**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

**FORM 10-Q**

 

| **ý****QUARTERLY REPORT PURSUANT  TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                        |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                          |
| **For the Quarterly Period Ended March 31, 2003**                                                                                                                                                             |
|                                                                                                                                                                                                          |
| **OR**                                                                                                                                                                                                        |
|                                                                                                                                                                                                          |
| **o****TRANSITION REPORT PURSUANT  TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                            |
|                                                                                                                                                                                                          |
| **For the transition period                  to                ** |
|                                                                                                                                                                                                          |
| **Commission File Number 1-14472**                                                                                                                                                                            |

 

**CORNELL COMPANIES, INC.**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                                                    |   | **76-0433642**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State or other jurisdiction  of incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
|                                                            |   |                                  |
| **1700 West Loop South, Suite 1500, Houston, Texas**            |   | **77027**                             |
| (Address of Principal Executive Offices)                        |   | (Zip Code)                            |
|                                                            |   |                                  |
| Registrant’s telephone number, including area code:        |   | **(713) 623-0790**                    |

 

Indicateby a check mark whether Registrant (1) has filed all reports required to befiled by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months, and (2) has been subject to such filing requirements forthe past 90 days.

 

| Yes ý  No o |
|--------------------------------------|

 

Indicateby check mark whether the Registrant is an accelerated filer (as defined inExchange Act Rule 12b-2).

 

| Yes ý  No o |
|--------------------------------------|

 

At April 30, 2003 Registrant had outstanding 13,076,570 shares of itsCommon Stock.

 

 

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**PART I          FINANCIALINFORMATION**

 

**ITEM 1.          FinancialStatements**

 

**CORNELL COMPANIES, INC.**

**CONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

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

 
|                                                                                                                                 |   | **March 31,  2003** |    | **December 31,  2002** |   |
|--------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|---------|------------------------|--------|
| ASSETS                                                                                                                               |   |                |    |                   |   |
| CURRENT ASSETS:                                                                                                                      |   |                |    |                   |   |
| Cash and cash equivalents                                                                                                            |   | $                   | 51,309  |                   | $      | 52,610 |   |
| Accounts receivable, net                                                                                                             |   | 58,017              |    | 60,035                 |   |
| Other restricted assets                                                                                                              |   | 12,803              |    | 14,767                 |   |
| Deferred tax asset                                                                                                                   |   | 3,300               |    | 3,300                  |   |
| Prepaids and other                                                                                                                   |   | 5,968               |    | 5,528                  |   |
| Total current assets                                                                                                                 |   | 131,397             |    | 136,240                |   |
| PROPERTY AND EQUIPMENT, net                                                                                                          |   | 254,487             |    | 255,450                |   |
| OTHER ASSETS:                                                                                                                        |   |                |    |                   |   |
| Debt service reserve fund                                                                                                            |   | 24,163              |    | 24,157                 |   |
| Goodwill                                                                                                                             |   | 7,721               |    | 7,721                  |   |
| Other intangible assets, net                                                                                                         |   | 5,151               |    | 5,341                  |   |
| Deferred costs and other                                                                                                             |   | 12,220              |    | 12,382                 |   |
| Total assets                                                                                                                         |   | $                   | 435,139 |                   | $      | 441,291 |   |
|                                                                                                                                 |   |                |    |                   |   |
| LIABILITIES  AND STOCKHOLDERS’ EQUITY                                                                                           |   |                |    |                   |   |
|                                                                                                                                 |   |                |    |                   |   |
| CURRENT LIABILITIES:                                                                                                                 |   |                |    |                   |   |
| Accounts payable and accrued liabilities                                                                                             |   | $                   | 24,766  |                   | $      | 32,622 |   |
| Current portion of long-term debt                                                                                                    |   | 7,628               |    | 7,630                  |   |
| Total current liabilities                                                                                                            |   | 32,394              |    | 40,252                 |   |
| LONG-TERM DEBT, net of current portion                                                                                               |   | 232,254             |    | 232,258                |   |
| DEFERRED TAX LIABILITIES                                                                                                             |   | 5,314               |    | 4,954                  |   |
| OTHER LONG-TERM LIABILITIES                                                                                                          |   | 2,802               |    | 3,875                  |   |
| Total liabilities                                                                                                                    |   | 272,764             |    | 281,339                |   |
|                                                                                                                                 |   |                |    |                   |   |
| 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, 14,251,524 and 14,005,482 shares issued and outstanding,  respectively |   | 14                  |    | 14                     |   |
| Additional paid-in capital                                                                                                           |   | 140,369             |    | 140,085                |   |
| Notes from shareholders                                                                                                              |   | (449                | )       | (442                   | )      |
| Retained earnings                                                                                                                    |   | 32,205              |    | 30,248                 |   |
| Treasury stock (1,477,086 and 1,109,816  shares at cost, respectively)                                                               |   | (11,510             | )       | (11,038                | )      |
| Deferred compensation                                                                                                                |   | (599                | )       | (811                   | )      |
| Accumulated comprehensive income                                                                                                     |   | 2,345               |    | 1,896                  |   |
| Total stockholders’ equity                                                                                                      |   | 162,375             |    | 159,952                |   |
| Total liabilities and stockholders’ equity                                                                                      |   | $                   | 435,139 |                   | $      | 441,291 |   |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

2

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**CORNELL COMPANIES, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS ANDCOMPREHENSIVE INCOME (LOSS)**

**(Unaudited)**

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

 

 
|                                                                                                      |   | **Three Months Ended  March 31,** |   |
|-----------------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                                                      |   | **2003**                          |   | **2002** |   |
|                                                                                                      |   |                              |   |   |   |
| REVENUES                                                                                                  |   | $                                 | 66,026 |   | $ | 68,475 |   |
| OPERATING EXPENSES, EXCLUDING DEPRECIATION  AND AMORTIZATION                                              |   | 51,780                            |   | 53,808 |   |
| DEPRECIATION AND AMORTIZATION                                                                             |   | 2,569                             |   | 2,206 |   |
| GENERAL AND ADMINISTRATIVE EXPENSES                                                                       |   | 3,898                             |   | 6,086 |   |
|                                                                                                      |   |                              |   |   |   |
| INCOME FROM OPERATIONS                                                                                    |   | 7,779                             |   | 6,375 |   |
| INTEREST EXPENSE                                                                                          |   | 4,847                             |   | 5,795 |   |
| INTEREST INCOME                                                                                           |   | (385                              | )      | (528 | ) |
| MINORITY INTEREST IN LOSSES OF CONSOLIDATED  SPECIAL PURPOSE ENTITIES                                     |   | —                            |   | (40 | ) |
|                                                                                                      |   |                              |   |   |   |
| INCOME BEFORE PROVISION FOR INCOME TAXES  AND CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE         |   | 3,317                             |   | 1,148 |   |
| PROVISION FOR INCOME TAXES                                                                                |   | 1,360                             |   | 513 |   |
| INCOME BEFORE CUMULATIVE EFFECT OF CHANGE  IN ACCOUNTING PRINCIPLE                                        |   | 1,957                             |   | 635 |   |
|                                                                                                      |   |                              |   |   |   |
| CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING  PRINCIPLE, NET OF RELATED INCOME TAX BENEFIT OF ($671) IN 2002 |   | —                            |   | (965 | ) |
|                                                                                                      |   |                              |   |   |   |
| NET INCOME (LOSS)                                                                                         |   | $                                 | 1,957  |   | $ | (330 | ) |
|                                                                                                      |   |                              |   |   |   |
| EARNINGS (LOSS) PER SHARE:                                                                                |   |                              |   |   |   |
| BASIC AND DILUTED                                                                                         |   |                              |   |   |   |
| Income before cumulative effect of change  in accounting principle                                        |   | $                                 | .15    |   | $ | .05 |   |
| Cumulative effect of change in accounting  principle                                                      |   | —                            |   | (.08 | ) |
| Net income (loss)                                                                                         |   | $                                 | .15    |   | $ | (.03 | ) |
|                                                                                                      |   |                              |   |   |   |
| NUMBER OF SHARES USED IN PER SHARE  COMPUTATION:                                                          |   |                              |   |   |   |
| BASIC                                                                                                     |   | 12,784                            |   | 12,952 |   |
| DILUTED                                                                                                   |   | 12,940                            |   | 12,952 |   |
|                                                                                                      |   |                              |   |   |   |
| COMPREHENSIVE INCOME (LOSS):                                                                              |   |                              |   |   |   |
| Net income (loss)                                                                                         |   | $                                 | 1,957  |   | $ | (330 | ) |
| Unrealized gain on derivative instruments                                                                 |   | 449                               |   | — |   |
| Comprehensive income (loss)                                                                               |   | $                                 | 2,406  |   | $ | (330 | ) |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

3

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**CORNELL COMPANIES, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

**(in thousands)**

 
|                                                                                            |   | **Three Months Ended  March 31,** |   |
|-------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                                            |   | **2003**                          |   | **2002** |   |
|                                                                                            |   |                              |   |   |   |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                           |   |                              |   |   |   |
| Net income (loss)                                                                               |   | $                                 | 1,957  |   | $ | (330 | ) |
| Adjustments to reconcile net income (loss)  to net cash provided by operating activities — |   |                              |   |   |   |
| Cumulative effect of change in accounting  principle                                            |   | —                            |   | 965 |   |
| Minority interest in consolidated special  purpose entities                                     |   | —                            |   | (40 | ) |
| Depreciation                                                                                    |   | 2,349                             |   | 1,986 |   |
| Amortization of intangibles and other  assets                                                   |   | 220                               |   | 220 |   |
| Amortization of deferred compensation                                                           |   | 86                                |   | 44 |   |
| Amortization of deferred financing costs                                                        |   | 289                               |   | 95 |   |
| Provision for bad debts                                                                         |   | 1,179                             |   | 480 |   |
| Deferred income taxes                                                                           |   | 360                               |   | (159 | ) |
| Change in assets and liabilities:                                                               |   |                              |   |   |   |
| Accounts receivable                                                                             |   | 839                               |   | 3,174 |   |
| Restricted assets                                                                               |   | 5                                 |   | 1,757 |   |
| Other assets                                                                                    |   | (604                              | )      | (1,369 | ) |
| Accounts payable and accrued liabilities                                                        |   | (7,856                            | )      | (8,078 | ) |
| Deferred revenues and other liabilities                                                         |   | (596                              | )      | (377 | ) |
| Net cash used in operating activities                                                           |   | (1,772                            | )      | (1,632 | ) |
|                                                                                            |   |                              |   |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                           |   |                              |   |   |   |
| Capital expenditures                                                                            |   | (1,383                            | )      | (1,973 | ) |
| Net decrease in restricted debt service  fund                                                   |   | 1,953                             |   | 1,425 |   |
| Net cash provided by (used in) investing  activities                                            |   | 570                               |   | (548 | ) |
|                                                                                            |   |                              |   |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                           |   |                              |   |   |   |
| Proceeds from long-term debt                                                                    |   | —                            |   | 542 |   |
| Payments on capital lease obligations                                                           |   | (9                                | )      | (37 | ) |
| Proceeds from exercise of stock options and  warrants                                           |   | 382                               |   | 466 |   |
| Purchases of treasury stock                                                                     |   | (472                              | )      | — |   |
| Net cash provided by (used in) financing  activities                                            |   | (99                               | )      | 971 |   |
|                                                                                            |   |                              |   |   |   |
| NET DECREASE IN CASH AND CASH EQUIVALENTS                                                       |   | (1,301                            | )      | (1,209 | ) |
| CASH AND CASH EQUIVALENTS AT BEGINNING OF  PERIOD                                               |   | 52,610                            |   | 53,244 |   |
| CASH AND CASH EQUIVALENTS AT END OF PERIOD                                                      |   | $                                 | 51,309 |   | $ | 52,035 |   |
|                                                                                            |   |                              |   |   |   |
| OTHER NON-CASH INVESTING AND FINANCING  ACTIVITIES:                                             |   |                              |   |   |   |
| Borrowing on capital leases                                                                     |   | $                                 | 3      |   | $ | — |   |
| Other comprehensive income                                                                      |   | $                                 | 449    |   | $ | — |   |
| Purchases of treasury stock by deferred  bonus plan                                             |   | $                                 | — |   | $ | 250 |   |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

4

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**CORNELL COMPANIES, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**1.****             ****Basis of Presentation**

 

Theaccompanying unaudited consolidated financial statements have been prepared byCornell Companies, Inc. (the “Company”) pursuant to the rules and regulationsof the Securities and Exchange Commission. Certain information and footnote disclosures normally included infinancial statements prepared in accordance with generally accepted accountingprinciples in the United States (“GAAP”) have been condensed or omittedpursuant to such rules and regulations. In the opinion of management, adjustments and disclosures necessary fora fair presentation of these financial statements have been included.  Estimates were used in the preparation ofthese financial statements.  Actualresults could differ from those estimates. These financial statements should be read in conjunction with thefinancial statements and notes thereto included in the Company’s 2002 AnnualReport on Form 10-K/A as filed with the Securities and Exchange Commission.

 

**2.****             ****Accounting For Stock BasedCompensation**

 

TheCompany accounts for its stock-based compensation plans in accordance withAccounting Principles Board Opinion No. 25, “Accounting for Stock Issuedto Employees” (“APB No. 25”).  Inaccordance with the provisions of APB No. 25, stock-based employee compensationcost is not reflected in net income, as all options granted under those planshad an exercise price equal to or in excess of the market value of theunderlying common stock on the date of grant. The following table illustrates, in accordance with SFAS No. 148, theeffect of net income and earnings per share as if the Company had applied thefair value recognition provisions of SFAS No. 123, “Accounting for Stock-BasedCompensation,” to stock-based employee compensation (in thousands, expect pershare amounts):

 
|                                                                                                                                        |   | **Three Months Ended  March 31,** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                                                                                        |   | **2003**                          |   | **2002** |   |
|                                                                                                                                        |   |                              |   |   |   |
| Net income (loss), as reported                                                                                                              |   | $                                 | 1,957  |   | $ | (330 | ) |
| Add: stock based employee compensation  expense, net of related tax effect                                                                  |   | 52                                |   | 27 |   |
| Less: total stock-based employee  compensation expense determined under fair value based method for all awards,  net of related tax effects |   | (583                              | )      | (347 | ) |
| Pro forma net income (loss)                                                                                                                 |   | $                                 | 1,426  |   | $ | (650 | ) |
| Earnings (loss) per share:                                                                                                                  |   |                              |   |   |   |
| Basic, as reported                                                                                                                          |   | $                                 | .15    |   | $ | (.03 | ) |
| Basic, pro forma                                                                                                                            |   | .11                               |   | (.05 | ) |
| Diluted, as reported                                                                                                                        |   | .15                               |   | (.03 | ) |
| Diluted, pro forma                                                                                                                          |   | .11                               |   | (.05 | ) |

 

**3.****             ****New AccountingPronouncements**

 

TheCompany implemented Statement of Financial Accounting Standard (“SFAS”) No.143, SFAS No. 146 and SFAS No. 148 and FIN 45 in the three months ended March31, 2003 with no impact on the Company’s reported financial position or resultsof operations.

 

5

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InApril 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4,44, 64, Amendment of FASB Statement No. 13, and Technical Corrections” (“SFASNo. 145”), effective for fiscal years beginning after May 15, 2002.  SFAS No. 145 rescinds FASB Statement No. 4,44, 64 and amends SFAS No. 13, “Accounting for Leases,” to eliminate aninconsistency between the required accounting for sale-leaseback transactionsand the required accounting for certain lease modifications that have economiceffects that are similar to sale-leaseback transactions.  Additionally, SFAS No. 145 requires thatgains and losses on the extinguishment of debt to be classified as income orloss from continuing operations rather than as extraordinary items aspreviously required under SFAS No. 4. The Company adopted SFAS No. 145 as required on January 1, 2003 and willaffect the classification of the extraordinary losses previously reported inthe third and fourth quarter of 2001.

 

InJanuary 2003, the FASB issued Interpretation No. 46, “Consolidation of VariableInterest Entities” (“FIN 46”), which addresses the consolidation of variableinterest entities as defined in the Interpretation.  FIN 46 requires an assessment of equity investments to determineif they are variable interest entities. FIN 46 is effective immediately for all variable interest entitiescreated after January 31, 2003.  Forvariable interest entities created before February 1, 2003, the provisions ofFIN 46 must be applied no later than the beginning of the first interim periodor annual reporting period beginning after June 15, 2003.   In addition, if it is reasonably possiblethat an enterprise will consolidate or disclose information about a variableinterest entity, the enterprise must discuss the following information in allfinancial statements issued after January 31, 2003: (1) the nature, purpose,size or activities of the variable interest entity and (2) the enterprise’smaximum exposure to loss as a result of its involvement with the variableinterest entity.  The Company’s adoptionof FIN 46 does not change the Company’s accounting for the 2000 synthetic leasetransaction and the 2001 Sale and Leaseback Transaction, which are consolidatedfor reporting purposes.  The Company mayenter into future arrangements for the development of new facilities or tooperate facilities which may become subject to the provisions of FIN 46 and, insome cases, may be required to consolidate the related activities, facilitiesand financings.

 

InApril 2003 the FASB issued SFAS No. 149, “Amendment of SFAS No. 133 onDerivative Instruments and Hedging Activities” (SFAS No. 149).  SFAS No. 149 amends and clarifies theaccounting for derivative instruments, including certain derivative instrumentsembedded in other contracts, and for hedging activities under SFAS No.133.  SFAS No. 149 is effective forcontracts entered into or modified after June 30, 2003 and for hedgingrelationships designated after June 30, 2003, and should be appliedprospectively.  The provisions of SFASNo. 149 that relate to SFAS No. 133 implementation issues that have beeneffective for fiscal quarters that began prior to June 15, 2003 should continueto be applied in accordance with their respective effective dates.  The Company does not expect the adoption ofSFAS No. 149 to have a material effect on the Company’s financial position orresults of operations.

 

**4.     Change inAccounting Principle**

 

InJune 2001, the FASB issued SFAS No. 141, “Business Combinations” and SFAS No.142, “Goodwill and Other Intangible Assets,” effective for fiscal yearsbeginning after December 15, 2001. The new rules under these statements requirethat the purchase method of accounting be used for all business combinationsinitiated after June 30, 2001 and specifies the criteria for the recognition ofintangible assets separately from goodwill. Under the new rules, goodwill is no longer amortized but is subject toan impairment test annually.  Otherintangible assets that meet the new criteria under the new rules will continueto be amortized over their remaining useful lives.  The Company adopted SFAS No. 141 and SFAS No. 142 as of January1, 2002 and recorded a cumulative effect of change in accounting principlecharge of $965,000, net of tax, related to the impairment of goodwill for anacquisition made in November 1999.

 

6

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**5.     Other IntangibleAssets**

 

Otherintangible assets at March 31, 2003 and December 31, 2002 consisted of thefollowing (in thousands):

 
|                     |   | **March 31, 2003** |   | **December 31, 2002** |   |
|--------------------------|--------|--------------------|--------|-----------------------|--------|
|                     |   |               |   |                  |   |
| Non-compete agreements   |   | $                  | 8,330  |                  | $      | 8,300 |   |
| Accumulated amortization |   | (3,179             | )      | (2,959                | )      |
| Other intangibles, net   |   | $                  | 5,151  |                  | $      | 5,341 |   |

 

Amortizationexpense for non-compete agreements was approximately $220,000 for the threemonths ended March 31, 2003 and 2002. Amortization expense for non-compete agreements is expected to beapproximately $878,000 for each of the fiscal years ended December 31 for thenext five years.

 

**6.****             ****Credit Facilities**

 

TheCompany’s long-term debt consisted of the following (in thousands):

 
|                                                                                     |   | **March 31,  2003** |    | **December 31,  2002** |   |
|------------------------------------------------------------------------------------------|--------|---------------------|---------|------------------------|--------|
|                                                                                     |   |                |    |                   |   |
| **Debt of Cornell  Companies, Inc.:**                                                    |   |                |    |                   |   |
| Capital lease obligations                                                                |   | $                   | 31      |                   | $      | 37 |   |
| Subtotal                                                                                 |   | 31                  |    | 37                     |   |
|                                                                                     |   |                |    |                   |   |
| **Debt of  Consolidated Special Purpose Entities:**                                      |   |                |    |                   |   |
| Synthetic Lease Investor Note A due July  2005 with an interest rate of LIBOR plus 3.25% |   | 41,117              |    | 41,117                 |   |
| Synthetic Lease Investor Note B due July  2005 with an interest rate of LIBOR plus 3.50% |   | 8,134               |    | 8,134                  |   |
| MCF 8.47% Bonds due 2016                                                                 |   | 190,600             |    | 190,600                |   |
| Subtotal                                                                                 |   | 239,851             |    | 239,851                |   |
|                                                                                     |   |                |    |                   |   |
| Consolidated total debt                                                                  |   | $                   | 239,882 |                   | $      | 239,888 |   |
|                                                                                     |   |                |    |                   |   |
| Less: current maturities                                                                 |   | (7,628              | )       | (7,630                 | )      |
|                                                                                     |   |                |    |                   |   |
| Consolidated long-term debt                                                              |   | $                   | 232,254 |                   | $      | 232,258 |   |

 

TheCompany’s 2000 Credit Facility, as amended, provides for borrowings of up to$45.0 million under a revolving line of credit.  The commitment amount is reduced by $1.6 million quarterlybeginning in July 2002 and by outstanding letters of credit.  Accordingly, as of March 31, 2003, theCompany had $35.1 million available under the amended 2000 CreditFacility.  The Company had outstandingletters of credit of approximately $5.1 million at March 31, 2003.  The amended 2000 Credit Facility matures inJuly 2005 and bears interest, at the election of the Company, at either theprime rate plus a margin of 2.0%, or a rate which is 3.0% above the applicableLIBOR rate.  The amended 2000 CreditFacility is collateralized by substantially all of the Company’s assets,including the stock of all of the Company’s subsidiaries; does not permit thepayment of cash dividends; and requires the Company to comply with certainleverage, net worth and debt service coverage covenants.  Additionally, the Company is limited to $2.5million annually for the repurchase of its common stock with an aggregate limitof $7.5 million.  Due to theconsolidation, for

 

7

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financial reporting purposes,of MCF as of August 14, 2001, the Company was not in compliance with certainleverage ratio covenants.  On April 5,2002, the 2000 Credit Facility was amended to waive such non-compliance and torevise the covenants to levels that accommodate the Company’s consolidation ofspecial purpose entities in its consolidated balance sheets, statements ofoperations and cash flows.  As a resultof this waiver and amendment, the Company recognized a pre-tax charge tointerest expense of approximately $825,000 during the first quarter of 2002 forlender and other professional fees. Additionally, the Company has obtained a waiver from the lenders underthe amended 2000 Credit Facility regarding the pending contractual default forthe Moshannon Valley Correctional Center’s construction delay.  This waiver is effective through October 31,2004.  Included in the Company’s cashand cash equivalents at March 31, 2003 is approximately $39.5 million that isinvested in a separate account that is available to the Company for investmentpurposes or working capital with the approval of the lenders under the amended2000 Credit Facility.  This separateaccount is maintained, in part, to assure future credit availability.

 

Additionally,the amended 2000 Credit Facility provides the Company with the ability to enterinto synthetic lease agreements for the acquisition or development of operatingfacilities.  This synthetic leasefinancing arrangement provides for funding to the lessor under the operating leasesof up to $100.0 million, of which approximately $51.0 million had been utilizedas of March 31, 2003.  The Companyexpects to utilize the remaining capacity under this synthetic lease financingarrangement to complete construction of the Moshannon Valley CorrectionalCenter.  The Synthetic Lease Investor’sNote A and Note B have total credit commitments of $81.4 million and $15.1million, respectively.  The Company payscommitment fees at a rate of 0.5% annually for the unused portion of thesynthetic lease financing capacity.  TheSynthetic Lease Investor’s Notes A and B are cross-collateralized with theCompany’s revolving line of credit and contain cross-default provisions.  Under the provisions of FIN 46, utilizationof this synthetic lease financing arrangement to complete the construction ofthe Moshannon Valley Correctional Center will result in the continuedconsolidation of the facility and the related financing in the Company’sfinancial statements.

 

**7.     New Facilitiesand Projects Under Development**

 

TheCompany closed the New Morgan Academy in the fourth quarter of 2002 and iscurrently considering several options ranging from the sale of the facility toutilization of the facility for another type of program.  The Company is maintaining a small staff tomaintain the facility while the Company considers its options for the use orsale of the facility.

 

Thecarrying value of the property and equipment at the New Morgan Academy wasapproximately $31.1 million at March 31, 2003. Currently, management of the Company believes that its long-lived assetsat the New Morgan Academy are recoverable either from the cash flows of analternative program operating at the facility or upon the sale or lease of thefacility to a third party, and accordingly, pursuant to the provisions of SFASNo. 144, an impairment allowance is not deemed necessary as of March 31,2003.  However, management estimatesthat, were the Company to sell the facility, it is reasonably possible that theCompany would not be able to fully recover the carrying value of its long-livedassets for this facility.

 

InJanuary 2003, the Company executed a lease for the Bernalillo County Jail inAlbuquerque, New Mexico.  The facility,which will be vacated by the County in favor of a new jail, will be remodeledby the Company and used to provide adult secure confinement for a wide array ofgovernment agencies that have demonstrated a need for additional bedspace.  The facility will addapproximately 1,000 beds to the Company’s current service capacity.  The Company is currently re-negotiating thelease but expects the monthly rental payment to be approximately $80,000 to$100,000 over the five year lease term.

 

InMay 2003, the Company acquired the Texas Adolescent Center in San Antonio,Texas for approximately $2.1 million in cash.

8

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The Company is currentlyrenovating this 121 bed residential juvenile facility and expects it to becomeoperational in the third or fourth quarter of 2003.

 

InMarch 2003, the Company reached an agreement with the Commonwealth ofPennsylvania that resolved all outstanding administrative issues relative tothe contract awarded to the Company by the Federal Bureau of Prisons (“BOP”) tooperate the Moshannon Valley Correctional Center.  If the Company is able to negotiate an amendment to the contractwith the BOP, this agreement will allow the Company to move forward with theconstruction and operation of the facility, subject to re-approval of theproject by the lenders under the Company’s amended 2000 Credit Facility.

 

Asof March 31, 2003, the Company had incurred approximately $16.1 million forconstruction and land development costs and capitalized interest related to theMoshannon Valley Correctional Center. According to the BOP contract, as amended, the Company must complete theconstruction of the project by April 15, 2003. The Company did not complete construction within that time frame.  The Company is currently obtaining contractamendments monthly from the BOP. The Company anticipates obtaining anotherlong-term contract amendment from the BOP extending the constructiondeadline.  In the event the Company isnot able to negotiate a contract amendment with the BOP, then the BOP may havethe right to assert that the Company has not completed construction of thefacility within the time frame provided in the BOP contract, as amended.  Management expects that the contract will beamended to address cost and construction timing matters resulting from theextended delay.  In the event that theBOP decides not to continue with the construction of the Moshannon ValleyCorrectional Center and terminates the contract, management believes that theCompany has the right to and will recover its invested costs.  In the event any portion of these costs aredetermined not to be recoverable upon contract termination by the BOP, suchcosts would be expensed.  Managementcurrently believes that the invested costs would be fully recoverable in theevent of this contract being terminated.

 

AtMarch 31, 2003, accounts receivable include costs totaling approximately $1.4million for direct costs incurred by the Company since the issuance of theStop-Work Order in June 1999 for payroll and other operating costs related tothe Moshannon Valley Correctional Center. These costs were incurred with the understanding that such costs wouldbe reimbursed by the BOP.  Although noformal written agreement exists, management believes that these costs will bereimbursed by the BOP in the near term. In the event any portion of these costs are determined not to bereimbursable, such costs will be expensed in the period such determination ismade.

 

**8.****             ****Earnings Per Share**

 

Basicearnings per share (“EPS”) is computed by dividing net income by the weightedaverage number of shares of common stock outstanding during the period.  Diluted EPS reflects the potential dilutionfrom common stock equivalents such as stock options and warrants.  For the three months ended March 31, 2003there were 907,403 shares ($11.67 average price) of stock options that were notincluded in the computation of diluted EPS because to do so would have beenanti-dilutive.  Due to the loss incurredfor the quarter ended March 31, 2002, diluted EPS excludes the impact fromcommon stock equivalents because they were antidilutive.

 

**9.     Commitments andContingencies**

 

*Litigation*

 

InMarch and April 2002, the Company, Steven W. Logan, and John L. Hendrix, werenamed as defendants in four Federal putative class action lawsuits styled asfollows: (1) *Graydon Williams, On Behalf ofHimself and All Others Similarly Situated v. Cornell Companies, Inc, et al.*,No. H-02-0866, in the United

 

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States District Court for theSouthern District of Texas, Houston Division; (2) *Richard Picard, On Behalf of Himself and All Others Similarly Situatedv. Cornell Companies, Inc., et al.*, No. H-02-1075, in the UnitedStates District Court for the Southern District of Texas, Houston Division; (3)*Louis A. Daly, On Behalf of Himself and AllOthers Similarly Situated v. Cornell Companies, Inc., et al.,* No.H-02-1522, in the United States District Court for the Southern District ofTexas, Houston Division, and (4) *Anthony J.Scolaro, On Behalf of Himself and All Others Similarly Situated v. CornellCompanies, Inc., et al.,* No. H-02-1567, in the United StatesDistrict Court for the Southern District of Texas, Houston Division.  The aforementioned lawsuits are putativeclass action lawsuits brought on behalf of all purchasers of the Company’scommon stock between March 6, 2001 and March 5, 2002.  The lawsuits involve disclosures made concerning two priortransactions executed by the Company: the August 2001 sale leasebacktransaction and the 2000 synthetic lease transaction.  These four lawsuits have all been consolidated into the *Graydon Williams* action.  Flyline Partners, LP has been appointed asthe lead plaintiff and has filed a consolidated complaint.  The consolidated complaint alleges that thedefendants violated Section 10(b) of the Securities Exchange Act of 1934 (the“Exchange Act”), Rule 10b-5 promulgated under Section 10(b) of the ExchangeAct, Section 20(a) of the Exchange Act and Section 11 of the Securities Act of1933.  The consolidated complaint seeks,among other things, restitution damages, compensatory damages, rescission or arescissory measure of damages, costs, expenses, attorneys’ fees and expertfees.  The Company believes that it hasgood defenses to each of the plaintiffs’ claims and intends to vigorouslydefend against each of these claims.

 

InMarch 2002, the Company, its directors, and its former independent auditorArthur Andersen LLP, were sued in a derivative action styled as *William Williams, Derivatively and on Behalf ofNominal Defendant Cornell Companies, Inc. v. Anthony R. Chase, et al.*,No. 2002-15614, in the 127th Judicial District Court of HarrisCounty, Texas.  The lawsuit allegesbreaches of fiduciary duty by all of the individual defendants and assertsbreach of contract and professional negligence claims only against ArthurAndersen LLP.  The Company believes thatit has good defenses to each of the plaintiff’s claims and intends tovigorously defend against each of these claims.

 

InMay and June 2002, the Company and its directors were sued in three otherderivative lawsuits styled as follows: (1) *JuanGuitierrez, Derivatively on Behalf of Cornell Companies, Inc. v. Steven W.Logan, et. al.,* No. H-02-1812, in the United Stated District Courtfor the Southern District of Texas, Houston Division; (2) *Thomas Pagano, Derivatively on Behalf of CornellCompanies, Inc. v. Steven W. Logan, et. al.*, No. H-02-1896, in theUnited Stated District Court for the Southern District of Texas, HoustonDivision; and (3) *Jesse Menning,Derivatively on Behalf of Cornell Companies, Inc. v. Steven W. Logan, et. al.,*No. 2002-28924, in the 164th Judicial District Court of HarrisCounty, Texas.  These lawsuits allallege breaches of fiduciary duty and waste of corporate assets by all of thedefendants.  A motion to dismiss the *Guitierrez* and *Pagano* lawsuits was filed. The court dismissed the *Pagano*action as duplicative of the *Guitierrez*action.  The motion to dismiss the *Guitierrez* action is still pending.  The Company believes that it has gooddefenses to each of the plaintiffs’ claims and intend to vigorously defendagainst each of these claims.

 

Whilethe plaintiffs in these cases have not quantified their claim of damages andthe outcome of the matters discussed above cannot be predicted with certainty,based on information known to date, management believes that the ultimateresolution of these matters will not have a material adverse effect on theCompany’s financial position, operating results or cash flow.

 

**10.****      ****Segment Disclosure**

 

TheCompany’s three operating divisions are its reportable segments.  The adult secure institutional segmentconsists of the operation of secure adult incarceration facilities.  The juvenile segment consists of providingresidential treatment and educational programs and non-residentialcommunity-based programs to juveniles between the ages of ten and 17 who haveeither been adjudicated or suffer from behavioral

 

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problems.  The pre-release segment consists ofproviding pre-release and halfway house programs for adult offenders who areeither on probation or serving the last three to six months of their sentenceson parole and preparing for re-entry into society at large as well ascommunity-based treatment and education programs as an alternative toincarceration.  All of the Company’scustomers and long-lived assets are located in the United States ofAmerica.  Intangible assets are notincluded in each segment’s reportable assets, and the amortization ofintangible assets is not included in the determination of a segment’s operatingincome.  The Company evaluatesperformance based on income or loss from operations before general andadministrative expenses, incentive bonuses, amortization of intangibles,interest and income taxes.  Corporateand other assets are comprised primarily of cash, certain accounts receivable,deposits, property and equipment, deferred taxes, deferred costs and otherassets.

 

Theonly significant non-cash item reported in the respective segments’ income orloss from operations is depreciation and amortization.

 
|                               |   | **(in thousands)  Three Months Ended  March 31,** |   |
|------------------------------------|--------|---------------------------------------------------|--------|
|                               |   | **2003**                                          |   | **2002** |   |
|                               |   |                                              |   |   |   |
| Revenues                           |   |                                              |   |   |   |
| Adult secure institutional         |   | $                                                 | 25,062 |   | $ | 24,007 |   |
| Juvenile                           |   | 28,566                                            |   | 31,808 |   |
| Pre-release                        |   | 12,398                                            |   | 12,660 |   |
| Total revenues                     |   | $                                                 | 66,026 |   | $ | 68,475 |   |
|                               |   |                                              |   |   |   |
| Income from operations             |   |                                              |   |   |   |
| Adult secure institutional         |   | $                                                 | 6,676  |   | $ | 5,787 |   |
| Juvenile                           |   | 2,844                                             |   | 4,145 |   |
| Pre-release                        |   | 2,360                                             |   | 3,183 |   |
| Sub-total                          |   | 11,880                                            |   | 13,115 |   |
| General and administrative expense |   | (3,898                                            | )      | (6,086 | ) |
| Retention and incentive bonuses    |   | (245                                              | )      | (197 | ) |
| Amortization of intangibles        |   | (220                                              | )      | (220 | ) |
| Corporate and other                |   | 262                                               |   | (237 | ) |
| Total income from operations       |   | $                                                 | 7,779  |   | $ | 6,375 |   |

 
|                       |   | **March 31,  2003** |    | **December 31,  2002** |   |
|----------------------------|--------|---------------------|---------|------------------------|--------|
| Assets                     |   |                |    |                   |   |
| Adult secure institutional |   | $                   | 155,122 |                   | $      | 156,315 |   |
| Juvenile                   |   | 94,906              |    | 96,239                 |   |
| Pre-release                |   | 57,343              |    | 58,071                 |   |
| Intangible assets, net     |   | 12,872              |    | 13,062                 |   |
| Corporate and other        |   | 114,896             |    | 117,604                |   |
| Total assets               |   | $                   | 435,139 |                   | $      | 441,291 |   |

 

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**ITEM 2.          Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

**General**

 

TheCompany is a leading provider of privatized correctional, treatment andeducational services outsourced by federal, state and local governmentagencies.  The Company provides adiversified portfolio of services for adults and juveniles through its threeoperating divisions: (1) adult secure institutional services, (2) juveniletreatment, educational and detention services and (3) pre-release correctionaland treatment services.  As of March 31,2003, the Company had 69 facilities with a total service capacity of 15,945,including the New Morgan Academy, the Moshannon Valley Correctional Center andthe Texas Adolescent Center, which were not in operation.  The Company’s facilities are located in 13states and the District of Columbia.

 

Thefollowing table sets forth for the periods indicated total service capacity,the service capacity and contracted beds in operation at the end of the periodsshown and the average occupancy percentages.

 
|                                                           |   | **March 31,  2003** |   | **March 31,  2002** |   |
|----------------------------------------------------------------|--------|---------------------|--------|---------------------|--------|
| Total service capacity(1):                                     |   |                |   |                |   |
| Residential                                                    |   | 11,669              |   | 11,267              |   |
| Non-residential community-based                                |   | 4,276               |   | 4,177               |   |
| Total                                                          |   | 15,945              |   | 15,444              |   |
| Service capacity in operation (end of  period)                 |   | 14,515              |   | 14,349              |   |
| Contracted beds in operation (end of  period)                  |   | 9,436               |   | 9,503               |   |
| Average occupancy based on contracted beds  in operation(2)(3) |   | 99.9                | %      | 97.9                | %      |
| Average occupancy excluding start-up  operations(2)            |   | 99.9                | %      | 97.9                | %      |

 

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(1)          The Company’s servicecapacity is comprised of the number of beds available for service uponcompletion of construction of residential facilities and the average programcapacity of non-residential community-based programs.

(2)          Occupancy percentagesare based on contracted service capacity of residential facilities inoperation.  Since certain facilitieshave service capacities that exceed contracted capacities, occupancypercentages can exceed 100% of contracted capacity.

(3)          Occupancy percentages reflectless than normalized occupancy during the start-up phase of any applicablefacility, resulting in a lower average occupancy in periods when the Companyhas substantial start-up activities.

 

TheCompany derives substantially all its revenues from providing corrections,treatment and educational services outsourced by federal, state and localgovernment agencies in the United States. Revenues for the Company’s services are generally recognized on a perdiem rate based upon the number of occupant days or hours served for theperiod, on a guaranteed take-or-pay basis or on a cost-plus reimbursementbasis.  Revenues may fluctuate from yearto year due to changes in government funding policies, the number of people referredto the Company’s facilities by governmental agencies or the opening ofadditional facilities.

 

Factorsthat the Company considers in determining the per diem rate to charge include(1) the programs specified by the contract and the related staffing levels, (2)wage levels customary in the respective geographic areas, (3) whether theproposed facility is to be leased or purchased and (4) the anticipated averageoccupancy levels that the Company believes could reasonably be maintained.

 

TheCompany has historically experienced higher operating margins in its adultsecure institutional and pre-release divisions as compared to the juveniledivision.  Additionally, the Company’soperating margins within a division can vary from facility to facility based onwhether a facility is owned or leased, the level of competition for thecontract award, the proposed length of the contract, the occupancy levels for afacility, the level of capital commitment required with respect to a facility,the anticipated changes in operating costs over the term of the contract, andthe Company’s ability to increase a facility’s contract revenue.  A decline

 

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in occupancy of certainjuvenile division facilities may have a more significant impact on operatingresults than the adult secure division due to higher per diem revenues ofcertain juvenile facilities. The Company has experienced and expects toexperience interim period operating margin fluctuations due to the number ofcalendar days in the period, higher payroll taxes in the first half of theyear, and salary and wage increases that are incurred prior to certain contractrevenue increases.

 

TheCompany is generally responsible for all facility operating costs, except forcertain debt service and lease payments with respect to facilities for whichthe Company has only a management contract (11 facilities in operation at March31, 2003 and 2002).

 

Amajority of the Company’s facility operating costs consists of fixedcosts.  These fixed costs include leaseand rental expense, insurance, utilities and depreciation.  As a result, when the Company commencesoperation of new or expanded facilities, fixed operating costs increase.  The amount of the Company’s variableoperating costs, including food, medical services, supplies and clothing,depend on occupancy levels at the facilities operated by the Company.  The Company’s largest single operating cost,facility payroll expense and related employment taxes and costs, has both a fixedand a variable component.  The Companycan 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 aresubject to increases in tightening labor markets based on local economic andother conditions.

 

Followinga contract award, the Company incurs pre-opening and start-up expensesincluding payroll, benefits, training and other operating costs prior toopening a new or expanded facility and during the period of operation whileoccupancy is ramping up.  These costsvary by contract.  Since pre-opening andstart-up costs are factored into the revenue per diem rate that is charged tothe contracting agency, the Company typically expects to recover these upfrontcosts over the life of the contract. Because occupancy rates during a facility’s start-up phase typicallyresult in capacity under-utilization for at least 90 to 180 days, the Companymay incur additional post-opening start-up costs.  The Company does not anticipate post-opening start-up costs atfacilities operated under any future contracts with the BOP because thesecontracts are currently and expected to continue to be take-or-pay contracts,meaning that the BOP will pay the Company at least 95.0% of the contractualmonthly revenue once the facility opens regardless of actual occupancy.

 

Newlyopened facilities are staffed according to contract requirements when theCompany begins receiving offenders or clients. Offenders or clients are typically assigned to a newly opened facilityon a phased-in basis over a one- to six-month period, although certain programsrequire a longer time period to reach break-even occupancy levels.  The Company incurs start-up operating lossesat new facilities until break-even occupancy levels are reached.  Although the Company typically recoversthese upfront costs over the life of the contract, quarterly results can besubstantially affected by the timing of the commencement of operations as wellas development and construction of new facilities.

 

Workingcapital requirements generally increase immediately prior to the Company’scommencing management of a new or expanded facility as the Company incursstart-up costs and purchases necessary equipment and supplies before facilitymanagement revenue is realized.

 

Nofacilities were opened or expanded during the three months ended March 31, 2003and 2002 and as a result, the Company incurred no pre-opening or start-upexpenses in these periods.

 

Generaland administrative expenses consist primarily of costs for the Company’scorporate and administrative personnel who provide senior management, finance,accounting, human resources, payroll and information systems, costs of businessdevelopment and outside professional fees.

 

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**New Accounting Pronouncements**

 

TheCompany implemented Statement of Financial Accounting Standard (“SFAS”) No.143, SFAS No. 146 and SFAS No. 148 and FIN 45 in the three months ended March31, 2003 with no impact on the Company’s reported financial position or resultsof operations.

 

InApril 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4,44, 64, Amendment of FASB Statement No. 13, and Technical Corrections” (“SFASNo. 145”), effective for fiscal years beginning after May 15, 2002.  SFAS No. 145 rescinds FASB Statement No. 4,44, 64 and amends SFAS No. 13, “Accounting for Leases,” to eliminate aninconsistency between the required accounting for sale-leaseback transactionsand the required accounting for certain lease modifications that have economiceffects that are similar to sale-leaseback transactions.  Additionally, SFAS No. 145 requires thatgains and losses on the extinguishment of debt to be classified as income orloss from continuing operations rather than as extraordinary items aspreviously required under SFAS No. 4. The Company adopted SFAS No. 145 as required on January 1, 2003 and willaffect the classification of the extraordinary losses previously reported inthe third and fourth quarters of 2001.

 

InJanuary 2003, the FASB issued Interpretation No. 46, “Consolidation of VariableInterest Entities” (“FIN 46”), which addresses the consolidation of variableinterest entities as defined in the Interpretation.  FIN 46 requires an assessment of equity investments to determineif they are variable interest entities. FIN 46 is effective immediately for all variable interest entitiescreated after January 31, 2003.  Forvariable interest entities created before February 1, 2003, the provisions ofFIN 46 must be applied no later than the beginning of the first interim periodor annual reporting period beginning after June 15, 2003.   In addition, if it is reasonably possiblethat an enterprise will consolidate or disclose information about a variableinterest entity, the enterprise must discuss the following information in allfinancial statements issued after January 31, 2003: (1) the nature, purpose,size or activities of the variable interest entity and (2) the enterprise’smaximum exposure to loss as a result of its involvement with the variableinterest entity.  The Company’s adoptionof FIN 46 does not change the Company’s accounting for the 2000 synthetic leasetransaction and the 2001 Sale and Leaseback Transaction, which are consolidatedfor reporting purposes.  The Company mayenter into future arrangements for the development of new facilities or tooperate facilities which may become subject to the provisions of FIN 46 and, insome cases, may be required to consolidate the related activities, facilitiesand financings.

 

InApril 2003 the FASB issued SFAS No. 149, “Amendment of SFAS No. 133 onDerivative Instruments and Hedging Activities” (SFAS No. 149).  SFAS No. 149 amends and clarifies theaccounting for derivative instruments, including certain derivative instrumentsembedded in other contracts, and for hedging activities under SFAS No.133.  SFAS No. 149 is effective forcontracts entered into or modified after June 30, 2003 and for hedgingrelationships designated after June 30, 2003, and should be appliedprospectively.  The provisions of SFASNo. 149 that relate to SFAS No. 133 implementation issues that have beeneffective for fiscal quarters that began prior to June 15, 2003 should continueto be applied in accordance with their respective effective dates.  The Company does not expect the adoption ofSFAS No. 149 to have a material effect on the Company’s financial position orresults of operations.

 

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**Results of Operations**

 

Thefollowing table sets forth for the periods indicated the percentages ofrevenues represented by certain items in the Company’s historical consolidatedstatements of operations.

 
|                                                                                              |   | **Three Months  Ended March 31,** |   |
|---------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                                              |   | **2003**                          |   | **2002** |   |
|                                                                                              |   |                              |   |   |   |
| Total revenues                                                                                    |   | 100.0                             | %      | 100.0 | % |
| Operating expenses                                                                                |   | 78.4                              |   | 78.6 |   |
| Depreciation and amortization                                                                     |   | 3.9                               |   | 3.2 |   |
| General and administrative expenses                                                               |   | 5.9                               |   | 8.9 |   |
| Income from operations                                                                            |   | 11.8                              |   | 9.3 |   |
| Interest expense, net                                                                             |   | 6.8                               |   | 7.7 |   |
| Minority interest in consolidated special  purpose entities                                       |   | —                            |   | (.1 | ) |
| Income before provision for income taxes  and cumulative effect of change in accounting principle |   | 5.0                               |   | 1.7 |   |
| Provision for income taxes                                                                        |   | 2.1                               |   | .8 |   |
| Income before cumulative effect of change  in accounting principle                                |   | 2.9                               | %      | .9 | % |

 

*Three Months Ended March 31, 2003 Compared to Three MonthsEnded March 31, 2002*

 

Certaincomparisons contained herein have been made excluding the effect of theCompany’s recently closed New Morgan Academy, the Santa Fe County AdultDetention Center closed in 2001, an accounts receivable allowance charge in thepre-release segment and certain general and administrative expenses, asmanagement believes such comparison increases the reader’s understanding ofoperating trends.

 

*Revenues*.  Revenues decreased 3.6% to$66.0 million for the three months ended March 31, 2003 from $68.5 million forthe three months ended March 31, 2002.

 

Adultsecure institutional division revenues increased 4.4% to $25.1 million for thethree months ended March 31, 2003 from $24.0 million for the three months endedMarch 31, 2002 due primarily to increased occupancy at a number of facilitiesincluding the Baker Correctional Center, the Leo Chesney Correctional Center,the Wyatt Detention Facility, the D. Ray James Prison and the Big SpringComplex.  Additionally, a per diem rateincrease in March 2002 at a certain facility further increased revenues.  There were no revenues attributable tostart-up operations for the three months ended March 31, 2003 and 2002.  Average occupancy was 98.6% for the threemonths ended March 31, 2003 compared to 97.3% for the three months ended March31, 2002.

 

Juveniledivision revenues decreased 10.2% to $28.6 million for the three months endedMarch 31, 2003 from $31.8 million for the three months ended March 31, 2002 dueprimarily to the closure of the New Morgan Academy in the fourth quarter of2002, offset in part by an increase in revenue due to increased occupancy andservice hours at various juvenile facilities and programs.  The closure of the New Morgan Academydecreased revenues by approximately $4.8 million in the first quarter of 2003as compared to the same quarter of 2002. This decrease was offset by a net increase in revenue of approximately$1.5 million as a result of improved occupancy at various facilities includingthe Alexander Youth Center, Dauphin Mental Health, the Griffin JuvenileFacility and the Cornell Abraxas Center for Adolescent Females (“ACAF”).  There were no revenues attributable tostart-up operations for the three months ended March 31, 2003 and 2002.  Excluding the occupancy and contractcapacity for the New Morgan Academy, average occupancy was 92.3% for the threemonths ended March 31, 2003 compared to 90.9% for the three months ended March31, 2002.

 

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Pre-releasedivision revenues decreased 2.1% to $12.4 million for the three months endedMarch 31, 2003 from $12.7 million for the three months ended March 31, 2002 dueto decreased occupancy at several facilities and programs with higher per diemrates, offset in part, by increases in occupancy at several facilities withlower per diem rates.  Additionally, theCompany terminated the operations of the Santa Barbara Center in February 2003which decreased revenue for the three months ended March 31, 2003 byapproximately $55,000 as compared to the three months ended March 31,2002.  Average occupancy for the threemonths ended March 31, 2003 was 110.3% compared to 107.3% for the three monthsended March 31, 2002.

 

*Operating Expenses.* Operating expenses decreased 3.8% to $51.8 million for the three monthsended March 31, 2003 from $53.8 million for the three months ended March 31,2002.

 

Adultsecure institutional division operating expenses were $17.4 million for thethree months ended March 31, 2003 and 2002. Operating expenses for the three months ended March 31, 2002 include acharge of approximately $0.4 million to write-off the accounts receivablebalance at the Santa Fe County Adult Detention Center which was closed inSeptember 2001.  Excluding this 2002charge, operating expenses increased 2.3% or $0.4 million in the three monthsended March 31, 2003 as compared to the same quarter of 2002.  As a percentage of segment revenues,excluding the $0.4 million charge in 2002, adult secure institutional divisionoperating expenses were 69.6% for the three months ended March 31, 2003compared to 71.1% for the three months ended March 31, 2002.  The 2003 operating margin was impactedfavorably as a result of lower inmate medical costs at certain facilities inthe three months ended March 31, 2003 as compared to the same quarter of 2002.

 

Juveniledivision operating expenses decreased 8.2% to $25.0 million for the threemonths ended March 31, 2003 from $27.2 million for the three months endedMarch 31, 2002 due principally to the closure of the New Morgan Academy in thefourth quarter of 2002.  Operatingexpenses for the New Morgan Academy were approximately $0.5 million in thethree months ended March 31, 2003 compared to $4.1 million for the three monthsended March 31, 2002.  As a percentageof segment revenues, operating expenses were 87.4% for the three months endedMarch 31, 2003 compared to 85.4% for the three months ended March 31,2002.  The operating margin wasunfavorably impacted by the operating expenses recognized in the three monthsended March 31, 2003 for the New Morgan Academy for which there was nooffsetting revenue.  Excluding theoperations of the New Morgan Academy in the three months ended March 31, 2003and 2002, juvenile division operating expenses, as a percentage of revenue,were 85.8% and 85.4%, respectively.

 

Pre-releasedivision operating expenses increased 5.2% to $9.7 million for the three monthsended March 31, 2003 from $9.2 million for the three months ended March 31,2002 due primarily to a charge to bad debt expense of approximately $0.6million in the three months ended March 31, 2003 to provide an allowance forcertain insurance and medicaid receivable accounts.  Excluding this 2003 charge, operating expenses decreased 1.0%, or$89,000.  As a percentage of segmentrevenues, excluding the 2003 charge, operating expenses were 73.4% for thethree months ended March 31, 2003 compared to 72.6% for the three months endedMarch 31, 2002.

 

*Depreciation and Amortization*. Depreciation and amortization was approximately $2.6 million for thethree months ended March 31, 2003 compared to approximately $2.2 million forthe three months ended March 31, 2002. The increase in depreciation and amortization expense was primarily dueto depreciation and amortization related to current year property and equipmentpurchases.  Amortization of intangibleswas approximately $220,000 for the three months ended March 31, 2003 and 2002.

 

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*General and Administrative Expenses.* General and administrative expenses decreased to $3.9 million for thethree months ended March 31, 2003 from $6.1 million for the three months endedMarch 31, 2002.  General andadministrative expenses for the three months ended March 31, 2002 includedapproximately $1.7 million of legal and professional fees related to the specialcommittee review and the restatement of the Company’s financialstatements.  Excluding these charges,general and administrative expenses decreased approximately $0.5 million, or12.0% from the same quarter of prior year due primarily to cost managementstrategies implemented by management in the latter half of 2002.  The majority of these savings were realizedfrom a reduction in personnel and related costs.  Management expects general and administrative expenses toincrease over the remaining quarters of 2003 as certain open positions are filledand professional and other costs are incurred related to compliance with theSarbanes-Oxley Act of 2002.

 

*Interest.*  Interest expense, net ofinterest income, decreased to $4.5 million for the three months ended March 31,2003 from $5.3 million for the three months ended March 31, 2002.  For the three months ended March 31, 2002,interest expense includes approximately $825,000 for lenders’ fees and relatedprofessional fees incurred to obtain certain waivers and amendments to theCompany’s credit agreement obtained in conjunction with the restatement of theCompany’s financial statements. Excluding these charges, interest expense, net of interest income,increased by approximately $20,000.

 

Capitalizedinterest for the three months ended March 31, 2003 and 2002 was $186,000 and$197,000, respectively, and related to interest on the Company’s SyntheticLease Facility related to the construction costs for the Moshannon ValleyCorrectional Center.

 

*Minority Interest in Losses of Consolidated SpecialPurpose Entities*.  Minority interest in consolidated specialpurpose entities represents third party equity contributed to the specialpurpose entities consolidated by the Company for financial reporting purposes.  Minority interest is adjusted for income andlosses of the special purpose entities. The cumulative losses of MCF exceeded the recorded minority interest ofMCF during the first quarter of 2002. The cumulative losses of the Synthetic Lease Investor exceeded therecorded minority interest of the Synthetic Lease Investor during the thirdquarter of 2001.  Since the cumulativelosses of MCF and the Synthetic Lease Investor exceed the equity which isrecorded as minority interest by the Company, the excess losses are beingrecorded in the Company’s Consolidated Statement of Operations.

 

*Income Taxes.*  Forthe three months ended March 31, 2003 and 2002, the Company recognized aprovision for income taxes at an estimated effective rate of 41.0% and 44.7%,respectively.  The Company’s effectiverate decreased because of changes in the estimated income tax benefits on thelosses of the consolidated special purpose entities.

 

**Liquidity and Capital Resources**

 

*General*.  The Company’s primary capitalrequirements are for (1) construction of new facilities, (2) expansions ofexisting facilities, (3) working capital, (4) pre-opening and start-up costsrelated to new operating contracts, (5) acquisitions, (6) information systemshardware and software, and (7) furniture, fixtures and equipment.  Working capital requirements generallyincrease immediately prior to the Company commencing management of a newfacility as the Company incurs start-up costs and purchases necessary equipmentand supplies before facility management revenue is realized.

 

*Long-Term Credit Facilities.*  TheCompany’s 2000 Credit Facility, as amended, provides for borrowings of up to$45.0 million under a revolving line of credit.  The commitment amount is reduced by $1.6 million quarterlybeginning in July 2002 and by outstanding letters of credit.  Accordingly, as of March 31, 2003, theCompany had $35.1 million available under the amended 2000 CreditFacility.  The Company had outstandingletters of credit of approximately $5.1 million at March 31, 2003.  The amended 2000 Credit Facility matures inJuly 2005 and bears interest, at the election of the Company, at either theprime rate plus

 

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a margin of 2.0%, or a ratewhich is 3.0% above the applicable LIBOR rate. The amended 2000 Credit Facility is collateralized by substantially allof the Company’s assets, including the stock of all of the Company’ssubsidiaries; does not permit the payment of cash dividends; and requires theCompany to comply with certain leverage, net worth and debt service coveragecovenants.  Additionally, the Company islimited to $2.5 million annually for the repurchase of its common stock with anaggregate limit of $7.5 million.  Due tothe consolidation, for financial reporting purposes, of MCF as of August 14,2001, the Company was not in compliance with certain leverage ratiocovenants.  On April 5, 2002, the 2000Credit Facility was amended to waive such non-compliance and to revise thecovenants to levels that accommodate the Company’s consolidation of specialpurpose entities in its consolidated balance sheets, statements of operationsand cash flows.  As a result of thiswaiver and amendment, the Company recognized a pre-tax charge to interestexpense of approximately $825,000 during the first quarter of 2002 for lenderand other professional fees. Additionally, the Company has obtained a waiver from the lenders underthe amended 2000 Credit Facility regarding the pending contractual default forthe Moshannon Valley Correctional Center’s construction delay.  This waiver is effective through October 31,2004.  Included in the Company’s cashand cash equivalents at March 31, 2003 is approximately $39.5 million that isinvested in a separate account that is available to the Company for investmentpurposes or working capital with the approval of the lenders under the amended2000 Credit Facility.  This separateaccount is maintained, in part, to assure future credit availability.

 

Additionally,the amended 2000 Credit Facility provides the Company with the ability to enterinto synthetic lease agreements for the acquisition or development of operatingfacilities.  This synthetic leasefinancing arrangement provides for funding to the lessor under the operatingleases of up to $100.0 million, of which approximately $51.0 million had beenutilized as of March 31, 2003.  TheCompany expects to utilize the remaining capacity under this synthetic leasefinancing arrangement to complete construction of the Moshannon ValleyCorrectional Center.  The SyntheticLease Investor’s Note A and Note B have total credit commitments of $81.4million and $15.1 million, respectively. The Company pays commitment fees at a rate of 0.5% annually for theunused portion of the synthetic lease financing capacity.  The Synthetic Lease Investor’s Notes A and Bare cross-collateralized with the Company’s revolving line of credit andcontain cross-default provisions.  Underthe provisions of FIN 46, utilization of this synthetic lease financingarrangement to complete the construction of the Moshannon Valley CorrectionalCenter will also result in the consolidation of the facility and the relatedfinancing in the Company’s financial statements.

 

*Cash Flows From Operating Activities.*  Cashflows used in operations were approximately $1.8 million for the three monthsended March 31, 2003 compared to approximately $1.6 million for the threemonths ended March 31, 2002.  Theincrease is primarily attributable to working capital changes.

 

*Cash Flows From Investing Activities*. Cash provided by investing activities was approximately $0.6 million forthe three months ended March 31, 2003 due primarily to the use of cash from therestricted debt service fund to pay interest, net of deposits into therestricted debt service fund, offset by capital expenditures of approximately$1.4 million related to various facility improvements and/or expansions,information technology and software development costs.  Cash used in investing activities wasapproximately $0.6 million for the three months ended March 31, 2002 due to capitalexpenditures of approximately $2.0 million offset by the use of cash from therestricted debt service fund to pay interest, net of deposits into therestricted debt service fund.

 

*Cash Flows From Financing Activities*. Cash used in financing activities was approximately $0.1 million for thethree months ended March 31, 2003 due primarily to repurchases of approximately$0.5 million of treasury shares, offset by proceeds from stock option exercisesof $0.4 million.  Cash provided by thefinancing activities for the three months ended March 31, 2002 wasapproximately $1.0 million due primarily to proceeds from borrowings on theCompany’s Synthetic Lease Facility of approximately $0.5 million and

 

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proceeds from stock optionexercises of approximately $0.5 million. Annual principal payments will be reflected as an outflow from financingactivities when disbursed as scheduled by the MCF Debt Service Fund in the quarterended September 30.

 

*Treasury Stock/Repurchases.*  Asof January 1, 2003, the Company can purchase approximately $2.1 million more ofits common stock as permitted under the terms of the amended 2000 CreditFacility.  The Company repurchased inthe open market 47,500 shares of its common stock for approximately $0.5million in the three months ended March 31, 2003.  For the remainder of 2003, the Company can repurchaseapproximately $1.6 million of shares.

 

*New Facilities and Project Under Development.*  InJanuary 2003, the Company executed a lease for the Bernalillo County Jail inAlbuquerque, New Mexico.  The facility,which will be vacated by the County in favor of a new jail, will be remodeledby the Company and used to provide adult secure confinement for a wide array ofgovernment agencies that have demonstrated a need for additional bedspace.  The facility will addapproximately 1,000 beds to the Company’s current service capacity.  The Company is currently negotiating thelease but expects the monthly rental payment to be approximately $80,000 to$100,000 over the five year lease term.

 

InMay 2003, the Company acquired the Texas Adolescent Center in San Antonio,Texas for approximately $2.1 million in cash. The Company is currently renovating this 121 bed residential juvenilefacility and expects it to become operational in the third or fourth quarter of2003.

 

InMarch 2003, the Company reached an agreement with the Commonwealth ofPennsylvania that resolved all outstanding administrative issues relative tothe contract awarded to the Company by the BOP to operate the Moshannon ValleyCorrectional Center.  If the Company isable to negotiate an amendment to the contract with the BOP, this agreementwill allow the Company to move forward with the construction and operation ofthe facility, subject to re-approval of the project by the lenders under theCompany’s amended 2000 Credit Facility.

 

Asof March 31, 2003, the Company had incurred approximately $16.1 million forconstruction and land development costs and capitalized interest related to theMoshannon Valley Correctional Center. According to the BOP contract, as amended, the Company must complete theconstruction of the project by April 15, 2003. The Company did not complete construction within that time frame.  The Company is currently obtaining contractamendments monthly from the BOP. The Company anticipates obtaining anotherlong-term contract amendment from the BOP extending the constructiondeadline.  In the event the Company isnot able to negotiate a contract amendment with the BOP, then the BOP may havethe right to assert that the Company has not completed construction of thefacility within the time frame provided in the BOP contract, as amended.  Management expects that the contract will beamended to address cost and construction timing matters resulting from theextended delay.  In the event that theBOP decides not to continue with the construction of the Moshannon ValleyCorrectional Center and terminates the contract, management believes that theCompany has the right to and will recover its invested costs.  In the event any portion of these costs aredetermined not to be recoverable upon contract termination by the BOP, suchcosts would be expensed.  Managementcurrently believes that the invested costs would be fully recoverable in theevent of this contract being terminated.

 

AtMarch 31, 2003, accounts receivable include costs totaling $1.4 million fordirect costs incurred by the Company since the issuance of the Stop-Work Orderin June 1999 for payroll and other operating costs related to the MoshannonValley Correctional Center.  These costswere incurred with the understanding that such costs would be reimbursed.  Although no formal written agreement exists,management believes that these costs will be reimbursed by the BOP in the nearterm.  In the event any portion of thesecosts are not reimbursed, such costs will be expensed if they are determinednot to be reimbursable.

 

*Future Liquidity*. Management believes that the cash flows generated from operations, togetherwith the credit available under the amended 2000 Credit Facility and theoperating lease capacity thereunder, will provide sufficient liquidity to meetthe Company’s committed capital and working capital requirements for currentlyawarded contracts.  To the extent theCompany’s cash and current financing arrangements do not provide sufficientfinancing to fund construction costs related to future adult secureinstitutional contract awards or significant facility expansions, the Companyanticipates obtaining additional sources of financing to fund suchactivities.  However, there can be noassurance that such financing will be available or will be available on termsfavorable to the Company.

 

*Contractual Obligations and Commercial Commitments*.  TheCompany has assumed various financial obligations and commitments in theordinary course of conducting its business. The Company has contractual obligations requiring future cash paymentsunder its existing contractual arrangements, such as management, consultativeand non-competition agreements.

 

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TheCompany maintains operating leases in the ordinary course of its businessactivities.  These leases include thosefor operating facilities, office space and office and operating equipment, andthe terms of the agreements vary from 2002 until 2075.  As of March 31, 2003, the Company’s totalcommitment under these operating leases was approximately $34.5 million.

 

Thefollowing table details the Company’s known future cash payments (on anundiscounted basis) related to various contractual obligations as of March 31,2003 (in thousands):

 
|                                                 |   | **Payments Due by Period** |    |
|------------------------------------------------------|--------|----------------------------|---------|
|                                                 |   | **Total**                  |    | **2003** |   | **2004 -  2005** |   | **2006 -  2007** |   | **Thereafter** |   |
|                                                 |   |                       |    |   |   |   |   |   |   |   |   |
| Contractual Obligations:                             |   |                       |    |   |   |   |   |   |   |   |   |
| Long-term debt  - Special Purpose Entities           |   | $                          | 239,851 |   | $ | 7,600 |   | $ | 17,300 |   | $ | 69,451 |   | $ | 145,500 |   |
| Capital lease obligations  - Cornell Companies, Inc. |   | 31                         |    | 31 |   | — |   | — |   | — |   |
| Operating leases                                     |   | 34,542                     |    | 4,893 |   | 6,479 |   | 4,349 |   | 18,821 |   |
| Consultative and non-competition agreements          |   | 1,440                      |    | 380 |   | 840 |   | 220 |   | — |   |
| Total contractual cash obligations                   |   | $                          | 275,864 |   | $ | 12,904 |   | $ | 24,619 |   | $ | 74,020 |   | $ | 164,321 |   |

* *

The Company enters into letters of credit in the ordinary course ofoperating and financing activities.  Asof March 31, 2003, the Company had outstanding letters of credit of $5.1million related to insurance and other operating activities.  The following table details the Company’sletter of credit commitments as of March 31, 2003 (in thousands):

 
|                      |   | **Total  Amounts  Committed** |                  | **Amount of Commitment Expiration Per Period** |          |
|---------------------------|--------|-------------------------------|-----------------------|------------------------------------------------|---------------|
|                      |   |                          | **Less than  1 Year** |                                           | **1-3 Years** |   | **4-5 Years** |   | **Over  5 Years** |   |
|                      |   |                          |                  |                                           |          |   |   |   |   |   |   |
| Commercial Commitments:   |   |                          |                  |                                           |          |   |   |   |   |   |   |
| Standby letters of credit |   | $                             | 5,108                 |                                           | $             | 5,108 |   | $ | — |   | $ | — |   | $ | — |   |
|                           |        |                               |                       |                                                |               |  |  |  |  |  |  |  |  |  |  |  |

 

**ITEM 3.****                            ****Quantitative and QualitativeDisclosures about Market Risk**

 

Inthe normal course of business, the Company is exposed to market risk, primarilyfrom changes in interest rates.  TheCompany continually monitors exposure to market risk and develops appropriatestrategies to manage this risk.  TheCompany is not exposed to any other significant market risks, includingcommodity price risk, foreign currency exchange risk or interest rate risksfrom the use of derivative financial instruments.  Management does not use derivative financial instruments fortrading or to speculate on changes in interest rates or commodity prices.

 

**Interest Rate Exposure**

 

TheCompany’s exposure to changes in interest rates primarily results from itslong-term debt with both fixed and floating interest rates.  The debt on the Company’s consolidatedfinancial statements with fixed interest rates consists of the 8.47% Bondsissued by MCF in August 2001 in connection with the 2001 Sale and LeasebackTransaction.  At March 31, 2003,approximately 20% ($49.3 million of debt outstanding to the Synthetic LeaseInvestor) of the Company’s consolidated long-term debt was subject to variableinterest rates.  The detrimental effectof a hypothetical 100 basis point increase in interest rates would be to reduce

 

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income before provision forincome taxes by approximately $123,000 for the three months ended March 31,2003.  At March 31, 2003, the fair valueof the Company’s consolidated fixed rate debt approximated carrying value basedupon discounted future cash flows using current market prices.

 

**Forward Looking Statement Disclaimer**

 

Thisquarterly report on Form 10-Q contains forward-looking statements within themeaning of the Private Securities Litigation Reform Act of 1995. Thesestatements are based on current plans and actual future activities and resultsof operations may be materially different from those set forth in theforward-looking statements. Important factors that could cause actual resultsto differ include, among others, (1) the outcomes of pending putative classaction shareholder and derivative lawsuits, and related insurance coverage, (2)risks associated with acquisitions and the integration thereof (including theability to achieve administrative and operating cost savings and anticipatedsynergies), (3) the timing and costs of the opening of new programs andfacilities or the expansions of existing facilities, (4) changes ingovernmental policy and/or funding to discontinue or not renew existingarrangements or to eliminate or discourage the privatization of correctional,detention and pre-release services in the United States, (5) the availabilityof debt and equity financing on terms that are favorable to the Company, (6)fluctuations in operating results because of occupancy, competition (includingcompetition from two competitors that are substantially larger than theCompany), increases in cost of operations, fluctuations in interest rates andrisks of operations, (7) significant charges to expense of deferred costsassociated with financing and other projects in development if managementdetermines that one or more of such projects is unlikely to be successfullyconcluded, (8) results from alternative deployment or sale of facilities suchas the New Morgan Academy and (9) the Company’s ability to negotiate a contractamendment with the BOP related to the Moshannon Valley Correctional Center.

 

**ITEM 4.          Controlsand Procedures**

 

Underthe supervision and with the participation of our management, including ourprincipal executive officer and principal financial officer, we have evaluatedthe effectiveness of the design and operation of our disclosure controls andprocedures within 90 days of the filing date of this quarterly report pursuantto Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934 (the“Exchange Act”).  Based on thatevaluation, our principal executive officer and principal financial officerhave concluded that these controls and procedures are effective.  There were no significant changes in ourinternal controls or in other factors that could significantly affect thesecontrols subsequent to the date of their evaluation.

 

Disclosurecontrols and procedures are our controls and other procedures that are designedto ensure that information required to be disclosed by us in the reports thatwe file or submit under the Exchange Act is recorded, processed, summarized andreported, within the time periods specified under the Exchange Act.  Disclosure controls and procedures include,without limitation, controls and procedures designed to ensure that informationrequired to be disclosed by us in the reports that we file under the ExchangeAct is accumulated and communicated to our management, including our principalexecutive officer and principal financial officer, as appropriate to allowtimely decisions regarding required disclosure.

 

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**PART II         OTHERINFORMATION**

 

**ITEM 1.          LegalProceedings**

 

InMarch and April 2002, the Company, Steven W. Logan, and John L. Hendrix, werenamed as defendants in four Federal putative class action lawsuits styled asfollows: (1) *Graydon Williams, On Behalf ofHimself and All Others Similarly Situated v. Cornell Companies, Inc, et al.*,No. H-02-0866, in the United States District Court for the Southern District ofTexas, Houston Division; (2) *Richard Picard,On Behalf of Himself and All Others Similarly Situated v. Cornell Companies,Inc., et al.*, No. H-02-1075, in the United States District Court forthe Southern District of Texas, Houston Division; (3) *Louis A. Daly, On Behalf of Himself and All OthersSimilarly Situated v. Cornell Companies, Inc., et al.,* No.H-02-1522, in the United States District Court for the Southern District ofTexas, Houston Division, and (4) *Anthony J.Scolaro, On Behalf of Himself and All Others Similarly Situated v. CornellCompanies, Inc., et al.,* No. H-02-1567, in the United StatesDistrict Court for the Southern District of Texas, Houston Division.  The aforementioned lawsuits are putativeclass action lawsuits brought on behalf of all purchasers of the Company’scommon stock between March 6, 2001 and March 5, 2002.  The lawsuits involve disclosures made concerning two priortransactions executed by the Company: the August 2001 sale leasebacktransaction and the 2000 synthetic lease transaction.  These four lawsuits have all been consolidated into the *Graydon Williams* action.  Flyline Partners, LP has been appointed asthe lead plaintiff and has filed a consolidated complaint.  The consolidated complaint alleges that thedefendants violated Section 10(b) of the Securities Exchange Act of 1934 (the“Exchange Act”), Rule 10b-5 promulgated under Section 10(b) of the ExchangeAct, Section 20(a) of the Exchange Act and Section 11 of the Securities Act of1933.  The consolidated complaint seeks,among other things, restitution damages, compensatory damages, rescission or arescissory measure of damages, costs, expenses, attorneys’ fees and expertfees.  The Company believes that it hasgood defenses to each of the plaintiffs’ claims and intends to vigorouslydefend against each of these claims.

 

InMarch 2002, the Company, its directors, and its former independent auditorArthur Andersen LLP, were sued in a derivative action styled as *William Williams, Derivatively and on Behalf ofNominal Defendant Cornell Companies, Inc. v. Anthony R. Chase, et al.*,No. 2002-15614, in the 127th Judicial District Court of HarrisCounty, Texas.  The lawsuit allegesbreaches of fiduciary duty by all of the individual defendants and assertsbreach of contract and professional negligence claims only against ArthurAndersen LLP.  The Company believes thatit has good defenses to each of the plaintiff’s claims and intends to vigorouslydefend against each of these claims.

 

InMay and June 2002, the Company and its directors were sued in three otherderivative lawsuits styled as follows: (1) *JuanGuitierrez, Derivatively on Behalf of Cornell Companies, Inc. v. Steven W.Logan, et. al.,* No. H-02-1812, in the United Stated District Courtfor the Southern District of Texas, Houston Division; (2) *Thomas Pagano, Derivatively on Behalf of CornellCompanies, Inc. v. Steven W. Logan, et. al.*, No. H-02-1896, in theUnited Stated District Court for the Southern District of Texas, HoustonDivision; and (3) *Jesse Menning,Derivatively on Behalf of Cornell Companies, Inc. v. Steven W. Logan, et. al.,*No. 2002-28924, in the 164th Judicial District Court of HarrisCounty, Texas.  These lawsuits all allegebreaches of fiduciary duty and waste of corporate assets by all of thedefendants.  A motion to dismiss the *Guitierrez* and *Pagano* lawsuits was filed. The court dismissed the *Pagano*action as duplicative of the *Guitierrez*action.  The motion to dismiss the *Guitierrez* action is still pending.  The Company believes that it has gooddefenses to each of the plaintiffs’ claims and intend to vigorously defendagainst each of these claims.

 

Whilethe plaintiffs in these cases have not quantified their claim of damages andthe outcome of the matters discussed above cannot be predicted with certainty,based on information known to date, management believes that the ultimateresolution of these matters will not have a material adverse effect on theCompany’s financial position, operating results or cash flow.

 

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TheCompany currently and from time to time is subject to claims and suits arisingin the ordinary course of business, including claims for damages for personalinjuries or for wrongful restriction of, or interference with, offenderprivileges and employment matters.

 

**ITEM 6.        Exhibitsand Reports on Form 8-K**

 
| a.     |   | Exhibits             |
|--------|--------|----------------------|
|   |   |                 |   |
|   |   | 10.1                 | Employment  Agreement between the Company and Steven W. Logan |
|   |   |                 | effective  as of October 1, 2002. |
|   |   | 11.1                 | Statement  Re: Computation of Per Share Earnings |
|   |   | 99.1                 | Certification  of Chief Executive Officer |
|   |   | 99.2                 | Certification  of Chief Financial Officer |
|   |   |                 |   |
| b.     |   | Reports  on Form 8-K |
|   |   |                 |   |
|   |   | None                 |

 

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**SIGNATURES**

 

 

Pursuantto the requirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the Registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 

 
|   |          |   | **CORNELL COMPANIES, INC.**                              |
|--------|---------------|--------|----------------------------------------------------------|
|   |          |   |                                                     |
|   |          |   |                                                     |
| Date:  | May  15, 2003 | By:    | /s/  Harry J. Phillips, Jr.                              |   |
|   |          |   | HARRY  J. PHILLIPS, JR.                                  |
|   |          |   | Executive  Chairman, Chairman of the  Board and Director |
|   |          |   | (Principal  Executive Officer)                           |
|   |          |   |                                                     |
|   |          |   |                                                     |
| Date:  | May  15, 2003 | By:    | /s/  John L. Hendrix                                     |   |
|   |          |   | JOHN  L. HENDRIX                                         |
|   |          |   | Senior  Vice President and  Chief Financial Officer      |
|   |          |   | (Principal  Financial Officer)                           |
|        |               |        |                                                          |  |  |

 

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Cornell Companies, Inc.a Delaware corporation

CERTIFICATION OF CHIEF EXECUTIVE OFFICER

Section 302 Certification

 

I, Harry J. Phillips, Jr., certify that:

 

1.               I have reviewedthis quarterly report on Form 10-Q of Cornell Companies, Inc., a Delawarecorporation (the “registrant”);

 

2.               Based on myknowledge, this quarterly report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3.               Based on myknowledge, the financial statements, and other financial information includedin this quarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4.               The registrant’sother certifying officers and I are responsible for establishing andmaintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a) designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this quarterly reportis being prepared;

b) evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this quarterly report (the “Evaluation Date”); and

c) presented in this quarterly report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5.               The registrant’sother certifying officers and I have disclosed, based on our most recentevaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a) all significant deficiencies in the designor operation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

b) any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theregistrant’s internal controls; and

 

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6.               The registrant’sother certifying officers and I have indicated in this quarterly report whetheror not there were significant changes in internal controls or in other factorsthat could significantly affect internal controls subsequent to the date of ourmost recent evaluation, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 
| Date: May 15, 2003 |   |   |                                                    |
|--------------------|--------|--------|---------------------------------------------------------|
|               |   |   |                                                    |
|               |   |   |                                                    |
|               |   |   | By: /s/ Harry J. Phillips, Jr.                          |   |
|               |   |   | Harry J. Phillips, Jr.                                  |
|               |   |   | Executive Chairman, Chairman  of the Board and Director |

 

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Cornell Companies, Inc.

a Delaware corporation

CERTIFICATION OF CHIEF FINANCIAL OFFICER

Section 302 Certification

 

I, John L. Hendrix, certify that:

 

1.               I have reviewedthis quarterly report on Form 10-Q of Cornell Companies, Inc., a Delawarecorporation (the “registrant”);

 

2.               Based on myknowledge, this quarterly report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3.               Based on myknowledge, the financial statements, and other financial information includedin this quarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4.               The registrant’sother certifying officers and I are responsible for establishing andmaintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a) designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this quarterly reportis being prepared;

b) evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this quarterly report (the “Evaluation Date”); and

c) presented in this quarterly report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5.               The registrant’sother certifying officers and I have disclosed, based on our most recentevaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a) all significant deficiencies in the designor operation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

b) any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theregistrant’s internal controls; and

 

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6.               The registrant’sother certifying officers and I have indicated in this quarterly report whetheror not there were significant changes in internal controls or in other factorsthat could significantly affect internal controls subsequent to the date of ourmost recent evaluation, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 
| Date: May 15, 2003 |   |   |                                               |
|--------------------|--------|--------|----------------------------------------------------|
|               |   |   |                                               |
|               |   |   |                                               |
|               |   |   | By: /s/ John L. Hendrix                            |   |
|               |   |   | John L. Hendrix                                    |
|               |   |   | Senior Vice President and  Chief Financial Officer |

 

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