from)income
taxes from  continuing  operations  computed by  applying  the Federal statutory
rate of 34% and the  effective  income tax rate for the years ended December 31:


                                        2003        2002          2001
                                     ---------    --------     ---------
Provision for income taxes at      $   607,000   $ 567,000    $  451,000

State income taxes, net of              31,000      67,000           ---

Nondeductible expenses                  11,000      19,000        14,000

Change in valuation allowance                0    (73,000)     (523,000)

Change in prior year estimate         (38,000)    (33,000)        58,000
                                     ---------    --------     ---------

      Total provision for income   $   611,000 $   547,000  $        ---
=========================================================================

Deferred tax assets and
liabilities are as follows
at December 31:
                                       2003        2002
                                    ---------   -----------
Deferred tax assets related to:

   Investee losses                 $  343,000  $   344,000

   Accruals and allowances             78,000       64,000
                                    ---------   ----------
                                      421,000      408,000

   Less: Valuation allowance              ---          ---
                                    ---------   ----------
      Deferred tax assets             421,000      408,000

Deferred tax liabilities related

   Property and equipment            (518,000)   (491,000)
                                    ----------  ----------
      Net deferred tax asset       $ (97,000)  $  (83,000)
                                    ==========  ==========

                                    Page 33
<PAGE>

                        AVALON CORRECTIONAL SERVICES, INC


     The  Company's  deferred  tax assets and  liabilities  are  included in the
accompanying  consolidated  balance  sheets  at  December  31,  2003 and 2002 as
follows.


                                                        December 31,
                                               ----------------------------
                                                   2003           2002
                                               ------------  --------------
Deferred income taxes (included in other
  assets)                                        $  78,000     $   64,000

Deferred income taxes (non-current liability)    (175,000)      (147,000)
                                                 ---------      ---------

Net deferred tax asset (liability)               $(97,000)     $ (83,000)
                                                  ========      =========

     The  valuation  allowance  on tax  assets  decreased  $73,000  in 2002  and
$523,000 in 2001.  The  decrease  in  valuation  allowance  in 2002 and 2001 was
primarily due to the utilization of net operating loss carry forwards.

NOTE 15.  RELATED PARTY TRANSACTIONS

     The Company occasionally utilizes previously owned transportation equipment
for use in its operations.  The lenders  providing  financing for this equipment
require the debt to be secured by the personal  guarantee of the Company's Chief
Executive  Officer.  In these situations the Company has leased certain vehicles
from an entity  controlled  by the Chief  Executive  Officer.  The Company  made
payments  pursuant to such leases of $53,000,  $64,000 and $33,000  during 2003,
2002 and 2001, respectively.

     The Company  executed an  agreement to manage the  operations  of an entity
owned by an affiliate  in November  2000.  Fees  received  under this  agreement
totaled $0,  $180,000 and $548,000 for the years ended  December 31, 2003,  2002
and 2001, respectively.

     Certain of the Company's indebtedness is personally guaranteed by the Chief
Executive Officer as a requirement of the lenders.

NOTE 16.  COMMITMENTS AND CONTINGENCIES

     Total lease expense was $458,000,  $220,000 and $109,000 for 2003, 2002 and
2001,  respectively,  under all  operating  leases.  The  future  minimum  lease
payments are as follows: 2004 - $329,000, 2005 - $183,000, 2006 - $157,000, 2007
- $105,000, 2008 - $7,000.

     The Company  holds a 15% equity  interest in an assisted  living center and
has  guaranteed  debt  related to the  building of the  investee and has pledged
$1,600,000  in  certificates  of deposit  for the  guarantee.  The  Company  has
recognized  losses of the  investee  and has reduced its  carrying  value in the
investment to zero. The outstanding debt balances were approximately  $1,600,000
and  $1,700,000 at December 31, 2003 and 2002,  respectively.  The Company would
have  the  right  to sell  the  living  center  as a going  concern  and use any
proceeds,  after payment of debts,  to recover  amounts owed to it by the living
center in the event of default of the debt  payments.  The Company  expects that
the  appraised  value of the living  center will exceed the existing  debt.  The
Company believes the consolidation of this entity will be required under FIN 46,
as  revised  by  FIN  46 (R)  at  March  31,  2004  (see  Note  1) and if  after
consolidation, the Company would sell the asset for less than the carrying value
at  that  time,  the  Company  could  be  required  to  recognize  a loss on the
disposition  of the asset.  Total assets of the assisted  living center  totaled
approximately  $1,600,000  as of December 31, 2003 and losses for the year ended
December 31, 2003 equaled $110,000.

     The Company executed a three-year  employment  agreement with the Company's
CEO in  1997.  The  agreement  provides  for  compensation  at a base  rate  and
increases to be  determined  on an annual basis by the Board of  Directors.  The
agreement also contains provisions for severance pay and disability payments, as
well as a non-compete  agreement  preventing the CEO from engaging in a business
deemed  similar to that of the  Company.  The Board of Directors  extended  this
agreement for three  additional  years in December 2001. The Company  terminated
its deferred compensation plan for key executives in 2002.

                                    Page 34
<PAGE>

                        AVALON CORRECTIONAL SERVICES, INC

NOTE 17.  LITIGATION

     The  Company  is a party to  litigation  arising  in the  normal  course of
business.  Management  believes that the ultimate  outcome of these matters will
not have a material  effect on the Company's  financial  condition or results of
operations.

     The  Company  was  awarded  a  judgment  in  late  2003  in the  amount  of
approximately  $356,000  including  prejudgment  interest and attorney  fees and
expenses.  This  judgment  was  awarded  to the  Company  on a  contract  claim.
According to Oklahoma  Statutes,  the payment for such judgment is to be paid in
one-third installments  annually,  subject to the tax levy becoming final (which
occurred in the fourth  quarter) and  pursuant to the  collection  thereof.  The
Company recorded a receivable of approximately  $356,000  included as additional
revenues in 2003 related to this judgment.

NOTE 18.  SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

     Selected  quarterly  financial  data for each of the  quarters in the years
ended December 31, 2003 and 2002 is as follows:
<TABLE>
<CAPTION>

                                       First        Second      Third         Fourth       Totals
                                    -----------   ---------   ---------      ---------   -----------
            2003
---------------------------
<S>                                 <C>          <C>         <C>          <C>          <C>
Total revenues                       $ 6,170,000  $ 6,112,00  $ 6,346,00   $ 6,632,000  $ 25,260,000
                                      ==========   =========   =========    ==========   ===========
Net income                           $   260.000  $  252,000  $  311,000   $  351,000   $  1,174,000
                                      ==========   =========   =========    ==========   ===========
Earnings per common share - basic    $       .05  $      .05  $      .06   $      .08   $        .24
                                      ==========   =========    ========     =========    ==========
Earnings per common share - diluted  $       .05  $      .05  $      .06   $      .06   $        .22
                                      ==========   =========   =========    ==========   ===========

            2002
---------------------------
Total revenues                       $ 6,625,00   $ 6,744,00  $ 6,878,000  $ 7,209,000  $ 27,456,000
                                      =========    =========   ==========   ==========   ===========
Net income                           $  326,000   $  269,000  $   185,000  $   341,000  $  1,121,000
                                      =========    =========   ==========   ==========   ===========

Earnings per common share -          $      .07   $      .06  $       .04   $      .06  $        .23
                                      =========    =========   ==========    =========   ===========
Earnings per common share -          $      .06   $      .05  $       .04   $      .05  $        .20
                                      =========    =========    =========    =========   ===========
</TABLE>

                                    Page 35
<PAGE>

                      AVALON CORRECTIONAL SERVICES, INC

     ITEM 9. CHANGES IN AND  DISAGREEMENTS  WITH  ACCOUNTANTS  ON ACCOUNTING AND
FINANCIAL DISCLOSURE

      None.

ITEM 9A.    CONTROLS AND PROCEDURES

     The Company's  Principal  Executive Officer and Principal Financial Officer
have  reviewed and  evaluated  the  effectiveness  of the  Company's  disclosure
controls and  procedures (as defined in Exchange Act Rule  240.13a-15(e))  as of
the end of the period  covered by this  report.  Based on that  evaluation,  the
Principal  Executive Officer and the Principal  Financial Officer have concluded
that the Company's current  disclosure  controls and procedures are effective to
ensure that  information  required to be  disclosed by the Company in reports it
files or submits under the Exchange Act is recorded,  processed,  summarized and
reported  within the time  periods  specified  in the  Securities  and  Exchange
Commission's  rules and  forms.  There was no change in the  Company's  internal
controls that occurred  during the fourth  quarter of the period covered by this
report that has  materially  affected,  or is reasonably  likely to affect,  the
Company's internal controls over financial reporting.

                                   PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

MANAGEMENT -

      Name                          Age   Position(s) with the Company

      Donald E. Smith ..............51    Chief Executive Officer and Director
      James L. Saffle ..............51    President
      Patrick Sullivan .............37    Vice President of Texas Operations
      Thomas M. Sullivan ...........45    Vice President of Colorado Operations
      Randall J. Wood ..............45    Corporate Secretary, Vice President,
                                          and Counsel
      Tiffany Smith ................36    Vice  President of Corporate
                                          Communications
      David Grose... ...............51    Vice President of Finance
      Eric Gray ....................47    Vice President and Counsel
      Robert O. McDonald ...........65    Director
      Mark S. Cooley ...............46    Director
      James P. Wilson ..............45    Director
      Charles W. Thomas ............60    Director


Directors and Officers of the Company -

     The following is a brief description of the business  experience of each of
the above-named persons:

     Donald E. Smith is the Chairman,  Founder,  and Chief Executive  Officer of
Avalon Correctional  Services and its subsidiaries.  Mr. Smith has served as CEO
since the inception of the Company. Mr. Smith has owned, managed and developed a
number of private corporations since 1985 to provide private corrections, health
care and other related  services.  Mr. Smith has a Bachelor of Science degree in
Accounting   with  minors  in  Economics   and  Business   Administration   from
Northwestern State College.  Mr. Smith was employed by Arthur Andersen & Co. for
seven years prior to founding the Company.

     James L.  Saffle is  President  of the Company  and its  subsidiaries.  Mr.
Saffle  oversees the Company's  operating  facilities  throughout  three states.
Prior to joining  the  Company in 2001,  Mr.  Saffle  retired as Director of the
Oklahoma  Department of  Corrections,  where he was  instrumental in leading the
department  through a period of tremendous growth and change.  His distinguished
career  with the  Oklahoma  Department  of  Corrections  began as a  Corrections
Officer and progressed through the positions of sergeant,  lieutenant,  training
and safety officer,  chief of security,  deputy warden,  and warden.  He further
served the Oklahoma  Department of Corrections in the capacities of Southeastern
Regional  Director and Interim Director and ultimately was appointed as Director
of the Oklahoma  Department of Corrections by the Oklahoma Board of Corrections.
Mr. Saffle holds a Bachelor of Science in Criminal Justice and Psychology, and a
Masters of Science degree in Human Resources.

                                    Page 36
<PAGE>
                       AVALON CORRECTIONAL SERVICES, INC

     Patrick Sullivan is Vice President of Texas Operations and has over fifteen
years of  experience in the field of criminal  justice and security  operations.
His expertise is in staff management,  facility operations, risk management, and
rehabilitative  programs.  He currently has  administrative  responsibility  and
oversight for the Company's  Texas  intermediate  sanction secure and non-secure
correctional facilities.  Before joining Avalon, Mr. Sullivan was Vice President
of  Facility  Operations,   Unit  Director  for  a  multi-use  secure  facility,
Operations  Director,  and Life  Skills  Coordinator  for the Texson  Management
Group,  Inc.  Prior to Texson,  he held  positions  as Captain at the Kyle Unit,
Assistant  Shift  Supervisor,   and  Correctional   Officer  for  the  Wackenhut
Corrections  Corporation.  He attended  Sam Houston  University  in  Huntsville,
Texas, and San Antonio College.

     Thomas M. Sullivan is Vice President of Colorado  Operations.  Mr. Sullivan
is a 24 year veteran of law  enforcement and  corrections,  having worked at the
Montana State Prison, at the Alpha Center as Community Corrections provider, and
in  Denver  as a  Parole  Officer  and  Parole  Supervisor.  He is a  nationally
recognized  speaker on gangs and has  co-authored  a research book on the Racist
Asatru Religion. Mr. Sullivan continues to be the Colorado State Coordinator for
the National Major Gang Task Force. He is a veteran of the US Navy, and received
his bachelor's  degree from the University of Hawaii.  Mr. Sullivan was the 1994
Division of Adult  Parole  "Employee of the Year",  received the Colorado  STING
"Gang  Officer  of the  Year" in 2002,  and was the  recipient  of the  Colorado
Association of Robbery Investigators "Lifetime Achievement" award in 2002.

     Randall J. Wood joined Avalon in 1995 and serves as Corporate Secretary and
Counsel for the Company.  Prior to joining the Company,  Mr. Wood's practice was
focused primarily in the field of real property and commercial  litigation.  Mr.
Wood practiced with the firm of Stack & Barnes, P.C. for ten years, and was with
the firm of Hammons,  Vaught, & Conner prior to joining the Company. Mr. Wood is
a member of the  Oklahoma  Bar  Association  and is  authorized  to  practice in
Oklahoma  Federal  Courts and the Tenth  Circuit  Court of Appeals.  Mr. Wood is
responsible  for the  duties of the  Corporate  Secretary,  management  of legal
matters,  and compliance  with  government  regulations  for the Company and its
subsidiaries.  Mr. Wood received his law degree from the  University of Oklahoma
in 1983.

     Tiffany Smith joined the Company in 1994 as the Public Information  Officer
and was promoted to Assistant Corporate Secretary for the Company in 1997 and to
Vice  President of Corporate  Communications  in 1999. Ms. Smith served for four
years as  marketing  manager  for  Eagle  Picher  Industries,  a New York  Stock
Exchange listed company, prior to joining Avalon. Ms. Smith has developed and is
responsible  for  directing the Company's  Corporate  Communications  and Public
Relations department. Ms. Smith also developed and oversees Avalon's private-pay
program in  Oklahoma.  She is also  responsible  for  responding  to  government
requests  for  proposals  in  Oklahoma,  Colorado,  and Texas.  Ms. Smith is the
Company's  primary  contact for the Company's  shareholders  and investors.  Ms.
Smith  received a Bachelors  Degree in Business  Administration,  Marketing  and
Management  from Missouri  Southern  State  College.  Ms. Smith is the spouse of
Donald Smith, Chief Executive Officer.

     David Grose was appointed  Vice  President of Finance in January 2004.  Mr.
Grose has overall  responsibility for administration of the financial  reporting
functions for the Company and  subsidiaries.  Mr. Grose is also  responsible for
administration   of  the  Company's  human  resources   department,   and  other
administrative  functions  including GAAP and SEC  compliance.  Prior to joining
Avalon, he was Chief Financial Officer with Oxley Petroleum Company, formerly an
oil and gas  exploration  and  development  company,  Vice  President  and Chief
Financial Officer for Amerivision Communications,  a telecommunications company,
Vice  President and Chief  Financial  Officer of Bayard  Drilling  Technologies,
formerly a publicly  traded oil and gas  drilling  company  and  Director,  Vice
President and Chief Financial Officer of Alexander Energy Corporation,  formerly
a publicly traded oil and gas exploration  and  development  company.  Mr. Grose
graduated  from  Oklahoma  State  University  with a Bachelor  of Arts Degree in
Political  Science and from the  University  of Central  Oklahoma with a Masters
Degree in Business Administration.

     Eric Gray joined Avalon as a Vice  President in June 1999.  Mr. Gray serves
as  Corporate   Counsel  for  the  Company  and  is   responsible   for  various
administrative functions. Mr. Gray's responsibilities include pending litigation
matters,  contract  review and State law  compliance  issues.  Mr.  Gray is also
responsible for administering and directing the Company's  activities  regarding
implementation  of the  Oklahoma  Community  Sentencing  Act  and  the  Oklahoma
mandated prison transition  legislation.  Before joining Avalon, he was Managing
Director and President of his law firm, Gray and Goresen, P.C., an associate and
shareholder/director  of Edwards,  Roberts & Propester,  P.C.,  and an associate
with Kirk and Chaney.  He graduated  from the  University of  Pittsburgh  with a
Bachelor  of Arts  degree.  He holds  his Juris  Doctorate  from  Oklahoma  City
University.
                                    Page 37
<PAGE>

                       AVALON CORRECTIONAL SERVICES, INC

     Robert O.  McDonald was  appointed as a Director of Avalon in October 1994.
Mr.  McDonald is Chairman of the Board of Directors  of Capital West  Securities
and its parent holding company,  Affinity Holding Corp. Mr. McDonald started his
investment  career  in 1961  with  Allen  and  Company  and left in 1967 to form
McDonald  Bennahum and Co., which later joined with  Ladenburg  Thalmann and Co.
where Mr. McDonald was a Senior Partner.  Mr. McDonald joined Planet Oil Mineral
Corporation  in 1971 and became  president  in 1973.  From 1975 until 1993,  Mr.
McDonald was affiliated  with Stifel Nicolaus & Company and headed its municipal
syndicated  effort. Mr. McDonald received a Bachelors Degree in Finance from the
University  of  Oklahoma  in 1960.  He also  served as an  Officer in the United
States Army and Army Reserve.

     Mark S. Cooley was appointed as a Director of Avalon in January  1998.  Mr.
Cooley is a Principal  of Cooley & Company and Pro Trust  Equity  Partners.  Mr.
Cooley was with Citicorp and Chemical  Bank for twelve years in their  Corporate
Finance  Divisions in New York and Denver.  Mr.  Cooley  received his  Bachelors
degree in Economics  from DePauw  University  and an MBA in Finance from Indiana
University.

     James P. Wilson was  appointed as a  Director-elect  of Avalon in September
1998, and was elected as a Director by  shareholders at the 1999 annual meeting.
Mr. Wilson is a managing partner in the investment firm of Rice, Sangalis, Toole
& Wilson.  Prior to founding Rice,  Sangalis,  Toole & Wilson,  Mr. Wilson was a
vice president with First Texas  Merchant  Banking Group,  and was also an audit
manager with Arthur Young & Co. Mr. Wilson  received a BBA degree from Texas A&M
University, and is a Certified Public Accountant.

     Charles W. Thomas,  Ph.D.  was appointed as a  Director-elect  of Avalon in
December  2000 and was  elected as a Director  by the  shareholders  at the 2001
annual meeting.  Dr. Thomas received his B.S. degree from McMurry  University in
1966 and his  M.A.  and  Ph.D.  degrees  from the  University  of  Kentucky  in,
respectively,   1969  and  1971.  After  serving  on  the  faculty  of  Virginia
Commonwealth  University,  the  College of William and Mary,  and Bowling  Green
State  University,  he became a Professor of  Criminology  at the  University of
Florida in 1980. He retired from his academic  position in 1999 but continues to
publish the results of his on-going research on the economic,  legal, and public
policy aspects of privatization.  From 1997-2000, Dr. Thomas was a member of the
board of directors of Prison Realty Trust.  Dr. Thomas is now Vice President for
Quality  Assurance  at  ConnecGov,  Inc.,  a  privately  held  corporation  that
specializes in computer-based training and distance learning.

Corporate Governance Items

Audit Committee Financial Expert

     The information  required by this Item is herein  incorporated by reference
from the  Company's  Proxy  Statement  for the Annual  Meeting  of  Shareholders
scheduled for May 19, 2004, which Proxy Statement is to be filed within 120 days
after December 31, 2003.

Audit Committee Composition and Independence

     The information  required by this Item is herein  incorporated by reference
from the  Company's  Proxy  Statement  for the Annual  Meeting  of  Shareholders
scheduled for May 19, 2004, which Proxy Statement is to be filed within 120 days
after December 31, 2003.

Code of Ethics for Chief Executive Officer and Senior Financial Officers

     The Company has  adopted a Code of Ethics for the Chief  Executive  Officer
and the Senior Financial Officers, violations of which should be reported to the
Audit  Committee.  The Code of Ethics is  included  within the  Company's  Proxy
Statement to be filed within 120 days of December 31, 2003, and is  incorporated
herein by reference.  Any amendment to or waiver of the  application of the Code
of Ethics for the Chief Executive Officer and Senior Financial  Officers will be
promptly disclosed on the Company's web site at  www.avaloncorrections.com.  The
information  contained on or connected to the Company's  Internet website is not
incorporated  by reference into this Form 10-K and should not be considered part
of this or any other report that the Company files with or furnishes to the SEC.


                                    Page 38
<PAGE>
                       AVALON CORRECTIONAL SERVICES, INC

ITEMS 11, 12, 13 and 14.

     The information  required by these Items has been incorporated by Reference
from the  Company's  definitive  proxy  statement,  which will be filed with the
Commission not later than 120 days after December 31, 2003.

ITEM 15.  EXHIBITS AND REPORTS ON FORM 8-K.

       3.   i     Articles of Incorporation (1)
            ii    Bylaws (1)
            iii   Articles of Amendment to Registrant's Articles of
                  Incorporation (2)
            iv    Amendment to Registrant's Articles of Incorporation dated
                  December 31, 1995
            v     Certificate of Corporate Resolutions, dated December 13, 1993,
                  regarding authorization of Class B Common Stock and
                  Amendment to Articles (3)

       4.   i     Form of Stock Certificate (1)
            ii    Form of Convertible Debenture Agreement (6)

     10.    i     Stock Option Plan adopted by Board of Directors on August
                  16, 1994 (4)
            ii    Change of Control Agreement between Donald E. Smith and
                  Avalon Community Services, Inc. dated August 25, 1997. (5)
            iii   Employment Agreement with Donald E. Smith dated August 8,
                  1997.(5)
            iv    Agreement dated June 1, 1998 between Southern Corrections
                  Systems, Inc. and the Texas Department of Criminal Justice.
                  (7)
            v     Financing agreement between Avalon Community Services,
                  Inc., and Fleet Capital Corporation dated February 25,
                  1999. (8)
            vi    Amended and Restated Loan and Security Agreement between
                  Avalon Correctional Services, Inc., et al., and Fleet
                  Capital Corporation, dated December 9, 1999. (10)
            vii   Agreement dated September 16, 1998, between Avalon
                  Community Services, Inc., and RSTW Partners III. (9)

     21.    i     Subsidiaries of Registrant.  The Registrant's wholly owned
                  subsidiary, Southern Corrections Systems, Inc., is the sole
                  member of The Villa at Greeley, L.L.C., a Colorado limited
                  liability company.   Southern Corrections Systems, Inc., is
                  the sole voting member of Adams Community Corrections
                  Program, Inc., a Colorado nonprofit corporation.

     31.1  CEO Certification required under Section 302 of Sarbanes-Oxley Act
           of 2002.

     31.2  CFO Certification required under Section 302 of Sarbanes-Oxley Act
           of 2002.

     32.1  CEO Certifications required under Section 906 of Sarbanes-Oxley Act
           of 2002.

     32.2  CFO Certifications required under Section 906 of Sarbanes-Oxley Act
           of 2002.

     (b)   Reports on Form 8-K - none

Footnotes:
         1) Incorporated herein by reference to the Registrant's Registration
            Statement on Form S-18 dated March 26, 1991.
         2) Incorporated herein by reference to the Registrant's Post
            Effective Amendment No. 1 to Registration Statement on Form S-18
            dated August 3, 1992.
         3) Incorporated herein by reference to the Registrant's Form 10-KSB
            for the fiscal year ended December 31, 1993 and dated March 24,
            1994.
         4) Incorporated herein by reference to the Registrant's Registration
            Statement on Form SB-2 dated September 13, 1995 and amended.

                                    Page 39
<PAGE>

                       AVALON CORRECTIONAL SERVICES, INC

         5) Incorporated herein by reference to the Registrant's Registration
            Statement on Form S-2 Amendment No. 1 dated April 16, 1996 and
            amended.
         6) Incorporated herein by reference to the Registrant's Form S-2
            dated December 22, 1997.
         7) Incorporated herein by reference to the Registrant's Registration
            Statement on Form S-2 dated September 14, 1998.
         8) Incorporated by reference to the Registrant's Form 8-K dated
            March 10, 1999.
         9) Incorporated by reference to the Registrant's Form 8-K dated
            October 1, 1998.
        10) Incorporated by reference to the Registrant's Registration
            Statement on Form S-2 dated March 24, 2000


                                    Page 40
<PAGE>

                       AVALON CORRECTIONAL SERVICES, INC

SIGNATURES.

     In accordance  with Section 13 or 15(d) of the  Securities  Exchange Act of
1934,  the  Registrant has duly caused this report to be signed on its behalf by
the undersigned, there unto duly authorized.

                                          AVALON CORRECTIONAL SERVICES, INC.


                                          By:    s\  Donald E.Smith
                                          Donald E. Smith
                                          Chief Executive Officer and Director

                                          Dated: April 9, 2004

     In accordance  with the  Securities  Exchange Act of 1934,  this report has
been signed below by the following  persons on behalf of the  Registrant  and in
the capacities and on the dates indicated.



By:   s\ Donald E. Smith
Donald E. Smith
Chief Executive Officer and Director                      Dated: April 9, 2004



By:   s\ Robert O. McDonald
Robert O. McDonald
Director                                                  Dated: April 9, 2004



By:   s\ Mark S. Cooley
Mark S. Cooley
Director                                                  Dated: April 9, 2004



By:   s\ James P. Wilson
James P. Wilson
Director                                                  Dated: April 9, 2004



By:   s\ Charles W. Thomas, Ph.D.
Charles W. Thomas
Director                                                  Dated: April 9, 2004



By:   s\ David Grose
David Grose
Vice President of Finance                                 Dated: April 9, 2004



                                    Page 41
<PAGE>

                       AVALON CORRECTIONAL SERVICES, INC


                             ANNUAL CERTIFICATION

                                                                    Exhibit 31.1

I, Donald E. Smith, Chief Executive Officer, certify that:



(1)  I have  reviewed  this  annual  report on Form 10-K of Avalon  Correctional
     Services, Inc.;

(2) Based on my knowledge, this report does not contain any
     untrue  statement  of a  material  fact or omit to  state a  material  fact
     necessary to make the statements made, in light of the circumstances  under
     which such  statements were made, not misleading with respect to the period
     covered  by  this  report;

(3)  Based  on  my  knowledge,   the  financial
     statements, and other financial information included in this report, fairly
     present  in all  material  respects  the  financial  condition,  results of
     operations  and cash flows of the  registrant  as of, and for,  the periods
     presented in this report;

(4) The registrant's other certifying officer and
     I are responsible for establishing and maintaining  disclosure controls and
     procedures  (as defined in Exchange Act Rules  13a-15(e) and 15d-15(e)) for
     the  registrant  and  have:

     (a) Designed  such  disclosure   controls  and procedures,  or caused  such
         disclosure controls and procedures to be designed undeR our supervision
         to  ensure  that  material  information  relating  to  the  registrant,
         including its  consolidated subsidiaries, is made known to us by others
         within those entities,  particularly  during the period  in  which this
         report is being prepared;

     (b  Evaluated the effectiveness of the registrant's disclosure controls and
         procedures  and  presented  in  this report  our  conclusions about the
         effectiveness of the disclosure controls and  procedures, as of the end
         of the period covered by this report based on such evaluation; and

     (c) Disclosed  in  this  report  any  change  in  the registrant's internal
         control over financial reporting that occurred during the  registrant's
         most recent fiscal quarter (the registrant's  fourth  fiscal quarter in
         the case of an annual report)  that  has  materially  affected,  or  is
         reasonably  likely  to  materially  affect,  the  registrant's internal
         control over financial reporting; and

(5)  The registrant's other certifying  officer and I have disclosed,  based  on
     our most recent  evaluation of internal  control over financial  reporting,
     to the  registrant's  auditors and the audit  committee of the registrant's
     board of directors (or persons performing the equivalent functions):

     (a) All significant deficiencies and  material weaknesses  in the design or
         operation  of  internal  control  over  financial  reporting  which are
         reasonably likely to  adversely  affect  the  registrant's  ability  to
         record, process, summarize and report financial information; and

     (b) Any fraud, whether or not material,  that  involves management or other
         employees  who  have  a  significant role in  the registrant's internal
         control over financial reporting.



Date: April 9, 2004                         /s/ Donald E. Smith
                                            Donald E. Smith
                                            Chief Executive Officer
                                    Page 42
<PAGE>

                       AVALON CORRECTIONAL SERVICES, INC


                            ANNUAL CERTIFICATION

                                                                    Exhibit 31.2

I, David Grose, Vice President of Finance, certify that:


(1) I have reviewed  this  annual  eport  on Form  10-K of  Avalon  Correctional
    Services, Inc.;

(2) Based on  my knowledge, this report does not contain any untrue statement of
    a  material  fact or  omit to  state  a  material fact necessary to make the
    statements  made, in  light of the circumstances under which such statements
    were made, not misleading with respect to the period covered by this report;

(3) Based  on  my  knowledge,  the  financial  statements, and  other  financial
    information included in this report, fairly present in all material respects
    the  financial  condition, results  of  operation   an   cash  flows of  the
    registrant as of, and for, the periods presented in this report;

(4) The  registrant's  other  certifying  officer  and  I  are  responsible  for
    establishing and maintaining disclosure controls and  procedures (as defined
    in  Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

    (a) Designed  such  disclosure  controls  and  procedures,  or  caused  such
        disclosure controls and procedures to be designed under our supervision,
        to  ensure  tha   material  information  relating   to  the  registrant,
        including  its  consolidated subsidiaries, is made known to us by others
        within  those  entities, particularly  during  the  period in which this
        report is being prepared;

   (b)  Evaluated the  effectiveness of  the  registrant's  disclosure  controls
        and procedures and presented  in  this report our conclusions  about the
        effectiveness of the disclosure controls and procedures, as  of  the end
        of  the  period  covered  by  this  report based on such evaluation; and

    (c) Disclosed  in  this report  any  change  in  the  registrant's  internal
        control over financial reporting that  occurred  during the registrant's
        most recent fiscal  quarter (the registrant's fourth  fiscal  quarter in
        th   case  of  an  annual  report)  that  has materially affected, or is
        reasonably  likely  to  materially  affect,  the  registrant's  internal
        control over financial reporting; and

5)   The registrant's other certifying officer and I have  disclosed,  based  on
     our most recent evaluation of internal control over financial reporting, to
     the  registrant's  auditors  and  the  audit c ommittee of the registrant's
     board of directors (or persons performing the equivalent functions):

    (a) All significant deficiencies  and  material  weaknesses in the design or
        operation   of  interna  control  over  financial  reporting  which  are
        reasonably  likely  to  adversely  affect  the   registrant's ability to
        record, process, summarize and report financial information; and

    (b) Any fraud, whether or not  material, that involves  management  or other
        employees  who  have a  significant  role in the  registrant's  internal
        control over financial reporting.




Date: April 9, 2004                               /s/ David Grose
                                                  David Grose
                                                  Vice President of Finance
                                    Page 43
<PAGE>

                       AVALON CORRECTIONAL SERVICES, INC


                                                                  Exhibit 32.1

                          CERTIFICATION PURSUANT TO
                           18 U.S.C. SECTION 1350,
                            AS ADOPTED PURSUANT TO
                SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

     In connection with the Annual Report of Avalon Correctional Services,  Inc.
(the  "Company")  on Form 10-K for the period ended  December 31, 2003, as filed
with the Securities and Exchange  Commission on the date hereof (the  "Report"),
I, Donald E. Smith, Chief Executive Officer of the Company, certify, pursuant to
18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley
Act of 2002, that to the best of my knowledge:

          (1)     The Report fully complies with the  requirements  of section
                  13(a) or 15(d) of the Securities Exchange Act of 1934; and

          (2)     The information  contained in  the Report fairly  presents, in
                  all material  respects,  the financial  condition  and results
                  of operations of the Company.

/s/ Donald E. Smith

Donald E. Smith
Chief Executive Officer
April 9, 2004

                                    Page 44

<PAGE>

                       AVALON CORRECTIONAL SERVICES, INC
                                                                  Exhibit 32.2

                          CERTIFICATION PURSUANT TO
                           18 U.S.C. SECTION 1350,
                            AS ADOPTED PURSUANT TO
                SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection  with the Annual Report of Avalon  Correctional  Services,  Inc.
(the  "Company") on Form 10-K for the period ended December 31, 2003, as filed
with  the  Securities  and  Exchange   Commission  on  the  date  hereof  (the
"Report"), I, David Grose, Vice President of Finance,  certify, pursuant to 18
U.S.C.  section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley
Act of 2002, that to the best of my knowledge:

          (1)     The Report fully complies with the  requirements  of section
                  13(a) or 15(d) of the Securities Exchange Act of 1934; and

          (2)     The information  contained in  the Report fairly  presents, in
                  all material  respects,  the financial  condition and  results
                  of operations of the Company.

/s/ David Grose

David Grose
Vice President of Finance
April 9, 2004

                                    Page 45