Performance audit, Department of Corrections, Arizona correctional industries

              PERFORMANCE AUDIT
DEPARTMENT OF CORRECTIONS
ARIZONA CORRECTIONAL INDUSTRIES
Report to the Arizona Legislature
By the Auditor General
September 1991
91- 13
DOUGLAS R. NORTON, CPA
AUDITOR GENERAL
STATE OF ARIZONA
OFFICE OF THE
AUDITOR GENERAL
September 30, 1991
Members of the Arizona Legislature
The Honorable F i f e Symington, Governor
Mr. Samuel A. Lewis, Director
Arizona Department of Corrections
Transmitted herewith i s a report of the Auditor General, A Performance
Audit of the Department of Corrections, Arizona Correctional Industries
( A C I ) . This report i s in response to a June 14, 1989, resolution of the
Joint Legislative Oversight Committee.
The report addresses AClls i n a b i l i t y to operate in a self- supporting
manner due to several poor business practices. We found that although
ACI has reduced the size of the losses experienced by i t s predecessor,
ARCOR, i t has yet to demonstrate that i t can achieve the statutory
mandate of self- sufficiency.
My s t a f f and I w i l l be pleased to discuss or c l a r i f y items in t h i s report.
The report w i l l be released to the public on October 1, 1991.
Sincerely,
Audi or GenNeorartl on
DRN : l mn
Enclosure
2700 NORTH CENTRAL AVENUE SUlTE 700 PHOENIX, ARIZONA 85004 ( 602) 255- 4385 ' FAX ( 602) 255- 1 251
The Office of the Auditor General has conducted a performance audit of
the Arizona Department of Corrections ( DOC), Arizona Correctional
Industries. The audit was conducted in response to a June 14, 1989,
resolution of the Joint Legislative Oversight Committee as part of the
Sunset Review set forth in Arizona Revised Statutes ( A. R. S.) § § 41- 2351
through 41- 2379.
In 1987, the Legislature established Arizona Correctional Industries
( ACI) to provide employment for inmates, reduce inmate idleness,
manufacture goods, and provide services needed by State and local
governments, nonprofit organizations and the general public. The program
is required to be self- supporting as of July 1, 1991. Unlike i t s
predecessor, Ar i zona Correct i ona l En terpr i ses ( ARCOR), ACI operates under
the direct control of the Director of the Department of Corrections and
does not have a separate Board to provide private industry expertise.
According to the Department, ACI has corrected many deficiencies which
existed under ARCOR. ACI has also reduced the size of the losses
experienced during the ARCOR years. However, ACI has yet to demonstrate
an a b i l i t y to meet i t s statutory mandate of self- sufficiency.
Poor Business Practices Hamper ACl's Ability
To Become Self- Sup~ orting ( See pages 5 through 14)
In part, ACI has not become self- supporting due to a number of
inadequate business practices. Most importantly, ACl's sales e f f o r t is
poorly planned and managed, and sales f a l l far short of what is necessary
to sustain i t s operations. Over the past few years, ACI has remained in
business only by relying on State appropriations and i t s revolving fund
reserves rather than generating sufficient sales to support the program.
ACI lacks a sales plan and program to effectively market i t s products and
services. It has no structured sales approach to guide i t s four- person
sales s t a f f . Sales representatives do not work from a written schedule,
nor do they use a formal plan of action. We found that the three sales
staff involved in selling ACl's general product line averaged only eight
customer contacts per day ( including telephone calls), and that large
blocks of time ( as much as four hours in a day) are not accounted for.
The weak sales e f f o r t results in a limited customer base. ACI relies on
sales to two major customers, WC and the Department of Transportation,
which purchases license plates. These two customers generate nearly 70
percent of ACl's sales revenue. Some potential customers on ACl's master
l i s t of State and local agencies, school d i s t r i c t s , and hospitals are not
contacted by ACI sales s t a f f . In fact, the few new customers ACI obtains
each year appear to result mostly from the customers contacting ACI, not
from sales contacts.
In addition to problems with sales, we identified several other poor
business practices that any business could not sustain and remain in
bus i ness .
0 ACl's overhead may be too high for i t s sales volume.
Internal budgets do not provide an accurate picture of expenses and
are not always maintained and updated.
Financial information available to shop supervisors is not timely.
One shop supervisor we interviewed was so unaware of his shop's
financial status that he was under the impression his shop was making
a p r o f i t when, in actuality, i t was operating at a loss.
ACl's approach to product pricing is not competitive. For example,
ACI overbid a print job by two and one- half times the price offered
by the winning competitor.
Production scheduling is not conducive to timely delivery because
shops maintain a limited inventory of finished products.
Shop staffing is not always adjusted when workload and revenue
decline.
While ACI has spent time and e f f o r t developing plans to improve the
program, it has not been able to meet some of the goals i t established.
Instead, ACI has relied on i t s revolving fund reserves to continue
operations.
To Meet Its Mandate. ACI Mav Need
Further Chanaes ( See pages 15 through 21)
The Legislature and the Director may need to take further steps to
address ACl's deficiencies. It is not operating in a self- supporting
manner, nor is i t employing a sufficient number of inmates. We reviewed
financial information on shop performance for fiscal years 1988- 1989
through March 31, 1991. Only three of twenty industries that ACI
operated during that time have realized a p r o f i t . Several shops have
lost substantial amounts of money. For example, the print shop has lost
over $ 400,000 during the three- year period. ACl's only consistently
profitable business is i t s license plate shop, which earned gross p r o f i t s
of almost $ 2 million during the three- year period reviewed. However,
these earnings were s t i l l insufficient to offset losses sustained by most
of ACl's other enterprises.
In addition, ACI employs fewer inmates today than i t did when i t was
f i r s t established. In 1987 ACI employed 750 inmates, almost 8 percent of
the total prison population at that time. Today ACI employs only about
535 inmates, 3.7 percent of the inmate population. Other states we
contacted employ at least 6 percent of their inmate population, and some
employ over 10 percent.
Near the end of our audit ACI took several steps in an e f f o r t to
improve. A new marketing program was developed to assist the sales staff
in increasing sales. In addition, staff and shop overhead was reduced by
eliminating 18 positions and relocating some shops. Finally, ACI
developed a strategic plan that, i f met, w i l l allow ACI to achieve
break- even status this fiscal year and net p r o f i t s i n future years.
The Legislature should monitor ACl's attempts to achieve self- sufficiency
this fiscal year. I f ACI is unable to achieve this goal for fiscal year
1991- 1992, other options for the program should be considered. One
option is restructuring the program. Two states, Florida and
Mississippi, have restructured their programs. Florida's program has
been operated by a non- profit corporation since 1981 and has realized a
p r o f i t every year since 1984. In 1990 Mississippi created a private,
nonprofit corporation to manage i t s prison industries. Another option is
retaining ACI within the Department of Corrections, but making whatever
personnel and organizational changes are needed to bring success.
TABLE OF CONTENTS
INTROWCTION AND BACKGROUND. . . . . . . . . . . . . . . . . . .
FINDING I: ACI'S POOR BUSINESS PRACTICES
HAMPER ITS ABILITY TO BECOME
SELF- SUPPORT I NG . . . . . . . . . . . . . . . . . . . . . . .
ACl's Sales E f f o r t s Are Weak . . . . . . . . . . . . . . . .
Several Other Poor Business Practices Identified . . . . . . . . . . . . . . . . . . . .
ACI Has Not Adequately Addressed
I t s Operational Problems . . . . . . . . . . . . . . . . . .
Recommendations. . . . . . . . . . . . . . . . . . . . . . .
FINDING 1 1 : TO MEET ITS MANDATE, ACI MAY
NEED FURTHER CHANGES . . . . . . . . . . . . . . . . . . .
ACI Is Not Serving I t s Purpose . . . . . . . . . . . . . . .
ACI Has Taken Recent Steps To Improve. . . . . . . . . . . .
Other Opt i ons May Need ToBeConsidered. . . . . . . . . . . . . . . . . . . . . .
Recommendations. . . . . . . . . . . . . . . . . . . . . . .
AGENCY RESPONSE
Pane
1
LIST OF TABLES
TABLE 1 ACI Industries Statement of Operations. . . . . . 16
INTRODUCTION AND BACKGROUND
The Office of the Auditor General has conducted a performance audit of
the Arizona Department of Corrections ( DOC), Arizona Correctional
Industries. The audit was conducted in response to a June 14, 1989,
resolution of the Joint Legislative Oversight Committee as part of the
Sunset Review set forth in Arizona Revised Statutes ( A. R. S.) $ 941- 2351
through 41- 2379.
Backcjround
In 1981, the Legislature created Arizona Correctional Enterprises ( ARCOR)
for the purpose of employing inmates to provide services and to
manufacture various products for use by State agencies or for sale to the
genera I pub I i c . ( ' I ARCOR was intended to be managed cooperat ive Iy
between a nine- member advisory board ( a l l of whom were to have private
industry experience) and the Director of the Department of Corrections.
However, after five years of operation ARCOR faced numerous operating and
internal control problems. A 1986 review of ARCOR by the accounting firm
of Arthur Andersen & Co. revealed that ARCOR needed to improve internal
controls in the areas of cash receipts and disbursements, accounts
receivable and payable, and inventory. That review also found that
management's decision- making process often was not well documented and
there was inadequate up- front analysis of contemplated projects. In
ARCOR1s last two years of operations, i t had net losses of $ 1.8 million
and $ 2.7 million, respectively.
In 1987, the Legislature replaced ARCOR with Arizona Correctional
Industries ( ACI) as a division under the authority of the Director of the
Department of Corrections. According to the Assistant Director over ACI,
the Arthur Andersen & Co. report resulted in the implementation of a
number of operational changes:
Development of an internal operational budget
( 1) P r i o r t o t h i s time, correctional industries were operated i n the State prison i n
Florence. Most of the enterprises manufactured goods and services to be used within
the i n s t i t u t i o n rather than f o r sale to other governmental agencies or to the public.
Specific internal accounting controls that pertain to cash receipts,
cash d i sbu rsemen t s , accounts payab I e , accounts rece i vab I e and
inventory
Ongoing restructuring to curtail losses, maintain ACl's cash position
and improve ACl's image.
Although part of a State agency, ACI was expected to operate l i k e a
private business with revolving account funds generated through the sale
of goods and services. To achieve this goal, the Legislature i n i t i a l l y
provided $ 2.1 million, but mandated that ACI become self- supporting by
July 1, 1989. The Legislature later extended this effective date to
J u l y l , 1991, at the Director's request. ACI, with no State
appropriations, is expected to effectively and e f f i c i e n t l y employ inmates
to reduce inmate idleness, produce and market quality products and
services primarily to meet the needs of State and local governments and
non- profit organizations, and to operate according to sound, professional
business practices.
Current Operations
The administration of ACI is coordinated through three bureaus,
Operations and Agribusiness, Business and Finance, and Marketing and
Sales, with a current staff of 49 full- time employees.(') ACI staff are
responsible for --? aging, operating, and supervising industrial and
agribusiness en* ises that employ inmates committed to the State
prisons under t, jurisdiction of the Department of Corrections. An
average of 535 inmates are employed by ACI each month. Inmates that work
in ACI shops can earn up to $. 80 per hour and inmates that provide
contract labor earn minimum wage. ACI wages are substantially higher
than the wages earned by inmates in DOC'S other work program, Work
lncent ive Pay Plan ( WIPP), where inmates earn an average hourly rate of
$. 26. Typically, the inmates that work for ACI have higher s k i l l levels,
thus are able to obtain the higher paying jobs.
( 1) During the audit, ACI was staffed with 67 full- time employees. Near the end of the
audit ( July 1991) ACI announced the elimination of 18 positions i n an e f f o r t to reduce
overhead costs. This reduction i n s t a f f i s to be completed by mid- September 1991.
Additionally, another position i s expected to be el iminated i n early 1992.
ACI businesses include metal fabrication; the manufacture of license
plates, bedding, signs, vinyl binders, and office products; farming;
furniture refurbishing; data entry; graphic arts; rebate fulfillment
i . . , coupon processing); and sewing. ACI's catalog l i s t s over 600
standard products. Two- thirds of these products are on a State contract
as authorized by the State Procurement Set- Aside Committee. In addition
to manufacturing and agribusiness, ACI provides employment opportunities
for inmates with private sector companies through both contract labor and
joint ventures.
Most of ACl's industries have not been profitable. Only three of the
twenty enterprises that operated during the last three fiscal years have
made a gross p r o f i t . ACl's leading enterprise is the license plate shop,
which manufactures license plates for the Department of Transportation.
ACI has also had some success with i t s copying service and metal
fabrication shop. As of the third- quarter of fiscal year 1990- 1991, ACI
had a loss of $ 857,040 before receiving a State appropriation.
Scope And Methodoloay
This audit was conducted as part of the Sunset Review of the Department
of Corrections as defined by A. R. S. 541- 2352. The purpose of the audit
was to determine whether ACI is needed and the extent to which i t has
accomplished i t s statutory goals. The audit focuses primarily on ACl's
e f f o r t s t o achieve self- sufficiency as well as serving i t s purpose of
employing inmates and operating according to sound business practices.
During our audit, we u t i l i z e d the services of a volunteer consultant, Mr.
Morton Leeper, in our review of ACl's sales program. Mr. Leeper has an
extensive background in managing a national sales program as well as
experience in owning and operating a small chain of r e t a i l businesses.
This expertise proved invaluable in evaluating ACl's sales program.
We also contacted several states for comparative information.( i) These
states were selected based on the recommendation of various individuals
( 1 ) States contacted include California, Florida, Michigan, Minnesota. Mississippi,
Nevada, New York, Texas, and Washington.
having extensive knowledge of prison industries across the country. The
Federal prison industry program, UNICOR, was also contacted.
This audit was conducted in accordance with government auditing standards.
The Auditor General and staff express appreciation to the Director of the
Department of Corrections and Assistant Director and staff of Arizona
Correctional Industries for their cooperation and assistance during the
audit.
FINDING I
ACI'S POOR BUSINESS PRACTICES
HAMPER ITS ABILITY
TO BECOME SELF- SUPPORTING
ACl's poor business practices hamper i t s a b i l i t y to become
self- supporting. ACI operates with a weak sales e f f o r t and other
inadequate business practices that other businesses could not tolerate
and s t i l l survive. While many of these problems have been previously
identified in ACl's business and strategic plans, the problems s t i l l
persist.
ACl's Sales Efforts
Are Weak
AClfs sales program is not adequate and does not generate sufficient
revenue to meet i t s operating costs. Lack of a systematic sales approach
and inadequate oversight of the sales staff may be two reasons the
program is not effective. The ineffectiveness of the program has forced
ACI to rely on i t s revolving fund to support i t s operations.
ACI does not aenerate sufficient sales - ACI does not achieve the sales
volume necessary to become a self- supporting business. Financial
statements prepared by ACI(') indicate that for the f i r s t three quarters
of fiscal year 1990- 1991, production costs for the products and services
i t sold were $ 124,219 more than ACl ' s gross revenues of $ 3.9 mi l l ion.
Because of insufficient sales, ACI shops operate at less than f u l l
capacity. Each shop is dependent on the orders generated by i t s sales
staff to keep it operating throughout the year; therefore, each shop is
unable to operate at desired levels without sufficient sales efforts. A t
the time of the audit, we found that eleven of Act's fourteen shops were
( 1) These are unaudited financial statements, which have not been f u l l y adjusted f o r
accruals such as accounts receivable and accounts payable.
not operating at f u l l or, in some cases, even 50 percent capacity due to
insufficient sales. For example, the bedding shop was operating at 25
percent capacity due to a lack of sales.
Lack of a svstemat i c approach and inadequate supervision mav be reasons
ACl's sales proaram i s ineffective - ACI lacks a sales plan for
effectively marketing i t s products and services. At t resent time,
ACI has three sales representatives that are responsib' i r selling a l l
ACI products and services throughout the State. A fourth sales
representative is solely responsible for selling to the Department of
Corrections and for selling metal fabrication products outside the
State. While the t e r r i t o r y covered by each sales representative is large
and the types of products and services ACI sells are quite diverse, ACI
has no structured approach to sales that would provide direction for
effectively ma% neting a l l of i t s products and services. ACI does not use
a l i s t i n g to record and monitor customer purchases or the date of next
contact. A l l client documentation is the responsibility of the
individual salesperson and is not part of an overall sales e f f o r t .
Unlike the sales representatives in most states we surveyed, ACl's sales
representatives do not work from a written schedule or use a formal plan
of action which typically outlines a sale representative's planned sales
contacts for an upcoming week. Instead, ACI uses a customer l i s t as a
guide for i t s sales representatives. This l i s t is basically a li, ing of
a l l State and local governmental agencies, school d i s t r i c t s , and some
hospitals that is divided among three sales representatives. However,
some agencies on the l i s t have never been contacted by an ACI sales
representative. For example, when we reviewed a client l i s t with one
sales representative, he noted that he had primarily sold products to
about 50 percent of the agencies that were assigned to him. When asked
about the other agencies, he stated that he would not contact some of
them because he f e l t they lacked sales potential, he was unaware of the
location of some, and was apparently unaware of others on his l i s t
because he indicated that reviewing the l i s t was an " education" for him.
In addition, ACl's e f f o r t s to broaden i t s customer base are limited. For
instance, we found that new customer contacts were made infrequently by
sales s t a f f . For the f i r s t ten months of fiscal year 1990- 1991, ACI
received orders from 40 new customers. Follow- up interviews with 22 of
these new customers revealed that nineteen orders were i n i t i a t e d by the
customer rather than obtained as a result of a direct sales e f f o r t by ACI
sales s t a f f . Some of the customers we spoke with indicated that they
i n i t i a t e d the sales order based on their knowledge of ACI products or by
word of mouth from a previous customer. Rather than developing and
expanding i t s customer base, ACI relies largely on sales to two major
customers. ACl's largest customer, DOC, requires that the divisions
within the Department purchase from ACI whenever possible. An analysis
of customer sales for the f i r s t ten months o f f i s c a l year 1990- 1991,
revealed that sales to DOC amounted to approximately 37 percent of AClls
sales revenues. An additional 32 percent of ACl's revenue is generated
from sales to the Department of Transportation.
In addition to the lack of a systematic sales approach, ACI sales s t a f f
may also lack the necessary supervision to ensure that they s e l l t o t h e i r
optimum potential. While sales staff are meeting quotas set for them,
these quotas could be raised. An analysis of how the sales staff spend
their time shows a potential to increase sales. Sales staff are not
required to report their time; therefore, their time cannot be adequately
monitored to ensure i t i s u t i l i z e d in an e f f i c i e n t and effective manner.
We analyzed eight weeks of daily logs maintained by three sales
representatives during the course of our audit.(') We found that the
sales s t a f f made, on average, eight customer contacts per day ( which
includes telephone contacts). At least 19 percent of these contacts were
oriented more toward customer service than toward generating sales.
( 1 ) At the time of the audit, one sales representative was solely responsible for s e l l i n g
modular o f f i c e furniture. Because the nature of this business reduces the number of
c a l l s that can be made, this sales representative's contacts were not included i n our
analysis.
Activities such as attempts to resolve problemswith current orders and
picking up and delivering bids, purchase orders, and products were
frequently cited. In addition, we found that large blocks of time ( as
much as four hours in a day) were not accounted for.
ACI needs a more systematic approach to i t s sales program. A common
practice in private industry sales programs is to have sales personnel
prepare detailed schedules for sales contacts and to log their sales
contacts. A schedule and a daily log for recording sales a c t i v i t i e s ,
should be used for a variety of reasons: ( 1) to track sales calls, ( 2) as
a training device, ( 3) to monitor sales by customer, ( 4) to
systematically add new customers or delete nonproductive customers, and
( 5) to computerize, by customer, the results of sales efforts. Many
major corporations use schedules and daily logs as part of their sales
programs. In addition, of the seven correctional industry programs that
we contacted about their sales programs, six indicated that their sales
staff maintained daily logs that contained information such as the date
of the last v i s i t with the customer, the name of the person sales staff
spoke with, and the nature of the contact. This information is
computerized and used to monitor sales in one state. In a l l of the
states, sales managers use the logs to monitor sales by customer.
The sales management needs to have information available, by shop, to
determine the sales volume necessary to make each shop profitable. For
example, Cal i fornia's prison industry program noted that thei r shops
conduct break- even analyses that identify the amount of revenue needed
for the shop to break even. This amount is then considered in
determining the target for the sales representatives. Finally, sales
management needs to i ns t i l l a des i re t~ succeed and gu i de the emp l oyees '
energies into productive sales a c t i v i t y .
ACl's revolvinq fund is used to cover its continual losses - ACl's
revolving fund reserves w i l l be depleted i f i t continues to rely on the
fund to support i t s operations. Although ACI has a revolving fund with a
large balance ( approximately $ 2.4 mi l lion as of May 29, 1991), the future
of the revolving fund may be in jeopardy without increased sales. In the
last two fiscal years, ACI received approximately $ 1.9 m i l lion from State
appropriations and from the sale of assets.(') This infusion of funding
helped cover operating losses of more than $ 1.7 million during this
period.( 2) However, this funding w i l l not be avai lable in fiscal year
1991- 1992. Should such losses continue, ACI could deplete i t s entire
reserve within a few years.
Several Other Poor
Business Practices ldentif ied
In addition to problems with sales, we identified several other poor
business practices that any business could not sustain and remain in
business. Together, the practices listed below have resulted in ACl's
i n a b i l i t y to effectively manage i t s operations in a competitive,
businesslike manner.
Hiah Overhead - ACI appears to operate with high overhead costs.
ACl's general and administrative expenses have been approximately 16
percent of sales. Personnel, one- half of which are in the central
office, comprise most ( 72 percent) of ACl's overhead. In contrast,
Florida's general and administrative expenses are about 10 percent of
i t s total sales of approximately $ 81 mi l l ion.
The p r o f i t a b i l i t y of the shops is further hampered by having to carry
unplanned staff overhead. For example, while ACI had planned to
decrease staff costs in fiscal year 1990- 1991, no cuts had been made
and, as of April 30, 1991, ACI had spent $ 89,248 more than i t had
budgeted for in personnel costs ( salaries and ERE). However, in July
1991, ACI announced a reduction in staff of 18 positions which ACI
anticipates w i l l result in an annual cost savings of approximately
$ 590,000.
( 1) During f i s c a l year 1989- 1990, ACI sold i t s dairy herd, livestock herd, dairy,
slaughterhouse and hog operations, and received $ 385,463.
( 2) ACI's operating losses would have been even greater, however, ACI changed i t s
accounting procedures to allow i t to recognize revenue from 1 icense plate sales when
the contractual obligations were completed to provide a better matching of revenues
and expenditures. This change resulted i n an increase i n revenue and net income by
$ 909,783 and $ 162,551, respective1 y f o r f i s c a l year 1989- 1990.
Budaetinq - ACI's internal budgeting process could be improved.
During our review, we identified two shops that have operated without
a budget for fiscal year 1990- 1991. The vinyl binder shop had been
considered for closure at the beginning of the fiscal year. As a
result, ACI never established a budget for that shop. However, the
shop was not closed and has been operating without a budget for the
entire year.(') In addition, the sewing shop in Florence, which began
operation halfway through the fiscal year, has also operated without a
budget for fiscal year 1990- 1991.
8 Shop Financial Information - During our interviews with shop
supervisors, we found that one supervisor was under the impression he
was making a p r o f i t , when the shop was actually operating at a loss.
Other shop supervisors indicated that they were unaware of their
financial status. Further, some supervisors told us they do not
receive budget information on a timely basis. And, according to one
regional administrator, his biggest problem is providing the shops
with the necessary financial information they need to operate in a
cost e f f i c i e n t manner.
Product Pricinq - While ACI attempts to make a p r o f i t on the sale of
i t s products, i t s approach to pricing does not appear to be sensitive
to the competitive environment. Bid pricing is coordinated by ACl's
customer service division.( 2) Until recently, ACI had not analyzed
lost bids, which would provide information on the discrepancy between
ACl's bid and the winning bid as well as other competitors' bids. Of
the 51 bids which ACI lost between July 2, 1990 and June 6, 1991, ACI
did not have information on what the winning proposals were for 33
bids. For the 18 bids in which ACI had competitor information, we
found that ACl's bids are at times, not competitive. For example, 15
of ACl's bids were priced 25 percent higher than i t s competitors. In
addition, three of those 15 bids were priced over 100 percent higher
than ACl's competitors. According to an ACI o f f i c i a l , the Division
bids what i t needs to cover a l l expenses and to meet a predetermined
p r o f i t margin. However, i f i t s expenses are too high or i f the p r o f i t
sought is too large, ACI cannot compete. ACI needs to analyze lo.
bids on a regular basis to determine i t s competitive position and wha.
adjustments, i f any, are necessary.
8 Production Schedulinq - The manner in which ACI schedules i t s
production is not conducive to timely delivery. ACI operates with a
job shop approach in which i t carries a limited finished goods
inventory, and shops are not allowed to begin production u n t i l a work
order is received. Thus, in many cases, customers must wait ( up to 8
weeks) for delivery of their order, which may result in their buying
elsewhere. This method of production scheduling was ic ~ t i f i e d in
1988 in ACl's strategic planning process as in need or revision.
ACl's business plan noted that ACI should transfer i t s method of
operations from a job shop to a mass production approach in which
stock is produced for inventory rather than to f i l l an order. ( For
more information on ACl's business plan, see pages 11 through 13.)
( 1 ) According to the Assistant . Director, for fiscal year 1991- 1992, the vinyl binder
shop's budget w i l l be combined with the sign shop's budget.
( 2) Bids are forwarded to the appropriate shop to prepare a cost- of- manufacturing estimate
and then returned to customer service to prepare the paperwork and preliminary pricing.
10
Shop Staffinq - Staffing at ACI shops is not always adjusted in
response to the changing workload. For instance, in April 1991 the
sewing shop in Douglas was reduced from two shifts to one due to a
reduction in workload. When the two shifts were running, there were
two supervisors on each s h i f t who were responsible for up to 50
inmates per s h i f t . However, the consolidation of the shifts l e f t
four supervisors plus a shop manager on one s h i f t who are supervising
approximately 50 inmates. According to the Assistant Director,
staffing at the Douglas shop was based on projected orders from DOC.
However, during the year actual orders from DOC f e l l far below
projections. Anticipating orders would eventually increase, ACI
didn't adjust staffing because of the length of time i t would take to
reduce the work force following the State's reduction in work force
procedures.
ACI Has Not Adequately
Addressed Its O~ erational Problems
Despite operational problems, ACI has not taken the actions necessary to
overcome i t s weaknesses. A business plan developed in 1988 identified
the main weaknesses in ACl's operations and outlined a strategy to
improve the program. However, the steps ACI has taken have not been
sufficient to turn the program around.
Plan identified weaknesses - A business plan developed with the
assistance of an outside consultant in 1988 identified the weaknesses ACI
needed to address to become a successful enterprise. As part of a
strategic planning e f f o r t initiated in 1987, ACI u t i l i z e d the services of
an outside consultant to help design a business plan. The consultant who
had worked with the State of Florida in developing i t s successful PRIDE
program assisted in developing a business plan to guide future program
efforts. ACl's business plan was seen as the foundation upon which i t
could work toward a self- sufficient enterprise. The plan identified the
strengths and weaknesses facing the program and outlined a specific plan
of action to turn the program around.
Key weaknesses that had to be overcome were clearly spelled out in the
business plan. The plan notes that any business, including ACI, must
identify and quickly address i t s weaknesses in order to successfully
achieve i t s objectives. Among the major program weaknesses identified
were the foi lowing:
Sales - The plan noted that ACl's customer base was too small, i t s
sales volume was too low, and the Division depended too heavily on
i t s license plate ( tag) operation. In addition, ACI had not
adequately penetrated the State purchasing market. In i t s assessment
of AClls external business environment, the business plan stated that
a dramatic increase in sales volume was needed.
New ~ roducts - The p l an i den t i f i ed the need to deve lop new products
and industries, and the need to develop a product design and
improvement function. Again, in i t s assessment of AClls business
environment, the plan recognized the need to employ more inmates in
more shops and to improve the affordability of ACI products.
Twenty- one additional weaknesses were i d e n t i f i e d a t the time, many
involving AClls internal operations and management control systems. Many
of these weaknesses are similar to those we identified during our review.
The plan also spel led out the strategies and goals designed to overcome
AClls weaknesses and operational problems. Many of these strategies and
goals were specific and measurable and included dates for
implementation. For example, the plan called for an increase in the
number of e l i g i b l e inmates employed in the program, an increase in sales
volume, and the development of new industries. I t set goals of
increasing the number of inmates employed to a minimum of 750 inmates and
for increasing the percentage of sales from new customers from 5 percent
to a minimum of 8 percent. It also established a goal of developing more
concept papers for new industries. Most of these goals were to be
achieved by December, 1988.
Stem taken insufficient - While the plan spelled out actions needed to
improve, i t was never approved by the Director. Instead, the business
plan was subsequently replaced by strategic plans as part of a Department
wide integrated planning e f f o r t . The strategic plans reflect the general
objectives outlined in the business plan.
Despite having developed a business plan and subsequent strategic plans,
ACI has not taken sufficient actions to meet the statutory objectives of
becoming self- sufficient and employing inmates. The number of inmates
employed by the program has not increased since the plan was developed in
1988. In fact, fewer inmates are employed by ACI now than in 1987 ( see
Finding Il, pages 17 through 18). In addition, sales are s t i l l not
adequate to support the program and cover a l l costs. Furtherm~ re, ACI
has not concentrated i t s efforts on broadening i t s customer base. In
fact, sales from new customers in the f i r s t eleven months of fiscal year
1990- 1991 represented only 2 percent of total sales. Finally, ACI has
not always adequately researched new industries and/ or products prior to
implementation. Whi le the business plan cal led for ACI to complete
concept papers on several new industries and product opportunities, our
review of the concept papers revealed that the information compiled was
inconsistent and, in some cases, lacked important elements ( such as a
cost benefit analysis).
Perhaps the most serious departure from the business plan has been ACI
management Is re1 iance on the revolving fund reserves to cover the losses
of i t s unprofitable shops. The business plan viewed the revolving fund
reserves at the time as a strenath of the program. In fact, the plan
asserted that funds in the revolving fund account, while a strength of
the program, Ifmay not yet be sufficient to meet capital needs." By
relying on revolving fund reserves to continue operations, ACl may have
" mortgaged i t s futureM by jeopardizing i t s a b i l i t y to respond to i t s
future capital requirements. Thus, the reliance on the revolving fund
without adequate sales to support the program w i l l weaken ACl's financial
condition, and make i t s goal of becoming self- sufficient even more
d i f f i c u l t to attain.
RECOMMENDATIONS
1. ACI should develop a more structured sales program by
requiring sales staff to maintain daily logs of their
a c t i v i t i e s , such as the date of the last v i s i t with the
customer, the name of the person the sales representative spoke
with and the nature of the contact,
maintaining a data base for a l l customers to allow easy access
by sales staff to monitor customer histories and to use such
data to plan future sales contacts, and
placing greater emphasis on securing new customers.
2. ACI should conduct a comprehensive review of a l l of i t s business
practices and identify areas that w i l l enable i t to operate in a more
e f f i c i e n t and cost- effective manner. This analysis, at a minimum,
should address ACl's sales program, overhead expenses, internal
budgeting, shop financial information, product pricing and shop
staffing.
3. To reduce operational losses, ACI should closely study each of i t s
shops to determine which shops may not become profitable within a
reasonable period of time, and perhaps should be closed.
FINDING Il
TO MEET ITS MANDATE. ACI MAY
NEED FURTHER CHANGES
The Legislature and the Director may need to take further steps to
address ACl's deficiencies. The problems identified in Finding I,
contribute to ACl's i n a b i l i t y to operate in a self- supporting manner and
to employ a sufficient number of inmates. During the course of our audit
ACI took several steps in an e f f o r t to turn i t s program around. However,
ACI has yet to demonstrate that i t can achieve the statutory mandate of
self- sufficiency. I f ACI is unable to become self- sufficient during this
current fiscal year, Arizona should consider even stronger steps taken by
other states which also performed poorly in the past, but turned their
programs around.
ACI Is Not Serving
Its Purpose
ACI is not meeting i t s two prime objectives. It is neither operating in
a businesslike and self- supporting manner, nor employing enough inmates.
Most sho~ s losing mnev - Although ACI has reduced the size of the losses
experienced by i t s predecessor, ARCOR, most shops are s t i l l losing
money. In fiscal year 1985- 1986 ARCOR had net losses of $ 2,768,914.(')
As of i t s third quarter in fiscal year 1990- 1991, ACI had net losses of
$ 567,990. However ACl's statutes require it to be self- sufficient.
Currently most of ACl's shops are losing money. We reviewed financial
data on shop performance for fiscal years 1988- 1989 through the f i r s t
three quarters of fiscal year 1990- 1991. As shown in Table 1, page 16,
only three of the twenty industries that ACI operated during that time
have shown a gross p r o f i t . ( 2 ) Only five shops made gross p r o f i t s during
anv of the three fiscal years. Several shops have lost substantial
amounts of money. For example, the print shop had gross losses of
$ 400,000 during the nearly three- year period. ACl's only consistently
( 1) In fiscal year 1984- 1985, ARCOR had net losses of $ 1,852,803.
( 2) Gross profits or losses include indirect overhead allocations.
15
TABLE 1
ACI INWSTRIES
STATMENT OF OPERATIONS
Industry
Gross Profi t( Loss)
P r i n t i n g
Hog
Sewi ng( b)
Wood
Dai ry
Sign
Electronics
Vinyl Binders
Rebate Processing
Slaughterhouse
Furni ture Refurb.
Farm
Sheet Metal
Data Entry
Office Products
Engraving
Bedding
Metal Fabrication
Copy Service
License Plates
Gross Profi t( Loss)
Total Operating
Expenses( i1
Nonoperati ng Income
Gain on Assets Sold
Loss before State
Appropriation
State Appropriation
Net Income ( Loss)
Nine Months
Ended 3- 31- 91 Total
a
Discontinued
Includes the Florence and Doug1 as shops
Figure doesnlt include losses from operation of the Florence Shop. ACI places sales
and expenses f o r t h i s shop i n a miscellaneous category because the a v a i l a b i l i t y of
work i s sporadic. Because the sales and expenses are ' lmiscellaneous", no overhead i s
allocated. As of March 31, 1991, the operating loss was $ 11,469
Began operation i n June 1990
Combined wi th the Office Products shop
Began operati on i n February 1990
Combined with the Sign shop
This amount includes $ 308,016 of losses from discontinued agribusiness operations and
$ 104,770 of losses from disposal of assets
Includes s e l l i n g and general and administrative expenses
Source: ACI unaudited Financial Statements f o r Fiscal Years 1988- 1989, 1989- 1990, and as of
the t h i r d quarter Fiscal Year 1990- 1991
r)
16
profitable enterprise is i t s license plate shop, which earned gross
p r o f i t s of almost $ 2 million during the period reviewed. However, these
earnings were insufficient to offset the losses sustained by most of
ACl's other shops.
As noted in Finding I, pages 8 through 9, ACI has been able to cover i t s
losses by relying on reserves from i t s revolving fund. However, unless
i t s business practices change, revolving fund reserves w i l l be depleted
in a few years. A t that point, ACI w i l l need an appropriation from the
State's General Fund to continue, or i t w i l l have to shut down.
This problem was pointed out to the Director of Corrections in 1988. In
i t s 1987- 1988 annual report, the Assistant Director indicated in a letter
to the Director that ACl's mandate of self- sufficiency by July 1, 1989
was unachievable. At that time, the revolving account was used to fund
existing operations, including maintenance and repair costs and expanding
into new industries. The revolving fund could not, in addition, absorb
a l l ACI payroll costs. However, the letter stated that ACI could
maintain self- sufficiency by closing selected nonprofitable industries
and agribusiness. The Assistant Director proposed abolishing six
industries and a l l agribusiness. This would result in five industries
remaining, employing 160 inmates and generating an estimated p r o f i t of
$ 136,000. FIna!! y, the letter urged that the c r i t i c a l decision must be
made to either maintain financially unstable programs for inmate
employment purposes or eliminate unprofitable industries to achieve
self- sufficiency. The Director's position has been to consider ACI f i r s t
and foremost as an inmate work program. He has been reluctant to close
enterprises and reduce inmate jobs, in part, due to security concerns.
Lack of work for inmates results in idleness, which can become a serious
security matter. Additionally, the Director, before closing any shops,
wanted every e f f o r t made to make the programs succeed. Therefore, ACI
has continued to run unprofitable enterprises.
Inmate em~ lo_ vment insufficient - Despite the Director's desire, ACI is
not employing a sufficient number of inmates. ACI was established to
provide work for inmates. Prison industry jobs reduce idleness, help
develop good working habits, and teach marketable s k i l l s useful to
inmates in securing employment after they are released from prison.
However, this purpose i s not being f u l l y met as ACI employs only about
535 inmates, 3.7 percent of Arizona's prison population at the present
time. Moreover, despite the rapid growth of Arizona's prison population,
ACI employs fewer inmates now than i t did in 1987. In January 1987 ACI
employed 750 inmates, almost 8 percent of the prison population at that
time.
Other states employ a proportionately larger number of inmates in their
prison industry programs. Compared to nine other correctional industry
programs we contacted, Arizona ranks last in the percentage of inmates
employed. A l l the other prison industries we contacted employ at least 6
percent of t h e i r t o t a l inmate population; three states employ 10 percent
or more. The Federal prison industry program employs 24 percent of i t s
i nmates.
The goal of achieving self- sufficiency is not incompatible with the goal
of employing inmates, as the Department's philosophy seems to suggest.
States we examined which have encountered d i f f i c u l t i e s with their
programs, and managed to reverse their decline, have placed emphasis
f i r s t on running like a business. While inmate employment levels may
have been low i n i t i a l l y , levels of employment grew over time as sales
increased and businesses prospered. These states now employ
proportionately more inmates than does ACI despite the fact that inmate
employment is a secondary goal. ( See pages 19 through 21 for further
discussion of experiences in other states.)
ACI Has Taken Recent
Steps To Improve
ACI has begun making changes in an attempt to improve i t s program:
Sales Proqram - In an e f f o r t to upgrade i t s image and better compete
in the market place, a new marketing program was developed. The new
program consists of a new logo, a new catalog, product specific
brochures, direct mail pieces, and new signs, stationary and business
cards. ACI also plans to provide continued training to sales staff n
the areas of time management, special product knowledge, sales
techniques, use of the new marketing program and other sales
materials. According to AClts sales manager, the program should be
f u l l y implemented by early November 1991.
a Reduced Overhead - As mentioned earlier, late in the course of the
audit ACI eliminated 18 positions, resulting in a current staff size
of 49 full- time employees. Twenty- seven other positions that had
been vacant were also eliminated. ACI estimates that t h i s s t a f f
reduction w i l l result in an annual cost savings of approximately
$ 590,000.
ACI also plans to reorganize some of i t s shops. For instance, i t is
considering consolidating i t s two sewing shops into one shop in
Douglas. In addition, the management of the sign shop w i l l be
transferred to the Department. Finally, the Perryville office
products shop w i l l be relocated to Florence.
a improved Profits - ACl's fiscal year 1991- 1992 strategic plan calls
for ACI to break even. To achieve break- even status, AC! has
estimated revenues of $ 5.5 m i l l ion for the current fiscal year.
Seventy- six percent of these revenues are expected to come from
license plate sales, farm revenues, print shop, office products and
metal fabrication product sales.
Other Options May
Need To Be Considered
To date, neither ACI nor the majority of i t s industries have become
profitable. I f ACl's current attempts to improve i t s program are
unsuccessful, the Legislature and the Director may need to consider even
stronger measures. Other states facing similar problems have reorganized
thei r prison industry program. Two states have restructured, and others
have undergone significant management changes.
During our audit, we asked national organizations with expertise in
corrections and correctional industries to identify other states which
had successful prison industry programs. We focused on three states
repeatedly identified by experts - Florida, Washington, and Nevada -
because those states had performed poorly in the past and found ways to
turn their programs around. In our opinion, the experiences in these
states are relevant to Arizona. ACI has struggled in recent years and
needs to take positive steps to change i t s direction.
Restructuring - In the last decade, two states with problems simi lar to
AClfs have restructured their prison industry program. In fiscal year
1980- 1981, Florida's program experienced an operating loss of nearly $ 1
m i l lion. That year, Florida enacted legislation establishing a
non- profit corporation to run the prison industries program. By 1984,
Prison Industries and Diversified Enterprises ( PRIDE)' had assumed
responsibility for operating a l l of Florida's prison industries. The
program operates without a state appropriation and requires inmates to
return 60 percent of their base pay to the state to offset the costs of
incarceration and 10 percent of their base pay for victim restitution.
PRlDE has been profitable every year since 1984 and, as of fiscal year
1989- 1990, has returned almost $ 5 mi l lion to the state for inmate care.
In fiscal year 1989- 1990, PRlDE achieved gross sales of over $ 81 m i l lion
and continues to employ over seven percent of Florida's growing inmate
population.
PRlDE has successfully improved Florida's program without some of the
benefits avai lable to ACI and other states' programs, and without using
some of the statutory provisions designed to f a c i l i t a t e sales of i t s
goods and services. Unlike ACl's program and programs in some other
states, PRlDE is limited to selling i t s products to government agencies.
Further, PRlDE has not taken advantage of a state law allowing i t s
products to be c e r t i f i e d for state purchase. PRlDE o f f i c i a l s indicate
they prefer to obtain customers by producing quality products at
reasonable prices and not by forcing agencies to purchase through the
c e r t i f i c a t i o n process.
More recently Mississippi has also restructured i t s correctional
industries program. As the number of inmates employed slipped from about
700 to 150- 200, the Mississippi program faced serious problems. In 1990,
to improve the program, the Mississippi Legislature also organized a
private, nonprofit corporation to lease and manage the state's prison
industries. A chief executive officer ( CEO) with prison industry
experience was hired, and an eleven- member board of directors was
appointed by the Governor to direct the operation. The CEO operates and
manages the industry program and reports directly to the board of
di rectors.
Manaaement chanaes - Other states have focused on personnel and
organizational changes to improve their correctional industry programs.
For example, a few years ago, legislators in Washington and Nevada began
to question whether their prison industry programs should be continued
since both were experiencing serious d i f f i c u l t i e s and operating at a
loss. Each of these states appointed a new director and adopted stronger
business philosophies and practices. Both programs, although not
necessarily truly self- sufficient, now appear on their way to achieving
success and improved p r o f i t a b i l i t y .
Washington appointed a new director in 1988 and changed i t s operating
philosophy. It re- wrote i t s mission statement to emphasize the need to
run the program like a business. The director of Washington's program
specifically noted that the program's performance has improved largely
because of a change in philosophy, and a program that was i n i t i a l l y
established to reduce inmate idleness evolved into a program that needs
to make a p r o f i t in order to operate effectively. Washington's sales
have increased from about $ 2 m i l l i o n i n 1981 to over $ 15 million today.
The number of inmates employed has also increased from 200 to about 800.
The Washington State program has h i s t o r i c a l l y received a General Fund
appropriation which supports program administration. Thus, i t is not,
nor is i t required to be, truly self- sufficient. However, i t has
established a goal of achieving p r o f i t a b i l i t y for i t s correctional
industry fund, a goal which was reached for the f i r s t time in fiscal year
1989- 1990.
In 1987, Nevada hired a new program director and began placing a greater
emphasis on operating the program as a business. Over the past three
years, the program more than doubled i t s sales ( from $ 1 million to $ 2.4
million), and t r i p l e d the number of inmates employed ( from 100 to 300).
RECOMMENDATIONS
1. The Legislature should monitor ACl's progress in f u l f i l l i n g i t s goals
to achieve self- sufficiency during fiscal year 1991- 1992.
2. I f ACI is unable to achieve self- sufficiency during fiscal year
1991- 1992, two alternatives to further restructure Arizona
Correctional Industries should be considered:
the Legislature should consider establishing the program as a
private non- profit corporation, or
i f the program is continued within the Department of
Corrections, the Director should make whatever personnel and
organizational changes are needed to bring success.
1601 WEST JEFFERSON
PHOENIX. ARIZONA 85007
( 602) 542- 5536 a
FIFE SYMINGTON
GOVERNOR SAMUEL A. LEWIS
DIRECTOR
September 26, 1991
Douglas R. Norton, Auditor General
Office of the Auditor General
2700 N. Central Avenue, Suite 700
Phoenix, Arizona 85004
Dear Mr. Norton:
The Office of the Auditor General, State of Arizona, is looked upon
to be the governmental entity that can be relied upon to thoroughly
research facts, document findings, and present an opinion that is
objective, constructive, and factual. The reports issued by that
office should provide the reader with an accurate presentation of
facts from which the agency can be judged on the merit of the facts
as well as, hopefully, provide recommendations upon which the
agency can capitalize and make improvements.
Unfortunately, this has not occurred with the ACI performance
audit. Despite repeated attempts to provide the Auditor General
and his audit staff with facts that should not be ignored, the
performance audit that has been released contains many statements
that can be proved false and/ or without basis.
It is ironic that the Auditor General financial auditors have given
ACI unqualified opinions regarding the reliability of ACIFs
financial information for the last two audited years, but the
performance audit team refuses to acknowledge the facts presented
and, instead, have chosen to publish an error plagued report that
does not do justice to the Department of Corrections, the Office
of the Auditor General, the legislature or the taxpayers of
Arizona.
The errors in the report can be proven from historical data, the
same historical data that has led to previous unqualified financial
audits. However, the Office of the Auditor General has chosen to
ignore the facts presented and reported findings that defy reality.
Further, efforts to reconcile erroneous information has been
Douglas R. Norton
September 26, 1991
Page 2
thwarted by the Auditor General's staff refusing to divulge the
basis for their conclusions stating their work papers and sources
are confidential information. In a review of the government
auditing standards, the requirement of confidentiality of records
could not be confirmed.
Specifically, ACI was compared to Nevada and Washington whose
programs are described in the report as " having turned their
programs around", of " businesses prospering", and, in the case of
Washington, " having achieved prof itability in fiscal year 1989- 90. "
The facts are that without the appropriated money both states
receive, both Nevada and Washington would continue to lose money
with Washington's operating loss in fiscal year 1989- 90 being in
excess of $ 1.2 million. Despite our cautioning the Auditor General
to seek the facts to insure ACI and other states are compared on
the same basis, they have chosen to release mis- leading statements
that give the reader the impression that other states have achieved
success when this simply is not true. The Directors of both state
prison industry programs have stated that state funding will
continue for fiscal year 1991- 92. Nevada is to receive in excess
of $ 300,000, Washington $ 3.6 million. In contrast, ACI receives no
state funding support but relies solely on revenue generated from
the sale of goods and services provided by prison industry
programs.
Also of concern is the manner in which the audit itself was
conducted. After some difficulty, ACI management was able to
obtain from the Auditor General the manual of Government Auditing
Standards referred to in the report as the guide by which the audit
was conducted. In this manual it is stated that " due professional
care includes a mutual understanding of the audit objectives with
the audited entity." Audit objectives and scope of the audit were
to have been clearly defined and the means of measuring performance
against those objectives determined. This was never done.
a
Any findings of the auditors should " stand the tests of
sufficiency, relevance, and competence." This audit falls short of
these tests. Further, the manual indicates " titles, captions, and
the text of reports should be stated constructively" and this can
best be done by avoiding language that unnecessarily generates
defensiveness and opposition. The tone of the report does not
follow these guidelines and appears t. o purposely attempt to
influence the reader's opinion through many negative, while
subjective, comments.
Finally, the audit standards call for recognition of significant
management accomplishments and performance improvements. No
mention is made of the significant gains made in professionalizing
the ACI operations since 1986 when the organization was beset with
Douglas R. Norton
September 26, 1991
Page 3
management problems, audit investigations of impropriety, and
substantial operating losses. Nor does the report fully recognize
restructuring that occurred in July of this year which resulted in
a reduction in staff of 17 state employees, a new sales and
marketing program, and an overall cost reduction plan that projects
ACI breaking even in fiscal year 1991- 92.
In short, it was my hope and that of ACI management that the audit
would be conducted in a professional manner, that would be
objective, and that would result in an accurate comparison of the
past and present performance of ACI . I anticipated perhaps
constructive ideas and suggestions to support ACI's plan to be
self- sufficient recognizing the problems unique to the organization
and the efforts being made to cope with those problems. The
report, to be presented, falls far short of these expectations.
Consider this letter the Department's response to the ACI
performance audit and Sunset Factors.