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**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

** **

### **FORM 10-K/A**

### **(Amendment No. 2)**

 

**(Mark One)**
| **x**                                                                                                                                                                                                   | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES   EXCHANGE ACT OF 1934**    |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                    |                                                                                                     |
| **For fiscal  year ended December 31, 2008**                                                                                                                                                       |
|                                                                                                                                                                                                    |                                                                                                     |
| **OR**                                                                                                                                                                                                  |
|                                                                                                                                                                                                    |                                                                                                     |
| **o**                                                                                                                                                                                                   | **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 1-14472**

** **

**CORNELL COMPANIES, INC.**

(Exact Name of Registrant as Specified In ItsCharter)

 

| **Delaware**                                               | ** ** | **76-0433642**       |
|------------------------------------------------------------|------------|----------------------|
| (State  or Other Jurisdiction                              |       | (I.R.S.  Employer    |
| of  Incorporation or Organization)                         |       | Identification  No.) |
|                                                       |       |                 |
| **1700 West  Loop South, Suite 1500, Houston, Texas** | ** ** | **77027**            |
| (Address  of Principal Executive Offices)                  |       | (Zip  Code)          |

 

Registrant’s telephone number, including areacode:    **(713) 623-0790**

 

Securitiesregistered pursuant to Section 12(b) of the Act:

 

| **Title of Each Class**  | ** ** | **Name of Each Exchange on Which Registered** |
|-----------------------------------------|------------|-----------------------------------------------------------------------------|
| Common Stock, $.001 par value per share |       | New York Stock Exchange                                                     |
| Preferred Stock Purchase Rights         |       | New York Stock Exchange                                                     |

 

Securities registered pursuant to Section 12(g) ofthe Act:  **None**

 

Indicate by check mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes o   No x

 

Indicate by check mark if the registrantis not required to file reports pursuant to Section 13 or Section 15(d) ofthe Act.

Yes  o   No x

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the Registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days. Yes  x    No   o

 

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K (§229.405) is not containedherein, and will not be contained, to the best of Registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in Part IIIof this Form 10-K or any amendment to this Form 10-K. o.

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, a non-accelerated filer, or asmallerreporting company. See the definitions of “large accelerated filer,” “acceleratedfiler” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.Check one.

 

| Large accelerated Filer o |   | Accelerated filer x         |
|---------------------------|--------|-----------------------------|
| Non-accelerated filer o   |   | Smaller Reporting Company o |

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o  No  x

 

Theaggregate market value of voting stock held by non-affiliates of the registrantwas $263,852,896 on June 30, 2008. The registrant has 14,766,758 shares ofcommon stock outstanding on March 6, 2009.

 

**DocumentsIncorporated by Reference**

 

The information required by Part III of this Report, to the extentnot set forth herein, is incorporated by reference from the registrant’sdefinitive proxy statement relating to its Annual Meeting of Stockholders to beheld in 2009, which definitive proxy statement will be filed with theSecurities and Exchange Commission within 120 days after the end of the fiscalyear to which this Report relates.

 

 

 

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**CornellCompanies, Inc.**

** **

**Table of Contents**

 

**2008Form 10-K**

** **
| ** **            | **Page**                                                                                                            |
|-----------------------|---------------------------------------------------------------------------------------------------------------------|
| **Explanatory  Note** | 2                                                                                                                   |
| **PART I**       | ** **                                                                                                          |
| Item  1.              | Business                                                                                                            | 4 |
| Item 1A.              | Risk  Factors                                                                                                       | 14 |
| Item 1B.              | Unresolved  Staff Comments                                                                                          | 21 |
| Item 2.               | Properties                                                                                                          | 21 |
| Item 3.               | Legal  Proceedings                                                                                                  | 21 |
| Item 4.               | Submission  of Matters to a Vote of Security Holders                                                                | 22 |
|                  |                                                                                                                |
| **Part II**      |                                                                                                                |
| Item 5.               | Market for  Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities | 22 |
| Item 6.               | Selected Financial  Data                                                                                            | 25 |
| Item 7.               | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                         | 27 |
| Item 7A.              | Quantitative and Qualitative Disclosures About Market  Risk                                                         | 46 |
| Item 8                | Financial Statements and Supplementary Data                                                                         | 46 |
| Item 9                | Changes  In and Disagreements with Accountants on Accounting and Financial Disclosure                               | 84 |
| Item 9A.              | Controls  and Procedures                                                                                            | 84 |
| Item 9B.              | Other  Information                                                                                                  | 85 |
|                  |                                                                                                                |
| **Part III**     |                                                                                                                |
| Item 10.              | Directors, Executive Officers of the Registrant and Corporate  Governance                                           | 85 |
| Item  11.             | Executive  Compensation                                                                                             | 85 |
| Item  12.             | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                    | 85 |
| Item  13.             | Certain  Relationships and Related Transactions, and Director Independence                                          | 85 |
| Item  14.             | Principal  Accountant Fees and Services                                                                             | 85 |
|                  |                                                                                                                |
| **Part IV**      |                                                                                                                |
| Item 15.              | Exhibits  and Financial Statement Schedules                                                                         | 85 |

** **

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**Explanatory Note**

 

ThisAmendment No. 2 to Form 10-K (this “Second Amendment”) amends CornellCompanies, Inc.’s (the “Company”) Annual Report on Form 10-K for theyear ended December 31, 2008 (the “Original 10-K”) which was filed withthe Securities and Exchange Commission on March 6, 2009, as subsequentlyamended by Amendment No. 1 to the Original 10-K filed on July 2,2009.  The Company is filing thisAmendment No. 2 for the sole purpose of filing the revised Exhibits 31.1and 31.2 included in Amendment No. 1 together with the entire Original10-K.  The conformed signatures of theCompany’s Chief Executive Officer, President and Chairman of the Board andChief Financial Officer, Senior Vice President and Treasurer to these exhibitswere inadvertently not included in the Original 10-K.  Amendment No. 1 did not include theentire Original 10-K and this Amendment No. 2 is being filed to includethe entire Original 10-K.

 

Exceptas described above, no other changes have been made to the Original 10-K orAmendment No. 1.  The Original 10-Kcontinues to speak as of the date of the Original Filing, and Cornell Companies, Inc.has not updated the disclosures contained therein to reflect any events whichoccurred subsequent to the filing of the Original 10-K, or to modify thedisclosure contained in the Original 10-K other than to reflect the changesdescribed above.

 

**Forward-Looking Information**

 

The statementsincluded in this annual report regarding future financial performance andresults of operations and other statements that are not historical facts areforward-looking statements within the meaning of Section 27A of theSecurities Act of 1933 and Section 21E of the Securities Exchange Act of1934.  Forward-looking statements in thisannual report include, but are not limited to, statements about the followingsubjects:

 

·                  revenues,

·                  revenue mix,

·                  expenses, including personnel and medicalcosts,

·                  results of operations,

·                  operating margins,

·                  supply and demand,

·                  market outlook in our various markets,

·                  our other expectations with regard tomarket outlook,

·                  utilization,

·                  parolee, detainee, inmate and youthoffender trends,

·                  pricing and per diem rates,

·                  contract commencements,

·                  new contract opportunities,

·                  operations at, future contracts for, andresults from our Regional Correctional Center,

·                  the timing (including construction,completion and ramp of facility population), cost of completion and otheraspects of planned expansions, including without limitation the D. Ray JamesPrison and Walnut Grove Youth Correctional Facility expansions, and clientcontracts for such facilities,

·                  the construction and lease of the new facility in Hudson,Colorado and our contracts with the Colorado Department of Corrections,

·                  impact from Hurricane Ike,

·                    adequacy of insurance,

·                    debt levels,

·                    debt reduction,

·                    the effect of FIN No. 48,

·                    our effective tax rate,

·                    tax assessments,

·                    results and effects of legal proceedingsand governmental audits and assessments,

·                    liquidity, including future liquidity andour ability to obtain financing,

·                    financial markets,

·                    cash flow from operations,

·                    adequacy of cash flow for ourobligations,

·                    capital requirements,

·                    capital expenditures,

·                    effects of accounting changes andadoption of accounting policies,

·                    changes in laws and regulations,

·                    adoption of accounting policies,

·                    benefit payments, and

·                    changes in laws and regulations.

 

Forward-lookingstatements in this annual report are identifiable by use of the following wordsand other similar expressions among others:

 

·                 “anticipates”

·                 “believes”

·                 “budgets”

·                 “could”

·                 “estimates”

·                 “expects”

·                 “forecasts”

 

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·                 “intends”

·                 “may”

·                 “might”

·                 “plans”

·                 “predicts”

·                 “projects”

·                 “scheduled”

·                 “should”

 

Such statements are subject to numerous risks,uncertainties and assumptions, including, but not limited to:

 

·                     those described under “Item 1A. Risk Factors,”

·                     the adequacy of sources of liquidity,

·                     the effect and results of litigation,audits and contingencies, and

·                     other factors discussed in this annualreport and in the Company’s other filings with the SEC, which are availablefree of charge on the SEC’s website at *www.sec.gov*.

 

Should one or more ofthese risks or uncertainties materialize, or should underlying assumptionsprove incorrect, actual results may vary materially from those indicated.

 

All subsequent writtenand oral forward-looking statements attributable to the Company or to personsacting on our behalf are expressly qualified in their entirety by reference tothese risks and uncertainties. You should not place undue reliance onforward-looking statements. Each forward-looking statement speaks only as ofthe date of the particular statement, and we undertake no obligation topublicly update or revise any forward-looking statements.

 

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**PART I**

** **

#### **ITEM 1.****         ****BUSINESS**

####  

**Company Overview**

** **

***Cornell Companies, Inc.(together with its subsidiaries and predecessors, unless the context requiresotherwise, “Cornell,” the “Company,” “we,” “us” or “our”) was incorporated inDelaware in 1996. We are a leading provider of correctional, detention,educational, rehabilitation and treatment services outsourced by federal,state, county and local government agencies for adults and juveniles. Wepartner with these agencies to deliver quality, cost-efficient programs that webelieve enable our customers to achieve their missions while saving taxpayers’money. Our customers include the Federal Bureau of Prisons (“BOP”), U.S.Marshals Service (“USMS”), various state Departments of Corrections, and city,county and state departments of human services and similar agencies.***

*** ***

***We offer adiverse portfolio of services in structured and secure environments throughoutthree operating divisions:  (1) AdultSecure Services; (2) Abraxas Youth and Family Services; and (3) AdultCommunity-Based Services. Cornell, through predecessor entities, began juvenileoperations in 1973, adult community-based programs in 1974, and adult secureoperations in 1984. Our three divisions are our reportable operating segments.Financial information and a discussion concerning these segments for fiscalyears 2008, 2007, and 2006 is included in “Note 15 — Segment Disclosure” of the“Notes to Consolidated Financial Statements” included in this Form 10-K.***

*** ***

As of December 31,2008, we operated 68 facilities among the three operating divisions,representing a total operating service capacity of 19,875. We also had onefacility that was vacant, representing additional service capacity of 70.Service capacity is comprised of the number of beds currently available forservice in residential facilities and the average program capacity ofnon-residential community-based programs. Our facilities are located in 15 states and the District of Columbia.

 

Additionalinformation about Cornell can be found on our website, *www.cornellcompanies.com*. We makeavailable on our website, free of charge, access to our Annual Report on Form 10-K,Quarterly Reports on Form 10-Q, Current Reports on  Form 8-K, and all amendments to thesereports as soon as reasonably practicable after such materials areelectronically filed with or furnished to the Securities and ExchangeCommission (“SEC”). Information provided on our website is not part of this Form 10-K.

 

# **Company Operations**

# ** **

Weprovide a continuum of care to adults and juveniles in institutional,residential, and community-based settings. Regardless of operating division,each of our facilities emphasizes the importance of engaging in the communityas a productive, responsible citizen. In many of our adult secure institutions,we offer vocational training curricula, as well as literacy and GeneralEquivalency Diploma (“GED”) programs. In our adult community-based programs, weoffer job placement services, instruction on personal finance management andother skill-based training. In most of our juvenile facilities, we providefamily counseling services and behavioral counseling. In facilities throughoutthe organization, we provide drug and alcohol counseling for our clients.

 

***We operate ourfacilities and programs under the framework of our Seven Key Principles of Care***â.These principles state that our operations must maintain the safety andsecurity of our clients, our employees, and the local community. In addition,the principles require that we hold the individuals in our care accountable fortheir actions and expect them to assume responsibility. Furthermore, we expectour employees to act as role models, to communicate effectively and professionally,and to treat our clients with dignity and respect. Finally, our principles callfor us to manage physically clean and appropriately maintained facilities thatare safe and conducive to an environment of care.

*** ***

# **Quality ofOperations**

# ** **

Weoperate our facilities in accordance with both company and facility-specificpolicies and procedures. Where required by contract or otherwise deemedappropriate for our service environments, these policies and procedures aredesigned to meet requirements set forth by independent industry oversightorganizations, including the American Correctional Association (“ACA”), JointCommission on Accreditation of Healthcare Organizations (“JCAHO”), and NationalCommission on Correctional Health Care (“NCCHC”). Standards may also beimplemented to meet the requirements of state departments of public welfare,departments of protective and regulatory services and departments of humanservices and education. We believe that accreditation and the correspondingstandards of operation enhance our ability to provide quality programs andcontribute to the public’s increased acceptance of our services.

 

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Internalquality control, conducted by senior facility staff and senior management,takes the form of periodic operational, programmatic and fiscal audits;facility inspections; regular review of logs, reports and files; and strictmaintenance of personnel standards, including an active training program. Eachof our facilities is further subject to periodic audits and reviews performedby our contracting agencies.

 

# **Industry andBusiness Segment Summary**

# ** **

***Incarceration, detention, education and treatment servicesfor adults and juveniles have historically been provided by various governmententities. In the United States, the incarcerated and sentenced populations ofadults and juveniles has continued to increase while federal, state and local governmentsface continuing pressures to control costs and improve service quality. Webelieve these trends have caused growing consideration and acceptance towardsoutsourcing certain government services and functions. Moreover, the increasingdemand facing governments (from areas such as healthcare,maintenance/development of public infrastructure, etc.) has also createdcompetition for resources funding such services.***

*** ***

Servicesoffered among our three divisions include incarceration and detention, transitionfrom incarceration, drug and alcohol counseling and treatment, behavioralrehabilitation and treatment, vocational training and academic education forgrades 3–12. Private-sector companies, like us, contract with governmentagencies to deliver these services, at what we believe are the same or higherquality and for a lower cost than what the agency can otherwise provide.Although outsourcing these services has historically faced opposition in theU.S., public and government acceptance has increased as standards of serviceimprove and cost savings are documented. As government agencies face fiscalbudget constraints, outsourcing to private providers can offer economicallypositive alternatives. In addition, as a cost relief measure, governmentagencies have sought alternatives to incarceration, including reentry,education, substance abuse and behavioral health programs — all of which areservices we provide.

 

***Outsourcing has a longer history in the juvenile justice andadult community-based corrections sectors. Increasingly, states, counties andlocal governments have used both for-profit and not-for-profit organizations tomeet the needs of troubled youth and adults reintegrating into society after atime in residential treatment or prison. Governments have sought alternativesto the rising costs of incarceration for offenders who are non-violent and needtreatment, education and rehabilitation. Adult community-based reentry programsas well as education, substance abuse and behavioral health programs that cansuccessfully divert an offender from prison address this need.***

*** ***

###### ***AdultSecure Services***

###### *** ***

Increasingly, federal and state systems are relyingupon private providers to address their incarceration needs.  We also believe that the heightened attentionthat has been placed on border patrol and immigration enforcement will continueto drive demand for services such as those offered by private providers.

 

Webelieve that our adult secure services division is well positioned to respondto these marketplace conditions. We provide low-to-maximum-securityincarceration and detention services. In doing so, we ensure public safetythrough the operation of a physically secure environment, which entails, amongother security and safety measures, a routine patrol of the premises by trainedcorrectional officers, alarmed fencing and razor wire and centralizedmonitoring of activity via closed circuit camera systems. While incarcerated,offenders are offered a variety of educational, counseling and vocationalprograms aimed at providing a successful return to the community and asubsequent reduction in recidivism.

 

As of December 31,2008 we operated 10 adult secure facilities with an aggregate service capacityof 12,841. Within the division, we offer the following:

 

·                  Low-to-maximum-security incarceration anddetention,

·                  Confinement of juveniles adjudicated asadults,

·                  Facility design, construction andoperation,

·                  Use of modern security technology,including electronic controls and surveillance equipment,

·                  Education courses, including preparationand testing for the GED, English as a Second Language classes, and Adult BasicEducation (“ABE”),

·                  Holistic healthcare services, includingmedical, dental, vision, psychiatric, and individual and group counselingservices,

·                  Substance abuse counseling,

 

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·                  Life skills training, including angermanagement, hygiene, personal finance, employment and housing issues, andparenting skills,

·                  Religious opportunities and culturallysensitive programs,

·                  Food and laundry service, and

·                  Recreational activities, includingexercise programs.

 

## *AbraxasYouth and Family Services*

##  

Thejuvenile justice industry sector includes residential, detention, shelter careand community-based services, along with educational, rehabilitation andtreatment programs. This sector is highly fragmented with several thousandproviders operating across the country. Most of the private providers are smalland operate in specific geographic areas.

 

Juvenilejustice issues present a growing area of concern for many states due to thenumber of youth within the judicial system, as well as the related annualexpenditures for placement and treatment. Beyond addressing capacity issueswithin the juvenile justice system, states are also facing challenges posed bythe unique needs of specialized juvenile populations, such as those withmental/behavioral health issues. Partnerships with private providers such asCornell can provide quality alternatives for care.

 

Webelieve that our Abraxas Youth and Family Services division is uniquelyequipped to address the issues currently facing the juvenile justice system.While the market is fragmented with providers located across the country, weoffer a national presence with locations in both urban areas as well assuburban and rural settings.  We providea broad array of services to youth, typically between the ages of 10 and 18, inresidential and community-based settings. The programs and services provided atour facilities are designed to rehabilitate juveniles, hold them accountablefor their actions and behaviors, and help them successfully reintegrate backinto the community. An underlying principle of our juvenile programming is theBalanced and Restorative Justice (“BARJ”) model, which provides a restorativecomponent to the victim, be it an individual, family, or community. The use ofthe BARJ model, in connection with our Seven Key Principles of Careâ,emphasizes accountability, competency development and community protection.

 

As of December 31,2008, we operated 17 residential facilities and 10 non-residentialcommunity-based programs within our Abraxas division, representing operatingservice capacity of 3,237. We also had one vacant facility with a servicecapacity of 70. Within the division, we offer the following:

 

·                  Diverse treatment settings, includingphysically-secure, staff-secure, and community-based,

·                  Specialized treatment for uniquepopulations, including females, drug addicts, sex offenders, fire starters, andfamilies,

·                  Accredited alternative and specialeducation services,

·                  Wilderness training programs andnationally accredited ropes course challenges,

·                  Individualized treatment planning andcase management,

·                  Individual, group and family counselingand therapy, cognitive behavior therapy and stress and anger managementinstruction,

·                  Substance abuse counseling and treatment,relapse prevention and education,

·                  Life skills training, including hygiene,personal finance, employment and housing issues, and parenting skills,

·                  Holistic healthcare services, includingmedical, dental, behavioral health and psychiatric services, and

·                  Recreational activities, including exerciseprograms.

 

###### ***Adult Community-Based Services***

###### *** ***

Community-basedcorrections services involve the supervision of adult parolees andprobationers. Parolees are persons who have served time in a correctionalfacility and have been released due to either mandatory conditional release ora parole board decision. Probationers have been charged with a crime butsentenced to probation in lieu of incarceration. Services provided to paroleesand probationers include temporary housing, employment assistance, anger managementinstruction, personal finance management training, academic opportunities,vocational training and substance abuse or addiction counseling.

 

Community-basedtreatment services include both residential and outpatient substance abuseprograms. Services include short-term and long-term residential care,counseling, HIV/AIDS testing, counseling and prevention education, substanceabuse and addiction testing, detoxification and methadone maintenance.

 

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Webelieve that our adult community-based programs provide positive environmentsof care for both corrections and treatment clients. The market is fragmentedwith providers located across the country. Whereas most providers in theindustry are small and have limited geographic reach, Cornell offers a nationalpresence with locations in large urban areas, as well as suburban and ruralsettings. The adult community-based programs provide an alternative toincarceration and a focus on transitioning offenders from a correctionalfacility back into society. Through a system of education, employment training,treatment, monitoring and accountability, clients are given the necessary toolsto make positive life choices that can reduce the incidence of recidivism.

 

As of December 31,2008, we operated 28 residential community-based facilities and threenon-residential community-based programs with a combined total service capacityof 3,797.  Within the division, we offerthe following:

 

·                  Minimum-security and staff-secureresidential services,

·                  Home confinement and electronicmonitoring,

·                  Substance-abuse counseling and treatment,including detoxification, testing, 12-step programs and relapse preventionservices,

·                  Employment training and assistance,

·                  Education, including preparation andtesting for the GED, ABE, computer courses, college-level courses and access tolibraries,

·                  Vocational training,

·                  Individual, group and family counselingand therapy, cognitive behavior therapy and stress and anger managementinstruction,

·                  Life skills training, including hygiene,personal finance, housing issues, and parenting skills, and

·                  Municipal jailmanagement.

 

**Facilities**

 

At December 31,2008, we operated 68 facilities and had one vacant facility. In addition toproviding management services, we develop, design and/or construct many of ourfacilities.

 

Eitherthrough outright ownership or long-term leases, we control operating facilitiesrepresenting a large majority of our revenues. We believe that such controlincreases the likelihood of contract renewal, allows us to expand existingfacilities and thereby realize economies of scale, and enhances our ability towin new contracts and control repair costs. In addition, we believe thatlong-term control of our operating facilities allows us to better managecost-escalation pressures.

 

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Thefollowing table summarizes certain additional information with respect to ourfacilities as of December 31, 2008. As indicated, the majority of the facilities at which we provideservices are either owned or leased under long-term leases, which are generallyunder terms ranging from one to 45 years.

 
| **Facility Name and Location**                               | ** **   | **Total  Service  Capacity (1)** | ** **   | **Initial  Contract  Date (2)** | ** **   | **Company  Owned,  Leased or  Managed  (3)** | ** **   |
|-----------------------------------------------------------------------------|--------------|---------------------------------------|--------------|--------------------------------------|--------------|---------------------------------------------------|--------------|
|                                                                        |         |                                  |         |                                 |         |                                              |         |
| ***Adult Secure Services Facilities:  Residential Facilities***             | * *     | * *                              | * *     | * *                             | * *     | * *                                          | * *     |
|                                                                        |         |                                  |         |                                 |         |                                              |         |
| Baker Community Correctional Facility  Baker, California                    |         | 262                                   |         | 1987                                 |         | Owned                                             |         |
| Big Spring Correctional Center  Big Spring, Texas                           |         | 3,509                                 |         | 1989                                 |         | Leased                                            | (4)          |
| D. Ray James Prison  Folkston, Georgia                                      |         | 2,170                                 |         | 1998                                 |         | Leased                                            | (4)          |
| Great Plains Correctional Facility  Hinton, Oklahoma                        |         | 2,048                                 |         | 2007                                 |         | Leased                                            | (4)          |
| High Plains Correctional Facility  Brush, Colorado                          |         | 272                                   |         | 2007                                 |         | Owned                                             |         |
| Leo Chesney Community Correctional Facility  Live Oak, California           |         | 305                                   |         | 1988                                 |         | Leased                                            |         |
| Mesa Verde Community Correctional Facility  Bakersfield, California         |         | 360                                   |         | 2006                                 |         | Leased                                            |         |
| Moshannon Valley Correctional Center  Philipsburg, Pennsylvania             |         | 1,495                                 |         | 2006                                 |         | Owned                                             |         |
| Regional Correctional Center  Albuquerque, New Mexico                       |         | 970                                   |         | 2004                                 | (5)          | Leased                                            |         |
| Walnut Grove Youth Correctional Facility  Walnut Grove, Mississippi         |         | 1,450                                 |         | 2004                                 |         | Managed                                           |         |
|                                                                        |         |                                  |         |                                 |         |                                              |         |
| ***Abraxas Youth and Family Services Facilities:  Residential Facilities*** | *** *** | *** ***                          | *** *** | *** ***                         | *** *** | *** ***                                      | *** *** |
|                                                                        |         |                                  |         |                                 |         |                                              |         |
| Contact  Wauconda, Illinois                                                 |         | 51                                    |         |                                 | (6)          | Owned                                             |         |
| Cornell Abraxas Academy  New Morgan, Pennsylvania                           |         | 214                                   |         | 2006                                 |         | Owned                                             |         |
| Cornell Abraxas I  Marienville, Pennsylvania                                |         | 274                                   |         | 1973                                 |         | Leased                                            | (4)          |
| Cornell Abraxas II  Erie, Pennsylvania                                      |         | 23                                    |         | 1974                                 |         | Owned                                             |         |
| Cornell Abraxas III  Pittsburgh, Pennsylvania                               |         | 24                                    |         | 1975                                 |         | Owned                                             |         |
| Cornell Abraxas Center for Adolescent Females  Pittsburgh, Pennsylvania     |         | 108                                   |         | 1989                                 |         | Owned                                             |         |
| Cornell Abraxas of Ohio  Shelby, Ohio                                       |         | 108                                   |         | 1993                                 |         | Leased                                            | (4)          |
| Cornell Abraxas Youth Center  South Mountain, Pennsylvania                  |         | 72                                    |         | 1999                                 |         | Leased                                            |         |

 

*(Table continued on following page)*

 

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| ***Abraxas Youth and Family Services Facilities:   Residential Facilities (Continued)*** | * * | * * | * * | * * | * * | * * | * * |
|------------------------------------------------------------------------------------------|----------|----------|----------|----------|----------|----------|----------|
|                                                                                     |     |     |     |     |     |     |     |
| DuPage Adolescent Center    Hinsdale, Illinois                                      |     | 38       |     |     | (6)      | Owned    |     |
| Erie Residential Behavioral Health Program   Erie, Pennsylvania                          |     | 17       |     | 1999     |     | Owned    |     |
| Hector Garza Residential Treatment Center   San Antonio, Texas                           |     | 122      |     | 2007     | (7)      | Leased   | (4)      |
| Leadership Development Program   South Mountain, Pennsylvania                            |     | 120      |     | 1994     |     | Leased   |     |
| Psychosocial Rehabilitation  Unit   Erie, Pennsylvania                                   |     | 13       |     | 1994     |     | Owned    |     |
| Schaffner Youth Center   Steelton, Pennsylvania                                          |     | 63       |     | 2001     |     | Managed  |     |
| Southern Peaks Regional Treatment Center   Canon City, Colorado                          |     | 160      |     | 2004     |     | Owned    |     |
| Texas Adolescent Treatment Center   San Antonio, Texas                                   |     | 124      |     | 2003     |     | Owned    |     |
| Washington Facility   Washington, D.C.                                                   |     | 70       |     |     | (8)      | Owned    |     |
| Woodridge   Woodridge, Illinois                                                          |     | 122      |     |     | (6)      | Owned    |     |
|                                                                                     |     |     |     |     |     |     |     |
| ***Abraxas Youth and Family Services Facilities:   Non-Residential Facilities***         | * * | * * | * * | * * | * * | * * | * * |
|                                                                                     |     |     |     |     |     |     |     |
| Delaware Community-Based Programs   Milford, Delaware                                    |     | 66       |     | 1994     |     | Leased   |     |
| Harrisburg Day Treatment   Harrisburg, Pennsylvania                                      |     | 45       |     | 1996     |     | Leased   |     |
| Lebanon Alternative Education   Lebanon, Pennsylvania                                    |     | 225      |     | 2004     |     | Managed  |     |
| Lehigh Valley Community-Based Programs   Lehigh Valley, Pennsylvania                     |     | 60       |     | 1992     |     | Leased   |     |
| Non-Residential Detention/Non-Residential Treatment   Harrisburg, Pennsylvania           |     | 91       |     | 1999     |     | Leased   |     |
| Philadelphia Alternative Education   Philadelphia, Pennsylvania                          |     | 165      |     | 2004     |     | Managed  |     |
| Philadelphia Community-Based Programs   Philadelphia, Pennsylvania                       |     | 71       |     | 1992     |     | Owned    |     |
| State Reintegration Program   Harrisburg, Pennsylvania                                   |     | 225      |     | 1991     |     | Managed  |     |
| WorkBridge   Pittsburgh, Pennsylvania                                                    |     | 600      |     | 1994     |     | Leased   |     |
| York County Community Programs   Harrisburg, Pennsylvania                                |     | 36       |     | 1999     |     | Leased   |     |

* *

*(Table continued on following page)*

 

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| ***Adult Community-Based Services Facilities:   Residential Facilities***           | * *   | * *   | * *   | * *   | * *   | * *   | * *   |
|-------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Beaumont Transitional Treatment Center   Beaumont, Texas                            |       | 180        |       | 2002       |       | Owned      |       |
| Cordova Center   Anchorage, Alaska                                                  |       | 192        |       | 1985       |       | Leased     | (4)        |
| Dallas County Judicial Treatment Center   Wilmer, Texas                             |       | 300        |       | 1991       |       | Managed    |       |
| El Monte Center   El Monte, California                                              |       | 55         |       | 1993       |       | Leased     |       |
| Grossman Center   Leavenworth, Kansas                                               |       | 150        |       | 2002       |       | Leased     |       |
| Las Vegas Community Correctional Center   Las Vegas, Nevada                         |       | 100        |       | 2004       |       | Owned      |       |
| Leidel Comprehensive Sanction Center   Houston, Texas                               |       | 190        |       | 1996       |       | Leased     | (4)        |
| Los Angeles County Jails (9)   Los Angeles Metropolitan Area,  California |       | 264        |       |       | (9)        | Managed    |       |
| Marvin Gardens Center   Los Angeles, California                                     |       | 52         |       | 1981       |       | Leased     |       |
| McCabe Center   Austin, Texas                                                       |       | 90         |       | 1999       |       | Owned      |       |
| Mid Valley House   Edinburg, Texas                                                  |       | 96         |       | 1998       |       | Leased     |       |
| Midtown Center   Anchorage, Alaska                                                  |       | 32         |       | 1998       |       | Owned      |       |
| Northstar Center   Fairbanks, Alaska                                                |       | 135        |       | 1990       |       | Leased     |       |
| Oakland Center   Oakland, California                                                |       | 61         |       | 1981       |       | Owned      |       |
| Parkview Center   Anchorage, Alaska                                                 |       | 112        |       | 1993       |       | Leased     | (4)        |
| Reality House   Brownsville, Texas                                                  |       | 66         |       | 1998       |       | Owned      |       |
| Reid Community Residential Facility   Houston, Texas                                |       | 500        |       | 1996       |       | Leased     | (4)        |
| Salt Lake City Center   Salt Lake City, Utah                                        |       | 78         |       | 1995       |       | Leased     |       |
| Seaside Center   Nome, Alaska                                                       |       | 48         |       | 1999       |       | Leased     |       |
| Taylor Street Center   San Francisco, California                                    |       | 177        |       | 1984       |       | Owned      |       |
| Tundra Center   Bethel, Alaska                                                      |       | 85         |       | 1986       |       | Leased     | (4)        |

 

*(Table continued on following page)*

 

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| ***Adult Community-Based Services Facilities:   Non-Residential Facilities*** | * *   | * *   | * *   | * *   | * *   | * *   | * *   |
|-------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| East St. Louis East   St. Louis, Illinois                                     |       | 164        |       | (6         | )          | Leased     |       |
| LifeWorks   Joliet, Illinois                                                  |       | 116        |       | (6         | )          | Leased     |       |
| Southwood   Chicago, Illinois                                                 |       | 554        |       | (6         | )          | Owned      |       |

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| (1) |   | Residential  service capacity is comprised of the number of beds currently available for  service in our residential facilities. Non-residential service capacity is  based on either contractual terms or our estimate of the number of clients to  be served. We update these estimates at least annually based on the program’s  budget and other factors.                                                                                                                                                                                                              |
|-----|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | Date from which  we, or our predecessor, have had a contract for services on an uninterrupted  basis.                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| (3) |   | We do not incur  any facility use costs, such as debt service, rent or depreciation for  facilities that we operate under a management contract only; however, we are  responsible for all other facility operating costs at these managed  facilities.                                                                                                                                                                                                                                                                                                                         |
| (4) |   | Facility was  sold in August 2001 to Municipal Corrections Finance, L.P. (“MCF”) as  part of the 2001 Sale and Leaseback Transaction as discussed in “Note 11 —  Derivative Financial Instruments and Guarantees” of the “Notes to  Consolidated Financial Statements” in Item 8 of this Form 10-K.                                                                                                                                                                                                                                |
| (5) |   | We lease the Regional Correctional Center from Bernalillo County, New  Mexico. The lease commenced in January  2003 and we renovated the  facility in 2003 and 2004. The facility commenced operations in July 2004  and the lease runs to June 2009, and we have five one-year renewal options.  Refer to Item 7 — “Management’s Discussion and Analysis of Financial  Condition and Results of Operations - Significant 2008 Events — Regional  Correctional Center” of this report for further discussion concerning this  facility. |
| (6) |   | These facilities  are operated pursuant to the Cornell Interventions programs/facilities  contract with numerous agencies throughout Illinois. Initial contract dates  vary by agency and range from 1974 to 1997.                                                                                                                                                                                                                                                                                                                                                              |
| (7) |   | We closed the Hector Garza Residential Treatment Center in the fourth  quarter of 2005 and subsequently reactivated the facility in August 2007.  Refer to Item 7 — “Management’s Discussion and Analysis of Financial  Condition and Results of Operations — Contractual Uncertainties Related to  Certain Facilities — Hector Garza Residential Treatment Center” of this  report for further discussion concerning this facility.                                                                                                         |
| (8) |   | We closed the formerly leased Washington D.C. Facility in 2005 (we  acquired the facility in September 2007) and are currently considering  several options for use, including the operation of a new program.                                                                                                                                                                                                                                                                                                                                                             |
| (9) |   | Los Angeles County Jails represents eight individual locations in Los  Angeles County, California and the surrounding area. Initial contract dates  vary by agency and range from 1994 to 2008.                                                                                                                                                                                                                                                                                                                                                                                 |

 

 

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**Marketing and Business Development**

 

Our principal customers are federal, state and localgovernment agencies responsible for adult and juvenile corrections, treatmentand educational services. We manage our business development efforts to addressopportunities available in all of our divisions and potential markets. Whilesuch opportunities necessarily include forming relationships with newcustomers, we also believe that further potential lies in the management of ourexisting relationships through improved bed management (including bothutilization and customer mix) and through enhancements of our contract terms. Fromtime to time, we will also evaluate opportunities for accretive acquisition.

 

In most instances, we pursue developmentopportunities through Requests for Proposal (“RFPs”) or Requests forQualifications (“RFQs”), which are submitted in response to government agencies’solicitations for bids. The decision to respond to such solicitations is basedupon several factors, including management’s assessment of customer needs, ourability to service the needs in an operationally successful and acceptablyprofitable manner, and the fit of the potential program within our existingportfolio and strategic objectives. The solicitations generally require thebidder to demonstrate relevant operational experience. Furthermore, theresponse must also include descriptions of the services to be provided by thebidder and the price at which the bidder is willing to provide them. Servicescan include not only direct care, but also the design, construction, orrenovation of the related facility.

 

If we believe a project described in an RFP isconsistent with our strategic business plan, we will submit a proposal to therequesting agency. When responding to RFPs, we typically incur costs rangingfrom $10,000 to $100,000 per proposal. In addition, we could incur substantialcosts to acquire options to lease or purchase land for a proposed facility orto lease or purchase an existing building to house a program. The preparationof a response usually requires four to 12 weeks. The award process usuallytakes an additional three to nine months. If new construction is required bythe contract, the selected company’s operation of the facility generally beginsbetween nine and 18 months following award announcement, although in some casesas early as four months. In instances where construction is required, oursuccess depends, in part, upon our ability to acquire property that is not onlysatisfactory for programmatic needs but also that lies in a community wheresocial opposition does not significantly impede our ability to operate. We mayincur significant expenses in responding to such opposition, and our responsemay not be successful. In addition, we may choose not to respond to an RFP ormay withdraw a submitted proposal if significant legal action or other forms ofopposition are anticipated or encountered.

 

In addition to responding to RFPs, we also rely uponcourt-referrals, insurance- or managed care-referrals, and self-referrals forbusiness growth, particularly in our juvenile and adult community-basedtreatment programs. In such instances, court and community liaisons play asignificant role in developing our growing network of clients.

 

#### **Contracts**

####  

Our facility operating contracts generally providethat we will be compensated via an occupant per diem rate, fees for treatmentservices, guaranteed take-or-pay terms, a fixed fee, or cost-plusreimbursement. Factors we consider in determining billing rates include (1) thespecified programs provided for by the contract and the related staffinglevels, (2) wage levels customary in the respective geographic area, (3) whetherthe proposed facility is to be leased or purchased, and (4) theanticipated average occupancy levels that we believe could reasonably bemaintained (and the ramp up schedule required to reach stable populations). Compensationis invoiced in accordance with the applicable contract and is typically paid ona monthly basis. Some of our juvenile education contracts provide for annualpayments.

 

We pursue new contracts that leverage our existinginfrastructure and capabilities. A significant portion of our opportunities arecontracts producing revenue that varies with the number of individuals housedor served, the types of services provided and/or the frequency of the service.The balance of our contracts are take-or-pay contracts, which provide a fixedminimum revenue stream regardless of occupancy.

 

##### **Competition**

##### ** **

Because our services encompass several diversemarkets, we view our competition within these separate markets. We believe ourprincipal non-governmental competitors in the Adult Secure market areCorrections Corporation of America, Inc., The Geo Group, Inc., andManagement and Training Corporation. Within our two other segments — AbraxasYouth and Family Services and Adult Community-Based Services — we typically encountera significantly more fragmented competitor base, which includes not onlyfor-profit operators like ourselves but also not-for-profit organizations.Within the Abraxas Youth and Family Services division, some of our primarynon-governmental competitors include ViaQuest, Youth and Family CenteredServices, Securicor New Century and Ramsay Youth Services. Our largernon-governmental competitors in the adult community-based market include DismasHouse, Bannum, Gateway, Salvation Army and Volunteers of America.

 

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**Employees**

 

At December 31, 2008, we had 4,109 full-timeemployees and 300 part-time employees. We employ management, administrative andclerical, security, educational and counseling services, health services andgeneral maintenance personnel. Approximately 828 employees at four of ourfacilities are represented by labor unions.

 

**Regulations**

 

The industry in which we operate is subject tofederal, state and local regulations administered by a variety of regulatoryauthorities. Generally, prospective providers of correctional, detention,educational, treatment and community-based services must comply with a varietyof applicable federal, state and local regulations, including correctional,education, healthcare, environmental and safety regulations. Our contractsfrequently include extensive reporting requirements, including mandatorysupervision with on-site monitoring by representatives of our contractinggovernment agencies, as well as audits by these and other governmentaldepartments.

 

In addition to regulations requiring certaincontracting government agencies to enter into a competitive bidding procedurebefore awarding contracts, the laws of certain jurisdictions may also requireus to award subcontracts on a competitive basis or to subcontract withbusinesses owned by women or members of minority groups.

 

**Business Concentration**

 

For the years ended December 31, 2008, 2007 and2006, 34.2%, 32.6% and 29.1%, respectively, of our consolidated revenues werederived from multiple contracts with the BOP. No other single customer makes upgreater than 10% of our consolidated revenues for these years.

 

**Insurance**

 

We maintain general liability insurance for all ofour operations at an amount equal to $10 million per occurrence per facilityand in the aggregate. We also maintain insurance in amounts management deemsadequate to cover property and casualty risks, workers’ compensation, anddirectors’ and officers’ liability.

 

Our contracts and the statutes of certain states inwhich we operate typically require us to maintain insurance. Our contractsprovide that, in the event we do not maintain such insurance, the contractingagency may terminate its agreement with us. We believe that we are incompliance in all material respects with these requirements.

 

**EnvironmentalMatters**

 

Weare subject to various federal, state, and local environmental laws andregulations, and these laws can impose strict liability for the discharge ofhazardous or toxic substances. As an owner and operator of facilities, we aresubject to these laws and could be responsible for the discharge ofcontaminants at our facilities. We are not currently incurring material costsassociated with environmental compliance or remediation, although in the eventwe had an environmental issue at any of our current or previously-ownedfacilities, the costof complying with these environmental laws could materially adversely affectour financial condition and results of operations.

 

 

 

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**ITEM 1A.****      ****RISK FACTORS**

 

***Our significant level of indebtedness couldadversely affect our financial condition.***

 

Wehave a significant amount of indebtedness.  Our total consolidatedindebtedness as of December 31, 2008 was approximately $320.5million.  Our ability to make scheduled payments or to refinance our debtobligations depends on our financial and operating performance, which issubject to prevailing economic and competitive conditions and to certain otherfinancial, business and other factors beyond our control. We cannot assure youthat we will maintain a level of cash flows from operating activitiessufficient to permit us to pay the principal, premium, if any, and interest andadditional interest, if any, on our indebtedness.  We may need to reduceor delay capital expenditures, sell assets, seek additional capital orrestructure or refinance all or a portion of our indebtedness on or beforematurity.  However, we may not be able to complete these alternativemeasures on commercially reasonable terms or at all.  Additionally, asignificant portion of our assets is owned, and a significant percentage of ourrevenue is generated, by our subsidiaries. Our cash flows and our ability torepay our indebtedness depends upon the performance of these subsidiaries andtheir ability to make distributions.  See “Management’s Discussion andAnalysis of Financial Condition and Results of Operations—Liquidity and CapitalResources.”

 

Certainof our borrowings, including any borrowings under our Amended Credit Facility,will be at variable rates of interest and expose us to interest rate risk. Ifinterest rates increase, our debt service obligations on the variable rate indebtednesswould increase even though the amount borrowed remained the same, and our netincome would decrease.

 

***The volatility and disruption of thecapital and credit markets and adverse changes in the economy may negativelyimpact our ability to access financing, revenues and earnings.***

 

Thecapital and credit markets have been experiencing extreme volatility anddisruption for more than twelve months.  Since the third quarter of 2008and continuing through the first quarter of 2009, the volatility and disruptionhave reached unprecedented levels.  The markets have exerted downwardpressure on availability of liquidity and credit capacity for many issuers,including us.  While we intendto finance our operations with existing cash, cash flow from operations andborrowing under our Amended Credit Facility, we may require additionalfinancing to support our continued growth.  However, due to the existinguncertainty in the capital and credit markets, access to capital, includingcapital through the accordion feature of our Amended Credit Facility, on termsacceptable to us may be limited or unavailable.

 

Several large financial institutions have either recently failed or beendependent on the assistance of the federal government to continue to operate asa going concern. We can provide no assurance that all of the banks that havemade commitments to us under our revolving credit facility will continue tooperate as a going concern in the future or that such banks would be willing toparticipate in an expansion to the Amended Credit Facility in the event theCompany desires to exercise the accordion feature of the Amended CreditFacility.

 

If any of the banks in the lending group were to fail or decline toparticipate in the expansion of the credit facility under the accordionfeature, it is possible that the capacity under the revolving credit facilitywould not be expanded by the full amount that might be requested by us underthe accordion feature and might even be reduced to below the existing committedavailability. In the event that we could not obtain an increased commitment byvirtue of the accordion feature of the Amended Credit Facility, we could berequired to obtain capital from alternate sources in order to continue ourgrowth through future development and expansion initiatives.  Our options for addressing such capitalconstraints would include, but not be limited to (i) obtaining commitmentsfrom the remaining banks in the lending group or from new banks to fundincreased amounts under the terms of the Amended Credit Facility, or itsaccordion feature, (ii) accessing the public capital markets, or (iii) delayingcertain of the Company’s planned expansion projects. Such alternatives in thecurrent market would likely be on terms less favorable than under existingterms, which could have a material effect on the Company’s consolidatedfinancial position, results of operations, or cash flows.

 

 ***The restrictive covenants in our Senior Notes andAmended Credit Facility may affect our ability to operate our businesssuccessfully.***

 

Theindenture governing our Senior Notes and our Amended Credit Facility containvarious covenants that limit our ability to engage in specified types oftransactions. These covenants limit our ability to, among other things: incuradditional debt; pay dividends or other distributions; make certain types ofinvestments; incur liens; restrict distributions from our subsidiaries; enterinto transactions with affiliates; and consolidate or merge with or into, orsell substantially all of our assets to, another.

 

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Inaddition, our Amended Credit Facility requires us to maintain specifiedfinancial ratios. Any failure to comply with the restrictions of our AmendedCredit Facility and the indenture governing our Senior Notes or any othersubsequent financing agreements may result in an event of default.  Anevent of default may allow the creditors to accelerate the related debt as wellas any other debt to which a cross-acceleration or cross-default provisionapplies and terminate all commitments to extend further credit.  Furthermore, we have pledged a significant portion of our assets as collateralunder our Amended Credit Facility.  If we default on the financialcovenants in our Amended Credit Facility, our lenders could proceed against thecollateral granted to them to secure that indebtedness, which would have amaterial adverse effect on our business, results of operation and financialcondition.

 

***Despite current indebtedness levels, we maystill be able to incur substantially more debt. This could further exacerbatethe risks described above.***

 

Theterms of the indenture governing our Senior Notes and our Amended CreditFacility restrict our ability to incur but do not prohibit us from incurringsignificant additional indebtedness in the future.  We have severalongoing expansion projects underway and anticipate commencing other projects,and we will likely need to finance these future outlays of capital since ourcash on hand and cash flows from operations will not be sufficient to fullyfund all of these potential expenditures.  Depending on market conditionsand other factors, we will consider additional debt financing to fund theseoutlays of capital as well as to refinance a portion of our existingindebtedness.   If new indebtedness is added to our and oursubsidiaries’ current debt levels, the related risks that we and they now facecould intensify.

 

***We are dependent on government appropriations, which may notbe made on a timely basis or at all and may be adversely impacted by budgetaryconstraints at the federal, state and local levels.***

 

Ourcash flow is subject to the receipt of sufficient funding of and timely paymentby contracting governmental entities. If the appropriate governmental agencydoes not receive sufficient appropriations to cover its contractualobligations, a contract may be terminated or the amounts payable to us may be deferredor reduced.  Also, we are dependent upon funding for anticipated futurecontracts, including those for certain facility expansions and new constructionprojects that we have undertaken, such as those at D. Ray James and Hudson,Colorado.

 

Federal, state, county and local governments have encountered, and areexpected to continue to encounter, significant budgetary constraints that mayresult in a reduction of spending on the outsourced services that we provide.Such budgetary limitations may cause the contractual commitments to be reducedor even eliminated, which would make it unprofitable to continue operating acertain facility and require us to find alternate customers or close suchfacility. Any delaysin payment, or the termination of a contract, could have a material adverseeffect on our cash flow and financial condition, which may make it difficult tosatisfy our payment obligations on our indebtedness, including the AmendedCredit Facility, in a timely manner.

 

In addition, as aresult of, among other things, recent economic developments, federal, state andlocal governments have encountered, and may continue to encounter, unusualbudgetary constraints. As a result, a number of state and local governments areunder pressure to control additional spending or reduce current levels ofspending which could limit or eliminate appropriations for the facilities thatwe operate. Additionally, as a result of these factors, we may be requested inthe future to reduce our existing per diem contract rates or forego prospectiveincreases to those rates. Budgetary limitations may also make it more difficultfor us to renew our existing contracts on favorable terms or at all. Further, anumber of states in which we operate are experiencing significant budget deficitsfor fiscal year 2009. We cannot assure that these deficits will not result inreductions in per diems, delays in payment for services rendered or unilateraltermination of contracts. Recently, the State of California has notifiedvendors providing services to the state that it might have to temporarily issueIOU’s. We have not received notice that our services will be subject to suchIOU’s and our outstanding receivables related to California are consistent withnormal payment practices for the State.

 

Asa result of this increased budgetary pressure, in certain cases we have granteda few of our customers relief from formulaic increase provisions in theiragreements and some of our customers have not included in their appropriationlegislation amounts that would increase the per diem rates payable to us orhave otherwise attempted to reduce the contract value. Contractual rateincreases are generally intended to offset increases in expenses and inflation.To the extent rates are not increased or are reduced, our profitability will beadversely affected.  Examples of this budget pressure include the need ofthe federal government to operate under a continuing resolution as a result ofits failure to pass a new 2008/2009 year budget and reported budget pressuresin most states including Alaska, Arizona, California, Colorado, Georgia,Illinois, Pennsylvania and Texas.

 

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***We are subject to the short-term nature ofgovernment contracts.***

 

Manygovernmental agencies are legally limited in their ability to enter into fixedlong-term contracts that would bind elected officials responsible for futurebudgets. Therefore, many contracts with government agencies, including the BOP,typically either have a very short term or, even when for a longer term, aresubject to termination on short notice without cause. The majority of ourcontracts have primary terms of one to three years. Our contracts withgovernmental agencies may contain one or more renewal options that may beexercised only by the contracting governmental agency. Some of these contractsmay not be renewed by the governmental agency and no assurance can be given thatthe governmental agency will exercise a renewal option in the future. Inaddition, the governmental agency may elect to solicit bids pursuant to a RFPor RFQ rather than exercise a renewal option. We may not be successful inresponding to a RFP or RFQ.

 

Thenon-renewal or termination of any of our significant contracts withgovernmental agencies, our inability to secure new facility managementcontracts from others or our failure to successfully respond to a RFP or RFQcould materially adversely affect our financial condition, results of operationand liquidity. To the extent we have made significant capital expenditures andhave short-term contracts with our customers that are not renewed or extended,we may not recover our entire capital investment.

 

 ***Our ability to win new contracts to develop and managecorrectional, detention and treatment facilities depends on many factorsoutside our control.***

 

Ourgrowth is generally dependent upon our ability to win new contracts to developand manage new or expanded correctional, detention and treatment facilities.This depends on a number of factors we cannot control, including crime ratesand sentencing patterns in various jurisdictions. Accordingly, the demand forour facilities could be adversely affected by the relaxation of enforcementefforts, leniency in conviction and sentencing practices or through the legaldecriminalization of certain activities that are currently proscribed bycriminal laws. For instance, changes in laws relating to drugs and controlledsubstances or illegal immigration could reduce the number of persons arrested,convicted and sentenced, thereby potentially reducing demand for correctionalfacilities to house them and community-based services to transition offendersback into the community. Similarly, reductions in crime rates could lead toreductions in arrests, convictions and sentences requiring correctionalfacilities.

 

Whenseeking bids, most governmental entities evaluate the financial strength of thebidders. To the extent they believe we do not have sufficient financialresources, we will be unable to effectively compete for bids. Additionally, oursuccess in obtaining new awards and contracts may depend, in part, upon ourability to locate land that can be leased or acquired on favorable terms.Furthermore, desirable locations may be in or near populated areas and,therefore, may generate legal action or other forms of opposition fromresidents in areas surrounding a proposed site.

 

***Our profitability may suffer if the numberof offenders occupying our correctional, detention and treatment facilitiesdecreases or there is a shift in occupancy among our divisions.***

 

Ourcorrectional, detention and treatment facilities are dependent upongovernmental agencies supplying offenders and we do not control occupancylevels at our facilities. We believe the rate of growth experienced in theadult secure sector during the late 1980s and early 1990s is stabilizing.

 

Historically,a substantial portion of our revenues has been generated under contracts thatspecify a net rate per day per resident, or a per diem rate, sometimes with nominimum guaranteed occupancy levels, even though most correctional facilitycost structures are relatively fixed. Under such a per diem rate structure, adecrease in occupancy levels at a particular facility could have a materialadverse effect on the financial condition and results of operations at suchfacility. A decrease in the occupancy of certain juvenile justice, educationand treatment facilities would have a more significant impact on our operatingresults than a decrease in occupancy in the Adult Secure division due to higherper diem revenue at certain juvenile facilities.

 

Certainsocial commentators and various political or governmental representatives suggestthat community-based corrections of adults may be emphasized in the future asalternatives to traditional incarceration. We have historically experiencedhigher operating margins in the Adult Secure and the Adult Community-Basedsectors than in the juvenile services sector. A shift in occupancy among oursegments of business operations could result in a decrease in ourprofitability.

 

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***A failure to comply with existingregulations could result in material penalties or non-renewal or termination ofour contracts.***

 

Ourindustry is subject to a variety of federal, state, county and localregulations, including education, environmental, health care and safetyregulations, which are administered by various regulatory authorities. We maynot always successfully comply with these regulations, and failure to complycould result in material penalties or non-renewal or termination of facilitymanagement contracts. The contracts typically include extensive reportingrequirements and supervision and on-site monitoring by representatives ofcontracting governmental agencies. Corrections officers are customarilyrequired to meet certain training standards, and in some instances facilitypersonnel are required to be licensed and subject to background investigation.Certain jurisdictions also require that subcontracts be awarded on acompetitive basis or that we subcontract with businesses owned by members ofminority groups. The failure to comply with any applicable laws, rules orregulations and the loss of any required license could adversely affect thefinancial condition and results of operations at our affected facilities.

 

***Governmental agencies may investigate andaudit our contracts and, if any improprieties are found, we may be required torefund revenues we have received, and/or to forego anticipated revenues and maybe subject to penalties and sanctions, including prohibitions on our bidding inresponse to RFPs.***

 

Governmentalagencies we contract with have the authority to audit and investigate ourcontracts with them. As part of that process, some governmental agencies reviewour performance on the contract, our pricing practices, our cost structure andour compliance with applicable laws, regulations and standards. If the agencydetermines that we have improperly allocated costs to a specific contract, wemay not be reimbursed for those costs and we could be required to refund theamount of any such costs that have been reimbursed. If a government audituncovers improper or illegal activities by us or we otherwise determine thatthese activities have occurred, we may be subject to civil and criminalpenalties and administrative sanctions, including termination of contracts,forfeitures of profits, suspension of payments, fines and suspension ordisqualification from doing business with the government. Any adversedetermination could adversely impact our ability to bid in response to RFPs inone or more jurisdictions and significantly reduce the probability of oursuccess in the bid process for future contracts.

 

***If we fail to satisfy our contractualobligations, our ability to compete for future contracts and our financial conditionmay be adversely affected.***

 

Ourfailure to comply with contract requirements or to meet our client’sperformance expectations when performing a contract could materially andadversely affect our financial performance and our reputation, which, in turn,would impact our ability to compete for new contracts. Our failure to meetcontractual obligations could also result in substantial actual andconsequential damages. In addition, our contracts often require us to indemnifyclients for our failure to meet performance standards. Some of our contractscontain liquidated damages provisions and financial penalties related toperformance failures. Although we have liability insurance, the policy limitsmay not be adequate to provide protection against all potential liabilities.

 

***Competitors in our industry may adverselyaffect the profitability of our business.***

 

Wemust compete with government entities and other private operators on the basisof cost, quality and range of services offered, experience in managingfacilities, reputation of personnel and ability to design, finance andconstruct new facilities on a cost effective competitive basis. While there aresome barriers for companies seeking to enter into the management and operationof correctional, detention and treatment facilities, these barriers have notbeen sufficient to materially limit additional competition. Certain areas ofour operation may not pose a significant barrier to entry into the market byprivate operators. For example, private operators may not find it as difficultto bid for juvenile treatment, educational and detention services andpre-release correctional and treatment services as they do adult correctionaland detention services.

 

Further,our government customers may assume the management of a facility currentlymanaged by us upon the termination of the corresponding management contract or,if such customers have capacity at their facilities, may take inmates currentlyhoused in our facilities and transfer them to government run facilities. Theresulting decrease in occupancy levels would reduce our revenue due to the perdiem rate structure and could result in a significant decrease in theprofitability of our business.

 

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***A disturbance or violent occurrence in oneof our facilities could result in closure of a facility or harm to ourbusiness.***

 

Anescape, riot, disturbance or violent occurrence at one of our facilities couldadversely affect the financial condition, results of operations and liquidityof our operations. Among other things, the negative publicity generated as aresult of an event could adversely affect our ability to retain an existingcontract or obtain future ones. In addition, if such an event were to occur,there is a possibility that the facility where the event occurred may be shutdown by the relevant governmental agency. A closure of certain of ourfacilities could adversely affect the financial condition, results ofoperations and liquidity of our operations. Such negative events (including anoccurrence at a competitor’s facility) may also result in a significantincrease in our liability insurance costs.

 

***Negative media coverage, includinginaccurate or misleading information, could adversely affect our reputation andour ability to bid for government contracts.***

 

Themedia frequently focuses its attention on private operators’ contracts withgovernmental agencies. If the media coverage of private operators is negative,it could influence government officials to slow the pace of outsourcinggovernment services, which could reduce the number of RFPs. The media may alsofocus its attention on the activities of political consultants engaged by us,even when their activities are unrelated to our business, and we may be taintedby adverse media coverage about their activities. Moreover, inaccurate,misleading or negative media coverage about us could harm our reputation and, accordingly,our ability to bid for and win government contracts.

 

***We often incur significant costs beforereceiving related revenues, which could result in cash shortfalls and a risk ofnot recovering our investment.***

 

Whenwe are awarded a contract to manage a new facility, we may incur significantexpenses before we receive contract payments. These expenses include purchasingreal estate, constructing new facilities, leasing office space, purchasingoffice equipment and hiring and training personnel. As a result, when thegovernment does not fund a facility’s pre-opening and start-up costs, we may berequired to invest significant sums of money before receiving related contractpayments. In addition, payments due to us from governmental agencies may be delayeddue to billing cycles or as a result of failures by our governmental customersto attain necessary budget approvals and finalize contracts in a timely manner.Several juvenile services contracts related to educational services provide forannual collection several months after a school year is completed. In addition,a contract may be terminated prior to its scheduled expiration and as a resultwe may not recover these expenses or realize any return on our investment.

 

Wemay choose to undertake development projects without written commitments tomake use of such facilities. We may not be able to obtain contracts for thesefacilities in a timely fashion, if at all. To the extent we do not obtaincontracts, we could be unable to recover our investment and our financialcondition and results of operations would be adversely affected.

 

 ***We may be unable to attract and retain sufficientqualified personnel necessary to sustain our business.***

 

Ourdelivery of services is labor-intensive. When we are awarded a contract, wemust hire operating management, security, case management and other personnel.The success of our business requires that we attract, develop, motivate andretain these personnel. Our ability to recruit and retain qualified individualsvaries by facility and is related to the socio-economic factors in theparticular community in which the facility operates. The Department of Laborwages we offer our employees are often higher than wages they could obtainelsewhere in the community. However, if the local economy where a facility islocated is robust and unemployment is low, we may have difficulty hiring andretaining qualified personnel. In addition, there are inherent risks associatedwith the nature of the services we provide, which could cause certain qualifiedindividuals to seek other employment opportunities. We have typicallyexperienced high turnover of personnel in our juvenile and adult securefacilities within the first year of their employment. Our inability to hiresufficient personnel on a timely basis or the loss of significant numbers ofpersonnel could adversely affect our business.

 

***If we do not successfully integrate thebusinesses that we acquire, our results of operations could be adverselyaffected.***

 

Wemay be unable to manage businesses that we may acquire profitably or integratethem successfully without incurring substantial expenses, delays or otherproblems that could negatively impact our results of operations. Acquisitionsgenerally require the integration of facilities, some of which may be locatedin states in which we do not currently have operations.

 

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Moreover,business combinations involve additional risks, including:

 

·      diversion ofmanagement’s attention;

·      loss of keypersonnel;

·      assumption ofunanticipated legal or financial liabilities;

·      our becomingsignificantly leveraged as a result of the incurrence of debt to finance anacquisition;

·      unanticipatedoperating, accounting or management difficulties in connection with theacquired entities;

·      amortizationor possible impairment charges of acquired intangible assets, includinggoodwill; and

·      dilution toour earnings per share.

 

Also,client dissatisfaction or performance problems with an acquired business couldmaterially and adversely affect our reputation as a whole. Further, theacquired businesses may not achieve the revenues and earnings we anticipated.

 

***Because environmental laws impose strict,as well as joint and several, liability for clean up costs, unforeseenenvironmental risks could prove to be costly.***

 

Ourfacilities, and any facilities that we may acquire in the future, may besubject to unforeseen environmental risks. The federal ComprehensiveEnvironmental Response, Compensation, and Liability Act (CERCLA) imposesstrict, as well as joint and several, liability for certain environmentalcleanup costs on several classes of potentially responsible parties, including currentowners and operators of the property. Other federal and state laws in certaincircumstances may impose liability for environmental remediation, which costsmay be substantial. Further, the operation of our facilities, and thedevelopment of new facilities, requires that we obtain, and comply with,permits and other authorizations underenvironmental laws. Obtainingsuch permits and authorizations may affect our existing facilities or coulddelay the opening of new facilities, which could have a material adverse effecton our business and results of operations.

 

***We have in the past incurred, and maycontinue to incur, significant expenses for facilities that we no longeroperate.***

 

Ifwe close a facility, we may remain committed to perform our obligations underthe applicable lease, which would include, among other things, payment of thebase rent for the balance of the lease term. We may also be required to incurother expenses with respect to such facilities. The potential losses associatedwith our inability to cancel leases may result in our keeping openunderperforming facilities. As a result, ongoing lease operations at closed orunder-performing facilities could impair our results of operations.

 

***We may continue to operate underunprofitable contracts at facilities that we own to offset expenses associatedwith ownership of the facility.***

 

Ifour operations are unprofitable at a leased facility or if the leased facilityis performing significantly below targeted levels, we would typically terminatethe contract and the lease. However, we may continue to operate our contract atan owned facility to offset the expenses associated with ownership. Continuedperformance of such a contract could have a material adverse effect on ourbusiness and results of operations.

 

***We depend on a limited number ofgovernmental customers for a  significantportion of our revenues.***

 

Wecurrently derive, and expect to continue to derive, a significant portion ofour revenues from the BOP and various state agencies. The loss of, or asignificant decrease in, business from the BOP or those state agencies couldseriously harm our financial condition and results of operations. Our BOPcontracts accounted for approximately 34.2% of our total revenues for the yearended December 31, 2008 ($132.3 million), 32.6% of our total revenues forthe year ended December 31, 2007 ($117.5 million) and 29.1% of our totalrevenues for the year ended December 31, 2006 ($105.1 million). We expectto continue to depend upon the BOP and a relatively small group of othergovernmental customers for a significant percentage of our revenues.

 

***Because our revenues can fluctuate fromperiod to period, we may face short-term funding shortfalls from time to time.***

 

Revenuescan fluctuate from year to year due to changes in government funding policies,changes in the number of clients referred to our facilities by governmentalagencies, the opening of new facilities or the expansion of existing facilitiesand the termination of contracts for a facility or the closure of a facility.Our revenues fluctuate from quarter to quarter, based on the number ofcontracted days in each quarter. Because our revenues can vary, we may faceshort-term funding shortfalls from time to time. In addition, full-year resultsare not likely to be a direct multiple of any particular quarter or combinationof quarters.

 

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***Resistance to privatization of correctionaland detention facilities could result in our inability to obtain new contractsor the loss of existing contracts.***

 

Managementof correctional and detention facilities, particularly of adult securefacilities, by private entities has not achieved complete acceptance by eitherthe government or the public. The movement toward privatization of correctionaland detention facilities has also encountered resistance from certain groups,such as labor unions, local sheriff’s departments, religious organizations andgroups believing that correctional and detention facility operations shouldonly be conducted by government agencies. Changes in the dominant politicalparty in any market in which correctional facilities are located could have anadverse impact on privatization. Furthermore, some government agencies are notlegally permitted to delegate their traditional management responsibilities forcorrectional and detention facilities to private companies.

 

Inaddition, as a private prison manager, we are subject to government legislationand regulation restricting the ability of private prison managers to housecertain types of inmates, such as inmates from other jurisdictions or inmatesat medium or higher security levels. Legislation has been enacted in severalstates, and has previously been proposed in the United States House ofRepresentatives, containing such restrictions. Any such legislation may have amaterial adverse affect on us.

 

Anyof these resistances may make it more difficult for us to renew or maintainexisting contracts, to obtain new contracts or sites on which to operate newfacilities or to develop or purchase facilities and lease them to government orprivate entities, any or all of which could have a material adverse effect onour business.

 

***We are subject to significant insurancecosts.***

 

Worker’scompensation, employee health and general liability insurance representsignificant costs to us. We may continue to incur increasing insurance costs,typically due to adverse claims experience or rising healthcare costs ingeneral. Due to concerns over corporate governance and recent corporateaccounting scandals, liability and other types of insurance have become moredifficult and costly to obtain. In addition, stockholder lawsuits willgenerally serve to increase our directors’ and officers’ liability insurance.Unanticipated additional insurance costs could adversely impact our results ofoperations and cash flows, and the failure to obtain or maintain any necessaryinsurance coverage or the inability of an insurance carrier to perform underits obligations through issued coverage could have a material adverse effect onus.

 

***We are subject to risks associated withownership of real estate and related operation of our facilities.***

 

Ourownership of correctional and detention facilities subjects us to riskstypically associated with investments in real estate. Moreover, correctionaland detention facilities are relatively illiquid and therefore, our ability todivest ourselves of one or more of our facilities promptly in response tochanged conditions is limited. Investments in correctional and detentionfacilities subject us to risks involving potential exposure to uninsured loss.Our operating costs may be affected by the obligation to pay for the cost ofcomplying with existing laws, ordinances and regulations, as well as the costof complying with future legislation.  Our facilities are also subject tohazards such as fire, hurricanes, earthquakes and other natural disasters. For example, Hurricane Ike that came ashore in Texas in September 2008damaged our Beaumont Transitional Treatment Center, Leidel ComprehensiveSanction Center and Reid Community Residential Facility.  See Item 7- “Management’sDiscussion and Analysis of Financial Condition and Results ofOperations—Significant 2008 Events.”  In addition, although we maintaininsurance for many types of losses, there are certain types of losses, such aslosses from earthquakes, riots and acts of terrorism, which may be either uninsurableor for which it may not be economically feasible to obtain insurance coverage.As a result, we could lose both our capital invested in, and anticipatedprofits from, one or more of the facilities we own. Further, we couldexperience losses that may exceed the limits of our insurance coverage.

 

***We may be adversely affected by inflation.***

 

Manyof our facility management contracts provide for fixed management fees or feesthat increase by only small amounts during their term. If, due to inflation orother causes, our operating expenses, such as wages and salaries of ouremployees, and insurance, medical and food costs, increase at rates faster thanincreases, if any, in our management fees, then our profitability would beadversely affected.

 

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**ITEM 1B.****      ****UNRESOLVEDSTAFF COMMENTS**

 

None

 

**ITEM 2.****         ****PROPERTIES**

 

Welease office space for our corporate headquarters in Houston, Texas and aregional administrative office in Pittsburgh, Pennsylvania. We also leasevarious facilities we are currently operating or developing. For a listing ofowned, leased and managed facilities, see “Business - Facilities” in Item 1 ofthis report.

 

**ITEM 3.****         ****LEGAL PROCEEDINGS**

 

Weare party to various legal proceedings, including those noted below. Whilemanagement presently believes that the ultimate outcome of these proceedingswill not have a material adverse effect on our financial position, overalltrends in results of operations or cash flows, litigation is subject toinherent uncertainties, and unfavorable rulings could occur. An unfavorableruling could include monetary damages or equitable relief, and could have amaterial adverse impact on the net income of the period in which the rulingoccurs.

 

***Valencia County Detention Center***

 

InApril 2007, a lawsuit was filed against the Company in the FederalDistrict Court in Albuquerque, New Mexico, by Joe Torres and Eufrasio Armijo,who each alleged that he was strip searched at the Valencia County DetentionCenter (“VCDC”) in New Mexico in violation of his federal rights under theFourth, Fourteenth and Eighth amendments to the U.S. Constitution.  Theclaimants also alleged violation of their rights under state law and sought tobring the case as a class action on behalf of themselves and all detainees atVCDC during the applicable statutes of limitation.  The plaintiffs soughtdamages and declaratory and injunctive relief.  Valencia County is also anamed defendant in the case and operated the VCDC for a significantly greaterportion of the period covered by the lawsuit.

 

InDecember 2008, the parties agreed to a proposed stipulation of settlementand the Court has preliminarily approved the settlement.  The settlement amount under the terms of theagreement is $3.3 million.  Cornell’s portion of the stipulatedsettlement, based on the number of inmates housed at VCDC during the timeCornell operated the facility in comparison to the number of inmates housed atthe facility during the time Valencia County operated the facility, is $1.2million and was funded principally through our general liability andprofessional liability coverage.

 

Inthe year ended December 31, 2007, we previously provided insurancereserves for this matter (as part of our regular review of reported andunreported claims) totaling approximately $0.5 million.  During the fourth quarter of 2008, werecorded an additional settlement charge of approximately $0.7 million and therelated reimbursement from our general liability and professional liabilityinsurance.  The charge and reimbursementwere recognized in general and administrative expenses for the year ended December 31,2008.  The reimbursement was funded bythe insurance carrier in the first quarter of 2009 into a settlement account, where it willremain until payments are made to the settlement class members.  The Courtgranted preliminary approval of the settlement in the first quarter of 2009,and the claims administration process is underway.  We expect the claimsadministration process to be completed and the final court approval of thesettlement in the fourth quarter of 2009.

 

***Shareholder Lawsuits***

 

OnOctober 19, 2006, a purported class action complaint was filed in theDistrict Court of Harris County, Texas, 269th Judicial District (No. 2006-67413)by Ted Kinbergy, an alleged stockholder of Cornell. The complaint names asdefendants Cornell and each member of the board of directors at the time of thesuit, as well as Veritas Capital Fund III, L.P. (“Veritas”). The complaintalleges, among other things, that (i) the defendants have breachedfiduciary duties they assertedly owed to our stockholders in connection withour entering into the Agreement and Plan of Merger, dated as of October 6,2006, with Veritas, Cornell Holding Corp., and CCI Acquisition Corp., and (ii) themerger consideration is unfair and inadequate. The plaintiffs sought, amongother things, an injunction against the consummation of the merger. Theproposed merger was rejected at a special meeting of our stockholders held on January 23,2007. Consequently, we believe the case is moot and expect the plaintiffs toseek dismissal of their claims accompanied by a request for legal fees that maybe owed.  We do not expect the resolution of this matter to have amaterial adverse effect on our financial condition, results of operations orcash flows.

 

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***Other***

 

Wehold insurance policies to cover potential director and officer liability, someof which may limit our cash outflows in the event of a decision adverse to usin the matters discussed above. However, if an adverse decision in thesematters exceeds the insurance coverage or if the insurance coverage is deemednot to apply to these matters, it could have a material adverse effect on us,our financial condition, results of operations and future cash flows.

 

Additionally,we currently and from time to time are subject to claims and suits arising inthe ordinary course of business, including claims for damages for personalinjuries or for wrongful restriction of or interference with offenderprivileges and employment matters. If an adverse decision in these mattersexceeds our insurance coverage, or if our coverage is deemed not to apply tothese matters, or if the underlying insurance carrier was unable to fulfill itsobligation under the insurance coverage provided, it could have a materialadverse effect on our financial condition, results of operations or cash flows.

 

Whilethe outcome of such other matters cannot be predicted with certainty, based onthe information known to date, we believe that the ultimate resolution of thesematters will not have a material adverse effect on our financial condition, butcould be material to operating results or cash flows for a particular reportingperiod.

 

 
| **ITEM  4.** | **SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS** |
|--------------|----------------------------------------------------------|

 

None.

 

**PART II**

 
| **ITEM 5.** | **MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER  MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.** |
|-------------|-------------------------------------------------------------------------------------------------------------------------|

 

Ourcommon stock is listed on the New York Stock Exchange (“NYSE”) under the symbol“CRN.”  As of March 6, 2009, therewere approximately 504 shareholders of record of our common stock. Thequarterly high and low closing sales prices for our common stock for fiscalyears 2008 and 2007 are shown below.

 

| ** **     | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------|------------|----------|------------|---------|------------|
| 2007:          |       |     |       |    |       |
| First Quarter  |       | $        | 21.45      |    | $          | 18.22 |   |
| Second Quarter |       | 25.43    |       | 20.32   |       |
| Third Quarter  |       | 25.42    |       | 19.14   |       |
| Fourth Quarter |       | 27.69    |       | 21.44   |       |
| 2008:          |       |     |       |    |       |
| First Quarter  |       | $        | 23.01      |    | $          | 16.15 |   |
| Second Quarter |       | 24.50    |       | 20.16   |       |
| Third Quarter  |       | 28.32    |       | 22.00   |       |
| Fourth Quarter |       | 26.00    |       | 16.50   |       |

 

Wehave never declared or paid cash dividends on our capital stock. We currentlyintend to retain excess cash flow, if any, for use in the operation andexpansion of our business (which could include the reduction of outstandingborrowings) and do not anticipate paying cash dividends on our common stock inthe foreseeable future. The payment of dividends is within the discretion ofthe Board of Directors and is dependent upon, among other factors, our resultsof operations, financial condition, capital requirements, restrictions, if any,imposed by financing commitments and legal requirements. Our 10.75% SeniorNotes, as well as our revolving credit facility contain certain restrictions onour ability to pay dividends. See “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations - Liquidity and Capital Resources— Long-Term Credit Facilities” in Item 7 of this report.

 

Wedid not purchase any of our common stock in the fourth quarter of 2008.

 

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Thefollowing table summarizes as of December 31, 2008 certain informationregarding equity compensation to our employees, officers, directors, and otherpersons under our plans:

 
| ** **                                                  | ** ** | **(A)  Number of  Securities to be  Issued upon  Exercise of  Outstanding Options,  Warrants and Rights** | ** ** | **(B)  Weighted-average  Exercise Price of  Outstanding Options,   Warrants and Rights** | ** ** | **(C)  Number of  Securities Remaining  Available for  Future Issuance  Under Equity  Compensation  Plans (Excluding  Securities Reflected  in Column A)** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Plan Category**                                           | ** ** | ** **                                                                                                                              | ** ** | ** **                                                                                    | ** ** | ** **                                                                                                                                                                                              | ** ** |
| Equity compensation plans approved by security  holders     |       | 408,825                                                                                                                                 |       | $                                                                                             | 15.82      |                                                                                                                                                                                                    | 746,317    | (1) |
| Equity compensation plans not approved by security  holders |       | 76,874                                                                                                                                  |       | $                                                                                             | 10.83      |                                                                                                                                                                                                    | 266,753    | (2) |
| Total                                                       |       | 485,699                                                                                                                                 |       | $                                                                                             | 15.03      |                                                                                                                                                                                                    | 1,013,070  |   |

 

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(1)          Includes 133,550 shares issuable pursuantto our Employee Stock Purchase Plan and 43,623 shares issuable pursuant to our2000 Directors Stock Plan. The total number of shares issuable pursuant to ourAmended and Restated 1996 Stock Option Plan is equal to the greater of1,500,000 shares or 15.0% of the number of shares issued and outstandingimmediately after the grant of any option under the Plan.  Also includes 569,144 shares issuablepursuant to our 2006 Equity Incentive Plan.

 

(2)          Includes 100,000 shares issuable pursuantto our Deferred Compensation Plan and 166,753 shares issuable pursuant to our2000 Broad-Based Employee Plan. The number of shares issuable pursuant to our2000 Broad-Based Plan (2000 Plan) is equal to the greater of 400,000 shares or 4.0%of the shares issued and outstanding immediately after the grant of any optionunder the Plan.

 

**EquityCompensation Plans Not Approved by Security Holders**

 

***Deferred Compensation Plan***

 

Wemaintain a Deferred Compensation Plan for the purpose of providing deferredcompensation for eligible employees. The Deferred Compensation Plan is anonqualified plan.

 

Aparticipant in the Deferred Compensation Plan may defer into an account apercentage of compensation each year up to 75.0% of the participant’s compensationreceived from Cornell. In addition, we may make contributions to the DeferredCompensation Plan on behalf of each participant. Compensation deferred by aparticipant, or contributions made by us on behalf of a participant, will beinvested in mutual funds or the common stock of Cornell. Participants are fullyvested in their accounts and may elect to receive the amounts credited to theiraccounts either in a lump sum or in five or ten-year annual installmentpayments. In the event of a change of control (as defined in the Plan), theamounts in each participant’s account will be paid to the participant in a lumpsum.

 

***Warrants***

 

Inconjunction with the issuance of subordinated notes in July 2000 (whichnotes are no longer outstanding), we issued warrants to purchase 290,370 sharesof our common stock at an exercise price of $6.70. The warrants could only beexercised by payment of the exercise price in cash to us, by cancellation of anamount of warrants equal to the fair market value of theexercise price, or by the cancellation of indebtedness owed to the warrantholder. During 2001, 168,292 shares of common stock were issued in conjunctionwith the exercise and cancellation of 217,778 warrants.  During 2007, the remaining 72,592 shares ofcommon stock were issued in conjunction with the exercise and cancellation ofthe remaining 72,592 warrants.

 

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***2000 Broad-Based Employee Plan***

 

Underour 2000 Plan, we may grant non-qualified stock options to our employees,directors and eligible consultants for up to the greater of 400,000 shares or4.0% of the aggregate number of shares of common stock issued and outstanding immediatelyafter the grant of any option under the 2000 Plan. The 2000 Plan options vestover a period of up to five years and expire ten years from the grant date. Thevesting schedule and term are set by the Compensation Committee of theBoard of Directors. The exercise price of options issued pursuant to the 2000Plan can be no less than the market price of our common stock on the date ofgrant.

 

Uponnotice of an extraordinary transaction (as defined in the 2000 Plan), optionsgranted under the 2000 Plan become fully vested. Upon consummation of theextraordinary transaction, such options, to the extent not previouslyexercised, automatically terminate.

 

##### **Performance Graph**

##### ** **

Thefollowing performance graph compares our cumulative total stockholder return atDecember 31, 2008 to the Russell 2000 Stock Index and the Company’s peergroup, assuming the investment of $100 on January 1, 2004, at closingprices on December 31, 2003 and reinvestment of dividends. The peer groupcompanies are Corrections Corporation of America and The Geo Group, Inc.

 

 
| **Company Name**             | ** ** | **Dec-03** | ** ** | **Dec-04** | ** ** | **Dec-05** | ** ** | **Dec-06** | ** ** | **Dec-07** | ** ** | **Dec-08** | ** ** |
|-----------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| **Cornell  Companies, Inc.** |       | 100.00     |       | 111.21     |       | 101.25     |       | 134.30     |       | 170.85     |       | 136.20     |       |
| **Peer  Group**                   |       | 100.00     |       | 136.18     |       | 146.31     |       | 236.53     |       | 317.95     |       | 184.26     |       |
| **Russell  2000 Index**           |       | 100.00     |       | 118.32     |       | 123.72     |       | 146.42     |       | 144.16     |       | 95.44      |       |

 

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**ITEM 6.****         ****SELECTEDFINANCIAL DATA**

 

Thefollowing data has been derived from our audited financial statements,including those included in this Form 10-K for the year ended December 31,2008 and should be read in conjunction with the consolidated financialstatements and notes thereto and Item 7 - “Management’s Discussion and Analysisof Financial Condition and Results of Operations” included elsewhere in thisreport.

 
| ** **                                                                                                                                          | ** ** | **Year Ended December 31,**                         | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                                                                                          | ** ** | **2008**                                                           | ** ** | **2007** | ** ** | **2006 (1)** | ** ** | **2005 (2)** | ** ** | **2004 (3)** | ** ** |
| ** **                                                                                                                                          | ** ** | **(in thousands, except per share data)** | ** ** |
| **Statements of Operations Data:**                                                                                                                  | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues                                                                                                                                            |       | $                                                                  | 386,724    |   | $ | 360,604 |   | $ | 360,855 |   | $ | 310,775 |   | $ | 277,190 |   |
| Income from operations                                                                                                                              |       | 62,197                                                             |       | 45,009 |   | 44,798 |   | 27,866 |   | 14,459 |   |
| Income (loss) from continuing operations before  provision (benefit) for income taxes and minority interest in consolidated  special purpose entity |       | 38,239                                                             |       | 20,745 |   | 21,728 |   | 6,143 |   | (8,256 | ) |
| Income (loss) from continuing operations                                                                                                            |       | 22,636                                                             |       | 11,910 |   | 12,580 |   | 3,928 |   | (5,000 | ) |
| Minority interest in consolidated special purpose  entity                                                                                           |       | 445                                                                |       | — |   | — |   | — |   | — |   |
| Discontinued operations, net of tax                                                                                                                 |       | —                                                             |       | — |   | (707 | ) | (3,622 | ) | (2,433 | ) |
| Net income (loss)                                                                                                                                   |       | 22,191                                                             |       | 11,910 |   | 11,873 |   | 306 |   | (7,433 | ) |
|                                                                                                                                                |       |                                                               |       |   |   |   |   |   |   |   |   |
| Earnings (loss) per share:                                                                                                                          |       |                                                               |       |   |   |   |   |   |   |   |   |
| ·        Basic                                                                                              |       |                                                               |       |   |   |   |   |   |   |   |   |
| ·        Income (loss) from continuing operations                                                           |       | $                                                                  | 1.55       |   | $ | .84 |   | $ | .90 |   | $ | .29 |   | $ | (.38 | ) |
| Discontinued operations, net of tax                                                                                                                 |       | —                                                             |       | — |   | (.05 | ) | (.27 | ) | (.18 | ) |
| Net income (loss)                                                                                                                                   |       | $                                                                  | 1.55       |   | $ | .84 |   | $ | .85 |   | $ | .02 |   | (.56 | ) |
|                                                                                                                                                |       |                                                               |       |   |   |   |   |   |   |   |   |
| Diluted                                                                                                                                             |       |                                                               |       |   |   |   |   |   |   |   |   |
| Income (loss) from continuing operations                                                                                                            |       | $                                                                  | 1.51       |   | $ | .82 |   | $ | .89 |   | $ | .29 |   | (.38 | ) |
| Discontinued operations, net of tax                                                                                                                 |       | —                                                             |       | — |   | (.05 | ) | (.27 | ) | (.18 | ) |
| Net income (loss)                                                                                                                                   |       | $                                                                  | 1.51       |   | $ | .82 |   | $ | .84 |   | $ | .02 |   | (.56 | ) |
|                                                                                                                                                |       |                                                               |       |   |   |   |   |   |   |   |   |
| Number of shares used to compute EPS:                                                                                                               |       |                                                               |       |   |   |   |   |   |   |   |   |
| Basic                                                                                                                                               |       | 14,298                                                             |       | 14,149 |   | 13,918 |   | 13,580 |   | 13,203 |   |
| Diluted                                                                                                                                             |       | 14,698                                                             |       | 14,480 |   | 14,059 |   | 13,695 |   | 13,203 |   |

 

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| ** **                                                                        | ** ** | **Year Ended December 31,**                    | ** ** |
|-----------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                        | ** ** | **2008**                                                      | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                        | ** ** | **(in thousands, except occupancy data)** | ** ** |
| **Operating Data:**                                                               | ** ** | ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                                                              |       |                                                          |       |   |   |   |   |   |   |   |   |
| **Residential:**                                                                  | ** ** | ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service capacity (4) (9)                                                     |       | 17,592                                                        |       | 15,634 |   | 14,659 |   | 14,682 |   | 13,494 |   |
| Contracted beds in operation (end of period)  (5) (9)                        |       | 16,821                                                        |       | 14,211 |   | 13,492 |   | 11,929 |   | 11,479 |   |
| Average contract occupancy on contracted beds in  operation (6) (7) (9) |       | 92.0                                                          | %          | 99.6 | % | 97.5 | % | 96.0 | % | 98.6 | % |
| Average contract occupancy excluding start-up  operations (6) (7) (9)   |       | 92.0                                                          | %          | 99.6 | % | 97.5 | % | 100.4 | % | 101.9 | % |
| **Non-Residential:**                                                              | ** ** | ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service capacity (8) (9)                                                     |       | 2,353                                                         |       | 2,953 |   | 3,921 |   | 4,792 |   | 3,852 |   |
|                                                                              |       |                                                          |       |   |   |   |   |   |   |   |   |
| **Balance Sheet Data:**                                                           | ** ** | ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Working capital                                                                   |       | $                                                             | 48,395     |   | $ | 47,757 |   | $ | 75,078 |   | $ | 57,286 |   | $ | 107,597 |   |
| Total assets                                                                      |       | 636,921                                                       |       | 562,287 |   | 523,533 |   | 510,628 |   | 507,631 |   |
| Long-term debt, net of current portion                                            |       | 308,070                                                       |       | 275,298 |   | 255,471 |   | 266,659 |   | 279,528 |   |
| Stockholders’ equity                                                         |       | 227,722                                                       |       | 200,449 |   | 181,564 |   | 165,461 |   | 161,312 |   |
|                                                                                   |            |                                                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**Notes toSelected Consolidated Financial Data**

 

(1)                    Income from operations forthe year ended December 31, 2006 includes a charge of approximately $0.4million to record impairments to the carrying value of two of our adultcommunity-based facilities. Refer to “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” in Item 7 of this report.

(2)                    The statement of operationsand balance sheet data presented for the year ended December 31, 2005includes the assets, liabilities and operations of Correction Systems, Inc.(“CSI”) acquired in April 2005.

(3)                    Loss from continuingoperations for the year ended December 31, 2004 includes a charge of $9.3million to record an impairment to the carrying value of the Cornell AbraxasAcademy. Additionally, income (loss) from continuing operations includes a losson extinguishment of debt of approximately $2.4 million related to the earlyretirement of the Synthetic Lease Investor Notes A and B and the revolving lineof credit under our amended 2000 Credit Facility. Discontinued operations, netof tax for the year ended December 31, 2004 include charges totaling $0.8million to record impairments to the carrying values of two of our juvenilefacilities.

(4)                    Residential service capacity is comprised of thenumber of beds currently available for service in our residential facilities.

(5)                    At certain residential facilities, the contractedcapacity is lower than the facility’s service capacity. We could increase afacility’s contracted capacity by obtaining additional contracts or byrenegotiating existing contracts to increase the number of beds covered.However, we may not be able to obtain contracts that provide occupancy levelsat a facility’s service capacity or be able to maintain current contractedcapacities in future periods.

(6)                    Occupancy percentages reflect less than normalizedoccupancy during the start-up phase of any applicable facility, resulting in alower average occupancy in periods when we have substantial start-upactivities.

**(7)**                    Averagecontract occupancy percentages are calculated based on actual occupancy for theperiod as a percentage of the contracted capacity for residential facilities inoperation. These percentages do not reflect the operations of non-residentialcommunity-based programs. At certain residential facilities, our contractedcapacity is lower than the facility’s service capacity. Additionally, certainfacilities have and are currently operating above the contracted capacity. As aresult, average contract occupancy percentages can exceed 100% if the averageactual occupancy exceeded contracted capacity.

**(8)**                    Service capacity for non-residential programs is based on either contractualterms or an estimate of the number of clients to be served. We update theseestimates at least annually based on the program’s budget and other factors.

(9)                    Data presented excludesdiscontinued operating facilities.

 

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| **ITEM 7.**

  | **MANAGEMENT’S DISCUSSION AND  ANALYSIS OF FINANCIAL CONDITION****AND  RESULTS OF OPERATIONS** |
|---------------------|-----------------------------------------------------------------------------------------------------|

 

**Generalzz**

 

Cornell is a leading provider of correctional,detention, educational, rehabilitation and treatment services outsourced byfederal, state and local government agencies. We provide a diversifiedportfolio of services for adults and juveniles through our three operatingdivisions: (1) Adult Secure Services; (2) Abraxas Youth and FamilyServices; and (3) Adult Community-Based Services. At December 31,2008, we operated 68 facilities with a total service capacity of 19,875 and had onefacility with a service capacity of 70 beds that was vacant. Our facilitiesare located in 15 states and the District of Columbia.

 

Thefollowing table (which excludes data related to discontinued operatingfacilities) sets forth for the periods indicated total residential servicecapacity and contracted beds in operation at the end of the periods shown,average contract occupancy percentages and total non-residential servicecapacity.

 
| ** **                                                                              | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                              | ** ** | **2008**                         | ** ** | **2007** | ** ** | **2006** | ** ** |
| **Residential**                                                                         |       |                             |       |   |   |   |   |
| Service capacity (1) (2)                                                           |       | 17,592                           |       | 15,634 |   | 14,659 |   |
| Contracted beds in operation (end of period) (1) (3)                               |       | 16,821                           |       | 14,211 |   | 13,492 |   |
| Average contract occupancy based on contracted beds in operation  (1) (4) (5) |       | 92.0                             | %          | 99.6 | % | 97.5 | % |
| Average contract occupancy excluding start-up operations  (1) (4) (5)         |       | 92.0                             | %          | 99.6 | % | 97.5 | % |
| **Non-Residential**                                                                     |       |                             |       |   |   |   |   |
| Service capacity (1) (6)                                                           |       | 2,353                            |       | 2,953 |   | 3,921 |   |

 

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(1)                    Data presented excludesdiscontinued operating facilities.

(2)                    Residential service capacity is comprisedof the number of beds currently available for service in our residentialfacilities.

(3)                   At certain residential facilities, thecontracted capacity is lower than the facility’s service capacity. We couldincrease a facility’s contracted capacity by obtaining additional contracts orby renegotiating existing contracts to increase the number of beds covered.However, there is no guarantee that we will be able to obtain contracts thatprovide occupancy levels at a facility’s service capacity or that currentcontracted capacities can be maintained in future periods.

(4)                   Occupancy percentages reflect less thannormalized occupancy during the start-up phase of any applicable facility,resulting in a lower average occupancy in periods when we have substantialstart-up activities.

(5)                   Average contract occupancy percentagesare calculated based on actual occupancy for the period as a percentage of thecontracted capacity for residential facilities in operation. These percentagesdo not reflect the operations of non-residential community-based programs. Atcertain residential facilities, our contracted capacity is lower than thefacility’s service capacity. Additionally, certain facilities have and arecurrently operating above the contracted capacity. As a result, averagecontract occupancy percentages can exceed 100% if the average actual occupancyexceeded contracted capacity.

(6)                   Service capacity for non-residentialprograms is based on either contractual terms or an estimate of the number ofclients to be served. We update these estimates at least annually based on theprogram’s budget and other factors.

 

Our operating results for 2008 were significantlyimpacted by a few major events.  Wecompleted and activated expansions at several facilities including the D. RayJames Prison (300 beds in February 2008), the Great Plains CorrectionalFacility (1,100 beds in September 2008) and the Walnut Grove YouthCorrectional Facility (500 beds in September 2008). We also began anadditional 700 bed expansion at D. Ray James Prison and started construction ona new 1,250 bed facility in Hudson, Colorado. Our 2008 results of operationswere positively affected by a $1.5 million contract-based revenue adjustmentrecorded in March 2008 related to the Regional Correctional Center and a$1.55 million legal settlement (against which we incurred approximately $0.2million in expenses in 2008) we received relating to a lawsuit we had broughtagainst certain parties with regard to the operation of the Cornell AbraxasAcademy facility (see “—Significant 2008 Events”).

 

Our operating results for 2007 were significantlyimpacted by a few major events. At our Great Plains Correctional Facility inHinton, Oklahoma, we transitioned from our operating contract with the OklahomaDepartment of Corrections (“OK DOC”) to our new contract with the ArizonaDepartment of Corrections. During the marketing and transition phases, thatfacility was idle from April 2007 to September 2007, when the currentinmate ramp began. We also began expansions at several facilities including theBig Spring Correctional Facility, the D. Ray James Prison and the Great PlainsCorrectional Facility. Our 2007 results of operations were also negativelyimpacted by a reduction of Immigration and Customs 

 

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Enforcement(“ICE”) detainees at our Regional Correctional Center (“RCC”) and positivelyaffected by a $1.85 million legal settlement (against which we incurredapproximately $0.4 million in expenses in 2007) we received relating to legalrepresentation provided to us in connection with the Southern Peaks RegionalTreatment Center.

 

Although we believe we will continue to see steadydemand across our various business segments and our customer base (federal,state and local) in 2009, we are monitoring the declining economic trends andrelated government budget plans and the effect tightened spending plans couldhave on our business. We expect a key driver for our performance in 2009 to beour ability to manage our various facility expansions currently in process andbring them on line. We also plan to remain focused on our operating margins, onincreasing utilization (particularly in the Abraxas division) and improvingcustomer mix as we believe those initiatives are key elements of our financialperformance.

 

# **Management Overview**

# ** **

***Demand*****.** Our business is driven generally by demand for incarceration ortreatment services, and specifically by demand for private incarceration ortreatment services, within our three primary business segments: Adult SecureServices; Abraxas Youth and Family Services; and Adult Community-BasedServices. The demand for adult and juvenile corrections and treatment serviceshas generally increased at a steady rate over the past ten years, largely as aresult of increasing sentence terms and/or mandatory sentences for criminalsand as well a greater range of criminal acts, increasing demand forincarceration of illegal aliens and a public recognition of the need to provideservices to juveniles that will improve the possibility that they will leadproductive lives. Moreover, demand for our services is also affected by theamount of available capacity in the government systems to enable governments toprovide the services themselves, as well as desire and ability of these systemsto add additional capacity. In addition, the balance between community-basedcorrections treatment of adults as an alternative to traditional incarcerationcontinues to be analyzed by many political and societal parties.  Among other things, we monitor federal, stateand industry communications and statistics relative to trends in prisonpopulations, juvenile justice statistics and initiatives, and developments inalternatives to traditional incarceration or detention of adults foropportunities to expand our scope or delivery of services.

 

Thefederal government contracts with private providers for the incarceration ofadults, whether they are serving prison sentences, detained as illegal aliens,detained in anticipation of pending judicial administration or transitioningfrom prison to society.  Chief among thefederal agencies which use private providers are the BOP, U.S. Immigration andCustoms Enforcement (“ICE”) and USMS. We provide adult secure and adultcommunity-based services to the federal government. Most of the federalinvolvement in juvenile administration in the federal system is handled viaMedicare and Medicaid assistance to state governments. Although there arecircumstances in which we may contract with a federal agency on a sole sourcebasis, the primary means by which we secure a contract with a federal agency isvia the RFP bidding process.  From timeto time, we contract to provide management services to a local governmentalunit who then bids on a federal contract.

 

Statesand smaller governmental units remain divided on the issue of private prisonsand private provision of juvenile and community-based programs, although amajority of states permit private provision for our services.  We anticipate that increasing budget pressureon states and smaller governmental units may cause more states and smallergovernmental units to consider utilizing private providers such as us toprovide these services on a more economical basis. We believe capital budgetconstraints among prison agencies may encourage them to continue to exploreoutsourcing to private operators as an alternative to deploying their owncapital for prison construction or major refurbishment. Although it varies fromgovernmental unit to governmental unit, the primary political forces whotypically oppose privatization of prisons are organized labor and religiousgroups.

 

Privatejuvenile and community-based programs are utilized by states and localgovernmental units and are organized on a profit and not-for-profit basis.  We monitor opportunities in these segments viaour corporate and business division development officials.  Many opportunities are not published in anymanner and, accordingly, we believe that taking the initiative at the state andlocal levels is key in developing sole source opportunities.

 

***Performance*****.** We track a number of factors as we monitor financial performance.  Chief among them are:

 

·        capacity (the number of bedswithin each business segment’s facilities),

·        occupancy (utilization),

·        per diem reimbursementrates,

·        revenues,

·        operating margins, and

·        operating expenses.

 

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*Capacity. *Capacity, commonly expressed in terms ofnumber of beds, is primarily impacted by the number and size of the facilitieswe own or lease and the facilities we operate on behalf of a third party owneror lessee.  We view capacity as one ofthe measures of our development efforts, through which we may increase capacityby adding new projects or by expanding existing projects (as we have done in2007 and 2008 at several of our facilities including Great Plains CorrectionalFacility and D. Ray James Prison).  Aspart of the evaluation of our development efforts, we will assess (a) whethera given development project was brought into service in accordance with ourexpectation as to time and expense; and (b) the number of projects indevelopment or under consideration at the relevant point in time.  In addition to the focus on new projects,capacity will reflect our success in renewing and maintaining existingcontracts and facilities.  It will alsoreflect any closure of programs or facilities due to underutilization orfailure to earn an adequate risk-adjusted rate of return.  We must also be cognizant of the possibilitythat state or local budgetary limitations may cause the contractual commitmentto a given facility to be reduced or even eliminated, which would require us toeither secure an alternate customer or close the operation.

 

*Occupancy. *Occupancy is typically expressed in termsof percentage of contract capacity utilized. We look at occupancy to assess the efficacy of both our efforts tomarket our facilities and our efforts to retain existing customers orcontracts.  Because revenue variesdirectly with occupancy, occupancy is a driver of our revenues. Our industryexperiences significant economics of scale, whereby as occupancy rises,operating costs per resident decline. Some of our contracts are “take-or-pay,”meaning that the agency making use of the facility is obligated to pay for bedseven though they are not used. Historically, occupancy percentages in many of our facilities have beenhigh and we are mindful of the need to maintain such occupancy levels.  As new development projects are brought intoservice, occupancy percentages may decline until the projects reach fullutilization (as, for example, with the activation of the 1,100 bed expansion atGreat Plains Correctional Facility during the fourth quarter of 2008). Where wehave commitments for utilization before the commencement of operations, occupancypercentages reflect the speed at which a facility achieves fullservice/implementation. However, we may decide to undertake developmentprojects without written commitments to make full use of a facility. In theseinstances, we have performed our own assessment, based on discussions withlocal government or other potential customer representatives and analysis ofother factors, of the demand for services at the facility.  There is no assurance that we would recoverour initial investment in these projects. We will monitor occupancy as a measure of the accuracy of our estimationof the demand for the services of a development facility, and will incorporatethis information in future assessments of potential projects.

 

*Per Diem ReimbursementRates. *Per diem reimbursement rates are another key elementof our gross revenue and operating margin since per diem contracts represent amajority of our revenues (54.0% for the year ended December 31,2008).  Per diem rates are a function ofnegotiation between management and a governmental unit at the inception of acontract or through the bidding process. Actual per diem rates vary dramatically across our business segments,and as well as within each business segment depending upon the particularservice or program provided. The initial per diem rates often change during theterm of a contract in accordance with a schedule.  The amount of the change can be a fixedamount set forth within the contract, an amount determined by formulas setforth within the contract or an amount determined by negotiations betweenmanagement and the governmental unit (often these negotiations are along thesame lines as the original per diem negotiation — a review of expenses andapproval of an amount to recompense for expenses and assure the potential of anoperating profit).  In recent years, asbudgetary pressures on governmental units have increased, some of our customershave negotiated relief from formulaic increase provisions within their agreementsor have declined to include in their appropriation legislation amounts thatwould increase the per diem rates payable under the contract. Based on theeconomic turmoil which began in the second half of 2008, we are expecting suchpressures to continue in 2009 for many of our customers. In similar priorsituations we have attempted to mitigate the impact of these developments bynegotiating services provided, obtaining commitments for increased volume andother measures.  We may also choose toconsider terminating an existing relationship at a given facility and replacingit with a new customer (as was done with the Great Plains Correctional Facilityin 2007).

 

*Revenues. *We derivesubstantially all of our revenues from providing adult corrections andtreatment and juvenile justice, educational and treatment services outsourcedby federal, state and local government agencies in the United States. Revenuesfor our services are generally recognized on a per diem rate based upon thenumber of occupant days or hours served for the period, on a guaranteedtake-or-pay basis or on a cost-plus reimbursement basis. For the year ended December 31,2008, our revenue base consisted of 54.0% for services provided under per diemcontracts, 40.0% for services provided under take-or-pay and management contracts,3.8% for services provided under cost-plus reimbursement contracts, 2.0% forservices provided under fee-for-service contracts and 0.2% from othermiscellaneous sources.  For the yearended December 31, 2007, our revenue base consisted of 74.3% for servicesprovided under per diem contracts, 18.6% for services provided undertake-or-pay and management contracts, 4.7% for services provided undercost-plus reimbursement contracts, 2.1% for services provided underfee-for-service contracts and 0.3% from other miscellaneous sources.  The increase in the percentage of revenuesprovided under take-or-pay and management contracts for 2008 was due primarilyto the take-or-pay contract 

 

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awardedby the BOP to our Big Spring Correctional Center in 2007 and the 916 inmatetake-or-pay contract awarded by the Arizona Department of Corrections at ourGreat Plains Correctional Facility under which we began operations in September 2007.  The increase in the percentage of revenuesprovided under take-or-pay contracts was partially offset by 1) the transitionof certain of our management contracts including the Donald W. Wyatt DetentionCenter (in July 2007) to the facility owner and 2) the termination of ourmanagement contract for the Harrisburg Alternative Education School Program forthe 2007-2008 school year (due to lack of funding by the contractingagency).  The decrease in the percentageof revenues provided under per diem contracts in 2008 as compared to the prioryear was due primarily to the transition of the contracts at the Great PlainsCorrectional Facility and the Big Spring Correctional Center as previouslynoted.  This decrease was partiallyoffset by the addition of the High Plains Correctional Facility acquired in May 2007.

 

Revenues can fluctuate fromyear to year due to changes in government funding policies, changes in thenumber or types of clients referred to our facilities by governmental agencies,changes in the types of services delivered to our customers, the opening of newfacilities or the expansion of existing facilities and the termination ofcontracts for a facility or the closure of a facility.

 

Factorsconsidered in determining billing rates to charge include: (1) theprograms specified by the contract and the related staffing levels; (2) wagelevels customary in the respective geographic areas; (3) whether theproposed facility is to be leased or purchased; and (4) the anticipatedaverage occupancy levels that could reasonably be expected to be maintained andthe duration of time required to reach such occupancy levels.

 

*Revenues-Adult Secure Services. *Revenues for our Adult Secure Servicesdivision are primarily generated from per diem, take-or-pay and managementcontracts.  For the years ended December 31,2008, 2007 and 2006, we realized average per diem rates on our adult securefacilities of approximately $54.07, $54.69 and $56.12, respectively. Thedecrease in the 2007 rate is due primarily to the increase in occupancy at theMoshannon Valley Correctional Center during 2007 over the prior year. Thisfacility operates under a take-or-pay contract; as a result, the effectiveaverage per diem rate will decrease as the population at the facilityincreases.  The 2006 average per diemrate also benefited from the receipt of a contract-based revenue adjustment forthe contract year ended March 2006 in the amount of $2.4 million at theRCC. We periodically have experienced pressure from contracting governmentalagencies to limit or even reduce per diem rates. Many of these governmentalentities are under severe budget pressures and we anticipate that governmentalagencies may periodically approach us about per diem rate concessions (ordecline to provide funding for contractual rate increases).  Decreases in, or the lack of anticipatedincreases in, per diem rates could adversely impact our operating margin.

 

*Revenues-Abraxas Youth and Family Services. *Revenues for our Abraxas Youth and FamilyServices division are primarily generated from per diem, fee-for-service andcost-plus reimbursement contracts.  Forthe years ended December 31, 2008, 2007 and 2006, we realized average perdiem rates on our residential youth and family services facilities ofapproximately $192.15, $174.93 and $170.33, respectively. The increase in theaverage per diem rate for 2008 reflects the continued ramp-up of the CornellAbraxas Academy (reactivated in the fourth quarter of 2006), the reactivationof the Hector Garza Residential Treatment Center in August 2007 as well aschanges in the mix of services provided and customers served at otherfacilities.  For the years ended December 31,2008, 2007 and 2006, we realized average fee-for-service rates for ournon-residential community-based Abraxas Youth and Family Services facilitiesand programs, including rates that are limited by Medicaid and other privateinsurance providers, of approximately $48.28, $44.35 and $37.59, respectively.The increase in the average fee-for-service rates for 2008 and 2007 is due tochanges in the mix of services provided at our non-residential facilities. Themajority of our Abraxas Youth and Family Services contracts renew annually.

 

*Revenues-Adult Community-Based Services. *Revenues for our Adult Community-Based Servicesdivision are primarily generated from per diem and fee-for-service contracts.For the years ended December 31, 2008, 2007 and 2006, we realized averageper diem rates on our residential adult community-based facilities ofapproximately $68.47, $62.91 and $61.71, respectively. For the years ended December 31,2008, 2007 and 2006, we realized average fee-for-service rates on ournon-residential Adult Community-Based Services facilities and programs ofapproximately $11.00, $13.70 and $11.23, respectively.  Our average fee-for-service rates fluctuatefrom year to year principally due to changes in the mix of services provided byour various Adult Community-Based Services programs and facilities.

 

*Operating Margins. *We have historically experienced higheroperating margins in our Adult Secure Services and Adult Community-BasedServices divisions as compared to our Abraxas Youth and Family Servicesdivision. Our operating margin, in a given period, will be impacted by thosefacilities which may either be dormant or have been reactivated during theperiod. As previously discussed, we have reactivated several facilities,including the Cornell Abraxas Academy and the Hector Garza Residential TreatmentCenter in 2006 and 2007, respectively. We have also expanded several of ourAdult Secure facilities (D. Ray James Prison, Great Plains CorrectionalFacility and Walnut Grove Youth Correctional Facility, for example), whichprovides the opportunity to leverage existing infrastructure. Additionally, ouroperating margins within a 

 

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division can vary from facility to facilitybased on whether a facility is owned or leased, the level of competition forthe contract award, the proposed length of the contract, the mix of servicesprovided, the occupancy levels for a facility, the level of capital commitmentrequired with respect to a facility, the anticipated changes in operating costsover the term of the contract and our ability to increase a facility’s contractrevenue. Under take-or-pay contracts, such as the contract at the MoshannonValley Correctional Center, operating margins are typically higher during theearly stages of the contract as the facility’s population ramps up (as revenuesare received at contract percentages regardless of actual occupancy). As thevariable costs (primarily resident-related and certain facility costs) increasewith the growth in population, operating margins will generally decline to astabilized level. Following its activation in April 2006, we experiencedsuch operating margin impact pertaining to the Moshannon Valley CorrectionalCenter in the third and fourth quarters of 2006. A decline in occupancy at ourAbraxas Youth and Family Services facilities can have a more significant impacton operating margins than our Adult Secure Services division due to the longerperiods typically required to ramp resident population at a youth facility.

 

Wehave experienced and expect to continue to experience interim period operatingmargin fluctuations due to factors such as the number of calendar days in theperiod, higher payroll taxes (generally in the first half of the year) andsalary and wage increases and insurance cost increases that are incurred priorto certain contract rate increases. Periodically, many of the governmentalagencies with whom we contract may experience budgetary pressures and mayapproach us to limit or reduce per diem rates (including contractual priceincreases as well). We anticipate such customer behavior in 2009. Decreases in,or the lack of anticipated increases in, per diem rates could adversely impactour operating margin. Additionally, a decrease in per diem rates without acorresponding decrease in operating expenses could also adversely impact ouroperating margin.

 

*Operating Expenses. *Wetrack several different areas of our operating expenses.  Foremost among these expenses are employeecompensation and benefits and expenses, risk related areas such as generalliability, medical and worker’s compensation, client/inmate costs such as food,clothing, medical and programming costs, financing costs and administrativeoverhead expenses. Increases or decreases in one or more of these expenses,such as our experience with rising insurance costs, can have a material effecton our financial performance.  Operatingexpenses are also impacted by decisions to close or terminate a particularprogram or facility.  Such decisions arebased on our assessments of operating results, operating efficiency andrisk-adjusted returns and are an ongoing part of our portfolio management.  In addition, decisions to restructureemployee positions will typically increase period costs initially (at the timeof such actions), but generally reduce post-restructuring expense levels.

 

Weare responsible for all facility operating costs, except for certain debtservice and interest or lease payments for facilities where we have amanagement contract only. At these facilities, the facility owner isresponsible for all debt service and interest or lease payments related to thefacility. We are responsible for all other operating expenses at these facilities.We operated 14 facilities under management contracts at December 31, 2008,15 facilities at December 31, 2007 and 18 facilities at December 31,2006. Included in the 14 facilities under management contracts at December 31,2008 were the Walnut Grove Youth Correctional Facility and the eight LosAngeles County Jails, which represented 1,714 beds of service capacity, orapproximately 83% of the residential service capacity represented by managementcontracts.

 

Amajority of our facility operating costs consists of fixed costs. These fixedcosts include lease and rental expense, insurance, utilities anddepreciation.  As a result, when wecommence operation of new or expanded facilities, fixed operating costs mayincrease. The amount of our variable operating costs, including food, medicalservices, supplies and clothing, depend on occupancy levels at the facilities.Our largest single operating cost, facility payroll expense and relatedemployment taxes and expenses, has both a fixed and a variable component. Wecan adjust a facility’s staffing levels and the related payroll expense to acertain extent based on occupancy at a facility; however a minimum fixed numberof employees is required to operate and maintain any facility regardless ofoccupancy levels. Personnel costs are subject to increases in tightening labormarkets based on local economic environments and other conditions.

 

Weincur pre-opening and start-up expenses including payroll, benefits, trainingand other operating costs prior to opening a new or expanded facility andduring the period of operation while occupancy is ramping up. These costs varyby contract (and the pace/scale of the activation and related population ramp).Since pre-opening and start-up costs are generally factored into the revenueper diem rate that is charged to the contracting agency, we typically expect torecover these upfront costs over the life of the contract. Because occupancyrates during a facility’s start-up phase typically result in capacityunder-utilization for at least 90 to 180 days, we may incur additionalpost-opening start-up costs. We do not anticipate post-opening start-up costsat any adult secure facilities operated under any future contracts with the BOPwhich are take-or-pay contracts, meaning that the BOP will pay at least 80.0%of the contractual monthly revenue once the facility opens, regardless ofactual occupancy.

 

Newlyopened facilities are staffed according to applicable regulatory or contractualrequirements when we begin receiving offenders or clients. Offenders or clientsare typically assigned to a newly opened facility on a phased-in basis over aone- to six-month period. Our start-up period for new juvenile operations is 12months from the date we begin recognizing revenue unless break-even occupancylevels are achieved before then. The actual time required to ramp a juvenilefacility (with approximate capacity of 100 to 200 beds) may be a period of oneto three years. Our start-up period for new adult operations is nine months fromthe date we begin recognizing revenue unless break-even occupancy levels areachieved before then.  The approximatetime to ramp an adult facility of approximately 1,000 beds may be a period ofthree to six months, depending upon the customer requirements.  Although 

 

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we typically recover these upfront costs overthe life of the contract, quarterly results can be substantially affected bythe timing of the commencement of operations as well as the development andconstruction of new facilities.

 

Workingcapital requirements generally increase immediately prior to commencingmanagement of a new or expanded facility as we incur start-up costs andpurchase necessary equipment and supplies before facility management revenue isrealized.

 

Generaland administrative expenses consist primarily of costs for corporate andadministrative personnel who provide senior management, legal, finance,accounting, human resources, investor relations, payroll and informationsystems, costs of business development and outside professional and consultingfees.

 

#### **Significant2008 Events**

####  

***D. Ray James Prison***

 

InFebruary 2008, we completed the initial expansion of the D. Ray JamesPrison in Georgia to increase its service capacity by approximately 300 beds toa total service capacity of 2,170 beds.

 

InAugust 2007, we announced that we were initiating a second expansion ofthe D. Ray James Prison. This expansion project will increase the facility’sservice capacity by an additional 700 beds for a total service capacity ofapproximately 2,800 beds. This expansion project began in the first quarter of2008 and is expected to be completed by the end of the first quarter of 2009.We are marketing this additional expansion to multiple customers but  believe those beds are well suited for aGeorgia Department of Corrections (“Georgia DOC”) bid that requires expansionof an existing Georgia DOC-contracted facility. We can make no assurance thatwe will be awarded  this contract. Wecurrently estimate that the capital expenditures related to this expansionproject will be approximately $34.7 million.  As of December 31,2008, we had incurred and capitalized total costs (including interest) ofapproximately $33.9 million related to this expansion. We believe that ourexisting cash flow and available balance under our Amended Credit Facility willprovide adequate funding to complete this facility expansion.

 

***Great Plains Correctional Facility***

 

InMay 2007, we were awarded a contract by the Arizona Department ofCorrections (“Arizona DOC”) for our Great Plains Correctional Facility inHinton, Oklahoma. The contract calls for a total of 2,000 medium-securityinmates to be housed at the facility. We initially housed approximately 916inmates and the remainder was housed through the expansion of the existingfacility which was completed in the fourth quarter of 2008. As of December 31,2008 the ramp-up to approximately 2,000 inmates was complete.

 

***Hudson, Colorado***

 

InAugust 2008, we entered into an agreement pursuant to which we will lease a new1,250 male bed adult secure facility in Hudson, Colorado. The facility is ownedby a third party and is being built on land we sold to the third party. Weretained approximately 270 acres out of the original 320 acres we acquired in2007. We anticipate the construction, which began in the third quarter of 2008,to be completed in late 2009. We have signed an implementation agreement withthe Colorado Department of Corrections (“Colorado DOC”), which governs theconstruction of the facility and contemplates a service agreement which can beentered into upon completion of the implementation agreement.  We wouldexpect to begin receiving inmates upon the activation of the facility.  Weexpect to enter into a service agreement for the facility with the Colorado DOCbut can make no assurances that we will do so (or what the possible timingmight be).

 

***Hurricane Ike***

 

HurricaneIke, which came ashore in Texas in September 2008, damaged our BeaumontTransitional Treatment Center, Leidel Comprehensive Sanction Center and ReidCommunity Residential Facility. These damages are covered by our insurance,subject to normal deductibles, for which we recorded a charge of approximately$0.5 million in the year ended December 31, 2008. The Leidel facility wasable to continue near normal operations. The Beaumont facility reopened in mid-October 2008at near normal capacity. The Reid facility reopened in mid-October 2008 atapproximately 40 percent of its previous capacity of approximately 500. Webelieve the remainder of the operating capacity will be operational in thefirst quarter 2009. Reid generated revenues of approximately $4.9 million and$5.4 million in the years ended December 31, 2008 and 2007, respectively.

 

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***Regional Correctional Center***

 

TheOffice of Federal Detention Trustee (“OFDT”) holds the contract for use of theRegional Correctional Center on behalf of ICE, USMS and the BOP with BernalilloCounty through an intergovernmental services agreement, and we have anoperating and management agreement with Bernalillo County.  In August 2007, the Bureau ofImmigration and Customs Enforcement (“ICE”) removed all ICE detainees from theRegional Correctional Center in Albuquerque, New Mexico. ICE informed us in February 2008that it would not resume use of the facility.  The facility is still beingutilized by the USMS, and since May 2008 by the BOP, but not at its fullcapacity. In February 2008, the OFDT, attempted to unilaterally amend itsagreement to reduce the number of minimum annual guaranteed mandays under theagreement from 182,500 to 66,300.  Neither we nor Bernalillo County believe OFDThas the right to unilaterally amend the contract in this manner, and OFDT hasbeen informed of our position. Although either party to the intergovernmentalservices agreement has the right to terminate upon 180 days notice, neither partyhas exercised such right as of December 31, 2008.  Refer to “Results of Operations — Liquidityand Capital Resources - Contractual Uncertainties Related to Certain Facilities- Regional Correctional Center” for more information concerning this andother developments concerning the Regional Correctional Center. We recorded acontract-based revenue adjustment (in March 2008) of approximately $1.5million for the contract year ended March 2008, for which the relatedreceivable is carried in accounts receivable — trade at December 31,2008.

 

***Walnut Grove Youth CorrectionalFacility***

 

InAugust 2007, we were notified by the State of Mississippi that funding hadbeen approved for a 500 bed expansion of the 941 bed Walnut Grove YouthCorrectional Facility that we have been managing since 2004. Expansion of thefacility, which was entirely funded by the State of Mississippi, began in thethird quarter of 2007 and was completed and became operational in the thirdquarter of 2008.

 

***Settlement of Claim***

 

OnDecember 12, 2008, we settled a lawsuit the Company had filed in theUnited States District Court for the Eastern District of Pennsylvania againstthe Borough of New Morgan (the “Borough”), New Morgan Borough Council andcertain individual council members. The lawsuit involved the operation ofthe Company’s Abraxas Academy in New Morgan, Pennsylvania and a sewagetreatment facility that is owned by the Borough.

 

Inconnection with the settlement, all claims have been terminated and finallysettled, including those concerning the operation and occupancy of the facilityand the sewage treatment plant. Neither party has admitted liability forany claim or contention made by the other party. The Company received $1.55million from the Borough and agreed to pay the Borough unpaid sewage treatmentbills in the amount of $0.2 million through September 30, 2008.  The $1.55 million settlement is reflected inoperating expenses in the accompanying financial statements.

 

**Critical Accounting Policies and Estimates**

 

The preparation of our financial statements inconformity with GAAP requires management to make certain estimates andassumptions. These estimates and assumptions affect the reported amounts ofassets and liabilities, the disclosures of contingent assets and liabilities atthe balance sheet date and the amounts of revenues and expenses recognizedduring the reporting period. We analyze our estimates based on our historicalexperience and various other assumptions that we believe to be reasonable underthe circumstances. However, actual results could differ from such estimates.The following is a discussion of our critical accounting estimates. Managementconsiders an accounting estimate to be critical if:

 

·                     it requiresassumptions to be made that were uncertain at the time the estimate was made;and

·                  changes in the estimate ordifferent estimates that could have been selected could have a material impacton our consolidated financial position or results of operations.

 

For a summary of all of our significant accountingpolicies see “Note 2-Significant Accounting Policies” of the “Notes to   Consolidated Financial Statements” in Item 8of this Form 10-K.

 

***Revenue Recognition***

 

Substantiallyall of our revenues are derived from contracts with federal, state and localgovernmental agencies which pay either per diem rates based upon the number ofoccupant days or hours served for the period, on a take-or-pay basis,management fee basis, cost-plus reimbursement or fee-for-service basis.  Revenues are recognized as services areprovided under our established contractual agreements to the extent collectionis considered probable.

 

***Accounts Receivable and Related Allowancefor Doubtful Accounts***

 

Weextend credit to the governmental agencies contracted with and other parties inthe normal course of business.  Weregularly review our outstanding receivables and historical collectionexperience and provide for estimated losses through an allowance for doubtfulaccounts. In evaluating the adequacy of our allowance for doubtful accounts, wemake judgments regarding our customers’ ability to make required payments,economic events and other factors.  Asthe financial condition of 

 

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theseparties change, circumstances develop or additional information becomesavailable, adjustments to the allowance for doubtful accounts may occur. If,after reasonable collection efforts have been made, a receivable is determinedto be permanently uncollectible, it is written off.

 

***Insurance Reserves***

 

Wemaintain insurance coverage for various aspects of our business andoperations.  We retain a portion oflosses that occur through the use of deductibles and retention underself-insurance programs.  We regularlyreview our estimates of reported and unreported claims and provide for theselosses through insurance reserves. These reserves are influenced by risingcosts of health care and other costs, increases in claims, time lags in claimsinformation and levels of insurance coverage carried. As claims develop andadditional information becomes available to us, adjustments to the related lossreserves may occur.  Our reserves formedical and worker’s compensation claims are subject to change based on ourestimate of the number and the magnitude of claims to be incurred.

 

***Impairment or Disposal of Long-Lived Assets***

 

Wereview our long-lived assets for impairment at least annually or when changesin circumstances or a triggering event indicates that the carrying amount ofthe asset may not be recoverable in accordance with the provisions of SFAS No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets.”  SFAS No. 144 requires that long-livedassets to be held and used recognize an impairment loss only if the carryingamount of the long-lived asset is not recoverable.  Long-lived assets to be held and used are tobe reported at the lower of their carrying amount or fair value.  Assets to be disposed of by sale are recordedat the lower of their carrying amount or fair value less estimated sellingcosts. We estimate fair value based upon the best information available, whichmay include expected future discounted cash flows to be produced by the assetand/or available market prices. Factors that significantly influence estimatedfuture discounted cash flows include the periods and levels of occupancy forthe facility, expected per diem or reimbursement rates, assumptions regardingthe levels of staffing, services and future operating and capital expendituresnecessary to generate forecasted revenues, related costs for these activitiesand future rate of increases or decreases associated with these factors. Wealso consider the results of any appraisals on the properties when assessingfair value. These estimates may be highly subjective, particularly incircumstances where there is no current operating contract in place and changesin the assumptions and estimates could result in the recognition of impairmentcharges. The most subjective estimates made in this analysis for 2008 relate toCornell Abraxas 1, the Regional Correctional Center and the Hector GarzaResidential Treatment Center. The most subjective estimates made in thisanalysis for 2007 relate to the Regional Correctional Center and the HectorGarza Residential Treatment Center. We may be required to record an impairmentcharge in the future if we are unable to successfully negotiate a replacementcontract on any of our facilities for which we currently have an operatingcontract.

 

***Goodwill and Intangible Assets***

 

Weaccount for goodwill in accordance with the provisions of SFAS No. 142, “Goodwilland Other Intangible Assets,” which states that there is no amortization ofgoodwill or intangible assets with indefinite lives.  Impairment of these assets is assessedannually to determine if the estimated fair value of the reporting unit exceedsthe net carrying value of the reporting unit, including the applicablegoodwill.  The estimates of fair value arebased upon our estimates of the present value of future cash flows.  We make assumptions regarding the estimatedcash flows and if these estimates or their related assumptions change, animpairment charge may be incurred.

 

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** **

**Resultsof Operations**

 

Material fluctuations inour results of operations are principally the result of the level of newcontract development activity, the timing and effect of facility expansions,occupancy or contract rates, contract renewals or terminations and facilityclosures and non-recurring charges.

 

The following table sets forth for the periodsindicated the percentages of revenue represented by certain items in ourConsolidated Statements of Income and Comprehensive Income (Loss).

 
| ** **                                                          | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                          | ** ** | **2008**                         | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                                          | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues                                                            |       | 100.0                            | %          | 100.0 | % | 100.0 | % |
|                                                                |       |                             |       |   |   |   |   |
| Operating expenses                                                  |       | 72.6                             |       | 76.0 |   | 76.4 |   |
| Pre-opening and start-up expenses                                   |       | 3⁄4                           |       | 3⁄4 |   | 0.7 |   |
| Depreciation and amortization                                       |       | 4.6                              |       | 4.4 |   | 4.5 |   |
| General and administrative expenses                                 |       | 6.7                              |       | 7.1 |   | 6.0 |   |
| Income from operations                                              |       | 16.1                             |       | 12.5 |   | 12.4 |   |
| Interest expense, net                                               |       | 6.2                              |       | 6.7 |   | 6.4 |   |
| Income from continuing operations before provision for income taxes |       | 9.9                              |       | 5.8 |   | 6.0 |   |
| Provision for income taxes                                          |       | 4.0                              |       | 2.5 |   | 2.5 |   |
| Income from continuing operations                                   |       | 5.9                              |       | 3.3 |   | 3.5 |   |
| Minority interest in consolidated special purpose entity            |       | 0.2                              |       |   |   |   |   |
| Discontinued operations, net of taxes                               |       | 3⁄4                           |       | 3⁄4 |   | (0.2 | ) |
| Net income                                                          |       | 5.7                              | %          | 3.3 | % | 3.3 | % |

*** ***

***YearEnded December 31, 2008 Compared to Year Ended December 31, 2007***

*** ***

***Revenues*****.**  Revenues increasedapproximately $26.1 million, or 7.2%, to $386.7 million for the year ended December 31,2008 from $360.6 million for the year ended December 31, 2007.

 

*Adult Secure Services.** ***Adult SecureServices revenues increased approximately $26.1 million, or 14.2%, to $209.3million for the year ended December 31, 2008 from $183.2 million for theyear ended December 31, 2007 due primarily to (1) an increase inrevenues of $17.6 million at the Great Plains Correctional Facility which beganoperating under a contract with the Arizona DOC in September 2007 (thisfacility was vacant from April through August 2007) as well asincreased occupancy as a result of a facility expansion completed in September 2008,(2) an increase in revenues of $10.1 million at the Big SpringCorrectional Center due to increased occupancy resulting from a facilityexpansion completed in November 2007 related to the take-or-pay contractawarded to us by the BOP in 2007, (3) an increase in revenues of $4.8million at the D. Ray James Prison due to a facility expansion completed in February 2008,(4) an increase in revenues of $2.0 million at the High PlainsCorrectional Facility which we acquired in May 2007 and (5) anincrease in revenues of $1.2 million at the Walnut Grove Youth CorrectionalFacility due to a facility expansion completed in September 2008.  The increase in revenues due to the above wasoffset, in part, by (1) a decrease in revenues of $8.0 million at theDonald W. Wyatt Detention Center due to the transition of our managementcontract to the facility’s owner in July 2007 and (2) a decrease inrevenues of approximately $2.9 million at the Regional Correctional Center dueto the withdrawal of all ICE inmates as of August 2007 (revenues for 2008include a $1.5 million contract-based revenue adjustment for the contract yearended March 25, 2008).  Theremaining net increase in revenues of approximately $1.3 million was due tofluctuations in revenues at our other adult secure facilities.

 

Averagecontract occupancy was 91.8% for the year ended December 31, 2008 comparedto 100.4% for the year ended December 31, 2007. The decrease in theaverage contract occupancy is primarily due to the additional capacity ofapproximately 1,600 beds brought into operations in September 2008 (at theGreat Plains Correctional Facility and Walnut Grove Youth CorrectionalFacility), which we began ramping during the fourth quarter of 2008. The average per diem rate was $54.07 forthe year ended December 31, 2008 compared to $54.69 for the year ended December 31,2007.

 

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*Abraxas Youth and Family Services*. Abraxas Youth and Family Services revenues decreased approximately $2.0million, or 1.9%, to $107.3 million for the year ended December 31, 2008from $109.3 million for the year ended December 31, 2007 due primarily to (1) a decrease in revenues of $5.1 million at the Cornell Abraxas I facility (“A-1”)due to decreased occupancy, (2) a decrease in revenues of $1.6 million atthe Texas Adolescent Treatment Center (“TATC”) due to decreased occupancy, (3) adecrease in revenues of $1.8 million due to the termination of our managementcontract for the Harrisburg Alternative Education School Program for the2007-2008 school year (due to lack of funding by the contracting agency), (4) adecrease in revenues of $1.3 million due to the termination of our managementcontract for the Salt Lake Valley Detention Center as of September 2008and (5) a decrease in revenues of $1.2 million due to the termination ofour management contract for the Reading Alternative Education School Program inJune 2008.  The decrease in revenuesdue to the above was offset, in part, by (1) an increase in revenues of$4.5 million at the Cornell Abraxas Academy due to improved occupancy, (2) anincrease in revenues of $2.5 million at the Southern Peaks Regional Treatment Centerdue to improved occupancy and mix of clients at the facility, (3) anincrease in revenues of $1.6 million at the Cornell Abraxas of Ohio facilitydue to a new residential program activated in 2008 and (4) an increase inrevenues of $0.9 million at the Hector Garza Residential Treatment Center whichwe reactivated in August 2007.  Theremaining net decrease in revenues of approximately $0.5 million was due tovarious insignificant fluctuations in revenues at our other Abraxas Youth andFamily Services facilities and programs.

 

Average contractoccupancy was 80.6% for the year ended December 31, 2008 compared to 92.0%for the year ended December 31, 2007. The decrease in the 2008 averagecontract occupancy reflects the under-utilization at certain facilities,including A-1and TATC.

 

The average per diem ratefor our Abraxas Youth and Family Services facilities was approximately $192.15for the year ended December 31, 2008 compared to approximately $174.93 forthe year ended December 31, 2007. The increase in the 2008 average perdiem rate reflects the continued ramp-up of the Cornell Abraxas Academy(reactivated in the fourth quarter of 2006), the reactivation of the HectorGarza Residential Treatment Center in 2007 as well as changes in the mix ofservices provided at other facilities, including a new residential program atour Cornell Abraxas of Ohio facility. The average fee-for-service rate for our non-residential community-basedAbraxas Youth and Family Services facilities and programs was approximately$48.28 for the year ended December 31, 2008 compared to approximately$44.35 for the year ended December 31, 2007.  Our average fee-for-service rate canfluctuate from year to year depending on the mix of services provided at ourvarious non-residential Abraxas Youth and Family Services facilities andprograms.

 

*Adult Community-Based Services.*****AdultCommunity-Based Services revenues increased approximately $2.1 million, or3.1%, to $70.2 million for the year ended December 31, 2008 from $68.1million for the year ended December 31, 2007 due to (1) an increasein revenues of $1.1 million at the Cordova Center due to improved occupancy, (2) anincrease in revenues of $0.5 million at the Midtown Center which was reactivatedin September 2007, (3) an increase in revenues of $0.6 million atSouthwood due to increased occupancy, (4) revenues of $0.3 million at anew jail (Bell Gardens Jail) we began operating in March 2008 and (5) anincrease in revenues of $0.5 million at the Oakland Center due to improvedoccupancy.  The increase in revenues wasoffset, in part, by (1) a decrease in revenues of $1.3 million due to thetermination of our management contract for the Lincoln County Detention Centerin May 2008 (we gave notice of early termination of our managementcontract for the facility in February 2008 due to continual staffing andother issues in the rural area. This contract generated revenues ofapproximately $0.6 million and $1.9 million in the years ended December 31,2008 and 2007, respectively), (2) a decrease in revenues of $0.9 millionat the Grossman Center due to reduced occupancy and (3) a decrease inrevenues of $0.5 million at the Reid Correctional Facility as a result ofdecreased occupancy due to the damages caused by Hurricane Ike.  The remaining net increase in revenues of$1.8 million was due to various insignificant fluctuations in revenues at ourvarious other adult community-based facilities and programs.

 

Average contractoccupancy was 99.0% for the year ended December 31, 2008 compared to101.1% for the year ended December 31, 2007.

 

The average per diem ratefor our residential Adult Community-Based Services facilities was $68.47 forthe year ended December 31, 2008 compared to $62.91 for the year ended December 31,2007. The average fee-for-service rate for our non-residential AdultCommunity-Based Services facilities and programs was approximately $11.00 forthe year ended December 31, 2008 compared to approximately $13.70 for theyear ended December 31, 2007.  Ouraverage fee-for-service rates can fluctuate from year to year due to changes inthe mix of services provided by our various non-residential AdultCommunity-Based Services facilities and programs.

 

***Operating Expenses.***  Operating expenses, excluding depreciationand amortization, increased approximately $6.5 million, or 2.4%, to $280.6million for the year ended December 31, 2008 from $274.1 million for theyear ended December 31, 2007.

 

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*Adult Secure Services.*  Adult SecureServices operating expenses increased approximately $5.1 million, or 3.9%, to$135.6 million for the year ended December 31, 2008 from$130.5 million for the year ended December 31,2007 due primarily to (1) an increase in operating expenses of $8.8million at the Great Plains Correctional Facility due to increased occupancyfollowing the facility expansion completed in September 2008, (2) anincrease in operating expenses of $3.5 million at the D. Ray James Prison dueto increased occupancy following the facility expansion completed in February 2008,(3) an increase in operating expenses of $1.8 million at the High PlainsCorrectional Facility acquired in May 2007, (4) an increase inoperating expenses of $1.5 million at the Big Spring Correctional Center due toincreased occupancy following a facility expansion completed in November 2007and (5) an increase in operating expenses of $1.3 million at the WalnutGrove Youth Correctional Facility due to increased occupancy following afacility expansion completed in September 2008.  The increase in operating expenses due to theabove was offset, in part, by (1) a decrease in operating expenses of $7.5million due to the transition of our management contract at the Donald W. WyattDetention Center to the facility’s owner in July 2007 and (2) adecrease in operating expenses of $3.1 million at the Regional CorrectionCenter due to decreased occupancy following the removal of all ICE inmates in August 2007.  The remaining net decrease in operatingexpenses of approximately $1.2 million was due to various insignificantfluctuations in operating expenses at our other adult secure facilities and divisionaloperating expenses.

 

As a percentage ofsegment revenues, adult secure services operating expenses were 64.8% for theyear ended December 31, 2008 compared to 71.2% for the year ended December 31,2007.  The 2008 operating margin wasfavorably impacted by the $1.5 million contract-based revenue adjustment forthe contract year ended March 2008 at the Regional CorrectionalCenter.  Additionally, the 2007 operatingmargin was negatively impacted by the termination of our contract at the GreatPlains Correctional Facility in April 2007 as we transitioned to itsreactivation in September 2007 under our new contract with the ArizonaDepartment of Corrections.

 

*Abraxas Youth and Family Services.* Abraxas Youth and Family Services operating expenses increased $2.1million, or 2.2%, to approximately $95.6 million for the year ended December 31,2008 from $93.5 million for the year ended December 31, 2007 due primarilyto (1) an increase in operating expenses of $1.7 million at the CornellAbraxas Academy due to increased occupancy, (2) an increase in operatingexpenses of $1.2 million at the Hector Garza Residential Treatment Center dueto increased occupancy, (3) an increase in operating expenses of $0.8million at our Cornell Abraxas of Ohio facility due to the addition of a newresidential program in 2008, and (4) an increase in operating expenses of$0.4 million at the Southern Peaks Regional Treatment Center due to increasedoccupancy.   The increase in operatingexpenses was offset, in part, by (1) a decrease in operating expenses of$1.8 million due to the termination of our management contract for theHarrisburg Alternative Education School Program for the 2007-2008 school year(due to lack of funding by the contracting agency), (2) a decrease inoperating expenses of $0.9 million due to the termination of our managementcontract for the Salt Lake Valley Detention Center as of September 2008, (3) adecrease in operating expenses of $0.9 million due to the termination of ourmanagement contract for the Reading Alternative Education School Program in June 2008and (4) a decrease in operating expenses of $0.6 million at the TexasAdolescent Treatment Center due to reduced occupancy.   The remaining net increase in operatingexpenses of $2.2 million was due to various insignificant fluctuations inoperating expenses at our various Abraxas Youth and Family Services facilitiesand programs.

 

As a percentage of segment revenues, Abraxasoperating expenses were 89.1% for the year ended December 31, 2008compared to 85.5% for the year ended December 31, 2007. The 2008 operatingmargin was negatively impacted by the lower utilization at those facilitiespreviously noted.

 

*Adult Community-Based Services.* Adult Community-Based Services operating expenses decreased $0.7million, or 1.4%, to $49.4 million for the year ended December 31, 2008from $50.1 million for the year ended December 31, 2007 due primarily to (1) adecrease in operating expenses of $1.2 million due to the termination of ourmanagement contract at the Lincoln County Detention Center as of September 2008,(2) a decrease in operating expenses of $0.5 million at the GrossmanCenter due to reduced occupancy and (3) a decrease in operating expensesof $0.1 million at the Reid Community Residential Facility due to reducedoccupancy resulting from damages sustained during Hurricane Ike. The decreasein operating expenses was offset, in part, by (1) an increase in operatingexpenses of $0.4 million at the Midtown Center which we reactivated in September 2007and (2) operating expenses of $0.3 million at a new jail we beganoperating in March 2008.  Theremaining net increase in operating expenses of $0.4 million was due to variousinsignificant fluctuations in operating expenses at our numerous adultcommunity-based facilities and programs.

 

Asa percentage of segment revenues, the segment’s operating expenses were 70.5%for the year ended December 31, 2008 compared to 73.5% for the year ended December 31,2007.  The 2008 operating margin wasfavorably impacted by increased operations driven by a change in the mix ofservices provided during the year.

 

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***Pre-Opening and Start-up Expenses.***** **There were no pre-opening and start-up costs for theyears ended December 31, 2008 and 2007. Pre-opening and start-up costs were approximately $2.7 million for theyear ended December 31, 2006 and were attributable to the Moshannon ValleyCorrectional Center. These expenses consisted primarily of personnel andrelated expenses, professional and recruiting expenses.

 

***Depreciation and Amortization*****.**  Depreciation and amortizationincreased approximately $1.9 million, or 11.9%, to $17.9 million for the yearended December 31, 2008 from $16.0 million for the year ended December 31,2007.  Depreciationincreased approximately $2.2 million due primarily to 1) an increase of $1.2million due to depreciation expense resulting from the facility expansionactivations and related furniture, fixtures and equipment purchases at the BigSpring Correctional Center (in November 2007), the Great PlainsCorrectional Facility (in September 2008) and the D. Ray James Prison (in February 2008)and 2) additional depreciation expense of $0.1 million as a result of thepurchase of the High Plains Correctional Facility in May 2007 and theWashington, D.C. Facility in October 2007. Amortization of intangibles was approximately $2.2 million and $2.4million the years ended December 31, 2008 and 2007, respectively.

 

***General and Administrative Expenses.***  General and administrative expenses increasedapproximately $0.5 million, or 2.0%, to $26.0 million for the year ended December 31,2008 from approximately $25.5 million for the year ended December 31,2007.  General and administrativeexpenses for 2007 include our reimbursement to Veritas of approximately $2.5million of costs related to the Merger Agreement (see Note 13 to theconsolidated financial statements concerning this Merger Agreement) and legaland professional fees and development costs of approximately $1.2 millionrelated to the Merger Agreement. Additionally, general and administrative costs for 2007 include a net$1.5 million legal claims settlement received in August 2007.

 

***Interest.***  Interest expense, net of interest income, decreasedapproximately $0.3 million to $24.0 million for the year ended December 31,2008 from $24.3 million for the year ended December 31, 2007. Interestincome for the year ended December 31, 2008 includes a net gain ofapproximately $1.2 million related to the change in fair value of certain derivativeinstruments pertaining to MCF, a special purpose entity (see Note 11 tothe consolidated financial statements).  Additionally,for the year ended December 31, 2008, we capitalized interest of $2.9million related to the facility expansion projects at the Great PlainsCorrectional Facility and the D. Ray James Prison. These were partially offsetby increased interest expense of approximately $2.4 million primarily driven byhigher average borrowings outstanding in 2008 under our Amended CreditFacility, partially offset by a declining interest rate environment in2008.  For the year ended December 31,2007, we capitalized interest of approximately $1.2 million related to thefacility expansion projects at the Big Spring Correctional Center, the D. RayJames Prison and the Great Plains Correctional Facility.

 

***Income Taxes.***** **For the year ended December 31,2008, we recognized a provision for income taxes on our income from continuingoperations at an estimated effective rate of 40.8%. For the year ended December 31,2007, we recognized a provision for income taxes at an estimated effective rateof 42.6%. The reduction in the estimated income tax rate in 2008 is principallydue to an increase in operating income across certain of our business segments,the decreased impact of certain nondeductible expenses and the utilization ofvarious tax credits.

 

***YearEnded December 31, 2007 Compared to Year Ended December 31, 2006***

*** ***

***Revenues*****.**  Revenues decreasedapproximately $0.3 million, or 0.08%, to $360.6 million for the year ended December 31,2007 from $360.9 million for the year ended December 31, 2006.

 

*Adult Secure Services.** ***Adult SecureServices revenues increased approximately $4.4 million, or 2.5%, to $183.2million for the year ended December 31, 2007 from $178.8 million for theyear ended December 31, 2006 due primarily to (1) an increase inrevenues of  $9.7 million at theMoshannon Valley Correctional Center which opened in April 2006, (2) revenuesof $2.9 million at the High Plains Correctional Facility acquired in May 2007,(3) an increase in revenues of $2.1 million at the Big Spring CorrectionalCenter due to an increase in the effective per diem rate under our newtake-or-pay contract with the BOP as well as increased occupancy as a result ofthe facility expansion completed in November 2007 and  (4) an increase in revenues ofapproximately $1.8 million at the Leo Chesney Community Correctional Facilityand $1.4 million at the D. Ray James Prison, both due primarily to per diemrate increases.  The increase in revenuesfrom the above was offset, in part, by (1) a decrease in revenues of $7.2million due to our termination of our management contract with OK DOC at theGreat Plains Correctional Facility in April 2007 (the facility beganreceiving inmates under a new operating contract with the Arizona Department ofCorrections in September 2007), (2) a decrease in revenues ofapproximately $4.9 million at the Regional Correctional Center due to thewithdrawal of inmates by ICE during the latter half of 2007 and (3) adecrease in revenues of $2.1 million at the Donald W. Wyatt Detention Centerdue to the transition of our management contract to the 

 

 

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facility’sowner in July 2007.  The remainingnet increase in revenues of approximately $0.7 million was due to variousinsignificant fluctuations in revenues at our other adult secure facilities.

 

Averagecontract occupancy was 100.4% for the year ended December 31, 2007compared to 98.2% for the year ended December 31, 2006.

 

The average per diem ratewas $54.69 for the year ended December 31, 2007 compared to $56.12 for theyear ended December 31, 2006.  The2007 average per diem rate was unfavorably impacted by the increase inpopulation at the Moshannon Valley Correctional Center which opened in April 2006.  This facility is operated under a take-or-paycontract.  As a result, the average perdiem rate will decrease as population increases.  The facility was ramping up in populationsubsequent to its April 2006 opening; as a result, the higher occupancy in2007 lowered the average per diem rate for the Adult Secure Servicesdivision.  Additionally, the 2006 averageper diem rate benefited from the receipt of a contract based revenue adjustmentfor the contract year ended March 2006 in the net amount of $2.4 millionat the RCC.  There were no revenuesattributable to start-up operations for the years ended December 31, 2007and 2006.

 

*Abraxas Youth and Family Services*. Abraxas Youth and Family Services revenues decreased approximately $6.5million, or 5.6%, to $109.3 million for the year ended December 31, 2007from $115.8 million for the year ended December 31, 2006 due primarily to (1) adecrease in revenues of $9.9 million due to the termination of our managementcontract at the Alexander Youth Services Center in January 2007, (2) adecrease in revenues of $1.9 million due to the termination of our managementcontract at the South Mountain Secure Treatment Unit (“SMSTU”) in June 2006and (3) a decrease in revenues of $1.2 million due to the termination ofour management contract for the Harrisburg Alternative Education SchoolProgram.  In July 2007, we werenotified that the funding for this program was discontinued for the 2007-2008school year.  The decrease in revenuesdue to the above was offset, in part, by (1) an increase in revenues of$3.5 million at the Cornell Abraxas Academy which we reactivated in October 2006,(2) revenues of approximately $0.7 million at the Hector Garza ResidentialTreatment Center which we reactivated in August 2007 and (3) anincrease in revenues of approximately $1.6 million at the LeadershipDevelopment Program due to increased occupancy. The remaining net increase inrevenues of approximately $0.7 million was due to various insignificantfluctuations in revenues at our other Abraxas Youth and Family Servicesfacilities and programs.

 

Average contractoccupancy was 92.0% for the year ended December 31, 2007 compared to 93.2%for the year ended December 31, 2006.

 

The average per diem ratefor our Abraxas Youth and Family Services facilities was approximately $174.93for the year ended December 31, 2007 compared to approximately $170.33 forthe year ended December 31, 2006. The increase in the 2007 average perdiem rate was due primarily to the reactivation of the Cornell Abraxas Academyin October 2006 and the Hector Garza Residential Treatment Center in August 2007.  Additionally, we received annual rateincreases at certain of our other Abraxas Youth and Family Services residentialfacilities.  The average fee-for-service ratefor our non-residential community-based Abraxas Youth and Family Servicesfacilities and programs was approximately $44.35 for the year ended December 31,2007 compared to approximately $37.59 for the year ended December 31,2006.  Our average fee-for-service ratecan fluctuate from year to year depending on the mix of services provided atour various non-residential Abraxas Youth and Family Services facilities andprograms.  There were no revenuesattributable to start-up operations for the years ended December 31, 2007and 2006.

 

*Adult Community-Based Services.*****AdultCommunity-Based Services revenues increased approximately $1.8 million, or2.7%, to $68.1 million for the year ended December 31, 2007 from $66.3million for the year ended December 31, 2006 principally due to anincrease in revenues of approximately $0.8 million from the operations of twojails in California which we began managing in January 2007 and anincrease in revenues of approximately $0.5 million at the Las Vegas Center dueto increased occupancy.  Additionally, wehad a decrease in revenues of approximately $0.9 million due to the terminationof our management contract for the SWICC Turning Point Program in October 2006.  The remaining net increase in revenues of$1.4 million was due to various insignificant fluctuations in revenues at ourvarious adult community-based facilities and programs.

 

Average contractoccupancy was 101.1% for the year ended December 31, 2007 compared to97.7% for the year ended December 31, 2006.

 

The average per diem ratefor our residential Adult Community-Based Services facilities was $62.91 forthe year ended December 31, 2007 compared to $61.71 for the year ended December 31,2006. The average fee-for-service rate for our non-residential Adult Community-BasedServices facilities and programs was approximately $13.70 for the year ended December 31,2007 compared to approximately $11.23 for the year ended December 31,2006.  Our average fee-for-service ratescan fluctuate from year to year due to changes in the mix of services providedby our various non-residential Adult 

 

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Community-Based Servicesfacilities and programs. There were no revenues attributable to start-upoperations for the years ended December 31, 2007 and 2006.

 

***Operating Expenses.***  Operating expenses decreased approximately$0.9 million, or 0.3%, to $274.1 million for the year ended December 31, 2007from $275.0 million for the year ended December 31, 2006.

 

*Adult Secure Services.*  Adult SecureServices operating expenses increased approximately $7.2 million, or 5.8%, to$130.5 million for the year ended December 31, 2007 from$123.3 million for the year ended December 31,2006 due primarily to (1) an increase in operating expenses of $7.9million at the Moshannon Valley Correctional Center which opened in April 2006(approximately $2.7 million of operating expenses at this facility wereincluded in pre-opening and start-up expenses in 2006), (2) an increase inoperating expenses of $2.6 million at the High Plains Correctional Facilitypurchased in May 2007, (3) an increase in operating expenses of $0.8million at the Big Spring Correctional Center due to increased occupancyfollowing completion of a facility expansion in November 2007 and (4) anincrease in operating expenses of $0.5 million at the Leo Chesney CorrectionalCenter due to increased occupancy.  Theincrease in operating expenses due to the above was offset, in part, by (1) adecrease in operating expenses of $2.2 million due to our termination of ourcontract at the Great Plains Correctional Facility with the OK DOC in April 2007(the facility began receiving inmates under our contract with the ArizonaDepartment of Corrections in September 2007) and (2) a decrease inoperating expenses of $1.7 million due to the transition of our managementcontract at the Donald W. Wyatt Detention Center to the facility’s owner in July 2007.  The remaining net decrease in operatingexpenses of approximately $0.7 million was due to various insignificantfluctuations in operating expenses at our other adult secure facilities.

 

As a percentage ofsegment revenues, Adult Secure Services operating expenses were 71.2% for theyear ended December 31, 2007 compared to 68.9% for the year ended December 31,2006.  The increase in the 2007percentage reflects the stabilization of the operating margin at the MoshannonValley Correctional Center (which operates under a take-or-pay contract)subsequent to its activation in April 2006.  Additionally, the 2007 operating margin wasnegatively impacted by the termination of our contract at the Great PlainsCorrectional Facility in April 2007 as we transitioned to its reactivationin September 2007 under our new contract with the Arizona Department ofCorrections.

 

*Abraxas Youth and Family Services.* Abraxas Youth and Family Services operating expenses decreasedapproximately $6.6 million, or 6.6%, to approximately $93.5 million for theyear ended December 31, 2007 from $100.1 million for the year ended December 31,2006 due primarily to (1) a decrease in operating expenses of $9.1 milliondue to the termination of our management contract at the Alexander YouthServices Center in January 2007, (2) a decrease in operating expensesof $1.6 million due to the termination of our management contract at the SMSTUin June 2006 and (3) a decrease in operating expenses of $0.7 milliondue to the termination of our management contract for the HarrisburgAlternative Education School Program (in July 2007, we were notified thatthe funding for this program was discontinued for the 2007-2008 schoolyear).  The decrease in operatingexpenses due to the above was offset, in part, by various increases (totalingapproximately $4.8 million) in operating expenses at both our residential andnon-residential Abraxas Youth and Family Services facilities and programs,including an increase in operating expenses of approximately $1.7 million dueto the reactivation of the Cornell Abraxas Academy in October 2006, aswell as an increase in operating expenses of $0.6 million at our Washington,D.C. facility as 2006 operating expenses at this facility were reflected indiscontinued operations in the year ended December 31, 2006.

 

As a percentage of segment revenues, Abraxasoperating expenses were 85.5% for the year ended December 31, 2007compared to 86.4% for the year ended December 31, 2006.

 

*Adult Community-Based Services.* Adult Community-Based Services operating expenses decreasedapproximately $1.6 million, or 3.1%, to $50.1 million for the year ended December 31,2007 from $51.7 million for the year ended December 31, 2006 due tovarious fluctuations in operating expenses at our numerous adult community-basedfacilities and programs including a decrease in operating expenses ofapproximately $0.9 million due to the termination of our management contractfor the SWICC Turning Point Program in October 2006 and a decrease indivisional administrative costs of approximately $1.1 million.  Additionally, we had an increase in operatingexpenses of approximately $0.6 million from the two jails in California webegan operating in January 2007.

 

Asa percentage of segment revenues, the segment’s operating expenses were 73.5%for the year ended December 31, 2007 compared to 78.0% for the year ended December 31,2006.  The 2007 operating margin wasfavorably impacted by lower divisional administrative costs in year ended December 31,2007 as compared to the year ended December 31, 2006.

 

***Pre-Opening and Start-up Expenses.***** **There were no pre-opening and start-up costs for theyear ended December 31, 2007. Pre-opening and start-up costs were approximately $2.7 million for theyear ended December 31, 2006 and were 

 

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attributableto the Moshannon Valley Correctional Center. These expenses consisted primarilyof personnel and related expenses, professional and recruiting expenses.

 

***Depreciation and Amortization*****.**  Depreciation and amortizationdecreased approximately $0.3 million, or 1.8%, to $16.0 million for the yearended December 31, 2007 from $16.3 million for the year ended December 31,2006.  Depreciationand amortization of property and equipment declined approximately $0.6 milliondue to a decrease in depreciation expenses related to certain fully depreciated(in 2007) furniture and fixtures, computer and other equipment of approximately$1.1 million, offset, in part, by an increase in building depreciation expenseof approximately $0.8 million related primarily to the Moshannon ValleyCorrectional Center which opened in April 2006, the High PlainsCorrectional Facility purchased in May 2007 and the purchase of theWashington, D.C. facility in October 2007. Amortization of intangibles was approximately $2.4 million and $2.2million the years ended December 31, 2007 and 2006, respectively.

 

***General and Administrative Expenses.***  General and administrative expenses increasedapproximately $3.8 million, or 17.5%, to $25.5 million for the year ended December 31,2007 from approximately $21.7 million for the year ended December 31, 2006due primarily to (1) our reimbursement to Veritas of approximately $2.5million of costs related to the Merger Agreement (see Note 13 to theconsolidated financial statements concerning this Merger Agreement), (2) anincrease in legal and professional fees and development costs of approximately$1.2 million related to the Merger Agreement and (3) an increase instock-based compensation expense of approximately $0.7 million.  The increase in general and administrativeexpenses due to the above was offset, in part, by the net $1.5 million legalclaims settlement received in August 2007.

 

***Interest.***  Interest expense, net of interest income, increasedapproximately $1.2 million to $24.3 million for the year ended December 31,2007 from $23.1 million for the year ended December 31, 2006.   For the year ended December 31, 2007,we capitalized interest of approximately $1.2 million related to the facilityexpansion projects at the Big Spring Correctional Center, the D. Ray JamesPrison and the Great Plains Correctional Facility.  For the year ended December 31, 2006, wecapitalized interest of approximately $1.5 million related to the MoshannonValley Correctional Center.  Furthermore,we incurred interest expense of approximately $0.4 million related to ourAmended Credit Facility during the year ended December 31, 2007 (noneincurred in 2006).  The decrease was alsodue to a reduction in interest income from approximately $3.1 million in theyear ended December 31, 2006 to approximately $2.0 million in the yearended December 31, 2007 (due to lower levels of invested funds (and rates)due to the on-going 2007 expansion projects and acquisitions).  These were partially offset by reducedinterest expense of approximately $0.8 million on the MCF bonds due to a $10.5million principal payment made in July 2007.

 

***Income Taxes.***** **For the year ended December 31,2007, we recognized a provision for income taxes on our income from continuingoperations at an estimated effective rate of 42.6%.  For the year ended December 31, 2006, werecognized a provision for income taxes at an estimated effective rate of42.1%.

 

**Liquidity and Capital Resources**

 

***General*****.** Our primary capital requirements are for (1) purchases,construction or renovation of new facilities, (2) expansions of existingfacilities, (3) working capital, (4) pre-opening and start-up costsrelated to new operating contracts, (5) acquisitions  of businesses or facilities, (6) informationsystems hardware and software and (7) furniture, fixtures andequipment.  Working capital requirementsgenerally increase immediately prior to commencing management of a new facility(or activation of facility expansion) as we incur start-up costs and purchasenecessary equipment and supplies before facility management revenue isrealized.

 

***Cash Flows From Operations.*** Cash provided byoperating activities was approximately $59.0 million for the year ended December 31,2008 compared to approximately $27.2 million for the year ended December 31,2007. The increase over the prior year was principally due to higher net incomeas well as changes in certain working capital accounts (including principallyaccounts receivable and accounts payable) due to timing of payments receivedand made.

 

***Cash Flows From Investing Activities*****. **Cash used in investing activities was approximately$81.7 million for the year ended December 31, 2008 due to (1) capitalexpenditures of $79.9 million related primarily to the facility expansionprojects at the Great Plains Correctional Facility and the D. Ray James Prison,(2) net payments to the restricted debt payment account of approximately$2.9 million, (3) proceeds from the sale of fixed assets of $0.8 millionand (4) sales of investment securities of $0.3 million.** **Cashused in investing activities****wasapproximately $64.5 million in the year ended December 31, 2007 due to (1) capitalexpenditures of approximately $50.9 million related primarily to constructioncosts associated with the Big Spring Correctional Center and the D. Ray JamesPrison expansions and development of the Hudson, Colorado site, (2) net salesof investment securities of $11.7 million, (3) the****purchase of the Washington, D.C. facilityfor $9.6 million, (4) the purchase of the High Plains CorrectionalFacility for approximately $8.9 million, (5) the Hudson, Colorado siteacquisition of

 

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approximately $5.1 million and (6) net paymentsto the restricted debt payment account of approximately $2.1 million.

 

***Cash Flows From Financing Activities*****. **Cash provided by financing activities wasapproximately $34.3 million for the year ended December 31, 2008 due to (1) netborrowings on our Amended Credit Facility of $45.0 million and (2) proceedsfrom the exercise of stock options of $0.6 million, partially offset bypayments on MCF bonds of $11.4 million. Cash provided by financingactivities was approximately $21.8 million for the year ended December 31,2007 due primarily to borrowings on our Amended Credit Facility of $30.0million, partially offset by a $10.5 million payment on MCF’s bonds in July 2007and proceeds from the exercise of stock options and warrants of approximately$2.8 million.  Additionally, werecognized a tax benefit on stock option exercises of approximately $0.4million and had payments of approximately $0.8 million for financing costsrelated to our Amended Credit Facility.

 

***Long-Term Credit Facilities.***  Our Amended Credit Facilityprovides for borrowings up to $100.0 million (including letters of credit),matures in December 2011 and bears interest, at our election depending onour total leverage ratio, at either the LIBOR rate plus a margin ranging from1.50% to 2.25%, or a rate which ranges from 0.00% to 0.75% above the applicableprime rate. The available commitment under our Amended Credit Facility wasapproximately $10.1 million at December 31, 2008.  We had outstandingborrowings under our Amended Credit Facility of $75.0 million and we hadoutstanding letters of credit of approximately $14.9 million at December 31,2008.  Subject to certain requirements, we have the right to increase thecommitments under our Amended Credit Facility up to $150.0 million, althoughthe indenture for our Senior Notes limits our ability, subject to certainconditions, to expand the Amended Credit Facility beyond $100.0 million.  We can provide no assurance that all of thebanks that have made commitments to us under our Amended Credit Facility wouldbe willing to participate in an expansion to the Amended Credit Facility shouldwe desire to do so.  The Amended Credit Facility is collateralized bysubstantially all of our assets, including the assets and stock of all of oursubsidiaries. The Amended Credit Facility is not secured by the assets of MCF,a special purpose entity. Our Amended Credit Facility contains commonly usedcovenants including compliance with laws and limitations on certain financingtransactions and mergers and also includes various financial covenants. We believe the most restrictive covenant under our Amended CreditFacility is the fixed charge coverage ratio.  At December 31, 2008,we were in compliance with all of our debt financial covenants.

 

MCF is obligated for the outstandingbalance of its 8.47% Taxable Revenue Bonds, Series 2001.  The bonds bear interest at a rate of 8.47%per annum and are payable in semi-annual installments of interest and annualinstallments of principal.  All unpaidprincipal and accrued interest on the bonds is due on the earlier of August 1,2016 (maturity) or as noted under the bond documents.  The bonds are limited, nonrecourseobligations of MCF and secured by the property and equipment, bond reserves,assignment of subleases and substantially all assets related to the facilitiesincluded in the 2001 Sale and Leaseback Transaction (in which we sold elevenfacilities (as identified in Item 1 of this report) to MCF).  The bonds are not guaranteed by Cornell.

 

In June 2004, we issued $112.0million in principal of 10.75% Senior Notes the (“Senior Notes”) due July 1,2012.  The Senior Notes are unsecuredsenior indebtedness and are guaranteed by all of our existing and futuresubsidiaries (collectively, “the Guarantors”). The Senior Notes are not guaranteed by MCF (the “Non-Guarantor”).  Interest on the Senior Notes is payablesemi-annually on January 1 and July 1 of each year, commencing January 1,2005.  On or after July 1, 2008, wemay redeem all or a portion of the Senior Notes at the redemption prices(expressed as a percentage of the principal amount) listed below, plus accruedand unpaid interest, if any, on the Senior Notes redeemed, to the applicabledate of redemption, if redeemed during the 12-month period commencing on July 1of each of the years indicated below:

 

| **Year**            | ** ** | **Percentages** | ** ** |
|---------------------|------------|-----------------|------------|
|                |       |            |       |
| 2008                |       | 105.375         | %          |
| 2009                |       | 102.688         | %          |
| 2010 and thereafter |       | 100.000         | %          |

 

Upon the occurrence ofspecified change of control events, unless we have exercised our option toredeem all the Senior Notes as described above, each holder will have the rightto require us to repurchase all or a portion of such holder’s Senior Notes at apurchase price in cash equal to 101% of the aggregate principal amount of thenotes repurchased plus accrued and unpaid interest, if any, on the Senior Notesrepurchased, to the applicable date of purchase.  The Senior Notes were issued under anindenture which limits our ability and the ability of our Guarantors to, amongother things, incur additional indebtedness, pay dividends or make otherdistributions, make other restricted payments and investments, create liens,incur restrictions on the ability of the Guarantors to pay dividends or otherpayments to us, enter into transactions with affiliates, and engage in mergers,consolidations and certain sales of assets.

 

In conjunction with theissuance of the Senior Notes, we entered into an interest rate swap transactionwith a financial 

 

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institutionto hedge our exposure to changes in the fair value on $84.0 million of ourSenior Notes.  The purpose of thistransaction was to convert future interest due on $84.0 million of the SeniorNotes to a variable rate.  The terms ofthe interest rate swap contract and the underlying debt instrument wereidentical.  The swap agreement wasdesignated as a fair value hedge.  Theswap had a notional amount of $84.0 million and matured in July 2012 tomirror the maturity of the Senior Notes. Under the agreement, we paid, on a semi-annual basis (each January 1and July 1), a floating rate based on a six-month U.S. dollar LIBOR rate,plus a spread, and receive a fixed-rate interest of 10.75%. For the year ended December 31,2007, we recorded interest expense related to this interest rate swap ofapproximately $0.1 million. Because the swap agreement was an effectivefair-value hedge, there was no effect on our results of operations from themark-to-market adjustment while the swap was in effect.  In October 2007, we terminated the swapagreement.  We received approximately$0.2 million in conjunction with the termination, which is being amortized overthe remaining term of the Senior Notes.

 

***Future Liquidity***

 

Ourshelf registration statement on Form S-3 for potential offerings from timeto time of up to $75.0 million in gross proceeds of debt securities, commonstock, preferred stock, warrants or certain other securities was declaredeffective by the Securities and Exchange Commission in September 2008.

 

Weexpect to use existing cash balances, internally generated cash flows andborrowings from our Amended Credit Facility to fulfill anticipated obligationssuch as capital expenditures, working-capital needs and scheduled debtmaturities over at least the next twelve months. As of December 31, 2008we have approximately $10.1 million of available capacity under our AmendedCredit Facility. We will continue to analyze our capital structure, including apotential refinancing of our Senior Notes and financing for our expected futurecapital expenditures, including any potential acquisitions. We will considerpotential acquisitions from time to time. Our principal focus for acquisitionsis anticipated to be in our Adult Secure and Adult Community-Based divisions,although we would also pursue attractively priced acquisitions in our Abraxas Youthand Family Services division. We may decide to use internally generated funds,bank financing, equity issuances, debt issuances or a combination of anyof the foregoing to finance our future capital needs. At December 31, 2008we believe we have sufficient liquidity necessary to complete those projectsfor which we have outstanding commitments.

 

Ourinternally generated cash flow is directly related to our business. Should theprivate corrections and juvenile businesses deteriorate, or should weexperience poor results in our operations, cash flow from operations may bereduced. We have, however, continued to generate positive cash flow fromoperating activities over recent years and expect that cash flow will continueto be positive over the next year. Our access to debt and equity markets may bereduced or closed to us due to a variety of events, including, among others,restrictions under our Senior Notes indenture or our Amended Credit Facility,industry conditions, general economic conditions, market conditions, creditrating agency downgrades of our debt and/or market perceptions of us and ourindustry. The extreme volatility seen in the financial markets beginning in thethird quarter of 2008 has continued into the first quarter of 2009 and isexpected to be present for the near term. Such volatility could result indecreased availability of capital at economical terms and could also putadditional financial and budgetary pressure on our customers. Such conditionscould potentially result in our inability to pursue additional future growthopportunities (such as facility expansions or new facility construction) and,if coupled with unexpected client, operational or other issues affecting our cashflow, in a need to seek additional financing at terms we would otherwise notaccept.

 

Inaddition, our accounts receivable are with federal, state, county and localgovernment agencies, which we believe generally reduces our credit risk.However, it is possible that situations such as continuing budget resolutions,delayed passage of budgets or budget pressures, may increase the length ofrepayment of certain of these receivables.

 

***Contractual Uncertainties Related toCertain Facilities***

 

***Regional Correctional Center.***  The Office of Federal Detention Trustee(“OFDT”) holds the contract for the use of the Regional Correctional Center onbehalf of ICE, USMS and the BOP with Bernalillo County through anintergovernmental services agreement, and we have an operating and managementagreement with Bernalillo County.  In July 2007,we were notified by ICE that it was removing all ICE detainees from theRegional Correctional Center and the removal was completed in early August 2007. The facility is still being utilized by the USMS, and since May 2008 by theBOP, but not at its full capacity.  In February 2008,ICE informed us that it would not resume use of the facility.  In February 2008, OFDT attempted tounilaterally amend its agreement with the County to reduce the number ofminimum annual guaranteed mandays under the agreement from 182,500 to66,300.  Neither we nor the County believe OFDT has the right tounilaterally amend the contract in this manner, and OFDT has been informed ofour position. Although either party to the intergovernmental services agreementhas the right to terminate upon 180 days notice, neither party has exercisedsuch right as of December 31, 2008.

 

Also,there is a motion pending in a lawsuit against the County concerning the Countyjail system that could involve the Regional Correctional Center in such case. Jimmy McClendon and other plaintiffs sued the County in federal districtcourt in 

 

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theDistrict of New Mexico in 1994 over conditions at the county jail, which wasthen located at what is now the Regional Correctional Center and run by theCounty.  The County subsequently built their new Metropolitan DetentionCenter to house the County inmates and also negotiated two stipulatedagreements in 2004 designed to end the McClendon lawsuit.  The court inthat case is considering the application of the lawsuit to the RegionalCorrectional Center as a result of the County’s ownership of thefacility.  The County has informed us that, should the court rule thatthe case applies to the facility, it plans to appeal the decision since theCounty does not believe McClendon should apply to the Regional CorrectionalCenter.  We do not believe we are contractually obligated to bear anyincremental costs of complying with McClendon although the County hasexpressed its desire for us to absorb a portion of any costs that would beincurred. Should the court rule that the lawsuit applies to the facility,we would further discuss the matter with the County. We plan to continue tooperate the facility and also continue with our marketing plans for theRegional Correctional Center.

 

Revenuesfor this facility were approximately $9.9 million (including a $1.5 millioncontract-based revenue adjustment for the contract year ended March 2008)and $12.8 million for the years ended December 31, 2008 and 2007,respectively. The net carrying value of the leasehold improvements for thisfacility was approximately $1.1 million and $3.0 million at December 31,2008 and 2007, respectively. Our lease for this facility requires monthly rentpayments of approximately $0.13 million for the remaining term of the lease(through June 2009). To date, we have brought in the BOP as anadditional customer for this facility; however the facility still hasavailable capacity. Our inability to expand the existing population withcurrent or new customers could have an adverse effect on our financialcondition, results of operations and cash flows.  We believe that pursuantto the provisions of SFAS No. 144, no impairment to the carrying value ofthe leasehold improvements for this facility has occurred.

 

***Hector Garza Residential TreatmentCenter.***  In October 2005,we initiated the temporary closure of this MCF leased facility in San Antonio,Texas. We reactivated the facility during the third quarter of 2007. The netcarrying value for this facility was approximately $4.0 million and $4.2million at December 31, 2008 and 2007, respectively.  We believethat, pursuant to the provisions of SFAS No. 144, no impairment to thecarrying value of this facility has occurred due to existing demand fromcurrent customers and anticipated incremental demand from additional multiplecustomers to whom the facility is being marketed.

 

###### ***Projects Under Development, Construction or Renovation***

###### *** ***

For a discussion of ourexpansion projects at the Great Plains Correctional Facility in Hinton,Oklahoma, the D. Ray James Prison in Folkston, Georgia and the Walnut GroveYouth Correctional Facility in Walnut Grove, Mississippi, see “-Significant2008 Events.”

 

###### ***Treasury Stock Repurchases***

###### *** ***

We did not purchase any of our commonstock in the years ended December 31, 2008 and 2007.

 

Underthe terms of our Senior Notes and our Amended Credit Facility, we can purchaseshares of our stock subject to certain cumulative restrictions.

 

###### ***Contractual Obligations and Commercial Commitments***

###### *** ***

Wehave assumed various financial obligations and commitments in the ordinarycourse of conducting our business.  Wehave contractual obligations requiring future cash payments, such asmanagement, consulting and non-competition agreements.

 

Wemaintain operating leases in the ordinary course of our business activities.  These leases include those for operatingfacilities, office space and office and operating equipment, and the agreementsexpire between 2009 and 2075. As of December 31, 2008, our totalcommitment under these operating leases was approximately $120.6 million.

 

 

 

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Thefollowing table details the known future cash payments (on an undiscountedbasis) related to various contractual obligations as of December 31, 2008(in thousands):

 
| ** **                                  | ** ** | **Payments Due by Period** | ** ** |
|---------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                  | ** ** | **Total**                                 | ** ** | **2009** | ** ** | **2010 - 2011** | ** ** | **2012 - 2013** | ** ** | **Thereafter** | ** ** |
|                                        |       |                                      |       |   |   |   |   |   |   |   |   |
| **Contractual Obligations:**                | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Long-term debt — principal             | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| · Cornell  Companies, Inc.        |       | $                                         | 112,000    |   | $ | — |   | $ | — |   | $ | 112,000 |   | $ | — |   |
| · Special Purpose Entities             | ** ** | 134,100                                   |       | 12,400 |   | 28,000 |   | 33,000 |   | 60,700 |   |
| Long-term debt — interest              | ** ** |                                      |       |   |   |   |   |   |   |   |   |
| · Cornell  Companies, Inc.        |       | 42,140                                    |       | 12,040 |   | 24,080 |   | 6,020 |   | — |   |
| · Special Purpose Entities             | ** ** | 55,936                                    |       | 11,358 |   | 19,482 |   | 14,534 |   | 10,562 |   |
| Revolving line of credit-principal          | ** ** |                                      |       |   |   |   |   |   |   |   |   |
| · Cornell  Companies, Inc.        |       | 75,000                                    |       | — |   | 75,000 |   | — |   | — |   |
| Revolving line of credit-interest           | ** ** |                                      |       |   |   |   |   |   |   |   |   |
| · Cornell  Companies, Inc.        |       | 6,518                                     |       | 2,205 |   | 4,313 |   | — |   | — |   |
| Capital lease obligations                   | ** ** |                                      |       |   |   |   |   |   |   |   |   |
| · Cornell  Companies, Inc.        | ** ** | 26                                        |       | 12 |   | 14 |   | — |   | — |   |
| Construction commitments                    |       | 6,795                                     |       | 6,795 |   | — |   | — |   | — |   |
| Operating leases                            |       | 120,635                                   |       | 7,598 |   | 16,662 |   | 21,748 |   | 74,627 |   |
| Consultative and non-competition agreements |       | 324                                       |       | 324 |   | — |   | — |   | — |   |
| Total contractual cash obligations          |       | $                                         | 553,474    |   | $ | 52,732 |   | $ | 167,551 |   | $ | 187,302 |   | $ | 145,889 |   |

 

Approximately $2.5 million of unrecognized taxbenefits have been recorded as liabilities in accordance with FIN 48 but arenot included in the contractual obligations table because we are uncertain asto if or when such amounts may be settled. Related to the unrecognized tax benefits not included in the tableabove, we have also recorded a liability for potential penalties ofapproximately $0.1 million and for interest of approximately $0.1 million.

 

We enter into letters of credit in the ordinarycourse of operating and financing activities. As of December 31, 2008, we had outstanding letters of credit ofapproximately $14.9 million primarily for certain workers’ compensationinsurance and other operating obligations. The following table details our letter of credit commitments as of December 31,2008 (in thousands):

 
| ** **                | ** ** | ** **                  | ** ** | **Amount of Commitment Expiration Per Period** | ** ** |
|---------------------------|------------|-----------------------------|------------|-------------------------------------------------------------------------|------------|
| ** **                | ** ** | **Total Amounts Committed** | ** ** | **Less than 1 Year**                                          | ** ** | **1-3 Years** | ** ** | **4-5 Years** | ** ** | **More Than 5 Years** | ** ** |
| Commercial Commitments:   |       |                        |       |                                                                    |       |   |   |   |   |   |   |
| Standby letters of credit |       | $                           | 14,854     |                                                                    | $          | 13,604 |   | $ | 1,250 |   | $ | — |   | $ | — |   |
|                           |            |                             |            |                                                                         |            |  |  |  |  |  |  |  |  |  |  |  |

 

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** **

**ITEM 7A.****                   ****QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

In the normal course of business, we are exposed tomarket risk, primarily from changes in interest rates. We continually monitorexposure to market risk and develop appropriate strategies to manage this risk.We are not exposed to any other significant market risks, including commodityprice risk, foreign currency exchange risk or interest rate risks from the useof derivative financial instruments. In conjunction with the issuance of theSenior Notes, we had previously entered into an interest rate swap of $84.0million related to the interest obligations under the Senior Notes, in effectconverting them to a floating rate based on six-month LIBOR. As discussed in Part II,Item 8, Note 8 to the accompanying financial statements, we terminated theinterest rate swap in October 2007.

 

**Credit Risk**

 

Dueto the short duration of our investments, changes in market interest rateswould not have a significant impact on their fair value.  In addition, ouraccounts receivables are with federal, state, county and local governmentagencies, which we believe generally reduces our credit risk. However, it ispossible that such situations as continuing budget resolutions, delayedpassage of budgets or budget pressures may increase the length of repayment ofcertain receivables.

 

**Interest Rate Exposure**

 

Our exposure to changes in interest ratesprimarily results from our Amended Credit Facility, as these borrowings havefloating interest rates.  The debt on ourconsolidated financial statements at December 31, 2008 with fixed interestrates consist of the 8.47% Bonds issued by MCF in August 2001 inconnection with the 2001 Sale and Leaseback Transaction and $112.0 million ofSenior Notes.  The detrimental effect ofa hypothetical 100 basis point increase in interest rates on our currentborrowings under our Amended Credit Facility would be to reduce income beforeprovision for income taxes by approximately $0.8 million for the year ended December 31,2008.  At December 31, 2008, thefair value of our consolidated fixed rate debt was approximately $308.0 millionbased upon quoted market prices or discounted future cash flows using the sameor similar securities.

 

**Inflation**

 

Otherthan personnel, resident/inmate medical costs at certain facilities, and employeemedical and worker’s compensation insurance costs, we believe that inflationhas not had a material effect on our results of operations during the past twoyears.  We have experienced significant increases in resident/inmatemedical costs and employee medical and worker’s compensation insurance costs,and we have also experienced higher personnel costs during the past two years.Most of our facility management contracts provide for payments of either fixedper diem fees or per diem fees that increase by only small amounts during theterm of the contracts. Inflation could substantially increase our personnelcosts (the largest component of our operating expenses), medical and insurancecosts or other operating expenses at rates faster than any increases incontract revenues. Food costs (part of our resident/inmate care costs) havealso been subject to rising prices in 2008. We believe we have limited ourexposure through long-term contracts with fixed term pricing.

 

**ITEM 8.**                              FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

 
| ** ** | ** **                                                                                                                                                | **Page** |
|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|----------|
| 1.         | Financial statements                                                                                                                                      |     |
|       | Report  of Independent Registered Public Accounting Firm                                                                                                  | 47       |
|       | Consolidated  Balance Sheets - December 31, 2008 and 2007                                                                                            | 48       |
|       | Consolidated  Statements of Operations and Comprehensive Income (Loss) for the years ended  December 31, 2008, 2007 and 2006                         | 49       |
|       | Consolidated Statements of Stockholders’ Equity for  the years ended December 31, 2008, 2007 and 2006                                           | 50       |
|       | Consolidated  Statements of Cash Flows for the years ended December 31, 2008, 2007 and  2006                                                         | 51       |
|       | Notes to consolidated financial statements                                                                                                                | 52       |
|       | Management’s Annual Report on Internal Control over  Financial Reporting                                                                             | 84       |
| 2.         | Financial statement schedules                                                                                                                             | 85       |
|       | All schedules are omitted  because they are not applicable or because the required information is  included in the financial statements or notes thereto. |     |

 

46

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### **Table of Contents**

 

### **Report of Independent Registered Public Accounting Firm**

### ** **

Tothe Board of Directors and Stockholders of

CornellCompanies, Inc.

 

Inour opinion, the accompanying consolidated balance sheets and the relatedconsolidated statements of income and comprehensive income, of shareholders’equity, and of cash flows present fairly, in all material respects, thefinancial position of Cornell Companies, Inc. and its subsidiaries****at December 31, 2008 and 2007, and the results oftheir operations and their****cash flows foreach of the three years in the period ended December 31, 2008 inconformity with accounting principles generally accepted in the United Statesof America.  Also in our opinion, theCompany maintained, in all material respects, effective internal control overfinancial reporting as of December 31, 2008, based on criteria establishedin *Internal Control - Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO).  The Company’s management isresponsible for these financial statements, for maintaining effective internalcontrol over financial reporting and for its assessment of the effectiveness ofinternal control over financial reporting, included in Management’s Report onInternal Control over Financial Reporting appearing under Item 9A.  Our responsibility is to express opinions onthese financial statements and on the Company’s internal control over financialreporting based on our integrated audits. We conducted our audits in accordance with the standards of the PublicCompany Accounting Oversight Board (United States).  Those standards require that we plan andperform the audits to obtain reasonable assurance about whether the financialstatements are free of material misstatement and whether effective internalcontrol over financial reporting was maintained in all material respects.  Our audits of the financial statementsincluded examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements, assessing the accounting principlesused and significant estimates made by management, and evaluating the overallfinancial statement presentation.  Ouraudit of internal control over financial reporting included obtaining anunderstanding of internal control over financial reporting, assessing the riskthat a material weakness exists, and testing and evaluating the design andoperating effectiveness of internal control based on the assessed risk.  Our audits also included performing suchother procedures as we considered necessary in the circumstances. We believe thatour audits provide a reasonable basis for our opinions.

 

Asdiscussed in Note 7 to the consolidated financial statements, the Companychanged the manner in which it accounts for uncertainty in income taxeseffective January 1, 2007, in accordance with Financial AccountingStandards Board Interpretation No. 48, “Accounting for Uncertainty inIncome Taxes.”

 

Acompany’s internal control over financial reporting is a process designed toprovide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordancewith generally accepted accounting principles. A company’s internal control over financial reporting includes thosepolicies and procedures that (i) pertain to the maintenance of recordsthat, in reasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (ii) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (iii) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

 

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements.  Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

 

PricewaterhouseCoopersLLP

Houston,Texas

March 6,2009

 

47

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Table ofContents

** **

**CORNELL COMPANIES, INC.**

**CONSOLIDATED BALANCESHEETS**

**(in thousands, except share data)**

 
| ** **                                                                                                                                                            | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                            | ** ** | **2008**              | ** ** | **2007** | ** ** |
| **ASSETS**                                                                                                                                                            |       |                  |       |   |   |
| **CURRENT ASSETS:**                                                                                                                                                   |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                                                             |       | $                     | 14,613     |   | $ | 3,028 |   |
| Investment securities available for sale                                                                                                                              |       | —                |       | 250 |   |
| Accounts receivable - trade (net of allowance for doubtful accounts  of $4,272 and $4,372, respectively)                                                              |       | 64,622                |       | 69,787 |   |
| Other receivables (net of allowance for doubtful accounts of $4,926  and $5,126, respectively)                                                                        |       | 4,766                 |       | 3,201 |   |
| Debt service fund and other restricted assets                                                                                                                         |       | 31,370                |       | 27,523 |   |
| Deferred tax assets                                                                                                                                                   |       | 9,151                 |       | 6,750 |   |
| Prepaid expenses and other                                                                                                                                            |       | 6,368                 |       | 6,131 |   |
| **Total current assets**                                                                                                                                              |       | 130,890               |       | 116,670 |   |
| **PROPERTY AND EQUIPMENT, net**                                                                                                                                       |       | 450,354               |       | 383,952 |   |
| **OTHER ASSETS:**                                                                                                                                                     | ** ** | ** **            | ** ** | ** ** | ** ** |
| Debt service reserve fund                                                                                                                                             |       | 23,750                |       | 23,638 |   |
| Goodwill, net                                                                                                                                                         |       | 13,308                |       | 13,355 |   |
| Intangible assets, net                                                                                                                                                |       | 2,320                 |       | 4,520 |   |
| Deferred costs and other                                                                                                                                              |       | 16,299                |       | 20,152 |   |
| **Total assets**                                                                                                                                                      |       | $                     | 636,921    |   | $ | 562,287 |   |
|                                                                                                                                                                  |       |                  |       |   |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                        |       |                  |       |   |   |
|                                                                                                                                                                  |       |                  |       |   |   |
| **CURRENT LIABILITIES:**                                                                                                                                              |       |                  |       |   |   |
| Accounts payable and accrued liabilities                                                                                                                              |       | $                     | 69,093     |   | $ | 57,502 |   |
| Current portion of long-term debt                                                                                                                                     |       | 12,412                |       | 11,411 |   |
| **Total current liabilities**                                                                                                                                         |       | 81,505                |       | 68,913 |   |
| **LONG-TERM DEBT, net of current portion**                                                                                                                            |       | 308,070               |       | 275,298 |   |
| **DEFERRED TAX LIABILITIES**                                                                                                                                          |       | 17,491                |       | 13,226 |   |
| **OTHER LONG-TERM LIABILITIES**                                                                                                                                       |       | 1,688                 |       | 4,401 |   |
| **Total liabilities**                                                                                                                                                 |       | 408,754               |       | 361,838 |   |
|                                                                                                                                                                  |       |                  |       |   |   |
| **MINORITY INTEREST**                                                                                                                                                 |       | 445                   |       | — |   |
| ** **                                                                                                                                                            | ** ** | ** **            | ** ** | ** ** | ** ** |
| **COMMITMENTS AND CONTINGENCIES**                                                                                                                                     |       |                  |       |   |   |
|                                                                                                                                                                  |       |                  |       |   |   |
| **STOCKHOLDERS’ EQUITY:**                                                                                                                                        |       |                  |       |   |   |
| Preferred stock, $.001 par value, 10,000,000 shares authorized, none  issued                                                                                          |       | —                |       | — |   |
| Common stock, $.001 par value, 30,000,000 shares authorized,  16,238,685 and 16,068,677 shares issued and 14,732,522 and 14,553,631 shares  outstanding, respectively |       | 16                    |       | 16 |   |
| Additional paid-in capital                                                                                                                                            |       | 164,746               |       | 160,319 |   |
| Retained earnings                                                                                                                                                     |       | 73,318                |       | 51,127 |   |
| Treasury stock (1,506,163 and 1,515,046 shares of common stock, at  cost, respectively)                                                                               |       | (12,034               | )          | (12,105 | ) |
| Accumulated other comprehensive income                                                                                                                                |       | 1,676                 |       | 1,092 |   |
| **Total stockholders’ equity**                                                                                                                                   |       | 227,722               |       | 200,449 |   |
| **Total liabilities and stockholders’ equity**                                                                                                                   |       | $                     | 636,921    |   | $ | 562,287 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

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** **

**CORNELL COMPANIES, INC.**

**CONSOLIDATED STATEMENTS OFINCOME AND COMPREHENSIVE INCOME (LOSS)**

**(in thousands, except per sharedata)**

 
| ** **                                                                                                              | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                              | ** ** | **2008**                                   | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                                                                                    |       |                                       |       |   |   |   |   |
| REVENUES                                                                                                                |       | $                                          | 386,724    |   | $ | 360,604 |   | $ | 360,855 |   |
| OPERATING EXPENSES, EXCLUDING DEPRECIATION                                                                              |       | 280,630                                    |       | 274,110 |   | 275,395 |   |
| PRE-OPENING AND START-UP EXPENSES                                                                                       |       | —                                     |       | — |   | 2,657 |   |
| DEPRECIATION AND AMORTIZATION                                                                                           |       | 17,943                                     |       | 15,986 |   | 16,285 |   |
| GENERAL AND ADMINISTRATIVE EXPENSES                                                                                     |       | 25,954                                     |       | 25,499 |   | 21,720 |   |
|                                                                                                                    |       |                                       |       |   |   |   |   |
| INCOME FROM OPERATIONS                                                                                                  |       | 62,197                                     |       | 45,009 |   | 44,798 |   |
| INTEREST EXPENSE                                                                                                        |       | 26,946                                     |       | 26,215 |   | 26,130 |   |
| INTEREST INCOME                                                                                                         |       | (2,988                                     | )          | (1,951 | ) | (3,060 | ) |
|                                                                                                                    |       |                                       |       |   |   |   |   |
| INCOME FROM CONTINUING OPERATIONS BEFORE PROVISION FOR INCOME TAXES  AND MINORITY INTEREST                              |       | 38,239                                     |       | 20,745 |   | 21,728 |   |
|                                                                                                                    |       |                                       |       |   |   |   |   |
| PROVISION FOR INCOME TAXES                                                                                              |       | 15,603                                     |       | 8,835 |   | 9,148 |   |
|                                                                                                                    |       |                                       |       |   |   |   |   |
| Income from Continuing operations                                                                                       |       | 22,636                                     |       | 11,910 |   | 12,580 |   |
|                                                                                                                    |       |                                       |       |   |   |   |   |
| MINORITY INTEREST IN CONSOLIDATED SPECIAL PURPOSE ENTITY                                                                |       | 445                                        |       | — |   | — |   |
|                                                                                                                    |       |                                       |       |   |   |   |   |
| DISCONTINUED OPERATIONS, NET OF TAX BENEFIT OF $381 in 2006                                                             |       | —                                     |       | — |   | (707 | ) |
|                                                                                                                    |       |                                       |       |   |   |   |   |
| NET INCOME                                                                                                              |       | $                                          | 22,191     |   | $ | 11,910 |   | $ | 11,873 |   |
|                                                                                                                    |       |                                       |       |   |   |   |   |
| EARNINGS PER SHARE:                                                                                                     |       |                                       |       |   |   |   |   |
| BASIC:                                                                                                                  |       |                                       |       |   |   |   |   |
| Income from continuing operations                                                                                       |       | $                                          | 1.55       |   | $ | .84 |   | $ | .90 |   |
| Loss from discontinued operations, net of tax                                                                           |       | —                                     |       | — |   | (.05 | ) |
| Net income                                                                                                              |       | $                                          | 1.55       |   | $ | .84 |   | $ | .85 |   |
|                                                                                                                    |       |                                       |       |   |   |   |   |
| DILUTED:                                                                                                                |       |                                       |       |   |   |   |   |
| Income from continuing operations                                                                                       |       | $                                          | 1.51       |   | $ | .82 |   | $ | .89 |   |
| Loss from discontinued operations, net of tax                                                                           |       | —                                     |       | — |   | (.05 | ) |
| Net income                                                                                                              |       | $                                          | 1.51       |   | $ | .82 |   | $ | .84 |   |
|                                                                                                                    |       |                                       |       |   |   |   |   |
| NUMBER OF SHARES USED IN PER SHARE COMPUTATION:                                                                         |       |                                       |       |   |   |   |   |
| BASIC                                                                                                                   |       | 14,298                                     |       | 14,149 |   | 13,918 |   |
| DILUTED                                                                                                                 |       | 14,698                                     |       | 14,480 |   | 14,059 |   |
|                                                                                                                    |       |                                       |       |   |   |   |   |
| COMPREHENSIVE INCOME (LOSS):                                                                                            |       |                                       |       |   |   |   |   |
| Net income                                                                                                              |       | $                                          | 22,191     |   | $ | 11,910 |   | $ | 11,873 |   |
| Unrealized gain (loss) on derivative instruments, net of tax  provision (benefit) of $324, $425 and ($75), respectively |       | 584                                        |       | 612 |   | (108 | ) |
| Comprehensive income                                                                                                    |       | $                                          | 22,775     |   | $ | 12,522 |   | $ | 11,765 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

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**CORNELL COMPANIES, INC.**

### **CONSOLIDATED STATEMENTSOF STOCKHOLDERS’ EQUITY**

**(in thousands, except share data)**

 
| ** **                                                      | ** ** | **Common Stock** | ** ** | **Additional** | ** ** | ** **  | ** ** | ** **   | ** ** | ** **              | ** ** | ** **   | ** ** | **Accumulated Other** | ** ** |
|-----------------------------------------------------------------|------------|-----------------------|------------|----------------|------------|-------------|------------|--------------|------------|-------------------------|------------|--------------|------------|-----------------------|------------|
| ** **                                                      | ** ** | ** **            | ** ** | **Par**        | ** ** | **Paid-In** | ** ** | **Retained** | ** ** | **Treasury Stock** | ** ** | **Deferred** | ** ** | **Comprehensive**     | ** ** |
| ** **                                                      | ** ** | **Shares**            | ** ** | **Value**      | ** ** | **Capital** | ** ** | **Earnings** | ** ** | **Shares**              | ** ** | **Cost**     | ** ** | **Compensation**      | ** ** | **Income(Loss)** | ** ** |
| ** **                                                      | ** ** | ** **            | ** ** | ** **     | ** ** | ** **  | ** ** | ** **   | ** ** | ** **              | ** ** | ** **   | ** ** | ** **            | ** ** | ** ** | ** ** |
| BALANCES AT  JANUARY 1, 2006                                    |       | 15,352,159            |       | 15             |       | 151,329     |       | 27,091       |       | 1,562,987               |       | (12,573      | )          | (990                  | )          | 589 |   |
|                                                            |       |                  |       |           |       |        |       |         |       |                    |       |         |       |                  |       |   |   |
| EXERCISE OF STOCK  OPTIONS                                      |       | 165,531               |       | 1              |       | 1,830       |       | 3⁄4       |       | 3⁄4                  |       | 3⁄4       |       | 3⁄4                |       | 3⁄4 |   |
| INCOME TAX  BENEFIT FROM STOCK OPTION EXERCISES                 |       | 3⁄4                |       | 3⁄4         |       | 224         |       | 3⁄4       |       | 3⁄4                  |       | 3⁄4       |       | 3⁄4                |       | 3⁄4 |   |
| ADOPTION OF SFAS  NO. 123R                                      |       | 3⁄4                |       | 3⁄4         |       | (990        | )          | 3⁄4       |       | 3⁄4                  |       | 3⁄4       |       | 990                   |       |   |   |
| OTHER  COMPREHENSIVE INCOME                                     |       | —                |       | 3⁄4         |       | 3⁄4      |       | 3⁄4       |       | 3⁄4                  |       | 3⁄4       |       | 3⁄4                |       | (108 | ) |
| DEFERRED AND  OTHER STOCK COMPENSATION                          |       | 58,327                |       | —         |       | 1,622       |       | —       |       | —                  |       | —       |       | 3⁄4                |       | — |   |
| ISSUANCE OF  COMMON STOCK TO EMPLOYEE STOCK PURCHASE PLAN       |       | 3⁄4                |       | 3⁄4         |       | 3⁄4      |       | 3⁄4       |       | (22,593                 | )          | 265          |       | 3⁄4                |       | 3⁄4 |   |
| ISSUANCE OF  COMMON STOCK UNDER 2000 DIRECTOR’S STOCK PLAN |       | 27,900                |       | 3⁄4         |       | 396         |       | 3⁄4       |       | 3⁄4                  |       | 3⁄4       |       | 3⁄4                |       | 3⁄4 |   |
| NET INCOME                                                      |       | 3⁄4                |       | 3⁄4         |       | 3⁄4      |       | 11,873       |       | 3⁄4                  |       | 3⁄4       |       | 3⁄4                |       | 3⁄4 |   |
|                                                            |       |                  |       |           |       |        |       |         |       |                    |       |         |       |                  |       |   |   |
| BALANCES AT  DECEMBER 31, 2006                             |       | 15,603,917            |       | 16             |       | 154,411     |       | 38,964       |       | 1,540,394               |       | (12,308      | )          | 3⁄4                |       | 481 |   |
|                                                            |       |                  |       |           |       |        |       |         |       |                    |       |         |       |                  |       |   |   |
| ADOPTION OF FIN  48                                             |       | —                |       | —         |       | —      |       | 253          |       | —                  |       | —       |       | —                |       | — |   |
| EXERCISE OF STOCK  OPTIONS AND WARRANTS                         |       | 234,182               |       | —         |       | 2,490       |       | —       |       | —                  |       | —       |       | 3⁄4                |       | 3⁄4 |   |
| INCOME TAX  BENEFIT FROM STOCK OPTION EXERCISES                 |       | —                |       | —         |       | 355         |       | —       |       | —                  |       | —       |       | 3⁄4                |       | 3⁄4 |   |
| OTHER  COMPREHENSIVE INCOME                                     |       | —                |       | —         |       | —      |       | —       |       | —                  |       | —       |       | —                |       | 611 |   |
| DEFERRED AND  OTHER STOCK COMPENSATION                          |       | 221,428               |       | —         |       | 2,644       |       | —       |       | —                  |       | —       |       | 3⁄4                |       | 3⁄4 |   |
| ISSUANCE OF  COMMON STOCK TO EMPLOYEE STOCK PURCHASE PLAN       |       | —                |       | —         |       | 94          |       | —       |       | (25,348                 | )          | 203          |       | 3⁄4                |       | 3⁄4 |   |
| ISSUANCE OF  COMMON STOCK UNDER 2000 DIRECTOR’S STOCK PLAN |       | 9,150                 |       | —         |       | 325         |       | —       |       | —                  |       | —       |       | 3⁄4                |       | 3⁄4 |   |
| NET INCOME                                                      |       | —                |       | —         |       | —      |       | 11,910       |       | —                  |       | —       |       | 3⁄4                |       | 3⁄4 |   |
|                                                            |       |                  |       |           |       |        |       |         |       |                    |       |         |       |                  |       |   |   |
| BALANCES AT  DECEMBER 31, 2007                             |       | 16,068,677            |       | 16             |       | 160,319     |       | 51,127       |       | 1,515,046               |       | (12,105      | )          | —                |       | 1,092 |   |
|                                                            |       |                  |       |           |       |        |       |         |       |                    |       |         |       |                  |       |   |   |
| EXERCISE OF STOCK  OPTIONS                                      |       | 36,390                |       | —         |       | 444         |       | —       |       | —                  |       | —       |       | —                |       | — |   |
| INCOME TAX  BENEFIT FROM STOCK OPTION EXERCISES                 |       | —                |       | —         |       | 140         |       | —       |       | —                  |       | —       |       | —                |       | — |   |
| OTHER COMPREHENSIVE  INCOME                                     |       | —                |       | —         |       | —      |       | —       |       | —                  |       | —       |       | —                |       | 584 |   |
| DEFERRED AND  OTHER STOCK COMPENSATION                          |       | 120,137               |       | —         |       | 3,271       |       | —       |       | —                  |       | —       |       | —                |       | — |   |
| ISSUANCE OF  COMMON STOCK TO EMPLOYEE STOCK PURCHASE PLAN       |       | —                |       | —         |       | 82          |       | —       |       | (8,883                  | )          | 71           |       | —                |       | — |   |
| ISSUANCE OF  COMMON STOCK UNDER 2000 DIRECTOR’S STOCK PLAN |       | 13,481                |       | —         |       | 490         |       | —       |       | —                  |       | —       |       | —                |       | — |   |
| NET INCOME                                                      |       | —                |       | —         |       | —      |       | 22,191       |       | —                  |       | —       |       | —                |       | — |   |
|                                                            |       |                  |       |           |       |        |       |         |       |                    |       |         |       |                  |       |   |   |
| BALANCES AT  DECEMBER 31, 2008                             |       | 16,238,685            |       | $              | 16         |        | $          | 164,746      |       | $                       | 73,318     |         | 1,506,163  |                  | $          | (12,034 | ) | $ | — |   | $ | 1,676 |   |
|                                                                 |            |                       |            |                |            |             |            |              |            |                         |            |              |            |                       |            |  |  |  |  |  |  |  |  |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

50

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**Table of Contents**

** **

**CORNELLCOMPANIES, INC.**

#### **CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in thousands)**

 
| ** **                                                                                              | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                              | ** ** | **2008**                                   | ** ** | **2007** | ** ** | **2006** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                                               | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                                              |       | $                                          | 22,191     |   | $ | 11,910 |   | $ | 11,873 |   |
| Adjustments to reconcile net income to net cash provided by  operating activities                  | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Minority interest in consolidated special purpose entity                                                |       | 445                                        |       | 3⁄4 |   | 3⁄4 |   |
| Impairment of long-lived assets                                                                         |       | 250                                        |       | 3⁄4 |   | 355 |   |
| Depreciation                                                                                            |       | 15,742                                     |       | 13,580 |   | 14,042 |   |
| Amortization of intangibles and other assets                                                            |       | 2,200                                      |       | 2,406 |   | 2,243 |   |
| Amortization of deferred financing costs                                                                |       | 2,728                                      |       | 1,552 |   | 1,772 |   |
| Amortization of Senior Notes discount                                                                   |       | 184                                        |       | 184 |   | 184 |   |
| Stock-based compensation                                                                                |       | 3,570                                      |       | 2,645 |   | 1,970 |   |
| Provision for bad debts                                                                                 |       | 2,741                                      |       | 2,063 |   | 2,702 |   |
| Gain on derivative instruments                                                                          |       | 1,160                                      |       | — |   | — |   |
| Loss/(gain) on sale of property and equipment                                                           |       | 84                                         |       | (190 | ) | (119 | ) |
| Deferred income taxes                                                                                   |       | 1,458                                      |       | 397 |   | 3,216 |   |
| Change in assets and liabilities, net of acquisitions:                                                  | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Accounts receivable                                                                                     |       | 614                                        |       | (3,757 | ) | (10,432 | ) |
| Other restricted assets                                                                                 |       | (1,058                                     | )          | (665 | ) | 976 |   |
| Other assets                                                                                            |       | 1,783                                      |       | 2,060 |   | 44 |   |
| Accounts payable and accrued liabilities                                                                |       | 7,771                                      |       | (4,890 | ) | 780 |   |
| Other liabilities                                                                                       |       | (2,884                                     | )          | (51 | ) | 58 |   |
| **Net cash provided by operating activities**                                                           |       | 58,979                                     |       | 27,244 |   | 29,664 |   |
|                                                                                                    |       |                                       |       |   |   |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                                               | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Capital expenditures                                                                                    |       | (79,915                                    | )          | (50,890 | ) | (12,317 | ) |
| Purchases of investment securities                                                                      |       | 3⁄4                                     |       | (241,425 | ) | (427,600 | ) |
| Sales of investment securities                                                                          |       | 250                                        |       | 253,100 |   | 422,925 |   |
| Facility acquisitions                                                                                   |       | 3⁄4                                     |       | (18,554 | ) | 3⁄4 |   |
| Site acquisition                                                                                        |       | 3⁄4                                     |       | (5,053 | ) | 3⁄4 |   |
| Proceeds from sale of property and equipment                                                            |       | 846                                        |       | 375 |   | 2,892 |   |
| Payments to restricted debt payment account, net                                                        |       | (2,901                                     | )          | (2,084 | ) | (3,367 | ) |
| **Net cash used in investing activities**                                                               |       | (81,720                                    | )          | (64,531 | ) | (17,467 | ) |
|                                                                                                    |       |                                       |       |   |   |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                                               | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Proceeds from line of credit                                                                            |       | 49,000                                     |       | 30,000 |   | 3⁄4 |   |
| Payments of MCF bonds                                                                                   |       | (11,400                                    | )          | (10,500 | ) | (9,700 | ) |
| Payments of line of credit                                                                              |       | (4,000                                     | )          | 3⁄4 |   | 3⁄4 |   |
| Payments of capital lease obligations                                                                   |       | (11                                        | )          | (10 | ) | (11 | ) |
| Payments for debt issuance and other financing costs                                                    |       | 3⁄4                                     |       | (845 | ) | 3⁄4 |   |
| Tax benefit of stock option exercises                                                                   |       | 140                                        |       | 355 |   | 224 |   |
| Proceeds from exercise of stock options and warrants                                                    |       | 597                                        |       | 2,786 |   | 2,096 |   |
| **Net cash (used in) provided by financing  activities**                                                |       | 34,326                                     |       | 21,786 |   | (7,391 | ) |
|                                                                                                    |       |                                       |       |   |   |   |   |
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                                    |       | 11,585                                     |       | (15,501 | ) | 4,806 |   |
| CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD                                                        |       | 3,028                                      |       | 18,529 |   | 13,723 |   |
| CASH AND CASH EQUIVALENTS AT END OF PERIOD                                                              |       | $                                          | 14,613     |   | $ | 3,028 |   | $ | 18,529 |   |
|                                                                                                    |       |                                       |       |   |   |   |   |
| **SUPPLEMENTAL CASH FLOW DISCLOSURE:**                                                                  | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest paid, net of capitalized interest of $2,886, $1,172 and  $1,494, respectively                  |       | $                                          | 18,596     |   | $ | 30,672 |   | $ | 25,317 |   |
| Income taxes paid                                                                                       |       | $                                          | 12,048     |   | $ | 7,613 |   | $ | 3,947 |   |
|                                                                                                    |       |                                       |       |   |   |   |   |
| **OTHER NON-CASH INVESTING AND FINANCING  ACTIVITIES:**                                                 | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Decrease in fair value of interest rate swap                                                            |       | $                                          | 3⁄4     |   | $ | (1,053 | ) | $ | (908 | ) |
| Purchases and additions to property and equipment included in  accounts payable and accrued liabilities |       | 3,409                                      |       | 4,156 |   | 3⁄4 |   |
| Common stock issued for board of directors fees                                                         |       | 490                                        |       | 325 |   | 396 |   |
| Equipment additions under capital leases                                                                |       | 3⁄4                                     |       | 3⁄4 |   | 56 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

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** **

**CORNELLCOMPANIES, INC.**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

**1.****             ****DESCRIPTIONOF THE BUSINESS**

 

Cornell Companies, Inc. (collectively with itssubsidiaries and consolidated special purpose entities, unless the contextrequires otherwise, “Cornell,” the “Company,” “we,” “us,” or “our,”) a Delawarecorporation provides integrated development, design, construction andmanagement of facilities to governmental agencies within three operatingsegments: (1) Adult Secure Services; (2) Abraxas Youth and FamilyServices and (3) Adult Community-Based Services.

 

**2.****             ****SIGNIFICANTACCOUNTING POLICIES**

 

***Consolidation***

 

The accompanying consolidated financial statementsinclude the accounts of the Company, our wholly-owned subsidiaries, and ouractivities relative to a financing of operating facilities. All significantintercompany balances and transactions have been eliminated. Minority interestin consolidated special purpose entities represents equity that other investorshave contributed to the special purpose entities. Minority interest is adjustedfor income and losses allocable to the owners of the special purpose entities.As the cumulative losses of the special purpose entity exceed the equity thatis recorded as minority interest, the excess losses are recorded in ourStatements of Operations and Comprehensive Income (Loss).

 

***Cash and CashEquivalents***

 

We consider all highly liquid unrestrictedinvestments with original maturities of three months or less to be cashequivalents. We invest our available cash balances in short term money marketaccounts, short term certificates of deposit and commercial paper.

 

***Investment Securities***

 

We had no investment securities at December 31,2008. Our investment securities at December 31, 2007 consisted ofcertificates of deposit.

 

Our certificates of deposit which totaledapproximately $0.3 million at December 31, 2007 earned interest at a rateof 3.80% at December 31, 2007.  Theyhad original maturities of one year.

 

Our marketable securities were categorized asavailable-for-sale securities. Unrealized marketable securities gains andtemporary losses were reflected as a net amount under the caption ofaccumulated other comprehensive income within the statement of stockholders’equity. Realized gains and losses were recorded within the statement of incomeunder the caption interest income or interest expense. For the purpose ofcomputing realized gains and losses, cost was identified on a specificidentification basis.

 

Contractual maturities of the underlying investmentsecurities held at December 31, 2007 matured in less than one year.

 

***AccountsReceivable and Related Allowance for Doubtful Accounts***

 

We extend credit to the governmental agencies andother parties with which we contract in the normal course of business. Weregularly review our outstanding receivables and historical collectionexperience, and provide for estimated losses through an allowance for doubtfulaccounts. In evaluating the adequacy of our allowance for doubtful accounts, wemake judgments regarding our customers’ ability to make required payments,economic events and other factors. As the financial condition of these partieschange, circumstances develop or additional information becomes available,adjustments to the allowance for doubtful accounts may occur. If, afterreasonable collection efforts have been made, a receivable is determined to bepermanently uncollectible, it will be written off.

 

At December 31, 2008 and 2007, otherreceivables include approximately $4.9 million and $5.1 million related tomisappropriated escrow funds for the Southern Peaks Regional Treatment Center,which is fully reserved at December 31, 2008 and 2007.

 

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Thechanges in allowance for doubtful accounts associated with trade accountsreceivable for the years ended December 31, 2008, 2007 and 2006 are asfollows (in thousands):

 

| ** **                           | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------|------------|--------------------------------------------|------------|
| ** **                           | ** ** | **2008**                                   | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                 |       |                                       |       |   |   |   |   |
| Balance at beginning of period       |       | $                                          | 4,372      |   | $ | 3,644 |   | $ | 3,278 |   |
| Provision for bad debts              |       | 2,741                                      |       | 2,063 |   | 2,702 |   |
| Write-offs of uncollectible accounts |       | (2,841                                     | )          | (1,335 | ) | (2,336 | ) |
| Balance at end of period             |       | $                                          | 4,272      |   | $ | 4,372 |   | $ | 3,644 |   |

 

***Restricted Assets***

 

Restricted assets at December 31, 2008 and 2007include approximately $27.9 million and $25.0 million, respectively, of MunicipalCorrectional Finance, LP’s (“MCF”) restricted cash accounts. MCF’s restrictedaccounts primarily consist of a debt service fund used to segregate rentalpayment funds from us to MCF for MCF’s semi-annual debt service. MCF’s fundsare typically invested in short term certificates of deposit, money marketaccounts and commercial paper. They will be used to fund a portion of MCF’sdebt service due in the coming year.

 

At certain facilities, we maintain bank accounts forrestricted cash belonging to facility residents, commissary operations andequipment replacement funds used in certain state programs. Restrictedassets at December 31, 2008 and 2007 include approximately $3.4 millionand $2.5 million, respectively, for these accounts. A corresponding liabilityfor these obligations is included in accrued liabilities in the accompanyingfinancial statements.

 

***Property andEquipment***

 

Property and equipment are recorded at cost.Ordinary maintenance and repair costs are expensed, while renewal and bettermentcosts are capitalized. Buildings and improvements are depreciated over theirestimated useful lives of 30 to 50 years using the straight-line method.Prepaid facility use cost, which resulted from the July 1996 acquisitionof the Big Spring Correctional Center and the December 1999 transfer ofownership of the Great Plains Correctional Facility to a leasehold interest, isbeing amortized over 50 years using the straight-line method. Furniture andequipment are depreciated over their estimated useful lives of 3 to 10 years using thestraight-line method. Amortization of leasehold improvements (including thosefunded by landlord incentives or allowances) is recorded using thestraight-line method based upon the shorter of the economic life of the assetor the term of the respective lease. Landlord incentives or allowances underoperating leases are recorded as deferred rent and amortized as a reduction ofrent expense over the lease term. See Note 4 to the consolidated financialstatements for further details concerning our property and equipment balancesat December 31, 2008 and 2007.

 

Wereview our long-lived assets for impairment at least annually or when changesin circumstances or a triggering event indicates that the carrying amount ofthe asset may not be recoverable in accordance with the provisions of SFAS No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets.”  SFAS No. 144 requires that long-livedassets to be held and used recognize an impairment loss only if the carryingamount of the long-lived asset is not recoverable from its undiscounted cashflows and to measure an impairment loss as the difference between the carryingvalue and the fair value of the asset. Assets to be disposed of by sale are recorded at the lower of their carryingamount or fair value less estimated selling costs. We estimate fair value basedupon the best information available, which may include expected futurediscounted cash flows to be produced by the asset and/or available marketprices. Factors that significantly influence estimated future discounted cashflows include the periods and levels of occupancy for the facility, expectedper diem or reimbursement rates, assumptions regarding the levels of staffing,services and future operating and capital expenditures necessary to generateforecasted revenues, related costs for these activities and future rate ofincreases or decreases associated with these factors. We also consider theresults of any appraisals on the properties when assessing fair value. Theseestimates may be highly subjective, particularly in circumstances where thereis no current operating contract in place and changes in the assumptions andestimates could result in the recognition of impairment charges.

 

***CapitalizedInterest***

 

We capitalize interest on facilities while underconstruction. Interest capitalized for the year ended December 31, 2008was approximately $2.9 million and related to the expansion projects at the D.Ray James Prison and the Great Plains Correctional Facility. Interestcapitalized for the year ended December 31, 2007 was approximately $1.2million and related to the expansion projects at the Big Spring CorrectionalCenter, the D. Ray James Prison and the Great Plains Correctional

 

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Facility.Interest capitalized for the year ended December 31, 2006 wasapproximately $1.5 million and related to construction of the Moshannon ValleyCorrectional Center.

 

***Debt ServiceReserve Fund***

 

The debt service reserve fund was established at theclosing of MCF’s bond issuance and is to be used solely for MCF’s debt serviceto the extent that funds in MCF’s debt service accounts are insufficient. Thedebt service reserve fund is invested principally in short term commercial instruments. See Note 11 to theconsolidated financial statements.

 

***Intangible Assets***

 

Weevaluate the carrying value of our existing intangibles (which are the resultof prior acquisitions — both business facilities and operating contracts) forimpairment annually. We have evaluated the carrying value of our existingintangibles and believe there has not been impairment to the carrying value ofour existing intangibles as of December 31, 2008. See Note 5 to theconsolidated financial statements for further details concerning our intangibleassets.

 

***Deferred Costs***

 

Costs incurred related to obtaining debt financingare capitalized and amortized over the term of the related indebtedness. At December 31,2008 and 2007, we had net deferred debt issuance costs of approximately $7.6million and $8.6 million, respectively. In the year ended December 31,2007 we incurred approximately $0.8 million in financing costs related to ourAmended Credit Facility.

 

***RevenueRecognition***

 

Substantially all of our revenues are derived fromcontracts with federal, state and local governmental agencies, which pay eitherper diem rates based upon the number of occupant days or hours served for theperiod, on a take-or-pay basis, management fee basis, cost-plus reimbursementor fee-for-service basis. Revenues are recognized as services are providedunder our established contractual agreements to the extent collection isconsidered probable.

 

***Pre-opening andStart-up Expenses***

 

Pre-opening and start-up expenses are charged tooperations as incurred. Pre-opening and start-up expenses include payroll,benefits, training and other operating costs during periods prior to opening anew or expanded facility and during the period of operation while occupancy isramping up. These costs vary by contract. Newly opened facilities are staffedaccording to applicable regulatory or contractual requirements when we beginreceiving offenders or clients. Offenders or clients are typically assigned toa newly opened facility on a phased-in basis over a one-to-six month period.Our start-up period for new juvenile operations is 12 months from the date webegin recognizing revenue unless break-even occupancy is achieved before then.Our start-up period for new adult operations is nine months from the date webegin recognizing revenue unless break-even occupancy is achieved before then.

 

***Proposal Costs***

 

We incur various expenses in conjunction with ourparticipation in the proposal process with government agencies for theirprocurement of our services. These costs include such items as payroll andrelated employee benefits and taxes, research, consulting, legal andreproduction costs and are expensed in the periods incurred.

 

***Operating andGeneral and Administrative Expenses***

 

We incur various expenses within the normal courseof our business. Included in operating expenses are direct expense items suchas personnel/employee benefits, resident/inmate care expenses and building/utilitycosts pertaining to the operations of our facilities and programs. Included ingeneral and administrative expenses are expense items such aspersonnel/employee benefits, professional services and building/utility costspertaining to our corporate activities.

 

***BusinessConcentration***

 

Contracts with federal, state and local governmentalagencies account for nearly all of our revenues. The loss of, or a significantdecrease in, business from one or more of these governmental agencies couldhave a material adverse effect on our financial condition and results ofoperations. For the years ended December 31, 2008, 2007 and 2006, 34.2%,32.6% and

 

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29.1%,respectively, of our consolidated revenues were derived from contracts with theFederal Bureau of Prisons (“BOP”), the only customer constituting more than10.0% of our revenues during each of these periods.

 

***Self InsuranceReserves***

 

Wemaintain insurance coverage for various aspects of our business and operations.We retain a portion of losses that occur through the use of deductibles andretention under self-insurance programs. These programs include workerscompensation and employer’s liability, general liability and professionalliability, directors and officers’ liability and medical and dental insurance.We maintain deductibles under these programs in amounts ranging from $0.5million to $1.0 million. We maintain excess loss insurance for amountsexceeding our deductibles.

 

Weregularly review our estimates of reported and unreported claims and providefor these losses through insurance reserves. These reserves are influenced byrising costs of health care and other costs, increases in claims, time lags inclaim information and levels of insurance coverage carried. As claims developand additional information becomes available to us, adjustments to the relatedloss reserves may occur. Our estimated reserves for workers compensation claimsincorporate the use of a 5% discount factor. Our reserves for medical andworker’s compensation claims are subject to change based on our estimate of thenumber and magnitude of claims to be incurred.

 

***Stock-BasedCompensation***

 

We have an employee stock purchase plan (“ESPP”) under whichemployees can make contributions to purchase our common stock. Participation inthe plan is elected annually by employees. The plan year begins on January 1st(the “Beginning Date”) and ends on December 31st (the “Ending Date”). For2007, however, the plan year began April 1, 2007. Purchases of commonstock are made at the end of the year using the lower of the fair market valueon either the Beginning Date or Ending Date, less a 15% discount. Under SFAS No. 123R, ouremployee-stock purchase plan is considered to be a compensatory ESPP, andtherefore, we recognize compensation expense over the requisite service periodfor grants made under the ESPP.

 

Our stock incentive plansprovide for the granting of stock options (both incentive stock options andnonqualified stock options), stock appreciation rights, restricted stock sharesand other stock-based awards to officers, directors and employees of theCompany. Grants of stock options made to date under these plans vest overperiods up to seven years after the date of grant and expire no more than 10years after grant.

 

At December 31,2007, 127,500 shares of restricted stock outstanding were subject toperformance-based vesting criteria (32,500 of these restricted shares wereconsidered market-based restricted stock under SFAS No. 123R). There werealso 79,000 stock options outstanding subject to performance-based vestingcriteria. We recognized $0.6 million of expense associated with these shares ofrestricted stock and stock options during the year ended December 31,2007.

 

At December 31,2008, 184,000 shares of restricted stock were outstanding subject toperformance-based vesting criteria (32,500 of these restricted shares wereconsidered market-based restricted stock under SFAS No. 123R). There werealso 52,700 stock options outstanding subject to performance-based vestingcriteria. We recognized $1.1 million of expense associated with these shares ofrestricted stock and stock options during the year ended December 31,2008.

 

The amounts above relate to the impact of recognizingcompensation expense related to stock options and restricted stock.Compensation expense related to stock options (52,700 shares) and restrictedstock (151,500 shares) that vest based upon performance conditions is notrecorded for such performance-based awards until it has been deemed probablethat the related performance targets allowing the vesting of these options andrestricted stock will be met. We are required to periodically re-assess theprobability that these performance-based awards will vest and record expense atthat point in time. During the year ended December 31, 2008 it was deemedprobable that certain performance targets pertaining to certain restrictedstock and stock options would be achieved by their vesting date. Accordingly,compensation expense of approximately $1.0 million was recognized in the yearended December 31, 2008 related to these performance-based awards.

 

We recognize expense for our stock-based compensation over the vestingperiod, which represents the period in which an employee is required to provideservice in exchange for the award. We recognize compensation expense forstock-based awards immediately if the award has immediate vesting.

 

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*Assumptions*

 

Thefair values for the significant stock-based awards granted during the yearsended December 31, 2008, 2007 and 2006 were estimated at the date of grantusing a Black-Scholes option pricing model with the following weighted-averageassumptions:

 

| ** **                       | ** ** | **Years Ended December, 31** | ** ** |
|----------------------------------|------------|----------------------------------------|------------|
| ** **                       | ** ** | **2008**                               | ** ** | **2007** | ** ** | **2006** | ** ** |
|                             |       |                                   |       |   |   |   |   |
| Risk-free rate of return         |       | 3.35%                                  |       | 4.56% |   | 4.31% |   |
| Expected life of award           |       | 5.7  years                             |       | 5.6  years |   | 5  years |   |
| Expected dividend yield of stock |       | 0%                                     |       | 0% |   | 0% |   |
| Expected volatility of stock     |       | 38.74%                                 |       | 42.19% |   | 45.48% |   |
| Weighted-average fair value      |       | $9.46                                  |       | $9.86 |   | $6.24 |   |

 

Theexpected volatility of stock assumption was derived by referring to changes inthe Company’s historical common stock prices over a timeframe similar to thatof the expected life of the award. We currently have no reason to believe thatfuture stock volatility will significantly differ from historical stockvolatility. Estimated forfeiture rates are derived from historical forfeiturepatterns. We believe the historical experience method is the best estimate offorfeitures currently available.

 

Inaccordance with SAB 107, we generally considered the “simplified” method for “plainvanilla” options to estimate the expected term of options granted during theperiods noted (where appropriate).  Forthose grants during these periods wherein we had sufficient historical orimpartial data to better estimate the expected term, we have done so.

 

Stock-basedaward activity during the year ended December 31, 2008 was as follows(aggregate intrinsic value in millions):

 
| ** **                                            | ** ** | **Number  of  Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|-------------------------------------------------------|------------|------------------------|------------|----------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------|------------|
|                                                  |       |                   |       |                                   |       |                                                |       |                            |       |
| Outstanding at December 31, 2005                 |       | 739,056                |       | $                                      | 12.25      |                                                | 5.0        |                            | $          | 9.1 |   |
| Granted                                               |       | 158,000                |       |                                   |       |                                                |       |                            |       |
| Exercised                                             |       | (164,661               | )          |                                   |       |                                                |       |                            |       |
| Forfeited or canceled                                 |       | (78,648                | )          |                                   |       |                                                |       |                            |       |
|                                                  |       |                   |       |                                   |       |                                                |       |                            |       |
| Outstanding at December 31, 2006                 |       | 653,747                |       | 12.87                                  |       | 6.1                                                 |       | $                               | 8.4        |   |
| Granted                                               |       | 72,950                 |       |                                   |       |                                                |       |                            |       |
| Exercised                                             |       | (161,590               | )          |                                   |       |                                                |       |                            |       |
| Forfeited or canceled                                 |       | (74,265                | )          |                                   |       |                                                |       |                            |       |
|                                                  |       |                   |       |                                   |       |                                                |       |                            |       |
| Outstanding at December 31, 2007                 |       | 490,842                |       | 14.19                                  |       | 7.3                                                 |       | $                               | 7.0        |   |
| Granted                                               |       | 45,000                 |       | 22.68                                  |       |                                                |       |                            |       |
| Exercised                                             |       | (36,390                | )          | 12.20                                  |       |                                                |       |                            |       |
| Forfeited or canceled                                 |       | (13,753                | )          | 17.73                                  |       |                                                |       |                            |       |
|                                                  |       |                   |       |                                   |       |                                                |       |                            |       |
| Outstanding at December 31, 2008                 |       | 485,699                |       | $                                      | 15.03      |                                                | 6.5        |                            | $          | 7.3 |   |
|                                                  |       |                   |       |                                   |       |                                                |       |                            |       |
| Vested and expected to vest at December 31, 2008 |       | 477,218                |       | $                                      | 14.93      |                                                | 6.5        |                            | $          | 6.9 |   |
|                                                  |       |                   |       |                                   |       |                                                |       |                            |       |
| Exercisable at December 31, 2008                 |       | 390,581                |       | $                                      | 14.77      |                                                | 6.3        |                            | $          | 5.8 |   |

 

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Thetotal intrinsic value of stock options exercised during the years ended December 31,2008, 2007 and 2006 was $0.5 million, $1.5 million and $0.6 million,respectively. Net cash proceeds from the exercise of stock options wereapproximately $0.4 million, $2.5 million and $2.1 million for the years ended December 31,2008, 2007 and 2006, respectively.

 

Asof December 31, 2008, approximately $0.2 million of estimated expense withrespect to nonvested stock-based awards had yet to be recognized and will beamortized into expense over the employee’s estimated remaining weighted averageservice period of approximately 7.9 months.

 

Thefollowing table summarizes information with respect to stock optionsoutstanding and exercisable at December 31, 2008.

 
| **Range of Exercise Prices** | ** ** | **Number  Outstanding** | ** ** | **Weighted  Average  Remaining  Life (Years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|---------------------------------------------|------------|-------------------------|------------|-----------------------------------------------------|------------|----------------------------------------|------------|-------------------------|------------|----------------------------------------|------------|
|                                        |       |                    |       |                                                |       |                                   |       |                    |       |                                   |       |
| $ 3.75  to  $10.00 |       | 20,855                  |       | 2.6                                                 |       | $                                      | 5.90       |                    | 20,855     |                                   | $          | 5.90 |   |
| 10.01  to  13.50        |       | 156,519                 |       | 5.6                                                 |       | 12.82                                  |       | 143,576                 |       | 12.81                                  |       |
| 13.51  to  14.50        |       | 193,500                 |       | 6.7                                                 |       | 13.95                                  |       | 135,000                 |       | 13.87                                  |       |
| 14.51  to  25.00        |       | 114,825                 |       | 8.2                                                 |       | 21.52                                  |       | 91,150                  |       | 21.21                                  |       |
|                                        |       | 485,699                 |       | 6.5                                                 |       | $                                      | 15.03      |                    | 390,581    |                                   | $          | 14.77 |   |

 

Stock-basedaward activity for nonvested awards during the year ended December 31,2008 was as follows:

 

| ** **                          | ** ** | **Number  of  Shares** | ** ** | **Weighted Average  Grant Date  Fair Value** | ** ** |
|-------------------------------------|------------|------------------------|------------|-------------------------------------------------------------|------------|
|                                |       |                   |       |                                                        |       |
| Nonvested at December 31, 2005 |       | 362,669                |       | $                                                           | 13.14      |   |
| Granted                             |       | 158,000                |       | 14.02                                                       |       |
| Vested                              |       | (191,919               | )          | 13.43                                                       |       |
| Canceled                            |       | (8,093                 | )          | 13.16                                                       |       |
|                                |       |                   |       |                                                        |       |
| Nonvested at December 31, 2006 |       | 320,657                |       | 13.40                                                       |       |
| Granted                             |       | 72,950                 |       | 21.40                                                       |       |
| Vested                              |       | (101,683               | )          | 15.68                                                       |       |
| Canceled                            |       | (74,265                | )          | 13.48                                                       |       |
|                                |       |                   |       |                                                        |       |
| Nonvested at December 31, 2007 |       | 217,659                |       | 14.99                                                       |       |
| Granted                             |       | 45,000                 |       | 22.68                                                       |       |
| Vested                              |       | (153,788               | )          | 16.32                                                       |       |
| Canceled                            |       | (13,753                | )          | 17.73                                                       |       |
|                                |       |                   |       |                                                        |       |
| Nonvested at December 31, 2008 |       | 95,118                 |       | $                                                           | 16.09      |   |

 

***Restricted Stock***

 

We have previously issuedrestricted stock under certain employment agreements and stock incentive planswhich vests either over a specific period of time, generally three to fiveyears, or which will vest subject to certain market or performanceconditions.  During the year ended December 31,2008, we issued restricted stock as part of our normal equity awards under our2006 Equity Incentive Plan.  These sharesof restricted common stock are subject to restrictions on transfer and certainconditions to vesting.

 

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Restricted stock activityfor the year ended December 31, 2008 was as follows:

 

| ** **                          | ** ** | **Number  of  Shares** | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
|-------------------------------------|------------|------------------------|------------|---------------------------------------------------------|------------|
|                                |       |                   |       |                                                    |       |
| Nonvested at December 31, 2005 |       | 111,673                |       | $                                                       | 12.37      |   |
| Granted                             |       | 3⁄4                 |       | 3⁄4                                                  |       |
| Vested                              |       | (15,676                | )          | 17.15                                                   |       |
| Canceled                            |       | (10,997                | )          | 17.15                                                   |       |
|                                |       |                   |       |                                                    |       |
| Nonvested at December 31, 2006 |       | 85,000                 |       | 10.87                                                   |       |
| Granted                             |       | 287,000                |       | 22.30                                                   |       |
| Vested                              |       | (5,000                 | )          | 21.33                                                   |       |
| Canceled                            |       | (64,000                | )          | 9.80                                                    |       |
|                                |       |                   |       |                                                    |       |
| Nonvested at December 31, 2007 |       | 303,000                |       | 21.75                                                   |       |
| Granted                             |       | 161,000                |       | 22.38                                                   |       |
| Vested                              |       | (33,876                | )          | 16.77                                                   |       |
| Canceled                            |       | (27,000                | )          | 21.47                                                   |       |
|                                |       |                   |       |                                                    |       |
| Nonvested at December 31, 2008 |       | 403,124                |       | $                                                       | 22.44      |   |

 

We recognized $1.5million of expense associated with nonvested time-based restricted stock awardsduring the year ended December 31, 2008. As of December 31, 2008, approximately $3.0 million of estimatedexpense with respect to nonvested time-based restricted stock awards had yet tobe recognized and will be amortized over a weighted average period of 2.3years. Approximately $3.1 million of estimated expense with respect tononvested performance-based restricted stock option awards had yet to berecognized as of December 31, 2008.

 

***Income Taxes***

 

We utilize the liability method of accounting forincome taxes. Under this method, deferred tax assets and liabilities arerecognized for the future tax consequences attributable to differences betweenthe financial statement carrying values of existing assets and liabilities andtheir respective tax bases based on enacted tax rates. In providing fordeferred taxes, we consider current tax regulations, estimates of futuretaxable income and available tax planning strategies. If tax regulations,operating results or the ability to implement tax planning strategies vary,adjustments to the carrying value of tax assets and liabilities may occur. SeeNote 7 to the consolidated financial statements.

 

***Earnings PerShare***

 

Basic earnings per share (EPS) are computed bydividing net income by the weighted average number of shares of common stockoutstanding during the period. Diluted EPS reflects the potential dilution fromcommon stock equivalents such as stock options and warrants. For the year endedDecember 31, 2008, there were 64,200 shares ($23.24 average price) ofstock options that were not included in the computation of diluted EPS becauseto do so would have been anti-dilutive. For the year ended December 31, 2007, there were 19,200 shares($24.56 average price) of stock options that were not included in thecomputation of diluted EPS because to do so would have been anti-dilutive. Forthe year ended December 31, 2006, there were no anti-dilutive shares.

 

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The followingtable summarizes the calculation of income (loss) and the weighted averagecommon shares and common equivalent shares outstanding for purposes of thecomputation of earnings (loss) per share (in thousands, except per share data):

 
| ** **                                                               | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                               | ** ** | **2008**                                   | ** ** | **2007** | ** ** | **2006** | ** ** |
| Income from continuing  operations                                       |       | $                                          | 22,191     |   | $ | 11,910 |   | $ | 12,580 |   |
| Loss from discontinued  operations, net of tax                           |       | 3⁄4                                     |       | 3⁄4 |   | (707 | ) |
| Net income                                                               |       | $                                          | 22,191     |   | $ | 11,910 |   | $ | 11,873 |   |
|                                                                     |       |                                       |       |   |   |   |   |
| Weighted average common shares  outstanding                              |       | 14,298                                     |       | 14,149 |   | 13,918 |   |
| Weighted average common share  equivalents outstanding                   |       | 400                                        |       | 331 |   | 141 |   |
|                                                                     |       |                                       |       |   |   |   |   |
| Weighted average common shares  and common share equivalents outstanding |       | 14,698                                     |       | 14,480 |   | 14,059 |   |
|                                                                     |       |                                       |       |   |   |   |   |
| Basic income (loss) per share:                                           |       |                                       |       |   |   |   |   |
| Income from continuing  operations                                       |       | $                                          | 1.55       |   | $ | .84 |   | $ | .90 |   |
| Loss from discontinued  operations, net of tax                           |       | 3⁄4                                     |       | 3⁄4 |   | (.05 | ) |
| Net income                                                               |       | $                                          | 1.55       |   | $ | .84 |   | $ | .85 |   |
|                                                                     |       |                                       |       |   |   |   |   |
| Diluted income (loss) per share:                                         |       |                                       |       |   |   |   |   |
| Income from continuing  operations                                       |       | $                                          | 1.51       |   | $ | .82 |   | $ | .89 |   |
| Loss from discontinued  operations, net of tax                           |       | 3⁄4                                     |       | 3⁄4 |   | (.05 | ) |
| Net income                                                               |       | $                                          | 1.51       |   | $ | .82 |   | $ | .84 |   |

 

***FinancialInstruments***

 

Thecarrying amounts of our financial instruments, including cash and cashequivalents, investment securities, accounts receivable and accounts payableand accrued expenses, approximate fair value due to the short maturities ofthese financial instruments. At December 31, 2008, the carrying amount ofconsolidated debt was $320.5 million, and the estimated fair value was $308.0million. At December 31, 2007, the carrying amount was $286.7 million, andthe estimated fair value was $303.2 million. The estimated fair value oflong-term debt is based primarily on quoted market prices or discounted cashflow analysis for the same or similar issues.

 

***DerivativeInstruments***

 

Derivatives are recognized at fair value in theconsolidated balance sheet.  Forderivatives designated as hedging the exposure to changes in fair value of an assetor liability, the gain or loss is recognized in earnings together with theoffsetting gain or loss on the hedged item. For derivatives designated as hedging the exposure of variable cashflows, the effective portion is reported in other comprehensive income andsubsequently reclassified to earnings when the forecasted transaction affectsearnings.  For derivatives not designatedor de-designated as a hedging instrument, the gain or loss is recognized inearnings in the period of change.

 

***Use of Estimates***

 

Our financial statements are prepared in accordancewith accounting principles generally accepted in the United States of America,which require that we make certain estimates and judgments that affect ourreported amounts of assets, liabilities, revenues and expenses and thedisclosures of contingent assets and liabilities. We evaluate our estimates onan on-going basis, based on historical experience and on various otherassumptions that we believe to be reasonable based on the information available.Actual results could differ from these estimates under different assumptions orconditions. The significant estimates that we make in the accompanyingconsolidated financial statements include the allowance for doubtful accounts,accruals for insurance and legal claims, accruals for compensated employeeabsences, valuation allowance for deferred tax accounts, the realizability oflong-lived tangible and intangible assets and the fair value of financialinstruments.

 

***Reclassifications***

 

Certain reclassifications have been made to theprior period financial statements contained herein to conform to current yearpresentation. The impairment charge of $0.4 million in the year ended December31, 2006 was reclassed to operating expenses in the accompanying ConsolidatedStatements of Income and Comprehensive Income (Loss).

 

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**3.****    ****NEW ACCOUNTING PRONOUNCEMENTS**

 

***Statementof Financial Accounting Standards No. 157***

 

InSeptember 2006, the FASB issued SFAS No. 157, “Fair ValueMeasurements” (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework formeasuring fair value within generally accepted accounting principles andexpands disclosures about fair value measurements for financial assets andliabilities, as well as for any other assets and liabilities that are carriedat fair value on a recurring basis in the financial statements. SFAS No. 157became effective for financial statements issued for fiscal years beginningafter November 15, 2007, and interim periods within those fiscalyears.  This statement appliesprospectively to financial assets and liabilities. In February 2008, theFASB issued FSP 157-2, which delayed the effective date of SFAS No. 157 byone year for nonfinancial assets and liabilities.  Our adoption of SFAS No. 157 on January 1,2008 with respect to financial assets and liabilities did not have a materialfinancial impact on our consolidated results of operations or financialcondition.  We are currently evaluatingthe impact of implementation with respect to nonfinancial assets andliabilities on our consolidated financial statements.

 

Weadopted SFAS No. 157 on January 1, 2008 for our financial assets andliabilities measured on a recurring basis. As defined in SFAS No. 157, fair value is the price that would bereceived to sell an asset or paid to transfer a liability in an orderlytransaction between market participants at the measurement date (“exit price”).  SFAS No. 157 requires disclosure thatestablishes a framework for measuring fair value and expands disclosures aboutfair value measurements.  SFAS No. 157requires that fair value measurements be classified and disclosed in one of thefollowing categories:

 
| Level 1 | Unadjusted  quoted prices in active markets that are accessible at the measurement date  for identical, unrestricted assets or liabilities;                                       |
|---------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |                                                                                                                                                                              |
| Level 2 | Quoted  prices in markets that are not active, or inputs that are observable, either  directly or indirectly, for substantially the full term of the asset or  liability; and     |
|    |                                                                                                                                                                              |
| Level 3 | Prices  or valuation techniques that require inputs that are both significant to the  fair value measurement and unobservable (i.e., supported by little or no  market activity). |

 

Asrequired by SFAS No. 157, financial assets and liabilities are classifiedbased on the lowest level of input that is significant for the fair valuemeasurement.  The following tablesummarizes the valuation of our financial assets and liabilities by pricinglevels, as defined by the provisions of SFAS No. 157, as of December 31,2008:

 
| ** **                | ** ** | **Fair Value as of  December 31, 2008 (in thousands)** | ** ** |
|---------------------------|------------|-------------------------------------------------------------------------------------------|------------|
| ** **                | ** ** | **Level 1**                                                                          | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
| Assets:                   |       |                                                                                      |       |   |   |   |   |   |   |
| Cash and Cash Equivalents |       | $                                                                                         | 14,613     |   | $ | — |   | $ | — |   | $ | 14,613 |   |
| Corporate Bonds           |       | —                                                                                    |       | 10,286 |   | — |   | 10,286 |   |
| Money Market Funds        |       | —                                                                                    |       | 41,402 |   | — |   | 41,402 |   |
|                           |            |                                                                                           |            |  |  |  |  |  |  |  |  |  |  |

 

Thecorporate bonds and money market funds are carried in debt service fund andother restricted assets and the debt service reserve fund in the accompanyingbalance sheet. The derivative instrument was carried in other long termliabilities in the accompany balance sheet. The derivative instrument wasdetermined to have no fair value at December 31, 2008. See Note 11 to theconsolidated financial statements. 

 

SFASNo. 157 requires a reconciliation of the beginning and ending balances forfair value measurements using Level 3 inputs. The table below sets forth areconciliation for assets and liabilities measured at fair value on a recurringbasis using significant unobservable inputs (Level 3) during the year endedDecember 31, 2008 (in thousands): 

 

| Derivative instruments as of December 31, 2007 |   | $      | 2,151  |   |
|-----------------------------------------------------|--------|--------|--------|--------|
| Change in fair value                                |   | (2,151 | )      |
| Derivative instruments as of December 31, 2008 |   | $      | — |   |

 

Thecounterparty to our derivative became insolvent in 2008. We did not record anasset due to the insolvency.

 

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***FASB Staff Position SFAS No. 157-3***

 

InOctober 2008, the FASB issued FSP SFAS No. 157-3, “Determining theFair Value of a Financial Asset When the Market for That Asset Is Not Active” (“FSPSFAS 157-3”).  This FSP clarifies theapplication of SFAS No. 157 in a market that is not active and provides anexample to illustrate key considerations in determining the fair value of afinancial asset when the market for that financial asset is not active.  This FSP was effective upon issuance,including prior periods for which financial statements have not beenissued.  We applied this FSP to financialassets measured at fair value on a recurring basis at December 31, 2008. Theadoption of FSP SFAS 157-3 did not have a significant impact on ourconsolidated financial position, results of operations or cash flows.”

 

***Statement of Financial Accounting Standards No. 159***

 

In February 2007,the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assetsand Financial Liabilities — Including an amendment of FASB Statement No. 115”(“SFAS No. 159”). SFAS No. 159 permits entities to choose to measuremany financial instruments and certain other items at fair value that are notcurrently required to be measured at fair value and establishes presentationand disclosure requirements designed to facilitate comparisons between entitiesthat choose different measurement attributes for similar types of assets andliabilities. SFAS No. 159 became effective for financial statements issuedfor fiscal years beginning after November 15, 2007, provided the entityelects to apply the provisions of SFAS No. 157. Our adoption of SFAS No. 159on January 1, 2008 did not have any impact on our consolidated results ofoperations or financial condition as we have elected not to apply theprovisions of SFAS No. 159 to our financial instruments or other eligibleitems that are not required to be measured at fair value.

 

**New Accounting Pronouncements Not Yet Adopted**

 

***Statementof Financial Accounting Standards No. 141 (Revised)***

 

In December 2007,the FASB issued SFAS No. 141 (Revised 2007), “Business Combinations” (“SFASNo. 141R”).  SFAS No. 141Rsignificantly changes the accounting for business combinations.  Under SFAS No. 141R, an acquiring entitywill be required to recognize all the assets acquired and liabilities assumedin a transaction at the acquisition-date fair value with limitedexceptions.  SFAS No. 141R changesthe accounting treatment for certain specific items, including acquisitioncosts, noncontrolling interests, acquired contingent liabilities, in-processresearch and development costs, restructuring costs and changes in deferred taxasset valuation allowances and income tax uncertainties subsequent to theacquisition date.  SFAS No. 141Rapplies prospectively to business combinations for which the acquisition dateis on or after the beginning of the first annual reporting period beginning onor after December 15, 2008.  Earlieradoption is not permitted.

 

***FASBStaff Position No. FAS 142-3***

** **

ThisFASB Staff Position (“FSP”) amends the factors that should be considered indeveloping renewal or extension assumptions used to determine the useful lifeof a recognized intangible asset under SFAS No. 142, “Goodwill and OtherIntangible Assets”.  The intent of thisFSP is to improve the consistency between the useful life of a recognizedintangible asset under SFAS No. 142 and the period of expected cash flowsused to measure the fair value of the asset under SFAS No. 141 (Revised2007), “Business Combinations” and other U.S. generally accepted accountingprinciples.  This FSP is effective forfinancial statements issued for fiscal years beginning after December 15,2008, and interim periods within those fiscal years.  Early adoption is not permitted.  We do not expect this FSP to have asignificant impact on our consolidated financial position, results ofoperations or cash flows.

 

***Statement of Financial Accounting StandardsNo. 160***

 

In December 2007,the FASB issued SFAS No. 160, “Noncontrolling Interests in ConsolidatedFinancial Statements — An Amendment of ARB No. 51” (“SFAS No. 160”).  SFAS No. 160 establishes new accountingand reporting standards for the noncontrolling interest in a subsidiary and forthe deconsolidation of a subsidiary. SFAS No. 160 requires the recognition of a noncontrolling interest(minority interest) as equity in the consolidated financial statements andseparate from the parent’s equity.  Theamount of net income attributable to the noncontrolling interest will beincluded in consolidated net income on the face of the income statement.  This statement clarifies that changes in aparent’s ownership interest in a subsidiary that do not result indeconsolidation are equity transactions if the parent retains its controllingfinancial interest.  In addition, thisstatement requires that a parent recognize a gain or loss in net income when asubsidiary is deconsolidated.  Such gainor loss will be measured using the fair value of the noncontrolling equityinvestment on the deconsolidation date. SFAS No. 160 also includes expanded disclosure requirementsregarding the interests of the parent and its noncontrolling 

 

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interest.  SFAS No. 160 is effective for fiscalyears, and interim periods within those fiscal years, beginning on or after December 15,2008.  Earlier adoption is prohibited.

 

***Statement of Financial Accounting Standards No. 161***

 

InMarch 2008, the FASB issued SFAS No. 161, “Disclosures aboutDerivative Instruments and Hedging Activities — an Amendment of FASB Statement133” (“SFAS No. 161”).  SFAS No. 161is intended to improve financial reporting about derivatives and hedgingactivities by requiring enhanced qualitative and quantitative disclosuresregarding derivative instruments, gains and losses on such instruments andtheir effects on an entity’s financial position, financial performance and cashflows.  SFAS No. 161 is effectivefor fiscal years and interim periods beginning after November 15, 2008. Weare currently evaluating the impact that this pronouncement may have on ourconsolidated financial statements.

 

***Statement of Financial Accounting Standards No. 162***

 

InMay 2008, the FASB issued SFAS No. 162, “The Hierarchy of GenerallyAccepted Accounting Principles (“SFAS No. 162”).  SFAS No. 162 identifies the sources ofaccounting principles and the framework for selecting the principles to be usedin the preparation of financial statements of nongovernmental entities that arepresented in conformity with generally accepted accounting principles in theUnited States of America.  SFAS No. 162is effective sixty days following the SEC’s approval of Public CompanyAccounting Oversight Board amendments to AU Section 411, “The Meaning of ‘PresentFairly’ in Conformity with Generally Accepted Accounting Principles.”  We do not expect this pronouncement to have asignificant impact on our consolidated financial position, results ofoperations or cash flows.

 

***FASB Staff Position No. EITF 03-6-1***

 

This FASB Staff Position (“FSP”) addresses whether instruments grantedin share-based payment transactions are participating securities prior tovesting and, therefore, need to be included in the earnings allocation incomputing earnings per share (“EPS”) under the two-class method described inFASB Statement No. 128, “Earnings Per Share”.  This FSP is effective for financialstatements issued for fiscal years beginning after December 15, 2008, andthe interim periods within those years. All prior-period EPS data will have to be adjusted retrospectively(including interim financial statements, summaries of earnings, and selectedfinancial data) to conform to the provisions of this FSP.  Early application is not permitted.  We do not expect this FSP to have asignificant impact on our earnings per share.

 

**4.****             ****PROPERTYAND EQUIPMENT**

 

Property and equipment were as follows (inthousands):

 

| ** **                                | ** ** | **December 31,** | ** ** |
|-------------------------------------------|------------|-----------------------|------------|
| ** **                                | ** ** | **2008**              | ** ** | **2007** | ** ** |
|                                      |       |                  |       |   |   |
| Land                                      |       | $                     | 43,005     |   | $ | 38,763 |   |
| Prepaid facility use                      |       | 71,323                |       | 71,323 |   |
| Buildings and improvements                |       | 353,093               |       | 284,041 |   |
| Furniture and equipment                   |       | 39,514                |       | 33,954 |   |
| Construction in progress                  |       | 41,154                |       | 38,261 |   |
| Sub-total                                 |       | 548,089               |       | 466,342 |   |
| Accumulated depreciation and amortization |       | (97,735               | )          | (82,390 | ) |
| Total property and equipment              |       | $                     | 450,354    |   | $ | 383,952 |   |

 

The increase in land was due primarily to theHudson, Colorado site acquisition.  Theincrease in buildings and improvements was due primarily to the purchase of theHigh Plains Correctional Facility, the Washington, DC Facility and the facilityexpansion completed at the Big Spring Correctional Center.  The increase in construction in progress wasdue primarily to development costs associated with the Hudson, Colorado siteand construction costs related to the facility expansions at the D. Ray JamesPrison and the Great Plains Correctional Facility.

 

Wereview our long-lived assets for impairment at least annually or when changes incircumstances or a triggering event indicates that the carrying amount of theasset may not be recoverable in accordance with the provisions of SFAS No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets.”  SFAS No. 144 requires that long-livedassets to be held and used recognize an impairment loss only if the carryingamount of the long-lived asset is not recoverable from its 

 

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undiscountedcash flows and to measure an impairment loss as the difference between thecarrying value and the fair value of the asset. Assets to be disposed of by sale are recorded at the lower of theircarrying amount or fair value less estimated selling costs. We estimate fairvalue based upon the best information available, which may include expectedfuture discounted cash flows to be produced by the asset and/or availablemarket prices. Factors that significantly influence estimated future discountedcash flows include the periods and levels of occupancy for the facility,expected per diem or reimbursement rates, assumptions regarding the levels ofstaffing, services and future operating and capital expenditures necessary togenerate forecasted revenues, related costs for these activities and futurerate of increases or decreases associated with these factors. We also considerthe results of any appraisals on the properties when assessing fair value.These estimates may be highly subjective, particularly in circumstances wherethere is no current operating contract in place and changes in the assumptionsand estimates could result in the recognition of impairment charges. The mostsubjective estimates made in this analysis for 2008 relate to Cornell Abraxas 1and the Hector Garza Residential Treatment Center. The most subjectiveestimates made in this analysis for 2007 relate to the Regional Correctional Center and the Hector GarzaResidential Treatment Center.  We may berequired to record an impairment charge in the future if we are unable tosuccessfully negotiate a replacement contract on any of our facilities forwhich we currently have an operating contract. Given the nature of theevaluation of future cash flows and the application to specific assets andspecific times, it is not possible to reasonably quantify the impact of changesin these assumptions.

 

In conjunction with ourreview of certain of our long-lived assets based on estimated market valuesassociated with these assets, we determined that our carrying value for acurrently vacant site of land was not fully recoverable and exceeded its fairvalue and, as a result, we recorded an impairment charge of $0.3 million in theyear ended December 31, 2008 (none in the year ended December 31,2007).  This charge is reflected in operatingexpenses in the accompanying financial statements. In conjunction with our review of our long-livedassets based on forecasted operating and cash flow losses associated with theseassets at December 31, 2006, we determined that our carrying value for twoof our adult community-based facilities was not fully recoverable and exceededtheir fair value and, as a result, we recorded an impairment charge of $0.4million in the year ended December 31, 2006. This charge is reflected inoperating expenses in the accompanying financial statements.

 

**5.****             ****INTANGIBLEASSETS**

 

Intangible assets at December 31, 2008 and 2007consisted of the following (in thousands):

 

| ** **                                               | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------|------------|-----------------------|------------|
| ** **                                               | ** ** | **2008**              | ** ** | **2007** | ** ** |
| Non-compete agreements                                   |       | $                     | 8,200      |   | $ | 9,040 |   |
| Accumulated amortization —  non-compete agreements  |       | (7,595                | )          | (7,541 | ) |
| Acquired contract value                                  |       | 6,240                 |       | 6,442 |   |
| Accumulated amortization —  acquired contract value |       | (4,525                | )          | (3,421 | ) |
| Identified intangibles, net                              |       | 2,320                 |       | 4,520 |   |
| Goodwill, net                                            |       | 13,308                |       | 13,355 |   |
| Total intangibles, net                                   |       | $                     | 15,628     |   | $ | 17,875 |   |

 

The changes inthe carrying amount of goodwill for the year ended December 31, 2008 areas follows (in thousands):

 

| ** **                           | ** ** | **Adult Secure** | ** ** | **Abraxas Youth and Family** | ** ** | **Adult Community-Based** | ** ** | **Total** | ** ** |
|--------------------------------------|------------|------------------|------------|------------------------------|------------|---------------------------|------------|-----------|------------|
|                                 |       |             |       |                         |       |                      |       |      |       |
| Balance as of December 31, 2006 |       | $                | 2,902      |                         | $          | 1,060                     |       | $         | 8,377      |   | $ | 12,339 |   |
| Reduction to goodwill                |       | —           |       | —                       |       | 1,016                     |       | 1,016     |       |
| Balance as of December 31, 2007 |       | 2,902            |       | 1,060                        |       | 9,393                     |       | 13,355    |       |
| Reduction to goodwill                |       | —           |       | —                       |       | (47                       | )          | (47       | )          |
| Balance as of December 31, 2008 |       | $                | 2,902      |                         | $          | 1,060                     |       | $         | 9,346      |   | $ | 13,308 |   |

 

In 2008, werecorded a reduction to goodwill as a result of the final release of amountspreviously placed in escrow related to the acquisition of Correctional Systems, Inc.(“CSI”) in April 2005.  At December 31,2008, we believe that there is no impairment to our existing goodwill.

 

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Amortizationexpense for our acquired contract value was approximately $1.1 million in eachof the years ended December 31, 2008, 2007 and 2006. Amortization expensefor our acquired contract value is expected to be approximately $1.1 millionfor the year ended December 31, 2009 and approximately $0.6 million forthe year ended December 31, 2010.

 

Amortization expense forour non-compete agreements was approximately $0.8 million, $1.3 million and$1.1 million for the years ended December 31, 2008, 2007 and 2006, respectively.Amortization expense for our non-compete agreements is expected to beapproximately $0.6 million in the year ended December 31, 2009.

 

**6.****             ****ACCOUNTSPAYABLE AND ACCRUED LIABILITIES**

 

Accounts payable and accruedliabilities consisted of the following (in thousands):

 

| ** **                                     | ** ** | **December 31,** | ** ** |
|------------------------------------------------|------------|-----------------------|------------|
| ** **                                     | ** ** | **2008**              | ** ** | **2007** | ** ** |
|                                           |       |                  |       |   |   |
| Accounts payable                               |       | $21,754               |       | $20,321 |   |
| Accrued compensation                           |       | 10,242                |       | 9,837 |   |
| Accrued interest payable                       |       | 11,329                |       | 5,707 |   |
| Accrued taxes payable                          |       | 6,680                 |       | 3,926 |   |
| Accrued insurance                              |       | 8,003                 |       | 7,779 |   |
| Accrued legal                                  |       | 5,197                 |       | 5,306 |   |
| Resident funds                                 |       | 3,538                 |       | 2,598 |   |
| Other                                          |       | 2,350                 |       | 2,028 |   |
| Total accounts payable and accrued liabilities |       | $69,093               |       | $57,502 |   |

 

**7.****             ****INCOMETAXES**

 

In July 2006,the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48,“Accounting for Uncertainty in Income Taxes – an Interpretation of FASBStatement No. 109” (“FIN 48”).  FIN48 established a single model to address the accounting for uncertain taxpositions.  FIN 48 clarifies theaccounting for income taxes by prescribing a minimum recognition threshold atax position is required to meet before being recognized in the financialstatements.  FIN 48 also providesguidance on the measurement, recognition, classification and disclosure of taxpositions, as well as the accounting for the related interest and penalties,transition and accounting in interim periods.

 

TheCompany adopted the provisions of FIN 48 effective January 1, 2007.  As a result of our adoption of FIN 48, werecorded a cumulative effect adjustment of approximately $0.3 million whichincreased retained earnings at January 1, 2007.  As of December 31, 2007 and December 31,2008, we had unrecognized tax benefits in the amount of $3.0 million and $2.5million, respectively. If these unrecognized tax benefits were recognized infuture periods, approximately $0.8 million and $0.9 million would reduce ourincome tax expense and our effective tax rate for the years ended December 31,2007 and  2008, respectively.  A reconciliation of the beginning and endingamount of unrecognized tax benefits is as follows (in thousands):

 

| Balance at January 1, 2007                          |   | $      | 2,948  |   |
|----------------------------------------------------------|--------|--------|--------|--------|
| Additions based on tax positions related to current year |   | 569    |   |
| Additions for tax positions in prior year                |   | 4      |   |
| Reductions for tax positions in prior year               |   | — |   |
| Lapse in Statutes of Limitations                         |   | (503   | )      |
| Balance at December 31, 2007                        |   | $      | 3,018  |   |
| Additions based on tax positions related to current year |   | 521    |   |
| Additions for tax positions in prior year                |   | 23     |   |
| Reductions for tax positions in prior year               |   | — |   |
| Lapse in Statutes of Limitations                         |   | (1,094 | )      |
| Balance at December 31, 2008                        |   | $      | 2,468  |   |

 

Estimatedinterest and penalties related to the underpayment of income taxes areclassified as a component of income tax expense in the accompanyingConsolidated Statements of Income and Comprehensive Income and totaledapproximately $0.1 million in the year ended December 31, 2007 and ($0.1)million in the year ended December 31, 2008. Accrued interest and penalties were approximately $0.3 million and $0.2million at December 31, 2007 and 2008, respectively.

 

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We aresubject to income tax in the United States and many of the individual states weoperate in.  We currently havesignificant operations in Texas, California and Pennsylvania.  State income tax returns are generallysubject to examination for a period of three to five years after filing.  The state impact of any changes made to thefederal return remains subject to examination by various states for a period upto one year after formal notification to the state.  We are open to United States Federal IncomeTax examinations for the tax years December 31, 2005 through December 2007.The 2006 federal income tax return is currently under audit by theInternal Revenue Service.  We expect theaudit to close within the next 12 months.

 

We donot anticipate a significant change in the balance of our unrecognized taxbenefits within the next 12 months.

 

Thefollowing is an analysis of our deferred tax assets and liabilities (inthousands):

 

| ** **                         | ** ** | **December 31,** | ** ** |
|------------------------------------|------------|-----------------------|------------|
| ** **                         | ** ** | **2008**              | ** ** | **2007** | ** ** |
| Deferred tax assets:               |       |                  |       |   |   |
| Accrued liabilities and allowances |       | $                     | 10,582     |   | $ | 8,535 |   |
| State operating loss carryforwords |       | 3,005                 |       | 2,088 |   |
| Deferred compensation              |       | 2,276                 |       | 1,176 |   |
| Other                              |       | 157                   |       | 1,878 |   |
| Total deferred tax assets          |       | 16,020                |       | 13,677 |   |
|                               |       |                  |       |   |   |
| Deferred tax liabilities:          |       |                  |       |   |   |
| Property and equipment             |       | 18,769                |       | 15,531 |   |
| Prepaid expenses                   |       | 917                   |       | 832 |   |
| Other                              |       | 1,155                 |       | 749 |   |
| Total deferred tax liabilities     |       | 20,841                |       | 17,112 |   |
|                               |       |                  |       |   |   |
| Valuation allowance                |       | (3,005                | )          | (2,088 | ) |
|                               |       |                  |       |   |   |
| Net deferred tax liability         |       | $                     | 7,826      |   | $ | 5,523 |   |

 

As of December 31,2008, we have net operating losses for state income taxes of approximately$34.4 million. Our tax returns are subject to periodic audit by the variousjurisdictions in which we operate. These audits, including those currentlyunderway, can result in adjustments of taxes due or adjustments of the NOLswhich are available to offset future taxable income.

 

Valuationallowances of $3.0 million have been established for uncertainties in realizingthe benefit of certain state income tax loss carryforwards. For the years endedDecember 31, 2008, 2007 and 2006, changes in our state operating losscarryforwards (decreased)/increased our valuation allowance by $0.9 million,($0.4) million and $0.3 million, respectively. In assessing the realizabilityof carryforwards, we consider whether it is more likely than not that someportion or all of the deferred tax assets will be realized. The valuationallowance will be adjusted in the periods that we determine it is more likelythan not that deferred tax assets will or will not be realized.

 

The components of our income tax provision were asfollows (in thousands):

 

| ** **                                 | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------|------------|----------------------------------|------------|
| ** **                                 | ** ** | **2008**                         | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                       |       |                             |       |   |   |   |   |
| Federal current provision                  |       | $                                | 11,200     |   | $ | 6,213 |   | $ | 4,332 |   |
| State current provision                    |       | 2,947                            |       | 1,276 |   | 1,617 |   |
| Total current provision                    |       | 14,147                           |       | 7,489 |   | 5,949 |   |
|                                       |       |                             |       |   |   |   |   |
| Federal deferred provision                 |       | 1,250                            |       | 1,034 |   | 3,114 |   |
| State deferred provision                   |       | 206                              |       | 312 |   | 85 |   |
| Total deferred provision                   |       | 1,456                            |       | 1,346 |   | 3,199 |   |
|                                       |       |                             |       |   |   |   |   |
| Total provision from continuing operations |       | $                                | 15,603     |   | $ | 8,835 |   | $ | 9,148 |   |

 

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Our tax returns are subject to periodic audits bythe various jurisdictions in which we operate. These audits including thosecurrently underway can result in adjustments of taxes due or adjustments of theNOLs which are available to offset future taxable income.

 

The following is a reconciliation of income taxes atthe statutory federal income tax rate of 35% to the income tax provisionrecorded by us (in thousands):

 

| ** **                                 | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                 | ** ** | **2008**                                   | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                 | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Computed taxes at statutory rate           |       | $                                          | 13,384     |   | $ | 7,263 |   | $ | 7,602 |   |
| State income taxes, net of federal benefit |       | 2,046                                      |       | 1,109 |   | 1,042 |   |
| Other                                      |       | 173                                        |       | 463 |   | 504 |   |
|                                       |       | $                                          | 15,603     |   | $ | 8,835 |   | $ | 9,148 |   |

 

**8.****             ****CREDITFACILITIES**

 

Our long-term debt consistedof the following (in thousands):

 

| ** **                                                                                                                                                                  | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                  | ** ** | **2008**              | ** ** | **2007** | ** ** |
| **Debt of Cornell Companies, Inc.:**                                                                                                                                   | ** ** | ** **            | ** ** | ** ** | ** ** |
| Senior Notes, unsecured, due July 2012 with an interest rate of  10.75%, net of discount                                                                               |       | $                     | 111,356    |   | $ | 111,172 |   |
| Revolving Line of Credit due December 2011 with an interest rate  of LIBOR plus 1.50% to 2.25% or prime plus 0.00% to 0.75% (the “Amended  Credit Facility”) |       | 75,000                |       | 30,000 |   |
| Capital lease obligations                                                                                                                                                   |       | 26                    |       | 37 |   |
| Subtotal                                                                                                                                                                    |       | 186,382               |       | 141,209 |   |
|                                                                                                                                                                        |       |                  |       |   |   |
| **Debt of Special Purpose Entities:**                                                                                                                                       | ** ** | ** **            | ** ** | ** ** | ** ** |
| 8.47% Bonds due 2016                                                                                                                                                        |       | 134,100               |       | 145,500 |   |
|                                                                                                                                                                        |       |                  |       |   |   |
| Total consolidated debt                                                                                                                                                     |       | 320,482               |       | 286,709 |   |
|                                                                                                                                                                        |       |                  |       |   |   |
| Less: current maturities                                                                                                                                                    |       | (12,412               | )          | (11,411 | ) |
|                                                                                                                                                                        |       |                  |       |   |   |
| Consolidated long-term debt                                                                                                                                                 |       | $                     | 308,070    |   | $ | 275,298 |   |

 

***Long-Term Credit Facilities.***   Our Amended CreditFacility provides for borrowings up to $100.0 million (including letters ofcredit), matures in December 2011 and bears interest, at our electiondepending on our total leverage ratio, at either the LIBOR rate plus a margin rangingfrom 1.50% to 2.25%, or a rate which ranges from 0.00% to 0.75% above theapplicable prime rate. The available commitment under our Amended CreditFacility was approximately $10.1 million at December 31, 2008.  We had outstanding borrowings under ourAmended Credit Facility of $75.0 million and we had outstanding letters ofcredit of approximately $14.9 million at December 31, 2008.  Subject to certain requirements, we have theright to increase the commitments under our Amended Credit Facility up to$150.0 million, although the indenture for our Senior Notes limits our ability,subject to certain conditions, to expand the Amended Credit Facility beyond$100.0 million.  We can provide noassurance that all of the banks that have made commitments to us under ourAmended Credit Facility would be willing to participate in an expansion to theAmended Credit Facility should we desire to do so.  The Amended Credit Facility is collateralized by substantially all of our assets, includingthe assets and stock of all of our subsidiaries. The Amended Credit Facility isnot secured by the assets of MCF, a special purpose entity. Our Amended CreditFacility contains commonly used covenants including compliance with laws andlimitations on certain financing transactions and mergers and also includesvarious financial covenants.  We believethe most restrictive covenant under our Amended Credit Facility is the fixedcharge coverage ratio.  At December 31,2008, we were in compliance with all of our debt financial covenants.

 

MCF is obligated for the outstandingbalance of its 8.47% Taxable Revenue Bonds, Series 2001.  The bonds bear interest at a rate of 8.47%per annum and are payable in semi-annual installments of interest and annualinstallments of principal.  All unpaidprincipal and accrued interest on the bonds is due on the earlier of August 1,2016 (maturity) or as noted under the bond documents.

 

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The bonds are limited, nonrecourseobligations of MCF and secured by the property and equipment, bond reserves,assignment of subleases and substantially all assets related to the facilitiesincluded in the 2001 Sale and Leaseback Transaction (in which we sold elevenfacilities  to MCF).  The bonds are not guaranteed by Cornell.

 

In June 2004, we issued $112.0 million in principal of 10.75%Senior Notes (the “Senior Notes”) due July 1, 2012.  The Senior Notes are unsecured seniorindebtedness and are guaranteed by all of our existing and future subsidiaries(collectively, the “Guarantors”).  TheSenior Notes are not guaranteed by MCF (the “Non-Guarantor”).  Interest on the Senior Notes is payablesemi-annually on January 1 and July 1 of each year, commencing January 1,2005.  On or after July 1, 2008, wemay redeem all or a portion of the Senior Notes at the redemption prices(expressed as a percentage of the principal amount) listed below, plus accruedand unpaid interest, if any, on the Senior Notes redeemed, to the applicabledate of redemption, if redeemed during the 12-month period commencing on July 1of each of the years indicated below:

 

| **Year**            | ** ** | **Percentages** | ** ** |
|---------------------|------------|-----------------|------------|
|                |       |            |       |
| 2008                |       | 105.375         | %          |
| 2009                |       | 102.688         | %          |
| 2010 and thereafter |       | 100.000         | %          |

 

Asthe Senior Notes are now redeemable at our option (subject to the requirementsnoted) we anticipate we will monitor the capital markets and continue to assessour capital needs and our capital structure, including a potential refinancingof the Senior Notes.

 

Uponthe occurrence of specified change of control events, unless we have exercisedour option to redeem all the Senior Notes as described above, each holder willhave the right to require us to repurchase all or a portion of such holder’s SeniorNotes at a purchase price in cash equal to 101% of the aggregate principalamount of the notes repurchased plus accrued and unpaid interest, if any, onthe Senior Notes repurchased, to the applicable date of purchase.  The Senior Notes were issued under anindenture which limits our ability and the ability of our Guarantors to, amongother things, incur additional indebtedness, pay dividends or make otherdistributions, make other restricted payments and investments, create liens,incur restrictions on the ability of the Guarantors to pay dividends or otherpayments to us, enter into transactions with affiliates, and engage in mergers,consolidations and certain sales of assets.

 

Inconjunction with the issuance of the Senior Notes, we entered into an interestrate swap transaction with a financial institution to hedge our exposure tochanges in the fair value on $84.0 million of our Senior Notes.  The purpose of this transaction was toconvert future interest due on $84.0 million of the Senior Notes to a variablerate.  The terms of the interest rateswap contract and the underlying debt instrument were identical.  The swap agreement was designated as a fairvalue hedge.  The swap had a notionalamount of $84.0 million and matured in July 2012 to mirror the maturity ofthe Senior Notes.  Under the agreement,we paid, on a semi-annual basis (each January 1 and July 1), afloating rate based on a six-month U.S. dollar LIBOR rate, plus a spread, andreceived a fixed-rate interest of 10.75%. For the three and nine months ended September 30,2007, we recorded interest expense related to this interest rate swap ofapproximately $0.1 million and $0.2 million, respectively. The swapagreement was marked to market each quarter with a corresponding mark-to-marketadjustment reflected as either a discount or premium on the Senior Notes.  The carrying value of the Senior Notes as ofthis date was adjusted accordingly by the same amount. Because the swapagreement was an effective fair-value hedge, there was no effect on our resultsof operations from the mark-to-market adjustment as long as the swap was ineffect. In October 2007, we terminated the swap agreement. We receivedapproximately $0.2 million in conjunction with the termination, which is beingamortized over the remaining term of the Senior Notes.

 

Scheduled maturities of our consolidated long-termdebt are as follows (in thousands):

 

| ** **                            | ** ** | **Cornell  Companies, Inc.** | ** ** | **MCF**    | ** ** | **Consolidated** | ** ** |
|---------------------------------------|------------|-----------------------------------|------------|------------|------------|------------------|------------|
| ** **                            | ** ** | ** **                        | ** ** | ** ** | ** ** | ** **       | ** ** |
| For the year ending December 31, |       |                              |       |       |       |             |       |
| 2009                                  |       | $                                 | 12         |       | $          | 12,400           |       | $ | 12,412 |   |
| 2010                                  |       | 12                                |       | 13,400     |       | 13,412           |       |
| 2011                                  |       | 75,002                            |       | 14,600     |       | 89,602           |       |
| 2012                                  |       | 112,000                           |       | 15,800     |       | 127,800          |       |
| Thereafter                            |       | —                            |       | 77,900     |       | 77,900           |       |
| Total                                 |       | $                                 | 187,026    |       | $          | 134,100          |       | $ | 321,126 |   |

 

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**9.     COMMITMENTSAND CONTINGENCIES**

 

***FinancialGuarantees***

 

During the normal course of business, we enter intocontracts that contain a variety of representations and warranties and providegeneral indemnifications. Our maximum exposure under these arrangements isunknown as this would involve future claims that may be made against us thathave not yet occurred. However, based on experience, we believe the risk ofloss to be remote.

 

***Operating Leases***

 

We lease office space, certain facilities andfurniture and equipment under long-term operating leases. Rent expense for alloperating leases for the years ended December 31, 2008, 2007 and 2006 wasapproximately $10.2 million, $10.4 million and $11.5 million, respectively.

 

Landlord incentives or allowances under operatingleases are recorded as deferred rent and amortized as a reduction of rentexpense over the lease term. Those operating leases with step rent provisionsor escalation clauses that are not considered contingent rent are recognized ona straight-line basis over the lease term. For those leases that include anexisting index or rate, such as the consumer price index or the prime interestrate, the related minimum lease payments are recognized on a straight-linebasis over the lease term and the amount of rent considered to be contingent isrecorded as incurred and is not included in the straight-line basis rentexpense. We do not receive significant sublease rentals under any of ourexisting operating leases.

 

Certain of our leases contain renewal options, whichrange from additional rental periods of one to five years. Escalation clausesare also included in certain of our leases. There are no significantrestrictions imposed by our lease agreements concerning such issues as dividendpayments, incurrence of additional debt or further leasing.

 

As of December 31, 2008, we had the followingrental commitments under noncancelable operating leases (in thousands):

 

| For the year  ending December 31, | ** ** | ** ** | ** ** |
|----------------------------------------|------------|------------|------------|
| 2009                                   |       | $          | 7,598      |   |
| 2010                                   |       | 5,428      |       |
| 2011                                   |       | 11,234     |       |
| 2012                                   |       | 10,978     |       |
| Thereafter                             |       | 85,398     |       |
| Total                                  |       | $          | 120,636    |   |

 

The following schedule shows the composition oftotal rental expense for all operating leases (in thousands):

 

| ** **             | ** ** | **Year Ended  December 31,** | ** ** |
|------------------------|------------|-----------------------------------|------------|
| ** **             | ** ** | **2008**                          | ** ** | **2007** | ** ** | **2006** | ** ** |
| Minimum rentals        |       | $                                 | 9,708      |   | $ | 9,911 |   | $ | 11,107 |   |
| Contingent rentals     |       | 449                               |       | 458 |   | 426 |   |
| Less: sublease rentals |       | (221                              | )          | (246 | ) | (232 | ) |
| Total                  |       | $                                 | 9,936      |   | $ | 10,123 |   | $ | 11,301 |   |

 

***401(k) Plan***

 

We have a defined contribution 401(k) plan. Ourmatching contribution currently represents 50% of a participant’s contribution,up to the first 6% of the participant’s salary. We recorded contributionexpense of approximately $1.7 million, $1.3 million and $1.2 million for eachof the years ended December 31, 2008, 2007 and 2006, respectively.

 

***Legal Proceedings***

 

We are party to various legal proceedings, includingthose noted below. While management presently believes that the ultimateoutcome of these proceedings will not have a material adverse effect on ourfinancial position, overall trends in results of operations or cash flows,litigation is subject to inherent uncertainties, and unfavorable rulings couldoccur. An 

 

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unfavorableruling could include monetary damages or equitable relief, and could have amaterial adverse impact on the net income of the period in which the rulingoccurs or in future periods.

 

 ***Valencia County Detention Center***

 

InApril 2007, a lawsuit was filed against the Company in the FederalDistrict Court in Albuquerque, New Mexico, by Joe Torres and Eufrasio Armijo,who each alleged that he was strip searched at the Valencia County DetentionCenter (“VCDC”) in New Mexico in violation of his federal rights under theFourth, Fourteenth and Eighth amendments to the U.S. Constitution.  Theclaimants also alleged violation of their rights under state law and sought tobring the case as a class action on behalf of themselves and all detainees atVCDC during the applicable statutes of limitation.  The plaintiffs soughtdamages and declaratory and injunctive relief.  Valencia County is also anamed defendant in the case and operated the VCDC for a significantly greaterportion of the period covered by the lawsuit.

 

InDecember 2008, the parties agreed to a proposed stipulation of settlementand the Court has preliminarily approved the settlement.  The settlement amount under the terms of theagreement is $3.3 million.  Cornell’s portion of the stipulatedsettlement, based on the number of inmates housed at VCDC during the timeCornell operated the facility in comparison to the number of inmates housed atthe facility during the time Valencia County operated the facility, is $1.2million and was funded principally through our general liability andprofessional liability coverage.

 

Inthe year ended December 31, 2007, we previously provided insurancereserves for this matter (as part of our regular review of reported and unreportedclaims) totaling approximately $0.5 million. During the fourth quarter of 2008, we recorded an additional settlementcharge of approximately $0.7 million and the related reimbursement from ourgeneral liability and professional liability insurance.  The charge and reimbursement were recognizedin general and administrative expenses for the year ended December 31,2008.  The reimbursement was funded bythe insurance carrier in the first quarter of 2009 into a settlement account, where it will remainuntil payments are made to the settlement class members.   The Court granted preliminary approval of thesettlement in the first quarter of 2009, and the claims administration processis underway.  We expect the claimsadministration process to be completed and the final court approval of thesettlement in the fourth quarter of 2009.

 

***Shareholder Lawsuits***

 

OnOctober 19, 2006, a purported class action complaint was filed in theDistrict Court of Harris County, Texas, 269th Judicial District (No. 2006-67413)by Ted Kinbergy, an alleged stockholder of Cornell. The complaint names asdefendants Cornell and each member of the board of directors at the time of thesuit, as well as Veritas Capital Fund III, L.P. (“Veritas”). The complaintalleges, among other things, that (i) the defendants have breachedfiduciary duties they assertedly owed to our stockholders in connection withour entering into the Agreement and Plan of Merger, dated as of October 6,2006, with Veritas, Cornell Holding Corp., and CCI Acquisition Corp., and (ii) themerger consideration is unfair and inadequate. The plaintiffs sought, amongother things, an injunction against the consummation of the merger. Theproposed merger was rejected at a special meeting of our stockholders held on January 23,2007. Consequently, we believe the case is moot and expect the plaintiffs toseek dismissal of their claims accompanied by a request for legal fees that maybe owed.  We do not expect the resolution of this matter to have amaterial adverse effect on our financial condition, results of operations orcash flows.

 

***Settlement of Claim***

 

OnDecember 12, 2008, we settled a lawsuit the Company had filed in theUnited States District Court for the Eastern District of Pennsylvania againstthe Borough of New Morgan (the “Borough”), New Morgan Borough Council andcertain individual council members. The lawsuit involved the operation ofthe Company’s Abraxas Academy in New Morgan, Pennsylvania and a sewagetreatment facility that is owned by the Borough.

 

Inconnection with the settlement, all claims have been terminated and finallysettled, including those concerning the operation and occupancy of the facilityand the sewage treatment plant. Neither party has admitted liability forany claim or contention made by the other party. The Company received $1.55million from the Borough and agreed to pay the Borough unpaid sewage treatmentbills in the amount of $0.2 million through September 30, 2008.  The $1.55 million settlement is reflected inoperating expenses in the accompanying financial statements.

 

***Other***

 

Wehold insurance policies to cover potential director and officer liability, someof which may limit our cash outflows in the event of a decision adverse to usin the matters discussed above. However, if an adverse decision in thesematters exceeds the insurance coverage or if the insurance coverage is deemednot to apply to these matters, it could have a material adverse effect on us,our financial condition, results of operations and future cash flows.

 

Additionally,we currently and from time to time are subject to claims and suits arising inthe ordinary course of business, including claims for damages for personalinjuries or for wrongful restriction of or interference with offenderprivileges and employment matters. If an adverse decision in these mattersexceeds our insurance coverage, or if our coverage is deemed not to apply tothese matters, or if the underlying insurance carrier was unable to fulfill itsobligation under the insurance coverage provided, it could have a materialadverse effect on our financial condition, results of operations or cash flows.

 

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Whilethe outcome of such other matters cannot be predicted with certainty, based onthe information known to date, we believe that the ultimate resolution of thesematters will not have a material adverse effect on our financial condition, butcould be material to operating results or cash flows for a particular reportingperiod.

 

**10.  STOCKHOLDERS’EQUITY**

 

***Preferred Stock***

 

Preferred stock may be issued from time to time byour Board of Directors, which is responsible for determining the voting,dividend, redemption, conversion and liquidation features of any preferredstock.

 

***Options andWarrants***

 

Under our 2000 Broad-Based Employee Plan (the “2000Plan”) we may grant non-qualified stock options to our employees, directors andeligible consultants for up to the greater of 400,000 shares or 4% of theaggregate number of shares of common stock issued and outstanding immediatelyafter grant of any option under the 2000 Plan. The 2000 Plan options vest up tofive years and expire ten years from the grant date. Under our 1996 StockOption Plan, as amended and restated in April 1998 (the “1996 Plan”) wemay grant non-qualified and incentive stock options for up to the greater of1,932,119 shares or 15.0% of the aggregate number of shares of common stockoutstanding. The 1996 Plan options vest up to seven years and expire seven toten years from the grant date. The Compensation Committee of the Board ofDirectors, which consists entirely of independent directors, is responsible fordetermining the exercise price and vesting terms for the granted options. The1996 Plan and 2000 Plan option exercise prices can be no less than the marketprice of our common stock on the date of grant.

 

In conjunction with the issuance of subordinatednotes in July 2000 (which are no longer outstanding), we issued warrantsto purchase 290,370 shares of the common stock at an exercise price of $6.70.We recognized the fair value of these warrants of $1.1 million as additionalpaid-in capital. The warrants could only be exercised by payment of theexercise price in cash to us, by cancellation of an amount of warrants equal tothe fair market value of the exercise price, or by the cancellation of ourindebtedness owed to the warrant holder. During 2001, 168,292 shares of ourcommon stock were issued in conjunction with the exercise and cancellation of217,778 warrants. At December 31, 2006, 72,592 warrants wereoutstanding.  During 2007, all 72,592warrants were exercised and canceled.

 

For a summary of the status of our various optionplans at December 31, 2007, see Note 2 to the consolidated financialstatements.

 

***Treasury Stock***

 

We did not repurchase any of our common stock in theyears ended December 31, 2008 and 2007. Under the terms of our SeniorNotes and our Amended Credit Facility, we can purchase shares of our stocksubject to certain cumulative restrictions.

 

***Employee StockPurchase Plan***

 

We have an employee stock purchase plan under whichemployees can make contributions to purchase our common stock. Participation inthe plan is elected annually by employees. The plan year begins each January 1st (the “Exercise Date”) and ends on December 31st (the “Ending Date”). For 2007, however, theplan year began April 1, 2007. Purchases of common stock are made at theend of the year using the lower of the fair market value on either theBeginning Date or Ending Date, less a 15.0% discount. For the years ended December 31,2008, 2007 and 2006, employee contributions of approximately $0.1 million, $0.2million and $0.3 million were used to purchase 8,883, 25,348 and 22,593,respectively, of our common stock.

 

***2006 EquityIncentive Plan***

 

Our stockholders approved the establishment of the2006 Equity Incentive Plan (the “2006 Plan”) at our June 29, 2006 annualmeeting. The purpose of the 2006 Plan is to promote the interests of theCompany and its stockholders by (i) attracting and retaining employees,directors, and consultants of the Company and its affiliates, (ii) motivatingsuch individuals by means of performance-related incentives to achieve longer-rangeperformance goals, and (iii) enabling such individuals to participate inthe long-term growth and financial success of the Company. At the discretion ofthe Compensation Committee, any employee, director, or consultant of theCompany or its affiliates may be granted an award under the 2006 Plan. TheCompensation Committee administers the 2006 Plan.

 

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A total of 1,400,000 shares of common stock areauthorized for issuance under the 2006 Plan, all of which may be issuedpursuant to incentive stock options. These shares of common stock will be in a “fungiblepool” with shares subject to restricted stock, stock compensation and otherstock-based awards counted against this limit as two (2) shares for everyone (1) share granted and any shares subject to any other type of award tobe counted against this limit as one (1) share for every one (1) sharegranted. Stock options (both non-qualified stock options and incentive stockoptions), stock appreciation rights, restricted stock, restricted stock units,performance awards, stock compensation and other stock-based awards may begranted under the 2006 Plan.

 

In the event of a Change of Control, as defined inthe 2006 Plan, any outstanding stock option, stock appreciation right,non-performance based restricted stock or restricted stock unit award, andperformance based restricted stock, restricted stock units, performance shareor performance unit award (unless otherwise provided in the performance awardagreement) will automatically vest. Upon a Change of Control, the Board ofDirectors may also take any one or more of the following actions: (i) providefor the purchase of any outstanding awards by the Company; (ii) makeadjustments to any outstanding awards; or (iii) allow for the assumptionor substitution of outstanding awards by the acquiring or survivingcorporation.  Grants of 287,000 shares ofrestricted stock were made under the 2006 Plan during the year ended December 31,2007.  No grants were made to anyindividual under the 2006 Plan during the year ended December 31, 2006.

 

**11.  DERIVATIVEFINANCIAL INSTRUMENTS AND GUARANTEES**

 

***Debt ServiceReserve Fund and Debt Service Fund***

 

In August 2001, MCF completed a bond offeringto finance the 2001 Sale and Leaseback Transaction (in which we sold elevenfacilities (as identified in Item 1 of this report) to MCF. In connection withthis bond offering, two reserve fund accounts were established by MCF pursuantto the terms of the indenture: (1) MCF’s Debt Service Reserve Fund,aggregating $23.8 million at December 31, 2008, was established to makepayments on MCF’s outstanding bonds in the event we (as lessee) should fail tomake the scheduled rental payments to MCF and (2) MCF’s Debt Service Fund,aggregating $27.9 million at December 31, 2008, was established toaccumulate the monthly lease payments that MCF receives from us until suchfunds are used to pay MCF’s semi-annual bond interest and annual bond principalpayments. These reserve funds are typically invested in short-term moneymarkets and commercial paper. Both reserve fund accounts are subject to theagreements with the MCF Equity Investors (Lehman Brothers, Inc. (“Lehman”)) wherebyguaranteed rates of return of 3.0% and 5.08%, respectively, are provided for inthe balance of the Debt Service Reserve Fund and the Debt Service Fund. Theguaranteed rates of return are characterized as cash flow hedge derivativeinstruments. At inception, the derivatives had an aggregate fair value of $4.0million, which has been recorded as a decrease to the equity investment in MCFmade by the MCF Equity Investors (MCF minority interest) and as a liability inour Consolidated Balance Sheets. Changes in the fair value of the derivativeinstruments were recorded as an adjustment to other long-term liabilities andreported as other comprehensive income (loss) in our Consolidated Statements ofOperations and Comprehensive Income (Loss). Due to the bankruptcy of Lehman in2008, the derivative instrument no longer qualified as a hedge and was de-designated.Amounts included in accumulated other comprehensive income are reclassifiedinto earnings during the same periods in which interest is earned on the debtservice funds. Changes in the fair value of this derivative after de-designationare recorded into earnings. At December 31, 2008, the fair value wasdeemed to be zero, and the change in fair value of $1.2 million was credited tointerest income.

 

In connection with MCF’s bond offering, Lehman also provideda guarantee of the Debt Service Reserve Fund if a bankruptcy of the Companywere to occur and a trustee for the estate of the Company were to include theDebt Service Reserve Fund as an asset of the Company’s estate. This guaranteewas characterized as an insurance contract and its fair value was beingamortized to expense over the life of the debt. Due to the bankruptcy of Lehmanin 2008, the full carrying value of the guarantee was determined to beunrecoverable.  Accordingly, we recordeda charge of $1.3 million in the year ended December 31, 2008. This chargeis included in interest expense in the accompanying consolidated financialstatements.

 

**12.  RELATEDPARTY TRANSACTIONS**

 

InSeptember 1999, we entered into a consulting agreement with Cornell’sfounder, David Cornell, who was a director of Cornell through October 2003.  Services rendered under the consultingagreement included serving as a director of Cornell over the initial four yearsof the term of the agreement and assisting in such areas as the development ofnew business, acquisitions, financings and executive managementassimilation.  As compensation forconsulting services, we agreed to an annual payment of at least $255,000 foreach of the first four years of the seven-year initial term of the consultingagreement with an annual payment of at least $180,000 for each of the lastthree years of the initial term. As additional compensation, 

 

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weagreed to an annual bonus, subject to certain limitations, equal to $75,000during the first four years of the initial term and an annual bonus of $60,000during the last three years of the initial term. The initial term concluded in2006 and the final bonus payment of $60,000 was paid.  The agreement was not renewed.

 

Wealso entered into a non-compete agreement with Mr. Cornell.  The non-compete agreement has a term of 10years and required us to pay a monthly fee of $10,000 for the seven-yearinitial term of the consulting agreement. We capitalize the monthly payments and amortize the amounts over the 10-yearterm of the non-compete agreement. Due to his death in December 2008, theremaining unamortized balance was written-off. We recognized amortizationexpense related to this agreement of approximately $84,000 for each of theyears ended December 31, 2008, 2007 and 2006.

 

Wemaintained a life insurance policy for Mr. Cornell and made paymentsrelated to this policy of approximately $0.2 million for each of the yearsended December 31, 2008, 2007 and 2006. As a result of Mr. Cornell’sdeath in December 2008, we received a return of cash premiums previouslypaid of approximately $2.0 million in December 2008.

 

Totalpayments made for the above to Mr. Cornell were $0.06 million and $0.5million for the years ended December 31, 2007 and 2006, respectively. Nopayments were made to Mr. Cornell in the year ended December 31, 2008.

 

Weentered into a consulting agreement with a former director, Arlene Lissner,which expired in December 2008. Services rendered under this agreement include research and analysis forvarious topics including data collection, support and training for programdevelopment; performance-based contractual requirements andperformance-improvement processes, accreditations and regulatoryrequirements.  Payments under thisagreement totaled $0.3 million for each of the years ended December 31,2008, 2007 and 2006.  The agreementconcluded in 2008 and was not renewed.

 

**13.   TERMINATED****MERGERAGREEMENT**

 

OnOctober 6, 2006, we entered into an Agreement and Plan of Merger (the “MergerAgreement”) with The Veritas Capital Fund III, L.P., a Delaware limitedpartnership (“Veritas”), Cornell Holding Corp., a Delaware corporation (“Parent”)and CCI Acquisition Corp., a Delaware corporation and wholly owned subsidiaryof Parent (“Merger Sub”), pursuant to which the Merger Sub would be merged withand into us (the “Merger”), with Cornell surviving after the Merger as a whollyowned subsidiary of Parent.

 

OurBoard of Directors unanimously approved the Merger Agreement. In connectionwith the Merger, the Parent and certain of our stockholders entered into aVoting Agreement dated on or about October 6, 2006, whereby suchstockholders agreed, among other things, to vote their respective shares of ourstock in favor of the Merger Agreement, the Merger and the transactionscontemplated thereby. At a special meeting of our stockholders held on January 23,2007, the proposed Merger Agreement was rejected.

 

Underthe terms of the Merger Agreement, because the Merger was terminated, wereimbursed $2.5 million of costs incurred by Veritas, Parent and Merger Sub inconnection with the proposed merger in February 2007. Such costs for legaland external professional and consulting fees are reflected in general andadministrative expenses for the year ended December 31, 2007.

 

**14.**** ****DISCONTINUED OPERATIONS**

 

        We classifyas discontinued operations those components of our business that we hold forsale or that have been disposed and have cash flows that are clearlydistinguishable operationally and for financial reporting purposes from therest of our operations. For those components, we have no significant continuinginvolvement after completion of disposal and their operations are eliminatedfrom our ongoing operations. During the year ended December 31, 2005, weclassified certain components as discontinued operations as the result of amanagement decision to close certain facilities. Notifications were made to therequired contracting entities regarding the termination of the relatedprograms. At December 31, 2008 and 2007, we did not have any significantnet property and equipment balances pertaining to these former operations.There were no revenues generated by these discontinued operations in the yearsended December 31, 2008, 2007 and 2006.

 

**15.  SEGMENTDISCLOSURE**

 

Our three operating divisions are our reportablesegments. The Adult Secure Services segment consists of the operations ofsecure adult incarceration facilities. The Abraxas Youth and Family Servicessegment consists of providing residential 

 

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treatmentand educational programs and non-residential community-based programs tojuveniles between the ages of 10 and 18 who have either been adjudicated orsuffer from behavioral problems. The Adult Community-Based Services segmentconsists of providing pre-release and halfway house programs for adultoffenders who are either on probation or serving the last three to six-monthsof their sentences on parole and preparing for re-entry into society at largeas well as community-based treatment and education programs as an alternativeto incarceration. All of our customers and long-lived assets are located in theUnited States of America. The accounting policies of our reportable segmentsare the same as those described in the summary of significant accountingpolicies in Note 2 to the consolidated financial statements. Intangible assetsare not included in each segment’s reportable assets, and the amortization ofintangible assets is not included in the determination of a segment’s operatingincome. We evaluate performance based on income or loss from operations beforegeneral and administrative expenses, incentive bonuses, amortization ofintangibles, interest and income taxes. Corporate and other assets arecomprised primarily of cash, investment securities available for sale, accountsreceivable, debt service fund, deposits, property and equipment, deferredtaxes, deferred costs and other assets. Corporate and other expense fromoperations primarily consists of depreciation and amortization on the corporateoffice facilities and equipment and specific general and administrative chargespertaining to corporate personnel (including the $1.85 million legal settlementreceived in the third quarter of 2007) and is presented separately as suchcharges cannot be readily identified for allocation to a particular segment.

 

The only significant non-cash items reported in therespective segments’ income from operations is depreciation and amortization(excluding intangibles) and impairment of long-lived assets (in thousands).

 

 

 

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| ** **                                        | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                        | ** ** | **2008**                                   | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                              |       |                                       |       |   |   |   |   |
| Revenue:                                          |       |                                       |       |   |   |   |   |
| Adult secure services                             |       | $                                          | 209,283    |   | $ | 183,199 |   | $ | 178,795 |   |
| Abraxas youth and family services                 |       | 107,278                                    |       | 109,297 |   | 115,765 |   |
| Adult community-based services                    |       | 70,163                                     |       | 68,108 |   | 66,295 |   |
| Total revenue                                     |       | $                                          | 386,724    |   | $ | 360,604 |   | $ | 360,855 |   |
|                                              |       |                                       |       |   |   |   |   |
| Pre-opening and start-up expenses:                |       |                                       |       |   |   |   |   |
| Adult secure services                             |       | $                                          | —     |   | $ | — |   | $ | 2,657 |   |
| Abraxas youth and family services                 |       | —                                     |       | 3⁄4 |   | 3⁄4 |   |
| Adult community-based services                    |       | —                                     |       | 3⁄4 |   | 3⁄4 |   |
| Total pre-opening and start-up expenses           |       | $                                          | —     |   | $ | — |   | $ | 2,657 |   |
|                                              |       |                                       |       |   |   |   |   |
| Depreciation and amortization:                    |       |                                       |       |   |   |   |   |
| Adult secure services                             |       | $                                          | 10,504     |   | $ | 8,570 |   | $ | 8,008 |   |
| Abraxas youth and family services                 |       | 2,866                                      |       | 2,736 |   | 3,118 |   |
| Adult community-based services                    |       | 1,535                                      |       | 1,525 |   | 1,892 |   |
| Amortization of intangibles                       |       | 2,200                                      |       | 2,407 |   | 2,243 |   |
| Corporate and other                               |       | 838                                        |       | 748 |   | 1,024 |   |
| Total depreciation and amortization               |       | $                                          | 17,943     |   | $ | 15,986 |   | $ | 16,285 |   |
|                                              |       |                                       |       |   |   |   |   |
| Income from operations:                           |       |                                       |       |   |   |   |   |
| Adult secure services                             |       | $                                          | 63,170     |   | $ | 44,096 |   | $ | 44,849 |   |
| Abraxas youth and family services                 |       | 8,829                                      |       | 13,069 |   | 12,574 |   |
| Adult community-based services                    |       | 19,191                                     |       | 16,511 |   | 12,362 |   |
| Subtotal                                          |       | 91,190                                     |       | 73,676 |   | 69,785 |   |
| General and administrative expenses               |       | (25,954                                    | )          | (25,499 | ) | (21,720 | ) |
| Amortization of intangibles                       |       | (2,200                                     | )          | (2,406 | ) | (2,243 | ) |
| Corporate and other                               |       | (839                                       | )          | (762 | ) | (1,024 | ) |
| Total income from operations                      |       | $                                          | 62,197     |   | $ | 45,009 |   | $ | 44,798 |   |
|                                              |       |                                       |       |   |   |   |   |
| Loss on discontinued operations, net of tax:      |       |                                       |       |   |   |   |   |
| Adult secure services                             |       | $                                          | —     |   | $ | — |   | $ | — |   |
| Abraxas youth and family services                 |       | —                                     |       | 3⁄4 |   | (706 | ) |
| Adult community-based services                    |       | —                                     |       | 3⁄4 |   | (1 | ) |
| Total loss on discontinued operations, net of tax |       | $                                          | —     |   | $ | — |   | $ | (707 | ) |
|                                              |       |                                       |       |   |   |   |   |
| Capital expenditures:                             |       |                                       |       |   |   |   |   |
| Adult secure services                             |       | $                                          | 76,703     |   | $ | 48,538 |   | $ | 9,811 |   |
| Abraxas youth and family services                 |       | 1,808                                      |       | 1,351 |   | 1,182 |   |
| Adult community-based services                    |       | 956                                        |       | 310 |   | 749 |   |
| Corporate and other                               |       | 448                                        |       | 691 |   | 575 |   |
| Total capital expenditures                        |       | $                                          | 79,915     |   | $ | 50,890 |   | $ | 12,317 |   |
|                                              |       |                                       |       |   |   |   |   |
| Assets:                                           |       |                                       |       |   |   |   |   |
| Adult secure services                             |       | $                                          | 358,406    |   | $ | 290,930 |   | $ | 233,670 |   |
| Abraxas youth and family services                 |       | 105,991                                    |       | 109,478 |   | 100,366 |   |
| Adult community-based services                    |       | 60,170                                     |       | 63,008 |   | 63,105 |   |
| Intangible assets, net                            |       | 15,628                                     |       | 17,875 |   | 19,265 |   |
| Corporate and other                               |       | 96,726                                     |       | 81,496 |   | 107,127 |   |
| Total assets                                      |       | $                                          | 636,921    |   | $ | 562,287 |   | $ | 523,533 |   |

 

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**16.  GUARANTOR DISCLOSURES**

 

Wecompleted an offering of $112.0 million of Senior Notes in June 2004. TheSenior Notes are guaranteed by each of our subsidiaries (“GuarantorSubsidiaries”). MCF does not guarantee the Senior Notes (“Non-GuarantorSubsidiary”). These guarantees are joint and several obligations of theGuarantor Subsidiaries. The following condensed consolidating financialinformation presents the financial condition, results of operations and cashflows of the Guarantor Subsidiaries and the Non-Guarantor Subsidiary, togetherwith the consolidating adjustments necessary to present our results on aconsolidated basis.

 

# **Condensed Consolidating Balance Sheet as of December 31, 2008 (inthousands)**

 
| ** **                                       | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor****Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------|------------|------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                       | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                        | ** ** | ** **       | ** ** | ** **       | ** ** |
| Current assets:                                  |       |       |       |                        |       |                              |       |             |       |             |       |
| Cash and cash equivalents                        |       | $          | 14,291     |                        | $          | 265                               |       | $                | 57         |             | $          | — |   | $ | 14,613 |   |
| Accounts receivable                              |       | 2,045      |       | 66,921                      |       | 422                               |       | —           |       | 69,388           |       |
| Restricted assets                                |       | —     |       | 3,432                       |       | 27,938                            |       | —           |       | 31,370           |       |
| Prepaids and other                               |       | 13,875     |       | 1,644                       |       | —                            |       | —           |       | 15,519           |       |
| Total current assets                             |       | 30,211     |       | 72,262                      |       | 28,417                            |       | —           |       | 130,890          |       |
| Property and equipment, net                      |       | 101        |       | 312,446                     |       | 141,975                           |       | (4,168           | )          | 450,354          |       |
| Other assets:                                    |       |       |       |                        |       |                              |       |             |       |             |       |
| Debt service reserve fund                        |       | —     |       | —                      |       | 23,750                            |       | —           |       | 23,750           |       |
| Deferred costs and other                         |       | 60,322     |       | 23,267                      |       | 5,367                             |       | (57,029          | )          | 31,927           |       |
| Investment in subsidiaries                       |       | 73,197     |       | 1,856                       |       | —                            |       | (75,053          | )          | —           |       |
| Total assets                                     |       | $          | 163,831    |                        | 409,831    |                              | $          | 199,509          |       | (136,250         | )          | $ | 636,921 |   |
|                                             |       |       |       |                        |       |                              |       |             |       |             |       |
| **Liabilities and Stockholders’ Equity**    | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                        | ** ** | ** **       | ** ** | ** **       | ** ** |
|                                             |       |       |       |                        |       |                              |       |             |       |             |       |
| Current liabilities:                             |       |       |       |                        |       |                              |       |             |       |             |       |
| Accounts payable and accrued  liabilities        |       | $          | 48,373     |                        | $          | 15,515                            |       | $                | 4,883      |             | $          | 322 |   | $ | 69,093 |   |
| Current portion of long-term  debt               |       | —     |       | 12                          |       | 12,400                            |       | —           |       | 12,412           |       |
| Total current liabilities                        |       | 48,373     |       | 15,527                      |       | 17,283                            |       | 322              |       | 81,505           |       |
| Long-term debt, net of current  portion          |       | 186,356    |       | 14                          |       | 121,700                           |       | —           |       | 308,070          |       |
| Deferred tax liabilities                         |       | 16,246     |       | 94                          |       | —                            |       | 1,151            |       | 17,491           |       |
| Other long-term liabilities                      |       | 5,851      |       | 113                         |       | 56,733                            |       | (61,009          | )          | 1,688            |       |
| Intercompany                                     |       | (320,717   | )          | 320,722                     |       | —                            |       | (5               | )          | —           |       |
| Total liabilities                                |       | (63,891    | )          | 336,470                     |       | 195,716                           |       | (59,541          | )          | 408,754          |       |
| Minority interest                                |       | —     |       | —                      |       | —                            |       | 445              |       | 445              |       |
| Stockholders’ equity                        |       | 227,722    |       | 73,361                      |       | 3,793                             |       | (77,154          | )          | 227,722          |       |
| Total liabilities and  stockholders’ equity |       | $          | 163,831    |                        | $          | 409,831                           |       | $                | 199,509    |             | $          | (136,250 | ) | $ | 636,921 |   |

 

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# **Condensed Consolidating Balance Sheet as of December 31, 2007 (inthousands)**

# ** **

| ** **                                       | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor****Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------|------------|------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                       | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                        | ** ** | ** **       | ** ** | ** **       | ** ** |
| Current assets:                                  |       |       |       |                        |       |                              |       |             |       |             |       |
| Cash and cash equivalents                        |       | $          | 2,565      |                        | $          | 408                               |       | $                | 55         |             | $          | — |   | $ | 3,028 |   |
| Investment securities                            |       | 250        |       | 3⁄4                      |       | 3⁄4                            |       | 3⁄4           |       | 250              |       |
| Accounts receivable                              |       | 1,814      |       | 70,495                      |       | 679                               |       | 3⁄4           |       | 72,988           |       |
| Restricted assets                                |       | 3⁄4     |       | 2,486                       |       | 25,629                            |       | (592             | )          | 27,523           |       |
| Prepaids and other                               |       | 11,362     |       | 1,519                       |       | 3⁄4                            |       | 3⁄4           |       | 12,881           |       |
| Total current assets                             |       | 15,991     |       | 74,908                      |       | 26,363                            |       | (592             | )          | 116,670          |       |
| Property and equipment, net                      |       | 270        |       | 242,297                     |       | 146,197                           |       | (4,812           | )          | 383,952          |       |
| Other assets:                                    |       |       |       |                        |       |                              |       |             |       |             |       |
| Debt service reserve fund                        |       | 3⁄4     |       | 3⁄4                      |       | 23,638                            |       | 3⁄4           |       | 23,638           |       |
| Deferred costs and other                         |       | 56,500     |       | 24,460                      |       | 6,035                             |       | (48,968          | )          | 38,027           |       |
| Investment in subsidiaries                       |       | 41,445     |       | 1,856                       |       | 3⁄4                            |       | (43,301          | )          | 3⁄4           |       |
| Total assets                                     |       | $          | 114,206    |                        | $          | 343,521                           |       | $                | 202,233    |             | $          | (97,673 | ) | $ | 562,287 |   |
|                                             |       |       |       |                        |       |                              |       |             |       |             |       |
| **Liabilities and Stockholders’ Equity**    | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                        | ** ** | ** **       | ** ** | ** **       | ** ** |
|                                             |       |       |       |                        |       |                              |       |             |       |             |       |
| Current liabilities:                             |       |       |       |                        |       |                              |       |             |       |             |       |
| Accounts payable and accrued  liabilities        |       | $          | 37,751     |                        | $          | 15,463                            |       | $                | 5,186      |             | $          | (898 | ) | $ | 57,502 |   |
| Current portion of long-term  debt               |       | 3⁄4     |       | 11                          |       | 11,400                            |       | 3⁄4           |       | 11,411           |       |
| Total current liabilities                        |       | 37,751     |       | 15,474                      |       | 16,586                            |       | (898             | )          | 68,913           |       |
| Long-term debt, net of current  portion          |       | 141,172    |       | 26                          |       | 134,100                           |       | 3⁄4           |       | 275,298          |       |
| Deferred tax liabilities                         |       | 12,387     |       | 94                          |       | 3⁄4                            |       | 745              |       | 13,226           |       |
| Other long-term liabilities                      |       | 6,705      |       | 162                         |       | 49,702                            |       | (52,168          | )          | 4,401            |       |
| Intercompany                                     |       | (284,258   | )          | 284,263                     |       | 3⁄4                            |       | (5               | )          | 3⁄4           |       |
| Total liabilities                                |       | (86,243    | )          | 300,019                     |       | 200,388                           |       | (52,326          | )          | 361,838          |       |
| Stockholders’ equity                        |       | 200,449    |       | 43,502                      |       | 1,845                             |       | (45,347          | )          | 200,449          |       |
| Total liabilities and  stockholders’ equity |       | $          | 114,206    |                        | $          | 343,521                           |       | $                | 202,233    |             | $          | (97,673 | ) | $ | 562,287 |   |

 

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# **Condensed Consolidating Statement of Operations for the year ended December 31,2008 (in thousands)**

# ** **

| ** **                                                | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor****Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------|------------|------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
|                                                      |       |       |       |                        |       |                              |       |             |       |             |       |
| Revenues                                                  |       | $          | 18,008     |                        | $          | 439,083                           |       | $                | 18,008     |             | $          | (88,375 | ) | $ | 386,724 |   |
| Operating expenses                                        |       | 16,136     |       | 352,355                     |       | 174                               |       | (88,035          | )          | 280,630          |       |
| Depreciation and amortization                             |       | —     |       | 14,364                      |       | 4,222                             |       | (643             | )          | 17,943           |       |
| General and administrative  expenses                      |       | 25,879     |       | —                      |       | 75                                |       | —           |       | 25,954           |       |
| Income (loss) from operations                             |       | (24,007    | )          | 72,364                      |       | 13,537                            |       | 303              |       | 62,197           |       |
| Overhead allocations                                      |       | (37,349    | )          | 37,349                      |       | —                            |       | —           |       | —           |       |
| Interest, net                                             |       | 8,000      |       | 5,093                       |       | 10,997                            |       | (132             | )          | 23,958           |       |
| Equity earnings in subsidiaries                           |       | 31,233     |       | —                      |       | —                            |       | (31,233          | )          | —           |       |
| Income before provision for  income taxes                 |       | 36,575     |       | 29,922                      |       | 2,540                             |       | (30,798          | )          | 38,239           |       |
| Provision for income taxes                                |       | 14,384     |       | —                      |       | —                            |       | 1,219            |       | 15,603           |       |
| Minority interest in  consolidated special purpose entity |       | —     |       | —                      |       | —                            |       | 445              |       | 445              |       |
| Net income                                                |       | $          | 22,191     |                        | $          | 29,922                            |       | $                | 2,540      |             | $          | (32,462 | ) | $ | 22,191 |   |

 

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# **Condensed Consolidating Statement of Operations for the year ended December 31,2007**(in thousands)

# ** **

| ** **                                     | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor****Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------|------------|------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
|                                           |       |       |       |                        |       |                              |       |             |       |             |       |
| Revenues                                       |       | $          | 18,008     |                        | $          | 406,673                           |       | $                | 18,008     |             | $          | (82,085 | ) | $ | 360,604 |   |
| Operating expenses                             |       | 19,843     |       | 335,879                     |       | 87                                |       | (81,699          | )          | 274,110          |       |
| Pre-opening and start-up  expenses             |       | 3⁄4     |       | 3⁄4                      |       | 3⁄4                            |       | 3⁄4           |       | 3⁄4           |       |
| Depreciation and amortization                  |       | 183        |       | 12,199                      |       | 4,222                             |       | (618             | )          | 15,986           |       |
| General and administrative expenses            |       | 25,424     |       | 3⁄4                      |       | 75                                |       | 3⁄4           |       | 25,499           |       |
| Income (loss) from operations                  |       | (27,442    | )          | 58,595                      |       | 13,624                            |       | 232              |       | 45,009           |       |
| Overhead allocations                           |       | (41,236    | )          | 41,236                      |       | 3⁄4                            |       | 3⁄4           |       | 3⁄4           |       |
| Interest, net                                  |       | 6,972      |       | 5,094                       |       | 11,889                            |       | 309              |       | 24,264           |       |
| Equity earnings in subsidiaries                |       | 13,244     |       | 3⁄4                      |       | 3⁄4                            |       | (13,244          | )          | 0                |       |
| Income before provision  for income taxes |       | 20,066     |       | 12,265                      |       | 1,735                             |       | (13,321          | )          | 20,745           |       |
| Provision for income taxes                     |       | 8,156      |       | 3⁄4                      |       | 3⁄4                            |       | 679              |       | 8,835            |       |
| Income from continuing  operations             |       | 11,910     |       | 12,265                      |       | 1,735                             |       | (14,000          | )          | 11,910           |       |
| Discontinued operations                        |       | 3⁄4     |       | 3⁄4                      |       | 3⁄4                            |       | 3⁄4           |       | 3⁄4           |       |
| Net income                                     |       | $          | 11,910     |                        | $          | 12,265                            |       | $                | 1,735      |             | $          | (14,000 | ) | $ | 11,910 |   |

 

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# **Condensed Consolidating Statement of Operations for the year ended December 31,2006 (in thousands)**

# ** **

| ** **                                                  | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor****Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
|                                                        |       |       |       |                        |       |                              |       |             |       |             |       |
| Revenues                                                    |       | $          | 18,008     |                        | $          | 408,832                           |       | $                | 18,008     |             | $          | (83,993 | ) | $ | 360,855 |   |
| Operating expenses                                          |       | 23,498     |       | 335,515                     |       | 33                                |       | (83,651          | )          | 275,395          |       |
| Pre-opening and start-up  expenses                          |       | 3⁄4     |       | 2,657                       |       | 3⁄4                            |       | 3⁄4           |       | 2,657            |       |
| Depreciation and amortization                               |       | 3⁄4     |       | 12,499                      |       | 4,222                             |       | (436             | )          | 16,285           |       |
| General and administrative  expenses                        |       | 21,617     |       | 3⁄4                      |       | 103                               |       | 3⁄4           |       | 21,720           |       |
| Income (loss) from operations                               |       | (27,107    | )          | 58,161                      |       | 13,650                            |       | 94               |       | 44,798           |       |
| Overhead allocations                                        |       | (40,432    | )          | 40,432                      |       | 3⁄4                            |       | 3⁄4           |       | 3⁄4           |       |
| Interest, net                                               |       | 6,653      |       | 5,085                       |       | 13,522                            |       | (2,190           | )          | 23,070           |       |
| Equity earnings in subsidiaries                             |       | 13,360     |       | 3⁄4                      |       | 3⁄4                            |       | (13,360          | )          | 3⁄4           |       |
| Income before provision for  income taxes                   |       | 20,032     |       | 12,644                      |       | 128                               |       | (11,076          | )          | 21,728           |       |
| Provision for income taxes                                  |       | 8,159      |       | 3⁄4                      |       | 3⁄4                            |       | 989              |       | 9,148            |       |
| Income from continuing  operations                          |       | 11,873     |       | 12,644                      |       | 128                               |       | (12,065          | )          | 12,580           |       |
| Discontinued operations, net of  income tax benefit of $381 |       | 3⁄4     |       | (707                        | )          | 3⁄4                            |       | 3⁄4           |       | (707             | )          |
| Net income                                                  |       | $          | 11,873     |                        | $          | 11,937                            |       | $                | 128        |             | $          | (12,065 | ) | $ | 11,873 |   |

 

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# ** Condensed ConsolidatingStatement of Cash Flows for the year ended December 31, 2008 (inthousands)**

 
| ** **                                                | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiary** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|
| **Cash flows from  operating activities:**                | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** |
| Net cash (used in) provided by  operating activities      |       | $          | (34,261    | )                           | $          | 78,937                          |       | $                | 14,303     |   | $ | 58,979 |   |
|                                                      |       |       |       |                        |       |                            |       |             |       |
| **Cash flows from  investing activities:**                | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** |
| Capital expenditures                                      |       | 3⁄4     |       | (79,915                     | )          | 3⁄4                          |       | (79,915          | )          |
| Sales of investment securities                            |       | 250        |       | 3⁄4                      |       | 3⁄4                          |       | 250              |       |
| Payments to restricted debt  payment account, net         |       | 3⁄4     |       | 3⁄4                      |       | (2,901                          | )          | (2,901           | )          |
| Proceeds from sale of fixed  assets                       |       | 3⁄4     |       | 846                         |       | 3⁄4                          |       | 846              |       |
| Net cash provided by (used in)  investing activities      |       | 250        |       | (79,069                     | )          | (2,901                          | )          | (81,720          | )          |
|                                                      |       |       |       |                        |       |                            |       |             |       |
| **Cash flows from  financing activities:**                | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** |
| Payments of MCF bonds                                     |       | 3⁄4     |       | 3⁄4                      |       | (11,400                         | )          | (11,400          | )          |
| Proceeds from line of credit                              |       | 49,000     |       | 3⁄4                      |       | 3⁄4                          |       | 49,000           |       |
| Payments on line of credit                                |       | (4,000     | )          | 3⁄4                      |       | 3⁄4                          |       | (4,000           | )          |
| Payments on capital lease  obligations                    |       | 3⁄4     |       | (11                         | )          | 3⁄4                          |       | (11              | )          |
| Proceeds from exercise of stock  options                  |       | 737        |       | 3⁄4                      |       | 3⁄4                          |       | 737              |       |
| Net cash (used in) provided by  financing activities      |       | 45,737     |       | (11                         | )          | (11,400                         | )          | 34,326           |       |
|                                                      |       |       |       |                        |       |                            |       |             |       |
| **Net increase  (decrease) in cash and cash equivalents** |       | 11,726     |       | (143                        | )          | 2                               |       | 11,585           |       |
|                                                      |       |       |       |                        |       |                            |       |             |       |
| **Cash and cash equivalents at beginning of****period**   |       | 2,565      |       | 408                         |       | 55                              |       | 3,028            |       |
|                                                      |       |       |       |                        |       |                            |       |             |       |
| **Cash and cash  equivalents at end of period**           |       | $          | 14,291     |                        | $          | 265                             |       | $                | 57         |   | $ | 14,613 |   |

 

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**Condensed Consolidating Statement of Cash Flows forthe year ended December 31, 2007 (in thousands)**

 
| ** **                                                  | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiary** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|
| **Cash flows from  operating activities:**                  | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** |
| Net cash provided by (used in)  operating activities        |       | $          | (59,489    | )                           | $          | 74,169                          |       | $                | 12,564     |   | $ | 27,244 |   |
|                                                        |       |       |       |                        |       |                            |       |             |       |
| **Cash flows from  investing activities:**                  | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** |
| Capital expenditures                                        |       | 3⁄4     |       | (50,890                     | )          | 3⁄4                          |       | (50,890          | )          |
| Purchase of investment  securities                          |       | (241,425   | )          | 3⁄4                      |       | 3⁄4                          |       | (241,425         | )          |
| Sales of investment securities                              |       | 253,100    |       | 3⁄4                      |       | 3⁄4                          |       | 253,100          |       |
| Facility acquisitions                                       |       | 3⁄4     |       | (18,554                     | )          | 3⁄4                          |       | (18,554          | )          |
| Site acquisition                                            |       | 3⁄4     |       | (5,053                      | )          | 3⁄4                          |       | (5,053           | )          |
| Payments to restricted debt payment account, net            |       | 3⁄4     |       | 3⁄4                      |       | (2,084                          | )          | (2,084           | )          |
| Proceeds from sale of fixed  assets                         |       | 3⁄4     |       | 375                         |       | 3⁄4                          |       | 375              |       |
| Net cash provided by (used in)  investing activities        |       | 11,675     |       | (74,122                     | )          | (2,084                          | )          | (64,531          | )          |
|                                                        |       |       |       |                        |       |                            |       |             |       |
| **Cash flows from  financing activities:**                  | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** |
| Proceeds from line of credit                                |       | 30,000     |       | 3⁄4                      |       | 3⁄4                          |       | 30,000           |       |
| Payments on MCF Bonds                                       |       | 3⁄4     |       | 3⁄4                      |       | (10,500                         | )          | (10,500          | )          |
| Payments for debt issuance and  other financing costs       |       | (845       | )          | 3⁄4                      |       | 3⁄4                          |       | (845             | )          |
| Payments on capital lease  obligations                      |       | 3⁄4     |       | (10                         | )          | 3⁄4                          |       | (10              | )          |
| Proceeds from exercise of stock  options and warrants       |       | 2,786      |       | 3⁄4                      |       | 3⁄4                          |       | 2,786            |       |
| Tax benefit of stock option  exercises                      |       | 355        |       | 3⁄4                      |       | 3⁄4                          |       | 355              |       |
| Net cash provided by (used in)  financing activities        |       | 32,296     |       | (10                         | )          | (10,500                         | )          | 21,786           |       |
|                                                        |       |       |       |                        |       |                            |       |             |       |
| **Net (decrease) increase in cash and cash****equivalents** |       | (15,518    | )          | 37                          |       | (20                             | )          | (15,501          | )          |
|                                                        |       |       |       |                        |       |                            |       |             |       |
| **Cash and cash  equivalents at beginning of period**       |       | 18,083     |       | 371                         |       | 75                              |       | 18,529           |       |
|                                                        |       |       |       |                        |       |                            |       |             |       |
| **Cash and cash  equivalents at end of period**             |       | $          | 2,565      |                        | $          | 408                             |       | $                | 55         |   | $ | 3,028 |   |

# ** **

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# **Condensed Consolidating Statement of Cash Flows for the year ended December 31,2006 (in thousands)**

 
| ** **                                                | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiary** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|
| **Cash flows from operating  activities:**                | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** |
| Net cash provided by operating  activities                |       | $          | 7,859      |                        | $          | 8,693                           |       | $                | 13,112     |   | $ | 29,664 |   |
|                                                      |       |       |       |                        |       |                            |       |             |       |
| **Cash flows from  investing activities:**                | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** |
| Capital expenditures                                      |       | 3⁄4     |       | (12,317                     | )          | 3⁄4                          |       | (12,317          | )          |
| Purchases of investment  securities                       |       | (427,600   | )          | 3⁄4                      |       | 3⁄4                          |       | (427,600         | )          |
| Sales of investment securities                            |       | 422,925    |       | 3⁄4                      |       | 3⁄4                          |       | 422,925          |       |
| Payments to restricted debt  payment account, net         |       | 3⁄4     |       | 3⁄4                      |       | (3,367                          | )          | (3,367           | )          |
| Proceeds from sale of fixed  assets                       |       | 3⁄4     |       | 2,892                       |       | 3⁄4                          |       | 2,892            |       |
| Net cash used in investing  activities                    |       | (4,675     | )          | (9,425                      | )          | (3,367                          | )          | (17,467          | )          |
|                                                      |       |       |       |                        |       |                            |       |             |       |
| **Cash flows from  financing activities:**                | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** |
| Payments of MCF bonds                                     |       | 3⁄4     |       | 3⁄4                      |       | (9,700                          | )          | (9,700           | )          |
| Tax benefit of stock option  exercises                    |       | 224        |       | 3⁄4                      |       | 3⁄4                          |       | 224              |       |
| Payments on capital lease  obligations                    |       | 3⁄4     |       | (11                         | )          | 3⁄4                          |       | (11              | )          |
| Proceeds from exercise of stock  options                  |       | 2,096      |       | 3⁄4                      |       | 3⁄4                          |       | 2,096            |       |
| Net cash (used in) provided by  financing activities      |       | 2,320      |       | (11                         | )          | (9,700                          | )          | (7,391           | )          |
|                                                      |       |       |       |                        |       |                            |       |             |       |
| **Net increase  (decrease) in cash and cash equivalents** |       | 5,504      |       | (743                        | )          | 45                              |       | 4,806            |       |
|                                                      |       |       |       |                        |       |                            |       |             |       |
| **Cash and cash equivalents at beginning of****period**   |       | 12,579     |       | 1,114                       |       | 30                              |       | 13,723           |       |
|                                                      |       |       |       |                        |       |                            |       |             |       |
| **Cash and cash  equivalents at end of period**           |       | $          | 18,083     |                        | $          | 371                             |       | $                | 75         |   | $ | 18,529 |   |

 

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**17.  SELECTED QUARTERLY FINANCIAL DATA (Unaudited)**

        **(inthousands, except per share data)**

 
| ** **                             | ** ** | **1****st****Quarter** | ** ** | **2****nd****Quarter** | ** ** | **3****rd****Quarter** | ** ** | **4****th****Quarter** | ** ** | **Year**   | ** ** |
|----------------------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------|------------|
| **2008:**                              | ** ** | ** **             | ** ** | ** **             | ** ** | ** **             | ** ** | ** **             | ** ** | ** ** | ** ** |
| Revenues                               |       | $                      | 95,392     |                   | $          | 94,646                 |       | $                      | 95,187     |       | $          | 101,499 |   | $ | 386,724 |   |
| Income from operations                 |       | 14,490                 |       | 14,914                 |       | 14,037                 |       | 18,756                 |       | 62,197     |       |
| Net income                             |       | 4,634                  |       | 5,345                  |       | 4,828                  |       | 7,384                  |       | 22,191     |       |
|                                   |       |                   |       |                   |       |                   |       |                   |       |       |       |
| Earnings per share:                    |       |                   |       |                   |       |                   |       |                   |       |       |       |
| Basic                                  |       | $                      | .32        |                   | $          | .37                    |       | $                      | .34        |       | $          | .52 |   | $ | 1.55 |   |
| Diluted                                |       | $                      | .32        |                   | $          | .36                    |       | $                      | .33        |       | $          | .50 |   | $ | 1.51 |   |
|                                   |       |                   |       |                   |       |                   |       |                   |       |       |       |
| **2007:**                              | ** ** | ** **             | ** ** | ** **             | ** ** | ** **             | ** ** | ** **             | ** ** | ** ** | ** ** |
| Revenues                               |       | $                      | 89,644     |                   | $          | 91,494                 |       | $                      | 87,327     |       | $          | 92,139 |   | $ | 360,604 |   |
| Income from operations                 |       | 7,835                  |       | 12,047                 |       | 10,537                 |       | 14,590                 |       | 45,009     |       |
| Net income                             |       | 664                    |       | 3,446                  |       | 2,416                  |       | 5,384                  |       | 11,910     |       |
|                                   |       |                   |       |                   |       |                   |       |                   |       |       |       |
| Earnings per share:                    |       |                   |       |                   |       |                   |       |                   |       |       |       |
| Basic                                  |       | $                      | .05        |                   | $          | .24                    |       | $                      | .17        |       | $          | .38 |   | $ | .84 |   |
| Diluted (a)                            |       | $                      | .05        |                   | $          | .24                    |       | $                      | .17        |       | $          | .37 |   | $ | .82 |   |
|                                   |       |                   |       |                   |       |                   |       |                   |       |       |       |
| **2008 Balance Sheet Data:**           | ** ** | ** **             | ** ** | ** **             | ** ** | ** **             | ** ** | ** **             | ** ** | ** ** | ** ** |
| Working capital                        |       | $                      | 41,697     |                   | $          | 35,444                 |       | $                      | 38,988     |       | $          | 48,395 |   | $ | 48,395 |   |
| Total assets                           |       | 578,530                |       | 602,787                |       | 628,107                |       | 636,921                |       | 636,921    |       |
| Long-term debt, net of current portion |       | 280,341                |       | 292,884                |       | 306,027                |       | 308,070                |       | 308,070    |       |
| Stockholders’ equity              |       | 206,877                |       | 212,711                |       | 219,179                |       | 227,722                |       | 227,722    |       |
|                                   |       |                   |       |                   |       |                   |       |                   |       |       |       |
| **2007 Balance Sheet Data:**           | ** ** | ** **             | ** ** | ** **             | ** ** | ** **             | ** ** | ** **             | ** ** | ** ** | ** ** |
| Working capital                        |       | $                      | 75,749     |                   | $          | 59,080                 |       | $                      | 22,827     |       | $          | 47,757 |   | $ | 47,757 |   |
| Total assets                           |       | 516,541                |       | 535,039                |       | 537,028                |       | 562,287                |       | 562,287    |       |
| Long-term debt, net of current portion |       | 256,085                |       | 254,463                |       | 245,083                |       | 275,298                |       | 275,298    |       |
| Stockholders’ equity              |       | 183,913                |       | 189,122                |       | 193,792                |       | 200,449                |       | 200,449    |       |

 

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| (a) |   | The sum of quarters may not equal  yearly amount as each quarter represents a discrete period and also due to rounding. |
|-----|--------|-------------------------------------------------------------------------------------------------------------------------|

 

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| **ITEM 9** | **CHANGES IN AND DISAGREEMENTS  WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE** |
|------------|-------------------------------------------------------------------------------------------|

 

None.

 
| **ITEM 9A.** | **CONTROLS AND PROCEDURES** |
|--------------|-----------------------------|

 

# **EVALUATIONOF DISCLOSURE CONTROLS AND PROCEDURES**

# ** **

We maintain disclosurecontrols and procedures designed to provide reasonable assurance thatinformation disclosed in our annual and periodic reports is recorded,processed, summarized and reported, within the time periods specified in theSecurities and Exchange Commission’s rules and forms. In addition, wedesigned these disclosure controls and procedures to ensure that thisinformation is accumulated and communicated to management, including the chiefexecutive officer (“CEO”) and chief financial officer (“CFO”), to allow timelydecisions regarding required disclosures. SEC rules require that wedisclose the conclusions of our CEO and CFO about the effectiveness of ourdisclosure controls and procedures.

 

We do not expect that our disclosurecontrols and procedures will prevent all errors or fraud. A control system, nomatter how well conceived and operated, can provide only reasonable, notabsolute, assurance that the objectives of the control system are met. Inaddition, the design of disclosure controls and procedures must reflect thefact that there are resource constraints, and the benefits of controls must beconsidered relative to their costs. Because of the inherent limitation in acost-effective control system, misstatements due to error or fraud could occurand not be detected.

 

Under the supervision andwith the participation of our management, including our principal executiveofficer and principal financial officer, and as required by paragraph (b) ofRules 13a-15 and 15d-15 of the Exchange Act, we have evaluated theeffectiveness of the design and operation of our disclosure controls andprocedures (as defined in Rules 13a-15(e) and 15d-15(e) of theExchange Act) as of the end of the period required by this report. Based onthat evaluation, our principal executive officer and principal financialofficer have concluded that these controls and procedures are effective at areasonable assurance level as of that date.

 

**CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING**

 

In connection with theevaluation as required by paragraph (d) of Rules 13a-15 and 15d-15 ofthe Exchange Act, we have not identified any change in internal control overfinancial reporting (as such term is defined in Rules 13a-15(f) and15d-15(f) under the Exchange Act) that occurred during our fiscal quarterended December 31, 2008 that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reporting.

 

**MANAGEMENT’S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING**

 

The management of Cornellis responsible for establishing and maintaining adequate internal control overfinancial reporting for Cornell.  Cornell’sinternal control over financial reporting is a process designed to providereasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance withgenerally accepted accounting principles. Cornell’s internal control over financial reporting includes thosepolicies and procedures that (i) pertain to the maintenance of recordsthat, in reasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the Company; (ii) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the Company are being madeonly in accordance with authorizations of management and directors of the Company;and, (iii) provide reasonable assurance regarding prevention or timelydetection of unauthorized acquisition, use, or disposition of the Company’sassets that could have a material effect on the financial statements.

 

Due to its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements.  Also, projectionsof any evaluation of effectiveness to future periods are subject to the riskthat controls may become inadequate because of changes in conditions, or thatthe degree of compliance with the policies or procedures may deteriorate.

 

We have assessed theeffectiveness of our internal control over financial reporting as of December 31,2008.  To make this assessment we usedthe criteria for effective internal control over financial reporting describedin *Internal Control — Integrated Framework*,issued by the Committee of Sponsoring Organizations of the Treadway Commission.Based on our

 

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assessment, we haveconcluded that, as of December 31, 2008, the Company’s internal controlover financial reporting was effective.

 

Our management’sassessment of the effectiveness of the Company’s internal control overfinancial reporting as of December 31, 2008 has been audited byPricewaterhouseCoopers LLP, an independent registered public accounting firm,as stated in their report which appears herein.

 

**REPORTOF THE REGISTERED PUBLIC ACCOUNTING FIRM**

 

See “Financial Statementsand Supplementary Data — Report of Independent Registered Public AccountingFirm” in Item 8 of this report.

 
| **ITEM 9B.** | **OTHER INFORMATION** |
|--------------|-----------------------|

 

None.

 

**PART III**

 

Items 10, 11, 12, 13 and14 of Part III have been omitted from this report because we will filewith the Securities and Exchange Commission, not later than 120 days after theclose of our fiscal year, a definitive proxy statement or a Form 10-K/A.  The information required by Items 10, 11, 12,13 and 14 of this report, which will appear in the definitive proxy statementand/or the Form 10-K/A, is incorporated by reference into Part III ofthis report.

 

**PART IV**

 
| **ITEM 15.** | **EXHIBITS AND FINANCIAL STATEMENT SCHEDULES** |
|--------------|------------------------------------------------|

 

(a)                                  **Financial Statements, Schedules and Exhibits**

 
| 1.     | Financial statements                                                                                                                                      |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | Report of Independent  Registered Public Accounting Firm                                                                                                  |
|   | Consolidated Balance  Sheets - December 31, 2008 and 2007                                                                                            |
|   | Consolidated Statements of  Operations and Comprehensive Income/(Loss) for the years ended  December 31, 2008, 2007 and 2006                         |
|   | Consolidated Statements of  Stockholders’ Equity for the years ended December 31, 2008, 2007 and  2006                                          |
|   | Consolidated Statements of  Cash Flows for the years ended December 31, 2008, 2007 and 2006                                                          |
|   | Notes to consolidated  financial statements                                                                                                               |
|   |                                                                                                                                                      |
| 2.     | Financial statement schedules                                                                                                                             |
|   | All schedules are omitted  because they are not applicable or because the required information is  included in the financial statements or notes thereto. |
|   |                                                                                                                                                      |
| 3.     | Exhibits                                                                                                                                                  |

 
| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                                                                           |
|------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1              |       | Restated Certificate of Incorporation of Cornell Companies, Inc. (incorporated  by reference to Exhibit 3.1 to the Company’s Annual Report on  Form 10-K for the year ended December 31, 1996 filed on  March 31, 1997).                    |
|             |       |                                                                                                                                                                                                                                                                      |
| 3.2              |       | Second Amended and Restated Bylaws of Cornell Companies, Inc. (incorporated  by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K  filed on December 13, 2007).                                                               |
|             |       |                                                                                                                                                                                                                                                                      |
| 3.3              |       | Certificate of Amendment of Restated Certificate of Incorporation of  Cornell Companies, Inc. (incorporated by reference  to Exhibit 4.2 to the Company’s Registration Statement on  Form S-8 (Reg. No. 333-42444) filed on July 28, 2000). |
|             |       |                                                                                                                                                                                                                                                                      |
| 4.1              |       | Form of Certificate representing Common Stock (incorporated  by reference to Exhibit 4.1 to the Company’s Registration Statement on  Amendment 1 to Form S-1 (Reg. No. 333-08243) filed on  August 26, 1996).                               |

 

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| 4.6    |   | Indenture dated as of June 24, 2004 between Cornell  Companies, Inc., the guarantors named therein and JPMorgan Chase Bank,  as trustee (incorporated by reference to Exhibit 4.1 to  the Company’s Current Report on Form 8-K filed on  June 25, 2004).                                                                                                                                             |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 4.7    |   | Form of 10 3/4% Senior Note due 2012 (included in  Exhibit 4.6).                                                                                                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 4.8    |   | Registration  Rights Agreement dated March 31, 1994, as amended, among Cornell  Corrections, Inc. and the stockholders listed on the signature  pages thereto (incorporated by reference to Exhibit 4.2 to the  Company’s Registration Statement on Form S-1 (Reg. No. 333- 08243),  filed on July 17, 1996, as amended).                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 4.9    |   | Registration Rights Agreement, dated October 14, 1999 among  Cornell Companies, Inc. and the investors party thereto (incorporated by  reference to Exhibit 4.7 to the Company’s Registration Statement on  Form S-3 (Reg. No. 333-91211) filed on November 18, 1999).                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.1*  |   | Cornell Corrections, Inc. Amended and Restated 1996 Stock Option  Plan (incorporated by reference to Exhibit B to the Company’s Schedule 14A  filed on March 9, 1998).                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.2*  |   | Form of Indemnification Agreement between Cornell  Companies, Inc. and each of its directors and executive officers (incorporated  by reference to Exhibit 10.3 to the Company’s Registration  Statement on Amendment 1 to Form S-1 (Reg. No. 333-08243) filed on  August 26, 1996).                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.3*  |   | Cornell Corrections, Inc. Employee Stock Purchase Plan (incorporated  by reference to Exhibit 4.7 to the Company’s Registration Statement on  Form S-8 (Reg. No. 333-80187) filed on June 8, 1999).                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.4*  |   | Cornell Corrections, Inc. Deferred Compensation Plan (incorporated  by reference to Exhibit 4.8 to the Company’s Registration Statement on  Form S-8 (Reg. No. 333-80187) filed on June 8, 1999).                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.5*  |   | Cornell Companies, Inc. 2000 Director Stock Plan (incorporated  by reference to Exhibit 4.9 to the Company’s Registration Statement on  Form S-8 (Reg. No. 333-42444) filed on July 28, 2000).                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.6*  |   | Cornell Companies, Inc. Deferred Bonus Plan (incorporated  by reference to Exhibit 10.44a to the Company’s Annual Report  on Form 10-K for the year ended December 31, 2002 filed on  March 31, 2003).                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.7   |   | Premises Transfer Agreement, dated August 14, 2001, among Cornell  Companies, Inc., Cornell Corrections of Georgia, L.P., Cornell Corrections  of Oklahoma, Inc., Cornell Corrections of Texas, Inc., WBP  Leasing, Inc., and Municipal Corrections Finance, L.P. (incorporated  by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K  filed on August 28, 2001). |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.8   |   | Master Lease Agreement (with addenda), dated August 14, 2001,  between Municipal Corrections Finance, L.P. and Cornell Companies, Inc. (incorporated  by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K  filed on August 28, 2001).                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.9   |   | Master Lease Agreement dated December 3, 1998 between Atlantic  Financial Group, Ltd. and WBP Leasing, Inc. and certain other  subsidiaries of Cornell Corrections, Inc. (incorporated by reference  to Exhibit 10.3 to the Company’s Quarterly Report on  Form 10-Q for the quarter ended September 30, 2001 filed on  October 30, 2001).                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.10  |   | Amended and  Restated Credit Agreement dated October 10, 2007 among Cornell  Companies, Inc., its subsidiaries, JPMorgan Chase Bank N.A., as  Administrative Agent, Bank of America, N.A., as Syndication Agent and the  Lenders party thereto (incorporated by reference to Exhibit 10.1 to the Company’s Current  Report on Form 8-K filed on October 12, 2007).                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.11* |   | Amended and Restated Employment Agreement, dated August 2, 2007,  between Cornell Companies, Inc. and James E. Hyman (incorporated  by reference to Exhibit 10.1 to the Company’s Current  Report on Form 8-K filed on August 6, 2007).                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.12* |   | Restricted Stock Agreement, dated March 14, 2005, between Cornell  Companies, Inc. and James E. Hyman (incorporated by reference  to Exhibit 10.2  to the Company’s Current Report on Form 8-K filed on March 15,  2005).                                                                                                                                                                            |

 

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| 10.13*     |   | Employment/Separation Agreement, dated March 9, 2005, between  Cornell Companies, Inc. and John R. Nieser (incorporated by reference  to Exhibit 10.3  to the Company’s Current Report on Form 8-K filed on March 15,  2005).                                                        |
|------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |   |                                                                                                                                                                                                                                                                                                               |
| 10.14*     |   | Amendment to Employment/Separation Agreement dated March 14, 2007  by and between Cornell Companies, Inc. and John R. Nieser (incorporated  by reference to Exhibit 10.2 to the Company’s Current  Report on Form 8-K filed on March 15, 2007).                                      |
|       |   |                                                                                                                                                                                                                                                                                                               |
| 10.15*     |   | Form of Severance Agreement (incorporated by reference  to Exhibit 10.40 to the Company’s Annual Report on  Form 10-K for the year ended December 31, 1999 filed on  March 30, 2000).                                                                                                |
|       |   |                                                                                                                                                                                                                                                                                                               |
|       |   | Amendment to Severance Agreement dated March 14, 2007 by and  between Cornell Companies, Inc. and Patrick N. Perrin (incorporated  by reference to Exhibit 10.4 to the Company’s Current  Report on Form 8-K filed on March 15, 2007).                                               |
|       |   |                                                                                                                                                                                                                                                                                                               |
| 10.16*     |   | Employment Agreement dated March 19, 2007 between Cornell  Companies, Inc. and William E. Turcotte (incorporated by reference to  Exhibit 10.16 to the Company’s Annual Report on Form 10-K for the  year ended December 31, 2007 filed on March 14, 2008).                     |
|       |   |                                                                                                                                                                                                                                                                                                               |
| 10.17*     |   | Cornell Companies, Inc. 2006 Equity Incentive Plan (incorporated  by reference to Appendix A to the Company’s Schedule 14A filed on  May 10, 2006).                                                                                                                                                 |
|       |   |                                                                                                                                                                                                                                                                                                               |
| 10.18*     |   | Form of Cornell Companies, Inc. Restricted Stock Award —  Performance Based (incorporated by reference to Exhibit 10.1 to the  Company’s Current Report on Form 8-K filed on March 12, 2008).                                                                                   |
|       |   |                                                                                                                                                                                                                                                                                                               |
| 10.19*     |   | Form of Cornell Companies, Inc. Restricted Stock Award —  Time Based (incorporated by reference to Exhibit 10.2 to the Company’s  Current Report on Form 8-K filed on March 12, 2008).                                                                                          |
|       |   |                                                                                                                                                                                                                                                                                                               |
| 21.1       |   | List of Subsidiaries (incorporated by reference to Exhibit 21.1 to the  Company’s Annual Report on Form 10-K for the year ended December 31, 2008  filed on March 6, 2009).                                                                                                                                   |
|       |   |                                                                                                                                                                                                                                                                                                               |
| 23.1† |   | Consent of PricewaterhouseCoopers LLP.                                                                                                                                                                                                                                                                             |
|       |   |                                                                                                                                                                                                                                                                                                               |
| 24.1       |   | Power of Attorney (incorporated by reference to the signature page to  the Company’s Annual Report on Form 10-K for the year ended December 31, 2008  filed on March 6, 2009).                                                                                                                                |
|       |   |                                                                                                                                                                                                                                                                                                               |
| 31.1† |   | Section 302 Certification of Chief Executive Officer.                                                                                                                                                                                                                                                         |
|       |   |                                                                                                                                                                                                                                                                                                               |
| 31.2† |   | Section 302 Certification of Chief Financial Officer.                                                                                                                                                                                                                                                         |
|       |   |                                                                                                                                                                                                                                                                                                               |
| 32.1† |   | Section 906 Certification of Chief Executive Officer.                                                                                                                                                                                                                                                         |
|       |   |                                                                                                                                                                                                                                                                                                               |
| 32.2† |   | Section 906 Certification of Chief Financial Officer.                                                                                                                                                                                                                                                         |
|       |   |                                                                                                                                                                                                                                                                                                               |
| 99.1       |   | Letter Agreement, dated September 5, 2001, as amended, between  Cornell Companies, Inc. and Lehman Brothers, Inc. (incorporated  by reference to Exhibit 99.2 to the Company’s Annual Report  on Form 10-K for the year ended December 31, 2001 filed on  April 16, 2002). |
|       |   |                                                                                                                                                                                                                                                                                                               |

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*      Managementcompensatory plan or contract.

†      Filedherewith

 

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**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this Amendment No. 2 to the Annual Reporton Form 10-K/A to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 
|   |            | CORNELL COMPANIES, INC. |
|--------|-----------------|-------------------------|
|   |            |                    |
| Dated: | August 14, 2009 | By:                     | /s/ James E. Hyman |
|   |            |                    | James E. Hyman |
|   |            |                    | Chief Executive Officer, President and |
|   |            |                    | Chairman of the Board |
|   |            |                    |   |
|   |            | By:                     | /s/ John R. Nieser |
|   |            |                    | Chief Financial Officer, Senior Vice President and Treasurer |

 

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